Making Things Better: Competing in

Manufacturing

February 1990

OTA-ITE-443

NTIS order #PB90-205469
Recommended Citation:

U.S. Congress, Office of Technology Assessment, Making Things Better: Competing in

Manufacturing, OTA-ITE-443 (Washington, DC: U.S. Government Printing Office, February

1990).

For sale by the Superintendent of Documents

U.S. Government Printing Office, Washington, DC 20402-9325

(order form can be found in the back of this report)
Foreword

U.S. manufacturing is in trouble. That spells trouble for the Nation, because manufacturing

provides well-paid jobs, pays for most privately funded research and development, and

dominates international trade. In industry after industry, U.S. manufacturers have lost out to

competitors who are able to make things better—products with better features and more

reliable quality, at lower cost. The key to this better performance is technology, which includes

not only new products and advanced manufacturing equipment but also efficient organization

of work and effective use of people. Once, U.S. manufacturers led the world in technology.

Now, in one field after another-first radios and TV, then automobiles, now semiconductors—

Japanese manufacturers are passing us by. Other Asian countries like Korea and Taiwan are

coming up fast, and Europe is mounting new challenges.

In a sense, these changes are welcome. Since World War II, U.S. policy has aimed to

strengthen the economies of advanced nations and help poorer ones develop, so it should be

no surprise that the world is now full of able manufacturers. It was not part of the plan for the

United States to fall to second rank, but that is what is happening.

This report considers ways to promote the restoration of American leadership in

manufacturing technology. Some of the things that most need doing are up to industry—

especially in handling people, from managers to engineers to shopfloor workers, and in

forming stable, productive relationships between different segments of an industry complex.

Government also has a critical role to play. The first essential is to create an economic

environment that supports manufacturing and encourages long-term investment in technology. This means higher national savings rates and a declining Federal deficit. Other less

traditional activities (at least for the U.S. Government) also deserve consideration-for

example, collaboration with industry on supporting R&D for strategic technologies.

For many years, national security was almost the only acceptable reason for government

support of commercial technologies and industrial excellence, but as the Cold War winds

down, this reason becomes less compelling. In an era of more secure peace but tougher

economic competition, national security is taking on new meanings. To preserve our long

tradition of industrial success and rising living standards requires continuing innovation and

successful adaptation of existing technology, and that is a task for industry, government, and

American citizens.

This report is the second in a series of three in OTA’s assessment of Technology,

Innovation, and U.S. Trade. The assessment was requested by the Senate Committee on

Finance; the Senate Committee on Banking, Housing and Urban Affairs; and the House

Committee on Banking, Finance and Urban Affairs. The first report in the series, Paying the

Bill: Manufacturing and America’s Trade Deficit, concluded that the stubbornly high U.S.

trade deficits of the 1980s and many other signs pointed to genuine weakness in American

manufacturing and lags in technology, compared to our best competitors. This report looks for

some of the reasons for the weakness, and suggests policies aimed specifically at repairing it.

The last report will examine the trade and industrial policies of Japan, other East Asian

countries, and Europe; and their possible relevance to the competitive position of the United

States.

~f~

AA’ ‘ 2

U

JOHN H. GIBBONS

 Directo r
Assessment on Technology, Innovation, and U.S. Trade

Advisory Panel

Lewis Branscomb, Chairman

Harvard University

Michael AhO

Council on Foreign Relations

Ralph Gomory

The Sloan Foundation

Howard Greis

Kinefac Corp.

Joseph Grunwald

University of California, San Diego

Thomas Hout

Boston Consulting Group

Ramchandran Jaikumar

Harvard Business School

Franklin P. Johnson, Jr.

Asset Management Co.

Lester C. Krogh

Minnesota Mining and Manufacturing

Paul R. Krugman

National Bureau of Economic Research

Alvin P. Lehnerd

Steelcase Inc.

Ann Markusen

Rutgers University

Ray Marshall

University of Texas

Regis McKenna

Regis McKenna, Inc.

Richard S. Morse*

Consultant

David Mowery

University of California, Berkeley

Paula Stem

The Stern Group

Brian Turner

AFL-CIO

Gus Tyler

International Ladies Garment Worker Union

Lewis C. Veraldi

Ford Motor Co.

Ezra F. Vogel

Harvard University

NOTE: OTA appreciates and is grateful for the valuable assistance and thoughtful critiques provided by the advisory panel members.

The panel does not however, necessarily approve, disapprove, or endorse this report. OTA assumes full responsibility for the

report and the accuracy of its contents.

iv
OTA Project Staff-Making Things Better: Competing in Manufacturing

Lionel S. Johns, Assistant Director, OTA

Energy, Materials, and international Security Division

Audrey B. Buyrn, Manager

industry, Technology, and Employment Program

Julie FOX Gorte, Project Director

Katherine Gillman, Deputy Project Director

Robert Weissler, Senior Analyst Robin Gaster, OTA Fellow

Samuel F. Baldwin George Eberstadt Joan Gutta

Sebastian Remoy Philip Shapira

Contributors

Brenda Brockman Robert Wade

Dorothy Robyn

Contractors

Elinor Horwitz Robert R. Miller

David Sheridan D. Hugh Whittaker

Yoshitaka Kurosawa Quick, Finan, and Associates, Inc.

Industry and Trade Strategies Massachusetts Institute of Technology

Tokaji and Hirsch, Inc. BSI Consulting, Inc.

Administrative Staff

Christopher N. Clary, Office Administrator

Diane D. White, Administrative Secretary

Publishing Staff

Katie Boss, Publishing Officer

Cheryl Davis, Desk-top Publishing

Dorinda Edmondson, Desk-top Publishing

Christine Onrubia Graphic Designer

Susan Zimmerman, Graphics
Contents

Page

Chapter l. Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3

Chapter 2. Strategies To Improve U.S. Manufacturing Technology:

Policy Issues and Options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39

Chapter 3. Financing Long-Term Investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93

Chapter 4. Human Resources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115

Chapter 5. Links Between Firms and Industries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 129

Chapter 6. Technology Transfer and Diffusion: Some International Comparisons . . . . . . . . . . 151

Chapter 7. Where We Stand: Public Policy and Technology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 173

.

vi
Chapter 1

Summary
CONTENTS

Page

INVESTMENT . . . . . . . . . . . . . . . . ... ...+.... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

PROMOTING COOPERATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .13

TRANSFERRING KNOWLEDGE .. .. .. .. .. .. .. .. .. ... .+. ....,... .. ... ,.. ...+...+ 18

POLICY ISSUES AND OPTIONS . . . . . . . . . . . . . . . . . . . . . .. ............+.=..+....,+. 20

Improving the Financial Environment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21

Human Resources . . . . . . . . . . . . . . . . . . . . . .. . .. .. ... . ... .....9. .. .. A T, ..+. ..+...... 23

Diffusing Manufacturing Technology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25

Strategic Technology Policy.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32

Figures

Figure Page

l-1. Merchandise Trade Balance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

l-2. Average Annual Productivity Growth in Manufacturing. . . . . . . . . . . . . . . . . . . . . . . . . 4

l-3. Merchandise and Manufacturing Trade Balances, 1960-88 . . . . . . . . . . . . . . . . . . . . . . 4

l-4. GDP Per Capita in 1988 U.S. Dollars . . . . . . . ......** . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

l-5. Fixed Investment in Machinery and Equipment as a Percentage of GNP/GDP . . . . 7

l-6. Productivity Performance, World Auto Manufacturers ● .*.... +...,,.. . . . . . . . . . . . 7

1-7. Quality Performance, World Auto Manufacturers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

1-8. Cost of Capital for Equipment and Machinery With 20-Year Physical Life . . . . . . . 10

1-9. Cost of Capital for R&D Project With 10-Year Payoff Lag . . . . . . . . . . . . . . . . . +... 10

1-10. Cost of Capital for Factory With 40-Year Physical Life . . . . . . . . . . . . . . . . . . . . . . . . 10

1-11. Real Long-Term Interest Rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

1-12. Twelfth Grade Achievement Scores in Geometry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12

1-13. Twelfth Grade Achievement Scores in Advanced Algebr a . . . . . . . . . . . . . . . . . . . . 13

1-14. Spending for Education Grades K-12, Percent of GDP, 1985 . . . . . . . . . . . . . . . . . . . . 14

1-15. Spending for Education Grades K-12, Per Pupil, 1985 . . . . . . . . . . . . . . . . . . . . . . . . . . 14

1-16. Shift in Market Shares for Wafer Steppers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

1-17. U.S. Market Shares of Selected Semiconductor Equipment . . . . . . . . . . . . . . . . . . . . . 17

1-18. World Semiconductor Equipment Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

Tables

Table Page

1-1. Work Force Involved in Manufacturing and Average Full-Time Equivalent

Compensation, 1984 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

1-2. Top Ten Semiconductor Equipment Suppliers, World Sales . . . . . . . . . . . . . . . . . . . . . . 16
Chapter 1

Summary

American manufacturing has never been in

more trouble than it is now. Its biggest challenge

is from Japan, where, more than in any other

nation, well-designed products are manufactured with great reliability, while costs are

rigorously controlled. Other nations, developed

and developing, are rising to the Japanese

challenge in creative ways. The important

difference is that many of those nations are

responding as nations, with the support and

participation of government. While some American companies and institutions have redoubled

efforts to improve manufacturing, the government is dozing at the switch. Certainly, there are

many problems that manufacturers must solve

themselves. But some of the problems are

generated by the American people and government. As a nation, we owe it to ourselves to help

with their solution.

Symptoms of America’s problems are clearly

visible: the merchandise trade deficit remains

stubbornly high, despite significant downward

adjustment of the dollar against major currenFigure 1-1--Merchandise Trade Balance

Billions of dollars

‘“~

o 1-

-50 -

-100 -

-150

I

m

-200 ‘ i 1 I 1 I 1 1 1 1 I 1 1 1 1 1 I 1 1 1 i 1 1 I 1 1 1 1 1 1 I

1960 1964 1968 1972 1976 1980 1984 1988

SOURCE: U.S. Department of Commer~, Bureau of Economic Analysis,

Business Conditions Digest, S@ember 1939 (VVashington,

DC: U.S. Government Printing Office, September 1989), table

822.

cies (figure l-l). Productivity growth is sluggish compared with that of many other advanced

and developing nations, including our ablest

competitors (figure 1-2). U.S. manufacturers are

increasingly dependent on foreign producers for

a wide range of machinery and tools of production. Even the microelectronics industry, once

the standard bearer for American competence

and inventiveness, is losing sales and market

share to Japanese, Korean, and Taiwanese

producers.

The weaknesses in U.S. manufacturing technology must be cured if the Nation is to enjoy

rising living standards together with a strong,

stable position in international trade. Most of the

U.S. trade deficit is in manufactured goods

(figure 1-3). The most constructive way to right

the deficit is to manufacture products that the

world will buy because the products are wellmade and reasonably priced (not just because a

low dollar makes them cheap). More fundamentally, manufacturing is valuable to the Nation as

a direct source of productive, well-paid jobs and

the indirect source of many better-than-average

jobs in the service sector (table l-l). Manufacturing also supports most of this country’s

commercial research and development.l

There is no single solution, but all the signs

point in one direction: U.S. manufacturing

technology must improve—in everything from

product design to manufacturing process development and refinement. For industrial nations,

technology is the key to competitive success.

Nations that rely on low wages to sell their

goods in the world market are, by definition,

poor, whereas superior technology raises productivity and thus supports rising standards of

living. Moreover, technology is a steady, predictable source of advantage, while others may

shift with political currents. For example, a

nation’s fiscal and monetary policies affect the

IFor mom de~l~ discussion of the place of manufacturing in international trade and the national economy, see Office of ‘kChIIOIOgY As=samm

Paying the Bill: Man@acturing and Americans Trade Deficit, OTA-ITE-390 (Sprin@leld, VA: National Technical Information Service, 1988).

- 3 -
4 ● Making Things Better: Competing in Manufacturing

Figure 1-2—Average Annual Productivity Growth

in Manufacturing

Percent growth in output/hour

9

7

5

3

1

5.5

3.7

4.4

7.8

U.S. Canada U.K. FRG France Italy Japan

SOURCE: U.S. Department of Labor, Bureau of Labor Statistics, “international Comparisons of Manufacturing Productivity and Labor

Trends, 1986,” June 1989, table 1.

value of its currency, which in turn affects the

salability of its manufactured goods in the world

market. But macroeconomic policies are changeable, and are far beyond the control of private

fins.

Americans are used to thinking of their nation

as leading the world in technology—with the

select company perhaps of a few other developed countries or a few foreign industries. But

the realization has dawned that we are no longer

at the forefront.2 Several major U.S. industries

have not only fallen behind in technology, but

will be hard put to catch up even if they adopt a

whole catalog of changes needed to reverse the

slide. Not all American industries are lagging,

but trends in many sectors, from computers to

aircraft, indicate that our ablest competitors can

now or soon will match our technology, and are

accelerating faster.

Figure l-3-Merchandise and Manufacturing

Trade Balances, 1960-88

Billions of dollars 50

0

-so -

-100 -

-150 -

-200 f

, 1 1 ! 1 1 1 , , i I 1 1 1 1 1 I 1 t 1 , I , , 1 i I

1960 1964 1968 1972 1976 1980 1984 1988

— 

Merchandise

— Manufacturing

SOURCES: U.S. Department of Commerce, Bureau of Economic Analysis,

Business Conditions Digest, September 1989 (Washington,

DC: U.S. Government Printing Office, September 1969), table

622; U.S. Department of Commerce, International Trade

Administration, Office of Trade and Information Analysis,

unpublished data, 1989; and President of the United States

and the Council of Economic Advisers, Economic Report of the

President (Washington, DC: U.S. Government Printing Office,

January 1987), table B-102.

Is this a problem? We have long accepted (in

principle, if not in fact) that our technological

lead across a wide range of industries was fated

to narrow or disappear as developed countries

recovered from war damage and poorer countries advanced. But we did not expect the gap to

close so rapidly, and we certainly never expected to fall behind.

The toughest challenge is coming from the

Far East. At the close of the 1980s, Japan has

emerged as the world’s premier industrial competitor. The United States is still the richest of

nations, with gross domestic product per capita

considerably higher than most others (only

Canada is close; see figure 1-4). Several European countries are strong performers in one or

another manufacturing sector or product—

especially Germany, which excels in metalworking and machinery, and consistently runs

large trade surpluses. But Japan’s record is

unique. It has led all major industrial countries

in productivity growth for decades—not just in

the early postwar years when it was rising from

the ashes, but also right through the 1970s and

2For ~wep ~~caton of ~erica’s relative technological performance, ibid., PP. 26-35.
Chapter I-Summary ● 5

Table l-l—Work Force Involved in Manufacturing and Average Full-Time Equivalent Compensation, 1984

Average annual

Percent of full-time

Wage and sector equivalent

salary workers employment compensation

involved in involved in (thousands of

manufacturing manufacturing dollars)

Agriculture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Mining . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Construction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Manufacturing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

All public and private services . . . . . . . . . . . . . . . . . . . . . .

Ail private services . . . . . . . . . . . . . . . . . . . . . . . . . .

Wholesale trade . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Transportation and warehousing . . . . . . . . . . . . . . . . . . . .

Business services . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Radio and TV broadcasting . . . . . . . . . . . . . . . . . . . . . .

Electric, gas, water and sanitary services . . . . . . . . . . . . .

Communications, except radio and television . . . . . . . . .

Automobile repair and services . . . . . . . . . . . . . . . . . . . .

Retail, except eating and drinking . . . . . . . . . . . . . . . . . .

Finance and insurance . . . . . . . . . . . . . . . . . . . . . . .

Hotels, personal and repair services (exe. auto) ,, .

Eating and drinking places . . . . . . . . . . . . . . . . . . . . . . .

Real estate and rental* . . . . . . . . . . . . . . . . . . . . . . .

Amusements . . . . . . . . . . . . . .

Health, educ. & social sew. and nonprofit org.....,

Government . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

792

443

575

19,396

6,492

6,343

1,501

704

1,276

50

171

129

79

1,176

413

207

428

72

46

89

149

27,697

50.4%

45.5

13.3

100.0

9.4

11.9

26.3

24.2

22.8

21,8

21.4

11.6

11.6

10.3

9.0

8.5

7.9

6.7

4,5

0.9

0.9

29.0%

$11.3

37.0

26.8

28.7

246

24,4

27.6

30.3

24.7

29.6

37.5

39.7

17.8

17.1

27.4

15.7

11,0

21.1

19.9

20.2

31.1

$27.4

SOURCE: Workersinvolved in manufacturing dataisderived from OTA input-OutputModel (1980 technicalcoeflicients, 1984 estimated demand, 1984BLS

employment, djustedforcapital flows, imports andduties). Compensation dataderived from Bureau of EconomicAnalysis, National lncomeand

Product Accounts, electronicdata, mappedto input-output industry classifications.

1980s, despite the oil shocks and two periods of

a steeply rising yen. Alone among advanced

industrial countries, Japan managed in the 1980s

to combine great productivity growth in manufacturing with rising manufacturing employment, rising wages and benefits, and greatly

rising output.

These singular achievements suggest some

systematic advantages in Japan that are well

worth examining. There are of course elements

of superiority in other countries too (including

the United States) and things to be learned from

them. But Japan’s sustained improvement in

productivity and its pre-eminence in several

industries that were once nearly an American

preserve (e.g., computers, semiconductors) make

Japanese manufacturing a subject of special

interest. Thus this assessment on the contribution technology makes to competitiveness in

manufacturing concentrates quite heavily—

though not exclusively--on Japan.

The Japanese accomplishment rests to a great

extent on technology. Broadly defined, manufacturing technology covers not only the generation of new products but also know-how in using

equipment, organizing work, and managing

people to make the products. Where U.S. firms

have fallen down in recent years is in the

manufacturing process. The American system,

including our great universities as well as

industrial labs, still excels at making technical

discoveries and inventing new products. But

foreign companies (especially Japanese companies) have repeatedly beaten U.S. firms in

getting new, improved versions of a great many

products to market while keeping costs competitive and quality high.
6 ● Making Things Better: Competing in Manufacturing

Figure 14-GDP Per Capita in 1988 U.S. Dollars

(Purchasing Pourer Parity Exchange Rates)

Thousands

25

20

15

10

5

0

U.S. Canada Norway Japan FRG France UK Italy

-1988 1987

SOURCE: U.S. Department of Labor, Bureau of Labor Statistics, Offioe of

Productivity and Technology, unpublished data, August 1989.

Over the past decade or so, we have learned

much about the sources of the Japanese manufacturing superiority. We have become familiar

with features such as kaizen, or continual

improvement in every detail of manufacturing;

the training of workers to participate in /wizen,

learn multiple skills, and work in teams; and

kanban, the just-in-time delivery system for

parts that depends on reliable high quality and

reveals failures to achieve it. These features are

all part of the “lean” production system that is

practiced by the leading Japanese manufacturers

and is widely credited with keeping costs low

and quality high. The “buffered” system,

common in U.S. plants, depends on having large

stocks of parts and work in progress, so that

faulty items can be replaced, and sizable repair

areas for fining up defects in the finished

product.

3 The lean system, by contrast, is

designed to expose problems while the work is

in process, solve the problems, and from there

on do it right the first time. If this report gives

only passing attention to some of these aspects

of Japanese manufacturing, that is not because

they lack importance, but because they are very

well-known.

Greater investment in advanced equipment is

another advantage of leading Japanese industries. From 1976 through 1987, Japanese investment in machinery and equipment consistently

ran from 14.9 to 20.6 percent of GNP; in

America, it ranged from 7.5 to 9.0 percent of

GNP4 (figure 1-5). Japanese capital investment

in the late 1980s was especially high, posting

double-digit increases in both 1988 and 1989. In

manufacturing, the rate of increase was even

greater--over 25 percent for both years. An

important reason for these whopping investment

increases was a shift in production to higher

value added goods.5 Capital investment in

American manufacturing rose only 9 percent

from 1988 to 1989 (less in real terms).

It is not simply advanced hardware that gives

Japanese manufacturers the edge, however.

Their genius lies at least as much in the

employment of people in relation to the hardware. This effective use of people is also a factor

in the Japanese ability to shorten the product

development cycle—to repeatedly incorporate

state-of-the-art improvements in their products

and bring them to market quickly. For example,

it takes Japanese auto companies about 3 1/2

years to get a new model from design to

full-scale production, compared to over 5 years

for American and European auto makers.6 A key

difference is the Japanese emphasis on simultaneous rather than sequential engineering. The

people doing research, development and design

of the new model are in constant communication

with the people responsible for manufacture.

Other factors are involved too, such as the

reliance of the major manufacturers on a trusted

group of suppliers to do part of the product

development work. The result is a headstart over

3--s~~M~ JOhn F. IQticik, ‘‘A New Diet for U.S. Manufacturing, ’ Technology Review, J~. 28, 1989.

4~~m~m~ ~~w~,wor~&-om~c o#/ook, April 1989. me Jap-fips exclude public investtnmt, while those for the united

Statea do not,

SW J- Development Bank, “The Japan Development Bank Reports on Capital Spending: Suwey for Fiscal Year 1988 to 1990,” Economic

and Industrial Reseamh Department, September 1989.

6W B. ~SIIC ad Takahiro Fujimoto, “OverlappingRoblem Solving in Product Development” working paper 87-048, Harvard Business School,

revised April 1988.
Chapter 1--Summary . 7

Figure 1-5-Fixed investment in Machinery and

Equipment as a Percentage of GNP/GDP

“~

Percent

20

15

10

5

0

1976-80 1981-85 1986 1987 1988*

= United States Japan** U West Germany

= France = United Kingdom

● January to June

w Figures for Japan exclude public investment.

SOURCE: International Monetary Fund (IMF), Wodd Economk OuUook

(Washington, DC: April 1989), table 17.

slower competitors in responding to consumer

preferences and, perhaps even more important,

in incorporating the latest technologies.

Some American managers are now adopting

Japanese-style approaches, or versions of them,

to turn out better goods at lower cost. For

example, in the early 1980s, it took twice as

many hours to assemble a standard car in an

average American auto plant as in the average

Japanese plant. By 1988, U.S. assembly plants

had improved enough that the Japanese advantage was down from 100 percent to about 50

percent (25.1 hours for assembly in the average

U.S.-owned and managed plant v. 16.8 hours in

the Japanese). The best Japanese plant had an

advantage of 5.4 hours over the best American

plant7 (figure 1-6).

In quite a few other industries (e.g., textiles

and steel), well-managed U.S. firms have shown

that they are able to turn some of the Japanesestyle approaches to good account. But that is no

reason for complacency. For one thing, the

target is moving. Faced with the high yen, which

raises the prices of goods they export, the

Figure 1-6-Productivity Performance, World Auto

Manufacturers

Productivity: hours/auto

60

50

40

30

20

10

0

Japanese plants,

North America

n

U S plants,

North America

n

= Best Average m Worst

● Includes foreign owned.

● * Includes East Asia, Mexico, and Brazil.

SOURCE: John F. Krafcik and John Paul MacDuffie, “Explaining High

Performance Manufacturing: The International Automotive Assembly Plant Study,” paper prepared for the International Motor

Vehicles Program International Policy Forum, May 1989.

Japanese Government and Japanese manufacturers redoubled their own efforts to improve

technology and competitiveness. For example,

the best Japanese plant shaved assembly time for

a standard model car from 16 to 13.2 hours in

just one year, 1987 to 1988, and the average

plant improved from 19.1 hours to 16.8.8 The

Japanese were also holding onto a lead in better

quality. In 1988, the average Japanese assembly

plant was turning out cars with less than

three-quarters of the defects of cars produced in

American plants. U.S. plants stacked up very

well against the Europeans, however, as shown

in figures 1-6 and 1-7.

The reasons for Japanese success are broad

and complex. Public as well as private actions,

and the interrelation between them, are very

much involved. The issues selected for analysis

in this assessment include both, and may be

grouped into a few broad areas: 1) the cost and

availability of capital, and its influence on

business decisions to invest for the long pull in

product and process improvements; 2) the use of

TJohnF. wcfi ad JoM pad Mac ~ffie, ‘Explaining High performance Manufacturing: The International Automotive Assembly PISnt Study,”

working paper of the International Motor Vehicles program of the Massachusetts Institute of Technology, May 1989.

‘Ibid., p. 5.
8 ● Making Things Better: Competing in Manufacturing

Figure 1-7--Quallty Performance, World Auto

Manufacturers

Quality: assembly defects/100 vehicles

250

200

150

100

50

0

1

European plants,

Europe I

n I

U.S. plants,

North Amsrlca I I I

Japanese plants,

North America n New entrants”

_ Best = Average m Worst

● Includes East Asia, Mexico, and Brazil

NOTE: Data are derived from 1988 J.D. Powers International Quality

Survey and corporate data.

SOURCE: John F. Krafcik and John Paul MacDuffie, “Explaining High

Performance Manufacturing: The International Automotive Assembly Plant Study,” paper prepared for the International Motor

Vehicles Program International Policy Forum, May 1989.

human resources to contribute to manufacturing

excellence, with special emphasis on engineers;

3) relations between supplier and customer

firms within an industry complex, in particular

the benefits of close, cooperative links; 4) ways

to diffuse new technologies from outside sources

to private companies, and especially to smaller

manufacturers; and 5) existing government

programs-Federal, State, regional and local—

that help (or in some cases hinder) U.S. manufacturing firms in using technology to improve

their competitive performance.

Lessons from the successes of other countries

are not always easy to apply. Some elements in

the Japanese system may be quite adaptable to

U.S. companies that are enterprising enough to

try them-for example, close relations between

different segments of an industry complex (e.g.,

chemical companies that make textile fibers,

textile producers, apparel makers, designers,

and retailers) in which suppliers are attuned and

responsive to the needs of their customer firms,

and purchasers are willing to form stable,

cooperative relations with their suppliers. Other

practices and policies of foreign nations would

be much harder to translate into American

terms-for example, the century-old system of

vocational education that trains half the young

people of West Germany in good work habits

and a variety of skills. And some policies of

other nations are quite foreign to our traditions

and outlook-for example, centralized direction

of trade and industrial policy as practiced in

Korea (until recently, when controls have loosened somewhat).

One way or another, however, the United

States must regain excellence in the manufacturing process. That is key to raising income for the

Nation. No longer can U.S. industries count on

profiting from new inventions for years before

competitors begin to produce them. Many

technical inventions cannot be protected from

skillful imitators-and the world is now full of

manufacturers who can quickly and ably produce things that were invented elsewhere (just as

U.S. manufacturers themselves have often done

with foreign inventions). Over the long run, a

country and its citizens cannot control or profit

from what they cannot produce competently.

Restoring or creating excellence is no easy

task. U.S. manufacturers who once were the

masters of mass-production grew complacent in

the years of American domination. Many still

cling to wasteful production systems that take a

narrow view of cost reduction, and do it at the

expense of reliability, flexibility, and customer

service. Many smaller manufacturers are far

behind the times technologically. Federal technology policy is still aimed much more at

research and the generation of new inventions

than at quickly diffusing new technologies

(whatever their source) and putting them into

practice. Some government policies run counter

to manufacturers’ efforts to improve their performance, although that is not their intention. Most

important is the government’s inability to eliminate the budget deficit, which increases pressure

to raise interest rates and the value of the dollar,

and directly diminishes manufacturers’ ability

to sustain long-term, risky investments. The

Federal Government, along with many State and

local governments, has initiated some new

programs to help manufacturers improve competitiveness and technology, but these are mod-
Chapter 1--Summary . 9

est at best. The dampening effects of macroeconomic and foreign policies can easily overwhelm them.

With will and effort, a nation’s industries can

change. Forty years ago, Japan was a poor

nation, backward in manufacturing technology,

lacking engineers and scientists, relying mostly

on low labor costs to make products attractive

enough for export. Between that Japan and the

Japan we know today are years of heavy

investment in people, technology, and machinery, and a great deal of sacrifice on the part of

consumers. The United States today is in a far

stronger position than Japan was then but,

ironically, this may make it harder to undertake

the sacrifices and changes needed to rebuild our

competitiveness. We are still a wealthy nation,

and there is no widespread feeling that we are in

or approaching a crisis. Under such circumstances, it would take extraordinary leadership

to summon the energies to make significant

changes. One hopeful sign is that the nations of

the European Community—also wealthy and

with no apparent crisis—have pulled together to

create a new economic order, with the Single

Market Act.

The European Community’s efforts to harmonize internal markets beginning in 1992 have

several things in common with the measures

Japan took to industrialize two decades ago.

They also have much in common with measures

the United States needs to consider to improve

our competitive performance. Broadly speaking, they are measures to promote investment in

people, technology, and equipment; to disseminate information and know-how; and to encourage cooperative efforts to solve common problems.

INVESTMENT

Investments in technology require patience.

Researchers, inventors, and designers often

must wait years—sometimes decades—for their

efforts to pay off. Although investments in

equipment are more predictable and less risky,

even these may not break even for years.

America’s financial climate is not conducive

to long-term investments in technology and

equipment, compared with Japan, Germany, and

the most rapidly developing Asian nations.

Several things contribute to this relatively

unfriendly environment. High U.S. capital costs

shorten the time horizons of investors, so do the

pressures exerted on companies by the stock

market, particularly by institutional investors

and takeover specialists. In sum, both government policies and business practices reinforce

an excessive concern with short-term profit in

America. If these conditions persist, it will be

increasingly difficult to keep up with technological advances made elsewhere.

U.S. capital costs have been and remain high

compared with those in Japan, the nation that

provides the greatest contrast with U.S. shortterm thinking. There is some disagreement over

just how large (or small) the differences are, but

most recent studies estimate significantly higher

capital costs in the United States9 (figures 1-8,

1-9, and 1-10). On the high side, the estimates

range up to 13 percentage points difference,

while the difference at the low end is on the

order of 1 or 2 percentage points. Even relatively

modest differences of a few percentage points in

capital costs can be a significant disadvantage in

making investments that take many years to pay

off.

U.S. capital costs are high for many reasons.

Interest rates rose in the 1980s and remain high

principally because of the enormous pressure of

the budget deficit, which is a large drain on

savings, and the fall in other savings rates. But

there is a great deal more to capital costs than

interest rates. The price a firm pays for capital is

also a function of its relationships with creditors

and equity holders, and the taxes it pays. During

Japan’s high growth period, which lasted until

1973-74, heavy reliance on debt financing from

main banks kept capital costs down for Japanese

%fich~] L. lkto~s,~ckmd K. kster, and Robert M. SoloW, Made in America: Rega”ning the Productive Edge (Cambridge, MA me~~ss,

1989).
10 ● Making Things Better: Competing in Manufacturing

Figure 1-8--Cost of Capital for Equipment and

Machinery With %)-Year Physical Life

Cost of capital 141 !

12 -

10 -

8

-

6-

1977 197819791980 1981 19821983198419851986 19871988

;~

‘

— United States ‘-+ Japan

SOURCE: Robert N. McCauley and Steven A. Zimmer, “Explaining

International Differences in the Cost of Capital,” Federa/

Reeerve Bank of New York C?uwteriy R&view, Summer 1969,

table 2.

Figure l-9-Cost of Capital for R&D Project With

10-Year Payoff Lag

20 -

15 -

10 -

5

o~

-

1977197819791980 1981 19821983198419851986 19871988

‘

– United States ‘ Japan

SOURCE: Robert N. MoCauley and Steven A. Zimmer, “Explaining

International Differences in the Cost of Capital,” Federa/

Reserve Bank of New York Quarterly Review, Summer 1989,

table 2.

manufacturing firms (particularly in favored

industries). A variety of Japanese Government

policies encouraged the banks to lend heavily at

low rates to large corporations. These policies

included direct government lending through the

Japan Development Bank (which is a signal to

private banks), administrative guidance from

the Ministry of Finance, and close regulation of

Figure I-l O-Cost of Capital for Factory With

40-Year Physical Life

Cost of capital

14

12 -

10

8

-

6

-

4 ‘

2

-

0

1 1 1 1 I 1 1 1 I 1

1977 197819791980 1981 19821983198419851986 19871988

‘

-- United States + Japan

SOURCE: Robert N. McCauley and Steven A. Zimmer, “Explaining

International Differences in the Cost of Capital,” Feded

Reserve Bank of New York (2uarterly Review, Summer 1989,

table 2.

every aspect of banking and finance, including

the disposition of household savings.

Today, Japan has enormous capital reserves,

and most major corporations finance all their

investment with retained earnings and depreciation. Moreover, Japan is deregulating its financial markets, and large Japanese companies are

getting more of their external capital in foreign

markets. Most estimates of U.S. and Japanese

capital costs still show American firms at a

substantial disadvantage-one study, for instance, reports U.S. cost of capital at 20.3

percent, compared with 8.7 percent in Japan.10

But even if nominal costs were the same,

differences in the financial environments in the

two countries would still favor Japanese firms.

Most of the stock of large Japanese corporations

is held by other corporations, often in the same

keiretsu (industry group), who agree to hold the

stock for long periods with few demands in

return. This system, known variously as cross

shareholding, mutual shareholding, or stable

shareholding, is in marked contrast with U.S.

practice. Here, shareholders must be given far

more attention; corporations pay larger dividends, and corporate managers are under heavy

lmo~~ N. McCauley and Steven A. Zirnmer, “Explaining International Differences in the Cost of Capital,’ Federul Reserve Bank o~fVew York

QwtertyReview, summer 1989, pp. 7-28. These figures apply to investments in research and development. Other investments, such as equipment and

machinery and factories, axe also shown to be more expensive in America than in Japan and West Germany.
Chapter 1--Summary ● 11

pressure to show a profit each quarter. In the

1980s, new financial instruments have made it

much easier for outsiders to mount takeover

bids, and managers in U.S. companies feel that

they must show profits or become vulnerable to

takeover attempts. American managers’ increasing preoccupation with the short-term bottom

line in the 1980s is in part due to that vulnerability.

Several other factors tend to reinforce shortterm bias in America. None by itself is conclusively important, but together they have a

considerable effect. Company size and structure

may account for some of the short term focus of

the semiconductor industry, in particular. The

leading Japanese semiconductor producers are

large, integrated, stable companies making a

variety of products, from semiconductors to

computers and consumer goods. The U.S. industry has a few large, integrated producers, making

chips mostly for their own use, but the merchant

firms that sell semiconductors to systems makers are mostly smaller, entrepreneurial companies. Such companies have been highly innovative, but also highly unstable. Personnel turnover (especially defections to start new firms) is

high, as are rates of entry and exit. Their

relatively small size, instability, and irregular

cash flow make it especially hard for them to

raise the large amounts of capital required for

semiconductor production. These factors exaggerate the short-term focus that is endemic in

U.S. financial markets.11

Government policies that increase uncertainty also aggravate the problem. For example,

in the 1980s, American business managers were

faced with a very high dollar, which made it

harder to sell goods abroad and to compete

against foreign goods at home. The dollar finally

began falling in 1985. But throughout the high

dollar period of the early 1980s, the U.S.

Government made no provision for firms working under that disadvantage. In contrast, the

Japanese Government put in place special loan

and loan guarantee programs to help Japanese

firms cope with endaka (high yen) after the

international accords that brought the dollar

down in 1985.

The single most important step the government could take to improve the financial environment is to greatly reduce the Federal budget

deficit, and eventually eliminate it. That would

help to lower interest rates and allow the dollar

to find a level that more accurately reflects the

competitiveness of American industry (Figure

1-11 shows real long-term interest rates in the

1970s and 1980s.) It would also be a powerful

signal to the business community that government could be relied on to provide some

stability.

None of this means that American manufacturing is entirely a victim of circumstances

beyond its control. U.S. companies are hobbled,

but not crippled, by a financial environment that

undervalues long-term investment. Some of the

myopia of U.S. firms could be overcome

through the will of top management. Against the

general background of short-term decisionmaking, a few firms standout as long-term investors.

Many of these firms have done well. But the

power of finance and accounting in American

corporations has lifted financial specialists to

Figure 1-1 l—Real Long-Term Interest Rates

Percent per annum

‘“~

2 I

-2

-4~ F---J

1974 1976 1978 1980 1982 1984 1986

SOURCE: Organization for Economic Cooperation and Development

(OECD), /iistorica/Statistics 1960- 1967 (Paris, France: OECD,

1989), table 10.10.

IIM~umS, et al., 1989, op. cit.
12 ● Making Things Better: Competing in Manufacturing

many top decisionmaking spots, and their biases

could be difficult to overcome, especially if the

rewards for managing for the short-term bottom

line do not start to dwindle.

In the discussion so far, investment in technology has been defined as investment in capital

equipment, research, and development. The

United States also needs well-educated and

trained people to make the best use of sophisticated technology. Currently, the investments we

make in human resources have disappointing

results.

Success in manufacturing depends on the

competence and inventiveness of people at all

levels. Increasingly, workers from the production line to the executive suite must be comfortable with advanced technology. Production

workers are responsible for implementing statistical process control procedures; designers, line

managers, and workers must interact frequently

and productively; and everyone must assume

broader responsibility for making high-quality

products effectively. The skills demanded for

these tasks are those of analysis and problemsolving. The days when most factory workers

used their hands more than their heads are

disappearing.

American workers are poorly equipped to

cope with these changes, in part because our

public schools do not educate many of our

children adequately, and in part because firms

have been slow to adopt production systems that

demand higher order skills, and to train workers

to use them. Firms, in turn, are often reluctant to

invest heavily in training for fear that they will

not be able to recoup their investments.

U.S. educational deficiencies are great in

science and mathematics. In the mid-1980s,

American junior high school students ranked

10th in arithmetic, 12th in algebra, and 16th in

geometry in tests of mathematics competence in

20 countries. In a another comparison of students in 14 nations, American 12th graders

ranked 12th in geometry and 13th in advanced

algebra (figures 1-12 and 1-13). In the 1960s,

American students performed as well as stuFigure l-12—Twelfth Grade Achievement Scores —

Hong Kong

Japan

England\ Wales

Sweden

Finland

New Zealand

Belgium(Flemish)

Scotland

Canada(Ont)

Belgium(French)

Israel

Us.

Hungary

Canada(B.C.)

Thailand

in Geometry

1 1 1 ( 1 1 1 0 10 20 30 40 50 60 70 80

Mean score

SOURCE: International Association for the Evaluation of Educational

Achievement, The Underachieving Curriculum: Assessing U.S.

School Mathematics From an International Perspective (Champaign, IL: Stipes Publishing Co., 1987).

dents anywhere in the world. Further evidence

of deterioration is the decline in Scholastic

Aptitude Test scores over the last quarter of a

century.

Workers who cannot cope with mathematics

or problem-solving are a liability in advanced

manufacturing. For example, Motorola determined that workers in its Factories of the Future

needed math skills equivalent to seventh grade

proficiency to get by. Even this modest requirement has obliged Motorola to invest tens of

millions of dollars in training.

Not only is our general public education

inadequate, our vocational education system

falls far short of the standards set by other

countries. It certainly does not match the

apprenticeship training taken by more than half

the young people of West Germany. This system

gets much of the credit for the broad diffusion of

technical competence throughout German manufacturing.

While there are small indications of improvement—a recent turnup in SAT scores, for

example-there is need for a great deal more.

The fact that American students are behind those
Chapter 1--Summary ● 13

Figure l-13-Twelfth Grade Achievement Scores in

Hong Kong

Japan

Finland

England\ Wales

Belgium(Flemish)

Israel

Sweden

Canada(Ont)

New Zealand

Belgium(French)

Scotland

Canada(BC)

Hungary

Us.

Thailand

Advanced Algebra

1 1 1 1

0 20 40 60 60 100

Mean score

SOURCE: lnternationaJ Association for the Evaluation of Educational

Achievement, The Underachieving Curriculum: Assessing U.S.

School Mathematics From an International Perspeti”ve (Charnpaigrt, IL: Stipes Publishing Co., 1987).

of other advanced nations—and of several

developing nations as well—makes it harder for

the United States to keep up in manufacturing.

Another worrisome trend is demographic. In the

past, most engineers and scientists were white

males; they now comprise a shrinking portion of

the population of school-age children. Minorities and women have historically performed

much less well than white males in math and

science, for reasons that are only partly understood. To avoid a future scarcity of technologists, the Nation must devote particular efforts

to improving math and science proficiencies—

of students of both sexes and all races—all the

way from grammar school to employerprovided training.

Do we need to invest more money? It is a

widely held belief that the United States invests

more in educating its children than other nations, both per capita and as a share of gross

domestic product.12 This is clearly true only if

post-secondary education is included. A recent

study that separated out education past high

school found that U.S. public and private

spending on schooling from kindergarten

through 12th grade, as a share of GDP, is lower

than in most industrialized countries-tied for

12th among 16 (figure 1-14). In spending per

student in grades K-12, the United States ranks

higher—5th of the 16 (figure 1-15).13 T h e

United States has some special educational

problems: our population is much more diverse

in culture and language than that of most of our

competitors. It could well take heavier investments in human resources to solve our unique

problems.

PROMOTING COOPERATION

Partly because of American traditions—the

emphasis on individual initiative, for example—

and partly because of public policies that limit

cooperation, U.S. firms tend to be isolated from

customers, suppliers, and competitors compared

with Japanese and many European firms. Japanese firms, in particular, are knitted into a

network of mutual obligation and cooperation.

This is not to say they don’t compete; competition is fierce, but is often greater in product

quality and features than in price.14 The bonds

of cooperation and obligation, together with

relatively limited price competition in the Japanese market, provide Japanese firms with two

advantages: access to a wider array of information and support than they would have alone,

and enough stability to encourage investment in

equipment, knowledge, and people.

U.S. companies, on the whole, do not form

strong collaborative links. The typical relationship between supplier and customer is distant,

even adversarial. Price has been the major basis

for dealings with both suppliers and competiIZF~eX~ple, ~Sident BA told the “Education Summit’ in September that the United States “lavishes unsurpassed resources IOUr children’s]

schooling.”

ISM. Mh -11 and Lawrenee Mi.shel, “Shortchanging E4hXtiOn,” Economic Policy Institute briefing paper, Washington, DC, January I%Xl.

14~ fwt ~Pnws of may Conwer g- made in Japm we lower ~ tie u~t~ Stare and other f~ign countries than in Japan iIXhCateS that

Japaneaemanufacturersdo not always compete vigorously on price, Japan’s complex distribution system amounts for some but not all of thehigherretail

price for many goods.
14 ● Making Things Better: Competing in Manufacturing

Figure 1-14--Spending for Education Grades K-12.

Sweden

Austria

Switzerland

Norway

Belgium

Denmark

Japan

Canada

FRG

France

Netherlands

U.K.

Italy

Us.

Australia

Ireland

percent of GDP, 1085

0 1 2 3 4 5 6 7 8

Percent of GDP

SOURCE: Lawrence Mishel and M. Edith Raaell, “Shortchanging Education,” Eoonomic Policy Institute briefing paper, Washington, DC,

January 1980. -

-.

tors. This is not invariable, nor is it without

advantages. In some industries-notably, the

airline and aircraft industries-relationships between suppliers and customers are traditionally

strong; and in some where relations used to be

distant or hostile--such as textiles and apparel—

they are becoming stronger. Moreover, price

competition among suppliers or between competitors, is desirable and healthy. But taken too

far, narrow reliance on price competition can

sever close links between customer and supplier, and reduce incentives to improve quality

and timeliness, Close and stable relationships

with customer firms are incentives for supplier

firms to invest in human resources and in

equipment that may take several years to pay

off. To illustrate the point, in a recent study of

metalworking companies, about half the firms

that had not bought numerically controlled (NC)

or computer numerically controlled (CNC) machine tools cited lack of stable demand for their

product as the reason.15

Both parent and supplier companies in Japan

benefit from close, cooperative relationships.

Without having to manage every detail, the

parent company is able to demand favorable

Figure 1-15--Spending for Education Grades K-12,

Sweden

Switzerland

Norway

Canada

Us.

Austria

Denmark

Japanm

FRG

Belgium

France

Netherlands

Australia

U.K.

Italy

Ireland

.

Per Pupil, 1985

0 1,000 2,000 3,000 4,000 5,000

SOURCE: Lawrence Mishel and M. Edith Raaell, “Shortchanging Education,” Economio Policy Institute briefing paper, Washington, DC,

January 1990; arrd U.S. Department of Labor, Bureau of Labor

Statistic& unpublished data, August 1989.

terms for costs, quality, and delivery times. The

supplier has the advantage of a reliable customer

who can provide assistance with technical

problems and occasionally with finance if needed.

While these relationships are often quite stressful for the supplier companies, they have

promoted the diffusion of technology and knowhow to Japan’s myriad of small companies with

remarkable effectiveness, aided by an abundance of Japanese Government technology diffusion programs. (See the following section in

this chapter on Transferring Knowledge and ch. 6).

In contrast, American companies have traditionally opted for one of two strategies: vertical

integration, or arms’ -length dealing with competing suppliers. While vertical integration could

be thought of as the ultimate in close relationships, the control over cost that a company can

exercise with an outside supplier may be sacrificed. And pitting suppliers against each other—

making them compete for every contract on

price with no assurance of ever getting another

one—makes it more difficult to transfer technology and design responsibilities. The Japanese

system has been a remarkably effective compromise. A measure of its effectiveness is that

15Mqell~ R. Kelley @ H~ey Brooks, ‘‘The State of Computerized Automation in U.S. Manufacturing,” Joh F. Kenn~y SC~l of

&VtXIIIDUlt, Harvard hiveraity, 1988.
Chapter 1--Summary ● 15

many American industries-the motor vehicle

industry, as well as the textile and apparel

industries-are making similar arrangements

with their own suppliers.

Close relations between capital equipment

suppliers and their customer firms are especially

important to technological prowess, particularly

in fast-moving industries like microelectronics.

In the past two decades, American industry has

become steadily more dependent on foreign

manufacturers for its production machinery.

Japanese suppliers have come to dominate the

market for workhorse CNC machine tools;

Swiss, German, Japanese, and other European

makers lead the market for textile and paper

industry machinery; and U.S. producers of

semiconductor production equipment are fast

losing the lead to Japanese rivals.

In textile industry machinery, where the

domestic market share fell from 93 percent in

1960 to less than half in 1986, the reasons for the

demise of most U.S. producers are instructive.

The industry’s decline, which began in the

1960s, was due largely to its unresponsiveness

to customer needs and to a short-term perspective, reflected in scanty spending on research

and development compared with foreign competitors. The neglect of R&D spending was

made worse by the merger mania of the 1960s.

Most of the U.S. textile machinery companies

were bought by conglomerates.

Although the decline of the American textile

machinery industry has not, it seems, crippled

American textile makers. Nearly all report

satisfactory service from their foreign suppliers.

However, the situation is different in the semiconductor industry. As recently as 10 years ago,

American firms held more than three-fourths of

semiconductor production equipment world market. By 1988, the U.S. share was down to 47

percent and still dropping (table 1-2, figures

1-16, 1-17, and 1-18). This year, Perkin-Elmer,

one of the major remaining U.S. manufacturers

of lithography equipment, dropped out of that

market, which had become a money loser for the

company.

Already, losses in the American semiconductor equipment industry are a handicap for U.S.

semiconductor producers. U.S. producers say

that, for some critical production equipment,

they are unable to buy the latest model from

Japanese makers only after it has been in wide

use by Japanese chipmakers for months. Many

U.S. chipmakers are concerned that their ability

to get state-of-the-art equipment will decline

further in the future. The next generation of

lithography equipment is expected to use Xrays, and the Japanese are well ahead of U.S.

companies in developing X-ray lithography

equipment. If commercial use of X-ray lithography equipment begins, as expected, in the

1990s, it is likely that the first use will be in

Japan. That development would add to the

already substantial number of microelectronics

technologies dominated by Japanese producers.

Sematech, the U.S. industry-led consortium

to develop a process to manufacture a 16-

megabit DRAM, has given top priority to

improving relations between chipmakers and

equipment producers. Sematech’s directors see

better relations as essential to develop a range of

high-quality, affordable equipment and materials for American producers.

U.S. producers of supercomputers also risk

dependence on Japanese suppliers of components. Significantly, many of those suppliers are

also competitors, making supercomputers themselves, or else are closely aligned with competitors. For example, the highest performance

memory and bipolar logic components for

supercomputers come only from Japan. The

management of Cray, a U.S. manufacturer of

supercomputers, has at times been told that the

latest and best of these components are ‘‘not yet

available for export” from Japan.l6 They are,

however, available to Japanese supercomputer

161EF4CJSAB tit~ on -~ications and Information Policy, “U.S. SuperComputer Vulnerability,’ report to the IMhXe Of ~wtricd md

Electronics Engineers, Inc., prepared by the Scientific Supercomputer Subcommittee, Committee on Communications and Information Policy, United

States Activities Board (Washington, DC, August 1988).
16 ● Making Things Better: Competing in Manufacturing

Table 1-2—Top Ten Semiconductor Equipment Suppliers, World Sales

(millions of dollars)

1982 1988

Perkin Elmer . . . . . . . . . . . . . . . . . . . . ... .$162 Nikon . . . . . . . . . . . . . . . . . . . . . . . . . . . . ..$521

Varian . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100 Tokyo Electron (TEL) . . . . . . . . . . . . . . . . . 508

Schlumberger . . . . . . . . . . . . . . . . . . . . . . . 96 Advantest . . . . . . . . . . . . . . . . . . . . . . . . . . . 385

Takeda Riken(Advantest). . . . . . . . . . . . . 84 Applied Materials.. . . . . . . . . . . . . . . . . . . . 382

Applied Materials.,.. . . . . . . . . . . . . . . . . . 84 General Signal... . . . . . . . . . . . . . . . . . . . . 375

Eaton . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80 Canon . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 290

Teradyne . . . . . . . . . . . . . . . . . . . . . . . . . . 79 Varian . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 211

Canon . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78 Perkin Elmer . . . . . . . . . . . . . . . . . . . . . . . . 205

General Signal . . . . . . . . . . . . . . . . . . . . . . . 77 Teradyne . . . . . . . . . . . . . . . . . . . . . . . . . . 190

Nikon . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58 LTX . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 180

(Japanese Firms Italicized)

SOURCE: VLSIResearch,lnc.

Figure l-16-Shift in Market Shares for

Wafer Steppers

I

60 -

40 -Japan

\

Europe

o I I I I I I I

‘83’84 ‘85 ’86’87’88 ’89

est

NOTE: The wafer stepper is a device central to manufacturing semlconductors.

SOURCE: VLSIResearch,lnc.

makers, and the Japanese supercomputers themselves are ready for export. Closer relations with

U.S. suppliers is not just an advantage but a

necessity for maintaining market share, in a

world where a firm’s major suppliers are its

fiercest competitors.

Another wellspring of Japanese technical

prowess is cooperative research and development, which has the advantages of shared

expenses and synergism. Participants in consortia to develop new products or techniques can

gain access to research results they could not

afford on their own, and have the chance to work

with scientists or engineers from other firms and

institutions.

Complex manufacturing processes and sophisticated products demand increasing inputs of

research and development. The higher the cost

of R&D, the riskier the investment-too risky,

perhaps, for all but the largest and most stable

fins. For example, it is costing billions of

dollars to develop X-ray lithography, an amount

that strains the resources of even giant firms. In

Japan, a government-sponsored consortium is

helping to share the risk and effort involved in

developing commercial X-ray lithography.

R&D consortia have other attractions. For

example, they are often effective at diffusing

technology to participants; they help to avoid

problems of redundancy, or wasting of resources on reinventing wheels; and they can be

valuable training grounds for researchers. Especially when government is a participant, censortia can help to provide adequate investment in

technologies that have a great many externalities—

where the rewards cannot be captured by a

single firm. In this way, consortia can help

lengthen the short time horizons of American

management.

Consortia are not,of course, a panacea.They

seem to work best when there are clear goals and

least potential for conflict among members--for

example, in catch-up projects, where no firm can

hope to get a monopoly on a new technology. If

America were in the competitive position it

occupied two decades ago, we might well

conclude that the case for stimulation of consortia (especially ones with government participation) is dubious. But that is not the situation. The
Chapter I-Summary ● 1 7

Figure 1-17—U.S. Market Shares of Selected

Semiconductor Equipment

\ 1

-..-1 US. resist

--- - - - -

\ processing

80

K

-

.\ . - - -

t ~

\ \/

\ \

60-- U.S. integrated ‘ - ‘*H ‘%-?-.

circuit testers -\.

. —

\

- - -

N.

4’‘ \

\

“ \

40

/

\

\

\.

U.S. stepping ‘~ . .

\

aligners \ \

20-— — — — — — — — ~

o

1979 1980 1981 1982 1983 1984 1985 1986 1987 1988

Year

SOURCE: VLSI Research, Inc.

United States has serious competitive problems

to solve. The European Community, moreover,

has opted to support a profusion of new science

and technology consortia. These consortia are

largely aimed at overcoming what are perceived

as substantial foreign leads in a wide variety of

technologies. While the EC’s technology consortia probably will never amount to more than

10 percent of all the Community’s expenditure

on R&D, that small percent is viewed as critical,

both because it adds to the amount spent, and

because it gives the EC an important strategic

lever for guiding European manufacturing technology.

American industry and government have

moved cautiously toward collaborative R&D in

the past few years. The Federal Government put

up half the funding for Sematech, and it has

contributed $5 million per year for 3 years to the

National Center for Manufacturing Sciences, a

consortium designed to do generic research on

metalworking and other manufacturing technologies. The National Science Foundation’s Engineering Research Centers offer another approach. ERCs are university-based centers that

Figure 1-18--World Semiconductor Equipment Sales

Billions of dollars

5

4

3

2

1

0

1984 1985 1986 1987 1988 1989 1990 ‘

= United States Japa n

m Rest Of world m Joint ventures

● Forecast

SOURCE: VLSI Research, inc.

get half their funds from NSF, one-third from

industry—which must cooperate with the university in generating and running the research

program-and the rest from university, State,

and local funds. This small program encourages

interdisciplinary engineering research and education and promotes cooperation among university and industry researchers.

One obstacle that sometimes hinders greater

collaboration-more in downstream activities

like manufacturing than in R&D--is our antitrust law. The discouragement comes not because all collaborative projects would actually

violate antitrust law, but because the law is

rather unclear, its penalties can be harsh, and

trials are expensive. Antitrust law can also

interfere with U.S. firms’ merging to face

competition from larger foreign fins.

These problems suggest the need for modest

changes in our antitrust laws. They need to be

made carefully, so as to preserve the laws’

protection against price-fixing and other anticompetitive practices. Possible approaches include clarifying that conduct should be judged

with full consideration of the long-term benefits

of cooperation, reducing harsh penalties, and

providing for advance approval of cooperative

projects.
18 ● Making Things Better: Competing in Manufacturing

TRANSFERRING KNOWLEDGE

Public and private institutions for diffusing

new technologies across the manufacturing

sector are thin in the United States. In particular,

there is little technical assistance available to

small manufacturing enterprises. While some

small manufacturers are on the cutting edge of

technology-the Silicon Valley startup springs

to mind-most are not. Many cannot afford to

devote the time and attention to keeping up with

technological developments made in the United

States, to say nothing of technical advances

made abroad.

It is uncommon for large manufacturers in

America to lend technical assistance to their

suppliers—still less for the first line suppliers to

pass along technical help to smaller subcontractors. Both are everyday practice in Japan. There

is little in this country to compare with Japan’s

dense nationwide network of free, public technology extension services for small and mediumsize firms. Nor do we have anything like the

huge programs of financial assistance that

accompany technical assistance to small and

medium-size firms in Japan. In 1988, low-cost

direct loans to smaller firms from Japanese

national government financial institutions

amounted to more than $27 billion, not to speak

of $56 billion in loan guarantees, plus additional

technical and financial assistance from prefectural and local governments.

In the United States, aside from some small

programs for disadvantaged individuals, the

Federal government makes no direct loans to

small business. In fiscal year 1989, the Small

Business Administration underwrote guaranteed loans worth $3.6 billion. A few States have

industrial extension services to help small

manufacturers make informed decisions about

improving their production methods and implementing new technology. No accurate count is

available, but these State programs are probably

funded at about $25 to $40 millions per year.

Federal involvement in industrial extension is

sketchy, although Congress has recently taken

some steps to strengthen it. The Federal program

of technology extension consists mainly of three

Manufacturing Technology Centers created in

the Omnibus Trade and Competitiveness Act of

1988 and funded at $7.5 million in fiscal year

1990; three more centers are planned. Altogether, current industrial extension programs,

State and Federal, reach only a small fraction—

probably less than 2 percent per year-of the

Nation’s small manufacturing firms.

Government technical assistance to small

manufacturers in Japan far outpaces similar

programs in America. Because financial and

technical assistance programs are interrelated,

an estimate of the size of these programs is not

available, but they are large. For example,

Japan’s national government provides half the

funding for the nationwide system of 185

technology extension centers with the other half

provided by prefectural governments. Total

funding for the centers is over $470 million per

year. Local governments support additional

technology extension centers as well. But government assistance is not the only or even the

major form of technical assistance. In a recent

survey done by MITI’s Small and Medium Size

Enterprise Agency, 45 percent of respondents

(small and medium-size businesses) reported

that they received technical assistance from a

parent company, 37 percent got information, 28

percent were loaned or leased equipment, and 24

percent got training for their employees.17 In

some cases, vertical transfer of technology

within Japanese supplier groups is effective

enough to allow major manufacturers to delegate other functions to their suppliers. Both

Toyota and Nissan, for instance, have delegated

assembly of some of their cars to former

first-tier suppliers.

American companies—including all the Big

Three motor vehicle companies—have instituted similar programs recently, becoming both

17D.H. ~tt~er, ‘New TahIIoIogy ~q~isi~ion in srn~l JapaneW Enterprises: Government Assistance and Private hIitiative, ” COnWactm repofl

prepared for the Office of Technology Assessment, May 1989, p. 23.
Chapter 1--Summary ● 19

more demanding and more supportive of their

suppliers. They have pared down the numbers of

suppliers, given more technical assistance, and

are moving towards performance-based standards. But U.S. firms are still far behind Japanese

manufacturers in diffusing technology and knowhow along supplier chains, or among firms

within an industry, or from public institutions to

private fins.

Because of Japanese direct investment, some

American firms are experiencing the Japanese

system firsthand. According to a recent GAO

study, U.S. auto parts producers who work with

Japanese transplant assembly firms report that

their Japanese customers keep in closer contact

than their U.S. customer firms, and send many

more staff on site visits to the supplier’s plant.

They characterized the Japanese companies they

work with as ‘‘preventative’ in solving problems, rather than “reactive,” like American

firms.18

Large U.S. firms as well as small ones suffer

from isolation. Their customary arm’s-length,

adversarial relation with suppliers deprives

them of the back-and-forth collaborative work

on new technologies that takes place between

large firms and first-line suppliers in much of

Japanese manufacturing. This collaboration is

important to innovation in Japan. Japanese

manufacturers of all kinds of products, from

automobiles to office copier machines, are quick

to make incremental changes in products and

bring new models embodying the latest technology to market ahead of their competitors.

Another contributing factor to firms’ competitive position is their readiness to scan the world,

find out what new technologies are available and

plug them into new products. American firms

seem much less inclined to exploit technologies

that originate outside the fro-a stance often

called the not invented here (NIH) syndrome.

One study of 50 large Japanese firms and 75

large American firms found that Japanese firms

spent considerably less time and money than the

U.S. firms in developing new products and

processes, mostly because the Japanese were

adept at exploiting innovations made elsewhere,

while American firms were trying to generate

more of their innovation internally .19 The ability

to make effective use of external technology is

also related to short product cycles. Japanese

firms in automobiles and electronics have managed to pare product cycles so that they are

shorter than those of American competitors.

Since new ideas, from inside or outside, are

most likely to be adopted at the beginning of a

product cycle, shorter cycles mean more

innovation—and they do, for many Japanese

industries.

The reluctance of U.S. firms to adopt and

work with outside ideas has not undermined

their ability to apply big-bang, fundamentally

new technologies that can be exploited commercially. American companies in general have

been good at this, and many small startup firms

have found venture capitalists to stake them.

NIH applies more to technologies that are good

for incremental improvements. It may also help

to explain why U.S. firms take curiously little

advantage of new technologies developed in

Federal laboratories. However, another reason is

that the labs, short of money for technology

transfer and hampered by red tape, do not reach

out to industry.

Most of the $21 billion per year spent on

R&D in Federal labs is for defense or basic

research-missions not directly relevant to commercial manufacturing. Some of this R&D

could be made useful to civilian manufacturing,

both by transferring lab technology to industry

for further development and by lab-industry

cooperative R&D on subjects of mutual interest.

Although Congress passed several bills in the

1980s to encourage commercialization of technology from the Federal labs, such commercialization has been modest.

18u.s. G~~ ~w~g ~lce, Foreign Investment: Growing Japanese Presence in the U.S. AJUO l?tdW?Y, GAO~SIAD-88-l 1! M~h 1988”

lg~w~ -field, “Industrid bovation in Japan and the United States, ” Science, Sept. 30, 1988.
20 . Making Things Better: Competing in Manufacturing

One main reason is that the labs’ efforts at

encouraging commercialization have not been

adequately funded. Without line-item funding,

such efforts are often considered by personnel at

the labs and their parent agencies to be mere

distractions from their primary missions. Interactions between the Federal labs and private

industry require a new philosophy and new

procedures, and the resolution of some difficult

issues (e.g., potential conflicts of interest).

Resolving them is more difficult when agency

officials, such as the general counsel, put

forward objections and there is no strong

countervailing voice to push the process along.

In addition, some provisions of the law hinder

the labs from granting a firm exclusive rights to

technology. Without those rights, firms may not

find it worth their while to commercialize

technology coming out of the labs.

Concerns about exclusive rights extend to

R&D in general. Many American firms complain that in the United States and, especially

abroad, their new products and manufacturing

processes are copied by imitators who did not

pay to develop them. They desire stronger

intellectual property protection for new technology-chiefly patent rights, and copyrights

for software. Without it, they assert, they face

unfair competition and cannot pay for their

R&D.

This argument has some merit, and some

measures to increase protection would help. The

most promising ones include strengthening

patent enforcement in the United States and

Japan, and negotiating to harmonize and eventually unify the patent systems of different countries. However, there are limits to the benefits to

be expected from beefing up intellectual property protection. Developing countries may be

induced to add some protection but, on the

whole, they do not see stronger measures as in

their interest. More generally, strong protection,

while encouraging creation of technology, can

inhibit its diffusion and, in the long run, cannot

make up for disadvantages in manufacturing

quality and cost. Therefore, while stronger

intellectual property protection can help U.S.

manufacturing competitiveness somewhat, measures to improve manufacturing quality and cost

will help more.

POLICY ISSUES AND OPTIONS

In building a stronger technological base for

American manufacturing, both industry and

government have important parts to play. Many

of the things that must be done are squarely up

to manufacturers themselves. Company managers have to learn to use their people more

effectively by promoting a back-and-forth flow

of people and ideas between research (or design)

and production, insisting on design for easy

manufacture, pushing simultaneous engineering

of improved products and the processes to make

them, and giving shopfloor workers the training

and responsibility for improving efficiency and

product quality. Likewise, it is managers’ job to

get the fat out of the American production

system—for example, by trimming inventories

that cost money and hide problems, and by

organizing work for reduction of waste. And it

is largely up to managers to make the most of

forming cooperative relationships between large

firms and their smaller suppliers, or between

different segments of an industry complex.

There is also much that government can do.

Traditional U.S. R&D support, mainly for

defense and science, has been beneficial to the

Nation as a whole and often to industry in

particular, but it is not enough to maintain

technological leads, or even parity, in most

industries-especially since most of the other

OECD nations are making greater efforts to

advance civilian technology.

First, government policies that create an

environment more conducive to manufacturing

make it easier for companies to concentrate on

the things that only they can do to improve

technology. For example, if government policies succeed in lowering the cost of capital to

business, or lifting some of the pressure for

short-term profits, they are “preparing the

ground’ (as the Japanese say) for business to do

its job well.
Chapter 1--Summary ● 21

Government can also take more direct actions, some within traditional U.S. policy, and

others less so. Starting with broad policies

affecting the financial environment and human

resources, they could go on to stepped-up

programs for active diffusion of technology to

private firms and, still further, to a strategic

approach that would target government R&D

support to critical technologies.

The possibilities for government action do

not stop there. Many governments throughout

the world use means beyond R&D support to

promote industries they consider strategically

important. For instance, they may favor certain

industries with low-cost capital or governmentguaranteed purchases, and they may add further

support with trade policies designed to manage

competition from dominant foreign producers

during developmental phases. In building up its

industrial might, Japan relied heavily on coordinated technology, industry, and trade policies to

promote key industries. Korea and Taiwan

followed Japan’s lead, and the European Community is using many of the same industrial and

trade policy tools as it prepares for the European

single market in 1992.

Whether the United States should or even

could try to use such comprehensive government policies to bolster competitiveness will be

considered in another report, the final one in

OTA’s assessment of Technology, Innovation,

and U.S. Trade. That report will discuss industry

and trade policies of Europe and the Asian rim

countries, and in what way they might be

relevant to the United States.

In this assessment, the spotlight is on technology. The policy options analyzed in chapter 2

and summarized below are directed toward four

principal strategic aims:

. Improving the financial environment for

U.S. manufacturing firms. This means

lowering capital costs and relieving other

pressures in the financial markets to show

high short-term profits every quarter. The

goal is a more hospitable environment for

●

●

●

long-term investment in new technologies

and productive equipment.

Upgrading education and training of the

workers, managers, and engineers needed

in manufacturing. U.S. manufacturing suffers from the failings of our public schools,

but also from failures of managers in

organizing work and training people to use

advancing technologies effectively. Besides continuing efforts to improve education generally, government can help with

the retraining of active workers and the

betterment of manufacturing engineering.

Diffusing technologies throughout the manufacturing sector. Government can be much

more active than it has been up to now in

helping manufacturers acquire up-to-date

production equipment and learn to use it

effectively. Options might include steppedup Federal support for technology extension services and a subsidized equipment

leasing system. Such things as easier access to technologies coming from Federal

labs or foreign countries could benefit all

U.S. manufacturing.

Supporting R&D for commercially important technologies. Some technologies of

great potential benefit to society do not get

adequate private backing because the payoff for individual firms is too small,

uncertain, and far in the future. The U.S.

Government has sometimes given special

support to R&D for commercially important technologies, but in an ad hoc rather

than proactive way. A coherent, strategic

technology policy require having an agency

in charge that can set goals and choose

technologies to support that fit the goals.

Improving the Financial Environment

To keep up with the competition, U.S.

manufacturing firms need two basic things that

are mainly the province of government to

supply: well-educated workers and capital costs

that are not so high as to be disabling. As matters

stand, government in this country is not doing

well at supplying either of these necessities.
22 ● Making Things Better: Competing in Manufacturing

The combination of massive government

dissaving (the Federal budget deficit, at historic

highs in the 1980s) and anemic personal and

business saving (at historic lows in the 1980s) is

a powerful force driving up interest rates and the

cost of capital to business. Congress has made

some progress in reducing the Federal budget

deficit but it remains high. Some combination of

higher revenue and lower spending over several

years will be needed to reduce the budget deficit,

and this poses a problem. Many of the policy

options suggested in this report would, all other

things being equal, have a contrary effect,

because they would entail either increased tax

expenditure or reduced revenue. If these or other

policies are not to have the perverse effect of

increasing the deficit, even stronger measures

would be needed to reduce it. If the United

States succeeds in restoring its strong competitive position, then economic growth will help to

shrink budget problems in the future. There will

be a price to pay in the short run for improving

manufacturing, but if it restores our ability to

raise standards of living for the great majority of

Americans in the long run, it will be worth it.

The budget deficit is a significant source of

upward pressure on interest rates, but not the

only one. To make capital less costly, the supply

available for capital formation must also be

expanded. That means raising domestic savings

rates. Although the personal savings rate has

risen from its extreme low in 1987—less than 2

percent-it is still below the U.S. norm of 6 to

8 percent, and far below the rates in Japan and

most European countries. Some analysts argue

that the United States can continue to rely on

foreign capital to make up the difference between domestic investment and domestic savings, but that is inconsistent with lowering

capital costs. It takes high interest rates to attract

foreign capital.

To encourage household savings, Congress

could consider a national savings initiative,

which would reward increases in regular savings

(e.g., payroll savings) for households in all tax

brackets. To be effective, such a campaign

would need to include several substantial savings inducements, such as guaranteed interest

rates, high enough to be attractive, on widely

available savings instruments. One suggestion is

for anew type of government bond with a fixed

coupon rate. Reducing taxes on the interest

income to regular savings could also be considered.

Inducements to save may not be sufficient to

raise savings rates or promote capital formation

in industry without some accompanying measure to discourage consumption. Congress may

wish to consider a consumption tax, scaled to tax

luxury items most heavily, or with substantial

exemptions to avoid the severe regressivity of a

flat consumption tax. Another possibility is to

limit the deductibility of interest paid on home

mortgages more severely. There are some limits

now, but they are set very high; this encourages

consumption of housing and builds equity for

households, but the capital tied up in housing is

not available for industrial capital formation.

The measures suggested above could help to

bring down interest rates generally, and that

would tend to lower capital costs. Interest rates

and capital costs are not synonymous, however;

capital costs are also a function of taxes and of

relationships between capital suppliers and companies. Several measures could help to lower the

cost of capital to U.S. companies even if general

interest rates remain high. One set of options

Congress might wish to consider is special tax

inducements for technology development and

capital investments. The United States has tried

a few such measures in the past. For example,

the Accelerated Cost Recovery System (ACRS)

and the Investment Tax Credit (ITC) were

designed to promote capital investment, and the

research and development tax credit to increase

R&D spending. While the effectiveness of these

measures is debated, there is enough substance

to the arguments in their favor that they (or

measures like them) are worth considering. And

they should be considered separately, for they

are very different. ITC and ACRS were very

expensive (costing tens of billions of dollars,

when they were in full force); such measures

could, if designed carefully, promote mainly
Chapter 1--Summary ● 23

improvements in manufacturing technique. The

R&D tax credit is far less expensive, and has

more effect on new technology development

than on current practice.

Another set of forces affecting capital costs,

especially for long-term investment in technology development and capital equipment, is the

current wave of hostile takeover activity and

speculative turnover of stock. This activity, and

the threat of it, reinforces the effect of high

capital costs in impelling managers to focus on

short-term profits. The relative influence of the

takeover boom and high capital costs is a

controversial matter which OTA does not resolve. Nonetheless, it is reasonable to conclude

that takeover activity is a significant damper on

managers’ willingness to commit resources to

long-term projects, or to retain earnings for

reinvestment. The pressure from this source

might be manageable if overall capital costs

were lower, or if there were enough effective

countervailing measures to promote higher levels of investment in R&D and capital equipment

purchase.

As it is, Congress might wish to consider

mitigating the pressures of hostile takeover

activity by means of incentives for investors to

hold investments longer. This might be done by

adjusting the capital gains tax rate to favor

long-term gains and penalize short-term asset

turnover. This measure would have most effect

if the tax were extended to pension and other

funds that are currently tax-free, but account for

more than half the transactions in the financial

markets. Another option is to tax securities

transactions, which would penalize those whose

turnover is greatest. However, without real,

steady progress toward eliminating the budget

deficit, all of these other measures taken together will probably have only a marginal effect.

Finally, the financial environment of the

United States is unstable and unpredictable,

compared with our premier international competitors, Japan and West Germany. In Germany,

in particular, macroeconomic policymaking concentrates on maintaining stability in prices and

exchange rates and controlling inflation. Such

stability is an enormous asset to business,

especially in a country that is heavily dependent

on foreign trade (like West Germany), and

especially when supplier-manufacturercustomer links are increasingly likely to span

national borders (as the 1992 European Single

Market approaches).

Japan’s financial environment is also very

stable. Policymakers there are highly sensitive

to how macroeconomic developments affect

business, and they take steps to help the private

sector adjust. For example, after the international financial accords were reached to raise the

value of the yen (and other currencies) against

the dollar in the mid-1980s, the Japanese

Government put in place loan programs to help

firms (small ones, in particular) adapt to the

rising yen (endaka). Japan’s economy did slow

down in 1985 and 1986, at the beginning of

endaka, but the adjustment was swift. Much

more painful were the circumstances faced by

American manufacturers in the early 1980s

when the dollar began its long climb, and no

government policy was in place to ease the

adjustment. In sum, a major difference between

Japanese and U.S. policies is that little concern

is evident in the United States about the effects

of macroeconomic, trade, and other policies on

the competitiveness of U.S. firms in general or

manufacturers in particular. In Japan and West

Germany, competitiveness is customarily taken

into account. It plays a prominent role in making

and implementing those governments’ policies.

Human Resources

Human resources, like capital costs, have a

pervasive effect on manufacturing. In the past,

most manufacturing workers learned their jobs

by the sides of more experienced workers, and

an ordinary grammar school or high school

education was plenty of preparation for a

production worker in manufacturing. Today,

with automation affecting more workplaces and

less automated work being exported overseas,

production jobs in manufacturing require more

conceptual knowledge-and often competence
24 ● Making Things Better: Competing in Manufacturing

in statistical process control and managing

computerized equipment. Jobs typically encompass more diverse tasks than in the past, and

workers must grasp the relationships of different

parts of production to each other in ways never

required before. In other words, more is demanded of manufacturing workers. At the same

time, the typical American education is leaving

young people less well prepared for their

worklives. Managers have remarked for years

that young people could be better prepared, but

the situation now is commonly described as a

crisis. And it is likely to get worse before it gets

better. About half the new entrants to the work

force between now and the turn of the century

will be members of minority groups, and about

two-fifths of minority children live in poverty.

Poor children typically drop out of school in

disproportionate numbers, and many grow up

lacking the skills they need to be productive

workers.

There is a broad consensus that the Nation’s

public school system needs help. But even if

help arrived tomorrow, the results would be

many years coming. A more immediate approach is to help people already in the work

force to acquire needed skills. While some large

companies are providing education and training

themselves, the financial burden of such programsgood ones can run into hundreds of thousands to

millions of dollars-is another drain on limited

financial resources, Most small companies cannot afford extensive training programs.

Congress could consider several options to

help workers raise their educational levels and

improve their work skills. One is to offer

federally guaranteed student loans to employed

people taking classes part-time; another is to let

employers and employees deduct the costs of

training and education (the present tax law

already allows this, subject to some limitations).

Another possibility is to tailor military training

programs, which are already extensive, to fit

more closely the skills required of workers in

civilian jobs. The Federal Government provides

less than $10 million to a program that partially

funds demonstration projects for literacy teaching in workplaces. There is ample evidence of

additional demand for such projects; increased

funding could be used effectively and immediately. Training could also be made a part of any

technology extension services offered by the

Federal Government or funded in part by

Federal money, (See the section below on

Technology Extension.)

These suggestions do not constitute a complete list of options for training active workers.

A fuller examination of the possibilities for

congressional action will appear in a forthcoming OTA report, Worker Training: Implications

for U.S. Competitiveness.

Although well-educated and trained production workers are essential to improving manufacturing efficiency and quality, there are other,

equally critical needs for highly trained people.

Production workers are a steadily falling percentage of manufacturing employment; professional and technical employees are a growing

share. Engineers, in particular, are essential for

excellence in manufacturing. It could be more

difficult in the future to maintain an adequate

supply of engineers to sustain manufacturing.

There is not now an obvious shortage of

engineers in manufacturing; about as many

engineers are employed per thousand workers in

the United States as in Japan and Germany,

whose manufacturing is justly famous for its

excellence. But Japan is graduating more engineers per capita than the United States, and

Germany has what is probably the world’s finest

set of training institutions to provide technical

people for manufacturing, from the shopfloor to

the engineering workstation. Meanwhile, in the

United States, the demographic group most

inclined to enter engineering—white males-is

shrinking as a proportion of young people.

This trend is not new. Several Federal programs, are already in place to encourage women

and minorities to enter engineering. Larger

programs support the recruitment and training

of students generally in scientific and technical

careers, and special training for teachers.) Many

of these programs are producing good results
Chapter 1--Summary ● 25

and could be expanded. But without improvement in math and science education in the

elementary and high schools, their effects are

bound to be limited. Children who perform

poorly in elementary school arithmetic and math

are unlikely to choose engineering careers.

General education improvement, especially in

math, is the first necessity for keeping the

engineering pipeline filled.

Some possible programs could help shore up

the supply of engineering talent for the next few

years, before improvements in education (if they

are made) begin to yield results. If defense

programs wind down as expected over the next

few years, Federal programs might help retrain

and equip engineers who have been working in

the military sector to enter civilian manufacturing. More generally, programs to encourage or

fund midcareer training of engineers whose

knowledge needs updating might be considered.

The effective use of engineers is at least as

important as an adequate supply. There are

indications that U.S. manufacturers could make

better use of their engineers. Elitism among

engineering staffs, and their aloofness toward

shopfloor problems in producing their designs,

are often cited as a peculiarity of American

manufacturing. This kind of problem is best

solved by manufacturers themselves, but the

Federal government could encourage manufacturers to recognize and correct the problem,

through support of education and research in

manufacturing engineering. One option is to

increase Federal support of manufacturing engineering, possibly through the creation of a

Manufacturing Sciences Directorate in the National Science Foundation.

Diffusing Manufacturing Technology

Making the financial and human resource

environment more conducive to improved manufacturing quality, efficiency, and technology

may not be enough. American manufacturers

have lost too much ground to foreign manufacturers, in nearly every sector. Even with lower

capital costs and more competent people, some

manufacturers may still lack the resources or the

knowledge to find or develop and implement the

best technologies.

Congress might consider an array of options

to promote technology diffusion and transfer

more widely, or remove obstacles to diffusion.

None, by itself, will make a great deal of

difference; patience and an experimental approach will be required to make any of them

work. Some may fail. Yet it is likely that some

combination of policies to promote technology

transfer could pay off handsomely, given time,

the commitment to adapt to changing circumstances, and the willingness to learn from

experience.

Technology Extension

Large firms generally have the resources to

develop or acquire technologies they need,

although they may neglect to take what they

could from outside the firm. But many small

firms have a hard time staying abreast of

advancing technology. Americans like to cherish the notion that all small firms are like Silicon

Valley startups—technically and scientifically

advanced, staffed and run by entrepreneurial

innovators—but the image is hardly typical of

small manufacturing fins. For many of America’s 355,000 small and medium-sized manufacturing fins, exposure to new technologies is

haphazard, and the effort to keep informed is

beyond their means.

To contribute to the competitiveness of U.S.

manufacturing, small firms need to keep up with

technology as much as large ones. While small

enterprises are usually not heavily involved in

foreign markets themselves, their performance

is important to the ability of larger manufacturers, who are their customers, to compete. Large

auto companies, for instance, depend on the

ability of their myriad suppliers, some of which

are quite small, to deliver the right components,

well made, on time. As specifications become

more exacting, and the tolerance for defects

decreases, the demands for small firms to use

new technologies effectively grow. America’s

most adept competitors, Japan and West Germany, have broad, deep institutions that support
26 ● Making Things Better: Competing in Manufacturing

technology diffusion and transfer to small

enterprises.

Large firms can transfer technology to smaller

companies quite effectively themselves. Even in

Japan, however, an extensive network of government programs and institutions to support technology diffusion and training supplements these

private efforts. The United States, in contrast,

has a few State programs and, until recently,

very little at the Federal level. In 1988, the

combined technology transfer and technology/

management assistance programs of the 30

States that had such programs came to $58

million, and that included assistance to all kinds

of business, not just manufacturing. State industrial extension programs, giving one-on-one

technical advice to individual firms, probably

add up to about $25 to $40 million per year.

The Federal programs include: 1) three existing and three more planned Manufacturing

Technology Centers to demonstrate advanced

technologies and provide extension; 2) some

assistance to State programs; and 3) the Advanced Technology Program, a mechanism for

Federal guidance and participation in joint R&D

ventures with private firms. Together, the three

programs have funding of less than $19 million

for fiscal year 1990. A smattering of other

Federal programs also offer some technology

extension services; the largest of these is Trade

Adjustment Assistance for firms and industries,

funded at less than $10 million in fiscal year

1990. These small, scattered programs contrast

with billions of dollars’ worth of financial and

technical assistance to small and medium-sized

enterprises in Japan, plus Japanese Government

participation in dozens of R&D efforts. While

precise comparisons of funding for technical

assistance to small manufacturing enterprises

are impossible, it is certain that Japan’s commitment to upgrading the level of technical ability

in small firms is more than an order of

magnitude greater than that of the United States.

(See chs. 6 and 7 for details of the Japanese and

U.S. programs.)

If Congress wishes to deepen its commitment

to upgrading technology in small and mediumsized manufacturing enterprises, it could increase funding for the Manufacturing Technology Centers, provide more money for State

industrial extension services, or some of both.

Manufacturing Technology Centers are managed by the National Institute for Standards and

Technology, as authorized by the Omnibus

Trade and Competitiveness Act of 1988. They

are responsible for transferring technologies

developed at NIST to manufacturers, making

new technologies usable by small firms, providing technical and management information to

small firms, demonstrating advanced production technologies, and making short-term loans

of advanced manufacturing equipment to manufacturing firms with fewer than 100 employees.

Although funding was authorized at $20 million

per year, appropriations have been much smaller:

$5 million in fiscal year 1988, $6.85 million in

1989, and $7.5 million in 1990. These amounts

cover administration as well as technology

extension activities. The three existing Centers

have each received $1.5 million per year for

their first 2 years, and must match the Federal

funding. Federal funding starts to decline after

3 years, and drops to zero after 6 years.

In addition to the Manufacturing Technology

Centers, the 1988 trade act authorized a program

of Federal assistance to State technology agencies, administered by NIST. This program

received no funding until fiscal year 1990, when

Congress gave it $1.3 million to help States with

industrial extension programs expand those

programs. States receiving Federal money from

this program must match it with their own

funding.

Only a few States have real industrial extension services. (NIST, in a nationwide study,

found only 13 that met their definition of

“technology extension services,” but more

have since been established.) Several of those

are quite new. Nonetheless, State programs are

generally better developed than Federal ones,

and a very few have years of experience.
Chapter I-Summary ● 2 7

There is room for expansion of both State and

Federal efforts in technology extension. States

may do abetter job of service delivery, being in

better touch with the needs of local manufacturers. But there may be some things the Federal

Government can provide that States cannot. By

their nature, industrial extension offices specialize in the industries most prominent in their

service delivery area. And industries tend to be

regionally concentrated, spanning State lines;

Federal services are often better suited to serve

regional concentrations of industries. Also,

while some State programs are excellent, others

are less so; a Federal service could help ensure

consistent quality of service, or at least minimum standards. If Congress wishes to consider

expanding efforts in support of industrial extension, financial support for good State programs,

as well as technical and financial support for

States which are new to the effort, would be an

effective combination with support of Federal

extension services.

If Congress were to set a minimum goal of

extending industrial extension services to 24,000

small firms per year nationwide (7 percent of the

nation’s 355,000 small manufacturers), the total

cost would be $120 to $480 million, depending

on the level of service. If the Federal share of

funding were 30 percent, as it is in the Agricultural Extension Service, the cost to the U.S.

Government would be $36 to $144 million. That

would provide a modest level of service, one

that might easily be overwhelmed by requests

for assistance. The State of Georgia’s experienced, effective industrial extension program

serves a roughly similar proportion of its

manufacturers, and Georgia Tech, which operates the service, reports that it does not advertise

because it would be swamped with requests it

could not meet. However, considering the inexperience of State and Federal Governments in

providing industrial extension, moderate annual

increases may be all that could be handled now.

Financial Aid for Modernizing Manufacturing

Technical assistance to small business is

often most useful if it is accompanied by

21-700 0- 90 - 2

financial aid. Improving the general financial

climate for investment or offering special incentives to invest in research, development, and

capital equipment, will help all businesses. But

small businesses still have special problems

raising capital. They usually must pay more for

both debt and equity capital, and they often do

not have enough retained earnings to finance

modernization programs or training on their

own. Without help in financing, small firms may

not be able to implement the advice of industrial

extension services.

In fiscal year 1989, the Federal Government

made 47 million dollars’ worth of direct loans to

small businesses run by special groups (disabled

veterans, the handicapped, and others), and

guaranteed $3.6 billion in commercial loans to

small businesses. It contributed $154 million to

investment corporations, which make equity

investments and long-term loans to small businesses. These programs are not confined to

manufacturing. None is aimed at improving the

practice of manufacturing in general.

These programs are in striking contrast, both

in funding and in purpose, with Japan’s financial

assistance to small and medium enterprises

(SMEs). Japan’s SME programs spend $27

billion annually indirect loans and an additional

$56 billion in loan guarantees. Again, this

funding is not confined to manufacturing (which

makes it comparable to the figures given above

for American programs). Much of the Japanese

funding is tied to technical assistance, and some

is directly targeted to technology improvement.

Part of the reason for such heavy support to

SMEs in Japan is that for many years, small

business was a technological backwater. The

same is true in many sectors of American small

business.

There are, of course, important differences in

manufacturing in Japan and the United States.

One is that small firms play a bigger role in

Japan’s manufacturing sector-74 percent of

manufacturing employment is in small and

medium-size firms in Japan, compared to 35

percent in the United States. However, because
28 ● Making Things Better: Competing in Manufacturing

of the larger size of the U.S. economy, the

difference is less in absolute terms. Small

Japanese manufacturing firms employ 10.7

million people, compared to 6.8 million in the

United States. In both countries, small manufacturing plants play key roles as suppliers to the large

corporations that are major actors in the world

economy. And in both countries, small manufacturing fins’ needs for technical and financial

assistance have much in common.

Congress might consider several options to

encourage firms to invest more in advanced

technology and in training support required in

the service and to use the technology well. One

option is an equipment leasing system that

would make new production equipment available to manufacturers on below-market terms. If

the system bought U.S.-made equipment could

serve two related purposes: besides enabling

firms to get advanced equipment on easier

terms, it could also help assure U.S. makers of

production machinery a market for at least part

of their output. In both ways, the program would

help American manufacturers to focus more on

long-term investment and improvement. The

program could be open only to small manufacturing business, or to all manufacturers, possibly

with more favorable terms for smaller firms.

Another option to encourage technological

improvement in small business is more direct

financial support. As noted above, the government’s financial support (loans, loan guarantees, and investments in development corporations) was about $3.8 billion in 1989. This

compares with $487 billion in fixed investment

(structures and producers’ durable equipment)

by all private business in the same year. While

exact comparisons with Japan are not possible,

we do know that Japanese loan and loan

guarantee programs to small firms area at least 20

times greater than those of the United States, and

the level of subsidy in Japan is more substantial.

For example, even a federally guaranteed loan to

a small business in the United States may be a

couple of percentage points above the prime

rate, while in Japan, government-guaranteed

loans to small business are typically substantially below market rates, and in some cases

interest-free. While Japanese policies clearly are

not a template for American action, they do

make a difference in the competitiveness of

Japanese industry at all levels.

Greater financial aid for small manufacturers

could offer an opportunity to upgrade technology. One qualifying condition for financial aid

(either direct loans or loan guarantees) could be

that the firm receive a technical assessment,

possibly from an extension service, and that it

either follow the guidance of the assessor or

work out an alternative plan. This is not

necessarily intrusive. From the late 1970s

through 1989, hundreds of small U.S. firms

injured by import competition received technical help from a small U.S. Government program, Trade Adjustment Assistance for firms.20

(The program, formerly funded at about $15 or

$16 million per year, including assistance to

industries as well as firms, has been substantially reduced. Its fiscal year 1990 funding was

$9.9 million in new and carryover funds.) An

assessment was a precondition for assistance

under the program, and many participating firms

found it a valuable service. Many small firms in

Japan voluntarily undergo assessments each

year in order to learn of new techniques and

markets, and to get an independent (though not

detailed) assessment of the directions competitors are taking. This option presupposes an

industrial extension service that could deliver

competent, timely service nationwide.

Another possibility is to target financial aid to

investments in advanced equipment, as Japan

has done several times. Recently, for example,

producers were allowed to depreciate automated

electronic ("mechatronic" equipment very rapidly, encouraging many small and medium-

~or a description and analysis of the program, and the larger and better known program of Trade Adjustment Assistance for workers, see U.S.

Congress, Office of Technology Assessment, Trude Adjustment Assistance: New Meusjbr an Ofd Progmm, OTA-ITE-346 (Sprin#leld, VA: National

Technical Information Service, 1987).
Chapter 1--Summary ● 29

sized firms to acquire numerically controlled

machine tools. A drawback is that some firms

might invest in equipment they aren’t prepared

to use properly; but a technical assessment or

industrial extension service could help here.

Financial and technical assistance to small

firms could be explicitly extended to cooperatives of small firms as well. Managers of small

fins, with too few staff to dedicate even one

person to keeping up with technology-or for

that matter, with competitors, customers, or

suppliers-often have to depend on a few ad hoc

sources for information about changes that

affect their business. Cooperative networks can

help these managers in many ways, by pooling

the time and resources needed to keep up with

technology, changing markets, customers’ needs,

and competitors’ doing by obtaining quantity

discounts on equipment that individual firms

buy in ones or twos; and by providing an

independent source of information on new

technologies that does not have its own commercial interests at stake, as vendors do.

If Congress wishes to support the formation

of cooperative associations, it could consider

making the services of federally funded industrial extension services available to cooperatives, or extending financial assistance to cooperatives as well as firms. Congress might also

want to make provision for small firms to

cooperate in marketing and manufacturing without risking violation of the antitrust law.

Commercialization of Technology From

Federal Laboratories

The Federal Government spends $21 billion

each year on R&D in Federal laboratories, of

which three-fifths goes to defense applications.

Some of the defense R&D could be useful to

civilian industry, along with some of the basic

research done for nondefense applications in

Department of Energy (DOE) laboratories. For

example, industry has benefited from using

specialized facilities at some DOE labs, such as

the Synchrotrons Light Source at Brookhaven

National Laboratory and the Combustion Research Facility of Sandia National Laboratories.

On the whole it has not been easy for industry

to take advantage of the labs’ technology—

despite legislation enacted throughout the 1980s

to facilitate the process. There are still obstacles

on the Government’s side, and further measures

by Congress could help, although ultimately

success will depend on industry’s willingness to

tap into the labs.

Congress could consider earmarking some of

the labs’ R&D appropriation for promoting

commercialization. This would include identification and marketing of promising technologies,

patenting when appropriate, and cooperative

R&D projects to bridge the gap between the

laboratory and commercial exploitation. Earmarking some funds for cooperative R&D could

be particularly beneficial. (DOE’s hightemperature superconductivity pilot centers in

three national laboratories are examples of

cooperative R&D projects, planned from the

start with industry and funded 50-50 by industry

and the labs.) Congress might begin by mandating that a few percent of the labs’ budgets be set

aside for cooperative projects as appropriate.

This would encourage labs to seize opportunities for cooperative work promptly.

Another possibility is increased funding for

the Federal Laboratory Consortium. The FLC,

with a small central staff and volunteer representatives from over 300 labs, tries to match

inquiries from firms with the appropriate lab

researcher. Additional funding could help the

FLC to perform this function, and also to

increase its projects demonstrating new means

of technology transfer.

In addition, Congress could consider measures to remove several obstacles to technology

transfer and cooperative R&D. For example,

DOE’s national labs have sometimes been

stalled by Agency red tape when they wish to

license technology to firms. Congress has already taken some steps to give the labs more

independence in this regard and could go further

(e.g., by extending to all labs the power to take

automatic title to patents from lab research,

removing the necessity to wait for extended
30 ● Making Things Better: Competing in Manufacturing

agency review). To make cooperative projects

more attractive to industry. Congress could also

clarify DOE’s right to keep information developed in the projects proprietary, and allow

copyright of computer software created by

government employees involved in such projects.

Lab-industry cooperation raises several other

issues, such as possible conflicts between lab

employees’ duties at work and their desire to get

consulting work or royalties from the commercialization of their work. Congress could consider

forming an interagency legal task force which

could give a broader perspective than a single

agency has on these and other legal issues raised

by lab-industry cooperation. The task force’s

approval would not be required; but an agency’s

general counsel, if concerned about an issue,

could seek the task force’s advice.

Tapping Into Japanese Technology

American firms are often faulted for not

making greater efforts to investigate and import

technologies developed elsewhere—sometimes,

even in another division of the same firm. When

U.S. firms were technologically dominant in

most industries, this parochial attitude was no

great handicap. Now, with technological advantage more evenly distributed around the globe,

it is a significant hindrance. Many firms have

responded to the challenge to keep up with

technology developed abroad, but they face

special difficulties getting access to Japanese

technologies. One is simply the language. European languages are enough like English, and

enough Americans know some European language, that it is not too hard to get the gist of

technical articles or to have them translated. But

the Japanese language poses much more serious

translation problems. Another difficulty is that

much of Japanese technology is developed in the

industrial sector and thus is inherently less

accessible than technical expertise and knowledge freely available at universities and other

public or quasi-public institutions.

A sprinkling of U.S. programs promote

technology transfer from Japan. A few universities have fellowship programs that send graduates in science and engineering to Japanese

companies and research institutions; and the

National Science Foundation and the Government of Japan sponsor several new programs to

support long-term research by U.S. engineers

and scientists in Japan. The NSF-Japan programs were not fully subscribed as this report

was written, although there is reason to believe

that they will attract more applicants as they

become better known. Congress may wish to

monitor the progress of government-supported

programs, and provide additional funds when

and if they become overcrowded.

Other options are to establish a Congressional

U.S.-Japanese Fellowship Program, and to encourage government researchers working in Federal

labs or elsewhere in the Federal Government to

undertake long-term projects in Japan. Postdoctoral or midcareer fellowships for professionals other than scientists and engineers could

also be useful, not in directly transferring

technology, but in helping more people to

understand the workings of Japanese management and government-industry relations.

Congress might wish to consider increasing

the funding for the Office of Japanese Technical

Literature. While demand for the office’s products has been disappointing, expanding the

services available could create more interest.

Finally, the government could promote Japanese language instruction in public schools,

possibly by examining the critical foreign languages program in the 1988 education act to see

if it gives sufficient weight to Japanese. Another

option is to fund expansion of Japanese language programs in post-secondary and postdoctorate education, especially for scientists and

engineers.

Antitrust

Antitrust law and enforcement have been

relaxed in the past decade, but fear of running

afoul of antitrust statutes is still a potent force in

industry, because the law is complex and often

vague, penalty for violation can be stiff, and

private parties as well as the government can
Chapter 1--Summary ● 31

bring suit under the laws. There is good reason

for firm enforcement of antitrust law; for many

years, it has served this country well in maintaining competition. However, some kinds of

cooperation among firms could help American

competitiveness, and some modest changes in

antitrust law and enforcement could help promote them.

Congress has already amended and clarified

the law to make some joint activities easier.

Among other provisions, the National Cooperative Research Act of 1984 clarified that joint

R&D (as defined in the Act) will be judged

under the rule of reason if suit is brought. This

rule ensures full consideration of the activity’s

pro-competitive effects. Congress might wish to

consider extending this provision to joint manufacturing and standards-setting. The 1984 Act

also reduced private treble damages to single

damages for registered R&D projects. Congress

might wish to consider reducing treble damages

in other circumstances as well.

Advance certification for some kinds of joint

activities is another option. Firms could apply to

the Justice Department for a determination that

a proposed project complies with antitrust law.

Private parties could challenge that determination in court but could not collect damages for

activity covered by it. Another possibility is to

establish safe harbor market shares, below

which firms would not be in violation. Finally,

Congress could make findings that joint ventures or mergers between U.S. firms are sometimes necessary to fend off foreign competition,

and could instruct courts to evaluate such

activity based on long-term effects.

Whether modifying the antitrust laws or their

enforcement would unleash a great deal of

cooperative work, and whether such changes

would substantially improve manufacturing competitiveness, is unknown. It is also unknown whether

changes such as those suggested would have

substantial negative effects from lessening the

fear of antitrust suits-effects such as increased

hostile takeover activity or more price-fixing.

Changes in antitrust law and enforcement

should be made cautiously, but they deserve

serious consideration.

Innovation and Intellectual Property

Improvement of intellectual property protection could well start at home. Within the United

States, the greatest complaint is that patent

enforcement is slow. Patent cases that go to trial

take, on average, more than 2 1/2 years before a

decision. Congress could consider several ways

to speed up enforcement of patent infringement

statutes. It might designate special judges for

patent cases, or increase judicial manpower

devoted to hearing patent cases. In a way, there

is already extrajudicial manpower available; the

International Trade Commission employs four

administrative law judges to hear cases under

Section 337 of the Tariff Act of 1930. Under

section 337, a U.S. firm whose patent is

infringed by imported goods can apply for an

order to stop the goods from entering the

country. The procedures for hearing and settling

cases brought under Section 337 have been

found to violate GATT, however, and the

Administration is considering how to amend

Section 337 to satisfy GATT while keeping its

advantages of a quick trial and enforcement at

the border.

Effective domestic intellectual property protection is not sufficient, however. U.S. firms need

adequate protection in foreign markets as well.

To many innovative companies, the Japanese

patent system is a particular problem. It is

slower than ours in issuing and enforcing

patents, and it strongly favors licensing of

patents-something U.S. firms do not always

wish to do. The Administration is pursuing

negotiations to fix these problems. Another

problem for American firms is that they don’t

understand the Japanese system very well, and

can’t easily find out more. The language barrier

adds to the difficulties. Congress might wish to

establish a program in the U.S. Patent and

Trademark Office to collect and disseminate

information about the Japanese system.

Differing patent systems throughout the world

present a general problem. Usually, a firm must
32 ● Making Things Better: Competing in Manufacturing

apply for a patent in each country in which it

wants protection; this is expensive and timeconsuming. One option is to harmonize international patent law and application procedures, at

least among nations that trade heavily in hightechnology products. The United States has

been negotiating with Japan and the countries of

the European Community to this end. Any

agreement will probably require substantial

changes in the U.S. patent system. While such

changes--e.g., changing to a first-to-file system

rather than first-to-invent-will be controversial, Congress might give any such proposal

serious consideration, since a harmonized (and

eventually unified) system could take much of

the time and expense out of obtaining international patent protection.

Strategic Technology Policy

With few exceptions, the U.S. Government

has been reluctant to adopt proactive policies to

build competitiveness. For generations, most

American academics and policymakers have

been convinced that market mechanisms were

better than government planners at identifying

promising technologies. There are examples of

failures of central planning that reinforce these

beliefs, and for several decades, the economic

performance of the American economy also

justified that faith.

There are reasons to challenge this ideology

now. First is the simple fact that many American

industries are having great trouble in world

competition, and some of the ablest international competitors assuredly do not have freer

markets or lighter government involvement in

supporting industrial technologies than the United

States does. The governments of many European nations, Japan, Korea, and Taiwan, have all

actively promoted manufacturing technology

acquisition, development, and diffusion; and

while they have had their failures, they have had

many outstanding successes. This is not proof,

of course. Many other nations with less than

admirable economic performance have also

supported technology development and diffusion.

America’s own history provides examples of

successful commercial industries building on

abundant government support of technology.

Some of this has been an indirect effect; the

Department of Defense’s support of the early

development of semiconductors and computers

paved the way for substantial investments in

commercial technologies by the private sector.

But the United States has sometimes been

willing to make exceptions to the tenet that

direct government support should be limit

mostly to basic research and national security.

The development of a U.S. civilian aircraft

industry can be linked directly to governmentsupported research on airframe and propulsion

technologies in the early part of the century.

This support was justified on patriotic grounds,

and was not drawn so narrowly as to include

only military security needs. Government support of agricultural technology through the land

grant universities and the Cooperative Extension Service has been a key to the rapid

productivity growth of American agriculture in

the 20th century. Government support of the

space program from the 1950s onward rested as

much on national pride as on defense needs, and

has had some important commercial payoffs.

Still, the argument most often put forward for

Federal support of technology development

remains rooted in national security. The Department of Defense depends on the civilian microelectronics and other high technology industries

of its procurement needs. This was a key factor

in the consideration of whether and how much

to support Sematech, high-temperature superconductivity, and lately, high-definition television. But the idea that only the direct, immediate

needs of the military justify government support

of technology development is wearing thin. The

time is ripe for reopening the question of how

the Federal government could support development of civilian industrial technology proactively—

i.e., before the industry is so weakened that

national security is threatened.

Many people still reject this strategy. They

argue that selective government support of key

technologies or industrial sectors amounts to
Chapter 1--Summary ● 3 3

“picking winners” and that government bureaucrats are ill-equipped to make these choices.

This argument rests mostly on politics. The

American political system is too subject to

manipulation by special interests, it is argued, to

make rational choices among all the potential

industries and technologies that might merit

government support. This is a forceful argument, one to be taken seriously. Another pillar

of the argument is the simple claim that the

market, with its imperfections, is better than

government interference.

The other side has a powerful justification as

well. That is, that some technologies are so risky

or involve such large investments over the long

term that little or no development will be

undertaken unless society, which stands to

benefit, shares the risk of development. In the

U.S. financial environment, with its burdensome penalties on long-term investment, the

argument takes on special force.

The debate over “picking winners” has

resolved little. Those who argue that government cannot make consistently rational choices

can point to failures, such as the money poured

into the Synfuels Corporation in the early 1980s

to make wood-based, coal-based, and shalebased substitutes for petroleum. Japanese policies have not been invariably successful either.

Examples of projects that did not achieve their

initial objectives include efforts to jump-start

biotechnology development, the fifth-generation computer project, and entry in the civilian

air transport industry.

There have been some notable successes as

well. U.S. Government support for aircraft

technology development, through both civilian

and military agencies, and agriculture are examples. These industries, which have had much

greater government support than most, are

advanced technologically and successful internationally. Both can boast large trade surpluses.

Successes in Japan encompass the major industries on which that nation’s astounding postwar

economic achievements rest—first, steel, chemicals, and shipbuilding; then automobiles; and

now microelectronics, computers, and telecommunications.

More to the point, the argument cannot (and

should not) be resolved by counting up successes and failures. Any sustained effort to

support new technology development will include some failures, and some industries might

succeed more in spite of government support

than because of it. The fact is, the U.S.

Government is increasingly being asked to

support technology development, and it is

becoming ever more obvious that the reason is

to build civilian industrial competitiveness. It is

possible to take the best from the “picking

winners’ debate by focusing on how to design

institutions that are open to counsel from and

collaboration with industry and other interests,

but avoid becoming their captives. Another

lesson is that a crisis is a poor crucible for

making such decisions. The failure of the

Synfuels project can be traced largely to the

atmosphere of crisis in which it was born.

A Civilian Technology Agency

Efforts to support industrial technology will

require commitment and money. Both have their

limits. Public initiatives to help private manufacturing improve its performance cannot afford to

plunge into repairing and developing every

industry and technology. Yet the Federal Government has no institutional ability to discriminate between technologies and industries

that are most promising for the Nation’s economic future, and those that have some appeal

but are less important. While the U.S. Government has acted to support certain key technologies, the responses to declining competitiveness have been ad hoc, and are usually

justified by the seriousness of potential losses in

military security. If Congress wishes to consider

ways of responding to pleas for support of

technology toward the goal of economic security, one option is to create a civilian technology

agency.

One approach is to build on existing institutions. NIST’s Advanced Technology Program,

created in the 1988 trade act and funded for the
34 ● Making Things Better: Competing in Manufacturing

first time in fiscal year 1990, at $10 million has

the potential to develop into a CTA. A bill that

passed the Senate in 1989 authorized $100

million for the program to support industry-led

joint R&D in economically critical technologies. Five such technologies were spelled out in

the Act.

Other bills in both the 100th and the 101st

Congress proposed the creation of a Civilian

Technology Agency (CTA) within a new Department of Industry and Technology taking the

place of the Department of Commerce. The

agency would make grants or cooperative agreements with private performers of R&D on

high-risk projects that could have exceptional

value to the civilian economy. The closest

analogy among existing agencies to a CTA is the

Defense Advanced Research Projects Agency,

or DARPA, which supports development in

technologies and industries considered critical

to the nation’s defense. This small agency (staff

of 150, funding of nearly $2 billion per year) has

gained a reputation for placing intelligent bets in

serving U.S. military technology needs. It makes

long-term commitments that have added up to

decades for some of its projects. DARPA has at

times interpreted its mission broadly, supporting technology development that will benefit the

commercial sector because the military depends

on that sector. A CTA could learn a good deal

from DARPA’s experience on how to evaluate

the potential benefits and risks of investments in

new technology, and how to balance the pressures of industrial and parochial interests in

making such decisions. The CTA might be

subject to greater special-interest pressures, but

the difference is likely to be one of degree rather

than kind.

In some ways, a CTA would be quite different

from DARPA. Most important, a CTA would

interact closely with industry in choosing what

technologies to support and designing the R&D

projects. Until recently, DARPA did not fund

projects jointly with industry; a CTA would

probably finance most of its projects with

contributions from industry that are at least

equal to if not greater than the government

share. This joint funding is essential as assurance that industry is genuinely committed that

and the projects are really promising commercially, in the opinion of industry. Thus, the

problem of government’s “picking winners”

would be greatly diminished.

Where in the Federal bureaucracy the CTA is

placed may not matter very much. There are

some advantages to its being an independent

agency like the National Science Foundation.

With the right mandate, independent agencies,

even small ones, can wield influence beyond

what their size would indicate. (NSF is funded

at less than $2 billion per year.) However,

DARPA demonstrates that a small agency

within an enormous bureaucracy can be effective and powerful. With the right design, sufficient funds, top-notch staff, and a strong mandate from Congress, a CTA could probably

function well either within the Department of

Commerce (or a successor department) or independently.

Other issues are more important to a CTA’s

performance. Judging by the difference between

DARPA’s performance and the record of other

DoD technology development and acquisition,

it is clear that the agency should not be

constrained by detailed rules and procedures.

Giving the agency staff a large degree of

freedom and responsibility could help to attract

and keep technically first-rate people, which is

increasingly difficult as salaries for scientists

and engineers rise faster than government salaries.

One of CTA’s first tasks would be to develop

guidelines for the selection of industries or

technologies to consider for support. Here,

much can be learned from the debates over

whether to support specific technologies or

projects like HDTV, superconductivity, and

Sematech. There is an obvious preference for

industries that are high-tech, provide well-paid

jobs, and have high growth potential. In addition, CTA would need to consider entire technological systems, not just particular technologies.

For example, if it chose some semiconductor
Chapter 1--Summary ● 35

technologies, it would have to be sensitive to

R&D needs throughout the system, starting with

improved materials, and continuing through

things like lithography for etching chips, automated techniques for packaging, and soon. CTA

could also look for technologies important to

more than one application or industry downstream.

One of the surest ways to doom the effort

would be to subject a CTA to unrealistic

expectations. If CTA is expected to make

strategic choices of high-risk technologies, it

would have to be given time for its investments

to play out, and some leeway to make less than

perfect choices. The ability to make multi-year

funding could also be critical. As it is, American

business regards government support as volatile

and undependable. The fact that Silicon Valley

companies took very seriously recent rumors

that the Administration proposed to abandon

funding for Sematech illustrates the point. If the

agency is to succeed at pushing technology, it

would need to provide steady support for several

years to many different technologies. Even then,

it should not be expected to turn American

industrial competitiveness around singlehandedly.

Coordinated support in other policy areas like

trade and macroeconomic policy will be needed

to do that.
Chapter 2

Strategies To Improve

US. Manufacturing Technology:

Policy Issues and Options
CONTENTS

Page

FINANCING LONG-TERM INVESTMENT.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Capital Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Relationships With Providers of Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . +... . . . . . . . . . . .

Environmental Uncertainty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

HUMAN RESOURCES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Training the Active Work Force . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . .

Supply of Engineers: Keeping the Pipeline Filled . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Manufacturing Education and Research . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

DIFFUSING MANUFACTURING TECHNOLOGY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Technology Extension . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Financial Aid for Modernizing Manufacturing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Cooperative Networks of Small Manufacturing Firms . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Commercialization of Technology From Federal Laboratories . . . . . . . . . . . . . . . . . . . . . .

University-Industry Collaborations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Tapping Into Japanese Technology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Antitrust Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Innovation and Intellectual Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

STRATEGIC TECHNOLOGY POLICY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Picking Winners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Creating a Civilian Technology Agency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Designing a Civilian Technology Agency . . . . . . . . . +... . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Defining Goals, Choosing Projects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Government-Industry Collaboration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Beyond Technology Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

One Example of Technology Policy: The Case of Advanced Television . . . . . . . . . . . . .

42

46

49

50

51

52

52

53

53

57

61

61

64

65

66

69

71

71

73

76

77

78

79

80

Box

2-A.

2-B.

2-c.

Page

Government Backing for the Civilian Aircraft Industry . . . . . . . . . . . . . . . . . . . . . . . . . . 74

Digital and Analog Data: Television Transmission . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81

Technology Spillovers From Consumer Electronics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84
Chapter 2

Strategies To Improve U.S. Manufacturing Technology:

Policy Issues and Options

Only 5 years ago, the idea that American manufacturing was in trouble was not widely accepted.

Many people-including manufacturers themselves—

blamed the spiraling trade deficits on nothing more

than the overvalued dollar and unfair trading practices by other nations. As the 1990s begin, a soberer

view has taken over. Yes, the high dollar did

interfere with U.S. exports. Five years after the

dollar started down, the merchandise trade deficit

had dropped one-third from its peak and exports

were at anew high. But the deficit was still running

at over $100 billion a year and 2.1 percent of GNP

in 1989, and that is still very high by historical

standards; moreover, the dollar had started climbing

again. And yes, many of our trading partners,

including some of the richest, discriminate subtly or

openly against imports. Nevertheless, the Japanese

are beating us in our own home market in things like

autos and semiconductors, where not so long ago we

were the world’s best; the Koreans and Taiwanese

have become adept competitors in some kinds of

semiconductors and computers; and the European

success with the Airbus threatens our top remaining

export industry.

Today, there is much greater agreement that U.S.

manufacturing has to improve to keep up with the

competition, and that technology is key to the

improvement. It is not so clear that, as a nation, we

are ready to make the commitment-or the sacrifices—

that are required to reinvigorate U.S. manufacturing.

Much of the effort has to come from inside industry,

with better management and better relations between managers and workers. But some involves all

of us, as savers and consumers, teachers and students

and families of students, taxpayers and citizens.

For example, a major reason for the notorious

shortsightedness of American industry is high interest rates. The high cost of capital discourages

investment in new plant and equipment, and has an

even more dampening effect on research and development, with its more distant and uncertain payoff.

The massive U.S. Government budget deficits of the

1980s, combined with low personal savings rates,

are prime reasons for high interest rates. So far, there

is little sign that either political leaders or voters are

ready to make the disagreeable choices—higher

taxes or cuts in popular government programs or

both-that would make a real dent in the budget

deficit.

Despite the decline in real wages and stagnation

in family income over the past decade, Americans

are still the richest people in the world; only Canada

rivals the United States in income per capita.l We

got a free ride in rising consumption throughout the

1980s because foreign investors remained willing to

finance our budget and merchandise trade deficits.

And rising consumption led a record peacetime

expansion of the economy. It is a real question

whether such a nation-still comfortable, not really

hurting--can summon the energies needed to regain

technological leadership in an increasingly competitive world.

Traditionally, U.S. Government policy on technology for manufacturing has been to support basic

research, allowing private companies to help themselves to whatever items of commercial interest

come out of that research. Federal R&D aimed at

applications has mostly been limited to defense and

space (areas in which the government itself is

customer), health, energy (mainly nuclear), and

agriculture. On occasion in the past, Department of

Defense spending for both R&D and procurement

has given commercial industries a vital boost, in

such things as semiconductors, computers, and

aircraft. But these spinoffs are less common than

they used to be. Military systems have become more

esoteric and more are secret; differing business

practices in the military and civilian sectors erect

barriers to the transfer of technology; the processes

for manufacturing a few copies of a custom item (for

the military) has little in common with high-volume

low-cost manufacture (for commercial markets);

IFi~ 1.3 ShOWS grOSS domestic product per capita for the United States and other countries. in the United States, from 1977 tO 1988, tie avera~

family income was virtually unchanged in constant dollars. However, there were marked changes in distribution; in every income decile up through the

eighth, family income declined over the 12 years, and the lower the income the greater the decline. Only in the top decile was there a significant increase

in family income (16 percent), and the top 1 percent racked up an increase of 49 percent. (U.S. Congress, Congressional Budget Office, The Changing

Distributwn of Federal Taxes: 1975-1990 (Washington, DC: Congressional Budget Office, 1987), p. 39.

-39-
40 . Making Things Better: Competing in Manufacturing

and in many high-technology areas, the defense

sector is lagging behind the commercial.2 Today, if

the government wants to support industry in commercializing new technologies, it must usually do so

more directly.

Some changes are occurring. Recently, the U.S.

Government has shown increased interest in positive

actions to help American industry restore its technological edge. Part of the reason is defense-related.

Loss of competitiveness in the commercial sector

(especially in semiconductors) is a worry to the

defense establishment, because it means that weapons systems may either have to rely on foreign

suppliers or else take second best.3 More broadly,

the idea that economic performance is at least as

important to the United States as military security

has gained some ground.

Congress has taken several initiatives to offer

more government support for improving U.S. manufacturing performance. Legislation passed in the

1980s promotes technology transfer from the Federal laboratories. In the 1988 trade act, Congress

created regional centers to transfer advanced manufacturing technology to industry. It has appropriated

special funds to advance R&D in high-temperature

superconductivity. In a distinct departure from

traditional U.S. policy, it is providing $100 million

a year for 5 years to Sematech, the governmentindustry consortium for R&D in semiconductor

manufacturing technology. New ideas for a more

aggressive, commercially oriented technology policy are getting an attentive hearing in Congress.

Real change in this direction is by no means

certain, however. According to press reports in late

1989, the Administration was ready to rein in any

DoD support for technologies that are not strictly

military, and continued funding for Sematech was in

question. 4 Responding to protests from Congress,

the Administration denied the reports, but also took

pains to announce opposition to any increased

funding for Sematech or similar ventures.

The government programs actually undertaken so

far to improve technology in manufacturing have

been modest, and spending for them is low (Sematech’s $100 million a year is by far the most

expensive of the new initiatives). The costs could

rise considerably if the government sticks with the

programs already started, and possibly enlarges

them as it gains experience. Still more costly would

be real efforts to change some of the basic factors

affecting U.S. competitiveness-getting the cost of

capital down, doing afar better job of educating and

training the work force.

As the arms race with the Soviet Union dwindles,

the prospects are good for reducing military spending. Some of those savings could go for deficit

reduction, or for measures to improve education and

training, or for technology advance and diffusion.

Some might go for other social purposes. On the

other hand, the savings might be spent on further

lowering of taxes and the resulting increase in

private consumption. These are public policy choices.

National leaders, guided by the voters, will ultimately make them.

Quite a few government actions are worth considering as ways to promote a stronger technological base

for American manufacturing, some of them traditional and others with little precedent in this country.

These actions can be directed toward four somewhat

overlapping strategic targets.

. Financial Policies. These shape the financial

environment for industry, including the cost of

capital. The broadest of these policies--on

taxes, spending, and the Federal budget—affect

the whole sweep of the economy and are

subjects of intense national debate; they are

discussed in general terms in this report. Closer

attention is given to specific policies that might

help firms take a longer term view than

quarterly profit performance and invest more

heavily in technology development and up-todate production equipment.

W.S. ~n%ss, office of Technology Assessment, Commercializing High-Temperature Superconductivity, OTA-~-388 (Sprinsleld,VA:

National Technical Information Service, 1988), pp. %-98; and Holding the Edge: Maintaining the Defense Technology Base, OTA-ISCA20

(Washington, DC: U,S, Government Printing Office, 1989), passim and esp. pp. 174-178.

3u.s. &pwmentof Defense, ‘Bolstering Defense Industrial Competitiveness,” report to the Secretary of Defense by the Under Secretary of Defense

for Acquisition, July 1988; Defense Science Board, ‘‘Report of the Defense Science Board Task Force on Defense Semiconductor Dependency, ’ report

to the office of the Under Secretary of Defense for Acquisition, February 1987; U.S. Congress, Office of Technology Assessment, Hofding the Edge,

op. cit.

4New TeC&~gy Week, NOV. 6, 1989.
Chapter 2-Strategies To Improve U.S. Manufacturing Technology: Policy Issues and Options ● 41

●

s

●

Human Resource Policies. These affect the

availability of well-qualified people to fill

manufacturing jobs, and thus have a powerful

influence on competitiveness. Education of the

Nation’s children and the reeducation and

training of adult workers are subjects too broad

to fit completely within a report on manufacturing technology, but some policies with special

relevance to manufacturing performance are

selected for consideration.

Technology Diffusion Policies. These are

positive, deliberate government actions to help

firms improve their manufacturing processes

and commercialize new or improved products.

They support technological advance across the

board for all manufacturers, with no distinction

in kind (i.e., no special support for particular

technologies or industries). Congress has already taken a few steps in this direction. Further

options include such measures as easier access

to new technologies coming out of Federal labs

and stepped-up Federal support for technology

extension services to manufacturers.

Strategic Technology Policy. This includes a

coherent set of actions that would promote

general technology advance and also target

support to technologies that are seen as vital to

economic growth. The U.S. Government has

used some of the tools of strategic technology

policy in the past, sometimes quite successfully, but usually in an ad hoc way. Current

examples include the Federal funding for Sematech and the special collaborations on hightemperature superconductivity R&D in three

national labs. If a consensus develops in favor

of forming a coherent strategic technology

policy, an agency or institution would need to

be in charge, to define goals and choose

technologies for government backing that fit

the goals.

This list does not by any means exhaust the

possibilities for government actions to bolster the

competitiveness of manufacturing. Many nations

have used broader instruments of policy than these

to promote industries they consider essential to their

countries’ well-being. Japan, other East Asian nations and, increasingly, the European Community

have used a full range of technology, industry and

trade policies in support of the strategic industries

they wish to develop. Policy tools include such

things as preferential low-cost loans, governmentguaranteed purchases, and trade protection against

powerful foreign competitors during the infancy and

development of native industries.

Improving the financial environment and upgrading education and training are the fundamentals for

any set of policies to improve technology. It may be,

however, that the addition of policies to step up

technology diffusion and target government R&D

support to critical commercial technologies will not

go far enough to boost American manufacturing to

world class competitive level, when other nations

are doing much more. Whether the United States can

or should employ more comprehensive policies to

bolster competitiveness is an open question, only

touched on in this report. Industry and trade policies

of the Asian rim nations and the European community, and their possible relevance to U.S. policy, will

be considered in the final report of OTA’s assessment of Technology, Innovation, and U.S. Trade.

FINANCING LONG-TERM

INVESTMENT

American business managers have been less

willing than their Japanese and German competitors

to make investments in technology development or

equipment that requires many years to begin yielding a return. Paying attention to the bottom line in

the short term is obviously important, but too much

of it can be costly in a world where manufacturers in

other developed nations pay less attention to shortterm profit and more to long-term growth and market

share.

American shortsightedness will be hard to overcome. If it were mostly due to culture—the way

managers and decisionmakers are socialized and

taught to think about problems—some good might

be accomplished by progressive business schools

revamping their curricula. Also, if the problem were

merely cultural, experience would prove that managers who concentrate on long-term gain outperform

those who do not, and the problem would be

self-correcting. But the myopia is long-standing;

experience has not remedied it. And our best

business schools have led-not resisted—the effort

to analyze and propose solutions to the shortsightedness of American management. Undoubtedly, some

cultural changes are needed, but without changes in

the underlying financial environment, simply enlightening managers on the potential gains of longer

term vision probably will have little effect.
42 Making Things netter: Competing in Manufacturing

The underlying financial environment that makes

our undue emphasis on short-term profit a consistently rational choice for American managers consists of many parts. The most straightforward is the

cost of capital: even in the absence of other factors,

the fact that American manufacturers have faced

consistently higher capital costs than their Japanese

and West German competitors will shorten the

required payback period for American investments.5

Another factor is the relationship between providers

of capital and companies. Providers of both debt and

equity capital have pushed American corporations to

pay more attention to short term gains than to long

term market share. Japanese and West German

banks and other creditors and equityholders have

more incentives to focus on long-term growth rather

than short-term payout. American managers, particularly those most responsible for strategic decisions,

may also be encouraged personally to focus on

short-term profit. According to the MIT Commission on Industrial Productivity, there is ‘no shortage

of executive bonuses geared to yearly or even

semiannual performance."6 Finally, the uncertainty

of the business environment could also lead managers to be cautious about long-term investments.

Analysts point to uncertainties such as money

exchange rates, regulatory and fiscal policies, and

trade. 7 These factors all play some role in how

managers view long-term investment. Making significant changes in any of them will be difficult,

even where they are sensitive to Federal policy

intervention.

Capital Costs

Our ablest international competitors have made

arrangements to provide capital to industry on more

favorable terms than the market provides. So,

however, have a number of Third World countries

that are regarded as prime examples of the pitfalls of

bungled, state-led planning. Even in cases where

channeling of capital has rather clearly promoted

industrial development—Japan is most often cited—

the policy involved a heavy price to consumers. If

Congress wishes to overcome the disadvantage of

our capital costs, it should be known at the outset

that this cannot be done without sacrifice.

There are two basic approaches to the problem.

One is to make capital more available to everyone;

the other is to use selective policies to reduce its

costs for certain sectors or activities. The first

approach is to increase the pool of savings from

which capital is formed. This includes increasing

government saving, which means reducing the

Federal budget deficit in one way or another (raising

revenues or cutting spending). The second approach

involves the use of tax instruments to reduce the cost

of capital investment, R&D, and other productivityenhancing activities.

The obvious step is to reduce or eliminate the

Federal budget deficit. The tax cuts and increased

government spending of the 1980s were an enormous

fiscal stimulus to the American economy. To avoid

excessive inflation, the Federal Reserve has pursued

a very tight monetary policy. This, in turn, keeps

upward pressure on interest rates, which does help

control inflation but also gradually robs industries of

the capital they need to improve real wages and

productivity. 8 The alternative—a less restrictive

monetary policy—would not drive interest rates up

so high in the short run, but the resulting inflation

could result in disaster too. With high inflation and

lower interest rates, foreign investors who are now

financing a large share of American investment

could find investments here less attractive and might

even lose confidence in the soundness of investments in the United States, which could result in a

severe recession. Charles Schultze characterizes this

scenario-which he thinks unlikely to happen—as

‘‘the wolf at the door. Most experts agree that it is

impossible to eliminate the budget deficit rapidly,

that is, in a couple of years, but that some combination of higher revenue and lower spending over a

decade or so will be needed. Lest we forget, it was

a combination of lower taxes (revenue) and greater

5Robefl N. McCauley and Steven A Zimmer, “Explaining International Differences in the Cost of Capital,” Fe&ral Reserve Bank of New York

Quarterly Review, summer 1989, pp. 7-28.

b~chael L. WrtOUZOS, Richard K, Lester, and Robert M. Solow, Made in America: Regainhg the Productive Edge (Cambridge, MA: The~~ess,

1989), p. 62.

TIbid., p, 61.

s~is ~~ent is set out in Charles L. Schultze, “Of Wolves, Termites and Pussycats: Or, Why We Should Worry About the Budget Deficit,” The

Brookings Review, summer 1989, pp. 26-33.

gIbid., p. 26.
Chapter 2-Strategies To Improve U.S. Manufacturing Technology: Policy Issues and Options ● 43

Federal spending in the 1980s that caused the

Federal budget deficit to balloon after 1981.

Encouraging Savings

Saving is the source of capital. At any given level

of demand for capital, if domestic savings rates fall,

capital formation must fall unless foreign sources

make up the difference. Some dependence on

foreign capital is probably acceptable for any nation,

but excessive reliance on it is worrisome. American

savings rates have fallen in the 1980s, partly because

the budget deficit comprises a large chunk of

dissaving, but also partly because household and

business savings rates have dropped.

Of the two, the drop in household savings is much

greater,. Household savings averaged nearly 8 percent of GNP over the 1970s, and dropped to 2.1

percent by the mid-1980s, partially recovering

thereafter, to about 5 percent by the end of the

decade. To raise the household savings rate, Congress could consider incentives to save, such as

preferential tax treatment of interest income or

deferred taxation on income that is saved. The latter

has been tried in the form of deferred tax on money

placed in Individual Retirement Accounts (IRAs),

with disappointing results. The fact that the household savings rate fell while IRA tax incentives were

in place led many economists to conclude that

savings incentives by themselves are ineffective,

and that discouraging consumption must be a part of

any package to increase private savings rates. This

is not a universally accepted conclusion, however.

For example, Hatsopoulos, Krugman and Poterba

argue that a national savings initiative that would

encourage savings in all tax brackets and reward

regular savings rather than portfolio reshuffling

could be effective.10 Congress could consider a

national savings initiative, based on these principles

and accompanied by a public campaign to encourage

savings, as was done in Japan after World War II.

Before the war, Japanese household savings rates

were lower than American rates.

Clearly, Japan’s savings rates were a response to

much more than just a national savings initiative,

and it may well be that even heavy incentives and a

public campaign are not enough to raise savings to

the levels needed to sustain competitiveness (i.e.,

above the rates of the 1970s and 1960s). Americans

have been encouraged in various ways to consume,

and consumption reached all-time highs as a percent

of GNP in the 1980s. Congress may also wish to

consider some measures to discourage consumption. ll The classic device is the consumption tax,

which has been rejected before because of its

regressivity. 12 However, by scaling consumption

taxes to tax most lightly (or not at all) those items

regarded as necessities and most heavily those

considered luxuries, several European countries

have shown that consumption taxes are not necessarily overly regressive.

Another option might be additional limitations on

consumers’ ability to deduct mortgage interest

payments. Mortgage interest payments are 100

percent deductible up to the generous limit of two

homes (primary and secondary). Because of this

deductibility, and because Americans are allowed to

make relatively low downpayments, Americans

consume more housing and save less than people in

Japan, Germany, and many other advanced nations.

While home equity is a form of savings for a

household, the money tied up in housing is not the

same as savings accounts and other forms of savings

from society’s point of view, because of its illiquidity. It is again to the household, but not available for

other investments. Moreover, the buildup of home

equity may substitute for other kinds of savings for

many households. Limiting mortgage interest deductibility to one home could also help to raise

household savings rates. In fact, the current limits

may be doing so. While the deductions allowed on

mortgage interest payments are still substantial, they

l~mrge N. Ha~~~os, Paul R. mWm, and J~es M. Poterba, Overconsurqption: The challenge to U.S. hmmaic polio (w*@JKxIs Dc:

American Business Conference and Thermo Electron Corp., 1989), p. 14.

llsme steps have ~n ~en. ~ he 1986 t= act, con~= ~gan top- out the d~~tibili~ of interest on m~y tyWs of cxmsunwr cl@t~

1990, 10 pereent of eonsurner interest paid can be dedueted, and none after that-and placed additional (though not very restrictive) limits on mortgage

interest deductibility. These had little effect on the propensity to consume, however, because consumers can still deduct substantial amounts of interest

on home equity loans, which have substituted to some extent for other typ of cxmumercredit, Indeed, as consumer interest deductibility has diminished,

the value of home quity lines of credit has mushroomed. In 1986, the year of the Tax Reform Act, home quity loans totaled $35 billion; by 1989, the

total was $100 billion, Source: David Olson, SMR Researeh, personal communication, January 1989.

12pm exmple, tie late Jo~ph pa~m, a Prominent tax ex~rt at The Brookings Institution, maintained that c0n5UmPti0n trees would favor the

wealthy, and argued for a more progressive income tax. See Hobart Rowe~ ‘‘Joseph Pechman’s Simple Solution for Fairer Taxes, ’ The WusM”ngton

post, Dec. 31,1989.
44 ● Making Things Better: Competing in Manufacturing

are more limited than they were. This may be one

cause of the partial recovery of personal saving from

its nadir of 1987, and the slowdown in the rate of

growth of housing prices.

Selective Lowering of Capital Costs

Progress in budget-balancing and stimulating

saving would result in moderation of interest rates

and encourage more longer term investment. That

may not be enough to support the kind of change

needed to reverse the relative slide of American

manufacturing technology and productivity. After

all, before the run-up of interest rates brought on by

the burgeoning deficit, American manufacturing

productivity was still advancing at a slow pace,

compared with its earlier performance and compared

with Japan. Congress might wish to consider other

measures to lower the cost of investment for specific

sectors or purposes.

The United States has tried using tax instruments

to stimulate additional investment in technology

development and application in the private sector.

These measures include accelerated depreciation

allowances and tax credits or deductions for the

purchase of equipment and facilities, and research

and development tax credits. Different policies

affect different activities in the spectrum of technology development, implementation, and diffusion.

The rationale behind all of these measures is that the

market does not provide strong enough incentives to

invest in the supported activities, considering the

total of private and social benefits that stem from

investments in plant and equipment or research and

development.

Right now, the case for underinvestment in

equipment-particularly advanced equipment to

produce state-of-the-art products--probably is stronger

than arguments that we have underinvested in R&D.

However, both Japan and West Germany spend a

higher percentage of their GNP on civilian R&D,13

and the European Community is topping that off

with about $1.5 billion a year on R&D through the

Framework program.14 Most of the R&D performed

by these key competitors is dedicated to improving

civilian science and technology. The United States

spends more money on R&D, but much of it is

geared towards military technologies. About half the

total R&D spending in the United States is funded by

the Federal Government, and 70 percent of that by

DoD. In contrast, less than 5 percent of Japan’s

government R&D is spent on defense, and about 12

percent of West Germany’s.15 While lagging R&D

spending has not been a major competitive problem

for American industry in the past, it is becoming one.

Capital investment is probably a greater problem

at the moment. Particularly in high-technology

industries, capital equipment investment is a key

part of technical competitiveness, and America’s

high capital costs have damped investment. If

Congress wishes to provide incentives to stimulate

the development, commercialization, and implementation of new technology, it might consider

reauthorizing some form of rapid depreciation or

investment tax credit, both of which were eliminated

in the 1986 Tax Reform Act.

Both accelerated depreciation and investment tax

credits (ITC) can be aimed at encouraging businesses to acquire new capital equipment. Investment

tax credits have been applied, on and off, since the

early 1960s, most recently in the Economic Recovery Tax Act of 1981. This tax credit was eliminated

in 1986, in favor of an overall reduction in the

corporate tax rate. The Accelerated Cost Recovery

System (ACRS) was also eliminated (although

certain classes of assets still enjoy fast depreciation).

Some argue that the ITC and ACRS were inappropriate in the frost place—that because a firm can reap

all (or nearly all) the benefit of investing in new

capital equipment, it is inappropriate for society to

subsidize such purchases. It is also unclear how

effective the subsidy was, at least in the 1980s, at

stimulating capital investment. according to various

estimates, for every dollar of revenue the Treasury

foregoes as a result of the investment tax credit,

13BY 1$)8$ Jwan’5 to~ R&D spending was slightly above U.S. total R&D spending by 0.1 pefeent of G~, accor~g to a PmliminW fi-‘m

the National ScieneeFoundation. See National Science Fomtitim,fnter~tiow/ ScUwe and Technology Duru Updute 1987, NSF 87-319 (Washington,

DC: 1987).

14~e EC mn~bu~ about 5 percent of all government-funded R&D in the countries of the Eurwan Community.

15NSF, op. cit, p. 9.
Chapter 2--Strategies To Improve U.S. Manufacturing Technology: Policy Issues and Options ● 45

industry invests $0.12 to $0.80 in equipment, above

what would have been invested without the credit.l6

Despite the apparently modest results of the ITC,

there are arguments in favor of tax stimuli for

investment. Investment in durable equipment was

robust in the recovery from the 1982 recession, even

though real interest rates were high, so without the

ITC investment might have been smaller than it was.

If the intent of the ITC was to stimulate equipment

purchases to raise productivity, that, too, could be

claimed as a modest success. Productivity growth in

American manufacturing averaged 3.5 percent annually from 1979 to 1986, a substantial pickup from its

1.4 percent average annual increase in 1973-79, and

even higher than the 3.2 percent annual average of

1960-73, the heyday of American manufacturing. To

what extent this is causally related to investment

incentives in the 1980s is not known. For example,

some of the productivity growth of the period came

from the closure of inefficient plants, rather than

from new investments in plant and equipment.

However, the coincidence of high productivity

growth and investment stimulation is worth examination.

The effect of investment tax incentives on productivity improvement and the diffusion of best practice

in American manufacturing will require additional

analysis. Congress may wish to initiate such a study

in one of its analytical agencies, or by a panel of

experts. This is a topic of great importance, but

considerable uncertainty. Some analysis suggests

that investment tax incentives are inefficient, and

they are certainly expensive. Between 1979 and

1987, the ITC cost between $13 billion and $37

billion each year in tax expenditure; ACRS’ cost

varied from $8 billion in 1982 to $64 billion at its

peak in 1987.17 Unless Congress can find another

way to raise revenue, or effect other substantial

spending cuts, reinstating investment tax incentives

will only worsen the deficit and increase the pressure

to keep interest rates up. Yet in view of the pressing

importance of raising productivity and diffusing

state-of-the-art technology in manufacturing, these

tax changes deserve consideration.

R&D tax credits are less controversial, at least in

principle, and are a great deal less expensive. It is

widely agreed that there are many societal benefits

from the generation of new knowledge that individual firms cannot capture. As for the cost, in 1985,

before the provision for R&D tax credits in Economic Recovery Tax Act (ERTA) and Tax Equity

and Fiscal Reform Act expired and before the new

tax law, the tax revenues foregone because of the

R&D tax credit were estimated at $700 million by

the Joint Committee on Taxation.18 Estimates of the

amount of additional R&D generated by each dollar

of foregone revenue range from $0.35 and $0.99.19

The high estimate, if correct, indicates that the R&D

tax credit is quite efficient, compared with many

other tax instruments; but if the low estimate is

correct, the impact is modest.

One possible explanation for a moderate impact at

the low range of estimates is that the tax credit for

R&D is only one stimulus. R&D costs can be

expensed--educted from revenues to yield taxable

income—in the year they are incurred, which is the

ultimate in fast depreciation. While the R&D tax

credit has repeatedly been subject to sunset provisions, expensing has been an option for decades.

With a powerful stimulus already in place, we would

expect the additional impact of a tax credit to be

modest. Also, it is possible that the impact of the

R&D tax credit in the early 1980s was affected by

the ITC and ACRS, which made other competing

investments more attractive.

The R&D tax credit survived the Tax Reform Act

of 1986, but in a form that many agree is not as

effective as it could be. One often-mentioned

criticism is that the R&D tax credit has never been

16Joseph J. Cordes, ‘‘The Effect of Tax Policy on the Creation of New Technical Knowledge: An Assessment of the Evidence, ’ in Richard M Cyert

&David C. Mowe~ (eds.) The impact of Technological Change on Employment and Economic Growth (Cambridge, MA: Ballinger, 1988), and Robert

Chirinko and Robert Eisner, “Tax Policy and Investment in Major U.S. Macroeconomic Models, ” Journal of Public Economics, March 1983. These

estimates were developed using econometric simulations, and varying assumptions in the simulations account for the large range of the estimates.

ITJoint committee on Taxation, Estimates of Federal Tu Expend@res, Fiscal Years, A.IUNMl.

l~,sm ~Wss, CmWs610n~ Budget office, Feder~ Support for R&D and Innovation (Washington, DC: Congressional Budget offices APril

1984).

lgIbid., ~. 780 Bo~ the R&D tu c~t and the ~vestment ~cr~it were design~ to elicit ~dition~ ~nding on R&D md investment. While the

R&D tax credit was designed to apply only to incremental spending above a base level, there is little doubt that some of the credit was claimed for R&D

that would have been done anyway by companies increasing R&D; and many assert that corporations redefine certain activities as R&D in order to claim

the credit. llese are some of the considerations that are taken into account when estimating how much additional R&D was done as a result solely of

the tax credit.
46 ● Making Things Better: Competing in Manufacturing

made permanent, and it is therefore not something

business planners can count on. While there has been

no lapse in its availability, the form of the tax credit

has been changed twice since it was enacted in the

ERTA in 1981. It was reauthorized in the Omnibus

Budget Reconciliation Act of 1989, with a few

changes.20 So, while some analysts have pointed out

that R&D tax credits have not clearly stimulated

significant increases in R&D spending, uncertainty

over the form and duration of the credit itself maybe

partially responsible. Congress might wish to consider making the tax credit permanent.

When investment and R&D tax credits are subjected to tests of efficiency or effectiveness, both

seem to have only a modest impact.21 While analysis

of the effects of such measures can give some

insight, it is impossible to predict accurately the

responses of business to these stimuli to develop

new technology or diffuse best practice. Although a

few different combinations of stimuli have been

tried a few times, the possibilities of these measures

have not been exhausted. Meanwhile, there is strong

evidence that something is needed to stimulate

technology development and diffusion. Under these

uncertainties, it may be tempting to try something

small or temporary, as the R&D tax credit has

always been in the past, and as the ITC proved to be.

If the tools are used tentatively, however, modest

impacts should be expected. We may have to rely

more on informed judgment than economic analysis,

and make a stronger commitment to tax or other

stimuli to investment and R&D.

Relationships With Providers of Capital

In addition to high capital costs, there are other

pressures in the American financial environment to

focus on short-term gain and avoid long-term or

risky investments. Heavy turnover of stock in

market trading and the pressures on institutional

money mangers to show short-term gains in excess

of market averages are important factors affecting

the outlook of publicly owned American companies.

In Japan, these problems have been avoided through

stable (or mutual) shareholding, an arrangement

which permits a company to cache most of its

stock--estimates of 70 percent are common-in the

hands of other companies, where it is not often sold

or traded, and there is little pressure to pay large

dividends. 22 While Japan had a long tradition of

mutual shareholding within its prewar zaibatsu and

postwar keiretsu company groups, incentives to find

stable shareholders were increased in the early 1970s

when government agencies began to worry that

Japan’s heavy dependence on outside expertise was

bringing with it too much foreign investment. The

renewed zeal with which company managers sought

stable shareholders, then, was a response to the

threat of foreign takeovers.23

If Japanese companies can afford to treat their

shareholders as peripheral to the decisionmaking

process, American companies have come under

increasing pressure to do just the opposite. American

firms have always had to pay more attention to the

demands of their shareholders than Japanese firms.

However, recently, the demands of shareholders

have focused more than ever on short-term gains,

and as a consequence American fins’ concern with

short-term performance has become a preoccupation.

The change has come about in part because of the

wave of merger and acquisition (M&A) activity in

the 1980s. Mergers and acquisitions go on constantly, occasionally rising to peaks; however, the

activity seen at peak periods differs in kind as well

as magnitude from ordinary M&A. In the 1980s, the

difference was that far more institutions and individuals could become acquirers, even with relatively

small resources. In the past, M&A was characterized

by large firms acquiring-in friendly or hostile

fashion-smaller ones. The change resulted from

relatively loose antitrust law enforcement, and the

availability of short-term, high-interest capital from

specifically, the credit now applies to R&D spending over a fixed base, which is calculated as the ratio of a firm’s R&D expenses to gross receipts

from 1984 to 1988. In addition, the new law aIlows fmns to claim R&D on prospective lines of business, rather than limiting qualified credits to R&D

in current lines as the old law did. Source: David L. Brumbaugh, “The Research and Experimentation Tax Credit,’ CRS Issue Brief, updated Dec. 21,

1989.

21~e h@ e~ata of ~itim~ ex~ndi~e cauwd by tie ITC and tie R&D t~ c~it *OW hat bo~ could ~SO k Rgmdti ~ qUite eff~tivt?,

but most analysts seem to think that the true impact is well below the high end.

22s=, fm Cxmple, HidW Ishiluua, ‘Japan’s Compliant Sllmholkrs, “ The Asian WaflStreetJournal Weekfy, June 13, 1988; “Backof the Queue,

Please,” The Economist, Apr. 29, 1989; Robert J. Ballon and Iwao Tomita, The Financial Behavwr of Japanese Colorations (lbkyo: Kodansha

International, 1988), pp. 50-53.

23Bwm ~d ~mi~, op. Cit., pp. 5@51.
Chapter 2--Strategies To Improve U.S. Manufacturing Technology: Policy Issues and Options ● 47

high-risk bonds (“junk” bonds) for financing.

Finally, another characteristic of the 1980s peak was

the rise of the bustup takeover, where the acquirer

quickly split up the acquired company and sold

many of its pieces in order to reduce the debt

incurred in the takeover.

A great deal of effort has been spent trying to

understand the consequences of M&A activity, but

there are few areas of consensus. Some maintain that

the M&A peak in the 1980s was mostly positive,

correcting excesses of the 1960s wave of M&A,

when large firms tried to diversify their business and

stabilize their overall cash flows by buying smaller

companies. Longitudinal studies of many transactions show evidence of increased productivity and

profitability in acquired companies. Detractors point

out that the 1980s M&A wave resulted in much

increased corporate debt levels, which in turn forced

companies to curtail current or planned spending on

R&D, capital equipment, marketing, or other items

considered discretionary in the short run. While

some reductions in capital equipment purchase and

R&D may be taken without severe damage for a

time, prolonged reductions will cost a firm its ability

to compete technically.

According to the evidence, M&A overall has had

little or no direct effect on things like R&D

spending. However, National Science Foundation

(NSF) data show that high debt—which is characteristic of the 1980s-style takeovers, but not of friendly

mergers and acquisitions—was strongly associated

with a drop in R&D funding, while companies that

did not undergo high-debt restructuring increased

R&D funding. If the focus is narrowed from all

M&A to hostile takeovers and defenses against

them, the argument that takeovers are having deleterious effects on technology development, capital

equipment spending, and general willingness to

make long-term investments becomes stronger.

Institutional investors-mostly pension funds—

account for the lion’s share of the new short-term

pressure. Pension funds and other institutional

investors hold about a third of all outstanding stock,

but are believed to account for more than half of all

trading. 24 Pension and institutional fund managers,

in turn, keep or lose their jobs depending on whether

their stock portfolios have done as well as the

market. Firms, responding to these powerful investors, feel pushed to maximize their own short-term

profits, believing that the market will penalize them

for long-term investments that dilute those profits.25

The penalty is the threat of a hostile takeover. While

only a few companies have actually experienced a

takeover attempt, the possibility of facing one is

viewed with great consternation by many businessmen, and many CEOs devote valuable time and

resources to the problem. The irony is that some

companies have acted to avoid hostile takeovers by

plunging into debt to buy out shareholders, which

can have an effect on the company’s long-term

performance similar to that of a hostile takeover

itself, or the attempt to fight one off.

In some cases, hostile takeovers have had beneficial effects, replacing ineffective management and

restoring control to managers whose companies

were swallowed by large conglomerates unfamiliar

with the business of their subsidiaries and uninterested in measures of performance other than profit.

Few people, even the harshest critics of the wave of

hostile, bustup takeovers of the 1980s, would

advocate a cessation of all merger and acquisition

activity; most agree that some threat of a hostile

takeover is an important disciplinary force. Yet the

relative ease of hostile takeovers in the 1980s—

brought about principally by the availability of

high-risk bonds for financing, and also by less

stringent antitrust enforcement—has made the financial environment even less conducive to longterm investment than in the past.

Mitigating the pressure for short-term profits is

not simple. Any policy change would have to be

carefully crafted to have a substantial effect on

market behavior yet avoid working too well and

blunting the ability of shareholders to oust bad

management.

Most of the proposals for changing investors’

short-term time horizons are tax proposals. One that

is often advanced is that Congress provide incentives for holding stocks for a longer period by

reducing the rate of capital gains tax on gains from

those stocks. Currently, capital gains are taxed like

income, with a top rate that is, in effect, 33 percent.

24Alan Murray, “Capital-Gains Tax Bill Would Spur Asset Sales More than Investment,” The Wall Street Journal,” Sept. 28, 1989.

ZsMich=l L. ~~ouzos, Wchwd K. ~Ster, and Ro~fi M. Solow, Made /n America: Regaining the prod~tive Edge (Cambridge, MA: The MIT ~eSS,

1989), p. 62.
48 ● Making Things Better: Competing in Manufacturing

In the 1989 debates over lowering the capital gains

tax rate, one of the options before Congress was to

give preferential tax treatment-an effective rate of

20 percent over the next 2 years-for assets held for

a year or more, rising to a top rate of 28 percent rate

thereafter, but with the gain indexed to net out the

effect of inflation. Another included a two-step

schedule of capital gains tax: assets held for a year

or more would qualify for indexing, and those held

for 5 or more years would qualify for alternative

preferential treatment, with the option of calculating

taxable gains on 25 percent of the sale price rather

than the full indexed value.26 Another proposal, the

Packwood-Roth bill, would allow individuals to

exclude from capital gains tax a percentage of the

gain, depending on how long the asset is held.

Investors who have capital gains on assets held for

less than 1 year could exclude 5 percent of the gain

from tax; the amount excludable increases by 5

percent for assets held each additional year up to a

maximum excludable gain of 35 percent, after 7

years. Earlier, the President proposed atop rate of 15

percent on all capital gains.

Some proposals would make more fundamental

changes in the tax treatment of capital gains than any

so far considered in the 101st Congress. For

example, one scheme is to have a seven-step

schedule of capital gains taxes, taxing very heavily

(at 50 percent) those held for a year or less, and

lightly (at 10 percent) those held for 6 years or

more.

27 Another proposal would tax capital gains on

securities held less than a year at 50 percent, and

reduce the rate to 15 percent on gains on securities

held for more than 5 years.28 Both proposals also

broaden the base for taxing all capital gains, to

include institutional investors as well.

The above proposals, or a similar steeply variable

schedule of capital gains tax to reward long-term

investment, could help to lessen the pressures on

managers to show short-term profits. It would also

bean incentive for investors of all types to evaluate

and monitor more carefully the performance and

prospects of companies they invest in. That is all to

the good; inattentive investors with short time

horizons contribute little if anything to the management of business, and much less to technology

development in the private sector. However, there

are some potential problems as well. For example,

investors might be unduly influenced by tax considerations to leave their money in companies with

mediocre performance, blunting the signals the

market is expected to give to managers. But the

damage done by the short-term outlook to American

manufacturing is severe enough to warrant serious

consideration of significant changes in capital gains

rates.

Although a variable capital gains tax schedule

would encourage investors to hold assets longer, it

would not by itself affect the group of investors most

often cited as engaging in speculative turnover.

Institutional investors-pension funds and investment funds for nonprofit institutions like universities—

pay no capital gains tax. In order to quell the

speculative turnover on the stock market, therefore,

Congress might consider additional measures to

change the incentives of either institutional fund

managers or investment bankers who handle transactions. One proposal is to charge an excise fee on

the pension funds’ gains on stock turnovers if the

stock is held for 180 days or less. Another is to

subject these institutional investors to capital gains

taxes.

Another possibility is to charge a transactions tax

on all stock trading, or a securities transfer excise

tax. 29 This would raise the costs of stock transactions, but would disproportionately discourage rapid,

speculative turnover; the greater the turnover of

stock, the greater the disincentive caused by the

transactions tax. The securities transactions tax

would also raise the cost of capital, but according to

one analysis, not enough to match the beneficial

effects of increasing corporate time horizons and

reducing “the diversion of resources into the economy’s financial sector. ”30 An added benefit of a

securities tax is the revenue it raises; Summers and

Summers estimate that a 0.5 percent tax would raise

about $10 billion annually. Japan’s securities transaction tax raised $12 billion last year. All of these

MEliz&~ Wek, “fiamis~ Fault WVaI plans for Capital Gains cuu” Congresswnuf Qwterly, Aug. 19, 1989.

27D~@j p, Ba~n, U@d~~B~~on /n~~~tm~~~epO~, Vol, Lxx~, Noc 1,, J~, 3, 1989

‘/%Felix G< ROMP, “~~ituion~ ‘~ves~r’ or ‘Speculator’’?” The Wull Street Journal, June 24, 1988.

z~awence He s~em and Victoria P. Smers, “When Fimncial Markets Work Too Well: A Cautious Case for a Securities Transactions ‘Ihx,”

paper presented at the Annenberg Conference on Technology and Financial Markets, Washington, DC, Feb. 28, 1989.

3qbid., p. 1.
Chapter 2--Strategies To Improve U.S. Manufacturing Technology: Policy Issues and Options ● 49

proposals favor long-term investments, and could

discourage those leveraged buyouts (LBOs), hostile

takeovers, and junk bond transactions aimed at

short-term speculation.

So far, none of these proposals has been subjected

to thorough examination and public debate. Most of

the legislative proposals made so far would confer a

benefit to those who hold stock for more than a

certain time (6 months or 1 year, in different

proposals made before Congress), hardly long term

by the standards our strongest international competitors have set. None of the legislative proposals

considered so far would penalize those holding a

stock for less than 6 months to 1 year, beyond taxing

the gain at the marginal rates for ordinary income

and retaining limitations on the deductibility of a

loss. The potential risk-possibly reducing the

liquidity of investments in securities, and thereby

reducing the ability of the market to give appropriate

signals to company managers—is real, but we do not

yet know how great a risk this is. The issue centers

on just how important taxes are, relative to other

considerations, in the investment decisions of all

kinds of investors. That is one of the most important

questions to address in order to craft policies that

continue to encourage investors to make their

savings available to companies, but favor companies

that are managed for long-term gain as well as

short-term profit.

In addition to tax measures, a menu of other

measures could be considered to return hostile

takeovers to the role they played in the past—

namely, a disciplinary force on poor management.

They include extending the minimum duration of

tender offers, outlawing greenmail and golden

parachutes, shortening disclosure time when an

investor has acquired more than 5 percent of a

company’s stock, and requiring tender offers in

excess of 110 percent of share value to be made to

all stockholders.31 These are aimed specifically at

hostile takeovers. But by most accounts such raiding

is on the wane. If the flurry of junk-bond financing

and hostile tender offers is subsiding, Congress has

an opportunity to assess the effects of the bubble of

restructuring activity, without the sense of urgency

that caused many of the anti-takeover proposals to

be raised. Some limits on the ability to make and

finance hostile tender offers may therefore be worth

considering, even though such limits will have to be

balanced against the healthy and indeed necessary

effects of takeovers on managerial performance. In

an important sense, takeovers are the fundamental

enforcer of market forces on individual fins; the

trick is to keep the pressure on while ensuring that it

doesn’t get out of hand.

Environmental Uncertainty

American managers have long had to contend

with a macroeconomic and political environment

that was managed less for their welfare than for other

purposes. Foreign policy, macroeconomic policy,

international finance, and trade policy have at many

times been conducted with scant consideration for

the effects of different choices on the competitive

position of American producers. When America was

the world’s dominant maker of most goods and had

the best technology and manufacturing practice in a

wide variety of industries, this was not a debilitating

handicap. Now we must take it more seriously.

Although the process of making macroeconomic,

foreign, and trade policy is not manifestly more

indifferent to business (or manufacturing) competitiveness than it once was, the consequences of those

policies are now more important. In many areas of

obvious importance to the economy (e.g., parts of

the semiconductor industry), American manufacturing is struggling to survive. Changes in the general

economic and political environment that would have

been inconvenient in the past could be crippling

now.

This is not meant to suggest that the conduct of all

our most important domestic and international

policies be guided solely by the wish lists of

American manufacturers. But we might consider

building institutions that could advise policymakers

in key areas on the effects of their choices on

American competitiveness. Foreign policymaking,

for example, is often at odds with the commercial

interests of U.S. manufacturers. The Department of

State has just one office that concerns itself with a

commodity, rather than a country or region. That is

the Textile Division of the Bureau of Economic and

Business Affairs, the purpose of which is to keep

trade frictions in textiles and apparel from interfering with the foreign policy aims of the Department.

The U.S. Trade Representative’s office and the

Department of Commerce sometimes champion the

31Rmd V. WOg, “HOW I Fought Off the Raiders,” FORTUNE, Feb 27, 1989, p. 118.
50 ● Making Things Better: Competing in Manufacturing

competitiveness of American manufacturing, but

this is more a matter of the political persuasion of the

appointees and administration currently in office

than a standard practice.

There are many approaches to solving this problem, and various forms have appeared in legislative

proposals over the past several years. One approach,

often proposed, is to create anew, powerful voice in

the cabinet for competitiveness interests—a Department of Trade and Industry, loosely patterned after

Japan’s Ministry of International Trade and Industry. Another and more difficult approach would be to

create institutions within existing departments to

represent competitiveness and manufacturing interests, and to build sensitivity to those concerns into

all departmental decisionmaking. This, in fact, may

be more like the Japanese approach than creating our

own version of MITI. Nearly every Japanese ministry has strong incentives to consider the competitiveness of Japanese companies under its jurisdiction in

creating and implementing policies. If Congress

wishes to consider this approach, a thorough study

of what those incentives are in Japan and other

developed nations would be a good starting point.

HUMAN RESOURCES

Manufacturing managers, having grumbled for

years about the shortcomings of American public

schools and a poorly educated work force, have

begun to speak of a crisis. Semi-literate machine

fixers who used to repair machinery by looking at

how it worked are baffled by computerized equipment stuffed with invisible electronic components;

these machines need repairers who can read manuals

and diagrams. Young people leaving school with

meager math skills are not prepared to deal with

computer printouts and digital analyzers to monitor

quality on the assembly line.

Some large companies are trying to deal with the

problem by educating employees themselves. Motorola, for example, estimates that from 1989 to 1993

it will have spent $35 million teaching its workers

reading and arithmetic. Motorola is committed to

educating workers already on its payroll, but has

become more selective in hiring; it no longer takes

people who cannot do fifth-grade math and seventhgrade reading. At that, said a company vicepresident, ‘‘ We’ve had situations where we couldn’t

open the factory because we didn’t have the work

force.” 32

The situation threatens to get worse before it gets

better. More than half the net growth of the work

force from 1986 to 2000 will be from minority

groups, 33 and a great many minority children (38 to

45 percent) are growing up poor. Poor children drop

out of school in disproportionate numbers, and many

emerge sadly lacking in the skills they need for

economic survival. David Kearns, chairman of the

Xerox Corp., sees in this the ‘makings of a national

disaster." 34 

Few issues on the domestic front have received as

much attention in the past few years as the sorry

results of American public schooling. Indeed, it is

hard to overstate the importance of better education

in the basics, not only for national competitiveness

but also for a peaceful and prosperous society--one

which gives most people a chance at decent jobs and

a middle class livelihood. However, this report

concentrates on the factory rather than the school

room, and thus does not attempt to add much to the

many recent analyses and proposals for improvement in our children’s basic education. Other OTA

assessments, examining various aspects of education and training, have analyzed some public policy

issues that are particularly relevant to manufacturing

performance. 35 The discussion below flags some of

these issues and describes them briefly, without

analyzing specific policy options.

s~tidy Shycki, “me Company as Educator: Firms Teach Workers to Read, Write,” The Washington Post, Sept. 22, 1989, p. G1.

33~cor~gto tie B-au of Labor s~tistic~, 57 ~rcent of fie 20.9 mi]llon net ~o~ in tie labor force from 1986 to 2000 will come from minority

groups (6 million Hispanic, 3.6 million Black, and 2.4 million Asian and other). Ronald E. Kutscher, ‘‘Overview and Implications of the Projections

to 2CM)0, ” Monthly Lubor Review, September 1987, pp. 34.

sQEdw~d B. Fiske, “~pnding U.S. Jobs ‘Disaster’: Work Force Unqualified to Work, ” The New York Times, Sept. 25, 1989, p. 1.

35u,s. ~n~~, of ficeof Tec~oloW As=ssment, E~cating scie~~ts and E@neers: Gr& SChOOl to Gr~schoo[, OTA-SET-377 (WUhhgtOIt,

DC: U.S. Government Printing Office, June 1988); Technology and Structural Unemployment: Reenjoying Displaced Aaldfi, OTA-ITE-250

(Sprin@leld, VA: National Technical Information Service, 1986); [international Competitwn in Services, OTA-ITE-328 (Spnngfleld, VA: National

Technical Information Semice, 1987), chs. 7, 8, and 10; and the forthcoming assessment “Worker Training: Implications for U.S. Competitiveness”

(publication expected fall 1990). OTA has also conducted a several assessments of technology and public school education; two recent ones are Power

On/New Twhfor Teaching and Learning, OTA-SET-379 (Washington, DC: U.S. Government Printing Office, 1988) and Linkingforharning: A NCW

Course for Education, OTA-SET430 (Washington, DC: U.S. Government Printing Office, November 1989).
Chapter 2-Strategies To Improve U.S. Manufacturing Technology: Policy Issues and Options ● 51

Training the Active Work Force

Essential though it is, improvement of public

schooling is a longrun proposition. Children entering the first grade in 1990 will leave high school in

2002, and effective education often begins sooner

(as in the Headstart program, which starts at age 3)

and ends later. Thus, even if we improved public

education radically, starting tomorrow, the full

results would not show up in the work force until

well into the 21st century.

A more immediate approach to improving human

resources for manufacturing is to help people

already in the work force gain the skills they need for

modern jobs. ‘‘Skills training” covers abroad range,

from upgrading basic math and reading abilities to

mastery of a complex craft. Often the most urgently

needed skills are the basics, so that workers can

understand operating manuals and take part in

statistical process control for quality. In addition,

worker training is only one aspect of improving

human resources for manufacturing. Managers also

need training in organizing work and using people

effectively in relation to new technologies. Giving

shopfloor workers a genuine stake in the company

and real responsibilities for better quality and greater

efficiency; promoting team work (among engineers

as well as operatives); organizing work to make the

most of people’s abilities-all these things add up to

skillful management of human resources.

The Federal Government has had a long but

generally not very close or direct involvement in

training of adult workers who want to upgrade their

skills. The most pervasive Federal influences are

indirect: in government-guaranteed student loans,

which workers can use for taking part-time courses

while they hold down jobs; and in the tax laws that

let employers deduct the costs of employee training

from taxable income and, in some cases, allow

workers to deduct what they pay. 36 The biggest

direct Federal involvement is in the armed forces,

where training and R&D in how to provide it have

been major concerns since World War II. Some

computer-based training technologies developed for

the armed forces have found their way into

workplace training on the civilian side.37 Aside from

the military sphere, Federal activity is minor. A

small program that partially funds demonstration

projects for teaching literacy at workplace sites is

greatly oversubscribed. Congress provided $9.5

million for it in 1988, and a flood of proposals came

in, requesting a total of nearly $100 million; the

program was funded at $11.9 million in fiscal years

1989 and 1990. Another small effort on the Federal

Government’s part is encouragement and technical

assistance for employee involvement projects, provided by the Federal Mediation and Conciliation

Service and the Labor Department’s Bureau of

Labor-Management Relations and Cooperative Services.

Some of the States are far more active than the

Federal Government in supporting workplace training. Illinois, for example, in its Prairie State program

pays half the direct cost of worker training courses

for companies that are in trouble (as shown by their

tax returns). Typically, the companies are small ones

and the training is very often in statistical process

control-something that larger companies are increasingly demanding of their suppliers. Several

States that run industrial extension programs, offering technical assistance to small manufacturers,

have found that training is an absolutely essential

ingredient in the adoption of new technologies.38 At

least one program, the Michigan Modernization

Service, systematically pairs training with technology extension. In supporting State technology extension programs or developing Federal centers that

provide such services (see the discussion below), the

Federal Government might insist that training be

provided along with advice and assistance in acquiring advanced equipment.

A full examination of policy issues surrounding

the retraining of active workers will appear in a

forthcoming OTA report, Worker Training: Implications for U.S. Competitiveness.

sb~~ti~s f~ individ~s ~limi@ to WO&-rCl~ mining, and can be taken only if the amount spent for training plus all other mkdaWWS

deductions is more than 2 percent of the taxpayer’s adjusted gross income, Material hereon the Federal role in workplace training is abstracted from

work in progress on OTA’s forthcoming assessment of “Worker Training: Implications for U.S. Competitiveness. ”

s7SP~g ~ ~~p~mt of ~fenw on R&D for educat.iond technoiogks is ei@ times the combined spending of W National Science

Foundation and the Department of Education ($56 million a year, on average, v. $7 million). Charles Blaschke et al., “Support for Educational

Tedmology R&D: The Fe&ml Role,” contractor report prepared for OTA Sept. 30, 1987, p. vi., for the assessment Power On! (op. cit.)

38s= tie &scWion of this pint in the section entitled “Industrial Extension” in ch. 7.
52 ● Making Things Better: Competing in Manufacturing

Supply of Engineers: Keeping the

Pipeline Filled

In the next decade or so, it could become much

harder than it is today to maintain an adequate

supply of technically competent people for manufacturing, especially engineers. In the mid to late 1980s,

most analysts found that there was little evidence of

a real shortage of engineers in the United States—

yet.39 Also, the United States was about on a par with

Japan, Germany, and other advanced countries in the

proportion of engineers in the work force (see ch. 4).

But it looks as though this parity will not last long;

Japan is now graduating far more engineers per

capita than the United States.

Demographic facts suggests that maintaining

even the present level of supply could become more

difficult over the next 10 or 15 years. A growing

proportion of the young people coming through the

educational pipeline are from minority groups, and

up to now minorities have been very much underrepresented among engineers. Blacks are 12 percent

of the population and Hispanics 9 percent; each were

below 2 percent of all employed engineers in 1986.

Women, too, are underrepresented in engineering;

they are 45 percent of the Nation’s work force, but

only 4.1 percent of employed engineers. That rate

rose from 1.6 percent in 1976, however, and will

continue to rise, since nearly 15 percent of engineers

graduating with a bachelor’s degree in 1986 were

women. The proportion of blacks among employed

engineers rose more slowly over the 10 years, from

1.2 to 1.7 percent.40

Public policy has not been heedless of the fact that

white males-predominant in science and engineering in the past-are a dwindling proportion of new

entrants to the labor force. Several Federal agencies

offer special scholarships and grants to encourage

minority students, or women, or both, to study

science and engineering in college or graduate

school; 41 some also offer programs such as summer

internships to stimulate interest in science and math

among minority high school students.42 Many of

these programs have scored good results, and

deserve support. But they are inevitably limited. The

inclination toward a choice of science or engineering

usually comes early. Children who decide in elementary school that they don’t like or can’t learn

math are not likely to see themselves as engineers

when they grow up. This means that, to really open

wider opportunities to all children to choose engineering careers, we must do a better job of teaching

math and science from the beginning.

Meanwhile, retraining of midcareer engineers,

like the retraining of adult workers in general, could

help to shore up the supply of engineers available to

manufacturing in the next few years. If funding for

the Department of Defense declines as expected with

the melting of the Cold War, some of the engineers

doing military work will likely lose their jobs. Part

of a U.S. Government program for easing the

transition from military to civilian production and

employment could be providing retraining opportunities specifically designed for engineers With

government support, retraining courses might be

developed to fit the needs of manufacturing—

something that is generally neglected in university

engineering departments.

Manufacturing Education and Research

The quality of engineering is as important to

manufacturing performance as the quantity. The

elitism of design engineers and their remoteness

from problems of manufacturing (“throwing the

design over the wall”) are well-known failings in

American manufacturing. Insofar as these are problems of management, there is little that government

can do about them directly. However, efforts to

encourage more interaction between the design

center and the shop-floor (such things as designing

for manufacturability and simultaneous product and

process engineering) also involve education and

39u.s. Cm=ess, Offiu of TWhnoIoU Asses~ent, Demographic Trends and the Scient#ic and Engineering Work Force--A Technical

Memorandum, OTA-TM-SET-35 (Springfield, VA: National Technical Information Service, 1985), pp. 92-109; Higher Education for Science and

Engineerin~ Background Paper, OTA-BP-SET-52 (Washington, DC: U.S. Government Printing Office, 1989), p. 14 ff.

%ational ScieneeFoundation, ProjiletilectricallElectronicsEngineering: HwnanResourcesandFunding, NSF 88-326 (Washington, DC: U.S.

Government Printing Offke, 1988).

ql~e MARC progr~ (M.inotity Access to Research Careers) of the National Institutes of Health is a good example of such programs. It h done

well at bringing minority students into science careers, and currently provides 410 undergraduate scholarships and 69 graduate and faculty fellowships.

For a brief description, see OTA, Educating Scientists and Engineers, op. cit., p. 54.

QF~~ ~ncia ~m provi~ rn~ and science internships for high school students, college scholarships, and teaeher training sessions d model

courses that are open to everyone.
Chapter 2--Strategies To Improve U.S. Manufacturing Technology: Policy Issues and Options .53

research. For example, simultaneous engineering is

a difficult technical as well as management challenge. The technical problems might eventually be

solved with more R&D attention and more powerful

computers. In education and research, the government does have some leverage.

Few American universities have departments of

manufacturing engineering, nor do they offer much

education and research relevant to manufacturing in

their other engineering departments. This is partly a

matter of money. Manufacturing R&D gets little

Federal funding; it probably received well under 1

percent of the total $65 billion the U.S. Government

spent for R&D in 1989, and nearly all of that came

from the Department of Defense.43 Other Federal

support for manufacturing R&D is truly meager. The

Center for Manufacturing Engineering of the National Institute of Standards & Technology was

funded at $6.2 million in fiscal year 1989. Technology awards by the National Science Foundation’s

Manufacturing Systems Division were about $6.5

million, out of NSF’s total of $1.5 billion grants and

awards. The NSF-sponsored Engineering Research

Centers at 18 universities received about $33 million; some (not all) of these centers emphasize

manufacturing R&D, and are giving engineering

students cross-disciplinary training that is valuable

to manufacturing companies (see the discussion of

ERCs below). One option for raising attention to

manufacturing in universities beyond the present

level would be to elevate the NSF’s Manufacturing

Systems Division to a Manufacturing Sciences

Directorate. This would provide a solid, prestigious

base for government support of research and education specifically focused on manufacturing.

DIFFUSING MANUFACTURING

TECHNOLOGY

Throughout the 1980s, Congress has taken a

number of actions to transfer advanced technologies

from labs to factories, bring smaller firms up to date

in manufacturing technology, and modify laws that

may interfere with technology advancement in

manufacturing. Some of these actions are well

along; others have barely begun. Not one of them, by

itself, is likely to have any very dramatic effect,

certainly not overnight, Some, after a fair try, will

pan out and others will not. Given patience and an

open-minded experimental approach, it is likely that

some combination of these measures could make an

appreciable difference in improving manufacturing

performance.

Some of the most promising options are similar to

Japanese government programs (national and local)

that have served that country’s manufacturing firms

for years. There are of course many economic,

social, and political differences between the United

States and Japan; not everything that works there

would work here. However, as discussed below,

several of these Japanese programs do seem to be

quite adaptable to American conditions.

Technology Extension

One way for government to help manufacturers

adopt improved technologies is through various

kinds of technology extension services. A few States

are providing services of this kind with a good deal

of success. This is one of the programs that works

well in Japan. The nationwide network of technology extension services in Japan is much used by

small and medium-size manufacturers. (See chs. 6

and 7 for discussions of the importance of smaller

manufacturers to U.S. competitiveness and descriptions of government programs in Japan and the

United States that offer small firms technology

assistance.)

Until very recently, Federal involvement in technology extension was minimal. The States have

done more, but even so, in 1988 the combined

technology transfer and technology/management

assistance programs of 30 States added up to only

$58 million-and this figure overstates technology

extension to manufacturers, since it includes management assistance of various kinds to all sorts of

businesses (see ch. 7 for details). The total for State

technology extension services was probably between $25 million and $40 million.

In 1988 Congress created a framework for a

broader Federal program of technology extension.

The Omnibus Trade and Competitiveness Act of

1988 authorized several kinds of technology assistance to manufacturers, including Manufacturing

Technology Centers to demonstrate advanced techqsF~er~ s~ndingon R&D relate.dto manufacturing was no more than about $400 million in fiscal year 1989, and may have been less; preci= fi~s

are not available. U.S. Congress, Office of Technology Assessment, “U.S. Manufacturing: Problems and Opportunities in Defense and Commercial

Industries,” staff paper, December 1989.
54 ● Making Things Better: Competing in Manufacturing

nology and provide extension services, especially to

smaller firms; Federal assistance to State technology

extension programs; and the Advanced Technology

Program, a mechanism for Federal guidance and

participation in joint R&D ventures with private

business. The actual performance of these programs

has been modest so far. In fiscal year 1990, Congress

appropriated $7.5 million for the Manufacturing

Technology Centers and, for the first time, funded

aid to State programs, at $1.3 million.44 A smattering

of older Federal programs also provide some technology extension services.

At current levels, the combined Federal and State

technology extension programs cannot reach more

than a small fraction of the country’s 355,000 small

and medium-size manufacturing firms-those that

are most likely to need technical assistance. As

noted in chapter 7, one of the most valuable kinds of

technology extension is customized advice to individual manufacturers. Giving that service to just 7

percent of smaller manufacturers would cost a total

of $120 million to $480 million a year, depending on

the level and quality of service.

If Congress wishes to deepen its commitment to

technology extension, several choices are open. It

could provide more funds for Manufacturing Technology Centers under the Federal aegis. It could set

up a more generous program of Federal matching

funds to State industrial extension services than the

present law authorizes. Or it could do some of both.

These choices are discussed below.

The Federal Program: Manufacturing

Technology Centers

The Omnibus Trade and Competitiveness Act of

1988 gave the National Bureau of Standards new

responsibilities for technology transfer to manufacturers and renamed it the National Institute for

Standards and Technology (NIST). One part of the

law directed NIST to help create and support

non-profit regional centers for the transfer of manufacturing technology, especially to small and mediumsize firms. The tasks of the Manufacturing Technology Centers (MTCs) are to transfer technologies

developed at NIST to manufacturing companies;

make new manufacturing technologies usable to

smaller firms; actively provide technical and management information to these fins; demonstrate

advanced production technologies; and make shortterm loans of advanced manufacturing equipment to

firms with fewer than 100 employees.

The trade act authorized $20 million a year for

NIST technology extension, but appropriations have

been much less—$5 million in fiscal year 1988,

$6.85 million in 1989, and $7.5 million in 1990.

NIST has signed 6-year agreements with three

regional MTCs, giving each $1.5 million per year for

2 years in succession, through calendar year 1990.

(The remainder is for administrative expenses and

other technology extension activities.) The Centers

must match at least half the Federal dollars for the

first 3 years and an increasing share thereafter; under

the law, the Federal share declines to zero at the end

of 6 years.

Japan’s nationwide network of public testing and

research centers, which provide technology extension services to smaller manufacturers, has many

features in common with the NIST centers but is far

more extensive. In 1985, there were 185 of these

testing and research centers; they had 7,000 employees and annual funding of 66 billion yen ($470

million at 140 yen to the dollar), half from the

national government and half from the prefectures.

In addition, many Japanese cities, wards, and other

localities have industrial halls that offer much the

same kind of services. (See ch. 6 for details.)

In running the new manufacturing technology

program, NIST officials say they are not just passing

along Federal money but are taking an active hand

in advising the Centers and learning along with

them. Centers are encouraged to work with State

programs and take advantage of State resources and

experience. One of the criteria for selecting operators of the Centers is that they have previous links

with State and local extension programs. NIST has

also set up monthly meetings of all the Centers so

they can learn from each other.

A key question about the future of the NIST

technology extension program is how it can best be

meshed with State extension programs that aim to do

much the same thing, with as much coverage and as

little overlap and re-invention of the wheel as

possible. The 1988 trade act made some provision

for Federal support of State technology extension

programs, but in quite limited ways, as the next

section describes.

~The Mv- Technology Rogram, discussed in a later section of this chapter, also got its first funding, $10 million in fiscid Y= 1990.
Chapter 2--Strategies To Improve U.S. Manufacturing Technology: Policy Issues and Options .55

Federal Assistance to State Programs

The 1988 Omnibus Trade and Competitiveness

Act also set up a limited program of Federal

assistance to State technology extension programs.

Included was a nationwide study of State technology

extension services; technical advice on how to

transfer Federal manufacturing technology to firms;

and a clearinghouse for information about State

technology programs. The act also authorized a

small program of Federal financial aid to State

technology extension programs that already exist

and want to expand. States would have to increase

their own funding by the same amount as the Federal

contribution. Their proposals would be judged by

how many new firms they proposed to help under the

cooperative Federal-State agreement, whether they

could maintain service after the agreement expired,

and to what extent they intended to demonstrate new

and expanded uses of Federal technology.

As this report was written, NIST’s State technology extension program had just begun, having

received its first finding of $1.3 million in fiscal

year 1990. On reprogrammed funds, NIST had

already done the study of State technology extension

services 45 and started a small, one-man effort to

acquaint State agencies with NIST services and

resources. The clearinghouse was just getting organized, and Federal financial aid to State programs was

in the planning stages.

In its study of State programs, NIST defined

“technology extension services’ as programs whose

primary purpose is to provide direct consultation to

manufacturers for technology deployment. It found

only 13 State-supported organizations in 9 States

that fit the definition. More and more States,

however, are taking an interest in technology extension, and at least one new program (Nebraska’s) was

created shortly after the survey was done.

Although the State programs are few, scattered,

and mostly quite new, they are, on the whole, better

developed than technology extension services at the

Federal level. One or two have years of experience

behind them and have built up outstanding reputations. For example, Georgia Tech’s statewide industrial extension service dates back over a quarter of a

century and is so much in demand that it refrains

from any advertisement (see ch. 7). The Michigan

Modernization Service is less than 5 years old, but

it has gained a solid reputation and demands for its

services are growing; its budget rose 40 percent in

1989.

Getting the Job Done: Federal or State Programs,

or Both?

Despite the present flurry of State and Federal

interest in technology extension to manufacturers,

the actual coverage of such services is still very

small. It doesn’t begin to compare with the Agricultural Extension Service, with its funding of more

than $1.2 billion (31 percent Federal), its offices in

nearly every county in the 50 States, its 9,650 county

agents, and its 4,650 specialist scientific and technical staff.46 To put this in perspective, consider that

agriculture contributes 2 percent to the gross national product, and manufacturing 19 percent.

Before taking up the question of who can best

provide technology extension services, it is worth

stepping back and considering what a comprehensive nationwide system might look like. Since

manufacturing industries are regionally concentrated, technology extension centers would not be

evenly distributed across the country. In areas of

sufficient concentration, some centers could focus

on technologies for just one industry or group of

industries (e.g., electronics suppliers, auto parts and

components makers), while others would be more

eclectic.

If the average center served about 200 clients per

year, and if 24,000, or just 7 percent, of the Nation’s

355,000 small and medium-size manufacturing firms

took advantage of the services, then about 120

centers might be needed. This is a modest number,

based on the experience of the Georgia Tech

Qs’rhe Nation~ Governors’ Associ~ion conduct~ the study under contract for NIST. Results were published in Marianne K. Clarke and Eric N.

Dobson, Promoting Technological Excellence: The Role of State and Federal Extension Activities (Washington, DC: National Governors’ Association,

1989.)

~wo studies have found high rates of return on investments in agricultural research, extension, and farmers’ schooling. One study estimated internal

rates of return (value of agricultural product/research and extension expenditures) of 27 percent on such public investments in the State of Virginia

(George W. Norton, Joseph D. Coffey, and E. Berner Frye, ‘‘Estimating Returns to Agricultural Research, Extension, and Teaching at the State bvel,”

Southern Journal ofAgricultura/ Economics, July 1984). The other study found asocial internal rate of return to public crop research of 62 percent, and

15 percent to farmers’ schooling (Wallace E. Huffman and Robert E. Evenson, ‘‘Supply and Demand Functions for Multiproduct U.S. Cash Grain Farms:

Biases Caused by Research and Other Policies,’ American Journal of Agricultural Economics, August 1989.)
56 ● Making Things Better: Competing in Manufacturing

industrial extension service. The Georgia Tech

service, with 13 small offices statewide and a staff

of 26 professionals, makes site visits to about 480

clients per year, usually limits service to 5 days, and,

as noted, does not advertise, for fear of attracting

more clients than it can serve.47 Georgia has about 2

percent of the manufacturing establishments in the

United States. If other areas provided industrial

extension at only the same limited level, and each

center served about 200 clients per year, the centers

would number 120, the staff 3,120, and the clients

about 24,000.48

These figures are based on the assumption that the

technology extension services do a good job and

prove to be worth what they cost. Assuming that they

do, a nationwide technology extension service

obviously cannot arise overnight. There is room for

expansion of both State and Federal centers, and it

will take time. The question is whether one or the

other is better suited to provide the services. It is

often thought that States, being in closer touch with

their own citizens, do a better job of providing

business and technical services. On the other hand,

regional concentrations of industries cross State

lines, and it is usually difficult for States to combine

forces and provide services on a regional basis. Still

more important, some States simply do a better job

than others, and the interest in improving manufacturing competitiveness is more than parochial; it is

national.49

A combination of State and Federal programs

might best serve the national interest. (It is worth

noting that Japan’s technology extension network

combines national, regional and local support, with

the national government and prefectures sharing

equally the funding 185 centers nationwide, and

local governments funding more centers on their

own.) Federal grants to support expansion of experienced, high quality State programs and technical

assistance to bring newer ones along could be an

efficient use of resources. At the same time, there are

benefits in having Federal programs as well. Federal

officials who supervise technology extension have

the advantage of frost-hand knowledge, which is

valuable in evaluating State programs. Federal

technology extension centers may be especially

useful in places where concentrations of one industry or allied industries cross State lines, or in areas

that are otherwise underserved.

If Congress decides to support the expansion of

State programs, it might consider raising the present

authorization of $2 million in Federal matching

grants. That sum would not go far toward building

a comprehensive nationwide network of technology

extension services. Suppose that within 5 years the

U.S. Government is contributing to the support of 60

State programs, each with total funding of $1 million

to $4 million a year, depending on the level of

service. If the Federal share were 30 percent (as it is

in the Agricultural Extension Service), that would

amount to $18 million to $72 million a year. These

are extremely modest assumptions. If a nationwide

program were even as large, in proportion, as the

Georgia Tech extension service, it would include

120 centers and cost the Federal Government $36

million to $144 million a year.

Congress might also consider removing the condition that State programs, to receive funding, must

demonstrate methods to increase uses of Federal

technology. Helping U.S. manufacturers make better use of technology, whatever the origin of the

technology, is in the national interest.

As for Federal Manufacturing Technology Centers, Congress may wish to reconsider the law’s

sunset provision, under which Federal funding stops

after 6 years. NIST officials expect that the Centers

will generate some income themselves by charging

some fees for service, but that they will rely mainly

on State funds as Federal funds are phased out. If

Congress considers technology extension a matter of

continuing interest, it may want to extend Federal

funding at some level beyond the 6 years. Stability

and predictability is an important ingredient in the

success of institutions like these, and continued

Federal funding is a factor in stability.

d’l~e G~gia TWh pro- seines the same number of clients without site viSitS-a totzd Of tibout 960 Per y=.

AsThe e~mate of tie sim of a m~~~ n~ionwi~ extension service is based on the lower number, i.e., the 480 clients receiving site visits.

4~ome F~er~ ~rogms hat offer ~mts t. s~tes, ~th ve~ 1i~e in the way of oversight or guitince, ~ve run into the problem of uneven level

and quantity of senice in different States. An example is the displaced worker reemployment and retraining program of the Job Training Partnership

Act, See U.S. Congress, Office of Technology Assessment, Technology and Structural Unemphyment: Reemploying Displaced Adulti, OTA-ITE-250

(Springfield, VA: National Technical Information Service, 1986).
Chapter 2-Strategies To Improve U.S. Manufacturing Technology: Policy Issues and Options .57

Financial Aid for Modernizing

Manufacturing

Technical assistance is one part of the prescription

for improving the technology base in American

manufacturing, especially for small and mediumsize enterprises that do not have a large or diverse

technical staff. Another part is money. Unless a

small firm has an outstanding track record, it will

generally have a harder time raising money for

purchase of new production equipment than will a

large one. It is hard enough for large U.S. firms to

match the capital investment rates and R&D spending of their best foreign competitors, in view of the

high interest rates in the United States and a financial

climate that rewards short-term profits more than

Iong-term improvement in market share (see ch. 3).

For smaller fins, the difficulties are often compounded.

There are many U.S. laws on the books that give

special breaks to small business.50 For example, the

Buy American laws governing purchases by U.S.

Government agencies give American firms a 6

percent price advantage (the agency must buy

American unless the price of the foreign-made good

is at least 6 percent lower); but for small businesses,

the price advantage is 12 percent. Another example

is the Small Business Innovation Research program,

which sets aside about $350 million of Federal R&D

money per year for small businesses (see ch. 7).

Also, there are special guaranteed loan and

subsidized capital programs for small businesses.

Direct Federal loans to small business are limited to

special groups (disabled veterans, the handicapped,

low-income people), and totaled only $47 million in

fiscal year 1989. (Direct Federal loans to small

business were virtually abolished in the Reagan

years, on the philosophical grounds that government

loans were an interference with efficient allocation

of resources through the free market.) Federally

guaranteed commercial loans to small business

amounted to $3.6 billion.51 In addition, the Federal

Government subsidizes the Small Business Investment Corporation and the Minority Small Business

Investment Corporation, which make equity investments as well as long-term loans to small fins.

Congress appropriated $154 million for these two

programs in fiscal year 1989, and the corporations

made investments amounting to $715 million. All of

these financial programs, it should be noted, are for

all kinds of small and mid-size businesses, not just

manufacturers.

The point of most of these programs is to give

general support to smaller businesses on the grounds

that they are dynamic and entrepreneurial, and

contribute to economic growth and flexibility. The

programs have rarely been designed for the specific

purpose of promoting effective use of manufacturing

technologies. This contrasts with the Japanese

approach. In Japan, financial aid to small firms is not

only very much larger-some $27 billion in direct

loans from national government programs and an

additional $56 billion in loan guarantees (again, to

all kinds of small and mid-size businesses, including

a great many in the service sector)--but also, much

of the financial aid is tied to technical assistance and

some is directly targeted to technology improvements (see ch. 6).

Some options for linking government financial

aid to manufacture with technological improvements, and possibly raising the amount, are discussed below.

Equipment Leasing

To encourage the adoption of modern manufacturing equipment, Congress might consider creating

a government-supported equipment leasing system

that would: 1) make available to manufacturers

(especially small companies) new production equipment on easy terms; and 2) provide an assured

market for at least part of the output of companies

making production machinery.

The Japanese government’s equipment leasing

system, under which small and mid-size companies

can lease new equipment or buy it on the installment

plan at less than market rates, is a key technologypromoting measure, and one that seems reasonably

adaptable to the United States. The Japanese system

was frost created in 1966, but a new part was added

in 1986 that applies specifically to computers and

‘‘mechatronics" —such things as numerically controlled (NC) machine tools and robots. Both the

sqn tie Unitd stat=, tie km *Csm~l business” USually means firms with fewer than 500 employees, and thUS includes medium-sti business ~

well. In Japan, the tam small and medium-size enterprise (SME) usually means fms with fewer than 300 employees.

SIF~r~ly ~uant~loas Werekept ~ nmin~ly he me level from fisc~ yews 1980 ~CI@ 1989 (about $3.5 billion per year), although prices

rose by 47 pereent over the period, redueing the amount of real dollars.
58 ● Making Things Better: Competing in Manufacturing

national government and the prefectures contribute

funds to the system; in 1987, leases and installment

sales worth 49 billion yen ($350 million, at 140 yen

to the dollar) were made under the system. Besides

supporting this frankly subsidized system, the Japanese Government has also provided capital for

quasi-public leasing corporations that serve larger as

well as smaller companies. One of these is for lease

of computers, another for robots (see ch. 6).

Small companies benefit from the leasing system

in several ways. If they are strapped for cash, they

don’t need a downpayment; if they are not sure of the

economic benefits of a new piece of equipment they

can try it out without committing to it; and the

system provides technical consultations and guidance on what equipment they need. Besides these

benefits for users, the system also provides a

substantial, stable market for manufacturers of

production equipment (e.g., machine tools).

If Congress wishes to create and support such a

system for the benefit of users only, the country of

origin of the equipment does not matter. But if the

system is designed to build up the capacity of U.S.

makers of production equipment as well, then it

would be necessary to define what a U.S. company

is. The limited American experience with providing

government help to private industry in improving

manufacturing technology does not offer much

guidance on this question. The answer might vary

depending on practical circumstances. If one main

purpose of a government-subsidized leasing program were to rebuild the U.S. toolmaking industry,

it might make sense to restrict the purchases to

machine tools made in this country, perhaps by

U.S.-owned companies. (Such a requirement might

be phased in, since it might be against the interests

of machine tool users if U.S.-made machines were

not as good as foreign-made machines.)

A government-supported leasing system could be

set up in various ways. It might be open only to small

firms or to all firms without regard to size. If open to

all, it might give more favorable terms to small firms

if it were open only to small fins, the government

could also support in a less direct manner (i.e.,

provision of capital on favorable terms) a quasipublic leasing company that would be open to all.

Should Congress be interested in creating an

equipment leasing system, an opportune place to

start might be in the effort just getting underway to

develop a next-generation controller for machine

tools to be made in the United States. The National

Center for Manufacturing Sciences (made up of

about 90 manufacturing firms, large and small) and

the U.S. Air Force are sponsoring a 3- to 5-year joint

project to promote the development of a new,

U.S.-made, single-standard computer controller for

NC machine tools. A government-supported leasing

system could provide some assurance of a market for

U.S.-made machine tools using the new controller,

and could add impetus to the R&D effort. If

Congress wants to start small, on an experimental

basis, with a government-supported leasing system,

this could be a place to begin.

An equipment leasing system for NC machine

tools could start with quite modest funds. Total sales

of NC machine tools in the United States amounted

to $1.7 billion in 1988; one-quarter of that ($425

million) was spent for U.S.-made machines. U.S.

producers of machine tools (all kinds, not just NC)

lost an average of 11 percent per year in sales from

1981 through 1988. Suppose they regained sales of

NC machines at an average of 10 percent per year;

in the first year, their sales would rise by $43 million.

Suppose the government leasing system bought

roughly 30 percent of the incremental output, or 13

million dollars worth, and leased it at a subsidized

rate of about 80 percent of the sales price (i.e., a 20

percent subsidy). Then the cost of the program

would be $2.6 million for that year, plus a modest

sum for administrative expenses, less the taxes firms

would pay on their increased profits.

A question that is always asked about schemes

such as this is whether they really encourage wider

diffusion of manufacturing technologies, or whether

the government is simply subsidizing purchases that

companies would make anyway. No certain answer

can be given, but it seems likely that there would be

some real encouragement. First, experience suggests

that government purchases are a genuine factor in

promoting the development and manufacture of

new, advanced products; this incentive applies to the

makers of the machinery. As for users of the

machinery, a 1987 survey of representative metalworking companies found that uncertainty about

demand for the companies’ products and lack of

financial resources were the biggest obstacles to

investment in new plant and equipment. In plants

without any NC machines (or other programmable

automated equipment), managers gave as a leading
Chapter 2-Strategies To Improve U.S. Manufacturing Technology: Policy Issues and Options ● 59

reason that the payback period was too long.52

Leasing the equipment could help managers cope

with the uncertainty about demand, and subsidies

embedded in the leasing program would lessen

concern about financial resources and payback

periods.

Tying Technical Assistance to Financial Aid

In the United States, government financial aid to

small businesses is not necessarily aimed at technological improvement. But it could be shaped to serve

that purpose. For example, Congress might wish to

require a technical assessment as a condition for a

firm’s getting a federally guaranteed loan or capital

from one of the federally subsidized small business

investment corporations.53 But this requirement

makes sense only if a government-supported extension service exists and is able to supply competent

people to make the assessment. Any such requirement would probably have to wait for the development of a much more extensive network of technology extension services than the United States has

today.

Another caveat is that government-supported

loans and capital investments in small business are

currently a minor source of business financing—

about $3.8 billion in 1989. To put this in some

perspective, all freed investment (in structures, plant

and equipment) by all private business was $487

billion in 1988. Moreover, since only about 9

percent of small American enterprises are in manufacturing, it is unlikely that more than a small

portion of the U.S. financial aid to small businesses

goes to manufacturers. Furthermore, the aid probably reaches very few fins. In fiscal year 1988,

16,469 federally guaranteed loans were made to

small businesses, and the quasi-public small business corporations made a total of 4,137 financing.

If small manufacturers got a proportionate share of

these guaranteed loans and subsidized financing,

then 1,915 small manufacturing firms benefited—

about one-half of one percent of the 355,000 small

manufacturing firms in the country. Even if technical assessment were a condition forgetting financial

help, not many small manufacturers would get either

one.

This raises the question of whether U.S. Government financial aid to encourage the adoption of new

technologies, especially by small fins, is too

skimpy. Recognizing that there is no exact parallel

between the two countries, it is still notable that

Japanese loans and loan guarantees to small firms

are at least 20 times as high as U.S. Federal financial

aid to small business.54 Moreover, the amount of

subsidy in the Japanese loan programs is often

greater. Some examples: In the United States, the

terms for federally guaranteed loans are negotiated

between the borrower and private lender, but interest

rates can be as high as 2 3/4 percent above prime. In

Japan, interest charges on such loans are generally

well below the market rate. For instance, the

Equipment Modernization Loan Program (which

made direct loans of about $300 million in 1988)

lends up to half the amount of the equipment

purchase, and charges no interest.

In many ways, Japanese and American small

manufacturing are not really comparable. Manufacturing in Japan is much more weighted to small

fins, which account for 74 percent of Japanese

manufacturing employment but only 35 percent in

the United States.55 Although total manufacturing

employment is higher in the larger U.S. economy

(19.4 million vs. 14.5 million in Japan) the number

of employees in small and mid-size manufacturing

firms is nonetheless greater in Japan (10.7 million v.

6.8 million in the United States).

Considering the political and economic differences between the two countries, Japanese policies

obviously cannot be a template for U.S. policies. Yet

the great disparity in assistance to small businesses

does suggest that some higher level of aid to small

szM~ellen R. Kelley and H~ey Brooks, The S@te of Computerized Autornarh in U.S. Manufacturing, Hwtid university. John F. Kerm~y

School of Government (Cambridge, MA: October 1988). Managers of plants with no programmable automation also gave technological reasons for

non-adoption, the major one being that there were too few repeat runs to make the initial programming worthwhile.

sqM~Wement ~istmce is av~lable from tie Small Business Investment Corporation ~d the ~noriv En@Pfi* sm~l Bus~ess ~v~tm~t

Corporation, but is not a eortdition of getting capital funds from the corporations.

54Mmy SW= have s~i~ lea, gr~t, or capit~ investment programs for small businesses. OTA is nOt WSR of tiny estimate for~e tot~ of fi~ci~

aid to small business in all States, nor of any similar estimate of financial aid from prefectures, cities, or other local governments to Japanese small firms.

551n JWn, SMES ~ defm~ ~ fires M* fewer ~~ 3~ employ~s; in he unit~ st~s, fewer tian 5W employ~s. AIso, SMES contribute 56

pereent of value added to manufacturing in Japan, 21 percent in the United States. Employment, rather than value added, is used here as an indicator

of the importance of SMEs in manufacturing because the biggest component of value added is wages, and in both countries wages are substantially lower

in small manufacturing firms than in large ones.

21-7000- 90- 3
60 ● Making Things Better: Competing in Manufacturing

U.S. manufacturing firms is worth considering as a

way to raise their technological level and make them

more competitive. Government help to small U.S.

manufacturers could be especially significant, since

it is uncommon in this country for large customer

firms to give financial or technical aid to their

suppliers. By contrast, many Japanese subcontractors get some financial support from their customer

firms and a great deal of technical assistance.

If Congress wishes to consider an option of

greater financial aid to small manufacturers, expansion of guaranteed loans, which takes advantage of

the existing private banking system, probably has

more appeal than resurrection of direct loans. The

disaster of the 1980s with Federal savings and loan

insurance might argue against any new or expanded

program of Federal financial guarantees. However,

other loan guarantee programs, such as the Federal

Housing Administration’s guarantees for home mortgage loans have a better record. With the backing of

the government guarantee, banks can offer lower

than market rates for FHA mortgages and lower

requirements for downpayments and borrowers’

incomes. At the same time, an FHA inspection

provides some assurance that the property subject to

the loan is sound. This program can be reckoned a

success. At least until the great inflation in real estate

of the 1970s, FHA-backed loans made it possible for

people of quite modest means to own a home.

Although the default rates on FHA loans have risen

somewhat in recent years, they have generally been

moderate. Default rates on the quite limited program

of federally guaranteed loans to small business are

also moderate.56

If Congress should decide to raise the amount of

Federal loan guarantees for small manufacturers,

options for tying financial aid to technological

improvement assume greater importance. One option would be to target new financial aid to

investments in advanced equipment. The Japanese

Government has done this through its special leasing

program for high-tech electronic and “mechatronic” equipment, open to smaller manufacturers,

and also through selective tax breaks for high tech

investments (described below). There is evidence

that these targeted programs worked in Japan. After

they were offered, there was a surge in purchases of

NC equipment. (One Japanese manufacturer called

it ‘the NC-ization period. A possible drawback to

such inducements is that they might encourage firms

to buy equipment that they really do not know how

to use. They might even incite producers of the

equipment to cash in by raising prices.

Another option is the one mentioned above: make

Federal financial aid conditional on the fro’s

getting a competent technical assessment and either

following its guidance or working out an alternative

plan with the advisor. The obvious difficulty with

this option is that adequate public technology

extension services don’t yet exist.

Tax Incentives

An option much used in Japan is to give companies tax breaks-credits or accelerated depreciation—

for investments in new production equipment. Especially prominent are various tax incentives available

to small and medium-size enterprises (SMEs). In

effect, these tax breaks are subsidies, paid for

indirectly by the taxpayers. It has long been Japanese

Government policy to encourage business investment with programs that keep the costs of capital

low, and this seems to be eminently acceptable to the

public, who pay for it. In the United States, policies

for this purpose have been less consistent and are

much more controversial.

A general discussion of tax incentives as a way to

stimulate investments in plant and equipment appears in chapter 3 and an earlier section of this

chapter (Financing Long-Term Investment). Discussed there are the disagreements among analysts

on whether increases in investment due to tax

incentives are significant or trivial; the fact that

many special tax incentives were removed in the

1986 tax reform act as a quid pro quo for lowering

the overall corporate income tax rate; the perverse

effect of this bargain, in rewarding old investments

s~e ent~e ~owt of d~t busjness Ioans and the guarantd portion of guaranteed business loans disbursed by the Small Business Administration

from fiscal years 1953 to 1989 was $50.5 billion, of which $3.9 billion had been charged off as losses by September 30, 1989. On this basis, the loss

rate for SBA business loans and loan guarantees was 7,7 percent. (Information provided by the House Committee on Small Business.) However, the

“net loss rate,” figured on the same basis that commercial banks use, is lower, For 1986-88, SBA’S net loss rate for guaranteed business loans was 3.60

to 3.74 percent. This compares to net commercial and industrial chargeoffs by banks of 1.17 percent of commercial and industrial loans in 1987 (the

latest date available). Note that SBA takes greater risks than banks because its loans go to startups and other good prospects that need long-term loans

but have too literal equity or collateral to qualify for a bank loan. Allan S. Mandel, Assistant Deputy Administrator for Financial Assistance, U.S. Small

Business Administration, “The Role of SBA 7(a) Loan Guaranty Program in the U.S. Economy,” October 1989.
Chapter 2-Strategies To Improve U.S. Manufacturing Technology: Policy Issues and Options ● 61

in productive equipment at the expense of new

investments; the fact that tax incentives cost something and worsen the budget deficit, unless revenue

is found elsewhere to make up for them; and the

urgency of weighing all reasonable options for

improving manufacturing technology. In view of

these many complications and uncertainties, the

conclusion was that Congress might wish to mandate a study, with an early delivery date, of the

effects of tax incentives as a stimulus to capital

investment in manufacturing. This could include a

consideration of special tax incentives for small

manufacturers.

The broadest and most accessible of the Japanese

tax incentives for capital investment by SMEs is

accelerated depreciation-14 percent in the first

year, on top of normal depreciation-for any machine an SME purchases.57 A measure more directly

targeted to high-tech equipment is the SME New

Technology Investment Promotion Tax System

(established in 1984) which offers SMEs two

options for buying or leasing electronic and mechatronic technology: either a special first year depreciation of 30 percent, or a tax credit of 7 percent of the

value of the machine, up to 20 percent of total taxes

(in the case of leased equipment, 7 percent of 60

percent of the total leasing expense).

Cooperative Networks of Small

Manufacturing Firms

There is strength in numbers. Small firms that

band together to do cooperative research and development, get quantity discounts on new equipment,

share equipment that no single owner can afford,

find out about new technologies and new markets,

share orders that are too big for any one firm to

handle by itself, and find work for members when

orders are scarce, can strengthen themselves and

each other without losing competitive drive. Cooperative networks in textiles and metalworking grew

and prospered in mid and northern Italy in the 1970s

and early 1980s (but seemed to be undergoing some

reversal in the late 1980s). Such networks have

proven stable in certain industries in Japan, and may

be growing in importance.

Both the national and prefectural governments in

Japan are strongly supportive of cooperative associations. SME cooperatives can get the same tax

breaks and subsidized equipment leasing as individual small firms, and are eligible for low-cost loans

from some of the same government financial institutions. There are also special loan programs for

cooperatives with low (sometimes zero) interest

rates, as well as government support for joint R&D

by groups and cooperatives.

Nothing like this government support for cooperative networks of small manufacturing firms exists in

the United States. In fact, there is a certain deterrence

to cooperation among small firms from antitrust law

and enforcement—if not in demonstrable fact, at

least in widespread perception (see ch. 7 and the

section below on antitrust options.)

If Congress wishes to support the formation of

cooperative associations among small manufacturing firms, it might explicitly state that cooperatives

are eligible for the technology extension services

offered by the Manufacturing Technology Centers.

Cooperatives might also be eligible for small business loan guarantees, and if an equipment leasing

program is established, for that as well. If Congress

wishes to start in a modest way on a program

specifically targeted to cooperatives, it might begin

with a program of technical assistance on how to

organize cooperative activities, such as joint purchases of equipment at discount or shared use of

equipment.

Commercialization of Technology From

Federal Laboratories

Most R&D performed in Federal laboratories is

not directly applicable to civilian industry. Out of

$21 billion spent per year, about $13 billion is for

defense, and much of the rest is for basic research.

Some of this defense R&D and basic research can be

made useful to civilian industry, in two ways. First,

the labs’ expertise and results can be transferred to

industry, which then performs further work to

commercialize the technology. Technology transfer

can be accomplished in many ways, including

personnel exchange between labs and industry,

private fins’ use of specialized lab facilities, and

granting licenses to firms for commercializing the

labs’ patented technology. Generally, effective techsyM~ri~ in tis ~tionon t~ incentives for SMEcapit,al investments is drawn mostly from D.H. Whittaker, “New Technology Acquisition in sm~l

Japanese Enterprises: Government Assistance and Private Initiative,” contractor report to OTA, May 1989. This report also provides information on

the Japanese equipment leasing and financial aid programs.
62 ● Making Things Better: Competing in Manufacturing

nology transfer requires some person-to-person contact.

Second, there is cooperative R&D by the labs and

industry. Rather than simply transferring preexisting

technology to industry, the labs cooperate with

industry to create new technology, which the firms

involved can then commercialize. Cooperative R&D

builds on the labs’ existing work but takes it in a

direction useful to industry-helping to bridge the

gap between the labs’ work and industrial applications.

Cooperative R&D is a powerful tool. With the

Federal labs sharing the expense and risk, industry

could be better able to take on large, long-term

projects with a highly uncertain payoff; and both lab

and industry researchers can benefit from sharing

ideas with each other. This approach implies that

Federal labs should make some of their R&D

choices at least partly on the basis of their usefulness

to industry.

In some instances mechanisms for promoting

commercialization of lab technology have worked

well. For example, industry has benefited from using

specialized facilities at the Department of Energy’s

(DOE’s) multi-program national labs (e.g., Brookhaven

National Laboratory’s Synchrotrons Light Source,

and Sandia National Laboratories’ Combustion Research Facility in Livermore, California). However,

there is a consensus among industry, labs, and

government agencies that technology from Federal

labs with defense or basic research missions is being

commercialized much too slowly, despite the legislation that Congress passed throughout the 1980s to

encourage such commercialization.

On consideration, this result is not surprising.

These types of activities are difficult even when only

industry is involved. Firms with much in common

have difficulty in agreeing on cooperative research

projects, and it is even difficult to transfer technology from a firm’s central R&D facility to that firm’s

own plants. Government-industry interaction is still

harder. It requires a fundamental reorientation on

both sides, since traditionally the Federal Government and industry have opposed or ignored each

other. In particular, the Federal labs and their parent

agencies must address many difficult issues involving conflicts of interest, fairness to fins, national

security, and proprietary information. Labs also face

the formidable obstacle that U.S. firms are often

slow to take advantage of new technologies developed outside the firm (see ch. 6). When no firm

expresses an interest in a particular technology, it is

difficult for the government to identify those firms

that could benefit--especially since the government

traditionally has not been skilled at marketing.

Moreover, even if a lab finds a firm interested in its

technology, negotiations can bog down because of

bureaucratic inertia and because government agencies often do not understand industry’s business

constraints.

In the 1980s, Congress encouraged the labs to

include technology transfer in their main missions .58

Congress also authorized lab-industry cooperative

R&D,59 but made no special appropriations for it,

apparently hoping that it could be supported within

existing program budgets. This approach has often

foundered, for several reasons. Lab and agency

personnel often consider the promotion of commercialization an improper distraction from the lab’s

primary mission. Agency security offices make

conservative rulings on what information can be

released, general counsels are equally conservative

on which lab-industry arrangements are legally

permissible, and these rulings often actively interfere with the labs’ efforts to work with industry. And

in general, Federal labs and agencies face the

inevitable problem of institutional inertia, a serious

barrier to the new practices required for improved

lab-industry cooperation. Such a climate can stop

labs from working with industry unless there is a

strong supporting voice within the agency.

Congress could provide stronger incentives for

lab and agency personnel to help commercialize

technology. In practice, this probably means earmarking money for promoting commercialization.

Those who administer such money will want to

spend it, and those who spend it will be evaluated on

the technology that was commercialized. Congress

could also remove some obstacles, including agency

SsFor exmple, in the Stevenson-Wydler Technology Innovation Act of 1980 Congress declared the @icy that ‘the Federal Government sh~l s~ve

where appropriate to transfer . . . technology . . . to the private sector. In the Federal Technology Transfer Act of 1986 Congress added that

“[t]ednologytransfer, consistent with mission responsibilities, isaresponsibility of each laboratory science andengineeringprofessional.” 115 U.S.C.

3710(a).

59FXSl Technology Transfer Act of 1986, 15 U.S.C. 3710~
Chapter 2-Strategies To Improve U.S. Manufacturing Technology: Policy Issues and Options ● 63

red tape and legal problems with granting exclusive

rights.

Earmarking Money for Promoting

Commercialization

Most labs (or programs within labs) with missions

of either defense R&D or basic research do little

cooperative R&D with industry. Congress could

mandate that some part of the labs’ budgets be spent

only on cooperative projects with industry-perhaps

requiring equal matching funds from industry. A

possible model is DOE’s high-temperature superconductivity pilot centers in three multi-program

national labs, which are collectively spending several million dollars only on R&D that industry

proposes and cost-shares. Congress might start at a

few percent of a lab’s total budget, and depending on

experience increase that amount to perhaps 10 to 20

percent. Since cooperative R&D opportunities must

be seized quickly, labs and agencies would need a

general pool of money to apply as they saw fit to

cooperative projects, without going through a budget

cycle to justify each project individually. Congress

could also provide stable multi-year funding to give

firms the confidence to enter into long-term projects.

Requiring certain money to be spent on collaboration with industry would change the labs’ missions

somewhat-or at least add to their missions a

contribution to the commercial part of the economy.

If the labs’ budgets were not increased, then their

original missions might suffer. However, it might

not damage a lab’s original mission to choose a

small fraction of its research projects on the basis of

relevance to industry’s interests and needs; some of

these projects might still be in some way useful for

the mission goals. In any case, Congress might deem

it worthwhile to target some fraction of Federal

R&D money to projects that have a good chance of

leading to commercialization.

Transfer of existing technology to industry also

requires money. Activities include identifying appropriate technologies, patenting them as needed,

marketing them, and in some cases giving startup

firms some support (e.g., office space, help in

writing a business plan, access to venture capital) to

exploit lab technologies. Congress has directed

agencies to set aside ‘sufficient funding, either as a

separate line item or from the agency’s research and

development budget” to accomplish technology

transfer and to provide annual reports on past and

planned technology transfer activities.60 Congress

might wish to conduct oversight hearings to make

sure that sufficient funds are being allocated. Alternatively, Congress might mandate required funding

levels. 6l

Congress could also increase the funding of the

Federal Laboratory Consortium (FLC), currently

about $1 million per year. 62The FLC, with volunteer

representatives from over 300 labs and a small

central staff, functions for firms as a single point of

inquiry or entry into the Federal lab system. Additional full-time staff would help the FLC meet its

goal of matching an inquiry with an appropriate lab

researcher within 1 day, and would also give the

FLC more continuity. With its current reliance on

volunteers from the labs, the FLC inevitably suffers

from high turnover of personnel. (Full-time staff

might be recruited from the labs’ ranks; they would

then be familiar with the labs.) Additional funding

would also let the FLC pursue more projects to

demonstrate new ways to facilitate commercialization.

Congress might also designate funds specifically

for facilitating personnel exchange. Currently, it is

uncommon for industry researchers to take visiting

positions at Federal labs, and the reverse is quite

rare. Subsidizing visiting positions from a special

fund would provide an extra incentive for the firm,

the Federal lab, and/or the researcher. The fund

could at least be used to ensure that the researcher’s

pension benefits continue to accrue during his visit.

Removing Obstacles

Before undertaking either to commercialize existing Federal lab technology or to perform cooperative

R&D with a Federal lab, firms often require exclusive rights to the technology; otherwise their invest-

~ational Competitiveness Technology Transfer Act of 1989, Public Law 101-189, Sec. 3133(e) (amending 15 U,S,C, 3710(b)).

61Befo~ w p~~e of & National Competitiveness Technology Transfer Act of 1989, agencies were directed to set aside one-half percent of their

R&D budgets, though agency heads could waive this amount and some did. Stevenson-Wydler Tedmology Innovation Act of 1980, Public Law 96-480,

sec. 11, amended and renumbered as sec. 10 by the Federal Technology Transfer Act of 1986, Public Law 99-502, sees. 3-5,9(e)(l), codifkd at 15 U.S.C.

371O(I3).

~he FLC’S complex funding is set out at 15 U.S.C. 3710(e). Funding is set to expire aik FY 1991.
64 ● Making Things Better: Competing in Manufacturing

ment will not be worthwhile. Labs often face several

obstacles in granting these rights.

First, there is red tape while the labs’ parent

agencies review the agreement. This is a serious

problem, since delay can kill a deal. In 1986

Congress permitted agencies to delegate to government-operated labs the power to make agreements

for licensing and cooperative R&D (subject to

agency veto within 30 days).63 In April 1987,

President Reagan by Executive Order directed all

agencies to do so,64 but it took many agencies until

well into 1988 to comply and two (NASA and the

Navy) still had not complied late in 1989. Congress

might wish to make the delegation mandatory and

automatic by statute. In December 1989 Congress

passed legislation permitting a similar delegation to

contractor-operated laboratories.65 Congress might

also wish to make this delegation mandatory, and/or

to conduct oversight hearings to determine whether

the situation has improved for DOE’s contractoroperated labs, which have often experienced long

delays in getting approval for cooperative R&D.

Some of DOE’s labs have also been handicapped

by having to negotiate with DOE for patent rights

before they can grant such rights to a firm. Currently,

with certain exceptions, DOE’s labs run by nonprofit contractors can automatically take title to

patents from lab research;66 Congress may wish to

extend that rule to include labs run by for-profit

contractors as well, and narrow the exemptions—all

with appropriate safeguards such as requiring royalties to be used within the lab.

Another legal problem concerns copyright. Under

the law, works created in whole or in part by

government employees cannot be copyrighted. This

prohibition applies to software created at governmentoperated labs. Congress might wish to change the

law to allow a copyright for such software, so that

firms will have more incentive to commercialize

software from these labs (commercializing it usually

requires substantial further development work) and

to engage in cooperative R&D that will produce

software. Congress might also wish to clarify that

DOE may maintain secrecy for software or other

data developed cooperatively.

Lab-industry cooperation raises legal issues not

only about exclusive rights, but about many other

subjects as well, such as potential conflicts between

a researcher’s duty to the government and his desire

to get personal gain from consulting, royalties, or a

contemplated startup firm. To encourage general

counsels to overcome their caution, Congress might

establish an interagency legal task force for labindustry interactions. If a general counsel felt

uncertain about a proposed arrangement, he could if

he wished submit the question to the task force,

although the task force’s approval would not be

required.

University-Industry Collaborations

The National Science Foundation created Engineering Research Centers for several purposes: 1) to

integrate different engineering disciplines in R&D

projects that are useful to industry and improve U.S.

competitiveness; 2) to encourage cross-disciplinary

training of engineers; 3) to improve relations between university and industry researchers; and 4) to

generate strong participation from industry in research, education, and funding.

Early reports from this relatively new program

(begun in 1984) indicate progress toward these goals

(see the section on ERCs in ch. 7). In particular, the

early returns suggest considerable success in the key

objective of educating engineers in several disciplines. NSF is monitoring the centers closely to see

that their research is cross-disciplinary, is useful to

industry, and gives engineers a broad education.

Under this scrutiny, 2 of 18 centers have lost their

NSF funding.

The two basic options with a program that seems

to be going well are to leave it alone or to expand it.

In favor of leaving it alone is the argument the

program is still experimental and all the results are

not yet in. In any case, the Federal Government is

strapped for funds. The strongest argument in favor

of expansion is that a bigger program could produce

more engineers with the kind of cross-disciplinary

training that manufacturing needs. The vast majority

@ls USC. 3710a.

6’$Ex~utive &&r 12591, l%cilitating Access to Science and Technology, Apr. 10, 19W, sec. 1. Pa. b(l).

~~licIAW 101-189, Sec. 3133(a).

W35 U.S.C. 202(a).
Chapter 2--Strategies To Improve U.S. Manufacturing Technology: Policy Issues and Options . 65

of U.S. engineering students take no part in the

program.

67

As noted above, in the section on human resources, one way to increase support for manufacturing R&D and education in universities is to create a

Manufacturing Sciences Directorate in NSF. In

addition, a much broader program of support for

manufacturing R&D in universities might be one of

the things a Civilian Technology Agency could do.

(See the section below on Strategic Technology

Policy.)

Tapping Into Japanese Technology

Government-sponsored programs to encourage

transfer of technological research from Japan to the

United States are of two main kinds: sending

researchers to Japanese laboratories (people-topeople exchanges) and scanning the technical literature. Federal programs of both kinds are quite new

and still small; they have not yet come near their

potential as a source of technological advances. Both

would thrive better if more Americans learn to read

and speak the Japanese language.

People-to-People Technology Transfer

NSF programs to promote long-term research by

Americans in Japanese labs were established by

executive action. Congress has not enacted any laws

for this purpose, other than including in the 1988

trade act a direction to U.S. negotiators to ensure

symmetrical access to technological research.68 As

noted in chapter 7, new government programs to

support U.S. engineers and scientists doing longterm research in Japan, established in 1988 by the

Japanese Government and the National Science

Foundation, were not fully subscribed in 1989-90.

There is reason to believe these programs will have

many more applicants within a few years, since

privately sponsored programs to send researchers to

Japan have grown fast after a gestation period of a

few years. Congress may wish to monitor the

progress of the Japanese government and NSF

programs, with an eye to supplementing them if

applications multiply and, at some point, expansion

is needed.

Meantime, another option would be to establish a

Congressional U.S.-Japanese Fellowship Program,

taking advantage of the prestige that the sponsorship

of Congress confers. Congress might also wish to

encourage researchers working in Federal labs to

undertake long-term projects in Japan. In oversight

hearings, Congress might suggest that agencies

encourage sabbaticals for this purpose. For example,

the three national labs that have pilot centers

working on lab-industry collaborations in hightemperature superconductivity might be able to send

some of their people to the Japanese national

laboratories, MITI facilities, or university labs that

are giving high priority to basic and applied research

in this field. A modest but useful initiative that NSF

might undertake would be to put together in one

place information on all the programs, public and

private, that offer U.S. researchers the chance to

work in Japan.

In addition, Congress might consider establishing

a program of post-doctoral or midcareer commercial

fellowships in Japan, open to people other than

scientists and engineers, for example, economists,

business administration graduates, and experienced

business managers. The program might identify

positions in Japan that would enrich the fellows’

understanding of Japanese management techniques,

industry practice, and government-industry relations. For example, positions might be found in

Japanese Government agencies, in banks or securities companies (whether Japanese or foreignowned), or possibly in Japanese manufacturing

companies. As with exchanges of scientists and

engineers, any such program would have to start

small and build gradually as U.S. candidates find out

about the program and learn enough Japanese to

profit from it.

Scanning Japanese Technical Literature

In the Japanese Technical Literature Act of 1986,

Congress took steps to encourage the transfer of

technology through the written word. The Office of

Japanese Technical Literature, set up under the act

in the Department of Commerce, keeps up with new

technical developments in Japan and publishes

information about abstracts and translations of

Japanese technical literature. The office is small,

bTAt four ERCsex~~by OTA in visits and interviews, only about 1 percent of engineering undergraduates and4 to 11 IXXentof Wdwe ~ud~~

took part inthe ERC program. Only 18 universities have ERCs (two of these are being discontinued but two were added in January 1990); this compares

with 280 colleges and universities in the United States that offer engineering education.

@Khnnibus Trade and Competitiveness Act of 1988, Public Law 100-418, Part II., SW. 5171.
66 ● Making Things Better: Competing in Manufacturing

operating with two people on an annual budget of

$425,000.

If Congress wishes to take further steps to help

researchers penetrate Japanese technical literature, it

might wish to increase the appropriation for the

office. Possibly, ” the office could collaborate with

private services that offer abstracts and evaluations

of Japanese technical literature and, on demand,

translations. Because these services are expensive

but not very familiar to potential users, the Office

might consider offering users such as NSF grantees

or industrial subscribers partial, temporary subsidies. This would get users started, and allow them to

judge the value of the services before they have to

make full payment.

Japanese Language Studies

The ability to read and speak the Japanese

language is fundamental to transferring technology

from Japan, both through people and through

publications. The best way to learn languages is to

start young. Congress has already taken a step

toward getting Japanese language instruction in the

public schools. The 1988 education act authorized

Federal grants of up to $20 million a year to help

finance model foreign language programs.69 The

program supports instruction in “critical foreign

languages,” as defined by the Secretary of Education. Congress might wish to oversee the program

and evaluate whether it gives the study of Japanese

enough weight.

Congress might also wish to support an expansion

of Japanese language programs at the college level

and beyond. The NSF language courses for scientists

and engineers-are getting an eager response, but are

quite small-limited to 100 or so people a year-and

are at the post-graduate (mostly post-doctoral) level.

One option would be to fund a larger program of this

kind. Another would be to encourage the study of

Japanese at the undergraduate level, perhaps by

providing NSF fellowships for engineering undergraduates who want to study Japanese.

Antitrust Law

Antitrust law has a long and honorable history in

this country. It has been used to dismember monopolies (Standard Oil), induce dominant firms to yield

entry points to smaller firms (unbundling of IBM

computer hardware and software), and open many

fields to innovative newcomers. In recent years,

however, as international competitors have tightened the screws on domestic fins, some people

have questioned whether traditional tough enforcement of antitrust laws is still appropriate or wise.

In fact, antitrust law and enforcement have been

relaxed in the past decade. Congress amended the

law to make it easier for firms to get together for

cooperative research or to form export trading

companies. The Reagan Administration was generally considered less aggressive in antitrust enforcement than previous administrations. And the Federal

courts have interpreted the law in less stringent

ways.

Nevertheless, the antitrust laws may still deter

some cooperation among firms that could help their

competitive performance. Firms sometimes hesitate

to undertake such things as joint R&D or manufacturing, cooperation to set voluntary industry standards,

or simple sharing of information, for fear they will

run afoul of the antitrust laws. This is especially true

of cooperation among firms in the same business.

Generally, the problem is not so much that the

cooperation would actually violate the law, as that

the law is unclear and penalties of misinterpreting it

can be severe. Thus, firms often shy away from

activity that runs even a small risk of being deemed

a violation.

To minimize these effects, Congress could by

legislation clarify and modify the legal standard for

permissible activities and change enforcement procedures and penalties. It should be possible to draft

such changes in the law without letting down our

guard against anti-competitive activity. Several bills

pending in Congress attempt to strike a proper

balance by changing the law in certain limited

contexts.70

@Au_F, Hawk@.Ro~ ‘Z S@ffgrd Elemm~ and Secondary School Improvement Amendments of 1988, Public Law 100-2fJ7, Tide IL PW

B,

T%= bills inclu~ the Joint Manufacturing op~unities Act, H.R. 423; the National Cooperative Innovation md Commercialization A@ H.R.

1024; the National Cooperative Reseamh and Reduction Amendments Act, H.R. 1025; the High Definition Television Competitiveness Act, H.R. 1267;

the Cooperative Productivity and Competitiveness Act, H.R. 2264; the Advanced Television Competitiveness Act, H.R. 2287; the High Definition

Television Development Act, S. 952; and the National Cooperative Researeh Aet Extension Act, S. 1006.
Chapter 2-Strategies To Improve U.S. Manufacturing Technology: Policy Issues and Options ● 67

The Legal Standard

One uncertainty in antitrust law is whether an

activity will be judged using the rule of reason, under

which activities are permissible if pro-competitive

outweigh anti-competitive effects. Under the National Cooperative Research Act of 1984,71 joint

R&D (as defined in the Act) is always judged under

this standard.

Joint manufacturing, cooperative manufacturing

and marketing by small fins, and standard-setting,

which in general are more likely to have anticompetitive effects than joint R&D, were not

included in the 1984 Act. While the rule of reason

would normally be applied to these activities as well,

it is not clear that in all cases the pro-competitive

effects will be fully considered. Congress could

clarify that the rule of reason applies in these

contexts as well.72 This clarification would change

the existing legal rules (as interpreted by the courts)

little if at all. It would remove doubt as to what the

rules are, and (especially if accompanied by congressional findings) would signal courts to take seriously

the potential benefits of cooperation.

Congress “could also establish safe harbor market

shares, below which no violation would be found. In

practice, antitrust violations are now rarely found if

the firms involved have a combined market share of

under 20 percent. Establishing a safe harbor at that

level would not change the law much, but would

simplify and clarify it. Firms with less than 20

percent combined market share could proceed without fear; if sued they could get the lawsuit dismissed

early on. However, the measure would not apply

automatically to all firms claiming to fall below the

20 percent limit; they might still be judged to have

a greater combined market share, depending on how

the court defined the relevant market.

Antitrust law sometimes makes it difficult for

U.S. firms to merge or form joint ventures to resist

strong actual or threatened foreign competition. U.S.

firms do not get any special lenient treatment in this

context, because our antitrust law, as a matter of

principle, is nationality-blind (U.S. and foreign

firms are treated equally).

Congress might be reluctant to introduce national

bias into our antitrust system. Yet even within a

nationality-blind framework, antitrust law could be

made more sympathetic to mergers or joint ventures

of domestic firms under threat of foreign competition. By law, Congress could instruct the Federal

enforcement agencies and the courts to take a

long-term view and to listen seriously to factual

arguments in particular cases that U.S. firms’ joining

forces will ultimately promote competition in the

U.S. market.

For example, it might be argued that foreign firms

currently having little share of some particular U.S.

market will capture all of it in a few years, unless

U.S. firms in the same industry merge or form a joint

venture to resist the foreign competition. Although

the merger would reduce the number of U.S.

competitors in the short run, the number would be

greater in the long run--e.g., one instead of none. As

a further example, it might be argued in a particular

case that competition in the U.S. market cannot be

achieved without a healthy U.S. industry. For

example, the exit of most U.S. firms from the

merchant DRAM market in the mid- 1980s left U.S.

computer firms exposed to high prices from foreign

DRAM producers. Also, there is some evidence that

U.S. computer and semiconductor firms that depend

on foreign, vertically integrated competitors for

critical components or equipment are last in line for

the latest technology.73 A joint venture or merge r

that has primarily anti-competitive effects in the

near term might be necessary in the long term to

maintain a healthy U.S. industry.

Both of these examples involve arguments that

U.S. firms in principle can make now in antitrust

suits. However, enforcement agencies and courts are

likely to reject such arguments as based too much on

speculation about the future. Congress could bolster

the arguments by writing into legislation: 1) findings

that scenarios like those described above can happen, and 2) a direction that the law should be applied

to enhance competition in the long term.

71~bli~ ~w 98462, 15 U,S$C. 4301 -4305,”

72HOR. 1025 ~~~dd~ ~ forjo~t ~an~actfing andm~keting; H. 1024 would do so forjointmanufacturing andmarketingto exploit R&D conducted

jointly or by one or more of the participants; H.R. 423 would do so for joint manufacturing and marketing by small businesses with at most 20 percent

combined market share; H.R. 2264 and S. 1006 would do so for joint manufacturing, but not joint marketing.

‘%3X Ch. 5.
68 ● Making Things Better: Competing in Manufacturing

Enforcement Procedures and Penalties

Federal antitrust law can be enforced both by the

government and by private parties. Successful private parties are awarded treble damages, plus

reimbursement of reasonable attorney fees. These

heavy awards in private suits increase the risks to

firms undertaking cooperative ventures; in particular, these awards encourage private parties to file

lawsuits even when they have weak cases, in the

hope of extracting a payment to settle the case.

Some analysts believe that few private antitrust

suits are justified and have concluded that private

enforcement should be eliminated. However, that

would leave enforcement of Federal antitrust law

totally up to the Federal Government, which might

not have the resources or the will to police the whole

country effectively .74

A less extreme approach would be to award only

single damages in private antitrust suits. This is the

provision of Japanese and EC law.75 Even with

single damages, Federal antitrust law would still

have stronger enforcement provisions than most

other U.S. laws, as it includes both public and private

enforcement, attorney fee awards in private suits,

and permission to States to sue on behalf of their

citizens.

Congress has taken some steps toward removing

treble damage provisions. Under the National Cooperative Research Act of 1984, R&D projects (as

defined in the Act) registered for publication in the

Federal Register are subject only to single damages.

Congress is now also considering bills to allow only

single damages for registered cooperative manufacturing ventures, registered cooperative manufacturing and marketing ventures, or registered cooperative manufacturing and marketing ventures by small

businesses with at most 20 percent market share.76

It might make sense to remove treble damages

only for projects registered for public disclosure,

because anti-competitive activities threaten competition less when they are disclosed to the public.

(Treble damages might be needed to discourage

firms from secret, clearly anti-competitive activities

that might not be discovered. Disclosure enables

others to quickly file suitor monitor the project.)

However, selective removal of treble damages

might be only partially effective. Some companies

might shun registration because it could give away

strategic information, and it involves some extra

expense as well, including the need to amend the

registration if the project’s scope changes. If the

reduction to single damages covers only certain

activities (e.g., as in the bills described above), firms

might have trouble predicting whether certain activities are covered. Adoption of single damages for all

activities would afford simplicity and certainty,

although it could make the law less effective at

discouraging some anti-competitive conduct.

A middle ground might be to adopt single

damages for certain registered activities and also in

individual cases where the accused firm can show it

acted in good faith. Good faith might be shown, for

example, by an opinion from counsel, or by the fact

that the firms had a reasonable (albeit losing)

argument that their activity would pass muster under

the rule of reason. If treble damages were reserved

for the relatively rare egregious cases, the risks of

inter-fro cooperation would be less, and private

parties would have less incentive to file suit with

weak cases .77

Another option, which could complement the

single damages approach, is to let firms apply to the

government for advance certification that a proposed

activity is permitted. The Export Trading Company

Act of 1982 followed this approach for export

trading companies. 78 One bill before Congress takes

this approach for joint manufacturing and marketing

that exploits R&D results.79 So long as firms stay

within the scope of the certification, they could not

be sued for damages or penalties, either by the

T4s= for exwp~e, Report of the American Bar Assoc@ion Section of Antitrust Lxzw, Tmk Force on the Atiitmt Division of the U.S. Dep~tme~

of Justice, July 1989, pp. 52-55 (finding that the Antitrust Division of the Department of Justice has inadequate resources and low morale).

Ts’rhom~J~de~d David T~e, “Innovation, Cooperation and Antitrust: Balancing Competition and Cooperation, ’ High IWvwlogyLawJowW

vol. 4, No. 1, spring 1989, p. 56 and fmmote 157. EC antitrust law applies only in certain circumstances; in other cases, the member states’ own antitrust

laws apply.

715H.R. 2264 and S. 1006, H.R. 1025, and H.R. 423, respectively.

77A ,similar rule exis~ for patent infringement. Treble damages may be awarded, but o~y in egregious c-.

T~bfic IAIW 97-290, 15 U.S.C. 4001 et seq.

79H.R. 1024.
Chapter 2-Strategies To Improve U.S. Manufacturing Technology: Policy Issues and Options ● 69

government or private parties. At most, they could

be ordered to stop what they were doing.

Advance certification gives greater protection to

firms than just replacing treble with single damages,

but could be costly and time-consuming. Present

procedures for non-binding approvals from the

Justice Department and the Federal Trade Commission often take several months and require considerable attorney time. Certification would be most

useful if, at least in simple cases, a firm could apply

for one without assistance of counsel, and it could be

issued within weeks, not months.

Innovation and Intellectual Property

Many concerned with our manufacturing competitiveness would put stronger intellectual property

protection worldwide for new technology (including

patents, copyrights for software, and trade secret

protection) near the top of their list. Stronger

protection, it is argued, rewards invention, which is

an American strength, and by encouraging R&D

would make U.S. products more competitive. Also,

it would discourage foreign firms from imitating

U.S. firms’ new products and processes—thus

protecting sales of U.S. firms, making them stronger

competitors in the present and better able to support

long-term development for the future.

It is not clear, however, that stronger protection

always encourages more R&D. And it is not clear

how much stronger protection would help increase

U.S. fins’ sales. There are limits, for example, to

how far we can push developing countries to go

along with stronger protection, since they do not see

it as to their advantage. From their point of view, it

would make their people pay more for foreign goods

and stop their firms from taking advantage of foreign

technology. More fundamentally, patents and other

forms of protection for technology usually provide

only a temporary edge, until competitors find or

invent an alternative way to get the job done. A surer

way to competitive success over the long run is to

improve the cost and quality of U.S. manufactured

goods.

Nevertheless, some changes could improve the

intellectual property environment. First, certain

features can be corrected in the United States-a

relatively easy thing to do, since it can be done

unilaterally. These improvements at home matter

since the United States remains the most important

market for most U.S. firms today. Measures requiring international negotiation can also be usefully

pursued. These concern not only the substance of

legal rights but also the procedures for enforcing

them. If intellectual property law is poorly enforced,

then even strong-sounding legal rights do not

amount to much in practice.

Protection of Patent Rights in the United States

Prompt enforcement of patent rights is the most

urgent need for improvement of intellectual property

protection in the United States. Patent cases that go

to trial take an average of over 21/2 years before

ending in a decision. During this time the firm with

the patent loses sales and must pay legal bills. Some

firms might not make it to the end of the trial. Even

if a firm survives and prevails at trial, compensation

awarded by the court might not fully makeup for the

harm caused by the infringer. (However, recent court

decisions show particular concern to provide full

compensation when possible, and also show willingness to find special circumstances justifying treble

damages or an award of attorney fees.)

One way to speed up patent infringement trials

would be to designate special judges for patent

cases. At present, patent cases are normally heard by

U.S. district court judges, who often have little

expertise in patent law. Congress could encourage or

require district courts to designate certain judges to

hear all patent cases. They could be chosen for their

expertise in patent law or build it up with experience.

This approach would conflict with the philosophy

that Federal judges should be generalists. However,

specialist Federal judges are not without precedent.

Since 1982 the U.S. Court of Appeals for the Federal

Circuit has handled all appeals in cases arising out

of patent law and in certain other specialized areas

of the law since 1982. That court is credited with

bringing order and predictability to patent law.

Because patent law is hard for the uninitiated to

grasp, it seems a good area of the law for specialist

judges. (If the Federal Circuit is any guide, specialist

judges also tend to favor patent owners.)

Congress might also consider increasing the

judicial manpower devoted to hearing patent cases.

One option might be to increase the number of

Federal district court judges across the board (with

the option of designating some of them patent

judges); alternatively, Congress might instruct the

courts to advance patent cases ahead of other cases.

However, our Federal judicial system in general
70 ● Making Things Better: Competing in Manufacturing

suffers from delay, and Congress might not believe

that patent cases need extra judges any more than,

for example, cases against drug dealers do.

In evaluating whether patent cases deserve a

special claim on limited judicial manpower, Congress might consider that, in effect, extra judges have

already been assigned to hear patent cases, and those

judges’ ability to handle cases quickly and competently has been hailed as a great strength of our

patent enforcement system. These are the four

administrative law judges at the U.S. International

Trade Commission. They are assigned to hear cases

of “unfair imports” under Section 337 of the Tariff

Act of 1930, as amended,80 most of which concern

patent infringement. Under Section 337, U.S. firms

can apply for an order to be enforced by the Customs

Service which stops infringing goods from entering

the country. The law mandates that cases be decided

in 1 year (18 months in a minority of cases declared

“more complicated’ ‘)—much faster than the average time for trial in Federal district court.

However, the General Agreement on Tariffs and

Trade (GATT) ruled in 1989 that Section 337

enforcement proceedings violate U.S. obligations

under the GATT treaty, by discriminating against

foreign goods. This decision put pressure on the

United States to change Section 337 procedures.

However, it is hard to satisfy the objections of the

GATT panel while keeping the advantages of: 1) a

quick decision, and 2) an order which can exclude all

infringing goods (or all infringing goods from

certain manufacturers), no matter by what route and

by whom they are imported. The Office of the U.S.

Trade Representative has been considering various

options, including handling all patent infringement

cases in a special court, or allowing the Commission

to issue temporary exclusion orders which would

then be reviewed by a court with a full trial. The

Administration may propose a solution along these

or other lines for consideration by Congress.

Protection of Patent Rights Abroad

The United States is engaged in bilateral and

multilateral negotiations to strengthen intellectual

property protection abroad. Two important goals are

changes in Japan’s patent system and a unified world

patent system.

●

U.S. firms find Japanese patents not very effective

in stopping imitation by Japanese firms. Japan’s

system is slower than ours in issuing and enforcing

patents, and it is strongly tilted toward licensing of

patents (see ch. 7). Often, U.S. firms wish not to

license patents to Japanese firms but rather to

exclude them. The reason is fear of losing all their

sales in Japan, since Japanese customers strongly

favor a Japanese supplier if one is available.

Successful negotiations to change the Japanese

patent system could help some American firms hold

on to sales in the rich and fast-growing Japanese

market.

Besides the problems inherent in the Japanese

patent system, there is the added problem that many

U.S. firms are ignorant of how the system works.

This ignorance sometimes extends to basic facts. For

example, one firm did not know that after the initial

application, a follow-up request must be made for

the Japanese patent office to examine the application. Congress might consider creating an office in

the Patent and Trademark Office to collect and

disseminate information about the Japanese patent

system.

The second goal, creation of a unified world

patent system, would help firms desiring patent

protection in more than one country. Currently, with

some exceptions, they must file separate applications in each country. This is expensive, requiring

legal and translation services in each country. In an

international patent system, one application would

be enough for a patent good in all participating

countries.

A prelude to this long-term goal is the harmonization of different countries’ patent laws and application procedures. The United States has been negotiating to this end, especially with Japan and the

countries of the EC. Any agreement will probably

require substantial changes in our own patent

system. For example, the United States now follows

a first-to-invent system (in which the first person to

make an invention is entitled to a patent); we would

probably have to change to a first-to-file system (in

which the first inventor to file an application is

entitled to a patent), which almost all other countries

now use. Also, the United States now keeps patent

applications secret; almost all other countries publish applications after 18 months. In this too we

8019 U.s.c. 13370
Chapter 2-Strategies To Improve U.S. Manufacturing Technology: Policy Issues and Options ● 71

would probably have to follow suit. While such

changes might face strong political opposition in

this country, Congress may wish to consider them

seriously if they are proposed by the Administration

as part of an overall treaty, containing important

concessions from other countries.

STRATEGIC TECHNOLOGY

POLICY

In the past 40 years, and especially in the last 10,

it has been an article of faith that government

support of research and development should stick to

basic science, or else to the government’s own

needs—mainly military security. Yet, government

backing for particular technologies seen as critical to

the nation’s economic progress is hardly unknown.

The most obvious example is in agriculture. The

U.S. Government contributes well over $1 billion a

year to the Cooperative Extension Service for

agricultural research and technology extension. The

Service itself is 75 years old, and its origins go back

still further, to the foundation of the land-grant

universities in the Merrill Act of 1862 and Federal

finding of State agricultural experimental stations,

begun under the Hatch Act in 1887.

A venerable example from manufacturing is the

civilian aircraft industry. Established in 1915, the

National Committee on Aeronautics (NACA, later

the National Aeronautics and Space Administration,

or NASA) conducted or funded significant research

on airframe and propulsion technologies for years.

NACA’s R&D typically went well past basic

research, extending to pre-commercial proof of

concept (tests of specific combinations of materials

and systems). The government’s decision in 1915 to

back the aircraft industry with scientific and engineering R&D was grounded in the conviction that

the entire nation had a stake in all phases of aviation,

and that the country where powered flight was

invented should be a leader in its continued development. The decision was made on patriotic, but not

narrow national security grounds.

After World War II, the idea took firm root that

only defense needs justify government development

of new technologies much beyond the basic research

stage. Although the government was the principal

force in the early development of computers and

semiconductors, both through R&D funding and

procurement, it did so in the name of defense.81

Sometimes the connection with defense was indirect. The Defense Advanced Research Projects

Agency (DARPA), whose mission is to support

long-term, risky research for national security needs,

justified some of its computer R&Don the grounds

that, since the Department of Defense was a major

user of computers, it would benefit in the end from

R&D that led to advancement of the technology in

the commercial sector.

A related argument was used recently to justify

the special government funding that semiconductor

R&D is receiving. Alarm over the precipitous loss of

the memory chip market to the Japanese led to

urgent requests from U.S. semiconductor producers

for government R&D help. Congress responded

with a contribution of $500 million over 5 years to

the Sematech consortium to improve the manufacture of DRAM chips, and put DARPA in charge of

the government’s part in the project. The idea is that

military security depends on a stable supply of

memory chips from U.S. suppliers. Congress also

gave DARPA a total of $46 million in fiscal years

1988-89 for R&D in materials, devices, and manufacturing process technology for high-temperature

superconductivity.

The national security argument is wearing thin,

however. As the military threat from the Soviet

Union recedes, the economic challenges from Japan,

the newly industrialized Asian countries, and a

unified Europe loom larger than ever. In the public

debates on government support for Sematech, hightemperature superconductivity, and lately on high-

-definition television (HDTV), the stakes in economic as well as military security got some frank

recognition. Not all parties agreed that our economic

security needs any bolstering from the government.

But the stage was set for a new debate in which the

grounds for public support of technology advance

could shift.

Picking Winners

Government funding for R&D in semiconductor

technology, high-temperature superconductivity, and

technologies for HDTV departs from usual U.S.

policy since each of these projects concentrates

much more on the applied than the basic end of

R&D. Indeed, the whole point of Sematech is to

glKenne~ F]-, “Gwcmment’s Role in Computers and Superconductors,” contractor report to the OTA, March 1988.
72 ● Making Things Better: Competing in Manufacturing

improve the manufacturing process for a particular

product—the 16-megabit DRAM semiconductor.

However, the recent cases are tentative and ad hoc

compared to the steady long-term R&D support that

civil aircraft manufacture has enjoyed, and the

combination of R&D and technology extension that

has been available to American agriculture since

early in the century, through the land grant colleges

and the Cooperative Extension Service.

The widely accepted economic argument for

selective but solid government support of commercially interesting technologies is that government

should share the risks of long-term, highly uncertain

R&D projects in which the potential for benefits to

society is great, but the payoff to individual firms is

likely to be small and not worth the risk. In the U.S.

financial environment, with its high cost of capital

and emphasis on short-term profit taking, the argument for government’s sharing the risks of long-term

R&D takes on special force.

The argument against giving selective support to

technologies that are vital to particular commercial

industries is mostly political. In brief, it runs as

follows: the American political system is pluralistic,

disorderly, and open at so many places to influence

from special interests that rational government

decisions on technology or industry policy are next

to impossible. The idea that government cannot

“pick winners,’ and if it tries to will just bungle the

job, rests partly on this political argument and partly

on the simple claim that the market, for all its

failures, is a better bet.

Politics probably interfere less in government

support for R&D than in ventures more directly

connected to commercial production, such as government-backed low-cost loans or purchase guarantees.

Such ventures are likely to cost more than R&D

support, and are closer to the intensely political issue

of jobs. Moreover, it is possible to erect safeguards

against ill-informed or political] y inspired choices of

technologies for government R&D support. Shared

R&D projects, in which industry takes part in

selecting the subject and puts up at least half the

money, are one way for government to escape

blatant pressure from special interests and also to

enlist industry and market forces in the process of

picking winners.

The record of the two industries that have received

most government support for technology advance

over the years belies the simple statement that

government cannot pick winners. These industries

can hardly be described as failures. Until the recent

challenge from Airbus (which has had billions of

dollars in R&D and working capital support from

four European governments) the U.S. air transport

industry was the undisputed world leader in technology, and it still produces a bigger trade surplus for

the United States than any other manufacturing

industry ($15.4 billion in 1988). Agriculture has

contributed trade surpluses for years ($16.4 billion

in 1988) and is a technology leader as well. Labor

productivity on U.S. farms has increased more than

elevenfold in this century .82

The history of both industries suggests that

government can not only pick winners but help to

create them. (See box 2-A for a brief account of

government support for the civilian aircraft industry.) Of course, there are failures too. For example,

in 1980 Congress voted to create the Synfuels

Corporation that President Carter had proposed the

previous year, providing $20 billion in loan guarantees for plants making wood-based, coal-based, and

shale-based substitutes for petroleum fuels, and

price guarantees for the output. Synfuels was one of

several initiatives designed to make the United

States energy-independent, some of which still

continue today. But expectations that the Synfuels

Corporation would be able to produce fuels from

domestically available feedstocks without additional research and development were unrealistic, oil

prices fell, and the Reagan Administration succeeded in killing the program. Synfuels, it is

generally conceded, was a failure.

Japanese industrial policies have missed the mark

too. Some examples of projects that did not achieve

their objectives include MITI’s effort to spur fast

development of the biotechnology industry, the fifth

generation computer project aimed at developing

artificial intelligence, and the entry into the civilian

gzsme a~c~tu~ technologies develo- and disseminated by the Department of Agriculture, the land grant universities, and tie Cooperative

Extension Service have raised labor productivity at serious cost to other values. For example, the overuse of broadscalepersistent insecticides in the 1950s

and 1960s did much environmental damage, and in the end did not work because the target insects became resistant, secondary pests were released, and

natural predators were killed off. However, continuing R&D in the Federal-State agricultural research and extension system is working on safer

approaches to pest management.
Chapter 2-Strategies To Improve U.S. Manufacturing Technology: Policy Issues and Options . 73

aircraft industry with the YS-11 commercial transport.

Thus, there are examples of both success and

failure. The failures do not prove that government is

inherently ineffective at fostering technologies of

interest to particular industries. Said one DARPA

employee, “We defend our right to fail.” This is an

essential right for anyone trying to develop something new, whether it is new to the world, like

aircraft in the early 20th century, or new to a nation,

like a commercial air transport industry was to Japan

in the 1950s.

Another lesson may be learned from our limited

and uneven record of picking commercial winners;

that is, if efforts are confined to crisis situations, they

will be more likely to fail than if a more proactive,

strategic approach is adopted. Synfuels was conceived in 1979 when, for the second time in the

decade, oil deliveries from the Middle East were

sharply curtailed for political reasons, prices shot up,

shortages appeared, and anxiety over energy dependence was at a peak. Today, there is an air of

urgency over whether or how to support America’s

late entry into the business of developing and

producing advanced television products. In a panic

situation, there is little time to construct or examine

options or weed out the wilder ones.

Creating a Civilian Technology Agency

One option to help avoid the pitfalls of technology

development by crisis is to establish a civilian

technology agency. The last few years have brought

arising chorus of pleas by and on behalf of industries

that are in danger, and it is likely there will be more

in the future. If Congress wishes to respond to those

pleas in an organized fashion, it could benefit from

having an agency whose job would be to anticipate

such developments, develop proactive options in

response, avoid some crises, and improve the

chances of responding well when they do arise. The

alternative is for Congress to continue responding ad

hoc—an option that some prefer, on grounds that

government support for commercial R&D should be

the exception, not the rule.

Congress has already established a small program

that might in time become a full-fledged civilian

technology agency—NIST’s Advanced Technology

Program. Created in the 1988 trade act, the program

got its first funding, $10 million, in fiscal year 1990.

The Program’s purpose, as stated in the law, is to

help U.S. businesses apply research results to the

rapid commercialization of new scientific discoveries, and to the refinement of manufacturing technologies. The Program can assist joint R&D ventures

with technical advice or can take part in them—

providing start-up funding or a minority share of the

cost, or lending equipment, facilities, and people to

the venture.

In October 1989, the Senate passed a bill that

would authorize the Advanced Technology Program

to receive as much as $100 million funding per year

and gave quite specific directions on where to put

this R&D support.83 The bill directed the Program to

give limited financial assistance to industry-led joint

R&D ventures in “economically critical” areas of

technology, and spelled out five areas that should get

most of the support: advanced imaging electronics,

including advanced television; advanced manufacturing; applications of high-temperature superconducting materials; advanced ceramic and composite

materials; and semiconductor production equipment

for the development of X-ray lithography.84

Other bills in the 100th and 101st Congresses,

taking a broader but less directive approach for R&D

support of strategic commercial technologies, proposed to create an Advanced Civilian Technology

Agency .85 It would be located in a new Department

of Industry and Technology, replacing the Department of Commerce. The agency would make grants

to and cooperative agreements with R&D entities,

with the government providing a minority share of

the funding. The purpose would be to support high

risk projects with potentially great value to the

civilian economy that would otherwise lack adeS3S. 1191, entitled tie TdmoIogy Administration Authorization Act of 1989.

~ebill specified that $75 million of the $100 million should be available for these five areas, with individual projectstobe approved by the %cretaty

of Commerce and the Directorof NIST; in reporting the bill, the Senate Committee on Commerce, Science and Transportation suggested specific amounts

for each of the five high technology areas. The bill also authorized $13 million for other technologies deemed of great economic importance by the

Secretary and the Director; $10 million was reserved for small businesses with promising technologies; and $2 million was specified for program

management, analyses, and workshops.

8S@e of~e= bills, S. 1233 ~ the looth Cmgew, WaS reported out of the Senate Committee on Governmental Aff*, anached to tie 1998 W*

act, and then dropped. Two similar bills, H.R. 3838 and S. 1978, were introduced in the IOlst Congress.
74 . Making Things Better: Competing in Manufacturing

Box 2-A--Government Backing for the Civilian Aircraft Industry

After the Wright brothers flight at Kitty Hawk in 1903, the U.S. Government was slow to get behind

aeronautical research and development.l Twelve years went by before the creation of the National Advisory

Committee for Aeronautics (NACA), a U.S. Government institution whose purpose was to further the science and

technology of aeronautics. Meanwhile, the Wrights (and some others, mainly Glenn Curtiss) had gone on building

planes and improving them, but with little research support. Most of the flying was left to barnstormers and stunt

flyers, whose hijinks and appalling safety record did not help to commend aviation to serious research attention.

The military services waited until 1907 to let their first contract for an airplane, and the first appropriation for

military aircraft-$25,000 for the Navy-came in 1911.

At the same time, European governments were taking very seriously the possibilities opened up by the first

successful powered flight. All over Europe, but particularly in France, Britain, and Germany, governments either

established or contributed to aeronautical research centers. Advances came quickly. In July 1909 Louis Bleriot flew

across the English Channel. In the next couple of years, many new European planes emerged (Bleriots, Farmans,

Antoinette), some demonstrating features such as allerons and monoplane design that were superior to the Wrights’

designs,

Aviation enthusiasts in America were mortified. They “found it a national embarrassment-not to say a

danger--that the country where aviation began should trail so far behind the Europeans.”2 By 1911, some of them

started to campaign in earnest for a national aeronautical laboratory. They were not to succeed until 1915, when

Theodore Roosevelt endorsed the idea and the Congress looked on it with favor. Even so, the joint resolution

creating NACA would have been lost in a close-of-session rush if it had not been backed by the powerful Naval

Affairs Committee and tied to a navy appropriation bill.

NACA’s charge was to ‘‘supervise and direct the scientific study of the problems of flight, with a view to their

practical solution, and to determine the problems which should be experimentally attacked.”3 By the 1920s, NACA

was an important contributor to R&D for the fledgling commercial industry. NACA pioneered in building and using

large wind tunnels, collaborated with both the civilian aircraft industry and the military on designing research

projects, and made its test facilities and a stream of test results available to both throughout the 1920s and 1930s.

NACA boasted among its accomplishments the design, modeling, and testing of a family of airfoil shapes, so

well-characterized that designers could select wing sections for various purposes off the shelf. The famous NACA

cowl, developed and tested in NACA’s propeller wind tunnel in the late 1920s, was credited with greatly reducing

wind resistance in the then-standard air-cooled radial engine, cutting engine drag by 75 percent with hardly any loss

in cooling. NACA research also helped to define optimal placement of the engine in the wing, thus contributing to

much greater engine efficiencies and higher speeds, When airline cruising speeds rose from 120 to 180 miles per

hour, overnight transcontinental runs became possible, and air travel boomed even in the midst of the depression.4

After World War II, NACA and its successor, the National Air and Space Agency (NASA) continued

aeronautical research and testing, but the aircraft companies were soon outspending them, and military R&D

dwarfed both.s However, the aircraft companies continued their close relations and collaborative research with

NASA, and a liberal system of cross-licensing of patents (originally backed by NACA and continued under NASA)

helped to diffuse technology advances throughout the industry.6 Technological spillover from military to civilian

aircraft remained consequential at least through the 1960s. For example, the airframe design of the Boeing 707

l~ex Roland, Mo&l Research: The National Adviso~ Committee for Aeronautics, 1915-1958 (Washington, DC: U.S. @vernment

Printing Office, 1985), vol. 1.

2

1bid., p. 4.

s~blic Law 271, 63d Cong., 3d sess., Mar. 3, 1915, cited in Roland, Op. Cit., vOi. 2, p. 394.

4Rol~nd, op. cit., vol. 1, pp. 92-94, 111-1 16; David C. Mowery and Nathan Rosenberg, ‘The Commercial Aircr* ~dus~~” Guver~@

and Technicul Progress, Richard R. Nelson, (cd,) (New York, NY: Pergarnon Press, 1982), pp. 128-129.

5From 1945 t. 19w, tm~ R&D Spn&ng in the ~cr~t indus~, mili~ and civilian, w= $l@ billi~ (1W2 doll~), of which $81

billion was provided by the military, $18 billion by industry, and over $9 billion by non-military Federal agencies. David C. Mowery, “Joint

Ventures in the Commercial Aircraft lndwstry,’’[nternutionul Collaborative Ventures in U.S. Manufacturing, David C. Mowery (cd.)

(Cambridge, MA: Ballinger Publishing Co., 1988), p. 75, For a brief history of government R&D support for the civilian airmfl industry, see

David C, Mowery, “Collaborative Research: An Assessment of Its Potential Role in the Development of High Temperature Superemductivity,”

comract report to the Office of Technology Assessment, January 1988.

%hma-licrxtsing was abandoned in 1975, due to the objections of the Antitrust Division of the Department of Justice,
Chapter 2-Strategies To Improve U.S. Manufacturing Technology: Policy Issues and Options ● 75

passenger plane was such a clone of the KC-135 refueling tanker that Boeing made for the Air Force that the first

prototype 707 wheeled out of the Seattle plant had no windows in the fuselage.7 Boeing eventually made more than

800 KC-135 tankers. Sharing development costs and moving down the learning curve together with its military twin

brought down costs for the 707 much faster than would have been possible otherwise.

The civil aircraft industry also benefited from other government policies besides NACA/NASA support for

R&D. From 1930 to 1934, U.S. Government contracts with airlines to carry the mail included subsidies, and helped

to sustain demand for civilian aircraft during the depression. (Indeed, at that time, the major aircraft companies were

vertically integrated with the airlines and with engine companies as well. The Air Mail Act of 1934 ended the

subsidies and forced dissolution of these vertically integrated firms.) In addition, regulation of airlines by the Civil

Aeronautics Board indirectly favored technology advance in aircraft manufacture. By ruling out price competition,

the CAB encouraged the airlines to compete on performance instead, and thus indirectly supported the aircraft

manufacturers’ commitment to technological excellence.8

CAB regulation is now ended; the airlines are competing more on price and passing on competitive pressures

to aircraft manufacturers. And the civilian aircraft industry relies less than it did in the past on government R&D.

The airframe companies-especially Boeing, which is far and away the biggest in the civil aircraft business---fund

most of their research and nearly all their development costs on the commercial side (engine companies still get

substantial Defense Department funds for commercial projects that may have a military payoff).9 Also, spinoffs are

fewer; civilian and military aircraft technology has increasingly diverged in the past 20 years or so, not only in the

overall product but to some degree in component technologies. 10 Nevertheless, NASA still spends a fair amount

on generic aeronautical research and testing (about $350 million to $400 million a year), which complements the

industry’s private R&D and reduces its costs to this day.

7&@Wev and Ro~~krg, op. cit.> P. 131“

8Mowery, “Collaborative Research,” op. cit.

9~ Coml=ion on industrial Productivity, “The U.S. Commercial Aircraft Industry and M Foreign Competitors,” The Working

Papers of the MIT Commission on lndu.mai Productivity (Cambridge, MA: The MIT Press, 1989), p. 16.

IOIbid., p. 17,

quate private support. The agency’s activities would It may be objected that DARPA is not appropribe overseen by a 21 -member Board with at least 14

from various industries and businesses, small and

large, and the rest from State and local governments,

academic institutions and nonprofit organizations.

A model that has sometimes been suggested for a

civilian technology agency is DARPA. Established

in 1958 (as ARPA-the D, for Defense, was added

later), this small elite agency has gained a reputation

for flexible, impartial decisionmaking, and for

intelligently placing its bets. It has of course, lost

some of its bets, and some have been a very long

time in paying off. For example, from its beginning

DARPA has been a major supporter of research in

artificial intelligence. Only in the early 1980s, after

20 years of steady investment by DARPA, did the

first commercial AI projects begin to emerge.86

ately compared to a civilian technology agency,

since it has a military mission and can be held

accountable to that mission. Yet, as noted above,

DARPA has often interpreted its mission very

broadly. The Department of Defense buys on the

commercial market, and it benefits if that sector

excels in technology, and suffers if it lags. And if the

commercial sector does lag, U.S. defense could

become too dependent on superior foreign producers. The fact that commercial companies are selling

AI machines based on research that DARPA has

funded for nearly 30 years illustrates how DARPA’s

broad interpretation of its mission can carry it well

into the commercial side of the economy. (This is not

always the case; DARPA’s support for broad R&D

projects with no obvious short-run military applicas~e f--st commerci~ AI machine was Xerox’s Interllsp work station, introduced in 1981. Although Xerox funded much of the development

internally, it also relied on DARPA projects and funds. By 1985, four U.S. firms were selling computers designed to program in the AI language LISP;

all had direct ties to DARPA-funded research. Flamm, op. cit.
76 ● Making Things Better: Competing in Manufacturing

tions has waxed and waned, depending on budgets

and competing DoD demands. )87

The parallels between DARPA and a civilian

technology agency go only so far. Choosing technologies that must eventually prove their worth in the

market is tougher, even allowing for failures, than

choosing ones for which there is some credible

military use, so that at least one customer—the

government-is likely to materialize. Also, the

choice of technologies to support may lend itself to

political pressure on the civilian more than on the

military side (though decisions about military procurement are hardly free from the competing claims

of different regions and industries). A civilian

agency would probably have to balance political

pressures more deftly than DARPA is called upon to

do, but the difference might be more a matter of

degree than of kind.

A distinct difference is that a civilian technology

agency would need to interact much more closely

with industry than DARPA does in choosing technologies to support, in the design of R&D, and in

joint payment for R&D. Until very recently, with

Sematech and some small HDTV projects, DARPA

has not funded projects jointly with industry. And

DARPA staff members exercise a great deal of

independent judgment about what technologies to

fund.

Perhaps the biggest threat to the long term success

of a civilian technology agency is exaggerated

expectations. Technology push, even if planned and

directed intelligently, certainly does not guarantee

successful commercialization. One reason for the

continuity and accomplishments of NACA/NASA

support for the civilian aircraft industry is that it was

low-key and did not promise miracles. To restore

world-class performance in U.S. manufacturing

industries will take much more than selective

government support for technologies up to the point

of commercial production. Technology push is just

one of the many things that must be done, by

industry and government alike.

Designing a Civilian Technology Agency

Any Civilian Technology Agency (CTA), whether

it develops from the NIST Advanced Technology

Program or is established more formally, would

certainly start small, and might remain so. DARPA

has a staff of 150, half of them in technology

development and the other half in administration,

and about $1.3 billion a year to spend on R&D

projects. Too much smaller, and the agency would

not have a critical mass. Too much bigger, and it

probably could not operate in the anti-bureaucratic

way DARPA does, which is to give each member of

the technology staff almost total responsibility for

the areas he or she manages.

After a few years’ experience, a CTA might take

over some technology projects from other agencies,

such as engineering projects of the National Science

Foundation (e.g., the Engineering Research Centers). But most of the big government technology

programs now in existence are solidly ensconced in

their present homes (NASA, DOE labs, National

Institutes of Health). If a CTA were to grow, it would

more likely result from years of success and

expansion in its own line of work than from

reshuffling present programs. The bills in the 101st

Congresses to establish an Advanced Civilian Technology Agency in a new Department of Industry and

Technology propose a small agency, starting with a

staff of 40 (primarily recruited from industry, on

temporary assignment) with a first year authorization of $100 million, rising to $240 million in the

third year.

A small agency funding technology R&D probably works best if the staff members are not hemmed

in by too many rules and guidelines, but can exercise

their own good judgment. DARPA attracts its

excellent staff by offering a combination of hard

work, low pay, great responsibility, and a chance to

do something for one’s country. If a consensus

develops that the foremost job for the Nation is to

secure our economic future, the chances would be

good that a CTA could hold out similar attractions—

with the difference that the staff would work much

more cooperatively with industry. One caveat: the

low pay (relative to private jobs) that government

can offer to highly trained scientists and engineers

has not stopped DARPA from getting good people,

though they tend to leave when their children reach

STFor exmple, during the heyday of the Strategic Defense Initiative in the 1980s, DANA cut back on its support of broad advances in ComPuter

technology in favor of the Strategic Computing Program, which was a part of SDI. Funds were diverted horn universities responsible for the earlier

programs (and their eventual success) to military contractors. The emphasis changed from long-term open-ended resuhs to milestones and conc~te

deliverables.
Chapter 2--Strategies To Improve U.S. Manufacturing Technology: Policy Issues and Options . 77

college age. Low pay could be a greater handicap to

a new agency just starting out.

Where in the government bureaucracy a CTA is

located may not matter much. Aside from the

President’s own staff and the upper reaches of the

Office of Management and Budget, power in the

executive branch of the Federal government is fairly

dispersed. It is probably an advantage to the National

Science Foundation to be independent of any

department. Yet DARPA, a tiny appendage to the

biggest and most hierarchical of all the Federal

agencies, still makes its voice heard through sheer

competence and dedication.

Defining Goals, Choosing Projects

Desirable as it may be to give the CTA management and staff freedom from red tape in working

with industry and choosing technologies for support,

some explicit overall goals should serve as a

framework for the choices. If Congress wishes to

establish a CTA, it might give the agency the duty of

developing a set of goals, based on a more general

mission defined by Congress. For example, proposals before the 101st Congress for a CTA defined its

mission as contributing to U.S. competitiveness by

‘‘supporting generic research and development projects . . . that range from idea exploration to prototype development and address long-term, high risk

areas . . . that are not otherwise being adequately

developed by the private sector, but are likely to

yield important benefits to the nation.”88 Similarly,

S. 1191, the bill passed by the Senate in 1989 that

aimed to beef up NIST’s Advanced Technology

Program, referred to “research that no one company

is likely to undertake but which will create new

generic technologies that will benefit an entire

industry and the welfare of the Nation. In defining

the mission, it would be unwise to limit the support

only to long-term, high-risk technologies with supernova potential. This could rule out catch-up

projects like Sematech, or projects for incremental

improvements in technologies that are already

well-known, such as a next-generation controller for

machine tools.

The “visions” that Japan’s Ministry of International Trade and Industry develops in consultation

with industry for Japan’s economic development

offer an example of goals that a CTA might advance.

MITI’s current vision is for a knowledge-intensive

economy. This means support not only for technologies important to Japanese industries that are obviously knowledge-intensive themselves (e.g., computers) but also projects that deepen knowledge

intensiveness in traditional industries (e.g., the

Automated Sewing System, a 7-year $90 million

MITI project that brought together 28 textile,

apparel, and textile-apparel machinery manufacturers in a cooperative R&D effort).

How the government’s fund should be divided

among various broad areas of technology is the most

fundamental of the choices to be made. How

much—if any—should go to high-temperature superconductivity? How does high-temperature superconductivity compare with competing claims for

technologies important to computers, or advanced

television, or industrial robots, or advanced automobile engineering? S. 1191 was specific in directing

NIST to support technologies in five particular high

technology areas. The bills aiming to create a CTA

was less directive, leaving it to the agency to make

these choices, with the guidance of its advisory

board. Thus, the CTA would have to pick winners;

that would be the nature of business. While the

agency would have the final responsibility for

deciding how government money should be spent on

technology R&D, it would rarely choose to support

a technology that did not also have strong industry

backing, including a financial commitment.

Another point is that a CTA would need to

consider whole technological systems rather than

isolated bits of systems. For example, if (as is quite

likely) it should select semiconductor technologies,

it would have to be mindful of R&D needs throughout the system, starting with improved materials for

the silicon crystals that are made into wafers, and

continuing through such things as X-ray lithography

for etching circuits on the wafers (including the

whole paraphernalia of a source for the X-rays,

lithographic equipment, photochemicals, masks and

substrates); automated techniques for packaging

chips; advanced methods for placing chips on a

board and interconnecting them; and so on. As part

of its strategic approach, the CTA should also look

for technologies that are central to more than one

application. Examples are advanced displays and the

technologies for manufacturing them, applicable to

both HDTV and computers; high-temperature super8SH.R. 3838 and S. 1978, part B—Advanced Civilian Technology Agency, SeC. 212(a).
78 ● Making Things Better: Competing in Manufacturing

conducting magnets, which could be important for

several steps in semiconductor manufacture (e.g.,

compact synchrotrons as a source of X-rays for

lithography) as well as for such futuristic things as

magnetically levitated trains.

Once a technology is selected for support, the

choice should be given a fair chance. Just as the CTA

could provide a way to look ahead and make

strategic choices rather than react to the technology

crisis of the day, it could also impart steadiness.

Continuity-a long-term, multi-year commitment—

may be the most important benefit government has

to bestow on a risky undertaking.

Government-Industry Collaboration

The main reason for government to put money

into technology R&D of commercial interest is that

the risks are too great for individual companies to

bear. But if private companies are not interested

enough to take some of the risk and do some of the

work, then the commercial potential may be very

remote. It might make sense for a CTA to reserve a

small portion of its funds for projects that are so

long-term and chancy that they do not attract much

industry support. But for the most part, if industry is

not willing to pay a hefty portion-usually at least

40 to 50 percent—the projects are probably not

worth pursuing. Other requirements for member

companies could be willingness to put wellqualified employees on the project, carry on complementary research, and make a fairly long-term

commitment, say 3 years.89

In the few collaborative projects that the U.S.

Government has recently proposed or undertaken,

industry participation has been no problem. All have

had enthusiastic takers. In the case of Sematech, it

was the semiconductor industry that did the proposing; the industry lobbied hard for the program.

Member companies pledged to contribute 1 percent

of their revenues, and they are paying about half of

the costs. The three national laboratories with pilot

programs for R&D leading to commercialization of

high-temperature superconductivity have cooperative agreements with two dozen companies, all

paying half the costs of their projects, and still more

companies want to join if the labs can find enough

matching funds. When DARPA proposed to put up

$30 million for collaborative R&D projects in

HDTV 87 companies wanted in.

Sematech has its own facilities, but some governmentindustry collaborative R&D could take place in the

company labs. Much more could be done in Federal

labs, especially the Department of Energy’s wellendowed national labs. (See the discussion in an

earlier section of this chapter on how DOE’s labs can

be made more hospitable to collaborative R&D.)

Since government money is involved and the

purpose is to bolster U.S. competitiveness, it may

make sense generally to limit membership in these

joint government-private R&D projects to U.S.

companies. Once again, the definition of a U.S.

company would have to be settled, and conditions

for foreign participation defined.90 European experience may shed some light here, since governmentindustry collaboration on R&D is increasingly

common in Europe. The European Community is

spending over $1 billion a year on its Framework

program (R&D collaborations with industry and

universities). Also, 19 European countries plus the

EC Commission collaborate with industry on applications-oriented R&D under the umbrella organization

EUREKA. In both the Framework and EUREKA

projects, foreign-owned companies can often take

part provided they have an ‘integrated presence”--

that is, research, production, and marketing-in

Europe. Not always, however. Foreign-owned companies with an integrated presence have been excluded from some of these R&D consortia (e.g., Ford

and General Motors of Europe are excluded from

PROMETHEUS, a consortium working on advanced transportation technologies). In some cases,

the determining factor seems to be whether Euro89H.I?. 3838, S. 1978, and S. 1191 would all require R&D entities receiving funds from the Advanced Civilian Tdmology Agency ortie Advancd

Technology Program to put in more money than the government contributes. Also, see ch. 7 for a discussion of the factors that make for success in R&D

consortia, and favorable conditions forgovernment-industry collaborations. See also U.S. Congress, Office of Technology Assessment, Commercializing

High-Temperature Superconductivity, OTA-ITE-388 (Springfield, VA: National Technical Information Service, 1988), pp. 133-37.

~,R. 3838 and S, 1978 (lOlst Congress) provide that “noproject which contains aforeigncompany orentity orasubsidiary thereof” shall reeligible

for government financial support, unless the foreign company makes material conrnbutions to the projects; the foreign company makes a substantial

commitment to manufacture products arising from the projects’s R&Din the United States and to buy from North American suppliers; the home country

of the foreign company affords reciprocal treatment to U.S. companies; and the Secretary of the Department of Industry and Technology certifies (after

consulting with North American participants in the project and the advisory board of the Advanced Civilian Technology Agency) that the foreign

company’s participation is in the interest of the United States. S. 1191 contains similar provisions.
Chapter 2-Strategies To Improve U.S. Manufacturing Technology: Policy Issues and Options ● 79

pean members want the foreign-owned companies in

or out.

Beyond Technology Policy

Technology policy, even a strategic one, carries

government involvement only so far-to the brink

of commercialization. After that it is up to industry.

Of course, many governments, including our own,

have gone farther than that in support of particular

industries seen as having a special importance to the

nation. Among the industrialized countries, Japan

has probably gone farthest down this road. Two

newly industrializing countries, Korea and Taiwan,

observing Japan’s success, have employed elements

of the same strategy, sometimes carrying it farther.

Japan and other Asian countries have combined

numerous policy tools besides long-term government support for technology R&D to promote

selected industries: preferential loans from government banks or banks that follow the government’s

lead; guaranteed purchases by governmental bodies

for home-grown products (e.g., semiconductors for

Nippon Telephone & Telegraph, supercomputers for

government agencies); government-subsidized leasing companies making guaranteed purchases of

advanced equipment and leasing them at preferential

rates (e.g., robots, CNC machine tools); formal or

informal barriers against imports, removed (or partly

removed) only after the domestic industry has

become a world-class competitor; strict limits on

foreign investment in manufacturing; government

negotiations for technology licenses on behalf of

industry; government guidance (not always followed) to rationalize industries, scrap overcapacity,

and encourage companies to get economies of scale

by specializing in certain parts of an industry (e.g.,

machine tools).

This is industry cum trade policy on a comprehensive scale. Other nations have used some of the

constituent policies with greater or lesser success.

For example, several European countries favor their

national champion computer and semiconductor

companies almost exclusively in government purchases. The members of the Airbus Industrie consortium get low-cost loans from their governments

(France, West Germany, the United Kingdom, and

Spain) and can wait to pay it back from revenues.

This is an enormous advantage in an industry where

it takes 10 to 14 years and at least 500 unit sales to

break even on a new transport plane. The Buy

American act in the United States gives a price

advantage to domestic producers. U.S. Government

purchases of semiconductors and computers were

critical to the success of those industries in their

infancies (though it cannot be said that these

purchases deliberately favored domestic producers,

since there were hardly any other producers at the

time).

The next, and final report in OTA’s assessment of

Technology, Innovation, and U.S. Trade will consider trade and industrial policies of Europe, Asian

nations, and the United States in depth. This report,

which focuses on technology, touches only lightly

on these matters, but it is relevant here to consider

how strategic technology policy relates to industrial

and trade policy. The justification for government’s

spending money on technology R&D—potentially

great benefits for society, coinciding with returns to

individual firms that are too small or remote to

outweigh the risk-could apply, in some situations,

to commercial production. This is part of the

argument for protection and support of infant

industries, especially ones where capital requirements are extremely high or the manufacturing

technology is complex and demanding, so that it

takes a long time to learn how to do it right and get

costs down. Both conditions apply, for example, to

civilian aircraft manufacture. According to the MIT

Commission on Industrial Productivity, “no aviation company has ever succeeded without government help,” though the form, degree, and timing of

help has differed.91

This kind of thinking has led to calls for government help to get U.S. companies into the business of

making consumer electronics items such as high

definition TV that use advanced digital integrated

circuit semiconductors and have many core technologies in common with computers (see the discussion

of advanced television at the end of this chapter).

One proposal is to set up a private corporation,

backed by “pledges of support’ from Federal, State

and local governments, to provide “low-cost, very

patient capital” to U.S. companies making ad91 MIT Commission on Industrial Roductivity, “The U.S. Commercial Aircraft Industry and Its Foreign Competitors,” The Working Papers of the

MIT Commission on Industrial Productiviq (Cambridge, MA: MIT Ress, 1989, vol. 1, p. 16.
80 ● Making Things Better: Competing in Manufacturing

vanced consumer electronics products.92 Government backing of this kind would tilt the odds in favor

of investing in consumer electronics. It is one

part-but a small part-of the package that adds up

to industrial policy. A comprehensive public policy

aimed at building up an industry for national

economic security reasons would involve much

more, and would probably include some aspects of

trade policy, such as domestic content requirements

or government negotiations on behalf of industry for

foreign technologies. Opposition to such policies is

based on the idea that if government actions override

market signals, the result will be economic inefficiency and high prices, the extreme case being

central control of the economy with shortages of

everything people want, as in Poland.

A look around the world, however, shows that

some governments have selectively helped industries they consider crucially important to the nation,

using a full panoply of technology, financial and

trade policies while still leaving the economy open

to market signals. It is not an easy trick, and it is

certainly not cost-free. Japanese consumers, for

example, pay higher prices for some of the goods

that Japanese industry excels in producing (e.g.,

compact cars, color television sets) than do American consumers for imports of the same products, and

this difference has something to do with government

policy. Yet those same Japanese consumers are

worlds better off than they were 20 or 30 years

ago-and this has something to with government

policy too.

The last report in this assessment will take on the

question of how industrial and trade policies in other

nations have helped-or failed to help-their industrial advance, and which if any of these policies

might be useful for the United States to try. In this

report, we can say that, based on its limited use in

this country and more extensive application abroad,

strategic technology policy offers some attractive

options for Congress to consider. This is the least

intrusive and least expensive of public policies to

improve the performance of industries seen as

critical to the nation’s economy, yet it has never yet

received a broad trial in the United States. The

traditional U.S. science and technology policy,

which shunned government support of commercial

technologies, served well enough in the postwar

years when the United States was king of the

mountain. Now, with U.S. manufacturing in obvious

competitive difficulties, it may bean opportune time

to try other approaches.

One Example of Technology Policy:

The Case of Advanced Television

HDTV is an improved form of television, with a

larger screen, more detail, and better color than

conventional TV. If that were all it is—a bigger,

more alluring form of television for home entertainment—HDTV might not have become the front page

news item and center of political controversy that it

was in 1989. But it is something more. Its requirements could drive a range of technologies that have

important applications in other parts of the electronics industry—in particular, computers and telecommunications. 93

There are two key reasons why technological

spillovers from HDTV are likely. First HDTV’s core

technologies-for production, storage, transmission, processing and display of information-are in

the same family as those used in computers and

telecommunication devices. They are based on

digital electronics. Conventional TV and many other

consumer electronics items depend mainly on analog electronics technology. (Box 2-B outlines the

differences between digital and analog electronics.)

In some digital electronic technologies, HDTV is

ahead of computers. For example, one of HDTV’s

requirements is the ability to process and display

huge amounts of picture data very rapidly. Because

of this, HDTV must advance the state of the art in

display technology (also in fast processing, although

the chips and hardware being developed for this

purpose for HDTV are specialized). Computers

don’t yet need such advanced display technology

because their general-purpose hardware is slower at

generating data. As computers’ speed of operation

increases, they will be able to take advantage of

HDTV’s display technology, using it in such activities as weather forecasting and computer-aided

‘%4 Strategic lti~ at Risk, a rep to the President and the Congress fmm the National Advisory Committee on Semiconductors (WttSh@On,

DC: The Committee, 1989), p. 20.

Q3Much of tie maten~ ~ ws ~ti~ is ~a~ from a foficoming OTA report, The Big Picture: High-De finitwn Television and High Resola”on

Systems, which provides a comprehensive account of HDTV’S history, technology linkages to other electronics industries, and relation to the U.S.

communications infrastructure.
Chapter 2--Strategies To Improve U.S. Manufacturing Technology: Policy issues and Options ● 8 1

Box 2-B--Digital and Analog Data: Television Transmission

In electronics, information can take two forms, digital and analog. In the digital form, numbers represent

information; the numbers are generally written in the binary system, which has only two numerals, zero or one. (The

familiar decimal system has ten numerals, zero through nine,) Modern digital computers represent each binary digit,

or bit, as a switch; if the switch is on, the bit is one, and if off zero. In computer calculations, numbers are simply

numbers, written in binary; e.g., 8 is 1000. Other data, such as letters of the alphabet, are converted to numbers

according to a code, Letters usually take up eight bits; for example, the capital letter “A” is often denoted as the

sequence 01000001.

In the analog form, information is represented by physical characteristics (e.g., distance or voltage) which vary

continuously. Traditional sound recordings are analog. Grooves in the record have tiny physical patterns that vary

continuously and correspond to the original sound. The needle of the phonograph arm rides over small bumps in

the grooves, which apply pressure to a crystal (or other pickup system) in the cartridge, which in turn generates a

voltage that varies with the degree of pressure applied by the needle. The electronic signal thus generated is then

converted back into sound. Compact disk recordings, in contrast, are digital. Sounds are recorded on an optical disk

as small pits, representing zeros or ones, which denote various characteristics-frequency, volume, and so

on-according to a prearranged code. In the disk player, a solid state laser detects the pits (or their absence), and

that digital signal is then converted into the corresponding sound.

When continuously varying quantities are represented in digital form, the original quantities are only

approximated. For example, frequencies and volume vary continuously in music, but only certain discrete levels

of frequency and volume can be represented on an optical disk. It might therefore seem that digital representation

is inferior. However, the problem is handled by allowing for a great many finely spaced choices of frequency,

volume, etc. The more choices allowed, the greater number of bits the system must use to represent the information.

The cost of storing and manipulating great amounts of digital data continues to decline, so that a very good

approximation can be quite affordable-the compact disk is one such example.

The digital form has some important advantages. Even though the initial representation in digital form is an

approximation, it can be held to its original form without subsequent errors. Each copy of a digital recording

reproduces exactly the sound pattern of the master, because it copies the master’s pattern of ones and zeros. In

traditional analog sound recording, the copying of masters introduces some distortion-which generally differs

from one record to another. Distortion shows up even more in electronic transmissions. For example, when a cable

television program is transmitted to a home, the signal typically passes through about 25 amplifiers along the way

to keep the signal strong. Each amplifier introduces some distortion, and the distortions are compounded in the final

signal received in the home. If the picture were represented in digital form, at the end of each leg the pattern of ones

and zeros could be sensed and a fresh, distortion-free signal sent along the next leg of the trip. So long as the signal

is good enough at the end of each leg to tell which bits have value zero and which bits have value one, the final

picture can be received error free.l

Another advantage of the digital form is that information is easier to manipulate. For example, splicing film

segments or creating special visual effects (e.g., superimposing two images) is much easier to do if the picture is

stored in digital form: it is easier to rearrange data inside a machine (essentially, a special-purpose computer) than

to cut or otherwise manipulate film. For another example, filtering ghost images out of television is practicable only

if the picture is represented in digital form. Still another advantage is that digital data can be compressed, allowing

more information to be conveyed over a given TV channel (see the discussion below). Its intrinsic advantages and

sharply declining costs have made the digital form increasingly popular in recent years. Sound recording is one

example. Television promises to be the next.

Conventional television uses predominantly analog information, while high definition television (HDTV)

relies much more on digital information. This difference is at the heart of what is new and important about HDTV.

In conventional analog TV, the picture is recorded in the studio as a series of frames (30 per second) on film or tape.

Each frame shows continuous gradations in color and brightness, corresponding to the original scene. For

transmission, each frame is broken down into hundreds of horizontal bands, called lines. A scanner sweeps

Isome ~wlY ~OmPUter~ ~ePreWnt~ ~tir~ in analog fo~ and had tie same problems of increasing distofion. Numbers wodd be

represented, for example, as voltage differences. But tie voltages could not be set wff~tly accurateh) so quantities rePresent~ ~side he

machine had some error. As these quantities were added, multiplied, etc., the error increased; moreover, the errors were somewhat random, so

that the same calculation might yield different results. For these reasons analog computers were rejected in favor of digitat computers.
82 ● Making Things Better: Competing in Manufacturing

continuously across each line in turn, sensing the color and brightness of each part of the picture as it goes. These

continuously varying characteristics are encoded into a continuously varying electromagnetic wave (the carrier

wave) which represents the visual signals through variations (modulations) in its amplitude (strength). Information

can also be encoded by modulation of the wave’s frequency (number of wave cycles per second), or phase (when

the cycle begins); the TV sound signal is encoded by frequency changes. Any of these modulations has the effect

of changing slightly the observed frequency of the carrier wave. The range over which the frequency may vary is

called the bandwidth. The carrier wave, sent over the air or over cable, is picked up by a television receiver tuned

to the wave’s frequency band. The receiver senses the modulations in the wave, and decodes them to reconstruct

the original, continuously varying, pattern of color and brightness for each line. Because of noise in transmission,

the received signal has slight errors, causing some distortion in the picture displayed.

HDTV, in contrast, is a largely digital system. In some proposed systems, transmission will be entirely digital;

others include an analog component for compatibility with existing receivers. While HDTV systems might be

developed in ways that vary somewhat, for simplicity one example is chosen for discussion here.2 For HDTV, the

screen is divided into about 1 million or more equal rectangular or square segments, known as pixels, In any one

frame, each pixel is treated as having uniform color and brightness. These characteristics are recorded in the studio

as numbers on magnetic tape.3 The color and brightness of each pixel are represented together as a sum of the three

primary colors in appropriate brightnesses. For each primary color, 256 different brightnesses are possible

(including the dimmest, no light at all); this requires eight bits to represent each brightness, or 24 bits to represent

all three. Color and brightness do not vary continuously because only certain discrete combinations of primary

colors are allowed. However, so many variations of color and brightness are available that each pixel can come very

close to the original. Also, the size of the pixel limits the physical detail that can be shown, but with 1 million or

more pixels, that is fine detail. These slight imperfections are less than those caused by noise in conventional TV.

Each television frame is recorded as a string of numbers that represent the color and brightness of each of the

1 million or so pixels. To record the 30 frames which comprise one second of television requires about 1 billion

bits. This large amount of data must be recorded very quickly to produce HDTV programs, and it must also be

manipulated quickly for transmission, reception in the home, and display on the screen,

The numerical data are encoded into an electromagnetic carrier wave, modulating its amplitude, frequency, and

phase. (As with analog television, the result is to vary slightly the observed frequency of the carrier wave.) While

for conventional analog television the wave’s amplitude and frequency vary continuously, for HDTV they vary in

only a limited number of steps, corresponding to the numerical patterns being encoded. The television receiver

senses the discrete but swiftly changing variations in the incoming wave’s amplitude, frequency, and phase, and

then reconstructs the original pattern of bits for each frame. Based on the information for each frame, the display

must be quickly updated.

For both conventional television and HDTV, the television carrier wave is allowed to vary only within a certain

range of frequencies, or bandwidth; other frequency bands over the air are used for other television charnels, or for

other uses such as radio and cellular telephones. Generally, the more bandwidth is available, the more information

can be sent per second, As noted, the frames in 1 second of HDTV are represented by about 1 billion bits. To send

that much information per second would require much more bandwidth than is available for television channels

broadcast from terrestrial towers; while more bandwidth might be available by cable or satellite, even that amount

would probably be insufficient. This is not surprising, since it takes much more information to transmit the finer

resolution HDTV image than that to transmit the image for conventional television programs.

The solution to this shortage of bandwidth will probably involve a combination of techniques. First, the number

of bits actually transmitted can be reduced or compressed, primarily by getting rid of redundant or otherwise

unnecessary information, For example, if a blue sky background does not change for several seconds, it does not

need to be rebroadcast in every frame. (Analog data, used in conventional TV, cannot be similarly compressed.)

Also, since the eye cannot perceive fine details of fast moving objects, those objects could be sent in less detail. The

calculations that do this compression before transmission, and then decompress the information on reception, are

done by digital signal processor (DSP) chips, a kind of integrated circuit. HDTV will require advances in

compression techniques.

2The ~l~tion of @is ex~ple does not imply that any particular system of design specifications iS Superior to any Otim.

3~ ~me C*S, a pqram is first recorded in analog form and later converted to digital form.
Chapter 2--Strategies To Improve U.S. Manufacturing Technology: Policy Issues and Options ● 83

Even with compression, however, HDTV will probably also require an improvement over current technology in

the amount of information that can& transmitted per second in a given bandwidth. Improved equipment will be

needed to encode the bits into modulation of the carrier wave and to decode the modulation on reception. HDTV

wiil also require developing DSP chips in the receiver to perform calculations to reduce or eliminate ghost images,

flicker, snow, and other picture imperfections.

Actually, conventional television and HDTV are merely points on a continuum. Intermediate versions of

television improved Definition Television (IDTV) and Enhanced Definition Television (EDTV), offer a finer

resolution picture than conventional television, but not as fine as HDTV, For IDTV and EDTV, analog picture data

is sent over the air (or over cable) but upon reception the picture is converted to digital form,

IDTV and EDTV have the advantage of being compatible with existing television systems. IDTV receivers

are designed to receive current television transmissions, are being sold commercially, and are already in use in some

homes. EDTV receivers require some change in the transmitted signal, but the new signal would still work with

conventional receivers, HDTV transmissions that are composed of encoded compressed digital data would make

no sense to conventional television receivers, which are designed to receive transmissions with analog data encoded.

IDTV and EDTV receivers perform some digital data handling similar to that needed for HDTV. For example,

DSP chips reduce or remove ghost images and other flaws in the picture; also, each frame must be displayed quickly

as for HDTV. However, IDTV and EDTV break the screen into fewer pixels, so that not as much data has to be

manipulated each second. In sum, IDTV and EDTV are technological stepping stones to HDTV, and some of this

technology is already in commercial use.

design. Other business applications, e.g., medical floor. Once advanced manufacturing techniques are

imaging, education, and publishing, might also use

the advanced display technology developed for

HDTV--indeed some early versions are already in

use.

Manufacturing processes under development for

HDTV might find still wider application. For

example, in the long run, the most promising

medium for displaying the fine-grained HDTV

picture is the flat panel liquid crystal screen. The

techniques needed to make these screens can be

applied to methods for interconnecting chips on

boards (a process that is common to almost all

consumer electronics products and computers), and

to other electronics products and processes as well.

mastered for making electronic components for

HDTV, those same techniques can be applied to

lower volume business products.

Cost reductions through mass production can be

dramatic. For example, in the early 1970s, Plessey

Ltd., a British semiconductor firm, developed a

high-speed digital device able to count about 1

billion events per second. These counters, made for

low-volume military and business applications,

were expensive and required care to ensure proper

performance. RCA, then a leader in the manufacture

of television sets, saw the counters’ potential application to TV tuning systems. Within about 3 years,

RCA had made its own circuits, with similar

This spillover to a variety of manufacturing performance characteristics but more robust, and

processes in electronics brings up a second major was mass-producing them for about $1.50 to $3.00

point. To succeed in mass markets for consumer apiece--one-fiftieth of their former cost.94

electronics products and their components, manu- The technological importance of consumer elecfacturers must meet some exacting demands: high- tronics is sometimes underestimated, but the fact is

volume production, low costs and profit margins, that some aspects of the industry---especially manuand high product reliability. HDTV is interesting not facturing processes—are at the leading edge. Not

just because it demands new microelectronic com- infrequently in the past, manufacturing technology

ponents, but because it is a potentially large market developed for consumer electronics has been applied

that will also push advances in manufacturing to good effect in business products, and this kind of

processes, These advances come both from labora- transfer is increasing as the consumer electronics

tory R&D (e.g., designing for manufacturability) products converge with business products in the use

and from continuous improvements on the shop- of digital technology (box 2-C). U.S.-owned firms

94JohII Henderson, Head, systems Technology Research, David Sarnoff Research Center, personal COmInIJniCatlOn, Jan. 5, Iw.
84 ● Making Things Better: Competing in Manufacturing

Box 2-C—Technology Spillovers From Consumer Electronics

Technology developments in consumer electronics have often paved the way for advances in other families

of electronics products, such as computers. For example, automatic insertion of components into a printed circuit

board was first developed for car radios and other consumer products, and was refined for television. That process

has since been used to build computers and many other products. Another example: mass production of cathode

ray tube (CRT) screens for television brought down their price enough that it was attractive to use them in personal

computers.

Technological spillovers from consumer electronics to computers and other business applications are gaining

importance, because the technologies are converging, For many years, business applications used mostly digital

circuits, while consumer products relied more heavily on analog circuits. Recently, consumer goods have used more

and more digital circuitry; and HDTV, with its huge appetite for digital circuits, some of them quite advanced in

design, promises to accelerate the trend.

Already, some digital technologies that first appeared in consumer electronics are finding applications in

computers. For example, the digital magnetic tape Sony developed for its 8-millimeter portable camcorder, and the

digital audio tapes developed by Sony and others, are now used in computer systems to store backup data---at about

one-twentieth the cost of tapes previously available.1 Also, the digital optical disks developed for compact disk

sound recordings are now used for permanent data storage for personal computers (they are known as CD-ROMs,

or compact disk read-only memories in the computer world).

The spillover of technologies honed for high-volume consumer goods to other electronics sectors is uncommon

in U.S. companies today. Only one major U.S.-owned company (Zenith) is still in the television business. But

foreign firms-especially the Japanese-continue to use their consumer electronics technology to improve their

position in computers and other business products. While Japanese firms have had other advantages as well, this

transfer of technology within the firm was often a significant factor. For example, firms in Japan, Korea, and Taiwan

adapted the superior CRTS they developed for television to computers, and took a 1arge share of that CRT market.

Seiko and Casio exploited their liquid crystal display technology, first developed for watches, to move up to pocket

computers (used for such things as computerized address books) and then to laptop computers which they sell in

Japan. Canon used its expertise in optics, developed in producing consumer cameras, to help in gaining its present

eminence in photocopiers. Perhaps most important, Japanese firms producing consumer products such as VCRs

gained experience with automated production lines which they are now applying to the manufacture of computers. 2

IRofe~r ~vid Me~rsctiitt, Department of Electrical Engineering and Computer Science, University of California W Be*eley,

personal cmnmunication, Dee, 7, 1989.

2Th~ ex=ple~ ~gre #ven by ~k w~n, ~r~t~r, International and Associated Eograms, k’fkrOt?kXtiOnicS & Comput~rT~~~I~s

Corp., personal communication, Dec. 13, 1989 and Dec. 28, 1989.

have largely retreated from the consumer electronics and Extended Definition Television (EDTV); tofield; this has sometimes put U.S. firms making

business electronics products, such as computer

CRT displays, at a disadvantage (box 2-C). HDTV,

which could be one of the premier next-generation

consumer electronics products, might either reverse

or accelerate this trend, depending on whether U.S.

firms get into HDTV production in a significant

way.

At this point, some questions are in order. First, as

with all new products, projections of the eventual

market for HDTV are uncertain. One question is

whether consumers might settle for intermediate

improvements that go partway towards HDTV.

These are Improved Definition Television (IDTV)

gether with HDTV, they are known collectively as

advanced television (ATV). EDTV and IDTV handle less data than HDTV; however, all the ATV

systems rely on digital electronics (HDTV being the

farthest along this path) and all require advances in

manufacturing processes. In any case, both Japan

and the European Community are pouring substantial government as well as private resources into

making HDTV a reality. This dedication of resources into a new technology itself affects the

market’s growth, since it helps to drive down prices,

Moreover, the Japanese Government and industry

are whetting the consumers’ appetites. The 1988

Seoul Olympics were broadcast in HDTV to television sets at 81 public sites in Japan; daily l-hour
Chapter 2-Strategies To Improve U.S. Manufacturing Technology: Policy Issues and Options ● 85

HDTV broadcasts by satellite began in 1989; and

NHK (the Japanese national broadcasting company)

was planning to broadcast 6 or 7 hours of HDTV

programs every day by 1991.

Another question is whether semiconductors,

computers, telecommunications, and other electronics fields in which American firms are strong

competitors might not do as well as HDTV in

advancing technologies with important spillovers to

electronics sectors other than their own. The foregoing discussion suggests that HDTV itself is not so

significant a technology driver as are the underlying

systems for data processing, transmission, and

display, and the process technologies for manufacturing these systems. Two answers suggest themselves. First, HDTV is pretty clearly ahead in a few

of the core technologies. But second, it is often

impossible to be certain which application is ahead,

or will remain ahead, as the driver of many of these

important core technologies-and this uncertainty

does not really matter. HDTV, computers, communications, and other electronics fields are all developing on separate but related tracks. So long as many

of their core technologies are fundamentally similar,

then advances in any or all of them are synergistic.

The same research can be used to advance different

industries. Each helps the others along.

This kind of synergism is less available to

U.S.-owned electronics companies than to Japanese

and European, because few U.S. firms are in the

consumer electronics business in a major way. The

Japanese Government and electronics industry are

well aware of the synergisms and do their best to

exploit them.95 The same is increasingly true in the

European Community.

Advanced Television as Technology Driver

Some of the core technologies being developed

for HDTV, and to a lesser extent for other forms of

ATV, look to be pathbreaking, and could have

significant spillovers to other electronics applications. 96 Others are based on technologies that were

already well developed for other uses; further

development for ATV probably will not create major

breakthroughs, but might offer incremental improvements useful elsewhere. Still others that are

needed for ATV may be developed first for other

uses. While some of the following examples of

technologies in which ATV seems to have the lead

may turn out to be mistaken, others, in hindsight,

probably could be found to take their place.

Flat Panel Liquid Crystal Displays-Display is

high on the list of technologies likely to driven by

HDTV—indeed by all forms of ATV. Not only will

the displays themselves be adaptable to other uses,

the manufacturing processes for making them could

also be widely applied.

Looking ahead to the year 2000, the best candidate for displaying the HDTV picture (and probably

any ATV picture) appears to be flat panel liquid

crystal displays. This form of display has the

advantages of low power consumption, good color

range, and compact size.

97 The display contains a

glass screen with elements made of a liquid crystal,

which change the way they pass or reflect light when

they are subjected to a small polarizing voltage.

Electrical circuits are put right on the glass to control

each of the liquid crystal elements to produce the

desired picture.

Liquid crystal displays have long been in use, e.g.,

in digital watches. The challenge is to make them in

the large size and with the fast response and great

detail (millions of display elements) needed for

HDTV--all at a cost that consumers can afford.

Making liquid crystal displays for HDTV will push

some areas of manufacturing technology that have

wide application in other electronics sectors. (The

same is true of IDTV and EDTV, although to a

slightly lesser degree, because they require fewer

pixels for display than HDTV and the screen might

g5GngoV T=y, c ‘S~tW~ Chage and com~tit;veness: The U.S. Semiconductor Industry, TechnofogicalForec@ing a~soci~c~nge) vol.

38,1990 (forthcoming); Barry Whalen, Senior Vice President for Plans and Programs, and Mark Eaton, Director, International and Associated Programs,

Microelectronics & Computer Technology Corp., letter to John Glem, Chairman, Senate Committee on Governmental Affairs, July 31,1989, reprinted

kProspectsforDevebpmnt o~a U.S. HDTV Industry, hearings before the Senate Committee on Governmental Affairs, Aug. 1,1989, [S, Hrg.] 101-226,

pp. 522,524-25 (letter discusses Japan’s Giant Electronics project, and includes translation of two pages of project’s plan); Lansing Felker, Director,

Industrial Technology Partnership Program, U.S. Department of Commerce, personal communication, Nov. 21, 1989.

%Fm a more de~~ discussion of llnkages ~tween HDTV and o~er el~tronics indus~~, ~ OTA’S forthcoming report, The Big ~lCtUW, op. Cit.,

ch. 5.

gTThe ~Tdisplays currently used for television consume much more power. They are also bulky-nearly as deep as the screen is wide, ~ todaY’s

models-and breakable. Unless greatly slimmed down, with the large screen required to show off HDTV to advantage (40-inch diagonal or more), they

would weigh several hundred pounds and would scarcely fit in the door of most houses.
86 ● Making Things Better: Competing in Manufacturing

be somewhat smaller. See box 2-B for a definition of

pixels.)

Some of the advances in manufacturing required

for making liquid crystal displays for ATV are: the

ability to make extremely flat glass panels of large

size (the area of the display screen); precise etching

of electric circuit patterns over the entire screen area;

deposition of thin films of material over this area

with uniform thickness; and new techniques for

attaching electrical leads and testing finished circuits. Japan’s Ministry of International Trade and

Industry expects that Japanese R&D for flat panel

liquid crystal displays, all told, will have applications in a great many areas. Some examples are

ultra-high density optical recording systems, ultrathin photocopying systems, solar cells, optical

engraving, large flat light sources, high-precision

electronic components, and a better method for

interconnecting semiconductor chips.

This last application is particularly significant.

The requirement for interconnection of integrated

circuits (chips) is ubiquitous in consumer electronics

and computer applications. The traditional practice

is to put each chip in a plastic or ceramic package

with metal electrical leads, then mount the packages

on a printed circuit board (a pattern of circuits

consisting of copper foil laminated to sheets of

fiberglass reinforced epoxy), and then connect the

chip’s leads to the board’s circuits. The method is

expensive and somewhat unreliable (connections

occasionally come loose), and it limits how densely

circuits can be packed. The less dense the packing,

the longer the path the electrical signals must take;

longer paths slow down computations, and thus limit

the speed of computers based on this technology for

interconnections.

The emerging ‘chip on glass” technology allows

greater density and reliability. In this system, the

bare, unpackaged chips are mounted directly onto

glass (or another insulating substrate), and the chips’

own tiny leads are connected to a fine pattern of

circuits etched on the glass. The technology demands high precision over a large area both in

etching the circuits and in film deposition. Large

area lithography-a technique to do these steps at

low cost for mass production of chips on glass-will

probably be developed frost (at least in part) for

manufacturing HDTV displays.

Another requirement for the chip on glass technology is a method of connecting the chip’s minute

leads to the precision etched circuit on the glass. One

such technique is tape automated bonding (TAB), in

which adhesive tape with electrical leads connects

the chips to the circuit board-and in television with

a liquid crystal display, to the display as well.

Japanese firms are already using TAB to make

miniature televisions with liquid crystal displays; in

fact, the Sony Watchman miniature television uses

more demanding TAB than the NEC SX-2 supercomputer. 98 In developing HDTV, Japanese firms

are pushing TAB technology still further. U.S.

electronics firms have lagged behind in TAB technology, even though it was invented in the United

States.

As manufacturing of liquid crystal displays for

ATV improves, the displays will become cheaper

and more reliable, and will probably find many

applications in business products-specially computers. Liquid crystal displays for ATV and for

computers are essentially similar, although ATV

displays require more choices of color and brightness and computer displays require more closely

spaced pixels. Lap-top personal computers already

use flat panel displays. More powerful computers

will probably follow.

Digital Signal Processor Chips and Computer

Simulation--The amount of information in a realtime, high-definition, full color HDTV signal is

huge—as much as 1.2 billion bits per second in some

systems. HDTV is driving state-of-the-art technology in processing so much information at high

speed. The chips that process the information flows

for HDTV are tailored to its specific needs but might

be adapted to other signal processing applications,

such as compressing speech for transmission. More

generally, some of the technologies needed to handle

HDTV’s complex, high-speed chips could have

important spillovers--e.g., high-performance circuit boards made of new, cheaper materials. Another

spillover could come from the methods used to

design chips for HDTV.

HDTV picture data are so voluminous that they

demand more bandwidth than is available in most

98N~i~~ReXh~~cil, Commission on Engin~fig and T~hnic-al Systems, Man~acttingStudies Board, The Future ofElectrow”csAssernbly:

Report of the Panel on Strategic Electronics Manufacturing Technologies (Washington, DC: National Academy Press, 1988), p. 55.
Chapter 2-Strategies To Improve U.S. Manufacturing Technology: Policy Issues and Options ● 87

transmission systems (certainly in broadcasts from

terrestrial towers), and therefore have to be compressed before transmission. This compression of

data, and decompression upon reception, are done by

specialized integrated circuits, digital signal processor (DSP) chips. DSP chips are also used in all ATV

to reduce or eliminate ghost images, flicker, snow,

and other picture imperfections. The design of the

complex calculations to be performed by those chips

is made much faster and cheaper by computer

simulation. Operations the chip would perform with

hardware are first tried out by software on the

computer, since the computer can readily be reprogrammed to experiment with different designs

before a real chip is ever made.

Because the DSP chips for HDTV must perform

calculations with many billions of steps per second,

computer simulations of their operation are difficult.

Normally, computers running simulation programs

perform much more slowly than the hardware being

simulated. It is a major challenge to get computers

to simulate DSP calculations fast enough to generate

video images at the normal viewing speed. (Viewing

at normal speed is necessary to assess the picture

quality.)

A working prototype computer to perform such

simulations has been built by the David Sarnoff

Research Center in the United States, under contract

to Thomson Consumer Electronics, a U.S. subsidiary of the French firm (partly owned by the French

Government) Thomson SA.99 In late 1989, Thomson

began to use this machine as a design testbed to

develop IDTV receivers; Thomson expects to use it

to help develop DSP chips for all future advanced

television systems.100 Japanese firms have been

developing similar testbed computers.

To achieve simulation at actual viewing speeds,

the firms involved have chosen a parallel processing

approach, in which many processors (essentially,

many individual computers) all work on the problem

at the same time. Parallel processing-especially

when it uses many hundreds of processors—is a

cutting-edge area of computer technology, useful for

solving a great many problems from aircraft design

to weather forecasting. Massively parallel machines

will take an increasing share of the supercomputer

market because they provide great computing power

at relatively low cost. The firms that use parallel

processing computer testbeds to design DSP calculations are gaining experience in hardware and

software for parallel processing generally. This

helps Japanese firms’ efforts to catch up to U.S.

firms in parallel processing.

Digital Filters--The digital filter, a kind of DSP

chip, has many uses in electronics products, including selecting frequencies and reducing noise. ’In TV

reception, for example, the home set may receive not

only the direct television signal but also a weaker,

delayed version of the signal reflected off a building.

This causes a ghost image, which digital filters can

reduce or remove when the picture is represented

inside the TV receiver in digital form. Digital filters

are also used in other systems--e. g., in telephone

networks, to reduce noise from reflections within the

system; in military radios, to select frequencies and

reduce noise; and in compact disk players, to select

frequencies. Despite much past R&D, digital filters

are still hard to design. As part of its HDTV

development work, Thomson Consumer Electronics

has engaged the David Sarnoff Research Center for

work on making the design easier. This research will

permit easier design of digital filters for other

applications as well.101

Digital Modulation Techniques—HDTV will

require new transmission and reception systems, to

allow the transmission of more information in a

given bandwidth than is needed for conventional

color television today. Among other things, these

systems will use new, more efficient ways of

encoding digital data into variations in the amplitude, frequency, and phase of an electromagnetic

wave. This encoding is called modulation. Once

more efficient modulation techniques are developed

for HDTV, they might be used generally to enhance

the information-carrying capacity of other digital

-Omson Consumer Electronics consists of the old RCA consumer products group, which General Electric bought and then sold to Thomson SA.

loo~, D. Joseph I)o@w, Senior Vim President, Technology and Business Development, Thomson Consumer Electronics, PrSOnd co~unication,

Jan. 2, 1990; see also Danny Chin, Joseph Passe, et al.,lle Princeton Engine: A Real-Time Video System Simulator,’ IEEE Transactions on Consumer

Electronics, vol. 34, No. 2, 1988, p, 285.

IOIJOh.11 H~erson, Hd, systems Technology Research, David Sarnoff Research Center, personal communication, Dec. 7, 1989. while digiti

faltering can be done by soflware, that would be too slow for television applicadons. ‘he digital filters used for television are hardware devices. ‘fhey

are adaptive filters, meaning that they can adjust their operation to a changing delay between the original signal and its reflection. The filter senses the

delay using a special calibrating signal transmitted at regular intervals.
88 . Making Things Better: Competing in Manufacturing

communications systems, such as microwave phone

links and digital satellite transmissions.

Fiber Optic Communications--HDTV might

provide the first demand for fiber optic communications to the home. If a large proportion of U.S. homes

are connected to a fiber optic network, the network’s

electronic components residing in the homes would

be manufactured in very large quantities, and would

justify R&D to reduce manufacturing costs. The

electronics needed to connect each home have a

great deal in common with electronics needed

elsewhere in the network. For example, requirements for wiring up the home would include: 1)

electronic components for receiving and amplifying

light signals;1°22) digital signal processing adapted

to the available bandwidth (greater than that available for over-the-air broadcasts); and 3) fiber optic

cable which is easy for a service technician to install

and repair. All of these features are also needed at

other points in fiber optic networks.103 Companies

that cut costs for mass wiring of homes would realize

cost advantages generally in building a fiber optic

network. They would have the advantage in providing other fiber optic services, such as data transfer

between computers.

Government Policy and ATV

Although the technological spillovers among

different branches of the electronics industry cannot

be pinned down or forecast with precision, the

examples given above suggest the breadth of the

synergism between the advancing, increasingly

digitalized consumer electronics branch-with HDTV

in the lead—and the computer and telecommunications branches. Because of these interactions, some

of the technologies that have to be developed for

advanced television systems look like strong candidates for government support. There are strong

candidates as well in fields other than advanced

television. As of now, however, no agency of the

U.S. Government has the mandate to select from

among these possibilities, or the money to give

strong R&D support to civilian technologies that

have the potential for large, long-term benefits to

society, but are too risky to attract adequate private

investment.

The U.S. microelectronics industry is at a double

disadvantage in creating and exploiting advanced

technologies that are common to consumer and other

electronics sectors. First, the consumer electronics

industry in this country is limited. In television, only

one major company (Zenith) is U.S.-owned; all the

rest are foreign-owned. This is not an insuperable

barrier to development of new technologies important to ATV within the United States—witness the

fact that Thomson Consumer Electronics (Frenchowned) engaged the Sarnoff lab (American-owned

and staffed) to build a computer that could help

design DSP chips for ATV. It is a handicap,

however, that most U.S. electronics companies are

not in the TV business. Second, government is

playing a critical role in developing HDTV technologies in both Japan and Europe. 104 This kind of help

is almost entirely lacking in the United States.

The Japanese Government has worked with industry for over 25 years on developing HDTV and

its components, putting HDTV in the wider context

of technology development for a knowledgeintensive economy. NHK, Japan’s quasi-public national television and radio broadcast company, has

invested about $150 million in R&D related to

HDTV since the mid- 1960s, financing its contributions from household TV subscription fees. NHK

also organized and parceled out some of the R&D

done by private companies. (Private investment over

the years is estimated at $700 million to $1.3

billion.) MITI and the Ministry of Posts & Telecommunications (MPT) added support for R&D,105

while the government’s low-cost loan programs

have encouraged private investment in production

facilities. NHK and private companies have also

concentrated on developing programs for HDTV,

and the government-supported space program launches

the satellites for broadcasting.

European countries got a later start but, according

to those close to the scene, were only a couple of

years behind the Japanese by 1990. First, at a

meeting on international telecommunications standlU21f ~Nice~ ~qufing tw~way ~ommmlcatlon, such ~ te]e.shopping, are provid~, Components tO ~ansmit optical signals would dso k needed.

I(LiThe= exmples ~em @ven by J~es Bellisio, Manager, Video Systems Twhnology Research Division, BellCore, personal communication, Jan. 2,

1990.

104For a mom det~l~ di~cuwlm of fomlw goverment~’ suppofi of HDTV development, w OTA, ~~ Big Picfure, Op. cit., ch. 2.

105M1T1, for exmple, orgai~ and p~i~ly supwfis tie Giant El~~onics ~oj~t, a ‘7.year effo~ to develop co~ twbologies relevant to a40-inch

flat panel display and many other applications by 1996.
Chapter 2-Strategies To Improve U.S. Manufacturing Technology: Policy Issues and Options ● 89

ards in May 1986, the European countries refused to

accept the Japanese HDTV production standard, on

grounds that it was incompatible with European

systems, but also because of the threat to European

TV manufacturers. A month later, the Europeans

formed the joint venture EUREKA Project 95 to

develop their own version of HDTV; the consortium

now includes two dozen organizations from nine

European countries. When the first phase of the

project ended in December 1989, the members had

spent $318 million, of which 40 percent was

contributed by governments and the rest by private

companies, and the consortium was ready to begin

satellite transmission tests. It expects to make

full-scale HDTV broadcasts by 1994. Meanwhile,

the European Community has adopted local origin

requirements for electronics, in which EC goods are

defined as those where the “most substantial transformation’ took place in Europe. Non-EC goods are

subject to tariffs, quotas, discrimination in public

procurement and, when dumping is claimed, antidumping actions (which the EC is vigorously

pursuing).

The U.S. Government, by contrast, has been very

little involved with HDTV. Indeed, the U.S. State

Department originally supported the Japanese standard for producing HDTV program material; not

until May 1989 was this position reversed. The one

positive government action to support HDTV technology came from the Department of Defense. In

December 1988, the Defense Advanced Research

Projects Agency (DARPA) invited industry participation in a 3-year $30 million program of R&D for

high-resolution displays and supporting electronics.

Within a few months, 87 companies applied to

collaborate with DARPA, in proposals totaling $200

million. By the end of 1989, DARPA had selected

five contractors, with more to come.

Despite its technical savvy and fine record,

DARPA is not the ideal agency to support technologies of great importance to the civilian economy. Its

central mission, after all, is to fund long-range R&D

that supports military security. Although it has

sometimes interpreted that mission broadly enough

to encompass technologies on the commercial side,

since they have military as well as civilian uses, it

has also, on occasion, had to narrow its focus and put

strictly military needs frost. A civilian technology

agency could be given the job of weighing the claims

of various commercial technologies in a systematic

and proactive way. Guided by industry’s counsel

and industry’s willingness to put up its own money,

the agency would have to consider what technologies are likely to fortify the long-range economic as

well as military security of the Nation, whether

government R&D support is needed, and if so, where

it would count most.

Government support for R&D is clearly no

guarantee of success in developing new commercial

technologies-especially when it comes to a consumer product like advanced television. Recall that

some of the most important linkages between

consumer electronics, on the one hand, and such

things as computers and telecommunications, on the

other, are in the manufacturing process. Both the

condition and dividend of success in the demanding

mass consumer electronics market is excellence in

manufacturing. And excellence in manufacturing

comes from interaction between the R&D that

generates better equipment and processes, and

practice on the shop floor. Thus, government R&D

support for the core technologies of importance to

several electronic sectors is only one ingredient in

the synergism that nurtures all of them.
. Chapter 3

Financing Long-Term Investments
CONTENTS

Page

INTERNATIONAL CAPITAL COSTS ...... +... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94

The Japanese Financial Market: Sharing the Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96

THE AMERICAN FINANCIAL MARKET . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .105

The Decline in Savings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . , ...+........,+,, . . . . . 106

Mergers and Acquisitions . . . . . . . . . . . . . . . . . . . .. . . . . . ...,...+. ., . .. . .. +.,,+,... . . 107

Figures

Figure Page

3-1. Capital Input Prices, United States and Japan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95

3-2. Comparative Capital Costs: Equipment and Machinery, 20-Year Life . . . . . . . . . . . . . 95

3-3. Comparative Capital Costs: R&D, 10-Year Payoff . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95

3-4. Comparative Capital Costs: Factory, 40-Year Life . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95

3-5. Net Savings, Percentage of Gross Domestic Product ........, .. .. .. .... +., . . . . . . . 97

3-6. Capital Formation in the United States, Japan, and OECD Europe . ........,..+,., 97
Chapter 3

Financing Long-Term Investments

Developing improved technology requires longterm investment. This is true of all the activities

involved in technological advance-research, development, commercialization, and acquisition of

new capital equipment. All these undertakings have

a better chance of success when there is a steady

commitment of money, often for several years

before the investment begins to pay off.

Much has been said about the short planning

horizons of American business managers compared

with the longer term view taken by foreign competitors, especially the Japanese. Because Japan’s economic success shows most clearly what long-term

investment can accomplish, this section concentrates mostly on Japan, although examples from

other countries (e.g., Germany and South Korea)

would be equally appropriate.

Several explanations have been offered for the

Japanese propensity to take the long-term view, and

for the American focus on shorter term returns. One

is, simply, national culture and, by extension,

business culture. But this is less an explanation than

an observation. A factor with more explanatory

power is the remarkable growth of the Japanese

economy since World War II, and the comparatively

sluggish growth, on average, of the post-1960s

American economy. American firms, doing most of

their business domestically, faced potential growth

rates whose mean was close to overall economic

growth-3 percent per year or so, in real terms.

Japanese manufacturers, however, were also looking

outward, and had not only their own rapidly growing

market to expand into, but the U.S. market as well.

When markets are expanding at a rapid clip,

investment for greater market share over the long

term can reap more rewards than playing for

short-term gains. Conversely, economic stagnation,

recession, or even sluggish growth can work to the

detriment of long-term investors and make winners

out of short-term profit takers.

Japan’s rapid economic growth in the postwar

period and its government’s effectiveness in promoting swift recovery from the oil shocks and recessions

of the 1970s and 1980s partially explain the penchant of Japanese managers to focus on the long term.

Likewise, sluggish growth explains some, but not

all, of America’s managerial myopia. Another determining factor is the financial environment. If a focus

on short-term returns and profits is hurting American

firms in competition with Japanese and German

fins-and this is widely accepted as true-then it

follows either that U.S. managers persist in illjudged strategies in the face of evidence to the

contrary, or that there is something about such

strategies that is rational, viewed from the perspective of the managers. To achieve any long-lasting

changes in the strategic behavior of American fins,

it is necessary to understand how the American

financial environment fosters short-term strategies,

and how the Japanese financial environment resists

such pressures.

A major part of the answer lies in the terms on

which capital is provided, which includes, but is not

limited to, its cost. By common consent, Japanese

firms have deep pockets and patient capital. Patient

capital is, almost by definition, low-cost capital, or

it behaves like low-cost capital. And there is

substantial evidence that Japanese businesses have

enjoyed lower cost capital than American firms over

most of the postwar period. Moreover, the financial

climate has encouraged relatively heavy investment

in things like R&D and fixed capital to an even

greater extent than differences in simple cost of

capital suggest. The question is why.

Today, when Japanese national income per capita

is among the world’s highest and Japanese corporations are swimming in profits, it may be hard to

remember that, not so long ago, capital was relatively scarce in Japan. The Japanese personal

savings rate has been extraordinarily high throughout the postwar period. But initially, incomes were

low, so the total amount saved was not very great.

On the other side of the ledger, demands for capital

were high, mainly to feed the appetite for investment

capital of a rapidly industrializing economy but also

to finance frequent deficits in the national government budget. The workings of free capital markets

do not explain the low cost of capital to Japanese

firms during those years. The wide gap between

American and Japanese capital costs, through the

mid-1970s at least, was a result of government

regulation of the Japanese financial market.

Today, after years of deregulation, Japanese

financial markets have become more open, and real

-93-
94 . Making Things Better: Competing in Manufacturing

interest rates, many suggest, have converged somewhat with American ones. Yet even if interest rates

were the same, the risks to business in making

long-term investments might still be lower in Japan.

That is, in large part, because both debt and equity

financing are provided on a less risky, more longterm basis in Japan (and Germany) than in the United

States, in effect lowering the cost of capital to

Japanese firms even if the cost of funds (interest rate

paid on debt capital, for example) were the same as

America’s.

INTERNATIONAL CAPITAL COSTS

An often-repeated argument holds that if money

flows freely between nations there should be no

difference in the cost of capital based on the national

identity of fins. Investment capital, regardless of its

origin, will seek investments that are expected to

yield the highest return, and investors will seek the

best terms from creditors. If there are enough of both

(that is, if no investor or creditor has inordinate

market power), capital flows should be sensitive

only to risk. This argument presumes, logically, that

there is no difference in risk based on nationality.

And indeed, one study concludes that there is no

persistent difference in real short-term interest rates

between the United States and Japan (the nation

most often alleged to enjoy favorable terms on

capital provision).1

There are many flaws in this kind of argument.

Short-term interest rates are not a very relevant basis

for comparison, and comparisons of other real rates

do show a difference between Japan and the United

States. For instance, the real lending rate in the

United States in the 1980s was higher than that of

Japan by 1.1 to 4.8 percentage points, averaging 2.6

percentage points.2 But a more fundamental flaw is

the failure to take into account the difference

between cost of funds—interest rates or the cost of

equity-and the cost of capital, which is influenced

by corporate tax rates, the economic depreciation of

the investment and its tax treatment, and other fiscal

incentives for investment.3 Numerous studies have

documented the gap-sometimes several percentage

points—between Japanese and American capital

costs over the past two or more decades.4 Jorgenson

and Kuroda, for example, estimate that Japan’s

lower capital costs have been a very important

contributor to the increasing international competitiveness of Japanese firms over the postwar period,

excepting the years 1973, 1978, and 1989 (figure

3-1).5

The most thorough study, comparing capital costs

of the United States, Japan, West Germany, and the

United Kingdom, calculated capital costs for various

types of investment, including research and development, new plants, and machinery and equipment.

The study concluded that American and British

capital costs for all types of investment were

substantially higher than those of Japan and West

Germany over the period 1977 to 1988 (figures 3-2

to 3-4). Specifically, each year from 1977 to 1988,

the cost of capital in America averaged 3.4 percentage points higher than the cost of capital in Japan for

investments in machinery and equipment with a

physical life of 20 years; 4.9 percentage points

higher for a factory with a physical life of 40 years;

and 8 percentage points higher for a research and

development project with a 10-year payoff lag.6

The impact of differences this great is profound.

Even small disparities can be important and have

long-lasting effects. A 1-percentage-point difference

IN~on~ Science Fo~dation, The semico~uc~r[~~, Report of a Federal Interagency Staff Working Group (Washington, DC: NOV. 16. 1987).

p. 36. This point is quite debatable, even on short-term rates. The NSF study does not mention which short-term rates were compared, and other studies

have concluded that there are substantial differences in short-term interest rates.

z~e p~e lending ra~ in tie United States, and tie lending rate in Japan, according to International Financial St~iSticS. The rates were deflat~

using GDP deflators, from the Organization for Economic Cooperation and Development.

3Rc)befl N. McCauley and Steven A Zimmer, “Explaining International Differences in the Cost of Capital,’ Federal Reserve Bank of New York

Quarterly Review, summer 1989, pp. 7-28.

qFor example, w ‘‘U.S. and Japanese Semiconductor Industries: A Financial Comparison, ’ Chase Financial Policy for the Semiconductor Industry

Association, June 9, 1980; George N. Ha~sopoulos and Stephen H. Brooks, ‘The Gap in the Cost of Capital: Causes, Effects, and Remedies,’ Technology

undEconomic Policy, Ralph Landau and Dale Jorgenson (eds,) (Cambridge, MA: Ballinger Publishing Co., 1986); Albert Ando and Alan J, Auerbach,

‘‘The Cost of Capital in the U.S. and Japan: A Comparison,’ Working Paper No. 2286, National Bureau of Economic Research, Inc., June 1987; and

Dale W. Jorgenson and Masahiro Kuroda, ‘Productivity and International Competitiveness in Japan and the United States, 1960- 1985,’ paper presented

at the Social Science Research Council Conference on International Roductivity and Competitiveness, Stanford, CA, Oct. 28-30, 1988.

SD~e W. Jorgenson and Masahiro Kuroda, “Productivity and International Competitiveness in Japan and the United States, 1960-1985,” paper

presented at the Social Science Research Council Conference on International Productivity and Competitiveness, Stanford, CA, Oct. 28-30, 1988.

GMcCa~ey and Zimmer, op. cit., p. 16.
Chapter 3--Financing Long-Term Investments ● 95

Figure 3-1--Capital Input Prices, United States and Japan

3~~

Prlce index

1 -

+

0.6 -

Ot 1 1 t 1 I 1 1 I 1 I 1 1 1 1 1 # , 1 1 I 1 1 i 1 I 1

1960 1962 1964 1966 1966 1970 1972 1974 1976 1978 198019821984

— Japan 1 + Japan 2 -++ Us.

SOURCE: Dale W. Jorgenson and Masahlro Kuroda, “Productivity and

International Competitiveness in Japan and the United States,

1960 -85,” paper presented at the Social Science Research

Council Conference on International Productivity, Stanford, CA,

CM. 28-30, 1988.

Figure 3-2-Comparative Capital Costs: Equipment

and Machinery, 20-Year Life

1s1

12 -

10 -

[ 1

F

0’ 1 1 1 1 1 1 1 1 1 I I

1977 1976 1979 1980 1981 1982 1983 1984 1985 1986 1967 1988

— United States + Japa n + Germany -% United Kingdom

SOURCE: Robert N. McCauley and Steven A. Zimmer, “Explaining

International Differences in the Cost of Capital,” Federal

Reserve Bank of New Yotk Quarter/y Review, summer 1989,

table 2.

in the after-tax cost of capital can result in differences in capital stock of 7 to 13 percent in the long

run.

7 Even if American and Japanese capital costs

were the same today—which they are not—

markedly lower costs in previous decades in Japan

would still favor the Japanese firms.

Figure 3-3-Comparative Capital Costs:

R&D, 10-Year Payoff

30 -

25 -

15 -

10 -

5 ‘

L I 1 1 , I 1 1 1 I I I

1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988

‘

– United States + Japa n 4 Germany * United Kingdom

SOURCE: Robert N. fvfeCauley and Steven A. Zimmer, “Explaining

International Differences in the Cost of Capital,” Federal

Reserve Bank of New York Quarterly Review, summer 1989,

table 2.

Figure 3-4-Comparative Capital Costs: Factory,

40-Year Life

1 4

I ,’ I

12 -

10[

8 -

6 -

\

0

1 1 1 1 1 I 1 I 1 , I

1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988

— United States + Japa n ‘+ Germany * United Kingdom

SOURCE: Robert N. McCauley and Steven A. Zimmer, “Explaining

International Differences in the Cost of Capital,” Federal

Reserve Bank of ~w York Quarter/y Review, summer 1989,

table 2.

Sustained differences in capital costs of the

magnitudes shown by McCauley and Zimmer are

not likely under free market conditions in international finance.8 Based on evidence of capital-cost

differences alone, we would conclude that the

financial market of either the United States or Japan

TM. Fukao ~d M. Hmaz~, “Internation~izati~ of Fin~ci~ Markets: Some Implications for Macroeconomic Policy and fOr the Allocation of

Capital,” OECD Working Paper, No. 3, November 1986.

81t is q~~ ~sible, however, mat sm~ler differences could be sustained simply by different cdcdat.ions of ~vestment ri* b~ on c~ncY

fluctuations, even if capital moves across national borders without restriction. A Japanese investor, for example, might insist on a higher return on a

foreign investment than on a comparable domestic one simply to cover the risk of losses induced solely by changes in currency value.
96 ● Making Things Better: Competing in Manufacturing

is not free to seek its own equilibrium. Since the

American financial market is known to be relatively

open internationally, and interest rates are higher

here, the hypothesis is that the Japanese financial

market has been controlled. That is in fact the case.

Moreover, regulated financial markets are not the

only influence on capital investment or formation.

Tax incentives and exemptions are widely used to

promote capital investment in Japan, often for quite

specific purposes. The Japanese main-bank system

has also played a crucial part in lowering capital

costs and reducing the risk of investment in Japan.9

So, too, has the Japanese network of stable shareholding, designed to help managers resist pressure

from equity owners to concentrate on short-term

profits and dividends at the expense of market share.

The American financial environment is markedly

dissimilar. Not only are there fewer provisions,

public and private, to promote investment, but the

government gives less effort to maintaining overall

macroeconomic stability, shareholders demand much

greater accountability, and relationships between

banks and companies they lend to are more distant.

Moreover, the pressure exerted by the financial

environment to focus on short-term payoff, or

simply to invest less compared with Japan, is

growing.

The Japanese Financial Market:

Sharing the Risk

Capital costs are based on risk. Riskier investments must promise higher returns to induce investors to provide capital. There is evidence based on

the likely future earnings potential of American and

Japanese firms in 1989 that the international Japanese manufacturing firms could now be better bets

than the American ones. While they were often

satisfied with lower profits in the past, many

international Japanese firms are earning handsome

profits now; their reputations are sounder, and their

capital spending plans are lavish. A 26.3 percent real

increase is anticipated in Japanese capital spending

in manufacturing in fiscal year 1989, and 11.8

percent overall,10 compared with a 12.1 percent

increase planned expenditures on new plant and

equipment on the part of U.S. manufacturers.11 A

stable prosperous future for Japanese manufacturers

is a recent development, at least in the eyes of

international investors. In the 1960s and even in the

1970s, large, long-term investments by Japanese

companies in markets dominated by European and

American corporate giants must have been viewed

with much more skepticism than comparable large

investments in Japan now. Yet this higher degree of

risk was not perceived in the same way in Japan, nor

was it reflected in the costs of capital for large

Japanese manufacturing concerns.

The regulation of many facets of the financial

system of Japan made it possible for these companies to get low-cost capital. According to Abegglen

and Stalk, "[t]he policy of the Japanese government

is, and long has been, to hold interest rates to

industry at as low a level as prudent monetary policy

management allows. ’ ’12 Until the 1980s, Japan’s

financial market was effectively closed to outsiders,

and Japanese investors had few options for investment outside Japan.13 Moreover, Japan’s financial

system spread the risks of long-term investments in

industrial development widely among banks, savers,

consumers, and corporations. This was done through

controlled interest rates; tax policies that limited

consumer spending, encouraged saving and transferred household savings to businesses on very

favorable terms; and a variety of tax incentives that

reduced the cost of investment. In America, much

more of the risk of long-term investment is borne by

9y. KUOWIW~ op. cit.

l~e Jqm ~vclqment B~nk, ‘ ‘me Japan ~velopment Bank Reports on capi~ Spending: Survey for Fiscal yew 1988 -90,’ mimeo, September

1989, pp. 2-3. Mr. Nobuyuki Arai, Deputy Manager and Economist of the Economic and Industrial Research Department of JDB expects these planned

targets to be met. Personal communication with Mr. Arai, November 1988.

1 Iu.s. ~partment of Commerce, Bureau of fionomic Analysis, “Plant and Equipment Expenditures, the Four Quarters of 1988, ’ Survey ofCurrent

Bwines.s, September 1988, p. 19.

12J~~s c. A@@ and George Stw, Jr., Kais~, the ~~anese co~or~ion (New York, NY: Basic BOOkS, hlc,, 1985), p. 178.

13The following dlsc~sion ~aws heavily from tie fol]ow~g ~Uces: M. ‘f’hemse Flaherty and H.iro~ Ita,mi, ‘ ‘Finance,’ Competitive Edge: The

Serniconductor[ndustry in the U.S. and Japan, Okimoto, Sugano and Weinstein (eds.) (Stanford, CA: Stanford University Press, 1984), pp. 135-76.

Philip A. Wellons, “competitiveness in the World Economy: The Role of the U.S. Financial System,” U.S. Competitiveness in the World Economy,

Bruce R. Scott and George C, In@ (eds.) (Boston, MA: Harvard Business School Ress, 1985), pp. 357-394.
Chapter 3--Financing Long-Term Investments ● 97

the corporation itself.14 In addition, Japan’s high rate

of savings and rapidly rising income levels have

provided an increasingly generous pool of capital for

investment. Since World War II, net savings as a

percent of GNP averaged well above 20 percent in

Japan through the late 1970s, and have declined only

modestly since. Net savings as a percent of GNP

have rarely approached as much as 15 percent in

other advanced industrial democracies. 15 America is

the worst performer among the most advanced

OECD nations; net saving hovered at just below 10

percent of GNP through the end of the 1970s, and

then plummeted, reaching a low of 2.4 percent in

1987, and then recovered slightly (figure 3-5).

Capital formation, as a percent of GDP, has also

been higher in Japan than in the United States or

OECD Europe (figure 3-6). Finally, Japanese lenders—stockholders and large city banks-tend to

have much closer and more influential relationships

with their corporate debtors than is the case in the

United States.l6

Although some of the conditions described above

are slowly changing as the Japanese financial system

is deregulated, their combined influence over the

postwar period was to give Japanese firms substantially more freedom to make riskier, long-term

investments at lower cost than American (or probably European) firms enjoyed. From this perspective,

Japan’s much-touted long-term vision—and correspondingly, the much remarked myopia of American managers—becomes understandable. Rational

managers, operating under the rules and conditions

of financing in both countries, could be expected to

behave quite differently. This view is persuasive

even if the numerical difference in interest rates—as

low as 1 to 3 percentage points, according to some

analyses--is modest.

The sharing of risk in Japan is not the result of any

single action or actor, but rather of a variety of

institutions and laws. Moreover, the risk-sharing

that lowers the cost of capital to corporations does

not apply to consumers. The factors that spread the

risk of business investment include closed or controlled financial markets, channeling of funds to

Figure 3-5-Net Savings, Percentage of Gross

Domestic Product

15

t I

)

10 -

[

5 -

I 1 I , I 1 1 1 1 1 I

1977 1978 1979 1980 1981 1982 1983 1984 1986 1988 1987

— United States + Japa n +7 Germany ~ Great Britain

SOURCE: Organization for Economic Cooperation and Development,

Historical Statistics 1960-87 (Paris, France: 1989), table 6.16.

Figure 3-6--CapitaI Formation in the United States,

Japan, and OECD Europe

Percent of GDP

40% [ I

1

‘+\ + 

-+~+—./ —+--+

30% -+%+—+—I

3 G . . . *

-..

.*. .- .*. - ..+ --- * --- .*-- -*-. -.

20% - 6

10%

I

0% ‘

I I 1 1 1 1 1 1 , , 1

1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985

— Us. + Japan - *- OECD Europe

SOURCE: Organization for Economic Cooperation and Development,

National AccourIts 1960-1964 (Paris, France: 1986).

businesses and away from consumer loans, a large

pool of savings for investment, and close relationships between companies and capital providers

(banks, affiliated financial institutions, government

institutions, and stockholders). For targeted industries-those viewed as having most promise for

development —there are other mechanisms as well,

lq~e @@p~ ~onomies of western Europe, except West Germany, more closely approximate the American model than the Japanese, at 1east in

terms of capital costs, according to available evidence. See, for example, Y. Suzuki, Money and Banking in Contemporary Japan (New Haven, CT: Yale

University Press, 1980).

ISFlahe~ and Itsmi, op. cit., p. 137.

16For Cxmple, cor~tt m~es he Point hat Japane= ba~S probably monitor the companies they lend heavily to more actively than is the Case in

other countries. See Jemy Corbett, “International Perspectives on Financing: Evidence from Japan, ” O#ord Review of Economic Policy, vol. 3, No.

4, 1987, p. 45.
98 ● Making Things Better: Competing in Manufacturing

some of them explicit (subsidies for R&D and

capital investment, for example) and some implicit

or consensual, such as protection from the threat of

hostile takeovers.17

Controlled Financial Markets—The history of

the Japanese financial system is a study in control

and fragmentation. Although recent market-opening

moves have gained widespread attention. it is only

in the 1980s, under intense internal and external

pressure, that real liberalization has occurred, and

even so, Japan’s financial market remains one of the

world’s more controlled.18 Between World War II

and the early 1980s, a dominant purpose of the

Japanese financial system was to revive and strengthen

Japanese industry, often at the expense of consumers. Guidance of the financial system had two aims,

subsumed under the single purpose of promoting

Japan’s reconstruction and economic development.

First, the system was designed to favor business

investment instead of current consumption, or, in the

words of an official of the Ministry of Finance, ‘‘to

prepare the ground for industry to walk on.”19

Second, the government selectively promoted heavier investment in certain sectors as a part of Japan’s

industrial policy, and also helped non-targeted

industries cope with the costs of adjustment.

Preparing the Ground-Japan was a poor country after World War II. Its needs for capital were

enormous. Much of its industry had been devastated

by or dismantled after the war, and the zaibatsu,

family-controlled bank-holding companies that were

major providers of capital pre-war, were dismantled

during the occupation. 20 To rebuild industrial production--and then, beginning in the 1950s and

1960s, to accelerate development of targeted industries like machinery, motor vehicles, and electronics--

required what capital there was in Japan to be

preferentially provided to utilities and manufacturing. Several things made this transfusion possible.

Japan’s financial institutions were compartmentalized and fragmented, each with its own rather

narrow purpose and with many proscriptions on its

behavior. Briefly, the institutions worked together to

increase savings rates (generating capital for investment) and pass them on to industrial users without

high costs. They also worked to reduce the risk

associated with financial downturns and the costs of

financial distress to the firms.2] The institutions that

promoted high savings rates in Japan included a

lump-sum payment at retirement (rather than a

lifetime annuity) and a marginal system of social

security (though this is changing to become more

generous); large required downpayments on houses;

the absence of scholarships at universities; a system

of postal savings banks authorized to pay interest

rates higher than rates available elsewhere on

deposits, and tax exemptions on interest on postal

savings up to a certain level (14 million yen in the

early 1980s); a bonus-pay system of compensation

in Japanese corporations; and very high interest rates

(with no tax deductibility of interest paid) on

consumer loans .22

Together, these measures discouraged consumption and encouraged saving. In addition to providing

a large pool of capital, the system also controlled the

cost of raising it. Households were paid low rates of

interest on the savings they put into banks,23 but

rewarded by the tax benefits, or ‘‘maruyu,’ for

doing so. Securities markets were tightly controlled

so as to concentrate household savings in postal

ITpC~~ ~O=miC~tim ~i~ROn~d ~re, ~wri~ college, University of London; and Edward J. Lincoln, The Brookings ktitution, ~ch 1989.

lg~on V&r, Jqanese Financial Markets (Homewood, IL: DOW Jones-Win, 1988).

l~erW~ ~m~c~on, OTA st~f witi W. Kit~~a, Financial Bureau, h4inistry of Finance, Tokyo, Japan. Mm. 13>1989.

~efollowingdiscussionof Japan’s financial system depends heavily on the following sources: Viner,op. cit.; Andreas R. Prindl, JqpaneseFinance:

A Guide to Banking in Japan (New York, NY: John Wiley & Sons, 1981); Philip A. Wellons, ‘‘Competitiveness in the World Economy: The Role of

the U.S. Financial System,’ in Bruce R. Scott and George C. Imdge, U.S. Competitiveness in the World Economy (Boston, MA: Harvard Business School

Press, 1984).

21 Wellms, op. cit., p. S(jl. ~o~er ~t of ~stltutlons, ~u~ly impfiant, gave J~anese fiis preferenti~ access to the domestic market, helping to

assure a demand for the products of Japanese industry without ruinouscompetition from (at that time) abler foreign competitors. Japan’s trade policies

and their relation to industry policy will be discussed in the final report of this assessment of Technology, Innovation, and U.S. Trade.

22Tobe specific, a change in the rules governing consumer finance companies-known as sarakin—in 1985 reduced the maximum rateon consumer

loans from 109.5 percent per annum to 73 percent, and set a maximum of 10 percent of amual salary of 500,000 yen to the amount one customer could

borrow. Source: Viner, op. cit., p. 339. For an explanation of how the bonus-pay system promotes savings, see Abegglen and StaJk, op. cit., p. 1%.

mB~s did not pay ~ hi@ intere~ rates ~ ~st~ ~vings, but tie upper limit on be ~o~t of any one ps~ savings account, the trouble of keeping

several accounts, and the fact that company employees are often encouraged to use the company’s main bank or an affiliate, kept some household savings

accounts in banks.
Chapter 3--Financing Long-Term Investments ● 99

savings and in banks, so that banks, with their

controlled interest rates, did not have to compete for

savings by paying high rates of interest to depositors, and thus narrow their profit margins. Interbank

transfers of funds were also handled so as to

minimize the eventual interest rate that industry

paid. The result of all this control was that money

was channeled from households through several

banks to corporations, at rates that greatly favored

industrial investment and expansion at the expense

of consumption. The extent of the transfer was huge.

According to one estimate, if these measures lowered the interest rate to business by 2 percentage

points in 1971,800 billion yen was transferred from

households to businesses in that year-money that,

under free market conditions, would not have gone

to the corporate sector.24

Both commercial and governmental banks lend

money to Japanese corporations, but the distinction

between them is rather more blurred than is the case

inmost other industrialized nations. The commercial

banks include the large city banks, which specialized

in lending to large, blue chip corporations during the

high growth period;25 regional banks, which tend to

lend to small and medium-sized companies; the

Bank of Tokyo, technically a city bank, but the only

one that could make foreign exchange transactions

until World War II, and is still a specialist in foreign

trade financing and foreign exchange; trust banks,

which specialize in managing pension funds; specialized banks; the postal savings system; and

long-term credit banks created in the 1950s and

1960s by government to make long-term funds

available for industrialization. These last (which

include the Industrial Bank of Japan and the Long

Term Credit Bank) were able to provide funding to

companies even when there were severe liquidity

shortages, thus reducing the vulnerability of Japanese firms to ordinary fluctuations in economic

conditions.

The government exercises control over and

through the banks in many ways. First, interest rates

have been tightly regulated since 1947, when the

Temporary Interest Rate Adjustment Law was

passed. 26 By 1986, after 2 years of steps toward

deregulation, about 80 percent of deposits in Japan

still came under fixed interest rate regulations.27

Interest rates have historically been negotiated by

the Ministry of Finance, the Bank of Japan, and

long-term credit banks, the financial institutions

most concerned with the competitiveness of Japan’s

industry. Equity-to-asset ratios have also been extremely low by international standards; they averaged 2.19 percent for the city banks as of March

1986, compared with 5 to 6 percent for U.S. banks.28

This allows Japanese banks to make low-interest

loans both domestically and (lately) abroad.

There are informal controls as well. The Ministry

of Finance exercises enormous (though waning)

control over all aspects of Japanese finance. Much of

this is through so-called administrative guidance,

which takes a variety of forms, and can affect

behavior at the level of the individual firm or bank.

MoF’s instructions and desires are not often ignored,

even when they are not backed by force of law. Its

staff are “the most gifted graduates of the best

universities. 29 Like many other powerful Japanese

institutions, MoF operates through frequent contact

and consensus building; it holds regular meetings

with the management of main Japanese banks,

influencing the actions of Japanese branch banks in

foreign nations as well as at home. When its senior

staff retire,30 many of them accept positions at the

long-term credit banks, which were privatized decades ago. According to Viner, “. . . it is neither

accurate nor meaningful to describe the three

long-term credit banks as private institutions. Their

24y+ K~o~wa, q). Cit., p. 13.

2SBo~ km~auonand tie fmaci~ SWcess of tie lwge corporations of Japan have encouraged the city btis to look for new kinds of b@ne~-

Now, with many large businesses financed mainly by bonds, depreciation, and retained earnings, the city banks are turning increasingly to medium-simd

businesses for customers. Personal communication with Mr. Tatsuo Takahashi, Manager, Public Relations Division, Japan Development Bank, March

1989.

-e word “temporary” is misleading; the law is still in effect.

zTViner, op. cit., pp. X16-3W.

Zgviner, OP. cit., p. 20*. ~s low ~uity.to.~wt ratio is typic~, despite the fact that the 1954 Banking Act required a ratio of 10 percent. wording

to Viner, “this level was considered absurdly high by banks and was ignored. ”

2~~, op. cit., p. 9.

q~e tem for this is um@duri, or ‘descent from heaven’—which by itself connotes a status of civil servants that is very different from American

experience.
100 . Making Things Better: Competing in Manufacturing

ties with the government are so close that in many

respects they resemble auxiliary components of the

Ministry of Finance. ”

Industrial Policy--Formal and informal controls

can be used both systemwide—to advance capital

relatively cheaply to firms and away from personal

consumption, for example-and in pursuit of more

industry-specific goals. The government acts both as

a direct lender and as a bellwether for other private

sector lenders. Its direct role is small-in 1980, only

5.6 percent of all funds placed in financial institutions in Japan reached business directly from governmental institutions,31 and long-term credit banks

provided another 5.2 percent. But this governmental

role is more powerful than its modest funding would

suggest. According to Wellons, “few dispute that

private lenders in Japan treat this lending as a sign

that the firm or project has government support,

which would reduce the risk of the credit. ” Many

Japanese sources agree. According to Kurosawa,

The government also helped to reduce risk; MITI

established specific goals and initiated investment

for companies, and when necessary, adjusted the

order [of] which group of companies should invest

first and which next (Rinban Toshi).32

One way the Japanese Government primes the

private lending pump is through the Japan Development Bank (JDB). When motor vehicles were

chosen for rapid development in the 1950s, and

electronics in the 1960s and 1970s, the Japanese

companies were generally far behind American and

European companies in technology, and financial

returns from heavy investments in those industries

were therefore quite uncertain. City banks, with

much of the lendable capital, might have been wary

of making heavy investments in such industries, but

were reassured by JDB’s lending. Throughout the

postwar period, JDB loans have been among the

most important sources of funds for new equipment

acquisition in manufacturing. In fact, even in the

1980s, long after the end of any real capital scarcity

in Japan, about one-fourth of JDB’s funds still go to

manufacturing. 33 Where JDB lends is, in turn,

decided by a variety of government departments,

with strong participation from MITI, and its lending

is meant to help major strategic industries directly.%

Financial support for both industry as a whole and

strategic industries in particular has been a crucial

element of Japanese industrial policy, but it is by no

means the only one. Government support takes a

variety of forms, including preferential access to the

Japanese market,35 support for research and development, market segmentation among domestic firms,

and control of foreign investment. With such a

panoply of tools at hand, and the demonstrated

willingness to use them to support development of

industries, government can pack a powerful punch

with a relatively modest direct financial role.36 Also,

the variety of available tools helps to make up for

weaknesses in the use of any one. For example,

pump priming alone would not have induced Japanese banks to invest in certain sectors where the

expected returns were especially low; it was decisive, however, where both expected returns and risks

were high.37

The government’s control over the financial

markets is lessening. Many Japanese financial institutions see narrowing opportunities for growth

31’’fh= fi~tutionS ~c]u~e the J~p~~ Development Ba~, the Japan Export.~pofl B*, and agencies to finance smd and MdkM-Skd business.

Source: Wellons, op. cit., p. 380.

32y- K~=wa, op. Cit., p. 16.

XIR~fi J. B~lon @ ~wao ~mita, The Fi~n~~l Behavior of Japanese corpor~~~ (Tokyo: Kodm~ International, 1988), p. 37.

sdperm~ cornm~c~on with W. Kitamura, Ministry of Finance, op. cit., and Ballon and Tomita. op. cit.

35This is ~t ~t~ Mwket pro~tion, ~ is ~met~e~ cl~m~; however, access to Japan’s markets in Wgeted tid~tries is c~fully controlled and

limited, as are opportunities for direct foreign investment and direct investment abroad. Preferential access allows Japanese producers to sell goods in

Japan at higher prices or of lower quality than they could if foreign products were allowed unlimited access. Barriers to foreign competition are usually

phased out once the Japanese indusrnes have grown to be formidable competitors. However, we are now beginning to see Japan resorting to voluntary

restraint agreements in industries that are under pressure with the rise of the yen and the growing competence of other Asian competitors. A more complete

discussion of these mechanisms will appear in the next and f-real, report in this OTA assessment.

36Althou@ ~e~ nu~r is ~lin~g, there we expe~s who @pute the dqy~ to w~ch Japan’s indu~d policies have been responsible for the

postwar success of her industries. Clearly, other nations have used tools similar to Japan’s without the same results, and Japan herself has demonstrated

remarkable ability to develop industries in eadier periods when policies were quite different, as in the decades following the Meiji Restoration in the

late 19th century. Thus, more than industrial policy is responsible for Japan’s reeent performance. However, industrial policy has been and remains a

critical factor in Japan’s development, as will be explained more fully in the next and fuial report in this OTA assessment.

3TS~ibWaEi~e, Ro&t Feldmm, ad Yum H~~a, The Japanese Fina~~ System in Compar@”ve perspective, study Pmpa for the U= Of

the Joint Economic Committee (Washington, DC: U.S. Government Printing Office, 1982).
Chapter 3-Financing Long-Term Investments ● 101

domestically, as prosperous Japanese firms are

increasingly able to finance themselves, or have

more freedom to choose among domestic and

foreign financing options. International pressure has

also been a factor forcing liberalization of Japanese

financial markets. However, it would be a mistake to

regard Japan’s financial market as open—the deregulation is proceeding deliberately, so as to avoid

major shocks--or to discount the advantage that

tight controls gave to Japanese industry during the

postwar period through the early 1980s. Without the

deliberate channeling of capital away from personal

consumption and towards industry-particularly

those that were targeted-it is unlikely that so many

Japanese industries would be so prominent on the

international scene as they are now. It is also prudent

to assume that, if Japanese manufacturing comes

under increasing international pressure, the financial

system is capable of mobilizing quickly in response.

Corporate Finance-It is well established that

Japanese firms rely more heavily on external

financing-both debt and equity—than American

firms, and that the reliance was greater in the past

than it is now. Debt financing in particular has

played a greater part in corporate finance in Japan

than in the United States (until very recently) and

other western industrialized nations, and it still does

so today, even though the percentage of equity

financing is growing in Japan.

Precise figures are somewhat deceptive, as many

critics have pointed out. The gearing ratios38 

reported are based on the book value of companies’

assets, which are reported at historic cost. Inflation,

especially the run-up in the value of property and

land in Japan, tends to understate asset value and

thus overstate gearing ratios. However, even when

the figures are corrected to reflect more realistic

measures of Japanese (and American) fins’ asset

values, gearing ratios in Japan were still roughly

twice as high as those in the United States only a few

years ago. In 1981, for example, Japanese gearing

ratios were estimated at 0.56 to 0.62; American at

0.28 to 0.30.39 Japanese dependence on bank financing is also high compared with that of European

nations. American companies have depended much

more heavily on retained earnings (internal financing) and equity. This remains true even with modest

moves away from debt as a source of new funds in

Japan and increases in debt in America,40 the latter

resulting mostly from takeovers and leveraged

buyouts to defend against the possibility of takeovers.

Japanese reliance on bank financing, particularly

when capital was much less available there than it is

now, underlines the importance of low interest rates

in Japan. It also means that fins’ relationships with

banks are more important than their relationships

with shareholders, compared with the United States

(and much of Europe). As long as Japanese banks_ are

sympathetic to the need to make long-term investments with little immediate return, firms are more

likely to make such investments. This would be true

even if Japanese fins’ relationships with their

shareholders were the same as those of American

fins; however, Japanese shareholders are also more

sympathetic to the long-term interests and performance of Japanese firms than in short-term financial

gains, compared with American shareholders.41 In

short, while the structure and regulation of Japanese

finance would alone lead to the conclusion that

Japanese firms are better able to make long-term,

relatively heavy investments than American firms,

the nature of the relationships between capital

providers and firms supports this conclusion as well.

Japanese banks-including both commercial banks

like city and regional banks, and government

institutions like the Japan Development Bank-are

more involved with their clients than are American

banks. This is true at every step of the process, from

screening to monitoring of firm performance.42 To

begin with, Japanese firms usually have a special

relationship with one bank, a system known as the

main-bank system, and this relationship is an

important part of the risk-sharing that allows Japanese firms to enjoy or act like they have lower capital

costs. Kurosawa characterizes the main bank system

this way:

s~e~ng r~o is defined as the sum of short- and long-term liabilities divided by total assets.

s~lWes ~P~in Jenny ~~~, ‘‘l,n~rnation~ Perspectives on Financing; Evidence from Japan,’ O#Ord Revi6’w of Ecown”c po/icY~ vol~ 3!

No. 4., p. 34.

Wen Bemanke, “Testimony on corporate debt,” mimeo, May 25, 1989.

AIThis is l~gely due to tie institution of stable shareholding, as is explained later in this chapter.

4~s coWlwim, ad much of tie following disc~sion about banks’ relationships with firms, depends heavily on CorbeV oP. cit., Passim.
102 ● Making Things Better: Competing in Manufacturing

The main bank almost always has the largest share

in such business relationships as lending, shareholding, trusteeship of bonds, deposits, and so on. It gives

special priority to the client firms in credit rationing,

and in the case of a severe slump or bankruptcy

crisis, coordinates the responses of other lending

financial institutions and acts as a mediator and

supporter for the clients’ survival. Consequently, it

is essential for the main bank to monitor the firm, and

for the other banks the actions of the main bank act

as a signal. If the actions of the main bank remain

unchanged, there are no problems in the fire-t. The

main bank’s additional loans in effect guarantee the

security of the other banks’ loans.43

Differences begin with the way they screen

potential borrowers. For example, city banks are less

concerned about debt/equity ratios and are more

sensitive to the firm as a going concern (rather than

as a default risk) than are non-Japanese banks. The

screening is extensive, so when a city bank takes on

a client it is generally considered a good credit risk

by others. Part of the screening is done by the city

banks, but they are also able to rely on extensive

screening by the Japan Development Bank and the

Industrial Bank of Japan (IBJ).44 There is some

genial disagreement between these two institutions

as to which developed the screening procedures both

employ—both lay claim to it—but in any case, it is

thorough. According to IBJ, the screen consists of

increasingly smaller sieves. First, the Industrial

Research Department (IRD) develops information

on specific industries, examining in detail possibilities for growth and international competition. The

IRD also examines new sectors and technologies,

such as biotechnology and superconductivity, for

their eventual commercial possibilities. Once industry prospects are understood, the Credit Department

screens individual companies. If IBJ accepts a

company, that is a powerful signal to other financial

institutions of the company’s creditworthiness, and

a pattern of heavy lending to any particular industry

or sector is also a bellwether.

There are several reasons why the close ties

between main banks and their corporate customers

could lead to a longer term outlook on the part of

businesses, and possibly even to better decisionmaking than in countries like the United States or

England, where ties between banks and the companies they lend to are more frequently arm’s-length.

As noted above, the close relationships between city

banks and their customers are based on massive

amounts of information, always a good basis for

sound advice and decisionmaking. The city banks,

along with other major Japanese financial institutions like JDB, have become powerful information

brokers, and their ability to gather and process

information about businesses and business conditions in a variety of industries around the globe

probably exceeds that of all but the very largest

corporations. Banks can therefore serve as important

sources of information for strategic and operating

decisions for their closest customers. This assistance

on the part of banks is influential in encouraging

companies to focus on longer term goals in Japan

and Germany.

Another difference between Japanese and American bank lending is that loans from city banks are

much more likely to be long term. According to the

Bank of Japan, about 40 percent of Japanese

corporate borrowing had a maturity of more than a

year, compared with only 19 percent in the United

States, as of 1985. However, the longer maturities of

many Japanese loans are not exceptional compared

with France and the United Kingdom (where about

40 percent of loans are classified as being long or

medium term) or Germany (where about 60 percent

of corporate loans are long term) .45

Finally, it is well established that the conditions of

loans are changed when economic conditions

change in Japan. Although this practice is also

common in western industrialized nations, the kinds

of changes made are different. Corbett points out

that a shortening of the term of a loan would be

expected if a firm gets into trouble; yet in Japan loan

maturities have lengthened at the same time that

bankruptcies increased. With heavy investments of

both capital and prestige in the successor failure of

their clients, Japanese (and also German) banks are

far more likely, in a crisis, to extend additional

financing and assistance before pulling the plug than

43Y. K~~Wa, op. cit., p. 18.

44~e~~~B~of Japmis me of J~an’s~~ong.~~ c~it ba~, ~d it is~s~ly descri~ u tie most prestigious of d Japanese @Vate

banks. Its purpose is to provide long-term capital to private corporations, witb priority given to industries that are part of the government’s industrial

policy.

d5Bti of JqM& ECO?WW St@stics Att?u@ VtiOUS ye~; ~d COrb@t, Op. cit.. P. 42.
Chapter 3-Financing Long-Term Investments ● 103

an American or a British bank.46 Japanese banks

often forgive payments on debt principal during

tough economic times, or restructure debt in order to

allow firms additional options to overcome their

problems. 47 While some firms do eventually go

bankrupt or are forced to restructure severely, banks

explore many other options with their clients (often

at great cost to themselves) before declaring loans in

default. Prindl tells the story of Ataka, the fourth

largest Japanese trading company in the early

1970s. 48 It got into trouble over excessive credit

extended to a refinery in Canada, and eventually had

to merge with another firm, C. Itoh. However, $370

million in uncollectable receivables were absorbed

by its house banks, Sumitomo and Kyowa. This was

possible, in part, because of the widespread belief

that no large bank would be allowed to fail. Indeed,

in 1986, Japan had its first bank failure since World

War H, and that was a result of ‘massive, long-term

corruption. This situation is changing, like so

much of Japanese business. According to Viner,

“banks have been informed that they can no longer

expect central bank rescue in the event of a liquidity

crisis.”49 So far, this new policy has not been tested.

Even the promise of government support does not

seem adequate to explain why Japanese banks are

more willing to go the distance with their clients, as

long as there is some chance of maintaining the

company in business. In part, it is because the main

bank’s relationship with a client company goes far

beyond a loan. Companies generally encourage their

employees to deposit their savings in their main

bank, and deal with the main bank or its affiliates for

life insurance and managing the pension fund. In

addition, the main banks, in return for bearing some

of the risk of the company’s long-term investment,

are privy to a great deal of information about the

company, and are allowed to take part in its

management should it get into trouble. Main banks

often accept deferment of payment on principal and

interest if a client gets into trouble,50 and will

coordinate rescue funds from other banks. In addition, however, they investigate whether the company can be restructured to get it out of trouble, and

often draw up the restructuring plan.51 Corbett

points out that exchanges of personnel at both senior

and junior levels between banks and large firms (and

government ministries) are common.52 Banks sometime suggest changes in strategy when evaluating a

customer’s request for a loan, and make more

forceful suggestions of strategic changes when a

firm gets into trouble.

The kind of involvement that large banks maintain with their customers resembles that of preferred

stockholders more than creditors, according to

Kurosawa. Preferred stock may have a fixed dividend, but if profits are insufficient to support it, the

rate will be reduced and carried over.53

But what about actual equity holders? Here, too,

there are different relationships in Japan. Most large

Japanese firms belong to groups known as keiretsu,

which translates as “group arranged in order. ”

These are companies that have primarily been

associated with one city bank, and hold relatively

large amounts of each other’s stock—1 to 3 percent,

typically, of the stock of each other member of the

group. The result is that a majority of shares of all

members are held by other members of the same

keiretsu.54 Japanese city banks also typically hold

stock in the companies they provide credit to, with

the maximum amount now limited to 5 percent.

Finally, although intra-keiretsu shareholding is decreasing, a majority of stock in Japanese corporations is still typically held by corporate and other

institutional investors, rather than by individual

shareholders. As of 1988, 69 percent of all shares

listed on the Tokyo exchange were held by domestic

institutional investors—19 percent by banks, 13

percent by life insurance companies, and 26 percent

by other corporations—while 25 percent was held by

‘WOrbett, op. cit.

a~erW~ com~c~on wi~ David HI,@ Whittier, 1988; Flaherty and Itami, op. cit., p. 144; Corktt, pp. 46-51 Passim.

4~~, op. cit., p. 64.

49Viner, op. cit., p. 196.

5TM5 should not be reg~d as a distant possibility, Ballon and ~rnita point out th~, “more often than not, [the] bank at some point in time has

had to stage a rescue operation for its mqjor clients with the cooperation of other parties concerned,” Ballon and ‘fbmita, op. cit., p, 60,

51Y. Kuosaw~ op. cit., pp. 19-20.

5~a~ti, op. cit., p. 45.

53Y. Kwsawa, op. Cit., p, 20.

54Viner, op. cit., p. 2.
104 . Making Things Better: Competing in Manufacturing

individual Japanese stockholders and 6 percent by

nonresidents. 55 In contrast, 57 percent of U.S.

equities were held by individuals as of mid- 1989.56

More important than the pattern itself is the

character of equityholding in Japan. Until the early

1970s, it was virtually impossible for more than a

tiny trickle of foreign capital to find away into Japan

without the express permission-indeed, sponsorship--of government. In 1971, the door was opened

a crack through revision of the Securities Exchange

Law, and along with the liberalization came mounting concern that foreign companies would take over

Japanese corporations. To prevent that, Japanese

companies—at the urging of government—resorted

to a system known as stable shareholding.

Stable shareholders are Japanese nationals who

can be counted on to keep their shares, no matter

what happens to their price. It is a primary duty of

financial officers of corporations to find stable

shareholders. According to Ballon and Tomita,

When a capital increase is planned, financial

executives usually visit the major shareholders who

might be willing to subscribe to new shares and

request their cooperation in purchasing the new

shares at par while retaining both old and new shares.

However, a request for further subscription of shares

frequently implies a favor in return. . . the firm may

at this time confirm its friendly relationship with the

bank by promising (albeit unwillingly) to buy more

bank shares.57

Stable shareholding has had the direct result of

permitting companies to keep a longer term view in

their capital investment. Stable shareholders prefer

retaining earnings to receiving high dividends,

permitting the company that issued the stock to

reinvest its earnings, This reinvestment, in turn, is

viewed as directly contributing to higher share

prices. Since stocks are carried on their owners’

books at purchase price, rather than market value,

the rapid increase in share value has allowed

Japanese banks and corporations to carry substantial

hidden reserves. These hidden reserves are the utility

infielders of Japanese accounting: they can be used

to manipulate the reported levels of profit, and

thereby, taxes and dividends. For example, if the

company has a loss and needs to show a small profit,

it can sell a portion of its investment securities,

whose book value is usually significantly underreported. Often, it sells these to an affiliate or another

stable shareholder, and expects in its turn to pay the

same consideration to its affiliates when needed.58

The amount of hidden reserves is staggering: at the

end of March 1988, the hidden reserves of securities

of the 13 city banks alone totaled $229 billion.59

Stable shareholding has served the needs of the

Japanese economy admirably. It permitted longterm investment at a time when Japan’s companies

were much more vulnerable to foreign competition

than they are now. It has helped Japanese companies

to continue expansion and market share-building

during the various economic upheavals that paralyzed their competitors—through energy shocks of

the 1970s, the recessions of 1974 and 1982, and

through endaka in 1985-86. Most observers expect

stable shareholding to continue for the foreseeable

future, although it will face increasing challenges in

the years ahead. Financial liberalization in Japan and

the expansion of Japan’s business and financial ties

around the world have made it more vulnerable to

outside economic uncertainties. While its recovery

during the postwar period has been robust, this new

international exposure could well reduce its power

in the future. The high yen, too, has put the whole

economy on a more precarious footing. Some of the

advantages Japanese firms receive have narrowed or

disappeared, and strong competition from a new set

of industrializing nations has left Japanese manufacturers with less ability to ride out a prolonged

downturn. In a downturn, stable shareholding might

start to unravel, as companies in trouble draw down

their hidden reserves. The demise of this institution

is unlikely without a major recession, and not certain

even with one; however, if it does happen, the

system is likely to come apart rapidly.60 That,

according to Ballon and Tomita, “would have

55H1dW Ishihwa, “Jap~’s Compliant Shareholders, “ The Asian Wall Street Journul Weekly, June 13, 1988, p. 17.

56sW~tia ~dwq ASWciation ~ta, ~mpi]~ from Fl~ of F~ A~~ou~s, F~er~ Re~~e Bo~d. Thi.s total is down from 65 percent in 1985

and 85 percent in 1%5.

sTB~lon and Tbmita, op. cit., p. 52.

ssB~lon and Tomita, op. cit., p. 202.

59y. K~o~wa, Op. Cit., p. 20.

@Personal communication, OTA staff with Kimihide Takano, Senior Analyst, Corporate Division, The Nikko Research Center, Ltd., Tbkyo, Mar,

22, 1989.
Chapter 3---Financing Long-Term Investments . 105

profound repercussions on the stock market and the

Japanese economy as a whole.”6l It would tend to

shorten the perspectives of Japanese managers and

firms, making them more like American fins.

However, given the pervasive effect of administrative guidance from the Ministry of Finance, it seems

unlikely that the Japanese financial market will

behave a great deal like that of the United States

anytime soon.

In sum, a network of policies, practices, and

relationships acts to support heavy investment in

long-term performance in Japanese industry by

spreading risk. In contrast, American firms must

carry more of the risk of such investments by

themselves. While changes are occurring in the

Japanese financial market, the backlog of more than

three decades of such advantages has been highly

effective in putting Japanese firms in the secure

positions they now hold, relative to American and

European competitor. Even if the changes were

dramatic and rapid (which they are not) these

advantages would not disappear quickly. It may well

be that alterations in the way American managers are

taught to think about business could foster a more

positive attitude toward long-term investment, particularly in improved technology. But it is the rules

under which they must operate rather than their

education that is the principal influence on how U.S.

managers view long-term investment.

Even with changes in the rules, however, there

will be outliers. High capital costs have hobbled but

not crippled American firms in international competition; some firms are able to make substantial

investments in technology development for many

years. If a firm exploits its R&D effectively, such

investments are rewarded, not penalized, by equity

holders. But now, with increasing competition, more

firms are forced to choose between supporting profit

margins or stock prices and postponable expenditures like R&D.

Some long-term investments pay off, and some

don’t. We should not expect that risk-sharing will

necessarily result in longer term investment across

the board in America, or that every long-term

investment will be successful. However, without

some changes in the financial rules of the game,

American companies will continue to focus mostly

on short-term profit, to their detriment in international competition.

THE AMERICAN FINANCIAL

MARKET

The problem for America is not only that Japan’s

capital costs are lower than those of the United

States, or that Japan’s providers of debt and equity

capital are content to take more of their rewards as

capital gains rather than as cash payments. Among

the developed nations, Japan goes unusually far

down these paths. America is, for the most part, at

the other end of the scale. Our capital costs are high

not only relative to Japan’s, but relative to those of

many European countries as well, and they are high

in real terms, compared to what they were in the

1960s and 1970s. Institutional investors are, if

anything, more insistent on receiving short-term

financial gains than they have been, and they have

powerful tools to use if their interests are not

addressed. Rather than mobilizing its resources to

support American manufacturing during its difficulties, the United States often seems indifferent to or

contemptuous of the nation’s manufacturers. The

problems of manufacturers, we often say, are selfgenerated; manufacturing is badly managed, and

badly managed firms ought to fail, or change hands.

The contrasts with Japan, and with Europe as well,

are great.

Some—not all--of what we attribute to bad

management is simply a matter of intelligent people

playing by the rules. If our interest rates are such that

American managers can prudently invest $0.37 in

return for $1.00 in 6 years, while a Japanese manager

could invest $0.66 for the same return,62 we would

expect to see about half as much long-term investment in America as in Japan. If stockholders

evaluate a company’s performance on the basis of

quarterly or half-yearly reports of profit, we would

expect managers to emphasize short-term profits,

even when it raises possible conflicts with longer

term investment. And if showing a profit for

shareholders is one of the most important factors in

the survival of a business, we should expect to see

financial specialists wielding more power in compa61B~lon and lbtnita, op. Cit., p. 53.

6~e= fiWes reflWt tie actu~ co5taf<api~ difference of Japan and Americ& according to one calculation. See J~es M. po~rbas ‘me cow of

Capital Consequences of Curbing Corporate Borrowing, ’ Testimony before the committee on Ways and Means, U.S. House of Representatives, May

16, 1989.
106 ● Making Things Better: Competing in Manufacturing

nies than in nations where share price is a less

pressing daily concern to company managers. The

preoccupation with finance and short-term share

price performance was reinforced by the wave of

mergers and acquisitions American business experienced in the 1980s. Rather than moving toward an

environment more conducive to long-term investment in the development and use of outstanding

technology, the U.S. system raised the hurdles.

Another complicating factor is instability in the

financial environment. Federal decisions affecting

the value of the dollar and interest rates take business

competitiveness into account only tangentially, if at

all; yet such changes can have profound effects on

the ability of businesses to make prudent long-term

investments. Again, Japanese policies contrast sharply.

U.S. Government support for long-term research,

development and investment has also been somewhat shaky, leaving businesses that invest in such

projects vulnerable. For example, the Administration sent confusing signals about its support for

technology development in semiconductors and

high definition television in 1989. Even if the

modest support for R&D in these areas is continued,

the unreliability of Federal commitment to such

programs could make industry wary of such ventures. 63 Another example of the inconstancy of

Federal efforts to promote technology development

and diffusion is the impermanence of tax measures

that favor capital spending or R&D.

In short, America’s financial environment is

generally unfavorable to long-term investments in

technology development and diffusion, and government actions that mitigate the effects of this unfavorable environment have lacked commitment.

The Decline in Savings

Nations must continuously invest in productive

assets-plant and equipment, people, and technology development—to sustain investment and living

standards. Investment funds come from saving,

domestic and foreign. In the 1980s, an increasing

proportion of U.S. investment has come from

foreign saving, because U.S. savings rates have

fallen.

In the 1970s, net national saving (the percent of

national income saved by business, government, and

households) averaged 7.9 percent. Of this, 96

percent was invested domestically, and 4 percent

was invested abroad. In the 1980s, savings rates

dropped, and by the middle of the decade-1985 to

1987—net national saving dipped to 2.1 percent

before rising to just above 5 percent in 1989. Net

domestic investment (the percent of national income

invested) dropped to 5.7 percent, lower than in the

1970s but greater than the amount of investable

capital provided domestically. The United States

made up the difference by becoming a net importer

of investment funds, borrowing $417 billion from

abroad over the 1985-87 period.64 To attract savings

from abroad, the United States has had to raise

interest rates, or the return to investors. Importing

capital allowed the United States to invest more than

its own savings would permit, but it also raised the

price of domestic investment. This means that

improving and replacing productive assets and

technology for U.S. firms became more expensive in

the 1980s. A nation trying to keep pace with

well-financed and technologically sophisticated competition can ill afford this.

The decline in savings occurred across the board.

The sharpest change in the 1980s was a decline in

government saving, manifested by budget deficits at

the federal level. Falling household and business

savings contributed to the decline as well. The

Federal budget deficit resulted from a tax cut, which

slowed the growth of revenue, and from increased

outlays, principally for defense.

The reasons behind falling household savings are

less obvious. Many explanations have been advanced for this drop-and conversely, the rise in

consumption as a percent of national income—but

there is little consensus on which are most significant. Some analyses attribute part of the decline to

high interest rates, which made it possible for

corporations to decrease contributions to pension

631n ]~e 1989,-Or$ of an A&ninis~ationpropos~ t. kill f~ding for Sematwh in tie fisc~ ye~ 1991 budget s~fac~. The nunor woseconcurrently

with Administration proposals to shut down the Defense Manufacturing Board, and an OMB proposal to reduce DARPA funding for HDTV, While the

Administration eventually denied any plan to kill funding, the rumor was widely believed and taken seriously by much of the electronics industry. See

‘‘Administration Charged With Seeking Funding Cuts for Sematech, Other Projects,’ lnternatwnal Trade Reporter, Nov. 15,1989, pp. 1481-1482; and

Lucy Reilly, “Death Knell for Sematech?” New Technology Week, Nov. 6, 1989, p. 1.

@George N. Hatsopoulos, Paul R. Krugman, and James M. Poterba, Overconsutnptwn: The Challenge to U.S. Econom”c Policy (New York, NY and

Washington, DC: American Business Conference and Thermo Electron Corp., 1989), pp. 6-7.
Chapter 3---Financing Long-Term Investments ● 107

funds (these are included in household savings). The

jury is out on the effect of demographics. Some think

the baby boom was a major factor in increasing

consumption rates: since young people typically

save less than the middle-aged, they expect personal

savings rates to rise as the baby boomers mature.

Others dismiss demographics as having little explanatory power. Another often-cited argument is

that gains in wealth in the 1980s--capital gains on

corporate equities and homes----encouraged consumption. If people feel richer because their assets

are increasing, goes the argument, they feel less need

to save. On the other hand, since real wages and

salaries dropped during the 1980s, falling savings

may reflect attempts to keep up consumption patterns in the face of (for most families) declining

incomes.65 Another theory is that the propensity to

consume may have been fueled by the easy availability of consumer credit.66

The enormous increase in Federal Government

debt and the fall in household savings rates were

enough by themselves to force a curtailment of

capital formation, or a switch to capital imports, or

both. The decline in business saving has been less

remarked, but is important for two reasons. Between

the mid-1960s and the late 1970s, business saving—

measured in national accounts by the retained

earnings of corporations-fell from 4.5 percent of

GNP to 2.75 percent. By the mid-1980s, business

saving fell still further, to 1 percent of GNP.67 Unlike

the ballooning Federal deficit and falling household

savings, the decline of business savings is longstanding, and cannot be fully understood in terms of

the events of the 1980s alone. Nonetheless, the

depression of business savings to the lows of the

1980s is part of another change in the financial

environment-that is, mergers and acquisitions—

that limits the willingness of American companies to

make long-term investments.

Mergers and Acquisitions

Mergers and acquisitions are a normal feature of

the U.S. financial landscape, and ordinarily not a

controversial one. Occasionally, though, merger and

acquisition (M&A) activity heats up, as it did in the

1980s, provoking debate and examination. M&A

activity has raised many questions including those of

basic efficacy (are mergers and acquisitions really an

effective managerial disciplinary force, for example)

and effect (do mergers and acquisitions generally

improve long-term productivity, or produce outcomes as desirable from society standpoint as from

target shareholders’?). None of the questions are

resolved. Even questions that are somewhat peripheral to the whole debate—such as the effect on

managers’ willingness to undertake longer term

investments in technology development and diffusion—are hotly debated. While there is a growing

body of research and empirical evidence on the

causes and consequences of M&A, there are few

points of consensus in the argument. But it is clear

that the takeover wave of the 1980s is a special

feature of the American financial environment,

much more prominent here than in any other nation.

The length of the following discussion is not meant

to imply that M&A is the only, or even the major,

factor that causes American managers to focus

strongly on short-term profit, but M&A does intensify the pressures of the American financial environment, characterized by high interest rates and capital

costs and macroeconomic instability.68

Briefly, the argument goes as follows. One point

of view-often articulated by businessmen—is that

corporate raiders have forced a preoccupation with

short run performance that has disrupted business

planning. With access to new capital instruments

(junk bonds), acquirers can afford to pay inflated

prices to get controlling interest in their targets. The

first defense against potential raiders, therefore, is to

keep the stock price high enough to fend them off.

Since stock prices can fall significantly on disappointing quarterly profit performance, business manGsKatherine Gillrnan and Joy -erley, “Is the Middle Class Shrinking?” Furures, April 1988.

~he following sources discuss reasons for falling savings rates: Barry P. Bosworth, ‘ ‘There’s No Simple Explanation for the Collapse in Saving,’

Challenge, July-August 1989, pp. 27-32; George N, Hatsopoulos, Paul R. Krugman, and James M. Poterba, Overconsumption: The Challenge to U.S.

Economic Policy (Washington, DC: American Business Conference, 1989); David E. Bloom and Todd P. Steen, “Living on Credit,” American

Demographics, October 1987, pp. 22-29; and William D. Nordhaus, ‘‘What Wrong With a Declirting National Saving Rate?’ Chullenge, July-August

1989, pp. 22-26.

67Nordhaus, Op. Cit., p. 23.

6s The u~t~ States is not ~W~le compm~ t. most Comtnes, but the American financial environment for business is less stable than that of either

Japan and West Germany, our premier international competitors.
108 ● Making Things Better: Competing in Manufacturing

agers must focus on keeping short term profits at

acceptable levels. This, in turn, exaggerates the

already short-term planning horizons of American

business. 69

In some cases, more drastic steps maybe taken to

fend off a potential takeover, such as taking the

company private by means of a leveraged buyout

(LBO), or implementing some kind of “poison pill”

defense. While these strategies can keep the company from changing hands, the effects on planning

horizons can, ironically, be no friendlier to longterm investment and planning. In the case of a

defensive LBO, the company exchanges equity for

debt, making it safer from raiders but harder pressed

to maintain cash flows. Debt payments must be

made, while dividends can be postponed during thin

times. Cash flows that could have been invested in

research and development, plant and equipment, or

other long-term projects must be at least partly

dedicated to paying interest and debt retirement; so

companies may defer long-term projects in favor of

meeting their short-run obligations.70

Current concern is spurred by the fact that the

availability of high-risk, high-return bonds has

subjected many more companies to the threat of a

takeover than in the past. Junk bond financing can

turn even relatively small operators into potential

raiders, and even large companies are not immune

from the possibility of a takeover. Any company that

appears undervalued may be fair game.71 Moreover,

a company’s value to a raider can seem inordinately

high to many business managers;72 

company managers feel pressed to keep their stock price above even

inflated asset value.

The foregoing argument raises two questions.

First, it is difficult to accept at face value the

contention that a price can be too high if a willing

buyer agrees to pay it. The difference between

managers’ estimation of the real value of their

companies and that of potential acquirers may

therefore be that outsiders can see higher yielding

opportunities for managing companies’ assets than

managers do. Experts hold divided opinions on

whether acquisition prices are too high.

The concern implicit in the arguments of many

businessmen is that equity markets consistently

undervalue long-term investments. If the resulting

stock prices do not fully reflect the companies’

investments in future output, then perhaps acquisition prices are not too high, but represent a more

realistic appraisal of long-term company value.

Here, too, there is no consensus of expert opinion,

but it should be pointed out that there is no necessary

inconsistency here: while ordinary stock prices may

be too low, acquisition prices may be too high.73

The opponents in the debate view debt very

differently. Those who see takeovers and mergers as

a necessary disciplinary force on management see

the higher debt levels that result from much of the

current takeover activity as keeping managers from

squandering corporate assets on less productive

ventures. 74 Others regard the high debt that often

results from a hostile takeover, or a defense against

one, as a ball and chain hampering companies’

abilities to invest, particularly in long-term ventures

like R&D. The pressure of high debt load is expected

cause many defaults or bankruptcies in a recession.

Even without a recession, however, the junk bond

market is troubled; in 1989, corporate bond defaults

were up 136 percent over 1987, largely due to

defaults on junk bonds.75

Most of the evidence indicates that the direct

effect of all kinds of M&A activity on R&D

expenditures or intensity (R&D as a percent of sales)

is small or negligible. Bronwyn Hall, examining

approximately 250 manufacturing acquisitions be-

@John C. Coffw, Jr., ~uis ~we~~in, and Susan Rose-Ackerman, Knighrs, Rai&rs and Targets (New York, NY: Oxford University ~ess. 1988),

pp. 34.

7Wor a briefsummary of the arguments on both sides of the controversy, see Robert R. Miller, ‘‘The Impact of Merger and Acquisition Activity on

Research and Development in U.S.-Based Companies,’ contractor report to OTA, November 1989. The report is a summary of interviews with R&D

directors of 19 fms with a variety of M&A experiences. Some had undergone friendly mergers, some hostile takeovers, some leveraged buyouts, and

a couple had no resent experience with M&A.

71 Miller, op. Cit., p. 3.

TzW~en E. Buffett, Mich~l D. Dingman, and Harry J. Gray, with Louis Lowenstein, Moderator, ‘‘Hostile Takeovers and Junk Bond Financing: A

Panel Discussion,” in Coffee, et al., op. cit., pp. 10-27.

T3Coff=, et al., op. cit., P. 4.

TqMiller, op. cit., p. 6.

75Richmd D. Hylton, “Corporate Bond Defaults Up Sharply in ‘89, ” The New York Times, Jan. 11, 1990.
Chapter 3--Financing Long-Term Investments . 109

tween 1977 and 1986, concludes that the postacquisition R&D intensity of the firms was about the

same as pre-acquisition; moreover, the R&D intensity of the post-acquisition firms was not different

from the R&D intensity of all manufacturing firms

during the same period.76 In addition, there is abroad

consensus that R&D-intensive firms are unlikely to

be attractive takeover targets, and that the majority

of M&A happens in firms that do relatively little

research and development.77

Some use this kind of evidence to dismiss the

possibility that M&A is having corrosive effects on

R&D in particular or long-term investment in

particular.78 Yet there is reason for skepticism. First,

while much of the evidence supports the contention

that the effect of M&A on R&D is small, it is not

unanimous. The National Science Foundation examined the R&D spending and intensity of the 200

largest industrial R&D performing companies in

1984-86. 79 These companies account for almost 90

percent of all U.S. industrial research and development. Among the 200 firms were 24 firms that had

either merged or undergone an LBO during the

period; these 24 accounted for nearly 20 percent of

the R&D spending of the entire group of 200 in

1987. The firms that did not undergo restructuring

increased real spending on R&D by 5.4 percent,

while the 24 firms that were restructured through

M&A reduced their R&D spending by 8.3 percent in

real (deflated) terms from 1986 to 1987. These

overall findings were consistent with comparisons

of restructured and unrestructured firms at the

industry level as well.80 The NSF data should be

interpreted cautiously-the study spans only 3

years, and some of the reductions in R&D might be

elimination of redundant programs in newly merged

companies—but they indicate a need for equal

caution towards studies that show negligible impacts

of restructuring.

One possible reason for inconsistencies between

the studies cited above is that not all restructurings

are alike. One of the few points of consensus in the

debate is that M&A in the 1980s is unlike earlier

waves of M&A activity, and is certainly different

from the background level of restructuring. Different

kinds of restructuring-friendly mergers, hostile

takeovers, defensive LBOs, and other management

buyouts, for example-would be expected to have

different effects on managers’ abilities and incentives to invest in R&D and other activities considered discretionary in the short run.

The last wave of M&A activity, which occurred in

the 1960s, was characterized by diversification and

agglomeration. The 1980s, in contrast, are characterized by so-called bustup takeovers of diversified

companies with subsequent selloffs of the components.81 Hall’s study includes many mergers from

what could be considered another era--the late

1970s--which may blur the effects observed by the

NSF study which focused on the mid-1980s. High

debt is closely associated with the bustup takeover.

Friendly mergers often have little or no effect on

overall corporate debt levels, while hostile takeovers

and defensive LBOs, in particular, often leave very

highly leveraged companies in their wake. One of

the striking effects of the 1980s wave of M&A is the

substantial increase in corporate debt attributed to it.

According to one estimate, the corporate debt

burden was 20 percent higher in 1988 than it would

have been without the effects of corporate restructuring. 82

7~ew ~eS~tS ~Sm~~ ~ c ‘TeStimony of Bronwyn H~l in He~ngs on corporate Res~c~g and its EffWts on R&D Before the Science,

Research, and Technology Subcommittee of the House Committee on Science, Space and Technology, July 13, 1989;” and Bronwyn Hall, “Effwt of

Takeover Activity on Corporate Research and Development,’ Alan J. Auerbach (cd.), Corporate Tdeovers: Causes and Consequences (Chicago, IL:

University of Chicago Press, 1988), pp. 69-96.

77sW, for exmple, Lawrence SummerS> “LBO Debt and Taxes,” Across the Board, April 1989; Hall, op. cit.; and Abbie Smith, “Corporate

Ownership Structure and Performance: The Case of Management Buyouts,’ Leveraged Buyouts and Corporare Debt, Hearing Before the Committee

on Finance, United States Senate, Jan. 24, 1989.

TWW exmple, w Jo=ph A. Grundfest~ ‘‘M&A and R&D: In Corporate Restructuring Stifling Research and Development?” Address to National

Academies of Sciences and Engineering, Academy Industry Program of the National Research Council, Oct. 11, 1989.

79The tem “~dm~~” refers to companies in mining, cons~ction, and manufacturing. The vmt majority are in mmUfaCtUring.

8~est~ony of ~. Willim L. Stewm, Nation~ Science Foundation, ~fom tie Committee on Science SpaCe and TtxhnoIogy, Subcommiu* on

Science+ Research and Technology, House of Representatives, July 13, 1989.

81Lym E. Browne and Eric S. Rosengren, “The Merger Boom: An Overview, “NW Enghd Economic Review, March/April 1988. P. 23.

s~ol~an Sachs, Fi~ncia/MarketF’ersPectives, December 1988, quot~ in Lawrence SummerS~ ‘‘Taxation and Corporate Debt,’ in U.S. Congress,

House of Representatives, tiveraged Buyouts and Cmporate Debt, Hearing Before the Committee on Finance, U.S. Senate, Jan. 25, 1989. The

Goldman-Sachs analysis shows the outstanding debt of nonfhancial corporations as a percent of the gross domestic product of those corporations at 66

percent in 1988, compared with an estimated 55 percent without restructuring.
110 . Making Things Better: Competing in Manufacturing

It is quite possible that high-debt restructuring has

a greater impact than friendly mergers on R&D. This

proved to be the case in OTA’s interviews with 19

manufacturing companies representing a variety of

different restructuring experiences. Although the

sample was not a statistically valid sample of M&A

as a whole, the firms that had increased debt as the

result of a takeover or as a defense against a takeover

consistently reduced R&D following the event. The

reductions may not prove permanent-companies

may rebuild R&D as they pay down their debt—but

most of the R&D managers of the firms that had cut

back also believed their firms’ future ability to

compete was compromised as a result. 83 Hall

downplays the overall importance of R&D cutbacks

following LBOs (which invariably results in much

higher leverage), citing evidence that most firms that

undergo LBOs do no R&D. Also, Hall points out

that in her sample of 200 manufacturing acquisitions, 30 were LBOs. Those 30 had very low R&D

intensity-on average, 0.4 percent of sales-and

accounted for only 1 percent of the R&D done in the

private sector in the years 1984-86.84

What all this seemingly conflicting evidence may

mean is that LBOs as a whole have not directly

affected R&D overall by a measurable amount, but

that LBOs in large manufacturing firms have resulted in reduced R&D, at least in the short run,

because of the pressures of high debt. Indirect

support for this conclusion comes from another

study. Abbie Smith found that R&D intensity

declined in firms that reported R&D expenditures

before their LBO, and that sold assets after the LBO.

Smith warns against any conclusory interpretation

of this result, however, because so few of the firms

in the population of LBOs studied reported any

R&D at all.85

Another complicating factor is firm size. Most

service firms and small manufacturing firms perform very little or no R&D. The fact that NSF’s top

200 R&D spenders accounted for 90 percent of all

industrial R&D is telling. Summers points out that

many LBOs occur when the owner-manager of a

small establishment approaches retirement, and that

these are “almost certainly benign.”86 In another

common LBO situation, a company finds that a

certain line of business no longer fits into its overall

strategy, and makes amicable arrangements with the

managers of a division for the sale. Again, these

buyouts could be expected to have little or no effect

on R&D, either because many of the firms involved

do little or none, or because amicable transfer of

ownership of a division to its current managers can

often be accomplished without the high acquisition

prices often associated with LBOs.

Analysts have concentrated more on the effects of

M&A on research and development than on its

effects on other discretionary expenditures. But

R&D isn’t the only kind of discretionary expenditure that affects a fro’s technology; the other is

capital expenditure. There are no clear and consistent answers to questions about the effects of

corporate restructuring. Capital expenditure is necessary if firms are to keep up with and advance

technology, but like R&D, capital expenditure may

be postponed for a short time without long-term

material damage to a fro’s technological base. The

duration and depth of sustainable cuts varies by

industry and by firm, but even so, available evidence

gives some cause for concern. Smith reports a

substantial and significant reduction in capital expenditures as a percentage of sales that occurred in

58 management buyouts between 1977 and 1986.87

This finding is consistent with anecdotal evidence.

For example, consider Houdaille, a machine-tool

maker that underwent an LBO in 1979. Pressured by

foreign competition and (later) the effects of the

1982 recession as well as its high debt burden,

Houdaille cut capital spending as a percent of

revenues in half following its post-buyout restructuring. 88 One owner of a machine-tool making

business states, “When we hear LBO, we know

they’re not going to be buying anything.”89

Most analyses of the consequences of M&A have

been confined to measurable direct effects—

spending on various activities or overall perform83Milkr, op. cit., p. 14.

‘Hall, op. cit., p. 3.

8SSmj@ Qp, Cit. PI 71o

%hunmers, op. cit., p. 187.

S7S~~, op. Cit., p. 47-

88M= Holl~d, “HOW to Kill a Company, “ The Wmhington Post, Apr. 23, 1989.

8gHowad G~is, ~sident, Kinefac, personal communication, NOV. 16, 1989.
Chapter 3--Financing Long-Term Investments ● 111

ance of companies that have undergone restructuring. Two others should also be considered. First,

there are qualitative effects, not readily measurable,

on R&D or firm activities. Again, we would expect

(and find, according to the limited evidence) that

different kinds of restructuring have different qualitative effects. In OTA’s interviews, firms that

mounted successful defenses against hostile takeovers (leaving the companies with high debt)

long-term R&D had invariably been significantly

cut back in favor of projects with promise of quicker

payoff. 90 Some analysts interpret this kind of cutback as making R&D more efficient, and this is

indeed possible in the short run. R&D is by its nature

a long-term process, and firms can cut back on new

long-term projects without impairing their ability to

exploit the results of projects undertaken in the past.

So a shift in emphasis toward shorter term projects

would be unlikely to show up as detrimental for at

least a year or two. But in the long run, it seems

unlikely that increasing the focus on short-term

projects on the part of American firms will permit

them to maintain even their current level of competitiveness.

Friendly mergers, on the other hand, had either

little impact on R&D, or effects that would be

generally accepted as positive. One example is the

purchase of Celanese Corp. by the West German

chemical firm Hoechst. Hoechst was interested in

expanding its U.S. operations through the purchase

of an American firm with strong R&D, and after the

acquisition increased Celanese’s R&D expenditures

by 10 percent annually. Significantly, the new

German managers were also more willing to commit

substantial resources to long-term projects with less

certain payoffs.91 A similar story was told by the

president of Materials Research Corp., a semiconductor equipment and materials company recently

acquired by Sony. After the deal was completed, the

president was told by Akio Morita, the president of

Sony, that he had “essentially unlimited capital,”

and was no longer obliged to concern himself with

quarterly profits. “I can think of projects that take

two years, ” said Dr. Sheldon Weinig, the president.

“It’s a wonderful way to live.”92

It is difficult to make a few cases add up to a

strong finding, but the anecdotes about the qualitative effects on manufacturing R&D of different

kinds of M&A activity are consistent with quantitative evidence, if the focus is adjusted correctly. In

other words, both the qualitative and quantitative

evidence suggest the following: in manufacturing

firms that have appreciable amounts of R&D,

restructurings that result in high debt levels depress

R&D spending or intensity, or both, and often

shorten the allowable time for completion of R&D

projects. Because such restructurings are not common—

most happen in firms that do little R&D, and many

of them are in service fins-the overall direct

effects of M&A on overall national R&D are not yet

large, and may never be, particularly as hostile

takeover/LBO activity seems to be winding down

for now. This does not justify complacency about

M&A. NSF’s data are disturbing, and will be more

so if the highly leveraged companies continue to lag

in R&D spending or long-term planning. Additional

depression of discretionary expenditures on capital

equipment or R&D could well occur in the event of

a recession, or perhaps even when growth is less than

robust. Such cutbacks, normal in recessions, are

more likely when companies are highly leveraged.

Finally, the indirect effects of M&A must be

considered. The 1980s added a new wrinkle to the

takeover enterprise: the expansion of the pool of

potential raiders. In the past, in most takeovers, large

firms acquired smaller ones. In the 1980s, junk

bonds made it possible for “individuals, smaller

entities, and investment banking fins” to take

part. 93 In another contrast to past takeover waves

(and ordinary M&A activity), these new players

often intended to dismantle the acquired company

rather than to assimilate it. Both factors-the

increase in number of raiders, and the consequences

of a successful takeover-have apparently increased

managers’ fears of takeovers markedly, and may

also have depressed discretionary expenditures.

Managers, feeling that an unwelcome takeover bid

might come at any time, might take steps that

approximate what they would do to defend against

a real hostile takeover bid, with the same effects on

spending for R&D and capital equipment. In mid-

~iller, op. cit., p. 18.

glMiller, op. cit., p. 31.

WAII*W Pollack, ‘Cne Challenge of Keeping U.S. Technology At Home, ” Z% New York Times, k. 10, 1989.

93John C. Coffee, Jr,, “Shareholders Versus Managers: The Strain in the Corporate Web,” in Coffee, et al,, op. cit., p. 77.
112 . Making Things Better: Competing in Manufacturing

1989, for example, Honeywell acted to discourage

potential raiders by cutting out certain lines of

business (reducing the breakup value of its assets),

eliminating 4,000 jobs, repurchasing up to 10

million shares of its own stock, and increasing its

annual dividend to shareholders by 31 percent.94

There had been speculation that Honeywell might be

a takeover target, but no actual bid.

Few companies make moves as dramatic as

Honeywell’s, but many members of corporate

boards and senior managers report that hostile

takeovers came to dominate corporate board meetings and decisionmaking to an unprecedented extent

in the 1980s. The effect on overall business planning, almost certainly, was to increase the emphasis

on distributing profits to shareholders in preference

to reinvesting in the company.

Hostile takeover activity seems to be winding

down, although not crashing; the number of deals

completed in the first 9 months of 1989 was smaller,

according to a preliminary estimate, than the number

in the first 9 months of any of the preceding 3 years.

The first three quarters of 1989 saw 2,298 completed

acquisitions, compared to 2,790 in 1988, 2,851 in

1987, and 2,707 in 1986. However, the value of these

deals in 1989 was $144 billion, just below the peak

of $144.7 billion in 1988. The story is different for

LBOs: there were slightly fewer completed in the

first 9 months of 1989 (214) than in a similar period

of 1988 (221), but the total value of those LBOs in

1989—$47 billion—was quite a bit higher than the

previous high of $29.1 billion in 1988.95 T h e

numbers aren’t the only story. There is a widespread

perception that the market has grown pickier about

the kind of deals that can be approved, and there has

been a flight from junk bonds.96 Acquisitions

continue, but many believe that the wave of highly

leveraged, bustup takeovers is on the wane. If this is

true, it could provide time to examine how much of

the negative effects of M&A is associated with this

particular type of financial activity, and time for

policymakers to evaluate how to tailor possible

regulation to the real problems.

%Tony Kennedy, “Honeywe]l ACE Agtist PotentiaJ Raiders,” The Washington poM j~Y 2571989,

95jUdi~ H. Dchyzinslci, “Deals, Yes. Maniac Deals, No,” Business Week, Ox. 30, 1989.

~hristopher Farrell, with I-ah J. Nathans, “The Bills Are Coming Due, ” Business Week, (M. 30, 1989.
Chapter 4

Human Resources
CONTENTS

EDUCATION: PREPARATION FOR COMPETITIVENESS

THE MANUFACTURING CONNECTION . . . . . . . . . . . . . . .

Page

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 117

THE TECHNICAL AND ENGINEERING WORK FORCE . . . . . . . . . . . . . . . ● . . . . . . . . . . . . . . + , 120

The Engineering and Scientific Work Force . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120

Numbers and Distribution of Scientists and Engineers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . +... 121

The Functions of Engineers in Japan and America . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 124

Figures

Figure Page

4-l. Twelfth Grade Achievement Scores in Geometry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 116

4-2. Twelfth Grade Achievement Scores in Advanced Algebra . . . . .+ . . . . . . . . . . . . . . . . . . . . . . . . 117

4-3. Scientists and Engineers per 10,000 Labor Force . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .122

4-4. Employment of Scientists and Engineers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 122

4-5. Trends in Science and Engineering Labor, 1976-88 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .123

4-6. Salaries of Engineers and Laborers of Large Establishments in Japan, 1987-88 +.. . . . . . . . . 124
Chapter 4

Human Resources

Manufacturing, like the rest of the economy,

depends on the competence and ingenuity of workers, from the shopfloor to the executive suite.

Sophisticated technology demands able people. Just

as powerful machines can enhance the productive

abilities of people, it takes well-trained people to get

the best out of the machines.

The need for highly qualified people is not

confined to an elite; the most productive technologies are those that exploit the talents of skilled

people at all levels. This has been a cherished

principle of American development, manifested in

many ways. One is the commitment of the United

States to universal education, probably the most

important investment a nation makes in its people.

During most of the 19th and 20th centuries, the

United States enrolled a larger percentage of its

population in school than did European countries.1

Even now, although there are many serious problems with educational quality, American enrollment

in primary and secondary education is among the

highest in the world, and in postsecondary education

the United States ranks much higher than any other

nation. Fifty-seven percent of the relevant age group

was enrolled in postsecondary education in the

United States in 1987, compared to a weighted

average of 38 percent in all other industrial market

economies and lower averages for developing and

less developed nations.2 Nathan Rosenberg, describing the factors that led to the rapid rate of technological innovation in 19th-century America, writes,

Not only did American society devote a large

proportion of its resources to inventive activities; it

is also apparent that the human resources of the

country were well-equipped through formal education with the skills which might raise their productivity both as inventors and as successful borrowers and

modifiers of technologies developed elsewhere.3

Kazuo Koike, writing about contemporary Japanese manufacturing and skills, puts it this way:

The essence of the contribution of high morale is

. . . in devising better work methods and production,

which in turn demand technological knowledge by

workers for maintenance . . . This kind of wideranging skill contains such knowledge and promotes

the ability of workers to determine the causes of

problems on the shopfloor and thus to contribute to

productivity. 4

Rosenberg and Koike both stress technological

knowledge, and that is no accident. All fast developing and developed nations put heavy emphasis on

education-both on high-quality education and on

broad participation by all ranks of citizens. Among

the developed countries, those best known for their

heavy investments in education are either the richest

(West Germany, Sweden) or the fastest growing

(Japan).

Many leading-edge companies that have been

most successful in applying advanced automation in

manufacturing put a particularly high premium on

the cognitive skills of workers. By replacing human

labor in the more routine tasks, they create a greater

concentration of tasks that require judgment and

complex knowledge. The best preparation for a

worklife that puts increasing emphasis on judgment

and knowledge is a good education. Providing this

preparation is now a grave challenge for America. It

is the wellspring of competitive ability in Japan,

several Asian developing nations, and many European nations.

EDUCATION: PREPARATION FOR

COMPETITIVENESS

During much of the 20th century, the United

States had the best educated work force in the world,

and American manufacturing was the world’s most

dynamic and competitive. There is a causal connection between these two, although it is not perfect. At

the turn of the century new forms of industrial and

work organization, known now as Taylorism and

lllichmd A. ~terlin, ‘A Note on the Evidence of History, ’ Education and Econon”c Development, C. Arnold Anderson and MMY Jean Bowrnm

(eda.) (Chicago, IL: Aldine Publishing Co., 1965). The figures are reproduced in Nathan Rosenberg, Techno/ogyandArnerican Economic Growth (New

York, NY: Harper & Row Publishers, 1972), p. 38.

z~e World Bank, Worfd DeveJOp~ntRepOr-t 1987 (New York, NY: Oxford University hss, 1987), Pp. 262-263.

qNfi Ro~nberg, ~ec~~fl mtdAmerkan Economic Growth (New York, NY: Harper& ROW Publishers, 1972), P. 35.

qKazuo Koike, “Human Resource Development and Labor-Management Relations, ” The Political Economy of Japan, Volume 1: The Domestic

Transformation, Kozo Yamamura and Yasukichi Yasuba (eds.) (Stanford, CA: Stanford University Press, 1987), p. 327.
116 . Making Things Better: Competing in Manufacturing

Fordism, tried to reduce jobs to their simplest

components, which sometimes also had the effect of

reducing the educational demands made on workers.

However, many ordinary workers continued to bring

ingenuity and creativity to their jobs, and it was this

fact, as much as the efficiency of the assembly-line

method, that impressed foreign observers about

American manufacturing.s It is not a coincidence

that America is now slipping on both counts,

educational performance and manufacturing competitiveness.

American students perform poorly on standardized tests compared with their counterparts in many

nations of Asia and Europe. Since the 1970s, they

have compared unfavorably with their predecessors

in American schools as well. In the mid-1980s

American junior high school students ranked 10th in

arithmetic, 12th in algebra, and 16th in geometry in

a survey of mathematics competence in 20 countries. 6 Twelfth graders, compared with students from

14 other nations, ranked 12th in geometry and 14th

in advanced algebra, according 1981-82 survey7

(figures 4-1 and 4-2). American students scored

below students in Canada (Ontario), Scotland,

Finland, Sweden, Japan, New Zealand, Belgium,

England and Wales, and Israel in functions and

calculus. Of the students tested, only those in

Hungary and the Canadian province of British

Columbia performed worse. Moreover, the survey

showed that the performance of American students

had worsened in the past two decades. At the time of

the frost international mathematics study in the early

1960s, the top 5 percent of American students were

performing as well as the top 5 percent anywhere in

the world. By the 1981-82 survey, the top 5 percent

of American students had sunk to the bottom quarter

of the scores of the top 5 percent in other nations.8

The results are similarly dismal in science. Also,

compared with students in many other developed

nations, American students are less likely to learn

foreign languages.

The deterioration in the performance of American

students since the 1960s is just as disturbing as their

Figure 4-l-Twelfth Grade Achievement

Hong Kong

Japan

England\Wales

Sweden

Finland

New Zealand

Belgium(Flemish)

Scotland

Canada(Ont)

Balgium(French)

Israel

Us.

Hungary

Canada(B.C.)

Thailand

Scores in Geometry

o 10 20 30 40 SO 60 70 80

Mean score

SOURCE: International Association for the Evaluation of Educational

Achievement, The Underachieving Curriculum: Assessing U.S.

School Mathematics From an International Perspective (Champaign, IL: Stipes Publishing Co., January 19S7).

poor showing in international comparisons. For

many decades, American students scored higher

year by year on standardized tests such as the

Scholastic Aptitude Test and the Iowa Test of

Educational Development. This progress was all the

more impressive considering the fact that the American educational system was at the same time

reaching more and more people. From 1890 to 1960,

time spent in school, daily attendance, and the

number of years of schooling completed all increased. For instance, the scores of 12th graders on

the Iowa Test of Educational Development rose

robustly between 1942 and the mid-1960s, with a

dramatic spike in test scores after Sputnik’s launch.9

During about the same period (1941-68), high

school graduation in Iowa, where the test was

administered, increased from 65 to 88 percent of the

relevant population. In the late 1960s, the gains

stopped. Scores on many standardized tests began a

decline that lasted for over a dozen years. The upturn

in test scores in the early 1980s has only partially

offset the decline. Young adults who entered the

5Je~.Jqu~ seman-sc~ei~r, The American Challenge (New York, NY: Atheneum, 1%9).

q-Iarold W, Stevenw, “America’s Math Problems,” Educational Leadership, October 1987; and International Association fOr the Evaluation of

Educational Achievement, The Underachieving Curriculum: Assessing U.S. School Mathematics From an Internatwnal Perspective (Champaign, IL:

Stipes Publishing Co, January 1987).

T~ternatio~ Association for the Evaluation of Education Achievement, op. cit.

g~len Hoffmm, “The ‘Education Deficit’, ” The Nationaf Journal, Ma. 14, 1987.

gJohn H. Bishop, “Is the Test Score Decline Responsible for the Productivity Growth Decline?” The American Econorru”c Review, March 1989.
Chapter 4--Human Resources . 117

Figure 4-2-Twelfth Grade Achievement Scores

in Advanced Algebra

Hong Kong

Japan

Finland

England\ Wales

Belgium(Flemish)

Israel

Sweden

Canada(Ont)

New Zealand

Belgium(French)

Scotland

Canada(BC)

Hungary

Us.

Thailand

I

1 1 1 1

0 20 40 60 80 100

Mean score

SOURCE: International Association for the Evaluation of Educational

Achievement, The Undwachkwing Curriwlum: Assessing U.S.

School Mathemati From an International Perqmctive (Champaign, IL: Stipes Publishing Co., January 19S7).

work force in the 1970s were less well prepared

academically than their predecessors, an unprecedented occurrence in America.10

THE MANUFACTURING

CONNECTION

The strength of a nation’s scientific and engineering work force is connected to manufacturing

innovation and competitiveness in immediate and

obvious ways. The academic accomplishments of

shopfloor workers are not so obviously related to

competitiveness. When we consider the nature of

much factory work—short-cycle repetitive tasks—

the relevance of performance in science and mathematics may seem slight.

Yet manufacturing work is changing with advances in technology, and the changes often demand

skills that are more in line with academic competence than those required in earlier generations of

mass-production factory work. Automated production makes each worker responsible for a larger

share of the production process, and creates a greater

need for each worker in the system to understand

other parts of the system. Emphasis on product

quality, often formalized into statistical process

control (SPC) procedures, requires workers to have

basic skills in reading and math. For example, at a

Fujitsu Microelectronics semiconductor plant in San

Diego, California, most production jobs require

good arithmetic skills, including proficiency with

fractions and decimals, to cope with the demands of

SPC.

ll

Automated production also requires sound judgment and skill in problem solving. An account of

work in a silicon wafer plant in North Carolina

states,

At DNS, the silicon log in its raw state is worth

between $2,000 and $5,000. This fact and the cost

and expense of the machines employed in sawing

make “down time” far more acceptable than scrap.

Although the only direct control an operator may

have over his or her process is an on/off switch,

timely and judicious use of that switch is becoming

a high skill.12

Programmable automation and/or flexible manufacturing systems require multiple skills, many of

them new for production workers. Programmable

equipment enables one machine or group of machines to make a much wider range of parts or

products than dedicated machines. In the past,

workers could learn in a few days or weeks, by

watching and working with an experienced worker,

how to operate a particular machine. Now, workers

must identify more closely with products than with

processes or machines, and they are less likely to be

buffered from other machines and workers by large

stocks of parts and loose schedules. As a result, they

must be more familiar with the whole production

process and able to operate multifunctional machines. In such a system, operators can no longer rely

on learning by example, but instead must be able to

read and understand manuals and specifications.13

These skills are hard to translate into grade-level

equivalents, but training directors of firms that have

confronted difficulties with problem-solving ability

recognize that a basic proficiency in reading and

mathematics is both a good foundation for and an

indicator of problem-solving ability. Motorola, for

lqbid., p. 193.

llpa~ V. ~l~r, “Wo~er Training: A Study of Nine Companies, ” contract report to OTA, September 1988.

lzIbidO

lsLarry Hirschhom, “Training and Technology in Context: A Study of Four Companies, ” contractor report to OTA, September 1987.
118 ● Making Things Better: Competing in Manufacturing

example, determined that workers in its Factories of

the Future-fully automated semiconductor production facilities-needed at least sixth grade math and

seventh grade reading to cope with demands for

mastering different jobs in a rotation system, assuming responsibility for quality control, and participating in problem-solving work teams.

While these requirements are modest, many

workers do not possess them. Of a group of 278

Motorola production workers who volunteered for

testing, 85 percent were in need of some remedial

instruction in order to meet the standard of sixth

grade math and seventh grade reading. Most of the

people who failed to meet the standard in both

reading and math were workers whose native

language was not English. Fujitsu’s San Diego plant,

producing integrated circuits and semiconductors,

had the same problem: lack of the basic skills needed

for effective participation in quality circles (work

groups focused on problem solving). Here, too, the

trouble stemmed largely from the fact that many

employees, including the Japanese plant managers,

were not native English speakers.

This does not mean that basic skills deficiencies

in American manufacturing are confined to immigrant populations. Many companies have found that

poor basic skills among native workers limit their

ability to adopt new technologies. Their experiences

are confirmed by results of the National Assessment

of Educational Progress’ survey of literacy proficiency among young adults aged 21 to 25. Although

the NAEP findings show that nearly all young adults

are literate in a rudimentary sense, 20 percent of

young American adults read no better than a typical

eighth grader and 6 percent do no better than the

average fourth grader.14 Moreover, very few young

adults were proficient in tasks requiring even a

moderate level of complexity. For example, only 9.5

percent of the group, given typical grocery store

price information on a unit-cost basis, could select

the least expensive of two brands of peanut butter.l5

While it is not focused on the basic skills requirements for work, the NAEP study makes clear that

large numbers of young American workers do not

come into the workplace with the basic academic

skills that employers could expect from their years

of formal schooling. Such problems are not confined

to new entrants, products of an educational system

with slipping standards. They are found also among

midcareer and older workers, people whose basic

proficiencies were perhaps not strong to begin with,

or whose skills have rusted with little use.

With the quality of American academic achievement only now showing signs of rebounding, the

prospect is that things will get worse, not better. The

growth rate of the labor force is slowing, and a high

proportion of the new entrants over the next decade

will be from demographic groups (blacks, Hispanics, and immigrants) that traditionally have been

educationally disadvantaged. Faced with a declining

pool of qualified applicants, employers may not be

able to be as selective in their hiring as in the past.

Even if educational quality rebounds strongly in the

primary and secondary schools, the generation of

people that entered the work force in the 1970s, and

into the early 1980s, could still depress overall

American productivity growth well into the next

century, unless employers and public programs take

strong measures to help large numbers of workers

learn to read, calculate, and communicate better.l6

Well-designed programs can help workers with

rusty basic skills improve enough to handle such

challenging tasks as statistical quality control and

daily maintenance of sophisticated equipment.17

In some countries-West Germany is a prime

example-a nationwide system for teaching young

people technical skills adds a further advantage to

that provided by a sound basic education. About

two-thirds of Germany’s young people go through a

3-year work apprenticeship after finishing compulsory academic schooling at age 16. The vocational

training combines classroom studies 1 day a week

with organized work the other 4 days, either in a

workshop or a regular workplace. To qualify as a

craftsman, the trainee has to pass practical tests and

a 4-hour written exam. There is evidence that this

century-old system (it started with Bismarck) pays

off handsomely in productivity, quality, and flexibility in manufacturing.

ldIIWiII S, Kirsch dAnn Jungeblut, Literacy: Profiles of America’s Young Adufts (Princeton, NJ: Educational Testing Serviw. 1986), P. ~.

IsIbid., p. 34.

160TA is conduc~g ~ as~ssmcnt of ‘Worker Training: Implications for U.S. tim~t.itiv~=s,” to be completed in 1990. Preliminary results of

this assessment indicate that the lack of basic skills among manufacturing workers is a solvable problem, but does require effort and expense.

17~~, op. cit., paati.
Chapter 4--Human Resources ● 119

A mid- 1980s series of studies comparing matched

British and German manufacturing plants-in metalworking, kitchen cabinet manufacture, and garment

making-found that the German plants had labor

productivity advantages of 60 to 130 percent.18 In

each case, the studies concluded that a major reason

for the German advantage was the country’s better

trained, more highly skilled shopfloor workers.

(Technical training of foremen and higher managers

was found to be at least as important, in some cases

more so.) For example, in the kitchen cabinet plants,

nine-tenths of all the German workers on the

shopfloor had had 3-year apprenticeships followed

by qualifying examinations. At best, one-tenth of

production workers in the British plants were so

qualified, and several British plants had no workers

with similar training. One result: the German

workers were adept at using computerized woodworking machinery and a linked system for feeding,

unloading, and stacking materials. Fully linked

machine lines were hardly to be found in the British

plants, one main reason being fear that one of the

linked machines would “go wrong” and stop the

whole line.

Breakdowns of all kinds of machinery were far

more frequent in the British plants-another sign of

insufficient worker training. The German operatives

routinely clean and maintain their machines, whereas

this kind of planned maintenance is virtually unknown in the British plants, according to the study .19

Similarly, in metalworking, breakdowns of machinery-especially of advanced computer, numerically

controlled machinery-were a serious, continuing

problem in British plants, while the German plants

reported only startup problems, never continuous

longstanding difficulties.20

Apprenticeship training was also credited with

helping German shopfloor workers adapt easily to

changing requirements. This adaptability is essential

to the strategy of the German clothing industry,

which concentrates on short runs of high-priced

quality products and pays relatively high wages—at

least 50 percent higher than wages in the British

industry. In the German plants visited for the study,

80 percent of sewing machine operators had completed a full 2-year apprenticeship; no British firm

had a single machinist with equivalent training.21

The German machinists needed only 2 days to reach

top-speed production on a new style, and most were

able to work on new operations directly from

technical sketches. The British machinists typically

took several weeks to master a new style, and few

could work from technical sketches. Also, quality

was apparently much better in the German plants,

since the number of quality controllers (passers) was

only 1 for 23 machinists, compared to 1 for 7 in

Britain. Undoing of faulty work was often observed

in the British plants visited, but not once in the

German.

It is not the apprenticeship training alone that

serves German manufacturing so well. The level of

math competence of the average school leaver (age

15 to 16) is substantially higher in Germany than in

Britain, and the relative advantage is especially

marked for the less academically ambitious students

(those most likely to take up operative work) .22 Nor

is a public system of vocational training the only

way to give production workers the technical skills

they need for advanced manufacturing. In Japan, for

example, immensely successful international firms

such as Toyota or Mitsubishi hire high-school

graduates with no special technical training and give

them company training. Japan’s publicly funded,

vocational training institutes typically serve the

needs of smaller companies. Many American managers also think they can train production workers

adequately, if the workers know how to read, figure,

and communicate adequately and have good work

habits. The sine qua non is good basic skills.

l%Wtivi~ wssfi~on he basis of physical units of production for similar items. The studies were: A. Daly, D.M.W.N. Hitchens, and K.

Wagner, “Productivity, Machinexy and Skills in a Sample of British and German Manufacturing Plants,’ National Institute Economic Review, February

1985; Hilary Steedman and Karin Wagner, “A Second Imok at Roductivity, Machineg and Skills in Britain and Germany,’ Nutiontdlmtitute Economic

Review, November 1987; Hilaty Steedrnan and Karin Wagner, “Productivity, Machinery and Skills: Clothing Manufacture in Britain and Germany, ”

National Institute Economic Review, May 1989. S= also these papers by S.J. Rais and Karin Wagner in the National institute Economic Review “Some

Practical Aspects of Human Capital Investment: Training Standards in Five Occupations in Britain and Germany,‘‘ August 1983; ‘ ‘Schooling Standards

in England and Germany: Some Summary Comparisons Bearing on Economic Performance,’ May 1985; “Productivity and Management: The Training

of Foremen in Britain and Germany,” February 1988.

lgs~m and Wagner (1987), op. cit., p. 89.

~aly et al., op. cit., p. 55.

zls~mm and Wagner (1989), op. cit., p. 49.

22Prais and Wagner (1985) and (1988), op. cit.
120 ● Making Things Better: Competing in Manufacturing

THE TECHNICAL AND

ENGINEERING WORK FORCE

Although good basic skills throughout the work

force are fundamental for good manufacturing

performance, the defects of ordinary American

education and the lack of a robust vocational training

system may be more damaging to the nation’s

technical operatives than to its blue collar workers.

Assuming that production workers are competent in

reading and simple math, or need no more than

brush-up courses, they can be trained for many

shopfloor jobs in a matter of weeks. Training of

technicians-those who do nonroutine maintenance,

programming, and repair of equipment—takes

months to years, on top of decent reading and math

skills.

One conclusion of the comparative studies of

German and British manufacturing plants was that

the superior training of foremen in Germany was a

key advantage to manufacturers. The German foreman combines technical and managerial skills. He or

she supervises workers in the routine care and

maintenance of machinery, adapts standard machines to specialized needs, and works with suppliers in developing new machines. The foreman is also

responsible for scheduling work (often using computers for the purpose) and ensuring delivery on

time.

Most foremen are qualified as Meister, or advanced mechanic. Candidates for the Meister qualification must first have at least 3 years’ full-time

work experience following their apprenticeship and

qualification as craftsman. Then they take a prescribed set of courses in technical topics, business

organization, and training responsibilities, either

part-time over 2 or 3 years or full-time for about 9

months. The courses are free but candidates take

them on their own time. The written examinations at

the end of the course typically take about 17 hours,

spread over 3 days. Advanced mechanics in textiles,

for example, must pass an exam covering the

following subjects:

1. origins and qualities of raw materials and

textile products;

2. yarn and thread production;

3. yarn and thread construction;

4. the organizational structure of the firm;

5. the rights and duties of workers;

6. safety rules and first aid;

7. adjustment and operation of fiber preparation

machines;

8. adjustment and operation of spinning machines;

9. ability to determine the quality of yarns and

threads;

10. maintenance of tools, machines, and equipment;

11. machine parts;

12. electronics;

13. fundamental metalworking; and

14. installation and repair of machines.23

This rigorous training and accreditation system

for technicians or foremen is routine in Germany,

but practically unknown in America. Yet, particularly in automated manufacturing systems, the need

is increasing for numbers of people who have the

kind of broad mastery described above, people who

understand the entire production system and keep it

running. Remedying a shortage of these skills is

made considerably more difficult when the work

force is populated by men and women whose basic

educational preparation is poor.

The Engineering and Scientific Work Force

The problem of poor preparation in public schools

may turn out to be more acute in the engineering and

scientific work force. It takes at least 4 years to

produce an engineer, assuming the student has had

a solid secondary education. It takes longer to

produce most scientists. If because of inadequate

basic education the United States cannot keep a

healthy flow of scientists into research and development and engineers into R&D and industry, American manufacturing industries will find it increasingly difficult to keep up with, not to mention

outperform, industries in other nations.

Several trends are worrisome. First is the number

of scientists and engineers in the work force,

particularly those employed by industry. The proportion of scientists and engineers in America’s

work force has remained fairly constant through the

last two decades, while in Japan it has risen steadily.

Now, Japan has about as many scientists and

engineers employed per thousand workers as AmerZswape Br~ke Nelson, I~roving Competitiveness in Mature Industries: Lessons From the West German Textile Industry, M&$ter’s ~esis,

Massachusetts Institute of Technology, October 1987.
Chapter 4--Human Resources ● 121

ica, but will soon have significantly more, unless the

trends change. Second, it will be hard to spur growth

in the number of engineering graduates in America

because of three impediments: the poor performance

of average American students in science and mathematics in secondary schools; the increasing proportion in the population of America’s young people of

minorities, who have traditionally done poorly in

science and math; and the increased efforts by

foreign governments to attract home their own

nationals who are graduates of American engineering and science programs.

There are also some more specific problems.

Improving productivity and quality in manufacturing means attracting more engineers to manufacturing, and not just to the lucrative electronics industries. Manufacturing engineering has enjoyed much

lower status than other engineering specialties, and

there are few signs of change. Also, many engineers

and scientists are diverted from civilian industries to

work on defense technology; it is estimated that 20

percent of U.S. engineers are in defense work.24 The

debate over how much of the engineering and

scientific knowledge generated by the DoD spills

over into civilian sectors will not be resolved here.

However, defense work provides few benefits to

most manufacturing industries (aerospace and, to a

lesser extent, electronics are where DoD technology

has most of its civilian application).

Finally, there are qualitative differences in how

Japanese and American engineers spend their days.

Japanese companies are structured to do what they

are renowned for: make things better, and faster, and

less expensively. Accordingly, their use of engineers

is well adapted to continual incremental improvement of products and especially manufacturing

process. They are not particularly known for coming

up with a steady stream of larger technological

breakthroughs. American companies, on the other

hand, are better known for the stimulation of

engineers’ creative abilities, but are less effective in

day-to-day improvement or in meshing engineers’

design with shopfloor production. While both countries are making efforts to reproduce each other’s

strengths, there is little doubt that the Japanese

system has served manufacturing competitiveness

better than the American system has in the past few

decades.

Numbers and Distribution of

Scientists and Engineers

The concentration of scientists and engineers in a

nation’s work force says much about its capacity for

innovation and improved productivity.

Among five industrialized nations-France, West

Germany, Japan, the United Kingdom, and the

United States—the United States ranks first in the

number of scientists and engineers per thousand

people in the work force by a small margin (figure

4-3). When it comes to the engineering work force,

the United States, with 175 engineers per 10,000

workers in 1984, has a slightly lower concentration

than Japan (187 per 10,000 in 1985) or West

Germany (194 per 10,000 in 1985), and a higher

concentration than the United Kingdom (144 per

10,000 in 1981) or France (105 per 10,000 in

1982). 25

The number of people entering or graduating from

science and engineering programs in this country

has responded readily to market forces in the past.

The boom in industrial demand for computer scientists, for example, has made computer science the

fastest growing field of science at all degree levels.26

Patricia Flynn, analyzing the shift in industrial

composition of the Lowell, Massachusetts area

between 1970 and 1982, found that:

The occupational education network was highly

responsive to overall occupational trends in the area

and to the particular needs of the high-technology

industries. Three-quarters of the occupational education programs, accounting for 85 percent of all of the

trained graduates, were “on target” or “reasonably

aligned” with occupational employment changes in

the Lowell area during the 1970s.27

Specifically, Flynn showed how local educational

institutions shifted to meet the change in local

zqNtioti Actimy of Sciences, The impact of Defense Speti”ng on Nondefense Engineering Labor Markets (Washington, DC: Nation~ Actiemy

Press, 1986), p. 74.

~National Science Foundat,i~, National Science Board, Science and Engineering indicators-1987, NSB 87-1 (Washington, DC: U.S. Govement

Rinting Offke, Nov. 30, 1987), p. 226, appendix table 3-15.

~U,S. con-, Office of TechnoloW Assessment, Ehcating Scientists andEngineers: Grade School to Grad School, OTA-SET-377 (WAin@n,

DC: U.S. Government Printing (Mce, June 1988).

?-~a~ciaM. Flynn, Facilitating Techno~gicalC~nge: The Human Resource Chalienge (Cambridge, MA: Ballingermbli*ing CO.? 1988), P. 101.
122 ● Making Things Better: Competing in Manufacturing

Figure 4-3-Scientists and Engineers

per 10,000 Labor Force

250

I

200

t

150

100

I

-, France West Germany Japan United Kingdom United States

= Scientists m Engineers

SOURCE: National Science Foundation, National Science Board, Science

atndEngineering h?dicators-1987, NSB87-1 (Washington, DC:

U.S. Government Printing Office, Nov. 30, 1987), appendix

table 3-15.

employment patterns and industrial growth. Traditional manufacturing in Lowell was marked by

declining average annual employment of 4.0 percent

in textiles, 4.9 percent in apparel, and 8.4 percent in

leather between 1976 and 1982. At the same time,

employment in high-technology sectors took off:

annual employment growth in nonelectrical machinery (including computers) was 43.3 percent; in

instruments, 23.6 percent; in transportation equipment (mostly aerospace), 7.2 percent; and in electrical and electronic equipment, 7.2 percent.28 Lowell’s educational institutions responded, and the

numbers of graduates from high-technology programs grew more than twice as rapidly as the number

of graduates from all the other occupational programs.

More generally, engineers and scientists seem to

be in adequate supply in the United States-so far.

During the past decade there has been healthy

growth in the nation’s scientific and engineering

work force (figure 4-4). Both market forces and

government policies have proven effective at drawing people into engineering and science schools, and

at attracting people who are qualified to work in

engineering from other fields. Federal funding of

graduate fellowships has encouraged enrollment in

Figure M-Employment of Scientists and Engineers

6~

Millions

3

2

1

0

1976 1978 1980 1982 1964 1986 1966

Yea r

- Total, Sci. & Eng. = Engineering

*Estimate.

SOURCE: National Soience Foundation, “U.S. Scientists and Engineers:

1988,” NSF 88-322, 1988, table 1.

science and engineering and caused some students to

shift their postdoctoral plans.29 Federal science and

technology initiatives, such as NASA programs and

those at the National Institutes of Health, have also

helped to create a healthy job market for graduates.

Finally, the boom in microelectronics and computer

industries in the 1970s and 1980s also drew many

people into science and engineering curricula, especially electronic engineering specialties and computer science. Between 1976 and 1986, for instance,

the work force increased just over 2 percent per year,

while the number of computer scientists increased

nearly 17 percent per year, and the number of

electrical engineers increased 7 percent per year

(figure 4-5).30

But the trend is a bit bleaker. In the past, engineers

and scientists were typically white males. They now

make up a shrinking proportion of the pre-college

population, which is itself growing smaller. The

greatest growth is in the Hispanic population, with

a more slowly rising proportion of black people. By

the year 2000, 25 percent of the college age

population will be black or Hispanic. These two

groups, which are more likely to live in poverty,

perform less well in school and have had higher

dropout rates than white or Asian ethnic groups. It

will take greater efforts to prepare and recruit them

‘

g

Ibid., p, 81.

2gIbid., p. 17.

~.S. Department of Labor, Employment and Eurnings, any issue; and National Science Foundation, U.S. Scientists and Engineers: 1986, NSF

87-322 (Washington, DC: U.S. Government Printing Office, 1987).
Chapter 4--Human Resources ● 123

Figure 4-5-Trends in Science and Engineering Labor,

1976-88

Scientists, engineers (thousands) Total work force (millions)

3000, ~ 140

2500

120

100

2000

80

1600

60

1000

40

500I 20

0 0

1976 1978 1980 1982 1984 1986 1988

Yea r

9 Computer scientists ~ Electrical engineers m AI I scientists

= All engineers * U.S. work force

● Estimates, except for total work force.

SOURCES: National Seienoe Foundation, “U.S. Scientists and Engineers:

1988,” NSF 88-322, 1988, table 1; and U.S. Department of

Labor, Bureau of Labor Statistics, “Employment and Earnings,” vol. 36, No. 12, Deeember 1989, table Al.

into the ranks of scientists and engineers. If fewer

young people enter engineering and science programs, salaries will be bid up, and employers might

face rising costs of securing technical talent. Even

with manufacturing employment shrinking, the demand for engineers and scientists might not decline

or might even rise, as it takes increasing numbers of

scientists and engineers to keep manufacturing

competitive. If salaries rise, it will be more expensive to solve technical problems in manufacturing,

develop technology, run and adapt equipment.

While large companies and high-technology companies will continue to employ engineers and

scientists, more small companies will find it hard to

afford even one engineer.

To guarantee a steady stream of qualified entrants

into college engineering programs, many actions

will be needed. One is investment in primary and

secondary school programs designed to improve

performance in math and science. Actions to attract

and retain larger numbers of students into engineering and science would require a substantial commitment of resources, and take many years to yield

significant results .31

In the meantime, the Japanese system is already

primed to prepare, recruit, and educate engineers.

Currently, the concentration of engineers in the

Japanese work force is only modestly higher than in

the U.S. work force (187 per 10,000 workers in

Japan v. 175 per 10,000 in the United States) and

their concentration of scientists is much lower (65

per 10,000 in Japan, compared with 101 per 10,000

in the United States) .32 But the educational system

of Japan is effectively geared to produce new

engineers of a high caliber, while the American

system needs substantial improvement before the

feed rate into engineering curricula can be stepped

up, or even maintained. Over 4 percent of 22-yearold university graduates in Japan hold degrees in

engineering, compared with less than 2 percent of

22-year-old college graduates in America. While the

absolute numbers are roughly comparable-71,400

new engineering graduates in Japan in 1985, and

77,900 in America-the emphasis of the Japanese

system is clear, considering that Japan’s population

and GNP are about half that of the United States.

Despite its current favorable position, Japan faces

its share of problems in engineering. Maintaining

strength in manufacturing may prove a bit more

difficult than Japan’s impressive record would

indicate. Endaka, or high yen, squeezed Japanese

manufacturing, and while industry responded admirably to the challenge, the constraints of being a

high-cost nation are beginning to have effects that

concern many Japanese observers. Specifically, with

the pressure to increase productivity and hold down

wages, many newly graduated engineers are opting

for careers that offer greater financial rewards than

manufacturing. Currently, beginning engineers in

manufacturing earn only a bit more than workers

with no more than a high school education. In

1987-88, average earnings for male systems engineers 20 to 24 years old were 150,000 yen per month

($1,071 at 140 yen to the dollar); their earnings

peaked at 401,400 yen per month ($2,867) for 45 to

49 year-olds (figure 4-6). Prospects for graduating

engineers are much more lucrative in Japanese

finance, at least for now. The salary of a midcareer

(35-year-old) employee in a Japanese bank is the

equivalent of $70,000 to $80,000 per year, about

31s= U.S. ConweSS, Office of T~~~@y Aswwment, &f~ati~g scie~~ts ad Engineers: Gr&e SC/WOi to Grad SChOOf, OTA-SET-377

(Washington, DC: U.S. Government Printing Office, June 1988) for a detailed discussion of these policy options.

szNatio~ Science Fo~dtiion, National Science Board, Science and Engineering indicators-1987, op. cit.

21-700 0- 90 - 5
124 ● Making Things Better: Competing in Manufacturing

Figure 4-8-Salaries of Engineers and Laborers of

Large Establishment= in Japan, 1987-88

Thousand yen per month

600

500 -

4 0 0 -

300 -

200 -

100

t

O L 1 I I 1 1 1 1

20 25 30 35 45 50 55 60

Average ag e

— ProductIon worker. + College graduates + System engineers

SOURCE: Japan Productivity Center, Practica/ Handbook of Productivity

and Labour Statisifcs ‘87-’88 (Tokyo, Japan: Japan Productivity

Center, 1988), tables 11 and 13.

double the salary of a midcareer manufacturing

professional. 33 Little wonder, then, that new engineering graduates should opt for other sectors as they

leave school.

The salary differentials-and possibly, the sinking prestige of a career in manufacturing compared

with other opportunities-are taking a toll. While 60

percent of graduates from all Japan’s engineering

universities still entering manufacturing (roughly

the same proportion as in the past), the sector is

losing its appeal for engineers graduating from the

three most prestigious universities (Tokyo University, Tokyo Institute of Technology, and Waseda

University). About 80 percent of the engineers from

those institutions chose to enter manufacturing in

1982. The proportion has been declining ever since,

dropping under 60 percent in 1988. Many of these

graduating engineers are being lured into banks and

securities companies, where the jobs pay more and

the opportunities are regarded as more exciting. A

recent survey of electrical engineers showed that

younger engineers feel more strongly than other

young workers in Japan that they are unable to fully

use their talents, and that they cannot do what they’re

interested in. In addition, like other young workers

in Japan, they feel underpaid.34

Thus, Japan is not free of difficulties in attracting

engineers into manufacturing. However, the superior educational preparation of Japanese students

may make Japan’s problems easier to solve than

ours. Japan’s large pool of people who are able to

enter science or engineering could be an important

safety valve as it enters its own version of uncharted

waters. Just as the United States is trying to cope

with international competition on an unaccustomed

scale, Japan is trying to improve its ability to

generate breakthrough advances in science and

technology while maintaining its strength in manufacturing process. The new emphasis on innovation

probably means that Japan will need many more

scientists than it has, and that it will have to spend

more on basic research both in industry and in

universities-which, compared to American universities, contribute much less to the national stream

of technological development and innovation. In

addition, some departures from the traditional,

seniority-based career paths of Japanese scientists

and engineers may be needed.

So far, it is hard to make any case that America

doesn’t have enough engineers, particularly in

manufacturing. There are nearly as many engineers

in manufacturing in the United States as in Japan and

Germany, and more scientists; there is no artificially

created scarcity. The number of people entering or

graduating from science and engineering programs

seems to respond readily to market forces or at least

has done so in the past. The boom in industrial

demand for computer scientists, for example, has

made computer science the fastest growing field of

science at all degree levels. The principal worry for

the near future, so far as supply is concerned, is the

trend in demographics.

The Functions of Engineers in

Japan and America

Japanese and German manufacturing, both renowned for their attention to precision and quality,

employ about the same number of engineers per

worker as American manufacturing, which no longer

has the same reputation. Obviously, it is not just the

number of engineers in manufacturing that counts

but also how they spend their time.

The Japanese have consistently surpassed their

U.S. competitors in manufacturing things reliably,

with high precision, and at reasonable costs. In other

words, they have devoted more effort than AmerissBob John~one, “A Tmhnical Hitch,” Far E@ern Economic Review, Feb. 16, 1989, p. 49.

~~wo Kojirna, Yoshio Nishimura, ~ Tom SUZ~I)“ “The Changing Role of Japan’ sEEs,” Electronic Engineering Times, Dec. 5, 1989.
Chapter 4--Human Resources ● 125

cans to ironing out the large and small problems of

manufacturing. In comparison, American firms have

tended to put more emphasis on innovation. Job

assignments differ for engineers in America and

Japan, as does the relation between design and

production engineers.

The careers of Japanese and American engineers

in industry differ starting from the time they

complete their schooling and join a manufacturing

firm. In sharp contrast to American engineers,

Japanese engineers are likely to stay with the firm

until retirement, and to progress along a fairly

predictable path through the hierarchy of the company. Few leave firms and move to another in

midcareer. They are more likely to be transferred by

their company to an area outside their specialty. The

objective is to broaden their job skills and broaden

their knowledge of other functions. American engineers are likely to become managers earlier than

their Japanese counterparts, and to broaden their

knowledge by transferring between companies rather

than within them.35

About one-third of American engineers work in

research and development (940,000 out of a total of

2.8 million, as of 1988).36 In addition, some 275,000

engineers are involved in the management of R&D.

Only about 17 percent of American engineers

(495,000 people) work on the shopfloor, in production and inspection.37 The same pattern, in a more

extreme form, prevails in West Germany, where 50

percent of engineers work in R&D, and only 12

percent in manufacturing production and repair.38

While comparable data are not available for Japan,

there are strong indications that the Japanese firm

deploys its engineers differently. Japanese engineers

are much more likely than their American counterparts to have at least one assignment in a new area

to broaden their skills: 62 percent of Japanese

engineers report at least one job rotation assignment,

compared with only 35 percent of American engineers. Thirty-five percent of Japanese engineers

were assigned at some point to production, compared with only 14 percent of American engineers,

and 50 percent of Japanese engineers have served

one outside assignment in research, design, and

development activities, compared with only 14

percent of American engineers.39

These standard job rotations afford Japanese

engineers the opportunity to acquire a firsthand

knowledge of and sensitivity to the problems and

constraints of manufacturing. Most observers agree

that this understanding explains much of the ability

of Japanese manufacturers to bridge design and

engineering functions effectively. American engineers, who rotate functions less frequently but

change firms far more often, may acquire some

understanding of both manufacturing and design,

but the record of Japanese and American manufacturing suggests that it is relatively unusual. In Japan,

the transfer of research or development to manufacturing is accomplished by transferring people directly, while in the United States one manager is

more commonly assigned the responsibility for

transferring the knowledge from design teams to

production people.40 The fact that American firms

generally make much less effort than Japanese to

smooth the differences between product and manufacturing process design and startup shows up in

designs that are harder to manufacture, longer

startup times, and lower process efficiency.

Japanese engineers are more likely than their

American counterparts to take responsibility for

making sure their designs are manufacturable, a fact

supported by considerable anecdotal evidence. A

good example—also typical of the kinds of stories

told about interactions of design and manufacturing

engineers--comes from an engineer now at Sematech, the U.S. semiconductor manufacturing development consortium. The engineer once worked for

a major U.S. semiconductor manufacturer producing

1 megabit DRAMs, and then for Siemens on the

Mega Project, the European program to design and

manufacture 1M and 4M DRAMs. He recounted the

tale of the U.S. fro’s unsuccessful attempts to

manufacture 1M DRAMs efficiently (e.g., with high

yields and low cost). After developing the process

35s= ~nwd I-I. Lynn, Henry R. Piehler, and W. pad fiaY. “Engineering Careers in Japan and the United States: Some Early Findings From an

l%pirical Study,” rnimeo, n.d.; and D. Eleanor Westney and Kiyonori %lmkibara, “Designing the Designers,” Tech~lou ~evi~, APril 1986”

36Nation~ Science F~~dation, U.S. scie~istsad Engineers: ]988, NSF 88-322, 1988.

371bide

38Nat10@ science F~mdati~n, Scientiso a~Engi~ers in ~~wtria~ized cou~~es (Washington, DC: CIR Sttif Paper, November 1986), p. 25.

3~ym, et ~+, op. cit. The= ~rcen~ges describe only the job rotation experiences of engineers, not heir c~nt Positions.

WVestney and Sakakibara, op. cit., p. 28.
126 ● Making Things Better: Competing in Manufacturing

and prototypes in the laboratory, the company turned

the design over to the factory, where manufacturing

engineers were unable to get chip yields up to

competitive levels. The manufacturing engineers

protested that the process had no margin for error,

but they did not themselves have the resources or

knowledge to do paper analysis and make improvements. The designers, on the other hand, insisted that

they had developed a robust and manufacturable

process, and shied away from correcting the problems. At Toshiba, where the 1M DRAM process

quickly resulted in very high yields, the engineers

and scientists who developed the 1M DRAM

process and presented the results to the scientific

community 4l were also responsible for yield improvement activities.42

Case studies also indicate that Japanese firms

often have more engineers on the shopfloor than do

U.S. firms. In a study of flexible manufacturing

systems (FMSs) in the United States and Japan,

Jaikumar concluded that the Japanese companies

used the systems far more effectively than the

American fins. They got their systems up and

running in much shorter time and made many more

kinds of parts. Further, their machines had far less

down time. Much of the difference arose from the

ways in which the two countries used their engineers. U.S. managers treated their FMSs inflexibly,

like hard-wired equipment, while the Japanese

continued to tinker and make incremental improvements.

The adjustments needed to exploit the flexibility

of programmable machinery can generally only be

done by engineers. In Japanese firms using FMSs, 40

percent of the staff were college-educated engineers,

and all the workers were specially trained in the use

of computer numerically controlled (CNC) machines. In the U.S. companies, only 8 percent of the

workers operating the FMSs were engineers, and

fewer than 25 percent of all workers had been trained

on CNC machines. In the U.S. firms, the project

team of engineers and software specialists who

designed the system disbanded and left after they

had it debugged and running. In Japan, the engineers

who designed the system remained to operate it,

making continual programming changes, writing

new programs, and staying with it until they

achieved untended operation at least 90 percent of

the time. In a fully automated FMS metal-cutting

operation, Jaikumar found, engineers would outnumber production workers three to one, but the

system would require less than half the number of

engineers needed in a conventional U.S. system.43

4

1 Syuso Fujii et al., “A 50 [mu]A Standby IMxl/256Kx4 SMOS DRAM With High Speed Sense Amplifier,” IEEE J. Solid-State Circuits, vol. SC

21, October 1986, pp. 643-647.

Q~erW~ comm~cation, D. Robyn, S. Baldwin, and A. Buyrn of OTA with Peter Nunan, Semattxh, May 10-12, 1989.

dsR~c~ndr~ Jailn.unar, “Postindustrial Manufacturing, “ Harvard Business Review, November-December 1986.

●
Chapter 5

Links Between Firms

and Industries
CONTENTS

Page

LINKS BETWEEN MAJOR MANUFACTURERS AND SUPPLIERS . . . . . . . . . . . . . . 129

LINKS BETWEEN SEGMENTS OF AN INDUSTRY COMPLEX . . . . . . . . . . . . . + . . . 135

LINKS BETWEEN MAJOR MANUFACTURERS AND CAPITAL

EQUIPMENT PRODUCERS . . . . . . . ........ + . . . . . . . . . . . “ ● . ● -. ● + . . ● . ● . + . ● ‘ ‘ . “ . . . 137

INTERNAL LINKS: VERTICAL INTEGRATION, PRODUCT DIVERSITY, AND

LARGE SIZE . . . . . . . . . . . . . . . . . . . . . . . . . . “ ~ð . . . . . . . ● . . . . . ● ● + . . . ● ● . . ● . ● ● ● . ● . * ..- ● 143

Links to Markets, Financial Stability . . . . . . . . . . . . . . +... ”.. !..””.”..”””+ +.. w.. ” +..143

Links With Consumer Electronics . . . . . . . . . . . . . . . . . . . . +.. ● ● ”.. ”... +++. i.• ● +. w.. ” + 147

Technology Links . . . . . . . . . . . . . . . . . . . . . . . . . . . .. ”. .. .. .” S. .. ..+. .” S.. .+O.. ...9.-0

Figures

Figure Page

5-l. Supplier Network for Fuji-Xerox . . . . . . . . . . .. .. . .. .. .. ... .. .......+. . . . . . . . . . . 131

5-2. Shift in Market Shares for Wafer Steppers . . . . . . . . . . . . . . . . . . . . . . . . . . ... ....,..+ 139

5-3. U.S. Market Shares of Selected Semiconductor Equipment .. .. .. .. . ..+. ......+. 139

5-4. World Semiconductor Equipment Sales ........””.o.0+0.’.’.+.* t+.’.+.”...””” 143

5-5. World Semiconductor Sales...*..............*. .....o.J.c...+0..+o’o +..”+....

Tables

Table Page

5-1. Main Reasons for Subcontracting, Japanese Firms,1986 .. .. .. .. .. ... ... .......+ 133

5-2. Top Ten Semiconductor Equipment Suppliers, World Sales .. ... ... +...... . . . . . . 141
Chapter 5

Links Between Firms and Industries

Industries do not standalone. They are linked with

suppliers of machinery and materials in one direction and with a chain of customers in the other. How

a firm or an industry handles these relations has a

good deal to do with its competitive performance. In

all kinds of manufacturing industries, close links and

stable relations between suppliers and purchasers

seem to be important factors in boosting overall

performance, including productivity, quality, and

innovation.

U.S. industries, on the whole, have not been

strong on collaborative vertical links. The traditional

relation between supplier and customer has instead

been distant, even adversarial, and based mainly on

price. 1 But there are signs of a trend toward more

collaboration. U.S. auto companies are trying to

form closer, longer-term relations with parts suppliers. Sematech, the industry-government consortium

dedicated to improving manufacturing technology

in semiconductors, began by strengthening ties

between chipmakers and producers of the materials

and equipment used to make chips. Textile companies are forging stronger links backward to fiber

suppliers, forward to apparel makers, and beyond to

retailers. Individual firms that have made a comeback against foreign competition use close supplier

links as part of their strategy, a leading example

being Xerox.

The trend toward closer links is certainly not

universal. Nor is it likely that American manufacturers will ever replicate the distinctively Japanese

style of close, mutually obligating bonds between

parent and subsidiary companies (even in Japan the

bonds are weakening somewhat). But the advantages of collaborative links, throughout an industry

complex and between related industries, are increasingly appreciated.

LINKS BETWEEN MAJOR

MANUFACTURERS AND

SUPPLIERS

Traditionally, U.S. manufacturers have either

supplied their own materials and parts (in vertically

integrated companies) or, when dealing with outside

suppliers, have kept them at arm’s length. A

common strategy has been to pit one supplier against

the other and drive the hardest possible bargain on

price. In offering their own goods to the next

producer down the chain, the main selling point has

also been price, with quality, service, and responsiveness to customers’ needs taking a lesser place.

This approach is not confined to the United States,

but is typical in many market-oriented industrial

countries.

A different pattern is common in Japan. In the

world-class industries that have led Japan’s strong

trade performance, manufacturers generally maintain long-term, collaborative relations with their

outside suppliers. They are demanding on price and

equally demanding on quality and just-in-time

delivery, but they also give their suppliers technical

help--occasionally financial help as well—in meeting these demands. Suppliers who show they are

able to satisfy the manufacturer’s demands can be

fairly confident of keeping the business, rather than

losing out to a price-cutting competitor. This pattern

is part of the overall Japanese approach of careful

attention to all aspects of manufacturing, including

the quality of components and supplies.

The manufacture of motor vehicles offers an

exceptionally clear picture of these alternate ways of

handling links with suppliers. Organization of supply is a central feature of the auto industry, since the

average car or truck contains some 15,000 parts.

Historically, U.S. automakers have chosen one of

the two opposite approaches: either vertical integration (as practiced by General Motors, which is 70

l~e pat~rn is not inv~able, For ex~ple, major ~r11ne5 have ]ofig had close, cooperative ties with the manufact~ers of aircritft, with tirline

engineers taking a leading part in design and purchase decisions. However, with deregulation of the industry, the ties are loosening; airlines are cutting

their engineering staffs andmakingpurchase decisions more strictly on the basis of price. See the case study of the commercial aircraft industry in Michael

L. Dertouzos, Richard K. Lester, Robert M. Solow, and the MIT Commission on Productivity, Made in America: Regaining the Competitive Edge

(Cambridge, MA: The MIT Press, 1989).

-129-
130 ● Making Things Better: Competing in Manufacturing

percent integrated), or arm’s-length purchase from

suppliers bidding against each other (Chrysler, 25

percent integrated). Vertical integration is supposed

to have the advantage of lowering barriers between

supplier and main company (reducing transaction

costs)--e.g., by assuring that suppliers’ interests are

the same as the company’s, or by making it easier to

transfer new technology to the supplier. The arm’slength bidding system is supposed to do a better job

of keeping suppliers’ prices low.

Japan’s highly successful auto manufacturing

industry uses the third approach, a middle way that

is sometimes termed the supplier group system.2 It

consists of a pyramid, topped by the final assembler,

who deals with a group of first-tier companies just

below that are responsible for major components.

The first-tier suppliers manage relations with the

second tier, who supply individual parts and themselves often deal with third-tier groups, which may

in turn reach down as far as a fourth tier of tiny firms

specializing in very narrow tasks. Some of these

supplier groups are tightly bound. This is especially

the case with the Toyota group, composed of 225

companies that own each other’s shares and lend

staff and equipment from purchaser to supplier,

starting with the assembler and reaching down

through the various tiers. Other companies, such as

Honda, have a looser structure, relying more on

independent suppliers who also serve other major

assemblers. But here too the relationships are close

and long-term.3

A leading virtue of the Japanese system is that it

is easier to manage than the older U.S. systems. A

study for the International Motor Vehicles Program

comparing General Motors procurement with Toyota’s found that, despite GM’s 70 percent vertical

integration, and despite stringent efforts to cut back

its purchasing departments, GM still had 6,000

buyers of outside components and supplies in 1987.

The Toyota Motor Co., only 20 percent integrated

and producing about 40 percent as many vehicles,

might be expected to need as many buyers as GM but

reportedly had 337.4 These figures very likely draw

an exaggerated picture of the differences, because

Toyota often uses engineers as purchasing agents so

that the number of its buyers is probably understated.

But the disparity is so large that some of it is bound

to be real, not definitional.

The answer to the seeming paradox is that, in the

Toyota system and others like it, purchasing is

delegated down the line. So are other responsibilities. The final assembler makes the car bodies,

engines and drive trains, and integrates the system.

But the first-tier suppliers are assigned the tasks of

designing, engineering, and testing components, as

well as producing them. Often, the supplier delivers

to the assembler pre-packaged subassemblies that

contain many parts (e.g., instrument panels or

suspension systems). The suppliers moreover have

the burdens of assuring quality and managing

just-in-time delivery. What they get in return is a

reliable purchaser for their particular components

for the life of the vehicle model, and often beyond—

subject to the understanding that they will continually reduce the component’s cost while maintaining

its quality. At the same time, to keep competition

keen, assemblers often do business with more than

one supplier of the same component.

Industries other than automating are just as

wedded to the supplier group system-e. g., the

manufacture of cameras (e.g., Canon), office copiers

(Fuji-Xerox), personal computers and printers (NEC

and Epson).5 Figure 5-1 illustrates the supplier

network for Fuji-Xerox. A rough indication of the

extent of the system is that the share of Japanese

2The Japanese gOUp system has ~n described by many authors; a comprehensive treatment of the system as practiced in the auto indusv is in

Michael Cusumano, The Japanese Automobile Industry: Technology and Management at Toyota and Nissan (Cambridge, MA: Harvard University Press,

1985), see esp. pp. 241-61. A succinct description is in James P. Womack and Daniel Roos, “Case Study: The Automouve Industry,” contract report

to the Office of Technology Assessment, Sept. 15, 1988; some of the material in this section on the motor vehicle industry is drawn from this report.

3A recent Japanese suwey found that 68 percent of subcontractors had never changed tieir ‘‘ Pment, ’ and that 53 percent had been doing business

with the same parent for 15 years or more. Chusho kigyo cho cd., Chusho kigyo hakusho (Small and Medium Size Enterprise White Paper) (Tokyo:

Okurasho instasu kyoku, 1988), p. 61, cited in D,H. Whittaker, ‘‘New Technology in Small Japanese Enterprises: Government Assistance and Private

Initiative,” contract report to the Office of Technology Assessment, May 1989.

dToshihiro Nishiguchi, ‘‘ Competing Systems of Automotive Components Supply: An Examination of the Japanese ‘Clustered Control’ Model and

the ‘Alps’ Structure,” Massachusetts Institute of Technology, International Motor Velucles Program Working Paper, May 1987, p. 15.

sKen-lchl ~~, ~ujlro Nonaka, and Hirotaka Takeuchl,“Managing the New Product Development Process: How Japanese Companies Learn and

Unlearn, ‘‘ in Kim B. Clark, Robert H. Hayes, and Christopher L,orenz (eds.), The Uneasy Alliance. Managing the Productivity-Technology Dilemma

(Boston, MA: Harvard Business School Press, 1985).
Chapter 5--Links Between Firms and Industries ● 131

Figure 5-1-Supplier Network for Fuji-Xerox

Fuji-Xerox a

I

Toritsu-Kogyo b

(primary subcontractor)

(secondary subcontractor)

v

Number of secondary subcontractors

a Has other primary subcontractors.

b Serves as subcontractor for other manufacturers.

SOURCE: Ken-lchi Imai, Ikujiro Nonaka, and Hirotaka Takeuchi, “Managing The New Product Development Process: How Japanese

Compantes barn and Unlearn,” in Kim B. Clark, Robert H.

Hayes, and Christopher Lorenz (eds.), The Uneasy Alliance:

Managing The Productivity Technology Dilemma (Boston, MA:

Harvard Business School Press, 1985), p. 364.

manufacturing companies using subcontracting rose

from 32.5 to 37 percent from 1976 to 1981; in the

electrical machinery industry, the share rose from 55

to 58 percent.6 And subcontracting in Japan usually

involves long-term relations and mutual obligations—

what the Japanese call the oyakigyo-kogaisha relationship (literally, parent business-child company,

but with connotations extending to many forms of

superior-subordinate relationships).7

The supplier group system is doubly advantageous to the lead manufacturers. They get many of

the benefits of both arm’s-length subcontracting

(control over costs) and of vertical integration

(responsiveness to the lead company’s needs).

Moreover, the requirement of uniformly high quality

from suppliers is part of the system of building in

quality throughout the manufacturing process, rather

than inspecting for defects at the end of the line.

With this system quality need not cost extra, since it

saves the cost of keeping large inventories of parts

and requires less re-work.

Close interactions between the major manufacturer and its suppliers also helps the lead company

field new models quickly, by dividing the labor of

product development among many small firms with

specialized skills. Shaving time off development can

give a firm a crucial headstart. Firms that are first to

respond to market changes and to adopt new

technologies in their products open a lead that is hard

for competitors to close.

In a study of the world’s motor vehicle assemblers, a Harvard Business School team found that

Japanese automakers take about 3.5 years to produce

a new car design, compared to 5 years for American

and European producers, and that the Japanese do it

with half the engineering effort.8 This takes into

account the different amounts of engineering effort

contributed by components suppliers in Europe, the

United States, and Japan. The advantage, the study

said, ‘‘appears to lie in the strength of the Japanese

supply base, and the way projects are organized and

managed. Within the lead company, the main

advantage lies in simultaneous rather than sequential

engineering, made possible by a continuing informal

dialog between people at different stages of the

design process, with give-and-take in both directions. But suppliers contribute to this interactive

process too. Often they take part in collective

engineering and analysis of key new components 2

years before manufacture of a new model. About 1

year ahead of time, first- and second-tier suppliers

6Ro&fl J. B~lon and 1wao ‘fomi~, ~~ F1~n~i~/ B~~~lor ~fJ~pa~se co~oratio~ (Tokyo and New York: K~ansha International Ltd., 1988),

p. 45, citing the Ministry of international Trade and Industry, White Paper on Small and Mealum Enterprises in Japan, 1987 (Tokyo: MITI, 1987).

l’~ld., ~h. 3. Many o~er ~u~ors have alW descn~ ~is interm~iatesystem, ~tween ~’s-leng~ con~acting and Vexlical integration, in a V~etY

of Japanese industries. For recent examples, see Nishiguchi, op. cit.; and Mari Sake, ‘Neither Markets nor Hierarchies: A Comparative Study of Informal

Networks in the Printed Circuit Board Industry, ’ paper prepared for The First Conference of the Project ‘Comparing Capitalist Economies: Variations

in the Governance of Sectors,” Wingspread, Wisconsin, May 1988.

s~m B. Clwk, W. Bruce Chew, and Takahiro Fujirnoto, ‘‘Product Development in the World Auto Industry: Strategy, Organization, Performance,’

paper presented to the Brookings Institution Macroeconomics Conference, Dec. 3, 1987 (available from Graduate School of Business Administration,

Harvard University).
132 ● Making Things Better: Competing in Manufacturing

may be brought in to run an assembly or subassembly line, to solve startup problems before actual

manufacture. 9

The supplier group system is also credited with an

important role in the Japanese strategy of manufacturing a greater variety of products at lower volume

than U.S.-style mass production has done, while still

keeping costs competitive. This ability is particularly striking in the auto industry. When it started out

in the early postwar years, Japanese auto production

was, perforce, in small batches and great variety. The

Japanese domestic market was small, exports were

virtually nonexistent, and producers were numerous

(they still are). The answer to the fragmented market

and extreme competition was to develop a flexible

production system within the factory. This included

multi-skill training of workers and efficient layout of

the factory and organization of work. It also included

the supplier group system, with its collaborative

engineering, just-in-time delivery, and assurance of

high-quality parts and components. The result was

an industry that initially succeeded in the rich U.S.

market with a niche product (the well-made, economical small car), and has continued to broaden its sales

appeal with frost-class entries into specialized markets (e.g., sports and luxury cars).

Today, the average annual production per model

of the Japanese automakers is about 120,000, half

that of U.S. producers. Since they introduce new

models more often and more quickly, the lifetime

production for the average Japanese model is about

500,000 units-less than one-quarter of the 2.1

million units for U.S. producers and well below the

lifetime 800,000 units per model for the high-priced

European specialists (BMW, Mercedes, Porsche,

Jaguar, Volvo and Saab), The group supplier system

is only one of the factors that make this flexibility

possible, but it is a considerable one.

As for the suppliers, they also get multiple

benefits from the system. Besides gaining reliable

markets for their products, they often get loans of

up-to-date equipment and sometimes financial help

in buying it; assistance from borrowed engineers or

technicians in learning how to use the equipment or

organize work more efficiently; and in general a

flow of advanced technology that has helped to

make many first-tier suppliers first-rate industry

leaders.l0 This technology transfer is not confined to

the first-tier companies but frequently extends to the

level of tiny family-run metalworking firms.11

Table 5-1 lists advantages of the subcontracting

system from the participants’ points of view, as

reported by Japan’s Small and Medium Enterprise

Agency. At the top of the list, for suppliers, is a

‘‘steady amount of orders. ’ This stability sometimes extends to a change in product line. For

example, one Japanese subcontractor who had

worked with an electronics manufacturer for many

years reported that he had changed from supplying

paint and sheet metal to supplying printed circuit

boards, at the customer fro’s request.12

On the down side, the system has a high level of

stress. Lead companies demand continual price

reductions as well as high quality, and if a supplier

fails to meet the demands, he may find his share of

sales cut back (or even cut off eventually) in favor of

a more compliant supplier. As noted, lead companies often have two or more firms supplying the

same item, and the competition is tough. While an

existing supplier may be safe from sudden shifts to

a new competitor offering drastically lower prices

(e.g., one electronics producer stuck with his supplier of printed circuit boards despite an offer from

a newcomer of a 40 percent lower price), frequent

‘‘requests’ by the lead firm for price cuts can narrow

the difference fairly quickly .13 Moreover, in a

recession, the supplier is expected to make do with

smaller orders, cut prices to the bone, and forgo

profits. In Japan’s economic downturn of 1986,

profit margins for the printed circuit board industry

fell from 2.5 percent of sales to 0.3 percent.14

However, the lead company has the obligation to

tighten its belt too; suppliers trust that their large

customers will not squeeze them into bankruptcy.

$“1’’oshihiro Nishiguchi, op. cit., p. 10.

IOReputable suppliers may get ind~~t financi~ benefits as well. Major manufacturers generally belong to a group that includes a lmge ba~; 1oam

on favorable terms from that bank are often made to a supplier on the lead manufacturer’s recommendation.

llSee ch. 6.

12Mari Sake, op. cit.

13Mari Sake, op. cit.

141bid.
Chapter 5---Links Between Firms and Industries . 133

Table 5-l—Main Reasons for Subcontracting, Japanese Firms, 1966

Subcontractor Parent company

Reasons Percentage Reasons Percentage

Steady amount of orders . . . . . . . . . . . . . . . . . . . . . . . . 50.1 Know-how of contractor not held by oneself . . . . . . . . 57.6

Product design and development difficult by oneself . . 45.8 Efforts concentrated into best suited work . . . . . . . . . . 48.2

Efforts concentrated on production activities . . . . . . . . 38.7 Past business relations with and reliability of

No worries about default or debts . . . . . . . . . . . . . . . . . 27.7 subcontractor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46.5

Improved reputation . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26.2 Increased flexibility through size of orders . . . . . . . . . . 37.1

Supply of raw materials, etc. . . . . . . . . . . . . . . . . . . . . . 21.7 Lower personnel costs and lower unit costs

Technical assistance provided . . . . . . . . . . . . . . . . . . . 14.7 of products . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36.5

Small lot sizes and thus greater efficiency

through production by small enterprises. . . . . . . . . . . . 30.6

, Overly large size of own company would

reduce operating rate . . . . . . . . . . . . . . . . . . . . . . . . . . 9.4

Competition among subcontractors ensures

high quality and lower unit price . . . . . . . . . . . . . . . . . . 8.8

SOURCE: Small and Medium Enterprise Agency, Survey In Division of Labor in Manufacturing Industries (Tokyo: SMEA, 1966), pp. 24-25.

Suppliers are also expected to push themselves to

the limit to meet urgent needs of important customers. For example, when Fuji-Xerox changed the

design of a part midway through development of a

new copier, it made an “utterly insane’ request for

early delivery of a newly designed part which the

subcontractor was able to meet only by working

through the nights. The subcontractor was later

rewarded with a generous payment. 15 But a more

important motive for such sacrifice is the fact that

the subcontractor’s own future depends on the

success of the lead manufacturer.

Finally, wages among subcontractors, especially

in the lower tiers, are at least 25 percent lower than

wages of the privileged lifetime employees of major

manufacturing firms.l6 Indeed, low wages for the

‘‘mom-and-pop’ suppliers at the bottom of the

pyramid has long been considered a competitive

advantage of Japanese producers. An integrated

company like GM could credibly claim this as a

handicap--although GM presumably found advantages in vertical integration to compensate, since it

competed successfully for years against Chrysler,

which had a substantial discrepancy between the pay

of its own employees and that of its suppliers. Recent

research suggests that disparities in incomes between small and large firms are not as great as

disparities in wages. The published data cover the

workers’ wages in small family-run companies, but

not the income of the owner, who gets profits as well

as wages. 

17 Many of these small entrepreneurs make

a good living. One investigator of subcontracting

firms in the Japanese auto industry reported that

owners of small firms made about 10 million yen a

year ($71,000) on average, compared to 5 million

yen for people of the same age and same high school

education who work for big companies. In interviews with over 100 of these small subcontractors,

the author found them “remarkably confident and

satisfied despite their seemingly unstable position in

the industrial economy.”18

In any case, many American managers now seem

persuaded that the system of buying from autonomous, but closely linked suppliers, offers benefits

quite apart from wage differentials. The big three

automakers are making moves toward adopting the

group supplier system, or parts of it. The GM-Toyota

joint venture, New United Motor Manufacturing,

Inc. (NUMMI), has adopted the system successfully,

largely with North American suppliers. It took time.

At first, NUMMI found three times as many defects

in the parts supplied by North American companies

as in those coming from Japanese companies. But

Toyota and NUMMI engineers worked with the 70

North American suppliers, and 4 years after the 1984

ls]m~, Non&a, and Takeuchi, op. cit., p. 371.

lbNom~~ly, wages in e~ablishments wi~ 5 to 29 workers are only 57 percent of wages in firms with 500 or more workers. Controlling fOr differences

in occupational employment eliminates about 20 percentage points of the 43 percent difference. The discrepancy has been growing; wages in the smallest

establishments were 63 percent of those in the largest in 1965, but dropped to 57 percent in 1983. (OTA interview with officials of the National Institute

of Education and Vocational Research, Tokyo, Mar. 15, 1989.)

17Tm~~ro Nishiguchi, op. cit.

lgIbid., p. 21.
134 . Making Things Better: Competing in Manufacturing

startup these suppliers were as good in cost, quality,

and delivery times as their Japanese counterparts.19

For U.S. companies in general, both lead companies and suppliers, the changes involved in moving

to the supplier group system are great and consequently slow. It means going from l-year contracts

with specifications and drawings (sometimes dies

and tooling as well) provided by the assembler to

multi-year, less formal arrangements, in which

suppliers are expected to help design and develop

parts, continuously improve them, and respond

quickly to requested changes during the model run.20

It also means requiring suppliers to deliver just the

right number of defect-free parts precisely when the

assembler needs them. The just-in-time delivery

system depends on getting high-quality parts, since

there are no stacks of backup parts to replace

defective ones. When the system works, it saves

costs in storage, handling, end-of-the-line inspection, rework, and repair after sale, and the quality

built in at every stage of supply up the pyramid leads

to a reliable product and customer satisfaction. But

the system also requires high competence on the part

of suppliers and a good working relationship between assembler and suppliers. These attributes are

not easy to develop overnight.

According to the General Accounting Office

(GAO), Japanese auto assemblers operating in the

United States impose on suppliers the rigorous

expectations described above. (GAO reports that

U.S. firms are also beginning to expect the same

kind of quality, prompt delivery, and engineering

capabilities from their suppliers.) A good many U.S.

suppliers are having trouble meeting the expectations. Japanese supplier firms, accustomed to working in this way and also benefiting from longtime

relationships with Toyota, Nissan, Honda, or Mazda

in Japan, often have the advantage. The number of

Japanese suppliers in America (some of them in joint

ventures with U.S. fins) is growing fast. Of 104

Japanese-affiliated suppliers operating in the United

States in August 1987, 102 answered queries by

GAO. Of these, 60 had opened up for business in

America since January 1981; 23 were established

from 1970 to 1980, and 19 before 1970.

Some U.S. suppliers have succeeded with the

Japanese transplant automakers. Of 30 representative firms GAO selected for interviews, 15 had done

business with at least one of the Japanese assemblers—

some in joint ventures with Japanese supplier firms.

Most of these U.S. firms found big differences in the

way the Japanese assemblers operated, compared

with their American counterparts. The Japanese

companies not only gave the suppliers added responsibilities but, several said, also kept in closer contact.

Where the U.S. assemblers would send a few people

on an occasional courtesy visit, the Japanese turned

up often, bringing a wide range of staff to give the

suppliers’ operations a complete evaluation. One

trim and body parts supplier said the Japanese

assembler he deals with calls every day to consult on

defects. A steelmaker said the Japanese company

visits were “preventative” where the American

company’s were ‘‘reactive. ’ Most of the U.S.

suppliers doing business with the Japanese transplant automakers rated the results positively. They

cited benefits of greater efficiency, better quality

control, and more attention to process and product

improvements. Some said the experience made them

more competitive, and that they were now demanding more from their own suppliers. And some noted

that U.S. automakers are adopting more and more of

the Japanese practices.

These positive comments came from the firms

that had succeeded in supplying the Japanese

companies. From less successful firms came comments that it is hard to overcome the longstanding

ties between Japanese assemblers and suppliers, and

that U.S. firms are at a disadvantage in culture and

language. These companies feared growing competition from Japanese-affiliated suppliers now locating in the United States. Although the Japanese

automakers have stated that they intend to increase

the U.S. content of their cars and trucks from about

50 percent in 1987 to about 70 percent by the early

1990s, it is not clear that “U.S. content” means the

products of U.S.-owned firms.21

19jo~ Fe fiafclk, “A New Diet for U.S. Manufacturing, “ Technology Review, Jan. 28, 1989, pp. 31-32.

me following discussion of U.S. and Japanese firms supplying automakers in the United States (both U. S.- and Japanese-owned) is based mostly

on U.S. General Accounting Office, Foreign investment: Growing Japanese Presence in the U.S. Auto Industry, GAO/NSIAD-88-l 1, March 1988.

21A~cording t. GAO, u-s. automakers repo~~ ~a[ tie domestic content of heir cars and ~cks was 86 to over 99 percent, depending on the model,

in 1986; the average for the industry was about 90 percent. These figures applied to auios made in North America, including Canada, and did not include

foreign-made cars with a U.S. nameplate (“captives” such as the Dodge Colt, which is Mitsubishi-made). U.S. automakers were expected to increase

the foreign content of their cars to about 17 percent by 1990, GAO said.
Chapter 5--Links Between Firms and Industries . 135

A fundamental change in outlook would have to

evolve if Japanese-style supplier relations were to

become the norm rather than the exception in U.S.

manufacturing. It is longstanding custom for American manufacturers to discourage-even forbid—

design engineers from developing close relations

with suppliers. Direct approaches to suppliers are

known as “going around the purchasing department,’ and are against company rules. Purchasing

agents themselves are frequently reassigned to

different types of supplies, so they won’t develop

overly cozy relations with suppliers. The ideas

behind all this are, frost, that maintaining arm’slength, impersonal, strictly contract-based relations

with suppliers is the best way to get a good price and

keep costs down; and second, that it is unfair to give

any supplier a privileged position and deny the

others an equal chance. Some company officials

even believe they might be subject to lawsuits if

suppliers were deprived of the chance to bid for

contracts.

For suppliers themselves, the Japanese-style system has distinct drawbacks as well as strong points.

While some may welcome the demands for constantly improving performance combined with help

in achieving it, others find the system entirely too

stressful. Moreover, the American tradition of rugged individualism exerts a pull against close bonds

with customer fins. Some small companies think

that if their quality and delivery times improve, they

should be rewarded with higher prices-not with a

long-term tie to a demanding customer. Some see

such ties as threatening to their independence. They

would prefer to take their chances in the bidding

battle rather than find themselves beholden to too

few major customers. The Japanese system does

make for heavier dependence on a few customers——

only tolerable, perhaps, in a situation where many

suppliers trade with their major customers for 15 or

20 years .22

A Japanese engineer who has observed relations

between large and small companies in both Japan

and the United States put it this way. In Japan, small

companies making parts for computers or copiers or

facsimile machines are very conscious that they are

in the office automation business. They carefully

monitor the price they have to stay under so that their

customers, the companies that assembles the machines, can be competitive. In the United States,

small companies are not so conscious of being part

of a whole.

Dependence may be lessening even in Japan; as

economic growth has slowed, some lead companies

have actively encouraged their suppliers to seek

other customers. The bonds of long-term relations

are still strong however. It must be remembered that

the system has roots in the centuries-old tradition of

mutual obligation, and that it developed over decades in the postwar period when it suited the needs

of all parties quite well. The major manufacturers

were growing too fast to do all their own work; the

smaller companies were eager to take part in the

growth, and also to get access to modern technology

at a time when foreign currency was scarce and

government restrictions allowed only a few firms to

import the latest machinery from Europe and America. Today, the parties to the bargain still seem

satisfied, on the whole, that it is working to the

advantage of all.23

LINKS BETWEEN SEGMENTS OF

AN INDUSTRY COMPLEX

A variant of the strategy of close relations

between major manufacturers and their suppliers is

close links between different segments of an industry complex--e.g., between the manufacturers of

chemical fibers, textile producers, apparel makers,

and retail clothing businesses. There is more than a

shade of difference in this variant. A chain of more

or less independent industries selling to and buying

22A 1983 survey of 1,54.() Japane~ subconwactors in the metal/machining industry found that, on average, these firms relied on one large customer

(parent firm) for 60 to 65 percent of their business. (D.H. Whittaker, op. cit.) Mari Sako found in her study of printed circuit board suppliers in Japan

and the United Kingdom (where customer-supplier practices are similar to those in the United States) that the Japanese suppliers depended much more

heavily on fewer customers. Comparing companies of similar size, Sako found that in Britain orders from the largest customer made up 6 to 25 percent

of suppliers’ total sales. In Japan, the largest customer accounted for 15 to 85 percent of the supplier’s total sales. (Mari Sake, op. cit.)

z3Korea and T~wan, ~~ch me followlng tie Japanew model of expofl-1~ gro~h in many Ways, have not emulated the Wppher gK)l,Ip SySteII1.

Korea’s chuebol are industrial empires, typically doing business in a few related sectors, under the ownership and management of a founding father and

his heirs. They do not rely on long-term, stable relations with small subcontractors but rather buy or start up new firms to meet their needs. In Taiwan,

business groups are much less prominent than in Japan or Korea. The groups that do exist arc made up of rather small firms in different economic sectors,

with horizontal rather than vertical relations; the same people or their relatives hold management positions in the different fins. Relations with

subcontractors are not particularly close or long-lasting. (Gary G. Hamilton, Marco Orru, and Nicole Woolsey Biggart, ‘‘Enterprise Groups in East Asia:

An Organizational Analysis, ’ Shoken Keizai, September 1987.)
136 ● Making Things Better: Competing in Manufacturing

from each other differs considerably from the

superior-subordinate relation of a lead manufacturer

and its network of suppliers. Nevertheless, even

among the nominally independent members of an

industry complex, a purchaser who has attractive

alternatives for material supplies wields more power

than the supplier. In the case of the fiber-textileapparel complex, it is designers and retailers who

hold this power. They can buy anywhere in the

world. Increasingly, in the past quarter-century, they

have done so. Imports account for well over onethird of what Americans spend on apparel.24

In nearly all high-wage countries, the textile and

apparel industries face a tough challenge from poor

countries. Apparel manufacture is labor-intensive.

Modern textile production is less so, but the capital

requirements are relatively modest—well within the

means of newly industrializing countries (e.g.,

Taiwan, Korea) and not out of reach for some poorer

ones (China). The textile-apparel industries that

seem to do best in high-wage countries are those

with close ties between industry segments, where

firms in the supplier industry focus their efforts on

responding to customers’ needs.

In the United States, textile producers and apparel

makers have traditionally had standoffish or even

hostile relations.25 The main concern of textile

producers was to mass-produce with high-speed

equipment, rather than deal individually with customers’ needs. Apparel makers, if they were big

enough, treated their textile suppliers as interchangeable and disposable, bargaining with numerous firms to drive the price down. This situation has

begun to change. Industry leaders are realizing that

closer links, from fiber production through retailing,

can lower costs, lend stability to all parts of the

complex, and give an edge to domestic producers.

The Quick Response system was devised by U.S.

industry leaders to foster these tighter links and

capitalize on the advantage of being close geographically to the big American retail market,26 Imports

(most of which are from low-wage countries) have

the attraction of lower prices;27 but there are also

extra costs in doing business with importers. Besides

the obvious ones—transportation, travel overseas,

advance letters of credit, and extra paperwork-the

long leadtimes usually involved in overseas purchases also mean extra cost. When retailers order a

year ahead of time they pay carrying costs for large

inventories; they lose profits when they have to mark

down unsold goods at the end of the season; and they

pay still more in lost sales when items the customers

want are out of stock. One industry expert estimates

that these costs add up to 25 percent of the value of

net retail sales.28

The Quick Response system uses just-in-time

principles to reduce these costs. It allows the retailer

to start the season with a wide but shallow selection,

and when stocks get low, to re-order and get fast

delivery. About 80 percent of retail apparel business

is in items that have a shelf life of only 10 to 20

weeks, either because they are ‘‘fashion” items in

styles that are quickly changed or because they are

seasonal. Quick Response is most obviously a useful

strategy in these lines. However, some producers of

textiles for non-seasonal products, such as bedding

or men’s underwear, are finding that close, stable

ties with their customers make it possible to cut

inventories nearly to zero by just-in-time management, and thus to save costs.

z40TA’~c~timateof fiprt ~ne~atjon ~ ~ppwel is 36 ~rcen~ for 1987. It is b~ on dollarval~e, and includes freight, insurance, and import duties;

shoes are not included. Other dollar value estimates of impons, which include the costs of transponation within the United States and other extras, put

the import penetration ratio for clothing at 57.5 percent. See “Import Penetration in the Apparel Industry: A Technical Study,’ prepared for the Fiber,

Fabric and Apparel Coalition for Trade, September 1988. Import penetration is less for textiles, about 9 percent. (The apparently low figure for textile

imports are misleading. Over the past 30 years, many foreign producers have switched from textile to apparel exports, because apparel has more value

added. The quotas limiting imports combine textiles and apparel; textiles embodied in the apparel are not counted separately.) The combined import

penetration ratio for textiles and apparel was 25 percent in 1987, according to OTA’s estimate.

~This is ~u~ly not~e of textile producers and industri~ cons~em, such as auto Compafies buying seat cover fabrics, or hotel chains buying carpet.

~pically, U.S. textile producers keep close ties with these industrial customers, and are very responsive to their needs. This is probably one reason for

the greater success of the industrial fabrics sector, compared with the apparel fabrics sector, in fending off imports.

26A conmlt~g fjm, Km s~mon Associates helped to devise the plan; the DuPont chemical company and Roger ~lliken of tie ~lliken textile

company have been leading champions. DuPont is an important producer of textile fibers.

27’rhe top foW ~xtile ad ~p~el ex~ers t. tie Unitti states~~a, TAwan, Korea, and Hong Kong have textile wages ranging from about 2

to 23 percent of U.S. wages; the next two-Japan and Italy-now have textile wages 30 to 40 percent above those of United States, since the fall of the

dollar.

Z8KW Salmon Associat~, The KSA Perspective (New York, NY: January 1986).
Chapter 5-Links Between Firms and Industries ● 137

To make Quick Response work, each of the

industry segments upstream not only has to cut

response time in its own operations but also needs to

cooperate with the purchaser or supplier next in line.

The example of Greenwood Mills, a large textile

firm specializing in denim, is illustrative. Until a few

years ago, Greenwood bought fiber from four

different suppliers, shopping around to drive the

price down. Greenwood’s biggest customers followed the same tactics, shifting orders among eight

or nine suppliers on the basis of lowest price.

Greenwood and its suppliers and customers have

since adopted a more collaborative way of saving

costs. Greenwood now buys fiber from just two

suppliers, who offer quality, service, and guaranteed

delivery times in return for assurance of a long-term

relationship. Using this system, Greenwood has cut

inventories from 3 weeks to a fraction of a week and

is able to hold $40 million less in stock. In the same

way, Greenwood’s two biggest customers are now,

by mutual agreement, reliable long-term purchasers.

Greenwood takes the responsibility of loading

denim into the trucks in sequence so that colors

always match, marking the cuts electronically, and

delivering so quickly and reliably that one jeans

maker cut inventory from 4 weeks to 3 days and the

other got rid of its warehouse. The denim is

delivered directly to the sewing room.29

The heart of Quick Response is responsiveness

and interaction with customer firms. Another example comes from the Dan River textile mill, a

company that concentrates on making high-quality

apparel fabrics and emphasizes close customer

relations. Individual looms at Dan River are marked

for production for specified customers. And a Dan

River representative was on the floor at one shirtmaker’s plant so often that he was mistaken for a

new employee.

A major achievement in the Quick Response

program was inter-industry adoption of a common

bar code standard. This allows electronic communication between retailers and producers all the way

back through the supply chain. When and if the

system is widely adopted, a textile mill, say, could

start preparing anew order to send to apparel makers

on the basis of electronic data passed back automatically from department store sales.

The close, responsive inter-industry links just

now being developed in the United States have long

been a feature of the Italian, Japanese, and German

textile-apparel industries-the three high-wage countries that are usually considered the most successful

in these industries. This is not to say that close

linkages are a guarantor of success. All these

industries have other features in their favor. For

example, the Italian and Japanese industries benefit

from a dense network of technical, organizational

and financial support, private and public. The

German industry has the advantage of an excellent

century-old vocational education system. All three

textile industries (and the U.S. industry as well) are

well-equipped with modern machinery. None of

these industries, even the best, is invulnerable to

competition from low-wage countries. But it seems

clear that suppliers’ ability to respond quickly to the

needs of their customers and purchasers’ willingness

to form stable, cooperative relations with their

suppliers are part of the mix that makes these

industries more competitive, and helps them to

survive without constantly escalating trade protection.

LINKS BETWEEN MAJOR

MANUFACTURERS AND CAPITAL

EQUIPMENT PRODUCERS

A special case of linkage with suppliers is the

relation between lead manufacturing companies and

the firms that make production equipment for the

industry. Perhaps even more than suppliers of parts

and components, makers of capital equipment depend for their success on close relations with the

manufacturers down the line who are their customers. In the semiconductor industry, for example,

customer firms (the chipmakers) were the source of

two-thirds of the ideas for advances in production

equipment in the last few years.30

Customer firms, in turn, benefit from easy and

continuing exchanges with the makers of their

production machinery. Sometimes they can achieve

this with foreign manufacturers, as seems to be the

case in textile manufacture. The virtual disappearance of U.S. firms from production of the most

important kinds of textile machinery is apparently

not crippling to textile producers. But in a rapidly

Z90TA intemiew wi~ Thomas 0’Gorrnan, President, Greenwood Mills, Dec. 11, 1987.

Swric Vm Hip@, The ~o~ce~ of ]nnovation (New York, NY: Oxford University Press, 1988), p. 4, table 1-1.
138 . Making Things Better: Competing in Manufacturing

advancing high-technology industry, close links can

be crucial. Already, U.S. semiconductor manufacturers are at something of a disadvantage because

U.S. equipment makers have lost out to Japanese

rivals, and the handicap could become greater.

The story of the U.S. textile machinery industry

illustrates the dependence of equipment makers on

close ties with their customers, The industry’s

precipitous decline was due largely to its failure to

respond to customers’ needs. In 1960, American

makers of spinning, weaving, and knitting machinery dominated the U.S. market, accounting for 93

percent of sales. By 1986, their share was 42 percent,

most of it in spare parts and ancillary machinery.

Several leading firms in the industry were organized

in the traditional Ford manner for mass production,

with semi-skilled workers on the assembly line

turning out long runs of limited kinds of machinery.

The attitude of these companies toward their customers was, “This is what we make; how many do

you want?”31

The merger mania of the 1960s also played a part

in the industry’s decline. During that decade, all the

Big Five U.S. textile machinery firms and many

smaller ones sold out to conglomerates. Rockwell

International, for example, not only bought Draper,

the leading U.S. manufacturer of looms, but also

smaller companies such as the Textile Machine

Works of Reading, PA, which made knitting machinery. Some of these companies had built their

businesses on a solid tradition of close relations and

good service to their customers. But the new

conglomerate owners lacked both technical knowledge of the business and interest in serving individual customers.

Scanty spending on research and development

was another major cause of the deline, with U.S.

producers lagging well behind the R&D spending of

competitors in Europe and Japan. When the American textile machinery industry was seriously challenged in the 1970s by innovative, responsive

European and Japanese manufacturers, willing and

able to make a wide range of sophisticated machines,

it lost.

According to people in the textile industry, the

retreat of U.S. textile machinery makers from the

biggest part of the field (spinning, weaving, and

knitting equipment) is not a serious technical

handicap. They say that their German, Swiss, Italian,

and Japanese suppliers keep improving equipment

in response to their needs, and that service (especially from the Japanese) is outstanding. The main

problem in dealing with foreign suppliers, as of the

late 1980s, was the fall of the dollar, which made

new equipment and parts suddenly much more

expensive.

Semiconductor producers are faring worse. Japanese firms are now the world leaders in making the

equipment that is most critical to chip production.

According to industry sources, Nikon was not

selling its leading edge model of this equipment to

U.S. chipmakers in 1989, though the model was

already widely used in Japan.32

As recently as 1979, U.S. firms dominated the

market for semiconductor production equipment,

accounting for 79 percent of world sales. By 1989,

the U.S. share was down to 47 percent and still

dropping33 (figures 5-2,5-3, and 5-4). A central part

of chipmaking is the fabrication of wafers, the 2- to

8-inch silicon disks on which dozens to hundreds of

individual chips are made. The most vital piece of

wafer fabrication equipment is the step and repeat

aligner, or stepper, which uses ultraviolet light to

project an outline of the chips’ circuit on the wafer;

the circuit is then etched in an acid bath or reactive

gas. An American firm, GCA, was first to commercialize a stepper, and it dominated the field until the

early 1980s. Nikon first pulled ahead in 1983.

Today, GCA (which was bought by General Signal

in 1988) is out of the Japanese market, has about 5

percent market share in Europe and 20 percent in the

United States. Nikon now occupies a commanding

position (table 5-2). It was Nikon’s latest and best

stepper, the G-body, that was unavailable to U.S.

firms in 1989.

Slchmles F. sa~l, Gary Herrigel, Richard Kazis, and Richard D&g, “How To Keep Mature Industries Innovative,” Technology Review, Apr. 28,

1987.

gz~cip~ ~Wces for the following section are OTA’S review of the literature and interviews with leaders in the semiconductor and allied industries,

and with officials of the Sematech consortium; other sources include Industry and Trade Strategies, ‘‘The U.S. Electronic Industry Complex,’ contractor

report to the Office of Technology Assessment, October 1988; William F. Finan and Jeffrey Frey, ‘‘Study of the Management of Microelectronics-Related

Research and Development in Japan,’ contractor report to the Office of Technology Assessment, November 1988.

33 VJ-,SI Rese~h, Inc., personal communication, Jan. 5, 1990.
Chapter 5--Links Between Firms and Industries ● 139

Figure 5-2--Shift in Market Shares for Wafer Steppers

80

60

Ewl-l

&L

40 - Japan

20 \

o I I I I I I I

’83 ’84 ’85 ’86 ’87 ’88 ’89

est

NOTE: The wafer stepper is a device central to manufacturing

semiconductors.

SOURCE: VLSI Researeh, Inc.

Of the several reasons why Japanese firms have

bested U.S. equipment makers, a leading one is that

U.S. chipmakers were themselves losing out to the

Japanese competition.34 Japanese firms began to

spend more on capital equipment than their U.S.

rivals in 1983, and continued to outspend American

firms throughout the industry’s worldwide slump in

1985 -86.35 Increasingly during this build-up, Japanese chipmakers bought Japanese-made production

equipment—in the case of steppers, overwhelmingly from Nikon. GCA, which had geared up to

produce 500 to 600 steppers (at $1 million apiece) in

1985, sold barely 100 for the year, and wound up

losing $94 million. Financially weakened, suffering

delays in delivery of lenses from the German firm

Carl Zeiss (Nikon made its own lenses), and making

Figure 5-3--U.S. Market Shares of Selected

Semiconductor Equipment

100

U.S. resist

processing

80 \ .\ .

.-.

/’ y‘:K

\ \.

\

\

60-- U.S. integrated \ - --a ‘-’p- \

circuit testers -~. —.

- - -

‘x.

A’‘\ “\

40 1 P I

/1’\

\

\.

U.S. stepping ‘~ .,

aligners ‘x

20

1979 1980 1981 1982 1983 1984 1985 1986 1987 1988

Year

SOURCE: VLSI Research, Inc.

a stepper that was no longer clearly the world’s best,

GCA never recovered.36

How Nikon caught up with GCA technologically

is another part of the story. Close relations between

the maker of production equipment and the customer

using it played an important role. The Nikon stepper

was an outgrowth of the very large-scale integration

(VLSI) project which MITI directed from 1976 to

1979. The goal of this cooperative industrygovernment project was to help Japanese companies

master the technology for making the newest generation of semiconductors and, more broadly, to encourage the national move toward more knowledgeintensive industries.

The emphasis of the VLSI project was on the

manufacturing process. One-third to one-half of the

budget went for purchase of equipment (including a

GCA stepper), and the five chipmakers who were the

3.11n 1981, Us. merchant ~ompafie~ (ho= hat pr~du~e chips for the open mmket, not just for their own intern~ u=) ~ared the big important market

for dynamic random access memory chips (DRAMs) equally with Japanese firms. By 1988, U.S. firms had 8 percent of the world merchant DRAM

market (this excludes chips made by integrated firms such as IBM for their own internal use), Japanese fms had 87 percent, and most of the rest was

divided between West Germany and Korea.

3sDatWuest fiWes, ~ show ~ T~ Sem”con&ctor ~~~~, rew~ of a F~er~ ~teragency Staff working Group (Washington, DC: National

Science Foundation, 1987), p. 28, chart 24. The data cover U.S. merchant (but not captive) producers. The rate of capital spending by Japanese companies

(i.e., spending on plant and equipment as a percent of revenues in the integrated circuit business) has been higher than the U.S. rate since 1982. For years

before 1981, the data on rates of capital spending are in conflict. OTA’s data for 11 U.S. merchant producers and 11 or 12 Japanese producers, show

that the Japanese rate was higher from 1973 to 1980, and nearly the same in 1981; see U.S. Congress, Office of Technology Assessment, lnrernutionuf

Competitiveness in Electrom”cs, OTA-ISC-200 (Springfield, VA: National Technical Information Service, November 1983), p. 274. According to

Dstaquest, the Japanese rate was about equal to the U.S. rate from 1977 through 1981 but in 1982 and thereafter was higher; see The Semiconductor

Industry, op. cit.

36~cording t. Us. ~du~ ~~ces, (he GCA stepwr has better focus and more pr~i~ alignment ~an tie NikOn—but only when WlgiIleel’S Set lt

up. The Nikon stepper is more robust and requires far less set-up time. h can run well day after day with little adjustment, and therefore is much superior

in throughput (an important consideration for mass production of commodity chips).
140 ● Making Things Better: Competing in Manufacturing

Figure 5-4--World Semiconductor Equipment Sales

‘~

Billions of dollars

4

3

2

1

0L

1984 IL1985 1986 1987 1988 1989 199 0

- United States = Japan D Rest of world ~ Joint ventures

-Forecast

SOURCE: VLSI Research, Inc.

main participants from industry worked hand in

glove with equipment makers. The project managers

selected Nikon to develop a made-in-Japan wafer

stepper—a logical choice since Nikon already had a

fine reputation as a maker of precision optical

equipment, cameras and lenses, and also precision

mechanical measuring instruments. Toshiba, the

first Japanese company to have used GCA steppers

on a production line, was chosen to work with Nikon

on behalf of all the member companies.

The collaboration was extraordinarily close. According to a GCA engineer familiar with the effort,

Toshiba set performance specifications but did not

provide a design. Instead, Toshiba engineers reviewed all details of development, manufacture, and

testing; provided technical help in design concepts,

electronics, and materials and components selection;

and in the process visited Nikon several times a

week. 37 The result was a stepper which, though not

radically different from GCA’s, gained the reputation of being more reliable.

The close relation between vendors and users was

not unique to the VLSI project. It is characteristic of

the Japanese semiconductor industry, and remains a

potent factor in the industry’s success. The same

engineers who oversee supplier companies’ development of a new piece of equipment are then

responsible for putting it to work on the production

line, where their familiarity with it pays off in rapid

achievement of high productivity and quality. This

kind of collaboration is largely missing in the U.S.

semiconductor industry. According to officials of

Sematech, the U.S. industry-government consortium that is working on generic improvements in the

semiconductor manufacturing process, the lack of

close relations between equipment producers and

chipmakers is a serious handicap. The consortium

has given top priority to improving those relations,

and to developing a full range of high-quality,

reliable, affordable equipment and materials for the

U.S. semiconductor industry.

Some firms-notably big ones like IBM and

AT&T—have worked closely with equipment producers. But the merchant firms (those that sell chips

on the open market rather than producing chips

largely for their own use) have typically had

arm’s-length relations with their equipment suppliers. Sometimes the relations are downright distrustful; new equipment firms are often started by

executives defecting from companies that manufacture chips or from other equipment firms. The

Japanese firms’ habit of collaboration extends to

their American as well as their Japanese suppliers.

Spokesmen for GCA noted that their Japanese

customers were more demanding than American

fins, asking for more fine-tuning and changes in the

equipment they bought. But they were also more

helpful in making suggestions for improving the

equipment.38

It is worth repeating that vendor-user relations

were not the only factor in Nikon’s (and later

Canon’s) emergence as world leaders in photolithographic equipment.39 The nearly instant preference Japanese semiconductor firms gave to the

Nikon stepper, combined with the large investments

in new equipment that these firms made through the

mid-1980s, were critically important. In 1981, GCA

had 95 percent of the Japanese market. The next

year, it had 40 percent. Today it has next to nothing.

Toshiba took the Nikon stepper as soon as it was out,

in April 1981. NEC followed in early 1982 when

3~~m ~d FRY, op. cit., citing JotI slgurd~n, “Industry and State Partnership in Japan: The VLSI Project,” Discussion Paper No. 168 (Lund,

Sweden: Researeh Policy Institute, 1986), p. 48.

SSOTA interview with GCA.

39when Nikon fwst brought out its stepWr, it Wm tie only Japane= pr~ucer; Croon stuck to m~ng the older process ~igner. Later, 8S GCA

weakened, Canon entered the stepper market.
Chapter 5----Link-s Between Firms and Industries ● 141

Table 5-2—Top Ten Semiconductor Equipment Suppliers, World Sales

(millions of dollars)

1982 1988

Perkin-Elmer . . . . . . . . . . . . . . . . . . . . . . ..$162 Nikon . . . . . . . . . . . . . . . . . . . . . . . . . . . . ..$521

Varian . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100 Tokyo Electron (TEL) . . . . . . . . . . . . . . . . . 508

Schlumberger . . . . . . . . . . . . . . . . . . . . . . . 96 Advantest . . . . . . . . . . . . . . . . . . . . . . . . . . . 385

Takeda Riken(Advantest) . . . . . . . . . . . . . 84 Applied Materials.. . . . . . . . . . . . . . . . . . . . 382

Applied Materials . . . . . . . . . . . . . . . . . . . . . 84 General Signal... . . . . . . . . . . . . . . . . . . . . 375

Eaton . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80 Canon . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 290

Teradyne . . . . . . . . . . . . . . . . . . . . . . . . . . 79 Varian . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 211

Canon . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78 Perkin-Elmer . . . . . . . . . . . . . . . . . . . . . . . . 205

General Signal . . . . . . . . . . . . . . . . . . . . . . . 77 Teradyne . . . . . . . . . . . . . . . . . . . . . . . . . . 190

Nikon . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58 LTX . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 180

(Japanese Firms Italicized)

SOURCE: VLSIReaearch,lnc.

prices offered by the two rivals, after intense

competition, were equal. NEC said its decision in

favor of Nikon was based on technical superiority,

availability of local service, and early delivery.

Then, when semiconductor sales nosedived in 1985,

U.S. chipmakers canceled their orders for GCA

steppers—a near mortal blow to a company that had

just invested heavily to expand capacity.

The troubled condition of Perkin-Elmer’s semiconductor equipment division, a major U.S. supplier

of photolithographic equipment, underscores the

point that other factors besides relations with customers are important to success in the semiconductor equipment business. For over 20 years, IBM

worked closely with Perkin-Elmer on various kinds

of equipment (though not the stepper, which PerkinElmer effectively ceded to GCA). Recently, with

IBM’s financial and technical help, the company

developed an advanced step-and-scan machine, the

MicraScan,that is said to be a technological wonder,

with the potential to vault over the Japanes e

competition.

@ Yet despite Perkin-Elmer’s technical

abilities, and despite its close-working relationship

with IBM, its semiconductor equipment division

was a financial loser in the 3 years 1987-89 (the main

part of the company’s business is in scientific

instruments).

41 In April 1989, Perkin-Elmer offered

its semiconductor equipment division for sale.

One reason for Perkin-Elmer’s decision to bow

out is the heavy spending for technology development that the fast-moving semiconductor business

demands; new generations of both chips and equipment appear about every 3 years. Perkin-Elmer(and

IBM) spent $100 million in 4 years to develop the

MicraScan, and faced costs of $50 to $l00 million

more to refine and update the equipment. The high

cost of capital and pressures for short-term profits in

the United States add to the burden of making

continuing high investments in advancing technology .

42 Nikon and Canon, Perkin-Elmer’s Japanes e

competitors, have the advantage of easier access to

low-cost capital and less pressure to show short-term

profit;and both these firms excel in engineering and

manufacture.

IBM declined to buy Perkin-Elmer’s semiconductor equipment division, on grounds that the expertise

for running a toolmaking business was outside its

area of competence. No other U.S. buyers had come

forward by the end of the year. Nikon; which has

both the technical and financial resources to run the

company, was the leading suitor but then backed off,

apparently because of U.S. political objections to the

sale.

The erosion of leadership in production equipment is already a handicap for the U.S. semiconduc40~-.ording t. ml R~searCh, ~ ~om~ting fim that sp~l~izes in semiconductor equipment, perkin-Eher’s new machine has a 3- to A-year lead

on ail the competition, including Nikon and Canon. Alan Cane, ‘‘Chips Are Down for Perkin-E1mer,’ Financial Times, Dee. 7, 1989, p. 21; see also

Andrew Pollack, “The Challenge of Keeping U.S. Technology at Home,” The New York Times, Dec. 10, 1989, p. 1.

QIThedivit&onhad revenues of$l~ mil]ion and operating losses and charges against earnings of $z~ million h tiethrm years, according to an aIldySt

with Shearson IAtrnan Hutton, Inc. (Pollack, op. cit.) The Perkin-Ehner company as a whole lost money in 1987 but made a profit in 1988.

42sW ch. 3 for a dl~cussion of tie us. financial environment and its eff~t on t~hno]ogy development.

43KoNm pr~ucem, wi~ ~elr Iow.co~ labor, me a bigger heat to Japan in l-megabit memory chips than U.S. manufacturers, and tie Koreans are

reported to be worried that their access to Japanese equipment may be restricted. (David E. Sanger, ‘‘South Korea’s High Tech Miracle,’ The New York

Times, Dec. 9, 1988, p. D1.)
142 ● Making Things Better: Competing in Manufacturing

tor industry, at least in wafer fabrication.43 (American companies are apparently able to buy some other

kinds of Japanese-made production equipment, such

as automatic assembly and testing equipment, on

fairly equal terms with Japanese chipmakers.) The

situation could deteriorate. Microelectronics is one

of the world’s most dynamic industries. Chipmakers

in the nation where critical new technology in wafer

fabrication is first developed will almost certainly be

the frost to use it, and thus will gain a vital advantage.

X-ray lithography is a strong candidate for the next

step, and in this emerging technology, the Japanese

are well ahead.

Photolithographic steppers, used to etch today’s

l-megabit chips, can go up as far as 16-megabits, but

the chips of the late 1990s and the early 21st century

(64 megabits and beyond) will have circuitry with

lines too fine for etching even by ultraviolet light.

X-rays, with their shorter wave length, have much

greater potential. Ultimately, chips made with X-ray

technology might be able to store 1,000 times as

much data as the current l-megabit chip.

Development of X-ray lithography is expensive.

The Sematech consortium, for example, had to rule

out extensive work on the technology because its

funds-about $200 million a year over 5 years—

would not stretch that far. In Japan, the half dozen

leading chipmakers, several supplier firms, and the

officially privatized (but still mostly governmentowned) Nippon Telegraph & Telephone (NTT) were

all involved in a MITI-led program to develop

various aspects of the X-ray technology. In the late

1980s, the Japanese effort was outspending American efforts at least five to one, and several firms were

engaged in developing a compact synchrotrons to

generate X-rays at the right wave-length and intensity, at commercially acceptable costs.44 In Japan, in

1989, ten compact synchrotrons were under construction or already at work on experimental projects, and five more were on the drawing boards.

Development of a compact synchrotrons was also far

along in Germany; government funds have helped

support the Siemens company in its development. In

the United States, only IBM was constructing a

commercial-type synchrotrons, and the cost was

straining even its resources. IBM invited other U.S.

chipmakers to participate in the effort, and Motorola

signed on in late 1989.

Commercial use of X-ray technology may very

well come about in the 1990s.45 If it does, the first

commercial use will most likely be in Japan, giving

that country’s semiconductor producers a big lead in

a new round of world competition. As the Japanese

semiconductor industry itself has shown, it is

possible to catchup even when one is far behind. The

United States has yet to demonstrate this ability,

although projects such as Sematech are a move in

this direction.

INTERNAL LINKS: VERTICAL

INTEGRATION, PRODUCT

DIVERSITY, AND

LARGE SIZE

Japanese firms are the world’s leading producers

of semiconductors, with 45 percent of the world

market in 1989. U.S. companies, which held 53

percent in 1984, were down to 42 percent and

declining 46 (see figure 5-5). Six of the world’s top 10

companies in sales of semiconductors on the open

market are Japanese, and all of them are large, stable,

integrated electronics firms that make everything

from chips to computers and consumer electronics.

They make more chips than they need and sell the

43 Korean pr~ucers, wi~ their low-cost labor, arc a bigger threat to Japan in l-megabit memory chips than U.S. manufacturers, and the Koreans are

reported to be worried that their access to Japanese equipment may be restricted. (David E. Sanger, *‘South Korea’s High Tech Miracle,’ The New York

Times, Dec. 9, 1988, p. D1.)

~~e J~pane~ Prowm had spnt $XM to $750 million by late 1988, and planned to spend $200 million more; comparable fig~es for tie ufit~

States were $50 to $100 million already spent, and $100 million planned. (John Markoff, “Experts Warn of U.S. Lag in Vital Chip Technology, ” The

New York Times, Dw. 12, 1988, p. 1.) A technology that generates X-rays by pulsed laser sources is a possible alternative to the synchrotrons, slower

but perhaps more practical. Japanese R&D is also pursuing this possibility.

4@pucal (u]&a-violet) ]i~o~aphy may lwt a while longer, however; Sematech is betting that it will, and is putting much of its effon into s~etchlng

the technology to its farthest limits. The history of the semiconductor industry shows that tedmologies sometimes last longer than expected, For example,

several Japanese companies got a headstart on U.S. firms in manufacturing the 64K dynamic random access memoty chip because they used an older,

conventional technology while the U.S. companies were trying to get the bugs out of a newer one.

4~e= figwes me from VLSI Re=uch Inc., and are for all semiconductor production, including ifltra.company captive production aS Wel] ilS

merchant production for the open market. Figures from Dataquest are for merchant semiconductor production only; they show U.S. producers holding

37 percent of the world market in 1988 (down from 61 percent in 1980), and Japanese producers holding 50 percent; see National Advisory Committee

on Semiconductors, A Strategic Industry ar Risk, a report to the President and the Congress (Arlington, VA: The Committee, 1989).
Chapter 5--Links Between Firms and Industries ● 143

Figure 5-5—World Semiconductor Sales

Billions of dollars

35 I

3 0

25

I

20

t

10

5

L

. . . :::

o

. . .

1983 1984 1985 1986 1987 1988 1989”

- United States = Japan ~ Europe D Rest of world

-Forecast

SOURCE: VLSI Researeh. Inc.

rest. Most U.S. companies that sell on the market are

smaller, less stable, and less integrated. Some make

virtually nothing but chips. Although there are large

integrated U.S. companies making chips—IBM,

AT&T, the Delco division of GM—they typically

use most of the chips they make and buy more

besides.

One explanation for the explosive success of the

Japanese is the structure of their industry. It has been

strongly argued that the vertical integration, large

size, and product diversity of Japanese firms give

them an advantage of staying power that is almost

unbeatable---even if the U.S. industry succeeds in its

strenuous efforts to catch up to the Japanese in

manufacturing excellence.47 Moreover, the big integrated firms can use their most advanced chips to

improve their own end products (computers, work

stations, robots) well before they sell the chips on the

open market to competitors.

It is true that Japanese firms are using their

structural features to advantage (American firms

with much the same features have not been so

successful, however). Possibly other arrangements—

close collaborative relations between suppliers and

customer firms, say--could give U.S. companies

many of the same benefits that the integrated

Japanese firms enjoy. These arrangements would

not, however, provide the kind of financial strength

that helped the Japanese firms weather the steep

semiconductor recession in 1985-86. (Volatile demand, independent of the business cycle in the

economy as a whole, is typical of the semiconductor

industry, although the 1985-86 downturn was deeper

than usual.) But it is well to remember that the

Japanese industry was not always so well-heeled as

it is today. One must look to other factors to explain

Japanese staying power before the plush era of the

later 1980s. Government support, financial and

otherwise, had much to do with it. So did the

well-known ability of Japanese managers to take a

long-run strategic view, rather than going for shortterm profits.

The supposed advantages of integration and large

size are most relevant to the semiconductor industry.

(Lesser integration is often proposed as a remedy for

other industries--eg., the supplier group system as

easier to manage and more conducive to innovation

than GM-style integration in autos; mini-mills as

more flexible, responsive, and efficient than the

integrated behemoths of the steel industry.) But the

semiconductor industry is well worth consideration

on its own, for it is at the heart of technological

advance in every sector of the economy, from autos

to computers to banks to defense.

Links to Markets, Financial Stability

All the leading Japanese semiconductor producers belong to big, vertically integrated firms. All sell

chips on the open market, but some 50 to 70 percent

of the chips they make are used internally or sold to

an affiliated firm in their industry group.48 Facing

competition in the open market probably strengthens

their performance, and having a large, reliable

demand lessens the risk in investing the $300

million or more that building a state-of-the-art

semiconductor plant now requires. In addition, a big,

diversified company can see its semiconductor

division through periodic downturns in demand, as

in 1985-86, when Japanese producers are estimated

to have lost $3 to $5 billion, and U.S. producers

some $2 billion in memory chips. While the demand

for computers, and consequently for memory chips,

plunged, the Japanese companies’ sales of other

electronics products such as VCRs and compact disk

47For ~ exmple, ~ Michael L. mt-IOUZOS, Richard K. Lester, Robert M. Solow and the MIT Commission on Industrial Roductivity, Made in

America: Regaining the Pro&cave Edge (Cambridge, MA: The MIT Press, 1989), pp. 248-262.

dgMichael G. BOITUS, C’omperingfor Contro/ Arnerlca>s Stake in Microelectronics (Cambridge, MA: Ballinger Publishing CO., 1988), P. 111> table

54.
144 ● Making Things Better: Competing in Manufacturing

players held up. The top six Japanese semiconductor

producers (NEC, Hitachi, Toshiba, Fujitsu, Matsushita, and Mitsubishi) are divisions of integrated

electronics firms that had sales of $10 to $23 billion

in 1987. Semiconductors accounted for only 8 to 17

percent of their sales.

The top U.S. firms are much more various. Of

eight leaders (companies ranking in the top 20 for

world market share), two, IBM and HewlettPackard, produce chips almost solely for their own

use. The rest range from about 20 percent outside

sales (AT&T, which recently began to push external

sales) to more than 90 percent. The leading U.S.

merchant producers—those that sell on the open

market-range in size from medium to modest

compared to the Japanese electronic giants. The two

largest are Motorola and Texas Instruments, both

diversified electronics firms of medium size, with

total company sales of around $5 to $7 billion in

1988. Much of their chip production is for their own

use but they are also big producers for the market;

semiconductors count for one-third or more of their

sales. The other leading merchant firms (Intel,

Advanced Micro Devices, National Semiconductor,

Fairchild) are primarily in the chip business.49 They

sell mostly to outside firms, and therefore lack the

assurance of a large internal market. They are

considerably smaller than Motorola and Texas

Instruments (not to mention the Japanese electronics

companies), with sales that run from about $1 billion

to $2.5 billion. (IBM is primarily a computer and

electronic systems company but is also the biggest

of all the semiconductor producers; its total sales in

all product lines were $54 billion in 1988.)

Large size, diversity of product, and vertical

integration can have their down sides too; for

example, bureaucratic clumsiness and top management that does not understand the semiconductor

business. Indeed, in the United States, the moderate

size and flexibility of entrepreneurial semiconductor

firms have been hailed as the source of creativity and

innovation. And, in this country at least, some highly

diversified and vertically integrated companies have

tried the semiconductor business with only limited

success (e.g., RCA and Westinghouse). AT&T, a

very large company ($34 billion in sales in 1988)

with a big internal market in telecommunications

equipment, recently abandoned production of DRAMs.

It seems that large size and a high degree of

integration are no guarantee of success in the

semiconductor business. But are they necessary

even if not sufficient? (The question applies to major

players in the game, not to small niche producers.)

And if large, diverse, integrated firms have a built-in

advantage, why hasn’t the U.S. industry taken that

direction? The answers to these questions are not

simple or obvious. The U.S. industry developed a

structure that was well-suited to an earlier period of

the microelectronics business but does not fit as well

with the requirements of a more mature industry.

(However, other factors besides industry structure

have also favored Japanese semiconductor producers as the industry matured; see the discussion

below.)

The pioneering era of the business, from 1950s up

to the mid- 1970s, was one of repeated technological

upheaval as products were rapidly introduced and

then just as quickly superseded. The germanium

transistor gave way to the silicon transistor; integrated circuits ousted the single transistor for most

uses; MOS (metal oxide semiconductors) succeeded

and largely replaced bipolar logic in highly integrated systems, as in the memory chips used in

computers. This environment of turmoil and frequent change was favorable to startups of new,

creative companies bankrolled by venture capital.

High turnover—20 percent a year on average,

including top ranking professionals and managers as

well as production workers—has been the hallmark

of Silicon Valley since its early days. Engineers and

scientists repeatedly peeled off and spawned new

generations of highly innovative, but often shortlived, firms with a strong focus on new products.

Along with the new products came substantial

changes in the manufacturing process.

In about the last dozen years, microelectronics has

settled down. Important changes are still occurring,

but they have become more incremental than revolutionary. The 1-megabit memory chip of the late

1980s is a fairly direct descendant of the 16-kilobit

chip of 10 or 12 years earlier. It is made by

essentially the same methods. But making chips

with ever finer lines and greater density requires ever

d~airchild Semiconductw cow., fo~erly a subsidiary of the international conglomerate Schlumberger, Ltd., was recently acquired by Nation~

Semiconductor Corp. The sales figures cited here are from the 1989 edition of Standard and Poor’s Register of Corporations, Directors and Executives

(New York, NY: McGraw-Hill, 1989); they do not reflect the acquisition.
Chapter 5--Links Between Firms and Industries ● 145

more complex machinery, more exacting conditions

of manufacture, and greater capital investments. The

$300 million or more that it takes to build and equip

a semiconductor plant for memory chips today

compares with an entry cost of $5 million or so in the

early 1970s.

Three characteristics of Japanese industry, apart

from structure, are advantageous in the present stage

of the microelectronics business. One is the demonstrated excellence of the Japanese in manufacturing.

As an industry matures and incremental improvement takes the place of radical innovation, what

counts most is the ability to shorten the cycle of

product development, to get the latest version of a

product to market quickly, and to make the product

to high standards of quality and reliability, at a

competitive price. This is just what the Japanese did,

beginning with the sudden conquest of half the U.S.

market for 16K random access memory chips in

1980 and continuing with its successors, up through

the l-megabit chip. Many well-known aspects of the

Japanese system of manufacturing--collaboration

between design and manufacturing engineers, scrupulous attention to every detail of manufacturing,

the team system for shop floor workers and their

close involvement in quality and productivity, close

cooperative links with suppliers, and a long-term

view on the part of managers-contributed to this

outcome.

Another factor is the relatively low cost of capital

in Japan and the favorable conditions banks and

shareholders have long offered to major manufacturers—a factor that grows in importance as capital

costs rise.50 Related to this is the long-term view

characteristic of Japanese managers. The lower

capital costs are, the longer a company can reasonably wait for payoffs on its investment. Also, the

lifetime employment offered by large Japanese

companies, and the fact that employees typically

stay with one company for their entire careers,

contributes to a strategy of counting on market

growth for prosperity, rather than taking instant

profits. The highly unstable attachment to companies in Silicon Valley pushes in the opposite

direction. Still another factor, not discussed here but

to be considered in a following report, is the

contribution of the Japanese Government’s industrial and trade policies to the success of industries

considered critical to the nation’s economic future—

government support of R&D and assurance of a

plentiful supply of low-cost capital, combined with

export promotion, tight restriction of foreign investment, and protection of the domestic market.

With this perspective, it may be seen that the

more-or-less assured markets for semiconductors

that a vertically integrated electronics firm can offer,

the stability furnished by product diversity, and the

greater power to make capital investments that

comes with large size are great assets for the big

Japanese electronics companies, but are not by

themselves the decisive assets. A recent example

from Japan underscores the point that vertical

integration is not prerequisite to success. NMB

Technologies Inc. is a subsidiary of a prosperous but

not very large Japanese company, Minebea, which

has a $1.5 billion yearly business in precision ball

bearings. Entering the semiconductor business in

1983, NMB invested $250 million in a world-class

fabrication plant, and started producing superfast

DRAMs in volume in 1985. Despite the world

recession in chips, NMB hung on, and was ready

with suitable fast memory chips when Intel and

Motorola introduced their 32-bit microprocessors

for top-grade personal computers in 1986. Granted,

fast DRAMs are something of a niche market; yet the

investment required to get into the business was far

from trivial. NMB may later fall victim to a bigger

company deciding to compete in fast DRAMs, but in

1989, only 4 years after starting production, it had 90

percent of the world market in fast DRAMs, and

expected to double its 1988 sales of $250 million.51

For stand-alone semiconductor firms there maybe

alternatives to the internal markets that integrated

companies provide. Long-term, stable relationships

between chipmakers and chip users (i.e., builders of

computers, work stations, telecommunications equipment, industrial machinery, automobiles, consumer

electronic goods) might offer similar benefits. An

example is the close ties between IBM and Intel,

which makes a microprocessor for IBM computers.

NMB owed much of its success to cultivation of

close links with users such as Compaq Computer

5~hc~~=t~~S@~ of the J~~~~~se ~]w~ofics Companies in the late Iggos (and inde~ of he entire Japanese Uonomy) has reduced the lnlpOllitllCe

of bank loans and outside equity holders; many of these companies today are capable of meeting most of their own financial needs. See ch. 3 for discussion

of this issue.

5

1 Larry Wailer, “How NMB Took Over the Fast-DRAM Market,” Eiecfronics, November 1988.
146 ● Making Things Better: Competing in Manufacturing

Corp. (its biggest customer) and Lockheed Aircraft

Corp.

Compared with their performance in manufacturing standard commodity memory chips, U.S. producers do better in the kind of chips where individual

product design and attention to customers’ needs are

paramount and price is secondary (e.g., microprocessors and application-specific integrated circuits,

or ASICs). However, two can play at this game. The

top three firms in ASIC sales are Japanese. Not only

do they sell ASICs at home, they operate design

centers in Boston and Silicon Valley, send the

designs back to Japan by satellite communication,

and deliver the custom (or semi-custom) chips by

air. The greatest remaining U.S. advantage is in

microprocessors, where the creative talent of designers (a U.S. strong point) is of paramount importance;

also, users of microprocessors tend to form longterm ties with producers because they invest in

software that fits their particular microprocessor and

its progeny.

For mass-production chips, however, investments

in semiconductor plants have become so huge and

the sales needed to justify them so large that it may

be a good deal harder for an independent. undiversified company to prosper now than it was in the past.

The plenitude of capital that the large, integrated

electronics companies of Japan possess may be a

critical asset. It is sobering to reflect that among U.S.

firms, only IBM, Texas Instruments and the much

smaller Micron Technology, Inc. stuck with DRAM

production through the late 1980s, and most of

Texas Instrument’s production was in its Japanese

facilities. (Motorola was getting back into production of DRAMs in 1989, after making an agreement

with Toshiba to swap a license to produce Motorola’s microprocessor in return for access to Toshiba’s

l-megabit DRAM technology.) As recently as 1980,

there were 11 U.S. companies making DRAMs. This

mass-production chip is essential to computers,

telecommunications, and many other kinds of equipment, and has been a favorite technology driver for

the industry .52

The purpose of Sematech, the governmentindustry R&D consortium in semiconductor manufacturing technology, is to help U.S. producers

regain competitiveness in DRAMs and other memory chips. Sematech is a novel venture for the United

States; not only has it put together industry and

government funding on a large scale, it is forming

stronger vertical links than have existed before in the

U.S. microelectronics industry and is creating unprecedented horizontal links between competitors.

Sematech is confined to R&D, stopping short of

manufacture. A more radical approach was the

proposal by several U.S. computer and semiconductor companies, announced in June 1989, to form a

consortium and produce DRAMs commercially.

The project failed to attract enough computer firms

as participants, however, and was abandoned in

January 1990.53

Links With Consumer Electronics

Another question about linkage in microelectronics is whether the loss of the U.S. consumer

electronics industry has deprived American chipmakers of an essential market. For Japanese chipmakers it is a huge market, taking 40 percent of

production; this compares to 7 percent for U.S.

producers. The decline in U.S. producers’ share of

the world semiconductor market does track to some

extent the decline in U.S. market share of consumer

electronic goods; in other words, other purchasers

have not fully made up for the lack of sales to makers

of television and radio sets, VCRs, compact disk

players, and the like.

Up to this point, the loss of sales in consumer

electronics has hurt U.S. chipmakers more financially than technologically. This is because most of

the chips used in consumer electronics differ basically from those used in computers, telecommunications equipment, and other high-technology products. Analog devices, which receive an analog signal

52Te-.~olog dnve.S ~e ~~pS ~how mmufacture provides learning experience mat can hen ~ app]ied to o~er kinds of chips or later generations

of the same chip. DRAMs are good technology drivers because: 1) they are produced in large enough volume to supply data quickly for statistical

analyses; 2) they are high-density integrated circuits that push the limits of current lithography technology; 3) they have a simple repetitive design, which

makes it easy to test them for design or production defects; and 4) the manufacturing equipment and process technology required for DRAM production

is similar to that required for other chips.

ssch~ermem~rs were tiee computer manufacturers (IBM, Digital Equipment Corp., and Hewlett-Packard) and four chipmakers (Intel, Advanc~

Micro Devices, Nationat Semiconductor, and LSI Logic). Both Apple Computer and Sun Microsystems decided not to participate, A spokeswoman for

Sun cited its “global purchasing strategy” and “existing long-term”agreements with other chipmakers as reason for refusal to join. ‘‘Electronics

Newsletter,” Electronics, December 1989, p. 17.
Chapter 5-Links Between Firms and Industries ● 147

and amplify it, are much used in consumer electronics. Computers and the like use digital chips. At one

time (until the late 1970s) this divergence was

something of a handicap to Japanese semiconductor

producers. While they excelled in manufacture of

analog devices for their booming consumer electronics business, much of that experience did not carry

over into the production of large-scale integrated

circuits based on digital electronics (with the VLSI

project, Japanese manufacturers got over this technological hump).%

Today, consumer electronic goods are changing

course toward much greater consumption of digital

chips. Compact disk players already use them. New

generations of television sets and related products

will use far more. There are about 160 million

television sets in the United States, which suggests

that the potential market for digital chips for

television alone could be large. Semiconductor

producers who fail to get into this market could find

themselves at a disadvantage-but not just in the TV

market. More importantly, they could fall behind in

the know-how required for making successive generations of computers and their applications. This is

because the core technologies for consumer electronics on the one hand, and computers plus many

other advanced business products, on the other hand,

are converging.

All digital chips are in the same family—i.e., they

are made with similar kinds of equipment and

manufacturing processes. Anyone who can meet the

exacting requirements for mass-producing digital

chips for consumer electronics items—high volume,

low cost, high reliability—gains valuable learning

experience in making similar kinds of chips, well

and cheaply, for computers and other business

products. The same goes for other components that

computers, telecommunications, and other business

products have in common with consumer electronics

items. Moreover, advanced television could be the

application where certain leading edge technologies—

e.g., advanced displays and the new manufacturing

technologies needed to make them—will be needed

first.55

The Japanese are making rapid progress toward

commercializing high definition television (HDTV),

and some companies are already poised to sell an

advanced version of conventional television that has

much improved definition. The United States is far

behind. Zenith, the last remaining U.S.-owned

producer of television sets, has not yet brought to

market an improved definition TV (IDTV), and is a

late and uncertain entrant in the HDTV race.

(Foreign-owned firms with production facilities in

the United States are pursuing advanced television

systems, however. The Dutch-owned Philips has an

IDTV on the market, and the French-owned Thomson Consumer Electronics has demonstrated an

extended definition TV.) After the Defense Advanced Research Projects Agency (DANA) set

aside $30 million to encourage U.S. producers to

make HDTV’s, Zenith proposed to collaborate with

AT&T on such a venture; a number of computer and

work station manufacturers are also interested. But

so far, HDTV activity by U.S.-owned companies is

confined to research and the earlier states of

development, with commercial production still years

away.

Technology Links

Another way that a vertically integrated company

may get ahead of the competition is to develop its

own advanced technology, and keep it for itself. For

example, both Hitachi and IBM are said to have

developed some superior production equipment that

they never sold or licensed to anyone else.

A similar kind of technology link is part of the

rising threat from Japan to the U.S. lead in supercomputers, the fastest and most powerful of computing machines. Three Japanese electronics companies

(NEC, Hitachi, Fujitsu) are narrowing the U.S. lead.

These large, integrated companies make their own

high-speed components. Currently the world leader,

and the only U.S. company making supercomputers,

is the comparatively small, stand-alone firm Cray

MU.S. Cmgess, Office of TtxhnoIon Assessment, internutwrud Competitiveness in Electronics, OTA-ISC-200 (Springfield, VA: Nation~

Technical Information Service, November 1983), pp. 196-198.

SSFor det~ls, see tie section on advanced television in ch. 2, and OTA’s forthcoming report, The Big picture.
148 ● Making Things Better: Competing in Manufacturing

Research Inc.56 Cray does not make the high-speed

components needed for supercomputers, and they

are hard to get from other U.S. companies. This is

one of the main reasons why the U.S. lead is

evaporating, according to a report by a panel of

computer science experts to the Institute of Electrical and Electronics Engineers, Inc. (IEEE) .57 The

report said:

The highest performance memory and bipolar

logic components useful for supercomputers . . . are

available only from Japan. The managements of

Cray and ETA have been quoted in the press at

various times as stating that these Japanese components are “not yet available for export’ from Japan

to Cray or ETA as devices-but they are available to

end users in the Japanese supercomputer systems.

Those systems are definitely available for export.

A senior NEC manager, Akihiro Iwaya, underscored the point in an interview with The New York

Times. He said: “We have our own chip divisions.

They can custom-make the high-speed chips we

need. Cray can’t. They have to buy them from

Japan. ’58

Officially, Cray managers have no complaint

about their Japanese suppliers. And indeed it is

unlikely that Japanese producers would cut off

supplies to Cray, partly because that would cause

political troubles for Japan, and partly because sale

of the chips is highly profitable. What is more likely

is delay in providing the latest and best chips to

Cray. According to one informed observer, both the

Japanese firms are delaying up to a year in providing

their latest chips to their American competitor.

Cray is under challenge from larger, more integrated companies in another way as well. Cray

gained its leading position in supercomputers by its

excellence in what the industry calls packaging, that

is contriving to arrange chips in close quarters for

speedy operation, while draining away the heat they

generate. While Cray still has the reputation for

outstanding engineering, it is facing very tough

competition from bigger companies that make a full

line of computers, from mainframes down through

personal computers. Such companies can afford to

devote a lot of engineering talent to solving packaging problems, since the results can eventually be

applied not just to supercomputers but to the full

line, and the costs recovered from this broad range

of products. The same consideration may apply to

other kinds of R&D spending as well, Not all of this

particular advantage resides in Japan, however. IBM

too makes a range of computers, and is supporting

the efforts of a former Cray engineer (Steven Chen)

to build a new improved supercomputer.

%e still smaller ETA, a subsidiary of Control Data Corp., dropped out of supercomputerproduction in April 1989. Also, in May 1989, Cray Research

spun off anew company, Cray Computer, to be run by Seymour Cray, the founder and chief designer of Cray Research. Funded by Cray Research with

$100 million over 2 yeim, the new company was setup to pioneer a promising but risky technology based on gallium arsenide chips. Reportedly, the

reascmfor the move was to free Seymour Cray from the short-term pressures of Wall Street. (AIan Kane and Imuise Kehoe, ‘Challenge to the U.S. Brains

Trust,” Financial Times, May 18, 1989.)

571EE~SAB Committee on Communications and hformation pO1iCy, “U.S. Supercomputer Vulnerability, ‘‘report to the Institute of Electrical and

Electronics Engineers, Inc., prepared by the Scientific Supercomputer Subcommittee, Committee on Communications and Information Policy, United

States Activities Board (Washington, DC, August 1988).

SsDavid E. Sanger, ‘‘A High-Tech Lead in Danger, ’ The New York Times, Dec. 18, 1988, sec. 3, p. 1.
Chapter 6

Technology Transfer and Diffusion:

Some International Comparisons
CONTENTS

Page

DIFFUSION OF ADVANCED MANUFACTURING EQUIPMENT . . . . . . . . . . . . . . . . . . . . . . . : 152

LOOKING OUTSIDE THE FIRM FOR NEW TECHNOLOGIES . . . . . . . . . . . . . . . . . . . . .,..., 156

TECHNOLOGY DIFFUSION TO SMALL FIRMS . . . . . . . . . . . . . . . . . . . . . . . . . . . 158

Major Companies and Their Suppliers +...... . . . . . . . . . . . . . . . . . . .

. . . . . . . . . . . . .

159

Japanese Government Programs for Small and Medium-Size Firms ~‘, : : 161

Horizontal Links Between Small Firms . . . . . . . . . . . . . .

. *...*........*..........,,,.*..,,, 167

Boxes

Page

6-A. A Small Plant in Yokohama,.........................,....... 164

6-B. A Plastic Mold Equipment Cooperative in Japan . . . . . . . . . . . . . . .

. . . . . . . . . . . . . . . . . . . . . .

. . . . . . . . . . . . . . . . . . . . . . . . 170

Tables

Page 6-1. Adoption Rates of NC Machine Tools in Five Major Industries,

United States (1988) and West Germany (1986) . . . . .

. . . ., . . . . . . . . . . . ., .,, ,., ,+ . . . 153

6-2. Penetration Rates of NC Machine Tools in Manufacturing Industries,

. . . . .

United States and Japan, 1987 . . . . +... . . . . . . . . . . . . . . . ... ...0 ... *., ,++, .,** +*, ++6. *,++6 154

6-3. Defense production and Use of NC Machines in U.S. Manufacturing

Establishments, 1988 . . . . . . . . . . . . . . . . . . . . . .

. . . . . . . . . . . . . . . . . . . . . . . .

6-4. Japanese Government Equipment Modernization Loan and Equipment

Leasing Systems for Small and Medium Enterprises . . . . . . . . . . . . . . . . . .
Chapter 6

Technology Transfer and Diffusion:

Some International Comparisons

Compared to our strongest competitors, the United

States is lacking in institutions to diffuse technology

to manufacturing companies. This is true in both the

public and private sectors, and it applies especially

to small companies. For example, scattered Federal

and State efforts to help small U.S. firms raise their

technological level are no match for the dense

nationwide program of financial and technical assistance to smaller manufacturers in Japan. Not many

major U.S. manufacturers give their suppliers technical help, as Japanese firms customarily do. Nor is

there anything in this country to compare with the

apprenticeship training taken by half the young

people of Germany and Sweden and credited with

producing a high level of technical skills in the work

force. In those countries, good worker skills are a

key factor in the diffusion of manufacturing technology.

Large companies as well as small ones suffer from

failures in technology transfer. With their typically

standoffish relation to suppliers, large U.S. manufacturing firms rarely get the benefit of collaboration

with suppliers on developing and applying new

technologies —a common practice in Japan (see ch.

5). Moreover, many U.S. firms are not as good as

their foreign competitors at scanning the outside

world for new technologies that would improve their

company’s products or manufacturing techniques.

Often, the company culture is inimical to anything

Not Invented Here—the NIH syndrome.

There is one kind of technology transfer in which

American companies do have an excellent track

record. That is in taking fundamentally new ideas

out of the laboratory and using them as the basis for

new families of products. Whole industries have

been founded on science-based inventions. For

example, the transistor, an invention that depended

on accumulated knowledge in quantum mechanics

and solid-state physics, was the progenitor of the

complex of microelectronic industries, including

semiconductors and computers. In the same way,

commercial biotechnology has risen on the foundation of scientific advances in molecular biology.

But U.S. firms are weaker at the more ordinary

kind of technological advance in which improvements are added bit by bit to existing products and

manufacturing processes. Over the past quarter

century, Japanese manufacturers have repeatedly

beaten American producers with incremental product and process improvements-first in transistorized radios and TVs, then autos, now semiconductors. 1 Some companies in Europe also excel at this

kind of evolutionary advance. For example, the

Germans, with their mastery of mechanical engineering and metalworking, are leaders in making

high-quality industrial machinery.

The strengths and weaknesses of American firms

in adopting new technologies reflect our institutional biases. U.S. Government science and technology policy is light on technology diffusion and

heavy on the traditional government missions of

defense, health, and basic research.2 In the private

sector, there is plenty of venture capital to support

attempts to commercialize science-based innovations coming out of research labs, and there are

plenty of footloose managers and engineers ready to

shift to promising new ventures. Thus, public policy

supports the kind of R&D that sometimes leads to

technological breakthroughs, and private institutions are suited to exploiting them commercially.3

What is lacking is a web of institutions to spread

throughout manufacturing, to small as well as large

firms, the more mundane and more gradual improvements in technology that spell success in the later

phases of a product’s lifecycle.

IJapae~e success is not confimed t. improvements of fami]iar products. For example, although the video cassette recorder was a descend~t of tie

U, S.-made Ampex commercial video tape recorder, it embodied so many new engineering ideas that it might be regarded as a new invention. And more

and more, the Japanese are putting efforts into scientific work as the basis for new technologies, m in high-temperature superconductivity.

ZFor a &scussion ~mp~ng “mission. oriented’ [echnology plicy (~ practiced in the united Slates, Britain, and France), ‘‘diffusion- oriented”

tedmology policy (Germany, Sweden and Switzerland), and a combination of the two (Japan), see Henry Ergas, “Does Technology Policy Matter?’

in Bruce R. Guile and Harvey Brooks (eds, ) Technology and Global Industry, Companies and Nations in the World Economy (Washington, DC: National

kademy Press, 1987).

sAt lemt, tie ~~itutions ~ suited t. supw~ing st~.up firms. However, high-tech st~-ups often f~ter in the transition to large-scale production.

–151–
152 . Making Things Better: Competing in Manufacturing

Government technology policies in other countries are much more strongly directed toward technology diffusion than are U.S. policies. Japan’s

long-established programs of general financial assistance to small firms and special measures to

encourage small manufacturers to adopt modern

technologies are of particular interest. Although

there are many differences between small manufacturers in Japan and the United States, some features

of the government programs that have worked well

there might be translated into American terms.

Small firms have received special attention from

the Japanese Government for several reasons. First,

they are numerous. The Japanese economy as a

whole is heavily weighted to small fins, and this is

true of manufacturing as well. Small and medium

size firms account for three quarters of manufacturing employment in Japan, compared to a bit over

one-third in the United States. Also, small Japanese

firms have often been technologically backward,

paid low wages, and operated under primitive

working conditions. Despite these disabilities, many

small Japanese manufacturers have turned in remarkable performances-especially those that are

suppliers for Japan’s world champion industries

(e.g., electronics, automobiles). Technology assistance given by the major customer firms has helped

the performance of these supplier companies, but the

government’s technical and financial assistance

programs get much of the credit too.

Many of Japan’s large firms have now entered the

ranks of the richest and most successful in the world

and no longer need much of the government

assistance that helped them get established. More of

the nation’s resources, public and private, are

available to smaller fins. This chapter describes at

some length the extensive technical and financial

programs available to small Japanese firms today,

keeping in mind their possible relevance to U.S.

policy. The relatively sparse Federal and State

technical and financial assistance available to small

manufacturers in the United States is described in

chapter 2 and chapter 7.

DIFFUSION OF ADVANCED

MANUFACTURING EQUIPMENT

One measure of technological sophistication in

manufacturing is the presence of advanced equipment—

such things as computerized machine tools, robots,

flexible manufacturing cells. This is only one kind of

measure, and by no means a complete one. Other

factors, especially the so-called soft technologies

involving organization of work and use of people,

are at least as important as hardware to manufacturing performance. Nevertheless, an industry that falls

behind the international competition in installing

advanced machinery will very likely find itself

falling behind in the cost, quality, and variety of its

products.

In the use of robots-defined as programmable,

multifunctional manipulators—U.S. industries are

far behind the foreign competition, especially the

Japanese.4 Although the invention and first use of

industrial robotics was in the United States, it is no

more than a minor factor in American manufacturing

today. Even in Japan, where robots have been

adopted far more aggressively, they are mostly

confined to special uses in a few industries (mainly

autos and electronics). A much more broadly used

technology is numerically controlled and computer

numerically controlled (NC and CNC) machines

(also invented here). These machines are the kind of

computerized production equipment most commonly found on manufacturing shop floors in the

United States, West Germany, and Japan (and in

other industrialized countries as well).

American manufacturers are closer to their top

foreign competitors in the use of NC machines than

in robotics.5 However, Germany leads by a fair

margin, and the margin is wider if U.S. military

production is omitted. The Japanese, who started

later than American firms in adopting NC machine

tools, were nearly even by the late 1980s and were

on a faster track. In a few years, unless things

change, NC machine tools will be more common in

Japanese factories than in American ones.

In 1988,41 percent of U.S. manufacturing establishments with 20 or more employees in five major

gK~~e~ Fkmtm, ‘The Changing Pattern of Industrial Robot Use, ’ in Richard M. Cyert and David C. Mowery (eds.), The im@Ct o~Technological

Change on Err@ymettt and Econom”c Growth (Cambridge, MA: Balhnger Publishing Co., 1988); Edwin Mansfield, Department of Economics,

University of Pennsylvania, “Technological Change in Robotics: Japan and the United States, ” Managerial and Decision Economics, Special Issue,

spring 1989, Pp. 3-12.

s~ tie following discussion, the term NC includes CNC.
Chapter 6--Technology Transfer and Diffusion: Some International Comparisons ● 153

industry groups were using one or more NC machines, according to a survey by the Bureau of the

Census. 6 The figure for German plants of the same

size in a similar group of industries is 48 percent.7

The Japanese data are shown on a different basis,

that is, NC machine tools as a percent of all the

machine tools in the shop. In 1987, 12.2 percent of

machine tools in Japanese establishments with 50 or

more employees in metal machining industries were

NC. The comparable figure for U.S. establishments

of the same size, at the same time, was 13.1 percent8

(tables 6-1 and 6-2). The seeming parity of U.S. and

Japanese metalworking plants in ownership of NC

machine tools may be misleading, however, since

the Japanese firms are acquiring the machinery at a

faster rate. U.S. metalworking firms increased their

installed computerized automation (mostly machine

tools) at an estimated rate of nearly 16 percent a year

from 1983 to 1988;9 the Japanese added NC machine

tools at a rate of 24 percent per year from 1981 to

1987.10

Another complicating factor in making these

comparisons is U.S. military procurement. The

Census Bureau’s survey of U.S. metalworking

establishments found that plants producing for the

military are more likely than the general run of

plants to use NC machines. Of all the plants in the

survey, 41 percent used this automated machinery.

Table 6-l-Adoption Rates of NC Machine Tools in

Five Major industries, United States (1988)

and West Germany (1986)

Size of establishment West Germany United States

(number of employees) (percent) (percent)

Under 20 . . . . . . . . . . . . . . . . . . . . 15.8

20-29 . . . . . . . . . . . . . . . . . . . . . . . 36.0 35.9

100-499 . . . . . . . . . . . . . . . . . . . . 55.9 50.0

500 and over . . . . . . . . . . . . . . . . 87.3 69.8

20 and over . . . . . . . . . . . . . . . . . 47.7 41.4

NOTES: “Adoption hate” means the percentage of surveyed firms reporting installation of at least one NC machine tool. “NC machine

tools” include CNC machine tools.

The five major industry groups are SIC 34-36 (Fabricated Metal

Products, Industrial Machinery and Equipment, Electronic and

Other Electric Machinery, Transportation Equipment, and instruments and Other Related Products) for the United States. The

German industry groups are similar although they may not be

identical.

n.a. = not available.

SOURCES: 14baf Germany Hans-Jurgen Evans, Carsten Becker, and

Michael Fritsch, “The Effects of Computer-Aided Technology

in Industrial Enterprises: It’s the Content that Counts,” in

Ronald Schettkat and Michael Wagner (ads.), Technkal

Change and Ernp/oyn?ertt (New YoM, NY: de Gruyter, in

press), and Michael Fritsch, Technische Universitat Berlin,

personal communication. United States: U.S. Department of

Commerce, Bureau of the Census, Manufacturing Technology

1988, SMT (88)-1 (Washington, DC: Department of Commerce, 1968), table 6-B.

For plants making products to military specifications, the figure was 58 percent; for those making no

mil spec products, only 36 percent reported using

NC machines. Similar discrepancies were reported

6u.s. ~p~ment of Commeme, Manufacturing Techno/ofl 1988, Current Industrial Reports, SMT (88)-1 (Washington, DC: U.S. Government

Printing Office, 1989). The survey covered 10,526 establishments, selected to represent a total universe of 39,556 manufacturing establishments in SIC

Major Groups 34, fabricated metal products; 35, industrial machinery and equipment; 36, electronic and other electric equipment; 37, transportation

equipment; and 38, instruments and related products.

THam.J~gen Ewers, Carsten Becker, and Michael F~tsch> “The Effects of the Use of Computer-Aided Technology in Industrial Enterprises: It’s

the Context That Counts, ’ in Ronald Schettkat and Michael Wagner (eds.), Technical Change and Ernpioyrnenz (New York, NY: deGruyter, in press),

and personal communication, Michael Frit.sch, Sept. 21, 1989.

SFor tie Unitd Shtes, daw me from tie 1987 National Survey Data about Machine Tool Use in Manufacturing Plants in Maryellen R. Kelley and

Harvey Brooks, Modernizing U.S. A4an@acturing (Cambridge, MA: MIT Press, forthcoming), and personal communication, Maryellen Kelley, Sept.

20,1989. The survey covered a representative sample of establishments of all sizes, including 1,368 metalworking plantsin21 industries. “Computerized

automation’ in the study was defined to include programmable numerically controlled (NC) machine tools, which are controlled by tape and have been

commercially available for more than 20 years; computer numerically controlled (CNC) machine tools, which include a microprocessor and a keyboard

at the machine, so that programs can be written and edited at the machine; and flexible manufacturing systems (FMSS), which consist of a number of

programmable machines (either NC or CNC) connected by automatic materials handling devices (e.g., conveyors or robots). At the time of the survey,

38 percent of computerized machine tools in use were the older NC type.

For Japan, data are drawn from a survey covering establishments of 50 or more employees in metal machining industries, conducted every 6 years

by the Ministry of International Trade and Industry (MITI). The MITI survey, like the Kelley-Brooks study, combines NC and CNC machine tools. Data

from the two surveys are only roughly comparable, because the industries covered differ somewhat. The source for the data in English is D.H. Whittaker,

“NC/CNC Penetration in Japanese Factories,” Appendix 1 to “New Technology in Small Japanese Enterprises: Government Assistance and Private

Initiative,” contract report to the Office of Technology Assessment, May 1989. In Japanese, the source is Tsusansho, Showa 62 nen duinanakui kosu.ku

kikaisetsubito tokeichosu hokokusho (Report of the 7th Sumey on Machine Tool Installation) (Tokyo: Tsusan todei kyokai), Appendix 1, pp. 282-284.

gMqe]len R. Kelley and H~ey Brooks, The state of co~~erized Autom#ion in U.S. Mawfacturing,H~~d University, John F. Kemedy

School of Government, October 1988, p. I-6. The average annual rate of adoption from 1968 to 1983 was 13.7 percent, with a slowdown in the years

1973-78 (8.4 percent per year) and a speedup in 1978-83 (18,6 percent per year). Anderson Ashbum, “The Machine Tool Industxy: The Crumbling

Foundation,” in Donald A. Hicks (cd.), /s New Technology Enough (Washington, DC: American Enterprise Institute for Public Policy Research, 1988),

p. 55. Sources of the data are the loth through 13th American Machinist Inventories.

IOMI~ smeys feud mat Japane~ plans in met~ machining indus~es had 4,861 NQcNc machine t~]s in 19’73, 19,549 in 1981, and 70,465 in

1987. Whittaker, op. cit. and D.H. Whittaker, ‘‘Machine Tool and NC Development in Japan, ” rnimco, n.d.
154 Making Things Better: Competing in Manufacturing

Table &2—Penetration Rates of NC Machine

Tools in Manufacturing Industries,

United States and Japan, 1987

Size of establishment United States

(number of employees)

Japan

(Percent) (Percent)

Under 50 . . . . . . . . . . . . . . . . . . . . 8.1

50-99 . . . . . . . . . . . . . . . . . . . . . . . 12.6 10.7

100-299 . . . . . . . . . . . . . . . . . . . . 13.7 11.2

300-499 . . . . . . . . . . . . . . . . . . . . 12.7 12.6

500-999 . . . . . . . . . . . . . . . . . . . . 12.3 13.5

Over 1,000 . . . . . . . . . . . . . . . . . . 13.8 12.8

Total over 50 . . . . . . . . . . . . . . . . 13.1 12.2

NOTES: ’’Penetration rate” means the ratio of NC machine tools to the total

number of machine tools installed in the establishments surveyed.

“NC machine tools” includes CNC machine tools. The metalworking industries surveyed are similar but not exactly the same in the

United States and Japan.

For Japan, the category “other machine tools” was excluded In

this table, because it was not included in the U.S. survey.

n.a. = not available.

SOURCES: Japan: Ministry of international Trade and Industry, Report of

the 7th Survey on Machine Tool Installation (Showa 62 nen

dainanakai kosaku kikai setsubito tokei chosa hokokusho)

(Tokyo: Tsusan todei kyokai), pp. 282-84; The source in

English is D.H. Whittaker, “NC/CNC Penetration in Japanese

Factories,” Appendix 1 to “New Technology in Small Japanese Enterprises: Government Assistance and Private initiative,” contractor report to the Office of Technology Assessment, May 1989.

Url/ted Statea: 1987 National Survey Data about Machine

Tool Use in Manufacturing Plants; Maryellen R. Kelly and

Harvey Brooks, Modernizing U.S. Manufacturing (Cambridge,

MA: MIT Press, forthcoming), and Maryellen R. Kelly, CarnegieMellon University, personal commumeation.

by prime defense contractors and subcontractors for

their military and non-military products (table 6-3).

This means that NC machines are used in American

plants much more for producing military goods than

for commercial goods, and thus contribute less than

it might appear to the Nation’s trade performance

and competitiveness.

The differences in NC machine tool use in the

United States, Germany, and Japan reflect differences in government policy. The policy with most

effect in the United States is satisfaction of military

needs. Numerical controls for machine tools were

invented here in the 1940s, and MIT developed a

highly sophisticated version for the Air Force in the

1950s. NC machining offered the great precision

that was needed for making integrally stiffened wing

skins for aircraft. The first substantial use of NC

machining, in the late 1950s, was in five-axis milling

machines that could hollow out the wing, leaving

stiffeners in place, and contour the outside skin to the

airfoil shape—all in one piece from a solid thick

plate of metal (an advance from the old method of

riveting the skin to ribs and stringers). The Air Force

bought the first 100 of these machines (after the

aircraft industry refused to invest in them) and put

them in its contractors’ factories. 11 Around the same

time, other machine tool builders were developing

simpler, cheaper, more flexible machines, taking

advantage of the progress in NC controls.

Just as defense contracts were critical in developing NC machining, military requirements have had

a continuing effect on its diffusion. The U.S.

Government has given little attention to specific

policies that would promote adoption of NC technology outside the military-industrial complex. An

exception, perhaps, was the investment tax credit, in

effect off and on from 1962 to 1986, that allowed

firms to deduct from their income tax 7 to 10 percent

of the price of any productive capital equipment,

including machine tools. There is some evidence

that the investment tax credit may have encouraged

orders for NC machine tools. ’z

Many people expected NC machine tools to

sweep U.S. metalworking shops soon after their

invention. They did not. Nevertheless, diffusion of

these machines has not been slow by historical

standards.13 Says Ashburn Anderson, an expert on

the machine tool industry, “It is not so much that

technology diffuses more slowly in the United States

than in the pastas that it now diffuses more rapidly

in Japan." 14

Early on, the Japanese licensed NC technology

and within 10 years had adapted the American

invention into simple, cheap, and robust machines of

their own design. Computerized controls (also a U.S.

invention) were added in the 1970s, and Japanese

firms became the world’s premier producers of

sturdy, relatively inexpensive workhorse CNC machine tools. The Japanese Government supported

these efforts, contributing generous amounts to

research and development consortia, and encouraging the thousands of small firms making machine

tools to coalesce and specialize in different segments

11A. Anderson, Op. Cit., pp. 44~7.

12A. hder~n, op. cit., pp. 69-71.

Issm, for exmple, ~win Mansfield> ‘‘The Diffusion of Industrial Robots in Japan and the United States, ” mimeo, n.d., which found that it took

the relatively short time of 5 years for half the major potential users to adopt NC machine tools.

14A. Anderson, op. cit., p. 79.
Chapter 4--Technology Transfer and Diffusion: Some International Comparisons ● 155

of the market to achieve economies of scale. (This

advice was not always heeded; firms tended to stay

small, but they did specialize more. )15

At the same time, Japanese government policy

actively supported widespread adoption of NC

machine tools. The government’s equipment leasing

systems bought machine tools and leased them at

low rates to small and medium-size manufacturers,

thus providing both a stable market for machine tool

builders and subsidies for machine tool users. The

government also provided low-cost capital to a

quasi-public leasing company that bought machine

tools and leased them to companies of any size.

Japan’s nationwide technology extension services

(discussed below) have helped small firms learn to

use the equipment effectively. In addition, Japanese

tax law was changed in 1984 to allow very rapid

depreciation of investments in high-technology

equipment (including NC machine tools) by small

and medium- size firms. This seems to have set off

a flurry of buying; one Japanese manufacturer calls

it the “NC-ization period. ”

In Germany, emphasis in many industries on

medium batch production rather than mass production may account in part for high adoption rates of

NC machine tools (hard-wired automation is often

more efficient in mass production) but basically,

both the production and use of NC machine tools

reflects Germany’s tradition, more than a century

old, of excellence in vocational and technical

training. The German training system is supported

by both government and industry; it includes 3-year

apprenticeships from ages 16 to 19 for operators and

further rigorous training, practical and theoretical,

for the master craftsmen who become foremen and

often middle managers.

Production machinery is an important export for

Germany, and that includes CNC machine tools at

the high end of the range. Germany’s dominance in

producing these complex and costly machines is due

in large part to the quality of its workers. The

training system also pays off in the use of NC

machine tools. A study of matched metalworking

plants in Germany and Britain (described in Chapter

4: Human Resources) found productivity two-thirds

higher in the German plants, with most of the

difference credited to training, especially of foreTable 6-3-Defense Production and Use of NC

Machines in U.S. Manufacturing Establishments, 1988

Number of Percent using

establishments NC machines

All establishments . . . . . . . . . .

Products made to military

specifications

Yes . . . . . . . . . . . . . . . . . . . . . . . .

No . . . . . . . . . . . . . . . . . . . . . . . .

Don’t knowa . . . . . . . . . . . . . . . . .

Not specified . . . . . . . . . . . . . . . .

Prima defense contractor

Yes: percent of products

shipped to defense:

1 to 25 percent . . . . . . . . . . . .

26 to 75 percent . . . . . . . . . . .

Over 75 percent . . . . . . . . . . . .

Don’t knowb . . . . . . . . . . . . . . .

No . . . . . . . . . . . . . . . . . . . . . . . .

Don’t knowc 

. . . . . . . . . . . . . . . . .

Not specified . . . . . . . . . . . . . . . .

Subcontractor to defense

Yes: percent of products

shipped to prime defense

contractor

1 to 25 percent . . . . . . . . . . . .

26 to 75 percent . . . . . . . . . . .

Over 75 percent . . . . . . . . . . . .

Don’t knowb . . . . . . . . . . . . . . .

No . . . . . . . . . . . . . . . . . . . . . . . .

Don’t knowc 

. . . . . . . . . . . . . . . . .

Not specified . . . . . . . . . . . . . . . .

39.556

14,588

19,439

2,141

3.388

10,010

1,012

683

601

22,874

1,028

3,349

11,533

2,738

880

1,83

12,901

6,070

3,605

41.4

58.1

36.1

38.4

1.5

51.7

62.5

61.2

37.3

41.2

42.0

2.0

53.7

67.1

67.4

44.3

32.9

42.0

4.1

NOTE: “NC machine tools” includes CNC machine tools.

a “Don’t know" means the respondent didn’t know what percentage of

products are made to military specifications.

b “Don’t know” means the respondent didn’t know what percentage of

products in the plant are shipped to Federal defense agencies or to prime

contractors of defense agencies.

C “Don’t know” means the respondent didn’t know whether any of the plant’s

products are shipped to Federal defense agencies or to prime contractors

of defense agencies.

SOURCE: U.S. Department of Commerce, Bureau of the Census, Manufacturing Technology 1988, Current Industrial Reports, SMT

(88)-1 (Washington, DC: US Government Printing Office, 1989).

men. Computerized machinery worked far more

smoothly in the German plant, with little downtime.

To summarize: the U.S. Government policy with

most effect on both the invention and diffusion of

CNC machine tools has been concern to meet

military requirements. In Japan, the government

supported efforts by machine tool builders to make

incremental improvements in the known NC technology, and it underwrote diffusion of the technology to machine tool users through subsidized

leasing, tax breaks, and technology extension services to smaller firms. In Germany, training was the

ISFOr a detailed accomt of the development of NC controllers and machine tools in Japan, see Ezxa Vogel, Comebuck (New York, NY: Simon A

Schuster, 1985).

21-700 0 = 90 - 6
156 ● Making Things Better: Competing in Manufacturing

most important contribution the government made

to the production, diffusion, and effective use of

computerized equipment.

None of this means that government policies were

the only or most important factor in either the

development or diffusion of NC machine tools in

these countries. A great deal depended on the private

actions and decisions of the companies and people

involved. For example, Fanuc, under the direction of

Dr. Seiuemon Inaba, has from the start combined

excellence of product with exemplary manufacturing practice, in which the latest automated equipment is used to make reliable, inexpensive controllers. (In Fanuc’s factory near Mount Fuji most of the

machining and some of the assembly is done without

operators.) American NC machine tool builders

have been much slower to install the very kind of

equipment they make-a case of the shoemaker’s

child, according to Anderson. Most important,

Japanese designers applied microprocessors (an

American invention) to CNC controls in 1976, a full

4 years before U.S. companies followed suit. That

4-year lead was probably decisive in giving Japanese NC machines first place in the U.S. market. l6 In

1988, half the NC machines sold here were made in

Japan and, according to preliminary estimates, the

Japanese share of the U.S. market rose to two-thirds

in 1989.

Finally, the point that hardware is only one part of

manufacturing success bears repeating. For example, studies of auto assembly plants in Japan, North

America, and Europe for the International Motor

Vehicles Program found that automation and a

“lean’ Japanese-style management system are each,

separately, important factors in manufacturing performance. l7 But they contribute most to high productivity and high quality when they occur together.

The best performing, world class companies (mostly

Japanese) first established a lean management system, and then improved their performance with

higher levels of automation. U.S. and European

companies that automated first and then tried to

improve their management of people and organization of work had a harder time reaching top

performance.

LOOKING OUTSIDE THE FIRM

FOR NEW TECHNOLOGIES

Incremental improvement of an existing product

is part of the “cyclic development process” in

manufacturing. 18 It is engineering-dominated, compared to the science-dominated process of making

commercial products from radically new technologies bred in the laboratory. Despite its less dramatic

character, cyclic development is no less significant

than radical breakthroughs, for its cumulative effects

can be profound. For example, just 20 years ago,

memory chips held 1,000 bits. The newest generation of commercial chips are capable of holding 4

million bits.

If U.S. manufacturing firms have fallen behind

foreign competitors in pursuing cyclic development,

one reason is their backwardness in exploiting

technological advances that originate outside the

company (the NIH syndrome). A well-known study

comparing R&D in a random sample of major firms,

50 Japanese and 75 American, found that the

Japanese companies spent less time and money than

their U.S. counterparts in developing new products

and processes. 19 But the Japanese advantage lay

entirely in innovations based on external technology. For innovations based on technology developed

internally, U.S. companies performed as well as the

Japanese. (The study did not attempt to assess what

opportunities these large U.S. firms might have

missed altogether because of their weakness in

exploiting external technologies.)

The timing demands of the product development

cycle suggest a possible reason for this seemingly

impervious attitude. Ralph Gomory, former chief

scientist for IBM, explains it this way:

If you want to get new ideas into the development

and manufacturing cycle from outside, timing is

16A. ~de~n, op. cit., p. 58.

ITJohn F. fiticik and JOhII Paul MacDuff’te, ‘Explaining High Performance Manufacturing: The International Automotive Assembly plant Study,’

paper presented to the IMVP International Policy Forum, May 1989, available from International Motor Vehicles Program, Massachusetts Institute of

Technology, Cambridge, MA. The authors described the lean production system as one ‘ ‘that nms ‘lean’ in its avoidance of pr~blem-hiding buffers and

stays ‘fragile’ in its willingness to rely on a skilled, flexible, motivated workforce for problem-solving and continuous improvement. ”

l~his term and much of the following discussion is drawn from Ralph E. Gomory, ‘‘Reduction to Practice: The Development and Manufacturing

Cycle,” in National Academy of Sciences, National Academy of Engineering, Institute of Medicine, and National Research Council, industrial R&D

and U.S. Technological Leaders@ (Washington, DC: National Academy Press, 1988).

l~win Mansfield, “Industrial Innovation in Japan and the United States, ” science, Sept. 30, 1988.
Chapter 6--Technology Transfer and Diffusion: Some International Comparisons ● 157

crucial. . . . You must propose these ideas at the

beginning of the cycle. . . . Halfway through is too

late . . . no matter how good the proposal, The

company is not going to interrupt the cycle, delaying

the whole project by a year and thus ending up with

a noncompetitive product.20

It may seem that this constraint should apply to

Japanese as well as to U.S. manufacturers. If it does

not, or does less, one reason is that major Japanese

industries contrive to keep the product cycle shorter.

Thus, the point at which new ideas can be plugged

in comes around faster. As noted in chapter 5, U.S.

and European auto manufacturers typically take 63

months from design to introduction of a new model,

while Japanese producers, on average, take 42

months-and use fewer engineering hours to do it.

Likewise, Japanese electronics companies gained a

critical advantage in the early 1980s when they got

the 64K Dynamic Random Access Memory (DRAM)

chip to market faster than most American producers;

their success in taking the lion’s share of this market

early was one of the factors that drove all but three

U.S. companies out of DRAM production. A shorter

development cycle can be a particular advantage in

a fast-moving field. The company that gets a product

incorporating the latest technology to market soonest reaps the reward of the innovator-even if it was

not the source of the new technology and has no

monopoly.

Two of the major factors that enable leading

Japanese companies to cut short the development

cycle and get new products to market fast are in

brief: 1) the supplier group system, in which

subcontractors take on some of the design and

development burden; and 2) frequent, close communication between the product designers and manufacturing engineers and rotation of people from

design to production. This second feature may be

thought of as a form of technology diffusion itself,

one that takes place within the company.

The time constraints of the development cycle

mean that people inside the firm must be instigators

in collecting new technologies from the outside

world. They are the only ones who know the cycle

well enough to bring new ideas in at the right time.

Government can help make this easier, by removing

impediments to the transfer of technology from

government-supported labs, and universities can

structure cooperative research programs to mesh

with industry needs.21 But the main task of bringing

the results of research to industry lies with a

company’s own engineers. Encouraging their engineers to attend professional meetings, read the

literature, keep in touch with research in government

and university labs, and learn about their competitors’ products are necessary steps for companies that

mean to keep up with the competition. Most big

Japanese companies do it. So do many U.S. firms.

Still, many U.S. firms regard outside activities for

engineers as indulgences that might advance the

engineer’s own professional career but are of little

direct benefit to the company.

Staying abreast of technology advance means

keeping up with developments abroad as well as at

home. In the past, U.S. manufacturers were good

collectors of technical information from other countries and good imitators of new products and

processes invented elsewhere. They had to be. Only

after World War II did the United States become so

pre-eminent in scientific research, and U.S. technology pre-war was by no means superior to that of

other countries. Yet our dominance in manufacturing was established early in the 20th century, when

the majority of scientific discoveries and a great

many technological advances based upon them were

still being made in Europe.22

In the postwar period, American industry has

continued to adopt and develop commercial technologies of foreign origin (e.g., the jet engine, polyester

fibers, the CAT scanner), but in some cases adoption

by U.S. producers has been years behind the

competition (e.g., radial tires and anti-skid braking

systems for automobiles). A special problem is

inattention to technologies from Japan. As the

Japanese concentrate more and more on leading

technology advances, rather than following and

improving on what others have done, Japan’s

importance as a source of innovation is rising fast.

%omory, op. cit., p, 14.

21S- ~h, 7 for a disc~~si~ of how R&~ ~sulN f~m ~Cder~ l~~rat~e~ and ~vefnment.sup~~ university research might be more effedvdy

transferred to private industry.

ZZA.S e~ly ss tie 1880.s, U.S. man~act~ng had ~ready begun its rise to dominance, in part because the continental scale Of the market ~lowed U.S.

manufacturers to benefit from economies of scale and learning curve effects earlier than the Europeans. By the 1920s, the United States produced twice

as much steel and electricity per capita as Europe’s leading industrial powers, Britain, France, and Germany.
158 ● Making Things Better: Competing in Manufacturing

Interest in technology transfer from Japan to the

United States is growing. Several public and private

programs encourage U.S. scientists and engineers to

learn Japanese, work in Japanese labs, and follow the

Japanese technical literature. But the results of these

programs are still modest. Most of the technology

flow still runs the other way.23

TECHNOLOGY DIFFUSION TO

SMALL FIRMS

Technological sophistication in small American

manufacturing firms runs the gamut. Firms at the

frontier of new technologies often start small; the

Silicon Valley computer company that started in

somebody’s garage is legendary. On the other hand,

the ranks of small manufacturing firms are also filled

with shops that make humbler items. Significantly,

small companies are suppliers of thousands of parts

and components for major manufactured products

that are leading items in the U.S. market and world

trade (e.g., cars, computers, farm and factory machinery, medical instruments). The cost, quality, and

prompt delivery of these supplies are key factors in

the Nation’s manufacturing performance. The level

of technology in small American manufacturing

firms-in product design, production equipment,

organization of work, training and use of workers—

is highly uneven. But technological backwardness is

common enough to be a real drag on U.S. competitiveness.

For many small companies, the bedrock of

technological competence is having up-to-date production equipment. It is not always easy for small

firms in the United States to decide what equipment

best fits their needs, or how to use it efficiently .24

Added to that are difficulties in financing; getting

funds for the purchase of new equipment is usually

harder for small fins, even creditworthy ones, than

for larger ones, and it costs more.

More important than simple possession of advanced equipment is an educated grasp of how to use

it. For example, staff members of several State

industrial extension services report that small companies fairly often buy computerized equipment

without fully understanding the training that workers-and managers as well—need in order to use the

equipment; then, they often do not know where to

turn to get the training.25 Note also the studies

mentioned above that compared German and British

metalworking plants and found productivity much

higher in the German factories. The difference was

not in the age or sophistication of machines, which

were much alike in both places, but in training.

As noted, NC machine tools are about as common

in U.S. metalworking plants as in Japanese; and in

both countries, small to medium-size plants (50 to

500 employees) have about the same proportion of

NC machines as larger ones—11 to 13 percent of all

the machine tools used in the shop (table 6-2). But

in using the machinery effectively-especially in

applying the soft technologies that involve organization of work and use of people—small Japanese

firms seem to outperform American firms, at least in

the flagship industries that have led Japan’s economic growth and export success. An example is in

the motor vehicle industry. Many U.S. suppliers of

parts and components have not been able to meet the

standards demanded by Japanese-owned auto companies operating in the United States. The small to

mid-size U.S. companies that have established

themselves as suppliers to the Japanese transplants

have usually required months or years of training in

Japanese methods (mostly soft technologies) before

they could match the cost, quality, and delivery

times of their Japanese competitors.26

Further evidence of the importance of things other

than hardware to the performance of small manufacturing firms comes from Tokyo’s Ota Ward, famous

for its thousands of innovative small factories (of

about 9,000 plants, 95 percent have 30 or fewer

employees). Only about one-third of the metalworking firms responding to a 1988 survey had even one

NC machine.27 Evidently, most of Ota-ku’s very

small firms still rely more on their traditional

23Fm discllssion of progr~s to encourage technology transfer to the United States from Japan, see ch. 7.

zQFor a description of some of the problems small companies face in getting advice from consdting firms, w ch. 7.

25]n tie P=t few ~em, agowingn~~rof States have established progr~s to extend t~~ic~ ~sis~nce and information to sm~lermanufacturing

fins. OTA examined five of these programs in visits and interviews in 1988, as discussed in ch. 7. Findings from this examination tdso appear in Philip

Shapira, “Industrial Extension: kuming from Experience, ” contractor report to the Office of Technology Assessment, November 1988.

%k tie brief account below of the training of North American suppliers for NUMMI, the Toyota----OM joint venture.

2TOf464 ~etal macfin~g fires ~esPnding t. tie Sumey, 150 (32.3 ~rcent) s~d they had at least one NC/CNC machine too1. This was UP from 18

percent in 1981, 22 percent in 1983, and 29 percent in 1986. Whittaker, op. cit.
Chapter 4--Technology Transfer and Diffusion: Some International Comparisons ● 159

strengths of flexibility, quick response to customers’

needs, and worker skills than on advanced equipment.

The situation in Japan seems to be changing.

Traditionally, Japan’s smallest fins-especially

those in sectors with no direct connection to the

leading growth-and-export industries--have been

backward. Many of the tiny “street-corner factories’ in Japan are still quite primitive, with no heat,

no indoor toilets, and only the simplest equipment.

However, purchase and sales data collected by the

Japan Machine Tool Builders’ Association (JMTBA)

suggest that small plants have recently kept up with

their bigger brothers in purchases of computerized

equipment. According to the MITI survey of establishments with more than 50 employees, 32 percent

of machine tools bought in the 3 years 1985-87 were

NC. In the same 3 years, the JMTBA figures show

that 35 percent of all the machine tools sold

domestically to all sizes of firms (including those

with fewer than 50 employees) were NC.28

Anecdotal evidence also indicates that a wide

range of up-to-date equipment can now be found in

many small family-run factories in Japan. For

example, one investigator who interviewed more

than 100 small automotive subcontractors in Japan

in 1986 reported that many were heavily equipped

with advanced technologies, including NC machines, laser machines, robots, and computer-aided

design. He described several scenes like this one:

In one second-tier subcontractor of Isuzu I saw

eight NC lathes, of which four were fed by robots.

The rest were minded by two skilled workers, two

semi-skilled workers and a part-time worker. The

firm was being run by an entrepreneur whose wife

was working as receptionist, secretary, finance

manager and “Jack of all trades. ” These were the

entire personnel of the firm!29

The success of small and medium-size Japanese

manufacturing firms in the soft technologies and

their recent rapid advances in installing up-to-date

equipment owe a great deal to a web of supporting

institutions, public and private. These include the

transmittal of new technologies by major manufacturers to suppliers and a broad range of government

programs for all small and medium-size manufacturers. These forms of technology transfer are uncommon, incomplete, or missing in the United States.

Major Companies and Their Suppliers

One of the many strong points of close, collaborative, long-term relations between lead manufacturers and their parts and components suppliers is that

they favor transfer of technical know-how from the

lead company down the supplier chain to mediumsize and smaller companies. 30 In Japan, major

companies often lend engineers and technicians to

their first tier suppliers to help them learn how to use

new equipment or arrange work more efficiently. It

is also quite common for parent companies to

advance funds to their subcontractors for operating

costs+ specially in cases where the subcontractor’s

sales to tile parent company are expanding, but the

subcontractor has to pay his own suppliers before he

finishes work on the product, delivers it to the parent

company, and receives payment.31

Sometimes parent companies help suppliers obtain financing for capital investment as well, but this

practice is less common than in the past.32 Japan

today has so much investment capital that banks are

aggressively looking for business among small and

mid-size firms, since larger ones are able to meet

most of their capital needs from retained earnings.

However, small companies applying for a bank loan

often find it is still a help if they are stable suppliers

to a large, famous company.

Z8jaPa Ma~hine Tml Builders’ Association, Machine TOOI Industry, Jupan 1988 (Tokyo, The Association, 1988). The domestic sales fiWes are

derived from figures on production, less exports, plus imports, omitting the category “Other Machine Tools”; they are in numbers of machine tools,

not value. The JMTBA figures show that NC/CNC machines accounted for 36 percent of all Japanese domestic machine tool sales in 1985, 39 percent

in 1986, and 30 percent in 1987.

Zwostihiro Nishiguchi, ‘‘ Competing Systems of Automotive Components Supply: An Examination of the Japanese ‘Clustered Control’ Model and

the ‘Alps’ Structure,” paper prepared for the International Motor Vehicles program (Cambridge, MA: Massachusetts Institute of Technology, May

1987), p. 22.

S%= Ch. 5 for f@er discussion of how major Japanese manufacturers transfer technology to their Suppliers.

31yoShit& KwoMwa, Jap~ne~ Development Bank and John F, Kennedy School of Governrnen[, Harvard University, ~rsonnal cOItllIlticatlon,

Sept. 7, 1989.

3zToyota spkeSmen, for exmple, told OTA in 1989 mat financial aid plays no part in their C1O% KhtlOIISWith SUPPllerS; tiey Concenwate entirely

on technical advice.
160 ● Making Things Better: Competing in Manufacturing

Technical assistance remains a prominent feature

in the relation of major Japanese firms to their

suppliers. For example, Toyota’s principles are to

select good companies to begin with, communicate

with them often from the very beginning of the

relationship, and give technical assistance as often

as needed to help the suppliers meet Toyota’s

unbending requirements for low cost, high quality,

and prompt delivery. The suppliers must take an

active part in raising their own standards. They know

their problems better than anyone else, and must be

involved in the solutions.

That the Toyota system of technology transfer to

suppliers is no fluke, but is characteristic of Japanese

manufacturers, was shown in a 1984 survey of

manufacturing subcontractors, done by the Small

and Medium Size Enterprise Agency (chusho kigyo

cho) of MITI. Some 45 percent of respondents said

they received technical assistance from a parent

company, 37 percent received information, 28 percent were loaned or leased equipment, 24 percent got

training for their employees, and 14 percent received

financial assistance.33 Moreover, 39 percent of

respondents said they introduced new technology at

the urging of parent companies (77 percent said the

reason was to raise their technological level).34

In their survey of computerized automation in

U.S. manufacturing, Kelley and Brooks found that

close links between supplier firms and their customers, of a kind that would help or spur the suppliers to

adopt computerized machinery, were not common in

America. 35 But in the infrequent cases where such

links existed, they made a difference. Only 3 percent

of suppliers got any financial help from customers in

buying new equipment; just 9 percent reported that

their customers requested or required the use of

computerized machinery. However, 20 percent of

supplier firms said that customer firms had loaned

engineering or programming staff. This kind o f

exchange was linked with a higher probability of

having at least one computer-controlled machine in

the supplier firm, suggesting that the loan of

technical people from a customer firm to a supplier

is an important conduit in the transfer of up-to-date

technology. 36

As noted earlier, the joint Toyota-GM venture,

New United Motor Manufacturing, Inc. (NUMMI),

is an outstanding U.S. example of technology

transfer from a lead manufacturer to suppliers. After

4 years of interaction with NUMMI engineers, North

American suppliers of parts and components for the

autos assembled in NUMMI’s Fremont, CA plant

were able to match Japanese suppliers in cost,

quality, and delivery time. 37 The NUMMI case

exemplifies technology transfer not only from auto

assembler to supplier, but also from Japan to the

United States.

In Japan, the vertical transfer of technology

sometimes develops to such a point that suppliers

take over major functions formerly performed by the

lead manufacturer. For example, both Toyota and

Nissan have totally delegated assembly of some of

their cars to companies that were formerly suppliers

of major components. This strategy (itaku seisan, or

consignment manufacture) enables the lead manufacturer to concentrate on high-volume production

of a relatively small number of platforms,38 while

spinning off to its deputies the production of cars

that are low or fluctuating in volume. In the Toyota

group, for instance, Kanto Auto Works produces

three different platforms on one assembly line;

namely, the high-volume Corolla, the luxury passenger car Mark II, and the low-volume sports car MR2.

Thus, Toyota exploits the economies of highvolume mass production in its home factory, while

preserving the flexibility to make a varied range of

products in the factories of its consigned assembiers. 39

JqWhit~er, op. cit., p. 23, citing Chusho kigyo cho (Small and Medium Size Enterprise Agency) cd., Chusho kigyo haku.rho (Sm whi~ PaPr)

(Tbkyo: Okurasho inSittSU kyoku, 1985).

341bid.

35Kd]ey and Brooks, Thz State of Computerized Automaton (1988) op. cit.

%e probability of a supplier’s adopting computer-controlled machinery with no technical support from customers was estimated at 0.49; with

customer-provided technical support, the probability rose to 0.58—about 20 percent higher.

JTIn r,hi.scW, much of the t~hnoloa transfemed was soft. Suppliers learned to apply Toyota’s lean production system, with its emphasis m t-work,

training, and getting it right the fmt time, rather than relying on a cushion of big inventories of parts and work-in-process, to compensate for late deliveries

and poor quality.

38A ‘*pl~f~’9 ~femto ~1 cm p~uc~on &e -ewheelb~; one platform may include several different models-cars with different sh=t metal

SkitlS and interiors.

39Nishi@chi, Op. cit., pp. 10-12.
Chapter 6-Technology Transfer and Diffusion: Some International Comparisons 161

Companies farther down the chain of suppliers

sometimes employ a similar strategy of first transferring technology to the level below them, and then

turning over major tasks to their feeder fins. Not

infrequently, talented employees of small third or

fourth tier companies leave to form their own

companies, but they still maintain close ties with

their former bosses, working for them as subsubcontractors. The ex-employers consider this hiving off natural, and often help out the new firm with

technical assistance, sometimes even financing.40 In

their view, skilled, enterprising workers are likely to

be more productive when working for themselves

than when working for somebody else, especially in

a small family-run firm where advancement possibilities are limited.

Nishiguchi offers the example of a subcontractor

who specialized in prototype manufacture for the

electrical, motor vehicle, and precision instrument

industries. His strong suit was meeting short deadlines; for this he could command premium prices. He

furnished his own factory with a facsimile machine

and such up-to-date equipment as CAD/CAM systems, laser milling machines, and CNC machines,

and he cross-trained his workers on several kinds of

equipment. Beyond this, he set up an ‘‘educational

factory” nearby, where he trained selected workers,

lent them money to buy machines and, after a year

or two of training, provided financing for them to set

up their own businesses, attached to the mother firm.

In 1986, when Nishiguchi interviewed him, this man

had a network of 62 subcontractors-all equipped

with advanced machinery-30 of whom had been

incubated at his firm. When he received a rush order

on his facsimile machine, he could spread the work

out among his own employees and his subcontractors, and often deliver the order within hours.41 The

result of such ties between patron companies and

suppliers is superior flexibility, combined with

advanced technology.

Japanese Government Programs for

Small and Medium-Size Firms

In Japan’s combined public-private support system for small and medium-size manufacturing fins,

the government role is pervasive. 42 Spending and

loans by the national government for help to all

small business (including non-manufacturing) amounted

to about 4.4 trillion yen in 1989, or $31.2 billion at

140 yen to the dollar. Of this, only $1.4 billion

appeared in the regular general account budget,

which is supported directly by taxes. The rest, $29.8

billion, was in the Fiscal Investment and Loan

Program, a capital budget often called the second

budget, which derives its revenues from government

trust funds and the country’s huge, governmentsubsidized postal savings program.43 Altogether,

spending for small business programs amounted in

1989 to nearly 5 percent of the total regular and

capital budgets of the national government.44 This

sum does not include spending by prefectures, cities,

and city wards, which also contribute handsomely to

programs for small businesses, matching the national government’s contribution in some cases.45

Modernization of small firms has long been a

concern of the Japanese Government; some loan

programs targeted to small businesses date back

more than 20 years. Reasons for the focus on small

and medium enterprises (SMEs) are social and

political as well as economic. SMEs play a very big

part in the Japanese economy. In 1986, in the

manufacturing sector alone, SMEs (300 or fewer

regular employees, and capitalized at 100 million

%en-ichi Irnai, Ikujiro Nonaka, and Hirotaka Takeuchi, ‘‘Managing the New Product Development Process: How Japanese Companies Learn and

Unlearn,” in Kim B. Clark, Rotxxt H. Hayes, and Christopher Imrenz, The Uneasy Alliance: Managing the Productivi&Technology Dilemma (Boston,

MA: Harvard Business School Press, 1985), pp. 365-366; also, Mari Sake, “Neither Markets nor Hierarchies: A Comparative Study of Informal

Networks in the Printed Circuit Board Industry,’ Ixcturer, Industrial Relations Department, Imndon School of Economics and Political Science, mimeo,

May 1988.

41 NishiW~, Op. Cit., pp. 2s-24.

4~he material in this section is drawn mostly from D.H. Whittaker, “New Technology Acquisition in Small Japanese Enterprises: Government

Assistance and Private Initiative,’ contract report to the Office of Technology Assessment, May 1989; and from OTA interviews in Japan in March 1989.

Yoshitaka Kurosawa, on leave to Harvard University from the Japanese Development Bank, contributed additional information in a letter to Julie Fox

Gorte, OTA project Director, dated Sept. 7, 1989.

4~e m~ ~overment subsidy fa ~~~ ~vings is in the form of a ~ exemption for interest. A]so, dfing the many years that Japanese financial

institutions were strictly regulated, the interest rate on postal savings was higher than for time deposits elsewhere.

~In @aI yea 1989, tie toud budget of the Japanese national government WSS92.7 trillion yen ($662 billion), including 60.4 tilllOIt yen in tie Wnerd

account, and 32.3 trillion yen in the Fiscal Investment and Loan Program. Japan Economic Institute, JE1 Report, May 12, 1989.

A5For Cxmpje, in fisc~ year 1988, tie pref~t~es match~ fie nation~ government’s provision of 2 bi]lion yen ($154 million) fOr the @ipmCtlt

Modernization Loan System and the Equipment basing System for smaller enterprises.
162 ● Making Things Better: Competing in Manufacturing

yen or less) represented 99.5 percent of establishments, 74.4 percent of employees, and 56.5 percent

of value added.46 At the same time, wages in these

small manufacturing firms are at least 25 percent

lower than in the major companies, working conditions are frequently dismal, and technologies have

often lagged behind the leaders. Besides these

reasons for government concern, there is the political fact that small business has been a steadfast,

strong supporter of the ruling Liberal Democratic

Party. Every election brings new pledges of measures to improve the climate for small business.

The Japanese national programs for SMEs include

both financial and technical assistance, and the two

are intertwined. In the 1980s, special attention has

been given to programs aimed to help small business

adopt high-tech equipment such as computerized

machinery and robots. Some key assistance programs that encourage purchase of advanced equipment are open only to still smaller firms, with no

more than 20 to 100 employees.47

Among the multiple services the government

offers SMEs are a big program of direct loans for

operating funds or plant and equipment investment

and a still bigger program of government guaranteed

loans. Other services include: a system to lease new

equipment to SMEs on generous terms or sell it on

the installment plan; loans to groups or cooperatives

of SMEs; management analysis for individual firms

—a condition for government loan approval; public

testing and research centers, where SMEs can use

expensive equipment for a nominal fee and can

consult with engineers on technical problems. SMEs

also get tax breaks for investment in new equipment,

especially high-tech equipment. For example, a

1984 law allows SMEs the option of taking a special

first year depreciation of 30 percent for investments

in electronic and ‘‘mechatronic’ technology, which

includes NC machine tools, computers, and robots.

The national government, mainly through MITI

and the Ministry of Finance, is the grand overseer of

the SME programs and is the top provider of funds.

The actual dealings with business people fall to the

prefectural and local governments, and to quasipublic organizations such as chambers of commerce

(in cities, or “societies of commerce and industry”

in towns and rural places) and federations of small

business associations.

In 1987, loans to SMEs via the three main

government financing institutions amounted to 3.8

trillion yen, or $27 billion.48 Japanese loan guarantee

programs for SMEs are still larger. The 52 nationwide credit guarantee associations underwrote 7.8

trillion yen ($56 billion) in loans to SMEs in 1987.

By way of comparison, U.S. small businesses (up to

500 employees) got $47.3 million in direct loans

from the Small Business Administration in fiscal

year 1989, and loans were restricted to special

disadvantaged groups. Federally guaranteed loans

are available more generally to U.S. small businesses; they amounted to $3.6 billion in 1989. These

figures are only illustrative; they do not include, for

either country, financial aid available from State (or

prefectural) and local governments. And, to put the

comparison in perspective, small businesses play a

bigger part in Japan than in the United States. Even

considering the larger size of the U.S. economy,

small and medium-size manufacturing firms are

more numerous and employ more people (10.7

million v. 6.8 million) in Japan than in the United

States. Finally, keep in mind that these figures for

government loans and loan guarantees are for all

small businesses in both countries, not just for

manufacturing firms. With all this, it is still notable

that the Japanese Government provides about 20

times more financial aid to small business than the

U.S. Government does.

Even so, government financing is not as important

to Japan’s SMEs as it was just a few years ago. (Box

46BY ~omp~Wn, in tie United Sutes in 19g6, sm~l businesses (enterprises with fewer than 500 employees) represented 85 Per~entof m~ufacturing

establishments, 35 percent of employment, and 21 percent of value added. An establishment is a single physical location where business is conducted.

An enterprise is a business organization consisting of one or more establishments under the same ownership or control. The State of Srnutl Business:

A Report of the President transmitted to the Congress, 1989 (Washington, DC: U.S. Government Printing Office, 1989), p. 21; table 13, p. 21; table A. 15,

pp. 80-81; table A.20, pp. 92-93.

47Jap~es~ firms with fewer than 100 employees constitute 97 percent of establishments, 55 percent of employment, and 39 percent of value add~

in private manufacturing in Japan; comparable figures for firms with fewer than 20 employees are 87 percent of establishments, 29 percent of employees,

and 15 percent of value added.

48ThiS fi~ is net of repayments; it includes 1.80 ~l]lon yen from tie chu~o kigyo kinyu (sm~l Business Finance corporation), 1.85 trillion yen

from the kokumin kinyu koko (Peoples’ Finance Corporation) and 128 billion yen from the shoko chukin (which is not always included in the group

of government financial institutions because it raises part of its funds from association members). The gross amount of loans made to SMES in 1987

by these three institutions was 5.6 trillion yen—2.26 trillion, 2.89 trillion, and 493 billion yen respectively.
Chapter 6---Technology Transfer and Diffusion: Some International Comparisons ● 163

6-A offers a Yokohama factory owner’s account of

his “graduation” from government financing and

technology transfer programs over the years.) In the

late 1980s, with the quick recovery from the rise of

the yen and the great prosperity that followed, Japan

was awash in capital. The august city banks, which

once gave most of their attention and funds to large

companies, were now scrambling to do business

with SMEs. In March 1981, for example, 25 percent

of city bank loans went to SMEs, but by August 1988

the figure was 64 percent. Even though the government loans are usually pegged at lower rates-e. g.,

4 percent instead of 5 percent to individual firms in

1989, as low as 2.7 percent when provided through

cooperative associations, and zero for the government’s half share of certain equipment modernization loans-companies often prefer the greater

simplicity of dealing with a bank.

Government loans are still an essential source of

financing for small startup companies with no track

record, for firms changing direction, and as a safety

net in times of adversity. For example, many of the

9,000-odd small manufacturers in the Ota ward of

Tokyo were hard hit by the yen’s rise in 1986-87. In

those 2 years, Ota-ku’s firms borrowed 1.5 billion

yen ($11.5 million) in emergency loans to cover

operating costs. But the overall trend in the late

1980s was for private loans to edge out government

financing. Government loans dropped from 13

percent of all outstanding loans to SMEs in 1980 to

9 percent in 1988. These figures understate the

government role in financing of SMEs, however,

because they omit the system of loan guarantees.

And despite the decline of Japanese Government

financing for SMEs, the volume remains huge in

U.S. terms.

Besides its big, general program of direct loans

available to all SMEs, the Japanese national government offers a whole menu of SME ‘‘measures,’

funded at about 225 billion yen ($1.6 billion) in

1987. Among these are two special programs

designed specifically to encourage SMEs to acquire

modern technology. One of these, the Equipment

Modernization Loan System, made 6,000 loans in

1987, totaling 41 billion yen ($293 million) in 1987.

The program is open only to firms with 100 or fewer

employees, as shown in table 6-4. It provides up to

half the amount of the funds needed for the

modernization project; notably, that half is interest

free. According to officials of MITI’s Small and

Medium Enterprise Agency, no collateral is required

for these government loans because commercial

banks can provide loans requiring collateral.49

The Equipment Leasing System, through which

firms can lease new equipment or buy it on the

installment plan, is another key technologypromoting measure. Nothing better illustrates the

Japanese policy of fusing financial assistance with

promotion of technological advance than this program. Founded in 1966 and open only to firms with

20 or fewer employees, its direct purpose is to help

small, struggling companies invest in new equipment at affordable terms (easier terms than those

offered by private leasing companies, and easier

even than the Equipment Modernization Loan System). The system has the added effect of providing

a quite substantial, assured market for producers of

capital equipment suitable for small shops, especially machine tools. A high-tech equipment and

machinery leasing system, added in 1986, is open to

firms with as many as 80 employees, giving added

support to the market for such things as NC machine

tools, robots, and computers. In 1987, about 4,500

leases or installment purchases, amounting to 49

billion yen ($350 million) were made under this

program. About one-third of the loans and leases

went to SMEs producing machinery and other metal

goods, mostly for buying or leasing NC machines .50

In this connection, it should be noted that the

government is also a partner in quasi-private leasing

companies that serve large as well as small companies. For example, the Japan Electric Computer

Corporation (JECC), founded in 1961 to buy computers and lease them to users at subsidized rates, got

half its capital from the Japan Development Bank, a

government institution. The similar Japan Robot

Leasing Company (JAROL) was founded in 1979,

with 60 percent of its capital coming from the Japan

Development Bank. In addition, in 1980 the Small

Business Finance Corporation allocated funds specifically for loans to small businesses buying

robots. 51 The existence of these leasing and loan

@C)TA intemiew with Kaz~~o Bando and Kazumi Suda, Small and Medium Enterprise Agency (ChUShO kigy~ cho), MIT1, Ma. 16, 1989.

sqn Tokyo, 37 ~rcent of~e loans m~e ~der the @uipment Modernization program in 1987 were for buying CNC mactines. (Tokyo Metfopolitan

Governrnent Labour Economics Office, untitled mimeo, 1989, cited in D.H. Whittaker, op. cit.)

slEma Vogel, Comeback (New York, NY: Simon & Schuster, 1985), pp. 90, 122-123.
164 ● Making Things Better: Competing in Manufacturing

Box 6-A—A Small Plant in Yokohama

Showa Precision Tools Co., Ltd., of Yokohama, Japan makes plastic processing dies, blanking dies,

progressive dies, and measuring and testing equipment.] The company’s name is well chosen. Everything about its

newly built factory in Kanazawa Industrial Park speaks of precision, from the understated architecture of the front

office to the neatly pressed company uniforms worn by the company president and founder, Mr. Masanari Kida,

and his chief engineer, Mr. Y. Yokoyama. Showa tools are esteemed for their quality and design. Because of that

reputation, the company is prospering. The first sentence in the company outline booklet says, “We are enjoying

a convenient life, thanks to the tools and machinery which have been developed. ”

Although Showa provides all its own capital now, Mr. Kida is well acquainted with Japanese Government

programs that offer financing for small and medium enterprises. Showa made frequent use of them from the time

it was founded 30 years ago until about 10 years ago. Even more recently, when Showa built a new factory in

Kanazawa Industrial Park, government financing filled a gap. Mr. Kida had the proceeds from the sale of his old

factory and a substantial loan from a bank, but was still short of what he needed for new machinery. Financing from

the government’s small and medium enterprise program made up the difference.

Although government financing is cheaper than a bank loan—the difference is a percentage point or so, or

about 4 percent instead of 5 percent-going through government programs is a hassle, Mr. Kida said. “If I go to

the bank, I can get the money today,” he explained. “If I borrow from a government program, it takes a month,

and I have to fill out a lot of forms. This hassle is still worth it, he believes, for brand new businesses that have

no track record or an established relationship with a bank. Indeed, government financing was essential for Showa

in its earlier years.

One part of the government program is still useful to Showa———technical advice. When Mr. Kida last used

government financing, advisors from the guidance center in the Yokohama city office gave him an analysis of his

financial arrangements. At his request, an advisor also evaluated some of his plans for new machine purchases. His

relationship with that advisor has lasted to the present day through the city’s yearly management service, which

provides technical information and evaluation to small and medium-size firms. In return, the advisor uses the

information he gets about the firm to enlarge his understanding of technology use and other conditions of small

businesses. The service also gives Mr. Kida general information on what his competitors are doing.

Firms like Showa can also get some training from the Yokohama city office. On request, the office will send

a sensei (teacher, or master) to train the employees total quality control techniques. This training is fairly extensive.

Between June and October 1988, the sensei came to Showa for eight 2-hour sessions to train 14 group leaders (these

are quality circle group leaders, not necessarily the formal authority figures). The sensei brings written materials

to every class, and then the group leaders are responsible for teaching the other people in the-group. The lessons

were:

●

●

●

●

●

●

●

●

What Are Small Group Activities?

Why Are Group Activities Necessary?

Small Group Activities and Total Quality Control

What Is Quality?

How To Introduce Small Group Activities

Let’s Master Quality Control Methods

The Way of Leadership

How To Succeed in Small Group Activities

The lessons do not accomplish miracles. Although the classes may get the group

workers are not always so enthusiastic. However, the group leaders do impart to others in

leaders ail fired up, other

the group what they learn,

and eventually the lessons of Total Quality Control are learned by all. Mr. Kida did not think the services offered

by Yokohama prefecture were unique. He admitted that Yokohama and Kanagawa were more positive about such

activities than other prefectures-but only a bit more.

Iinformar,im for this box comes from interviews conducted by OTA sttif in Yokoh~a, m~h 1989.
Chapter 6-Technology Transfer and Diffusion: Some International Comparisons ● 165

Despite its present independence from government financing, Showa is still part of a government-supported

cooperative association for small companies. Members can get up to 65 percent of their investment costs from the

small and medium enterprise public corporation, at 2.7 percent interest. The maximum term of such loans is 15

years, and the money is provided for additions to plant and equipment. The preferential financing is a strong

incentive to join a cooperative association. There is also a down side to joining. Money borrowed as a group has

to be repaid as a group, so if one member fails or gets into trouble, all the other members are responsible for his

debts and his recovery. Also, the land belongs to the group, and every inch of the precious stuff is used. So, if a

company wants to expand, it can do so only if someone else in the group goes under and their land becomes

available, and even then approval of the group is needed. Others may want to expand, too.

In response to questions about the drive to innovate in small fins, Mr. Kida’s unhesitating answer was

competition. ‘You must innovate or you get beaten,’ he said. Since 1986, Showa has bought 11 new NC machines.

and now about 70 percent of all his machines are NC. He never leases the machines, on principle, because leasing

costs a bit more than buying. However, companies that can’t secure the capital up front need to be able to lease

machines. Like government financing programs, leasing is a nice option for fledgling companies.

Mr. Kida has an extra incentive to be right at the cutting edge of new technology. His business is an independent

one, not in anyone’s supplier group or keiretsu. Companies in cooperative associations tend toward being more

independent, according to Mr. Kida. Many firms would like to be on their own, but it is harder than being

somebody’s supplier. ‘‘If you want to be independent, you have to study unceasingly,’ he says. He gets no technical

advice from his customers, although engineers do come from customer companies to discuss their technical

requirements. He has never gotten any financial assistance from a customer, either. But even in companies that are

in a supplier group, the parent companies are giving less advice and less financing than they used to, perhaps because

it isn’t necessary, and perhaps&cause of other changes in the environment of large companies—--moving offshore,

for example.

Finally, Mr. Kida was asked why he didn’t just sell up. “You could be a millionaire, and live anywhere you

wanted,” said the interviewer. “You could buy a ramen (noodle) shop, and stop the struggle. ” Mr. Kida seemed

speechless at the thought, so Mr. Yokoyama, the chief engineer, answered. He was horrified at the suggestion. “We

have 100 employees here,” he said earnestly, “and they have families. That’s 400 people. We’re responsible for

those people. What would they do if the owner bought a ramen shop? Where would they go? No, we have to stay

in business. Four hundred people depend on this business. ’

Table &4-Japanese Government Equipment Modernization Loan and Equipment Leasing Systems

for Small and Medium Enterprises

.— -.

Equipment leasing system

Equipment leasing (installment plan) Equipment Ieasing

Equipment modernization High-tech, information High-tech, information

loans system General equipment processing equipment processing equipment

Main recipients . . . . . . . . . Small and medium Small and medium

enterprises with 100 or enterprises with up to

less employees 20 employees

Maximum amount of

loan or value of

leased equipment . . . . Half of funds required Equipment worth up to

up to 30 million yen 25 million yen

Interest or charge . . . . . . . Free 4.5% of the cost of

equipment as per annum

charge (an additional

1 0°/0 guarantee money is

required)

Period, ... , . . . . . . . . . . . . 5 years with l-year grace 4 years and 6 months (11

Small and medium

enterprises with up to

80 employees

Equipment worth up to

50 million yen

4.5% of the cost of

equipment as per annum

charge (an additional

10% guarantee money is

required)

6 years and 6 months(11

period years and 6 months for anti-years and 6 months for antipollution equipment) pollution equipment)

Small and medium

enterprises with up to

80 employees

Equipment worth up to

50 million yen

About 7°% as per annum

charge (including tax and

insurance premium)

Up to 7 years (84 months)

SOURCE: Mmstry of International Trade and Industry, Small and Medium Enterprise Agency (chusho klgyo cho) SMEA mimeograph, 198 (untitled)
166 ● Making Things Better: Competing in Manufacturing

programs assured equipment producers of a solid

market, which probably encouraged them to gear up

for expanded output-even though, as it turned out,

not all the programs were heavily used. For example,

purchases of robots by Japanese firms turned out to

be so great that JAROL leased only 790 units in

1982, when shipments were almost 10,000.52

Still other national government “special measures” are designed to help bring SMEs up to speed

technologically. According to MITI officials, the

SME programs were originally formed with the view

that small companies needed information more than

financing. To get public financing under some

programs, firms must have a management analysis,

paid for by government funds and provided free by

local governments, associations of commerce, or

federations of small business associations. Often the

analyses focus on finance, sales, and marketing, but

advice on technology and production methods is

also given. As illustrated by Mr. Kida’s experience

(box 6-A), small businessmen may form a lasting

relationship with the person who does the original

analysis for the loan, often coming back repeatedly for

consultation on technical or other business matters.

Public testing and research centers also play a big

part in technology diffusion, Japan had 185 of these

centers in 1985, with 7,000 employees and an annual

budget of 66 billion yen (about $470 million), half

from the national budget and half from the prefectures. SMEs can come here and, for a small fee, use

inspection equipment that is too costly or used too

seldom to make purchase worthwhile. They can also

find consulting engineers for research and advice on

special problems, and they can bring the consultants

to their own factories if necessary.

Local technology demonstration centers supplement the national testing and research centers. The

industrial hall in Tokyo’s Ota ward is a good

example. Advisors at the hall have regular consultation hours for the Ota-ku’s thousands of tiny

businesses—Tuesday, Thursday, and Saturday, from

10 to 4, on mechanical matters, and the alternate

weekdays on electrical matters. The hall has about

500 consultation meetings a year in seven areas. In

order of popularity, they are: machines, measuring

devices, materials, machining process, electrical

problems, controllers, and a miscellaneous category

including legal problems. An example of an electrical problem: there are frequent, unpredictable daily

fluctuations in the voltage delivered by the city.

Small businesses need to learn how to cope with the

fluctuations and how to make machinery last in spite

of them. According to the managers of the hall, small

firms could figure out many of these problems

themselves, but they don’t have time.

Besides these regular consultations at the hall,

which are free, firms may ask advisors to visit their

plants for a fee of 10,000 to 20,000 yen a day (about

$70 to $140). For knottier problems, firms may be

referred to the Technology Experimental Center in

metropolitan Tokyo, which has about 160 highly

qualified consultants—30 in technical fields—and

200 technical advisors (this is one of the 185 national

public testing and research centers). Another service

the Ota industrial hall offers is use of specialized

measuring and calibrating machines, at a fee of

about $4 for half a day. In addition to all this, the hall

puts on exhibitions three times a year showing

machines made in the wards to buyers in the area.

Sometimes buyers from other countries are invited

as well. Occasionally, the prefecture exhibits Otamade machinery at shows in other places.

According to surveys of small businesses, public

programs rank low on the list behind parent companies and machine and equipment makers as sources

of technical information. This is no reflection on the

public programs; services like those at Ota-ku’s

industrial hall are used by SMEs and seem to be well

regarded. 53 It is more an indication that the level of

technology diffusion to SMEs in Japan, including

the active role taken by parent companies, is

extremely high. The role of parent companies may

be diminishing a bit, however, as the bonds between

parent companies and subcontractors are weakening

somewhat, The reasons are first, that major firms are

doing more subcontracting offshore; and second,

that small supplier firms, more prosperous than ever

S2Kenne~ Fl~, “changing Pattern of Industrial Robol USe, “ in Richard M, Cyert and David C, Mowcty (eds,), The Impact of Technological

Chunge on Employment and Economic Growth (Cambridge, W: Ballinger Publishing Co., 1988), p. 299. According to Vogel (op. cit.) virtually no

robots were exported from Japan in the early 1980s because domestic demand was so great.

sqThe small b~iness owners interviewed by OTA staff in Japan spoke favorably about government technical assistance. tic, who stid he gener~ly

prefers his own resources to government programs (though he had taken a large government loan to finance a new building for his factory), had no

resemation in praising the Tokyo technology center. He goes (here about once a month for testing of materials and inspection services. The service is

cheap-about 3,000 yen per visit—and the consulting engineer is very kindly and knowledgeable (’‘a good study person’ ‘),
Chapter 6--Technology Transfer and Diffusion: Some International Comparisons ● 167

before, are able to be more independent. In Ota-ku,

officials say, about 1,000 of the 9,000 manufacturing

firms are now independent, with no strong ties to

major firms. Many of these companies can make

good use of public technical assistance. The government is encouraging small independent firms to

form cooperative associations, to work together on

R&D and share technical, management, and marketing information among themselves (see the discussion below on horizontal links between small firms).

Government programs offer specific help to

startups, in addition to loans. An example of

public-private partnership to encourage high-tech

startups is the Kanagawa Science Park (near Yokohama). Building began in 1989. When completed, it

will provide common research facilities, including

precision measuring and calibrating equipment, plus

the usual business incubator services such as accounting and payroll. It is intended to be a communications center as well, the hub of an electronic

information network that will extend to many

businesses in the prefecture. Finally, there are plans

to make the Science Park an international convention center--complete with hotels, banks, and

restaurants-designed especially to serve resident

companies. The Science Park is set up as a stock

company, with construction and initial subscriptions

financed by funds from the Yokohama Bank and the

Kanagawa prefecture. Other prefectures are planning similar schemes, but Kanagawa is the first to

take action.

To sum up, financing new technologies seems to

be no big problem for Japanese SMEs, and the

abundance of government assistance is surely one

reason. Where small U.S. firms may find the

availability of capital a real barrier to investing in

modern equipment (e.g., a CNC machine tool), their

Japanese competitors can turn their attention to

whether the equipment precisely fits their needs,

whether it is better to buy it or lease it, and whether

getting a 4 percent loan from the government rather

than a 5 percent loan from the bank is worth the

bother of waiting a month instead of a day. In

addition, technical assistance is very broadly available from many sources, often linked with some kind

of financial assistance. Small manufacturers in the

United States are not nearly so richly supplied with

guidance in adopting and using new technologies.54

Horizontal Links Between Small Firms

Another way to promote the widespread adoption

of advanced technology, down to the level of tiny

family-run firms, is through horizontal networks that

give member firms help in developing and acquiring

new technologies, and advice on financing, management, and marketing as well. Such systems are

prominent in the textile and metalworking industries

of both Japan and Italy. They can be found elsewhere

too, as in Denmark’s textile and furniture industries.

These networks involve a considerable degree of

cooperation and information-sharing among competitive fins-practices that are quite foreign to U.S.

business tradition. In some countries, the networks are

supported by a range of government programs that are

mostly missing in the United States.

A well-known example of horizontal links among

small firms is in the northeast-central part of Italy,

known as the Third Italy .55 Networks of small,

technologically sophisticated textile and metalworking firms began to develop in this region in the late

1960s. By the early 1980s, these small enterprises

were supporting a prosperous economy. In EmiliaRomagna, for instance, manufacturing wage rates in

1980 were 125 percent of the Italian average. In

1985, the region ranked second among Italy’s 21

regions in per capita income, having risen from 17th

in the 15 years since 1970.

The cooperative networks that were key factors in

the region’s economic success were founded with

the help of local governments, but later on were

largely financed and operated by the firms themselves. Artisans’ trade associations, technical

schools and universities, and labor unions have also

supported the networks’ programs. The networks

provide technical advice on new equipment, products, and processes; financial help in acquiring new

54s= tie discussion in ch. 7.

SsThe many writings on cooperative networks in the Third Italy include Giacomo Becattini, “ The Development of Light Industry in Tbscany: An

Interpretation, ’ Economic Notes, vol. 3, 1978; Sebastian Brusco, “The Emilian Model: Productive Decentralization and Social Integration,”

Cambridge Journal of Economics, vol. 6, No. 2, 1982; Michael Piore and Charles Sabel, The Second Industrial Divide (New York, NY: Basic Books,

1984); Edward Goodman, Julia Bamford, and Peter Saynor (eds.), Srntdl Firms and Industrial Districts in ltaly (Imndon and New York: Routledge,

1989); Daniella Mazzonia and Mario Pianta, ‘‘An Innovation Strategy for Traditional Industries: Experience of the Italian Textile Districts of Prato and

Como,’ mimeo, September 1986; Robert E. Friedman, “Flexible Manufacturing Networks, ’ and Richard C. Hatch, “Uxuming From Italy’s Industrial

Renaissance,” in Corporation for Enterprise Development, Entrepreneurial Economy, July-August 1987.
168 . Making Things Better: Competing in Manufacturing

machinery and training in using it; business services

such as making up payrolls and sending out bills;

and advice on markets and assistance in parceling

out work on large orders. Local governments,

together with the artisans’ trade associations, have

also developed industrial parks where factory space

is offered at reasonable, stable rents. The concentration of small firms in the same area carries an added

bonus, making it easier for the firms to divide up

large contracts or find subcontractors if they get

jammed with too much work at one time.

A notable feature in the small firms that makeup

these manufacturing networks is their use of advanced equipment. Part of the reason lies in the

nature of the industries--cloth and clothing, shoes,

furniture, metal parts for machinery or precision

instruments. The investment needed for an efficient

unit of production in such industries is not formidably high. A cluster of CNC machine tools or

electronic sewing machines or weaving machines is

not beyond the financial means of a family-run

enterprise-especially when help in arranging financing is available to the small firm, as it is in this

part of Italy. Loan guarantee cooperatives (established by the trade associations) may arrange preferential bank financing for buying the equipment;

alternatively, members of artisans’ trade association

can lease machinery. Not only is the equipment

affordable but objective advice on what to buy and

consultation on using it is also available from

Service Centers serving specific industries (organized by trade associations together with local governments, labor unions and other business groups).

Government support of the networks is mostly

confined to the regional and municipal levels. The

national government has had little to do with it. The

distinctively Italian Eurocommunist government of

Emilia-Romagna was the pioneer, but rightist regional governments, such as the Christian Democratic one in the Veneto, have also lent their support.

As noted, the major contributions from the regional

government were made at the beginning, in the form

of financial and planning support for starting up

networks.

Whether these largely voluntary horizontal networks are sturdy enough to last through changing

economic conditions is an emerging question. Vertical as well as horizontal networks have always been

a part of the scene in the Third Italy; many small

firms are regular subcontractors for big enterprises

(e.g., Benetton in apparel). However, the presence of

strong horizontal networks has probably given small

firms an extra measure of independence and bargaining power. Today there may be a trend toward

greater dominance by lead firms. A recent study of

the textile districts of Prato (in Tuscany) and Treviso

(in Veneto) and the food-producing machinery

sector in Emilia-Romagna found increasing topdown control.56 The pattern is for small firms to

continue decentralized production, but under the

growing financial and strategic control (including

the choice of technology and subcontractors) of

locally dominant firms or outsider corporations.

Japan also has regional centers that are outstanding examples of network manufacturing, especially

in metalworking and textiles. Sakaki Township in

rural central Nagano Prefecture is one such.57 This

mountainous little community, with a population of

16,000, had 321 manufacturing enterprises in the

mid- 1980s, of which 257 had fewer than 10 employees and only 4 had more than 300. Among them,

these firms owned nearly 600 computer-controlled

machine tools.

Sakaki’s small metalworking firms began to

flourish in the 1960s, at first on the basis of auto

subcontracting. They have since become much more

diversified, branching out into general machining,

electronics, and plastics, thus escaping dependence

on the extremely demanding auto industry. The

financial underpinning for this growth was Japan’s

extensive national program of government loans and

loan guarantees to small business, administered by

the local association of commerce (shokokai). The

shokokai provides technical support along with its

financial aid, reviewing the plans of borrowers and

often proposing specific changes. It routinely arranges classes in computer programming to supplement the basic introductory course given by the

manufacturer of NC machine tools, and sometimes

3~Benne~ Htison, ‘ ‘Concentration WiMout Centralization: The Changing Morphology of the Small Firm hdustrial Districts of the Third It~y,’

paper presented to the International Symposium on Imcal Employment, National Institute of Employment and Vocational Research, Tokyo, Sept. 12-14,

1989.

sTFor adet~l~ de~~ri~ion of tie ~e@on~ met~working industry of Sakaki To~ship, ~ David Fri~~, T)w Mistiersrood Miracle: ZndU.$trbl

Development and Political Change in Japan (Ithaca, NY and London: Cornell University Press, 1988), ch. 5,
Chapter 6-Technology Transfer and Diffusion: Some International Comparisons ● 169

brings in specialists to help individual companies

with particular problems. In Sakaki, factory operators say that they know more about using the

equipment than the large firms they supply .58

In the Japanese textile industry, big firms predominate upstream in fiber making and spinning.59 But

weaving and knitting is done mostly in small

family-run firms with no more than 20 looms

(usually installed in a shed or annex to the weaver’s

home), a few family-member workers, and two or

three employees. This system of family weaving is

an outgrowth of the centuries-old custom of landlords providing looms for tenant farmers to use in the

winter slack season. With land reform, the tenants

became owners. These tiny enterprises are well-

-suited to producing short runs to order—a good fit

with the Japanese textile industry strategy of competing on the basis of diversity, high quality, and

responsiveness to customers’ needs.

Most of these small firms are part of vertical

networks; they are tied to one of the great spinning

companies or to trading companies that supply them

with yarn, buy their cloth and, quite commonly, give

them free technical advice. A second important

source of technological help is the regional industry

cooperatives. These are voluntary associations, funded

mostly by members but aided by the many government programs for SMEs and cooperatives. Typical

activities are to organize training programs in new

techniques and the use of new machinery, and to

help firms apply to special industry banks that serve

small and medium-size firms for government guaranteed loans. Some cooperatives are more active.

For example, the Nishiwaki Weaver’s Cooperative,

located in a rural area, owns and leases to members

about 2,000 of 11,348 looms in use by the membership. Typically, the cooperative pays two-thirds of

the purchase price and the weaver pays one-third,

plus lease payments for the remainder. The cooperative may also guarantee loans for members who want

to buy looms outright.

The state-operated system of research institutes

also helps small firms keep abreast of new technologies. Japan has 46 textile research institutes in its 47

prefectures. Besides collecting industry information

and providing a computer connection with the

Scientific Research Center in Tokyo, the institutes

conduct experiments and research for small firms,

charging a fee for service. The research is directed

toward practical problems (e.g., why a color may

fade), rather than broader, more basic topics that

would interest a university research team.

The Japanese networks, much more than the

Italian, have solid, consistent support from government programs, some available both to individual

small firms and associations, and some targeted only

to cooperative groups. The main program targeted to

groups is the SME Upgrading Capital System,

administered by the Japan Small Business Corporation (JSBC).60 It lends money to the prefectures

which, in turn, add funds of their own and make

loans to groups and cooperatives. Loans, for periods

of 7 to 16 years, are at low interest (2.7 percent) for

general activities and at zero interest for special

activities. In 1987, government-supported upgrading loans to groups and cooperatives amounted to

395.3 billion yen ($2.8 billion). Another source of

low-cost financing for cooperatives is the shoko

chukin bank, which collects money from coop

members, supplements it with government funds,

and then makes loans to members. In addition, a

small government program (national and prefectural) promotes joint R&D by small fins. It makes

awards at the level of $2 million to $3 million yearly

to a couple of dozen cooperative associations.

Cooperatives can also take advantage of the free or

low-cost public technology extension services.

The Japanese Government particularly encourages the formation of cooperatives in industries with

many very small, weak firms. Box 6-B describes the

activities of a cooperative of 18 plastic mold

equipment manufacturers in and around Tokyo and

Yokohama, and some of the government programs

that support it.

5S1bj&, p, 192, WE 17s

5~~ ~me~ for MS ~,~ ~dition t. s~nd~(j works on be world textile industries, are Ronald kre, Flexible Rigidities: ~nduttial po@’ and

Structural Adjustment in the Japanese Economy, 1970-1980 (Stanford, CA: Stanford University Press, 1986); and The MIT Commission on Industrial

F%xiuctivity, “The U.S. Textile Industxy: Challenges and Opportunities, “ in The Working Papers of the MIT Commission on In&strial Productivity

(Cambridge, MA: The MIT Press, 1989), vol. 2.

Whis program is in addition to the loan programs for individual SME firms,
170 ● Making Things Better: Competing in Manufacturing

— —-— . . — — ..——.—

Box 6-B—A Plastic Mold Equipment Cooperative in Japan

The Keihin Plastic Kanagata, or plastic mold equipment cooperative, is an association of 18 small companies

in Ota-ku (a city ward in Tokyo), other places in Tokyo, and Kanagawa-ken (a prefecture near Yokohama). ] The

cooperative’s modest offices are located in a compact building in a pleasant but unpretentious Tokyo neighborhood.

Within this rather humble exterior is a dynamo of activity.

The Japanese die and mold industry is characterized by a great diversity of products, custom manufacturing,

heavy reliance on skilled workers, and a great preponderance of small and medium-size enterprises. Nine of ten

plastics toolmakers are small firms with fewer than 19 employees. This kanagata is typical: the 18 member

companies are all very small, and for them the 6 million yen ($43,000) price of admission is steep.2 The rewards

for joining are large, however. Members can rely on the kanagata to collect orders from larger customer firms and

apportion them to members so that all are kept busy, and customers can usually be accommodated even when

business is booming. When business is slow, kanagata staff can pound the pavement in search of new orders. “We

try to make sure all the members are working at full capacity, explained Mr. S. Sugano, director of the cooperative.

The kanagata also helps with purchasing, giving member firms both technical assistance in finding good

equipment and quantity discounts. The discounts are not inconsequential; on some machines they are as much as

60 percent. (Discounts on quantity purchases are available not only to members of the coop but to a wider circle

of 53 firms, in an organization the coop founded. ) Another benefit is in machine leasing. For example, 4 years ago,

the kanagata bought 24 CNC machines and leased them out to members. Altogether, the machines cost 450 million

yen ($3.2 million). The kanagata used government loan programs to aid in buying them; one program provided

two-thirds of the money at 2.7 percent interest over 10 years, and another provided the other one-third at 7.6 percent

interest, also over 10 years.

Even with quantity discounts and leasing on favorable terms, it doesn’t always pay for members to acquire their

own equipment, if it is used quite infrequently. For example, a few years ago, the kanagata bought a CAD system;

a member of the coop staff who formerly worked for a plastic design company trains members to use it. Another

low-cost government loan, for 28 million yen ($200,000), helped the kanagata buy the equipment. Eventually, the

coop wants to be able to hook up the CAD system to computer- aided manufacturing in members’ plants. lt is

exploiting government programs to establish computer networks to make possible the CAD-CAM connection.

In addition, the cooperative can provide both long and short term loans to member companies. Long-term loans

are funneled through the kanagata from the shoko chukin bank, which collects money from coop members, adds

government funds, and makes loans on favorable terms to the members. A committee of the kanagata approves the

loans. Typically, long-term loans are used for operating capital. Members can also borrow up to 6 million yen

($43,000--the same as the membership fee) for 6 months at a rate of 1 percentage point above the commercial bank

prime rate (about 5 percent in 1989). These short-term loans are used mainly for special purposes such as employee

bonuses or debt service that firms are temporarily unable to cover (a common occurrence when firms were adjusting

to the rapid rise of the yen in 1986-87). Also, members can buy insurance from the coop to cover possible losses

if one of their customers goes bankrupt.

Finally, the cooperative also provides many kinds of education and information sharing services. For example,

members study CAD/CAM applications together, and in 1989 the kanagata had a study group examining the

implications to members of the new consumption tax.

The kanagata supports its staff and activities not only through membership fees but also by taking 1 percent

of the order value of the customer orders it handles. Also, in selling equipment to members at the discount price,

it adds a charge of 3 percent of the regular, undiscounted price and puts that into the coop’s operating fund (which

was about 600 million yen, or $4.3 million, annually in 1989).

Throughout Japan, there are about 12,000 Kanagawa associations. In the kanagata prefecture alone are 1,300

cooperative groups, with over 370,000 firms participating at some level. Probably most of the groups do not provide

such comprehensive services as the Keihin Plastic Kanagata, but they do typically offer financing assistance, if not

purchasing and order services.

IInfomauon for hisINX comes from interviews conducted by OTA Staff h Tokyo, Much 1989,

21n addition t. paying tie fee, companies must have the recommendation Of another membfX.

—.—. ———
Chapter 7

Where We Stand:

Public Policy and Technology
CONTENTS

INDUSTRIAL EXTENSION . . . . . . . . . . . . . . . . . . . . . . . .

. . . . . . ... ... ... ... .,+. +,. ,, +.4

Federal Programs for Technology Diffusion to Small Manufacturers . . . . . . . . . . . . . .

State Industrial Extension Programs . . . . . . . .

C0MMERCIALIZING TECHNOLOGY FROM FEDERAL LABORATORIES . . . . . . ““” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

The Federal Laboratories: An Overview . . . . . . . . . . . . . . . . . . . . .

DOE Labs . . . . . . . . . . . . . . . . . . .

. . . . . . . . . . . . . . . . . . . . . . . . . . .

DoD Labs

● . . . . . . . . . . . . . . . . . ...............,,,.,,+,+

● . . . . . . . . . . . . . . . . . . . . . . . . . .

Other Labs . . . . . . . . . . .

. . . . . . . . .............,.,,.,..+....+.,=,+,,

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Commercializing DOE’s Technology: Mechanisms +... . . . . . . . . . . . . . . . . . . . . . . .

General Applications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

. . . . . . . . . . . . . . . . .. ...........,...+.-,+,..,..

ENGINEERING RESEARCH CENTERS . . . . . . . . . . . . . . . . s . . . . . . .

TAPPING INTO JAPANEsE TECHNOLOGY . . . . . . . . . . . . . . .......,,.,+.,++

People-to People Technology Transfer . . . . . . . . . . . . . . . . . . . . . . .

... ... ... ... .,. ..+. .4. .+. .. ., + $ ., ., +.$.,...

Scanning Japanese Technical Literature . . . . . . . . . .

Learning the Japanese Language . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

R&D CONSORTIA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

. . . . . . . . . . . . . . . . . . . . . . . . . . Collaborative R&D in U.S. High Technology: Electronics . .........++,.,,,,

Cooperative R&D Ventures in Japan . ..........,....+...*,,*

. . . . . . . . . . . . . . . . . . . . . . . . . . . Making Successful Consortia . . . . . . . . . . . . . . . .....,..**..+**

. . . . . . . . . . . . . . . * . . . . .,, , + ., * .,,*,*..,

The Role of Government . . . . . . . . . . . . . .

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

INTELLEcTuAL PROPERTY . . . . . . . . . . . . . . . . . . . . . .

How Much Can Increased Protection Help? + .*..*...*.....,..,......,,**

. . . . . . . . . . . . . . . . . . .

Specific Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

. . . . . . . . . . . . . . . . . . . . . . . . ....,.......*.,+*.*+,* ANTITRUST LAW . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . The Changing Interpretation of the Law . . . . . . . . . . . . . . . . . . . . . .

. . . . . . . . . . ., ., ., . * ., + +*.*,,.*. The Terms of the Debate . . . . . . . . . . . . . . . .

. . . . . . . . . . . . . . +++.,,.+.

Effect on Business Activity . . . . . . . . . . . . . . . ... ... ... ,***. m.

. . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . .

Page

173

174

177

184

185

185

186

186

187

194

195

197

198

200

200

200

202

208

210

211

211

212

217

219

220

221

225

Boxes

Box

Page 7-A. Five State Industrial Extension Programs

. . . . . . . . . . . . . . . . . . . . . . . . .

. . ● . . + . . . . ● . . 179 7-B. DOE’s HTS Pilot Centers. ..,., +... +... . . . . . . . 188 7-C. The National Science Foundation Engineering Research Centers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

196 7-D. Intellectual Property Rights Protecting Innovation . . . . . . . . . . . . . .

213 7-E. BTU Feds the Heat . . . . . . . . . . . . . . . . . . . . .

. . . . . . . . . . . . . . . . . . . . . . . . . . . . .

. . . . . . . . . . . . . . . . . . . . .. . . . ., . ....*+.,. 230

Table

Table

Page 7-1. Expenditures on State Technology Programs, FY 1986 and FY 1988 . . . . . . . . . . . . 178
Chapter 7

Where We Stand: Public Policy and Technology

The science and technology policy of the U.S.

Government has traditionally been concerned with

basic science, health, energy, agriculture, and defense. It has been described as big science deployed

to meet big problems,l and as mission-oriented

rather than diffusion-oriented.2 With few exceptions

(the most important being agriculture and civilian

aircraft), U.S. Government policy has not been

directed toward helping private enterprises make

commercial use of advances in technology. Only

recently, as it became painfully obvious that one

U.S. industry after another was losing technological

leadership, have U.S. policy makers given serious

thought to a different approach. Some changes are

occurring, and of these, some are real departures

from the past. But they have been made in a

piecemeal, ad hoc fashion. No comprehensive set of

government policies has yet been adopted to promote the use of technology for better performance in

manufacturing.

The Federal Government undertook a truly novel

venture when it went halves with the semiconductor

industry in the Sematech R&D consortium, which

seeks to improve the manufacturing process for the

industry. Other government-supported R&D consortia have been considered (e.g., to promote R&D for

advanced television systems). Repeatedly, Congress

has enacted laws that urge the 700-odd Federal

laboratories to make their research results more

accessible to industry, and to undertake new R&D

projects designed and operated in collaboration with

industry. In establishing Engineering Research Centers in 18 universities, the National Science Foundation hopes to forge stronger links between academic

engineering research and training and the world of

industry. NSF is also encouraging U.S. scientists

and engineers to acquaint themselves with research

results coming out of Japan, and to foster the flow of

technology from Japan to this country. A growing

number of States are establishing industrial extension services to bring best practice technology to

smaller manufacturers, and the U.S. Government is

taking some initiatives in the same arena.

These programs represent deliberate actions by

Federal, State, and local governments in the United

States to improve the use of technology by U.S.

manufacturers. Other government actions, also intended to improve industrial performance, work

more indirectly. Among these are tax policies, such

as the present tax credit for increased R&D or the

past program of rapid depreciation for capital

investments in up-to-date plant and equipment.3

Laws protecting intellectual property (e.g., patent

and copyright laws) are intended to reward innovation and thus to foster technological advance.

Finally, Federal policies adopted for national goals

other than international competitiveness may still

affect it indirectly. One of these is antitrust law and

enforcement.

The following sections describe and analyze

government programs and policies as they existed in

1990 from the standpoint of their effect on U.S.

manufacturing technology. Chapter 2 of this report,

analyzing policy issues and options, discusses programs and approaches that Congress might wish to

consider for the future.

INDUSTRIAL EXTENSION

In the United States, government technical and

financial assistance to small and medium-sized

business is patchy and thin. Federal programs do not

begin to compare in size to the $31 billion per year

that the Japanese national government pours into its

combined program of direct loans and technical

assistance to smaller businesses—not to mention the

added contributions from prefectures, cities, and city

wards, plus the $56 billion in guaranteed loans for

small firms underwritten by government institutions.4

The U.S. assistance programs are not only much

smaller than the Japanese but also more hit-or-miss.

Every city in Japan and most rural towns have their

industrial halls, or federations of small business, or

chambers of commerce, dispensing technical help

along with plentiful funding for purchase or lease of

l~vin M- weln~rg, Reflections on Big Science (Oxford: Pergamon press, 1967).

zHenry Ergas, ‘Does Technology Policy Matter?’ Technology and Global /ndusmy: Compaw”es and Nutwns in the WorfdEconomy Bruce R. Guile

and Harvey Brooks (cd.) (Washington, DC: National Academy Press, 1987).

s~scuwion of tax policies affecting R&D and capital investment is inch. 2.

gFor a &scnption of Japanese national government programs to assist smaller businesses, see ch. 6.

-173 -
174 ● Making Things Better: Competing in Manufacturing

the latest production equipment. Japan is blanketed

with government or quasi-public institutions at the

service of small and medium-size enterprises. In the

United States, a small manufacturer in need of

technical advice is lucky to find a State or local

agency capable of providing it, much less a Federal

program that fits his needs.

Small firms form a sizable minority in U.S.

manufacturing. Some 358,000 small and mediumsize firms (defined as those with fewer than 500

employees) account for 98.8 percent of all manufacturing enterprises, and 35 percent of the manufacturing work forces According to one estimate, these

small firms represented 21 percent of value added in

manufacturing in 1982.6 However, employment may

be a better gauge of the contribution of small firms

to manufacturing, since wages are the major component of value added and wages are lower in small

manufacturing firms than in larger ones.

Many small outfits are suppliers of essential

materials and parts for large manufacturing firms,

and they are especially important in metalworking—

the fabrication and machining of metal parts. Over

94 percent of the firms in five major metalworking

industries are small plants with fewer than 100

employees. 7 How well these firms do their jobs

affects the cost, quality, and marketability of major

products from kitchen appliances to automobiles to

bulldozers, drilling rigs, and jet airliners. Small to

medium-size metalworking firms are also the heart

of the industries making production machinery,

from tools, dies, and jigs to block-long papermaking

machines. In other words, the technological upgrading of small and medium-sized manufacturers has

nationwide economic implications.

Many of these firms need technological upgrading. This does not mean that small factories need to

install 21st-century computer-integrated manufacturing systems. It does mean they need to acquire

up-to-date equipment, train people to use it well, and

organize work efficiently. Getting best practice

technology out to all corners of U.S. manufacturing

is not easy. Owners of small manufacturing firms are

often too busy doing a dozen jobs to find out for

themselves about technology improvements. Many

do not have their own manufacturing engineers,

because the engineers cost too much, or are not

needed full time, or are unavailable in out-of-the

way places where some manufacturing plants are

located. Consulting engineering firms are usually

more geared to serving large clients than small ones,

and many small manufacturers don’t trust their

ability to find a consultant who will tailor his advice

to what the manufacturer needs rather than what the

consultant has to sell. Vendors of production equipment can be good sources of technical advice, but

often they fall short of what is needed, especially in

adapting software to fit particular firms’ requirements and in training workers to use the equipment.

According to one director of a State industrial

extension service, you can’t just throw in a computer

and read the manual-you have to train people.

“We’ve had lots of companies with computers in

their closets. ” Finally, financing is the biggest

hurdle for many small manufacturers. A small firm

is less likely than a big one to have the contacts or

track record needed to get loans or otherwise raise

money for modernization, and financing is often

more expensive for small firms.

Federal Programs for Technology Diffusion to

Small Manufacturers

Recognizing the gaps in technology diffusion to

small and medium-size manufacturers, Congress has

recently created new programs of technical assistance to smaller firms. The Federal effort is still quite

limited, however, and there are no Federal loan

programs specifically aimed at promoting the adoption of new technologies by small manufacturers. In

fiscal year 1989, financial aid administered by the

Small Business Administration amounted to $47.3

million in direct loans (which are available only to

disadvantaged people) $3.6 billion in loan guarantees, and a contribution of about $150 million to two

quasi-public financing agencies for small firms. This

57_’~ Stite ~~Sw/~ B~ine~~: A Report ~~r~ p~~~ide~ (Wmhington, DC: U.S. Gover~ent ~nt~g office, 1989), table /4.15, pp. 80-81, and table

A. 17, pp. 84-5. The Japanese sector is more heavily weighted toward smaller fins; esmbiishments witi fewer ~an 300 emPloY~s are 99.5 Wrcent of

all manufacturing establishments and employ 74 percent of the sectoral work force.

6Jw1 popkin & Co., “Small Business Gross Product Originating: 1958 -1982,” contract report to the Office of Advocacy, Small Business

Administration, cited in ibid., p. 31.

7~ 1986, here were 134,7~ entewn=s in tie five major z-digit met~wor~ng s~tors, Fabfica~ Met~ Products, Machinery except Ekct.(icd,

Electric and Electronic Equipment, Transportation Equipment, and Instruments and Related Products (SIC 34-38), and of these, 126,700 were small

enterprises with fewer than 1(X) employees. Ibid,, table A.18, pp. 86-87.
Chapter 7—Where We Stand: Public Policy and Technology ● 175

aid is given to all kinds of small and medium-size

firms (most small businesses are in retail trade and

other services) for all kinds of purposes which may

have little to do with improving technology.

The biggest U.S. Government program promoting

technology advances in small manufacturing is the

Small Business Innovation Research (SBIR) program, established by Congress in 1982.8 Under this

program, Federal agencies with R&D budgets of

more than $100 million per year must set aside 1.25

percent to help small and medium-size firms compete for Federal research contracts and support these

small firms in bringing their R&D results to the point

of commercialization. In 1987, 1,276 small companies were awarded $350 million to do R&D work for

11 Federal agencies. The first phase in the SBIR

program is feasibility studies of promising ideas

(2,189 awards in 1987, for a total of $109 million);

the next is development of the ideas with the greatest

potential (768 awards, $241 million). SBIR does not

fund the final stages of bringing a product to market,

but the Small Business Administration does help

firms that have gained a place in the R&D program

find private financing for commercialization.

SBIR has been given high marks for funneling

Federal R&D money to small fins, and for helping

young, innovative companies develop advanced

technology products.9 Most of the projects are in the

areas of defense, health, and energy, where Federal

R&D is concentrated but where commercial possibilities are often limited. The program has been

especially helpful, however, in at least one commercially oriented field-biotechnology .10 What SBIR

does not do, and was not designed to do, is give best

practice technical assistance to the great majority of

small manufacturing businesses, which are not

involved in the development of products or processes at the frontier of advancing technology.

The Small Business Administration runs a few

programs that dispense business management and

marketing advice to the ordinary small company

(which, as noted, is most often in services or retail

trade). One of these is the counseling and brief

workshops on business management offered by

volunteers, the Service Corps of Retired Executives

(budgeted at $2.5 million). Another is the Small

Business Development Centers, mostly located on

university campuses, which provide counsel from

faculty or students on particular problems, some of

which may be technical. There are 53 such centers

nationwide, in all but four States; about half their

funding comes from the government ($45 million in

fiscal year 1989) and the rest from the universities.

Useful as these programs are, they are not focused on

the choice and use of technology in manufacturing.

Federal programs that concentrate on improving

manufacturing fins’ use of technology come down

to a very few. The oldest and largest is the

Manufacturing Technology (ManTech) program of

the Department of Defense, funded at $175.5 million

in fiscal year 1990. ManTech was created to

encourage the development and use of innovative

manufacturing technologies, and thus strengthen the

U.S. defense industrial base. The program is directed

to large companies as much as small ones, and is

concerned with production of military goods. Most

of the ManTech money goes to large defense

contractors, often for rather narrow projects promising near-term savings. 11 However, some ManTech

projects have brought forth new manufacturing

technologies of broad importance, civilian as well as

military. Numerically controlled machine tools were

developed in a ManTech project. More recent

projects with possible commercial applications include work on near net shaping of metals and

computer integrated manufacturing systems.

If the funding for ManTech programs (varying up

and down from $130 million to $200 million in the

1980s) seems a minuscule portion of the Defense

Department’s $40 billion R&D budget, it looms very

s~e sm~l Business Innovation Development Aet of 1982 established SBIR.

gCompUoller Gener~ of tie Unitd States, Gener~ Accounting Office, Implementing the Small Business lnwvation Develome~ Ac+The First

2 Years, GAO/RCED-86-13 (Washington, DC: October 1985); A Profile of Selected Firms Awarded Small Business Innovation Research Funuk,

GAO-RCED-86-113FS (Washington, DC: 1986); Effectiveness of Small Business innovation Research Program Procedures, GAO/RCED-87-63

(Washington, DC: 1987); Small Business Innovation Research Participants Give Program High Marks, GAO-RCED-87-161BR (Washington, DC:

1987).

1~.s. Congess, Offiu of T~hno@y As~ssment, New Development in Biotechnology: U.S. Investment in Bwtechnofogy, OTA-BA-360

(Springfield, VA: National Teehnical Information Service, 1988). OTA found that “SBIR funds are one of the few sources of direct Federal support

for applied researeh and development.

llMmufactW~g Studies Bo~d, Manufacturing Tec~/ogy: Corurstow of a Renewed Defense ]@tria/Base (Washington, DC: National

Academy Press, 1987).
176 . Making Things Better: Competing in Manufacturing

large compared to Federal spending for manufacturing technology on the commercial side-especially

diffusion of technology to small manufacture.

Technology diffusion programs include the 28-yearold Trade Adjustment Assistance, and the newly

minted Manufacturing Technology Centers (MTCs),

created in the 1988 trade act and operated by the

National Institute of Standards and Technology

(NIST, formerly the National Bureau of Standards). 12

Trade Adjustment Assistance (TAA) for firms is

open only to companies that can show they were hurt

by imports.13 It has usually been funded at about $15

to $16 million per year but in recent years its

prospects were uncertain (the Reagan Administration repeatedly proposed to abolish it) and its

funding was cut. In fiscal year 1990 it received $9.9

million in new and carryover funds. Nevertheless,

until 1988 TAA was the major Federal program

giving one-on-one technical assistance to small and

medium-size manufacturers. The TAA program also

gives advice to its clients on such things as

marketing and advertising, inventory control, and

financial management. Help is provided by 12 small,

regional, non-profit centers that act, in effect, as

industrial extension agencies.

The new Manufacturing Technology Centers are

charged generally with transfer of advanced technology to industry, with special emphasis on U.S.-based

small and medium-sized manufacturers. The law

directs the centers to make new manufacturing

technology ‘‘usable” to these smaller firms; actively provide them with technical and management

information about manufacturing; establish demonstration centers for advanced production technologies; and, for small firms with fewer than 100

employees, make short-term loans of advanced

manufacturing equipment. So far, three federally

funded Manufacturing Technology Centers (in Troy

NY, Cleveland OH, and Columbia SC) have been

established in the United States and three more are

planned. The three existing centers got a total of $4.5

million in Federal funds in 1989; matching funds

from local sources are required.

NIST expects the Manufacturing Technology

Centers to serve primarily small firms with 200 or

fewer employees, and to concentrate more on

off-the-shelf best practice technologies than on

high-tech cutting edge systems fresh from the R&D

lab. NIST officials also say that the primary service

offered by the Centers will be modernization plans,

customized to fit the needs of individual firms.

However, the language of the law gives NIST

latitude to support Centers with varying approaches,

and so far it has done so. The Troy MTC is

concentrating on transfer of high-technology systems from labs to selected fins, though it also

cooperates with State agencies and community

colleges in diffusing best practice to a broad range of

client firms. Field agents of the Cleveland MTC are

knocking on doors of thousands of small companies

in a concentrated industrial area and offering those

that respond individual business and technical plans.

The South Carolina MTC, which is closely linked to

the State’s technical college system, is installing

centers to demonstrate computerized metalworking

equipment.

NIST has its own small demonstration center in

the Shop of the 90s. This is a working machine shop

that fills job orders from government agencies but

also serves a technology extension purpose. It is an

offshoot of NIST’s highly automated, state-of-theart Advanced Manufacturing Research Facility (AMRF),

which was meant to serve in part as a learning center

for manufacturers. However, many people from

small manufacturing firms found the AMRF entirely

too advanced to have any practical application to

their businesses. The Shop of the 90s, using off-theshelf technology, fits their needs and experience

better. Because it is a working shop, with 60

employees and a business worth about $4 million a

year, the manager has credibility with small manufacturers. State technology agents are brought in for

presentations, and the Shop is open for tours and

phone inquiries.

One more small NIST program, also created in the

1988 trade act, is intended to provide technical and

financial assistance to State technology extension

lzNei~erprogr~ is st,rictly limi~ tO small and mtiium-size manufacturers, but in practice TM has mostly served small manufacturing fiis, and

the law creating the Manufacturing Technology Centers emphasizes dissemination of new technology to small and medium-size manufacturers. See the

Omnibus Trade and Competitiveness Act of 1988 (Public Law 1O(H18), Subpart B, Sec. 5121(a).

lsTrade AdJWtment Assis~nce ~so includes a r~mployment ~d rewfiing program for workers losing ~eir jobs due to imports; ~S pm Of TAA

is far bigger (recently funded at about $200 million per year) and better-known than TM for firms. For a description and evaluation of both programs,

see U.S. Congress, Office of Technology Assessment, Trade Adjustment Assistance: New Ideas for an Old Progr@pecial Report, OTA-lTE-346

(Springfield, VA: National Technical Information Service, 1987).
Chapter 7—Where We Stand: Public Policy and Technology ● 177

services. This program got no funding until fiscal

year 1990, when it received $1.3 million, but NIST

had already begun some modest outreach to States.

So far, it has mostly been a one-man show—a single

NIST official (sometimes accompanied by the manager of the Shop of the 90s) who travels to State

technology agencies explaining what resources NIST

has to offer, referring them to other sources of

Federal help, and helping various State agencies

make contact with each other.

Another federally funded technology demonstration center has been in business since 1988. That is

the National Apparel Technology Center in Raleigh,

NC, an outgrowth of the 10-year-old TC2 project.

TC2 (Textile/Clothing Technology Corporation) began

as a combined government-industry effort to develop a flexible, automated sewing system able to

take on a variety of complicated sewing jobs, such

as attaching the sleeve in a man’s suit jacket.

Although it has fallen short of some of its ambitious

technical goals, has produced some commercially

usable automated sewing equipment. In addition,

TC2 now supports the Raleigh center, which demonstrates a whole range of modern apparel-making

equipment to its member companies, large and

small, and arranges seminars with apparel engineering faculty of nearby North Carolina State University. The Federal Government’s contribution to TC2

has been $3.5 million per year for the past few years.

The Defense Logistics Agency also operates three

demonstration centers for apparel technology, each

funded at up to $5 million per year, with threequarters Federal funding. These centers are open to

civilian manufacturers as well as defense contractors.

Altogether, these Federal technology extension

efforts are scattered and small. Up to now, the

emphasis in Federal technology transfer programs

for small manufacturers has been much more on

pushing out sophisticated new products and processes (as in the SBIR program) than on helping

individual firms adopt best practice technology.

State Industrial Extension Programs

Most of the action in industrial extension is in the

States, and even there it is limited, though increasing. Exactly how much it amounts to is uncertain,

partly because surveys of State programs are incomplete and quickly outdated, and partly because

“industrial extension” is not very well defined in

the surveys. More than 40 States have programs to

‘‘promote technology, “ but most of their effort and

funding goes for research and development in

universities and for aid to high-technology startup

ventures-not for help to existing firms in adopting

best practice technology. According to a survey of

State programs done for NIST in 1988-89, only 13

programs in nine States had technology extension

programs whose main purpose was direct consultation with manufacturers on the use of technology .14

However, this number is already out of date. At least

one new program, Nebraska’s, was established after

the survey was completed.

One of the better recent surveys of State technology programs was done by the Minnesota Governor’s Office of Science and Technology .15 It found

that in 1988 States directly spent $550 million on

various kinds of technology programs, but only

about 10 percent of that—some $57 million—went

for technology transfer and technology/managerial

assistance (table 7-l). Technology transfer, which

got $46 million (8 percent) of the finds, was defined

as facilitating “the transmission of new technologies from the laboratory to the private sector. . . for

the creation of new businesses, the introduction of

new product lines for established firms, or the

revitalization of mature industries.”l6 Despite this

language, some activities that States call “technology transfer” might really be closer to industrial

extension services. At a guess, the States are

spending some $25 million to $40 million for such

services.

As used here, industrial extension means a service

something like this: an accessible office staffed with

a few engineers or people with experience in

industry invites telephone calls or visits from

managers of small manufacturing firms seeking

ld~~d R. J~~~n, ~ting ~rWtor, T@-~olo~ Semices, National ~stitute of Standwds and Tec~ology, te~imony before the U.S. House of

Representatives, Committee on Small Business, Sept. 28, 1989.

15@vernor’s Office of Science and TW~OlOW, Stite Tec~/o~ Progr- in the United Smtes, 1988 (St. Paul, MN: ~nnesota Wpaltment Of

Energy and Economic Development, 1988).

IGIbid., p. 1.
178 ● Making Things Better: Competing in Manufacturing

Table 7-l—Expenditure on State Technology Programs, FY 1986 and FY 1988

Number of Average

Expenditures States with State

programs spending

FY 1986a

FY 1988a FY 1988 FY 1988

Type of program $ Million Percent $ Million Percent $ Million

Technology/research centers . . . . . . 285.6 41.0 226.6 41.2 29 7.8

Research grants . . . . . . . . . . . . . . . . 126.7 18.2 150.2 27.3 25 6.0

Venture/seed capital . . . . . . . . . . . . . 159.6 22.9 37.4 6.8 18 2.1

Research Parks/incubators . . . . . . . . 75.6 10.9 36.9 6.7 22 1.7

Technology/managerial assistance . 10.5 1.5 11.0 2.0 30 0.4

Technology transfer . . . . . . . . . . . . . . 8.4 1.2 45.7 8.3 26 1.8

Other technology programs . . . . . . . . 30.1 4.3 42.4 7.7 41 1.0

700.0b100.0 b

550.0 100.0 44C

12.5

Notes: a There are differences in accounting procedures between the 1986 and 1988 reports, For some states, the 1986 figures represented muiti-year appropriations.

The 1988 figures are all on an annual basis.

b column sum does not add to total because of rounding.

c Number of States with one or more technology Programs.

SOURCE: Calculated from: Governor’s Office of Science and Technology, State Technology Programs in the United States, (St. Paul, MN: Minnesota

Department of Energy and Economic Development, September 1986); Governor’s Office of Science and Technology, State Technology Programs

in the United States, 1988, (St. Paul, MN: Minnesota Department of Trade and Economic Development, July 1988).

help. Promptly after the first interview, the office

sends a technical specialist (either someone from its

own staff or an engineer from the State university)

to make an onsite diagnosis. Then the extension

service produces a customized client report, and its

technical specialist or a consultant works one-onone with the firm to put into effect the improvements

recommended by the service and accepted by the

firm’s manager.

What small manufacturers need more than the

newest technologies fresh out of the laboratory is

off-the-shelf hardware and software and individual

help in choosing and managing them. They need

advice on these choices from an independent source

with no financial stake in the selection. And they

need to understand how much training is involved in

adopting new equipment, and where to get it. These

conclusions are drawn from the experience of people

involved in technology extension, both the agents

providing the services and the firms receiving them.

In visits and interviews with five State industrial

extension programs in 1988, OTA found that the

programs were serving genuine needs that were not

otherwise being met, and that demand for the

services was high.17 At least two of the States—

Georgia and Maryland-do not advertise the services they offer for fear of being swamped with

requests for assistance. (Box 7-A lists and briefly

describes the programs OTA visited.)

Individual Problem Solving

Everyone interviewed took it as given that one-onone contact between technical specialists and company managers is the bedrock of industrial extension. A good hard look at the company’s individual

problems is the starting point for all the programs.

This often includes an intensive telephone interview

to begin with, followed by a site visit and a

diagnostic report. Again and again, company managers remarked on the value of an objective,

experienced outsider taking a fresh look at the

company’s problems—something that managers of

small outfits are often too swamped to do. ‘‘I don’t

have time to do research,” said Jerry Lipkin,

Executive Vice-President of Moyco Industries, a

Philadelphia manufacturer of abrasives and dental

products. “I have to do sales, marketing, and

personnel. ’

Sometimes, the diagnosis may find that a company’s efforts to modernize are misdirected, or that

real problems have escaped the manager’s attention.

According to Travis Walton, director of Maryland’s

Technology Extension System (TES), some companies think they need sophisticated computer equipment when they don’t. For example, “If you make

the same product year after year you don’t need

CAD (computer-aided design)—you only need it if

you customize. ’ One company, Travis added, came

to TES for aid in setting up a computer system to

l~~dings from ~e~ Vlslts and interviews are also reported in Philip Shapka, ‘‘Industrial Extension: hrning from Experience,’ contractor report

to the Office of Technology Assessment, November 1988.
Chapter 7—Where We Stand: Public Policy and Technology 179

Box 7-A—Five State Industrial Extension Programs

In 1988 OTA visited five industrial extension programs in four States, some with long experience and some

just a few years old. Through interviews with program managers, extension agents, and clients, OTA sought

information on the kinds of technical assistance small manufacturers need and how the programs are meeting the

needs. The five programs, with acronyms and year of origin, are:

Georgia Institute of Technology Industrial Extension Regional Offices (GTRI, 1960) is headquartered at

Georgia Tech in Atlanta and supports 12 regional offices, each with a field staff of two or three people giving

individual service to client fins, The regional offices also link clients with specialized services at Georgia Tech,

including assistance on productivity, energy conservation, workplace safety, hazardous waste management, and

training. Funded at $3.8 million in 1988, GTRI had 26 professional employees and served 960 firms. Days of field

service averaged 2 to 5 and the average cost per client was $4,000.

Maryland Technology Extension Service (TES, 1983), based at the University of Maryland, offers

one-on-one client assistance at five regional offices. Field staff may refer problems to the university faculty. With

a full-time staff of seven people, and funding of about $400,000, TES served 250 to 300 clients in 1988, giving up

to 5 days of service at an average cost per client of about $1,500.

Michigan Modernization Service (MMS, 1985) is a State-sponsored program, affiliated with Michigan’s

Industrial Technology Institute. Its services include intensive diagnosis and onsite visits from a field representative,

experienced in industry and manufacturing technology, paired with a training specialist. Some 45 people staff the

program, but most of the 25 professionals are part-time consultants. The 1988 budget was $2.8 million (expected

to rise to $3.9 million in 1989) and 140 clients were served (250 expected in 1989). Cost per client was about

$20,000 for an average of 6 days of service.

Pennsylvania Technical Assistance Program (PENNTAP, 1965), a joint program of Penn State University

and the Pennsylvania Department of Commerce, provides technical information from faculty specialists and some

onsite visits, in response to client requests. Sometimes PENNTAP takes the initiative in acquainting firms with new

technologies. Total budget in 1988 (including in-kind facilities and services donated by the University) was about

$1.3 million and the staff was equal to 12 1/2 full-time slots. Some 850 firms and 450 local government bodies

received services; cost per industry client was $1,100 to $1,500. The length of service was not reported.

Pennsylvania Technology Management Group (TMG, 1984), a nonprofit corporation sponsored by the

State, concentrates on bringing best practice technology to small manufacturers (defined as having fewer than 250

employees, but in practice usually in the range of 20 to 40 employees). One of the small core staff (6 people)

evaluates the client’s problems, and TMG then shares the cost of a consultant, if needed. With a budget of $350,000

in 1988, TMG served about 40 clients, at an average cost of $8,800. The length of service averaged 8 days.

track inventory, but the real problem was that the company got the space it needed in only 25,000

inventory was “totally chaotic” and far too big,

tying up capital in unneeded items.

Another example comes from the Tnemec Co.,

Inc. of Baltimore. This branch plant of a small

company ($1 3 million sales per year) makes industrial protective coatings for water towers, wastewater plants, and the like. Tnemec wanted to expand to

handle a growing business, but the plant manager,

Frank Lavin, recognized that he needed help in

planning the expansion. “I’m in a small business

with a busy day-to-day routine, ’ he said. ‘‘I don’t

know how to build a new plant, ’ He called on TES.

In a site visit, the TES engineer found that a

complicated, inefficient flow of materials had developed over the years in the old plant, and suggested

a wholesale rearrangement. The result was that the

square feet, not 40,000 square feet as originally

planned. ‘‘At $25 a square foot, we saved a lot of

money," Lavin said. He added that if he had asked

a consulting firm for 40,000 square feet, they would

have built it without question. “Consulting engineers and architects build what you ask them to.

Trust

Lavin, like other company managers, praised the

‘‘objectivity and the expertise of the State extension service. Trust in the services’ impartiality-the

fact they are not trying to sell the companies

anything or collect big fees—is a key element in

their success. This was the reason several plant

owners and managers gave for turning to a State

agency instead of a private consultant. Besides, they

said, small firms have trouble getting competent
180 ● Making Things Better: Competing in Manufacturing

service from consulting engineers. One said bluntly:

“They are a waste of time and expensive.”

Brooks Manufacturing is one company that struck

out in trying to find the right private consultant. This

Philadelphia firm has a $6-million-a-year business

making electrical outlet strips, but it faces growing

competition (especially from Taiwan) in its basic

product line. Brooks is trying to build up its business

in more specialized, higher value-added items—

electrical outlet strips for medical carts, for example

and is developing a special power strip that is

compatible with sophisticated communications equipment. But the company is too small to support a

research and development department to design its

new products, and it failed to get what it needed from

three different consulting engineers. “The engineering service consultants usually send out the new

guys to small fins, ” President Gary Brooks said.

Pennsylvania’s Technology Management Group

(TMG) stepped in and helped Brooks find a capable

engineering consultant, who developed new product

designs and made blueprints for the company. TMG

also funded an evaluation of the company’s operations to see whether it needed and could handle a

Materials Requirements Planning (MRP) system,

which takes an order and breaks it down into the

individual components and material needed to fill

that order. On the basis of the evaluation, Brooks

adopted the system. TMG also found a qualified

consultant to help the firm tailor the system to its

needs.

At Moyco Industries in Philadelphia, Jerry Lipkin

remarked that the intervention of TMG in finding a

consultant meant that the fees were predictable and

there was a cap on final costs. “We have been

burned by consultants in the past, and the program’s

involvement helps reduce the risk of this happening.” That TMG puts up a little money (maximum

of $1 ,500) toward the consultant’s fee reassures the

company that TMG too has a stake in the outcome,

and that the consultant is qualified. For their part,

consultants seem to welcome referrals from State

extension services since this adds to their credibility

and opens doors to new business.

Extension services operating out of university

engineering departments can use members of their

own departments for consultations. For example,

when American Bottlers Equipment Co. (Ambec) of

Owings Mills, MD, came to Maryland’s Technology

Extension Service for help in computerizing its parts

list and linking the list with computerized drawings,

the service used its university connection. TES

works out of five regional offices but is based in the

Engineering Research Center of the University of

Maryland; it calls on engineering faculty members

in nearly half its cases. Travis Walton, director of the

program, says TES has a “visiting nurse” approach—

the engineers who staff the regional offices do what

they know how to do and call for help when the

problem is beyond them.

Ambec is a small company specializing in the

manufacture of stainless steel conveying and handling equipment for customers in the food and

beverage, pharmaceutical, electronics and other

industries. It has sales of $10 million per year and

about 100 employees. Essentially a job shop, Ambec

works to customer specifications, using families of

parts which it assembles to meet a particular

customer’s needs. Before consulting TES, Ambec

had gone through a bad experience with a private

consulting firm, which sold it a Material Resource

Planning software system that was supposed to keep

track of orders and parts, but never worked as

promised. Instead of trying that route again, the

company called on the State extension service. TES

linked Ambec with a University of Maryland

engineering professor and a student with good

computer skills. The student developed the program

Ambec wanted and later went to work full time for

the company.

Confidence in an extension service’s competence

is as important to a company as trust in its

objectivity. Connections with an institution that is

already well respected throughout the State help to

establish that confidence. In Maryland, for example,

that institution is the University’s highly regarded

engineering department. In Pennsylvania it is Penn

State University, in Georgia it is Georgia Tech, in

Michigan it is the Industrial Technology Institute in

Ann Arbor.

Sometimes, only experience will instill confidence. Terry Brady, president of Bradhart, Inc. of

Howell MI, consulted the Michigan Modernization

Service--MMS) only as a last resort. Bradhart is a

small but top-of-the-line job shop, machining highquality metal parts, especially bearings, to the

specifications of its customers in the aerospace,

ordnance, and oil industries. To stay competitive in

the new global economy, the company decided to

modernize. Moving to larger quarters, it installed
Chapter 7—Where We Stand: Public Policy and Technology ● 181

several computer numerically controlled (CNC)

machine tools and a computer system to integrate

orders and office processing with production. This

investment cost half a million dollars-a lot for a

company with sales of $3 million per year. Unfortunately, the company’s managers soon discovered

that they had seriously underestimated the startup

costs for training workers to use the new tools.

Further, the software for the computer system did

not run properly. The company had run out of credit.

It was in a make-or-break position.

At this point, Brady called MMS, but without

much hope of real help. He was surprised, frost at

getting a prompt businesslike response, and still

more so at the quality of training and other assistance

MMS was able to provide. Finally, MMS gave

Brady a vital boost in confidence when its evaluation

confirmed that the company was right to invest

heavily in modern equipment, and was headed in the

right direction. Brady remarked appreciatively on

the way MMS staff had served as a “sounding

board,” providing advisors who were not competitors but still had an understanding of business and

technology. “I still don’t believe,” he said, “that

someone would want to help the little guy. ”

Training

Nothing could better illustrate the importance of

training on new equipment than the Bradhart story.

Because the managers did not appreciate how much

training would cost, the company almost went under

in an otherwise sensible move to modernize. Fortunately, MMS was able to help Bradhart get State

training funds and find good training programs. (As

discussed below, MMS also helped the company get

a bank loan to tide it over the crunch, before the

investment in equipment and training began to pay

off.)

With help from MMS, Bradhart set up training

programs for employees, both in-house and at a local

community college. Shopfloor employees received

training on the CNC tools and in quality control

techniques; the office staff was trained in spreadsheet and database programs and job costing. In

addition, the company sent four or five employees at

a time through a local community college to learn

basic mathematics, quality control, and supervisory

skills. MMS also helped Bradhart untangle its

software.

Although the directors and staff in all five

industrial extension services stressed the importance

of training, MMS was the only one with a training

element routinely built into its services. It took time

for MMS to recognize the merits of marrying

training with technology. In its early days (perhaps

influenced by General Motors, which was then

trying to automate everything it could in auto

assembly) the program concentrated on hardware,

and training to use the hardware was not much

emphasized. Today, MMS takes care to emphasize

that it is not hawking technology per se but is

helping firms use technology, which means developing management and training. On every site visit,

MMS sends pairs of training and technology specialists to make the diagnosis and write the report, which

includes an assessment of training needs and options

for every client and actively helps clients design or

procure training. The Michigan program spends

roughly $1 dollar on training assistance for every $2

dollars it spends on technology deployment.

Other industrial extension services, though less

systematic about training than MMS, also know

where to refer clients for training advice and

assistance. For example, Pennsylvania’s TMG

linked Brooks Manufacturing with a community

college to get training in quality control, statistics,

teamwork, and basic math for its workers. However,

some of the services have a harder time finding

adequate training. Georgia Tech has a small industrial training unit able to provide limited training,

mostly for frost line supervisors. But in some of its

cases, training that extension agents recommend,

and companies are eager to get, is not available.

For example, in a productivity audit of Imperial

Cup’s paper and plastic cup manufacturing plant in

La Fayette, GA, the Georgia Tech engineer included

several recommendations for improved training. She

found the current training-2 days under a fret-line

supervisor-inadequate for working with the sophisticated machinery in the company’s paper department. Imperial tried to get a local vocationaltechnical school to train workers on the shop floor,

but the school offered only classroom training. The

company also had trouble finding workers with the

skills needed to maintain the machinery. The local

voc-ed school turned out electronics and auto

technicians, but not machinery repairers. In the past,

the company sent small groups of workers to the

machinery manufacturer in Wisconsin for training,

but the manufacturer recently expressed reluctance
182 ● Making Things Better: Competing in Manufacturing

to continue it. At the time of OTA’s visit, no solution

to Imperial’s training needs was in sight.

Financial Aid

Industrial extension services do not provide funds

for capital investment or operating expenses. They

are in the business of giving technical, not financial,

assistance. However, they can help small firms

coming to them with financial problems in two

ways. First, their diagnosis may reveal that what the

firm’s manager thought was a need for funds is really

more a problem of management that can be solved,

say, with a better use of space, flow of materials, or

control of inventory.

Second, the State agency can be very useful in

directing firms to sources of funds, and supporting

them in dealings with banks. For example, the

Michigan Modernization Service not only pointed

the Bradhart company toward State funds that could

help pay the big bills for their training needs. MMS

also helped the company get a bank loan, using State

economic development funds as equity (the funds

came from Community Development Block Grants,

contributed by the Federal Government to the

States). “This lessened the financial pressures,”

said Terry Brady, Bradhart’s president. “We would

have gone down without the State’s help.”

Besides the block grants and other economic

development funds, many States have special loan

programs for small businesses that extension services can tap. The extension services can also plug

into the Federal program of small business guaranteed loans. It is safe to say, however, that finding the

money to modernize a factory is a serious hurdle for

many small manufacturing firms in the United

States. They do not have the many options of the

small Japanese firm, which can afford to pass up a

low-interest government loan in favor of a bank loan

at a slightly higher rate, because the bank takes just

one day to consummate the deal, while the government loan might take a whole month (see box 6-A,

ch. 6).

Staff, Fees, Intensiveness, and Cost of Services

All the State agencies interviewed by OTA

reported that they had found ways of getting good

staff-even though most pay their engineers and

other technically trained people below-market salaries. For their small core staffs, they look for people

with broad technical competence (rather than depth

of knowledge in a narrow field) and an interest in

working with people as well as things. The Technology Management Group in Pennsylvania calls the

kind of person they look for NYTE--not your

typical engineer. TMG reports no trouble attracting

and keeping staff, even though the pay (on average,

$35,000 per year in 1988) is well below the median

for engineers. The pay in the Georgia Tech extension

service is higher (averaging in the mid-$40,000s),

but the program’s directors say the satisfaction of the

job is at least as important as pay in attracting good

people. Most of the extension offices are in rural

areas where the agents get plenty of local recognition, both for the job they do and as representatives

of prestigious Georgia Tech.

The Michigan Modernization Service relies mostly

on part-time consultants for its field representatives,

and has been through some periods of high turnover.

The program directors say that although it is a

challenge to get good people, it can be done. The pay

is pegged at the State rate for consultants—$250 per

day, which compares with $800 to $1,000 per day for

private engineering consultants. The field reps take

the work despite the uncompetitive rate, partly

because it opens the door for more contracts later,

partly because the State does much of the preliminary work—and also partly because they enjoy it.

Some of the field reps are retired industry engineers

(often from the auto industry) and they are enthusiastic about helping small firms learn how to solve

problems for themselves. The MMS has changed its

ideas about what makes a good field representative.

At first, they looked for people with specific

technical qualifications. Now they look for breadth

and the ability to establish trust, listen, and write a

good analytic report.

With its large roster of part-time field representatives (25 in 1988), MMS does not often need outside

consultants, but other programs (TMG in particular)

use private consultants quite regularly. TES relies

heavily on its faculty connections (using them for 45

percent of clients), and the Georgia Tech extension

offices taps the resources of the Georgia Tech

Research Institute in Atlanta for about 30 percent of

its clients. Thus, these programs are able to tackle a

shifting variety of technical problems while keeping

only a small permanent staff for continuity and a

sense of mission.

None of the State programs charges a fee for its

initial assessment. Only one, TMG, charges any fee

at all; in this program, firms pay apart (usually about
Chapter 7—Where We Stand: Public Policy and Technology ● 183

two-thirds) of the fee for consultants. The fact that

the firms pay nothing for the diagnostic assessment

makes it easy for them to enter the program, even

when (like the Bradhart company) they don’t have

very high hopes for it. Many of the company

managers interviewed by OTA said they would be

glad-next time-to pay for services they got from

the extension agencies. The problem with paying up

front is that they have no idea whether the agency

will deliver professional level services. In the case of

TMG, firms get their diagnosis before they are asked

to share payment for a consultant. And about 60

percent decide not to go ahead (though many of these

are able to make improvements on their own, based

on the diagnosis). Those that choose to go forward

know what their cost will be, since TMG takes

responsibility for dealing with the consultant. The

Michigan program is considering a second phase of

service that might charge user fees, but this would

follow the first, no-charge phase.

The cost per client of the five programs ran from

about $1,000 to $20,000 in 1988 (box 7-A). There

seemed to be a rough correspondence between the

cost and the intensiveness of the services clients

receive, although it is hard to say this definitively

because definitions of services differ, and so do

allocations of cost. MMS and TMG, both of which

emphasize field visits and individual consultations

based on a written diagnostic assessment, are at the

high end. MMS reported an average of 6 days of

service and a cost of $20,000 per client. TMG said

it gave an average of 8 days of service, at a cost of

$8,800 per client—but the cost rose to $19,400 for

those clients (40 percent) who elected to use a

consultant.

Maryland’s TES and the Georgia Tech extension

service both give up to 5 days service to their clients,

though neither is rigid about “setting” the clock

running.’ TES ‘ ‘usually’ makes field visits, though

not always. Georgia Tech may or may not; one

regional office reported having contact with 200

companies in a year, helping 100 in depth, and

making about 50 site visits. Another said that some

field officers are so familiar with a firm after dealing

with it over the years (Georgia Tech has been in the

industrial extension business since 1960) that a site

visit isn’t necessary. Both tend to give their clients

oral, not written reports. And both rely for specialized technical help on their university connections,

not private consultants. TES pays its faculty advisors for their time only when asked, and then at their

university salary (not private consultant) rates. The

faculty advisors may then use the money for

professional purposes such as travel or research

support. Georgia Tech can call on its parent organization for extra services to its clients-for example,

a productivity audit from the State-funded Georgia

Productivity Center program. The TES cost per

client is nominally $1,500, but most of the cost of

consultation with engineering faculty at the University of Maryland is not included in this figure.

Georgia Tech reported a cost per client of $4,000.

The least expensive of these programs,

PENNTAP, generally offers the least intensive

services. Often, the problems that companies bring

to it are narrowly technical and can be handled by a

telephone call, a fax message, or group meetings.

PENNTAP’s eight staff specialists (mostly engineers) do make site visits as well, however, and they

tailor responses to clients’ individual problems.

According to the program’s director, human contact

is the key to technology dissemination. PENNTAP

reported spending about $1,100 to $1,500 per client

firm, with no estimate of the days of service

rendered.

Improvements in Services Offered

Most of the people OTA interviewed, including

the staffs of the five extension services and their

clients, thought the programs were doing a good and

much-needed job. If there is one change they all

want to make, it is to expand the programs and serve

more firms, Two of the extension services, Georgia

Tech and Maryland’s TES, specifically stated that

they don’t advertise for fear of attracting too much

business. Georgia Tech asked the State legislature

for funds to open five more regional offices.

Michigan’s service was expanding in 1989, and

Pennsylvania established a new $10 million-a-year

program of Industrial Resource Centers, replacing

the much smaller TMG, which will serve as advisor

to the new centers.

At one of the programs, MMS, the staff had given

serious thought to expanding services to individual

companies, as well as extending service to more

companies. MMS staff members believe that the

average of 6 days of service they now give clients is

about right for a first bite. “Small and medium-size

firms face a digestion issue,” said Alan Baum,

director of research and analysis. “They can only

deal with so much at a time. ” But the staff is

seriously considering offering a second phase of
184 ● Making Things Better: Competing in Manufacturing

assistance of up to 20 days, with the firm paying for

some or all of the costs (the first phase, as noted

above, is free).

MMS has another idea in mind as well. That is to

strengthen horizontal links between small firms in

the same or closely connected businesses, freeing

them from too-great dependence on the larger firms

that are their customers. Interestingly, managers of

Japanese Government programs for small manufacturers are promoting more independence in much the

same way, through networks that provide cooperative product development and marketing services

(see ch. 6). Michigan’s Industrial Technology Institute, of which MMS is now a part, has made some

preliminary moves in this direction. Its PRIME

project (Program of Research in Modernization

Economics), started in 1985, is helping Michigan

auto parts and components suppliers meet new

demands from the Big Three automakers—

especially the demand for complete subassemblies

rather than disparate parts. For example, PRIME

might link a small foundry with a machine shop so

the two together could make a complete camshaft

subassembly.

Finally, some of the extension services-notably

Georgia Tech-would like to do more with training.

They believe that the training programs they currently offer are too “off-the-shelf” and depend too

much on the classroom. And they think that closer

links between industrial extension and State vocational educational systems are a must.

It would be a mistake to consider the examples

discussed above as typical of industrial extension

services in the United States. They are not. OTA

chose these five programs to examine not because

they are typical but because they are among the most

active and the best. The purpose was to suggest what

can be done with technical assistance to small

manufacturers, not to suggest that it is being done

nationwide. The situation is patchy. Several States

besides the four mentioned here also have active

programs, others are following the leaders and

establishing industrial extension services, and some

are doing little if anything. An accurate count is not

available, but it is likely that the State and Federal

programs combined are spending no more than $40

to $50 million per year on industrial extension. If

just 24,000 small American manufacturing firms

were to receive industrial extension services each

year (about 7 percent of small manufacturers roughly

similar to the proportion that is served in Georgia by

the Georgia Tech extension service), the total cost

would be $120 million to $480 million per year,

depending on the level of service.18

COMMERCIALIZING

TECHNOLOGY FROM FEDERAL

LABORATORIES

During the 1980s, the government has tried to

encourage the commercialization of technology

from the Federal labs by private industry, Congress

has passed several laws to promote it; scientific

advisers to the President and executive agencies

have strongly urged it; and President Reagan signed

an Executive Order laying out guidelines to accomplish it.19 The effects have been positive but modest.

The Federal labs still have a long way to go before

realizing their potential as a source of new ideas for

industry.

When the interaction works, lab-generated technologies can have an impact. For example, although

it focuses on nuclear weapons research for the U.S.

Department of Energy (DOE), Sandia National

Laboratories has also made contributions to civilian

industry. Sandia helped to develop important clean

room technology and the hot-solder leveler, used in

electronics manufacturing. Each was worth over

lgs~ ch. 2 for more detail on these estimates.

l~e lawspmmfig t~hnolo~ tr~sferinclude the Stevenson-Wydler Technology Innovation Act of 1980, the Patent and Trademark Amendments

Act of 1980, the Bayh-Dole Patent Amendments of 1984, the Federal Technolo~ Transfer Act of 1986, the Omnibus Trade and Competitiveness Act

of 1988, and the National Competitiveness Technology Transfer kt of 1989. Also, during 1988-89, subcommittees of the House Committee on Science,

Space, and Technology and of the Senate Committee on Energy and Natural Resources held hearings on technology transfer. Major reports to the

executive branch include Report of the White House Science Council Fe&ra/ Laboratory Review Panel, Office of Science and Technology Policy,

Executive office of the fiesiden~ 1983; Energy Research Advisory Board, Research and Technology Utilizatwn: A Report of the Energy Research

Advisory Board to the Unite dStates Department of Energy, DOQ&O067, 1988; and The Federal Technology Tran@er Act of 1986: The First 2 Years,

Report to the President and Congress form the Secretary of Commerce, July 1989. President Reagan’s order establishing guidelines for tie Federal labs

on technology transfer was Executive Order 12591, Apr. 10, 1987.
Chapter 7—Where We Stand: Public Policy and Technology . 185

$100 million to industry by 1987 according to

Sandia’s estimates.20

Technology transfer is increasing, albeit slowly.

Quantitative measures are elusive and fail to capture

the key ingredient of personal interaction. Nonetheless, some trends are indicative. Active license

agreements between DOE’s Oak Ridge National

Laboratory and industry were up from 2 in 1985 to

33 in June 1989.21 Industry increased its royalty

payments to DOE labs from $297,000 in FY 1987 to

$908,000 in the first 9 months of FY 1989,22 and are

likely to rise further.

The labs were set up mostly to pursue missions

other than commercially promising R&D-notably,

basic research and the development of science and

technology related to weapons—so there are limits

to the potential for technology transfer. However,

there are also barriers that are not integral to the labs

themselves. These can be overcome. Changes in the

funding, administration, and orientation of the labs

are necessary, and should help the labs to increase

their potential contribution to increase U.S. competitiveness in manufacturing. The following sections

explore how the labs are responding to legislative

and executive mandates to improve technology

transfer. While progress has been made, more could

still be done to make labs’ research available to

industry.

The Federal Laboratories: An Overview

The Federal Government spends approximately

$21 billion on its labs, mostly through: the Department of Defense (DoD), $10.5 billion; DOE, $4

billion; National Aeronautics & Space Administration (NASA), $2.5 billion; and National Institutes of Health (NIH), $1 billion. Various smaller

agencies, such as the Agricultural Research Service,

account for the remainder.23 Most of this money is

spent on lab work for defense and basic research.

Almost all of DoD’s money and about $2 billion of

DOE’s goes to defense-related R&D, largely weapons development. Most of the DOE labs’ remaining

resources (after defense-related spending) are spent

on basic energy research.

Neither of these two predominant missions, defense and basic research, is directly connected to the

needs of the private sector. Not only is defenserelated R&D designed to produce weapons systems

(not usually transferable to civilian manufacturing),

there are security-related barriers which tilt the

institutional culture of defense-related researchers

producers away from technology transfer into the

civilian sector. Basic research faces different, but

just as significant, problems in forging links to

developers and users of its technology. Basic

researchers are almost by definition interested in the

pursuit of knowledge, not its application. This tends

to be true for both the institution and the individual

researcher.

Nevertheless, defense R&D and basic research

can sometimes be made useful to commercial

manufacturing. Labs differ in their potential to help

the private sector, and in their success in giving such

help; they come in different sizes and with different

structures and orientations. It is therefore useful to

begin with a brief overview and some central

distinctions.

DOE Labs

The DOE labs are key factors in any discussion of

the Federal labs. Indeed, the nine multiprogram

DOE labs are usually simply called the national labs,

even though they account for only about a sixth of

total government spending on Federal labs.

The DOE labs are funded primarily through three

program areas,24 which orient the work that they

fund in different directions: Defense Programs ($3

billion) supports the DOE’s weapons work and

nuclear materials production; Energy Research Programs supports basic research in energy, mainly

nuclear energy ($2 billion); and the Nuclear Energy,

Fossil Energy, and Conservation and Renewable

Energy Programs (collectively referred to below as

20An& RePo~: Te~.lo~ Tra@er, Sad”a Natio~ ~or~orles, Fiscal yew 1987, SAND 87-0749, UC-13, April 1988 (Springfield, VA;

National Teehnical Information Service, 1988), p. 7; Robert Stromberg, Technology Transfer and Policy Department, Sandia National Laboratories,

personal communication, June 19, 1989.

zl~~d J*,Rogm A~inis~ator, Office of T~hnolo~ Applications, M~n Marietta Energy Systems, Inc., Oak Ridge National Laboratory,

personal communication, June 20, 1989.

22Rees L. Dwyer, III, Executive Assistant to the Assistant Secretary, Management and Administration. ~Partment of Ener8Y~ Wrsoti

communication, Oct, 18, 1989.

zsNational Sci~tl~Fomdatim,~~&r~ Fu~forResearch a~~eve~p~e~t: Fiscal years 198P, 1988, util$l?$l, VO1. 3’7, ~taikd Statistical Tablcs,

NSF 89-304 (Washington, DC: U.S. Government Riming Office, 1989), p. 29 (estimates for fiscal year 1989) (totals of figures shown for intramural

researeh and researeh in all Federally Funded Research and Development Centers (FFRDC s)). These figures are by agency, not by lab; agencies

sometimes spend money for research in other agencies’ labs. See ibid., pp. 4, 31.

zdsae o~r a~ncies also fund R&D in DOE labs.
186 ● Making Things Better: Competing in Manufacturing

Applied Energy programs) support various projects

beyond basic research that are not related to weapons

($1 billion). Only Applied Energy has commercialization of technology as a specific part of its

institutional mission.

These three programs support the work done in

three sets of labs: the four big national labs primarily

concerned with defense-related work (Lawrence

Livermore, Los Alamos, Sandia, and Idaho Engineering); the five medium-sized national labs that

focus primarily on basic research in energy (Argonne, Brookhaven, Lawrence Berkeley, Oak Ridge,

and Pacific Northwest); and 28 generally smaller

labs (e.g., the Princeton Plasma lab). Three of the

smaller labs —including the Solar Energy Research

Institute (SERI)—are run specifically by DOE’s

Applied Energy programs. In general, the larger labs

do some work for each of the three programs.

DOE labs are unlike nearly all the rest of the

Federal labs, in that all except two of the smaller

ones are operated by contractors (they are governmentowned, contractor-operated, or GOCOs). Almost all

other Federal labs are government-owned and government-operated (GOGOs). The contractors who operate GOCOS vary: some are profit-making, others

non-profit; some are industrial firms like Martin

Marietta, other are universities like the University of

California. GOCOS face some specific problems of

their own in the transfer of technology, as we shall

see later.

DoD LabS

There are some 68 DoD labs, and DoD spent

about $10.5 billion on lab R&D in 1989. These labs

are run directly by the Departments of the Army,

Navy, and Air Force.

Less is known publicly about the DoD than the

DOE labs, partly for security reasons. However, the

DoD labs have also been under increasing pressure

to encourage commercialization of the technology

that they develop. The Stevenson-Wydler Technology Innovation Act of 1980, the Patent &

Trademark Amendments Act of 1980, and the

Federal Technology Transfer Act of 1986 cleared

legal barriers blocking transfers from these labs and

promoted structural changes (like the delegation of

key decisions) that would encourage transfer. Some

DoD labs are clearly making a major effort in this

field and others have historically worked well with

the private sector. However, in October 1989 DoD’s

Office of the Inspector General published a report

that was sharply critical of the extent to which the

letter and spirit of the law had been implemented.25

Other Labs

NIH spends about $1 billion in Federal labs. All

NIH labs but one are GOGOS. NIH has a good

reputation for pushing its technology out toward the

private sector and encouraging its scientists to do

so.

26

NASA spends about $2.5 billion in the Federal

labs. All but one of NASA’s seven labs are GOGOS.

NASA’s labs (and those of its predecessor, NACA)

have been productive in collaborating with industry

(see box 2-A). Some of NASA’s lab work is still

useful to civilian aircraft manufacturers, but its main

focus today is the national space program.

NIST (the National Institute of Standards and

Technology, formerly the National Bureau of Standards) sees its work with industry as part of its

primary mission. NIST spends about$110 million in

its labs. The NIST labs have long worked closely

with industry in the areas of measurement, standards, materials science, and computer systems, and

NIST’s Center for Manufacturing Engineering (funded

at about $6 million) follows the tradition.

This section concentrates mostly on DOE’s nine

national labs. They are big, they work on a variety of

projects that could be of commercial interest, and

information about them is readily available. For

these reasons, the report uses an analysis of DOE’s

national labs to illustrate the problems and potential

of the Federal labs as a whole. As discussed below,

the light cast by the DOE national labs helps to

illuminate the positions of other agencies and labs.

While some might argue that DoD labs cannot be

expected to follow the same path toward the

commercialization of technology, there is evidence

that the defense-oriented DOE labs provide some

commercially important technology.

~U.S. ~p~rnent of ~fense, C)ffice of the inspector General, Report on the Audit ofthe DoD Domestic Technolo~ Tran$er Pro8ram, No. w-

(Arlington, VA: U.S. Department of Defense, Oct. 19, 1989).

W“he one area of special interest to manufacturing--biotechnology-is the subject of a separate OTA report, Biotechnology in a Global Economy,

scheduled for release in late 1990.
Chapter 7—Where We Stand: Public Policy and Technology ● 187

Commercializing DOE’S Technology:

Mechanisms

“Commercialization” here means making technology developed in the Federal labs useful in

industry. In the past, that typically meant nothing

more than the publication of research results in

conferences and journals, after which the results

would make their way to industry and eventually

find application. Today, such delay is costly, as U.S.

firms fall behind in applying the latest technology to

manufacturing. In these changed circumstances,

faster commercialization takes on more importance,

and several useful mechanisms to promote it have

emerged. Collaborative R&D is lab-industry teaming to create new technology for industrial use.

Spin-offs and startups transfer already existing

technology to existing and new firms respectively.

Various mechanisms (e.g., personnel exchanges)

can prepare the ground for either form of commercialization.

Collaboration

Collaborative R&D-planned, performed, and

sometimes funded jointly by the labs and industry—

is a powerful means of commercializing technology.

It is not entirely new for the Federal labs: NIH and

NIST, for example, have done collaborative work

with industry for years.27 However, it is not at all

common in DOE’s national labs; only 57 collaborative projects were under way in all national labs in

1987.28

Most of DOE’s collaborative R&D has been

carried out by its Applied Energy programs. These

have sometimes targeted particular industries for

ongoing R&D projects. This continuity allows the

labs and companies to get well acquainted with each

others’ interests, abilities, and needs, and to smooth

out ways of working together. For example, SERI,

which has worked on solar energy applications for

more than a decade, collaborated successfully with

U.S. industry in an effort to catch up with Japan in

the commercialization of amorphous silicon technology for solar cells. The SERI project lasted from

1984 to 1987 and had a 3-year budget of $19 million;

four firms put up 30 percent of the funds. A second

3-year program, lasting through 1990, is now under

way, and half of its $40 million funding is industrysupplied. In both programs, the firms are given

patent rights and certain proprietary rights to data,

enabling them to get a jump on the competition.29

DOE’s HTS pilot centers, also run by Applied

Energy, follow the targeting model. This experiment

is discussed in box 7-B.

Until recently, DOE’s Defense Programs viewed

commercialization as a distraction from its mission

of supplying the military’s needs, but it has come to

believe that the military would benefit from stronger

civilian industries.30 In 1989 it funded two labindustry consortia for work on dual-use technologies

(those having both military and civilian uses). One

group, working to improve the quality of specialty

metals such as nickel-based or titanium alloys, will

use Sandia’s specially instrumented research furnaces to monitor and control the production process.

During 1989-94, government will provide $2 million and the collaborating companies will contribute

$4.75 million. The industry share will increase

steadily, rising to 100 percent after 5 years. The

second consortium, the Advanced Manufacturing

Technology Initiative, will work on next-generation

manufacturing technologies such as advanced controller software and artificial intelligence. DOE has

funded this project at $500,000 for fiscal year 1990,

a level that will be maintained for four more years.

DOE funds for the two projects rose from $400,000

in FY 1989 to $1.1 million in fiscal year 1990.

Several other lab-industry collaborations for dual

use technologies are under consideration. These

include projects on plasma destruction of toxic

substances, combustion synthesis of ceramics, and

ceramic metal composites. However, the two projects noted above will entirely exhaust Defense

Programs’ funds for such collaborations for fiscal

year 1990.

‘z~,s, Gener~ ~cout~g Offjce, Tec~loU Tra~fer: ]Wiemen~tlon st~~ of the Federal Technology Tra@er Act of 1986, RCED-89-154

(Gaithersburg, MD: 1989), pp. 29-31.

z~ner~ Research Advisory Board, op. cit., p. 21.

zgIbid., pp. B5-B6.

soMilltW depdence on Civilian tw~olo= is &ScuSsed in U. S. Congress, Office of Technology Assessment, ~o~ing the Edge: Maint~”~”n8 fhe

Defeme Technology Base, OTA-ISC-420 (Washington, DC: U.S. Governrnent Printing Office, April 1989).

21-700 0- 90 - 7
188 ● Making Things Better: Competing in Manufacturing

Box 7-B—DOE’S HTS Pilot Centers

As part of its research program in high-temperature superconductivity (HTS), the Department of Energy (DOE)

started up HTS pilot centers at three of its national laboratories—Argonne, Oak Ridge, and Los Alamos—in October

1988. 1 These centers are planned as new ventures in lab-industry collaboration, a conscious experiment in rapid

technology development and transfer.

Each center has government funding of $1,6 million for FY 1989 (total $4.8 million), and $2.0 million per

center (total $6.0 million) is planned for FY 1990. In their first year of operation, the pilot centers negotiated 20

cooperative R&D agreements, with costs usually shared equally between the lab and industry. Industry was ready

to join in many more projects than the centers could fund.

Several features of the pilot centers are designed to expedite technology transfer. First, the centers have a

transfer-oriented mission and funds to accomplish that mission. The funds are spent only on projects requested by

industry. The labs and industry plan to collaborate over the whole R&D cycle, from basic research through product

development, with lessons from development fed back into research, Each center has an industry advisory board

which DOE consults on the substance and procedure of lab-industry collaboration.

DOE has tried to speed up the negotiation process by offering a model collaboration contract, which carries

automatic approval with changes requiring varying levels of clearance. At first, many firms found the model

contract’s terms unacceptable, but DOE has been revising the terms to meet the fins’ objectives. DOE also agreed

beforehand to waive rights to inventions made in pilot center research, to a greater extent than for cooperative R&D

generally. Also, for work funded at least half by industry, DOE allows, on a case-by-case basis, the withholding

of technical data from publication for up to 2 years. This delay, not generally allowed in DOE cost-shared research,

can give the firm a valuable head-start in the market.

The HTS pilot centers experiment will be evaluated after 2 years. DOE is committed to applying the lessons

learned to cooperative R&D in other programs,

1~~ AImos Natio~ Laboratory had rwmmxmied establishing these centers, when asked by DCIE to study how to involve industry

in developing HTS technology. John T. Whetten, associate director, Ims Atamos Nationat Laboratory, testimony at hearings before the House

Committee on Science, Space, and Technology, Subcommittee on Energy Research and Development, July 27, 1988, Serial No, 100-122, pp.

90-91.

In some cases of lab-industry collaboration, DOE Spin-Offs to Existing Firms

has put up all the money, with the private company

acting essentially as a contractor. This was the case Lab work done for purely research or defense

in the collaboration between Cray Research Corp. purposes sometimes turns out to have valuable and Los Alamos National Laboratory. Cray pio- commercial applications. Firms that make a point of neered the development of supercomputers. Its first staying in touch with the latest developments, in the and crucial customer was Los Alamos, which

needed massive computing power to simulate the government labs and elsewhere, can find out early

operation of weapons and nuclear power plants. about such promising research results and can adapt

Although Cray did most of the R&D and Los them to commercial purposes ahead of the competiAlamos paid for it, the lab was more than a passive tion. A firm’s own engineers are in the best position

customer, spending several person-years studying to glean research results from outside labs, because

Cray’s machines and suggesting design changes to they know their own product development cycle,

better suit the lab’s needs. The lab’s purchases were and hence the best times for incorporating new ideas.

crucial to Cray’s early survival. In 1976, when the However, monitoring the vast Federal labs system is

company was on the verge of bankruptcy,31 Los difficult even for large firms and often impossible

Alamos bought the first machine sold by Cray. By for smaller firms with more limited staff, Without

1989, Los Alamos had bought 14 Cray machines, for help from the labs, they are not likely to benefit from

a total price (net of trade-ins) of about $200 million. spin-off. The labs can help in several ways.

Slcray had appll~ t. the swfities and EX~h~ge Commission in 1975 for penmsslon to go pubhc, but its application WaS rejected because SEC

believed that there was no market for the Cray machine and the company would not survive.
Chapter 7—Where We Stand: Public Policy and Technology . 189

Occasionally, DOE labs have encouraged spin-off

by seeking out firms to apply the technology. For

example, Los Alamos gave copies of its Common

File System, software that lets different supercomputers share the same data, to several other government and commercial labs between 1980 and 1988.

To ease the burden of supporting the software and

also to reach a wider audience, Los Alamos found a

private firm to develop the software into a commercial product, and in January 1989 concluded an

exclusive licensing agreement providing for royalties and continued cooperation.32

Spin-off also takes place in less formal ways.

Firms with technical questions often get modest

amounts of free help from government labs. For

example, Sandia receives 600 industry visitors per

month and believes that its “free, helpful consultation” with industry is “probably the most productive and yet hard-to-quantify source of technology

transfer by the laboratory.”33 For example, the lab

has helped in designing high-pressure glass columns

for liquid chromatography; assisted in testing the

strength of metals; and provided manufacturers with

new types of glass that it developed for sealing to

metals. 34 Sandia staff even make house calls on

occasion. In one plant visit, the lab staff showed a

firm how to use new equipment to duplicate

Sandia’s superconductor fabrication process. This

help, according to the firm, ‘leaped us months ahead

of schedule. ’35 In turn, Sandia staff also learn how

their technology works in the field.

Startups

A lab’s technology is sometimes commercialized

not by an established firm but by a new firm started

for that purpose. Startups often can get a new

technology to market quickly and they may be more

committed to the technology than established firms,

but they may lack internal funding, experience in

manufacturing, plant or equipment, and distribution

channels. From 1985 to 1987, 87 startups were

formed to commercialize technologies from DOE

labs. 36

Researchers may leave a government lab to head

or work in the startups. Some labs encourage this by

granting entrepreneurial leave, with the right to

return to their old jobs within a stated time.37 These

labs see the movement of researchers into startup

firms as a good way to commercialize technology

quickly. However, some people are concerned that

lab research teams could be depleted and also that

labs might improperly favor their own researchers

over established firms for commercializing the

technology.

Some labs have gone farther in encouraging

startups. The Tennessee Innovation Center (TIC)

was formed in 1985 with $3.5 million from Martin

Marietta Energy Systems, the operator of Oak Ridge

National Laboratory .38 TIC provides numerous services to entrepreneurs, including office and lab space

and help in forming business plans and incorporation. TIC typically contributes capital of $30,000 to

$100,000 in return for a minority interest in the firm.

Its stock in its most successful investment was worth

about $7 million by June 1989.39

Another approach is offered by the non-profit

ARCH Development Corp., formed in 1986 as an

affiliate of Argonne National Laboratory and the

University of Chicago. ARCH is given patent rights

to virtually all inventions at Argonne and the

University of Chicago.40 It identifies those worth

patenting, bears the expense of obtaining patents,

and tries to license the inventions or, where it makes

SZC ‘Gener~ Atomics to Mtiet Los Alarnos Computer”softwme, ’ Los Alamos National Laboratory Public Affairs Office, Jan. 26, 1989; Raymond

Elliott, Computing and Communications Division, Los Alamos National Laboratory, personal communication, July 3, 1989.

33R. Geer, “Ta~olog Transfer Is a ~ocess of Q~et Matchm&ing, ” ~b N~s, vol. 41, No. 12, June 16, 1989, p. 1; Annual Report: Technology

Transfer, Sati”a National Laboratories, Fiscal Year 1987, op. cit., p. 9.

sdAn~ Report: Techno~~ Transfer, San&a National L.uboratories, Fiscal Year 1987, OP. cit., PP. 16, 23-25, 28-29.

35~.er from [author is ~onfidenti~] t. Dr. Dan Doughty, SuFWIWr, ~organicMateri~s, chemis~ Division1846, Sandia National Laboratories,

June 8, 1989.

sGEnergy Re~~h Advisory Board, op. cit., p. 42.

3Tu.s. Department of Energy, Technolo~ Tra@ers~ ry, July 1988, p. 6; see also David Kramer, “Two Los Alarnos Scientists Forma Spin-off

To Develop New Cell-Probing ‘Tweezers,’” McGraw-Hill’s Technology Tran.@er Report, February 1989, p. 3.

3EThc funding in turn came from the management fee paid by DOE

sg~n~d J~ed, ~ogm A&n~istrator, Office of T~hnolo~ Applications, M~~ M~ietta Energy Systems, OA Ridge National LtdX)ratory,

personal communication, June 20, 1989.

%incetheUniversity of Chicago, which operates Argonne, is a nonprofit organization, DOE waives its patent rights on request, with some exceptions.

The waiver process is discussed later in this section.
190 ● Making Things Better: Competing in Manufacturing

good business sense, forms a startup firm itself to

commercialize the invention. The startup’s initial

capital comes partly from a $9 million venture

capital fund managed by ARCH, but ARCH usually

waits to get additional capital from an unrelated

party, as an objective check on the proposed

company’s worth. ARCH is seeking to replicate the

environment at MIT and Stanford, which has done

well in supporting startup fins. MIT, with its

research budget of only $700 million and only seven

professional staff working on patents and licensing,

produces about the same number of licensing

agreements and new firm startups as all of DOE’s

labs combined, with their government budget of

more than $5 billion.41 The success of MIT and

Stanford owes much to the infrastructure of entrepreneurs, venture capitalists, business planners,

lawyers, and bankers, which ARCH is seeking to

replicate.

Other Forms of Technology Transfer

A common and relatively simple way of making

lab technology available for commercial purposes is

to let firms use the labs’ specialized facilities. This

is not a new idea. Before World War II the National

Advisory Committee on Aeronautics made its windtunnels and other test facilities available to commercial aircraft companies, and NASA continued to do

so after the war. Today, DOE’s national labs allow

private firms to use an array of expensive specialpurpose facilities. In 1987, about 185 scientific

facilities in the national labs were used by 1,623

industry and university participants.42 As of March

1989, Brookhaven National Laboratory’s two synchrotrons, set up as advanced X-ray sources, were

being used by more than 80 American universities,

23 U.S. fins, 14 other government labs, and 22

foreign institutions.43 The Combustion Research

Facility at Sandia National Laboratories offers

specialized lasers and computers for studying how

fuels burn. Its users include General Motors, Ford,

Chrysler, Exxon, Mobil, Conoco, Unocal, Combustion Engineering, AT&T, and GE.44

The Federal labs are also putting new emphasis on

technology transfer in their formal communications—

published papers, conferences, and so on. Several of

DOE’s national labs, for example, publish semitechnical brochures to acquaint industry with technologies which may be of interest. Meetings and

workshops focused on technology transfer are increasingly common.

The Federal Laboratory Consortium (FLC), composed of representatives from Federal laboratories,

also promotes communication with industry .45 The

FLC guides firms into the Federal lab system,

showing them where to go for help on a particular

problem--often within a day or so of the initial

inquiry. In conjunction with the Industrial Research

Institute, the FLC held lab-industry conferences to

identify possible areas of collaboration in manufacturing technology (in 1988) and in hazardous

waste management (in 1989). The FLC also funds

projects to demonstrate technology commercialization. For example, the University of Utah has a

database on specific interests of high-technology

firms, using it to market the University’s own

inventions. The FLC paid the university to adapt this

database for experimental use by three Federal labs.

Finally, the FLC, the Department of Commerce, and

DOE all maintain computerized general-purpose

databases on technologies of possible interest to

industry. Some of the labs also maintain specialized

databases, such as one on superconductivity at Oak

Ridge National Laboratory.

Many of the mechanisms described above rest

implicitly or explicitly on personal contact between

lab employees and private industry, and indeed the

exchange of personnel between labs and industry

offers another mechanism for technology transfer.

Lab researchers can take sabbaticals or visiting

positions to spend time (perhaps a year or two) in an

established company, and vice versa—with benefits

both of immediately transferring information in both

directions and developing personal contacts for the

future. Such formal exchanges have been rare in the

41 JohII T. Reston, Director, MJT Technology Licenstig Office, ‘ ‘Creating New Companies and Business Units Within Existing Companies via

University License Agreements, ” presented to the European Venture Capital Association 1987, modified April 1989; Senator Pete V. Domenici,

testimony at hearings before the Senate Committee on Energy and Natural Resources, Subcommittee on Energy Research and Development, May 11,

1988, SeriaJ No. 100-602 (Part 2), pp. 34.

qz~er~ ReWarch Advisory Board,, Op. cit., pp. 21, 61.

dsDavid timer, “For Mre: Lab Facilities,” McGraw-Hill’s Tech Transfer Report, Mwh 1989, P.1

~~bid.; An@ Report: Tec~~gy Transfer, Sandia Natwnal Laboratories, Fiscal Yeu 1987, op. cit., p. 8.

45~@~ly e~~blish~ by tie ~fe~~p~ment in 1971, the ~C evolv~ ~ an info~~ coordinating ~oup ~ti] it was given an offki~ mandate

by the Federal Technology Transfer Aet of 1986 (see 15 U.S.C. 3710(e)).
Chapter 7—Where We Stand: Public Policy and Technology ● 191

national labs. In 1987 just 19 industry researchers

came to them, and 4 lab scientists went to companies, in an exchange program underwritten by DOE.

However, about 400 more industry scientists and

engineers worked less formally at the national labs

at some time in 1987, using funds from industry and

DOE R&D programs. Lab researchers can also serve

as consultants to industry-a practice that increased

in the 1980s (from 266 consulting projects in 1981

to 697 in 1987).46

Barriers to Technology Transfer

A number of factors limit the Federal labs’

transfer of technology to industry. There are problems related to the labs’ historical mission, the

bureaucracies that run the labs and supervise them,

and the nature of technology transfer itself (especially in the area of exclusive rights). Industry itself

is not blameless: for example, both U.S. universities

and foreign corporations send more visitors to the

labs than does U.S. industry .47

Mission--The lion’s share of DOE labs’ funding

comes through the Defense and Energy Research

Programs. For these programs, commercialization

tends to be low priority. In contrast, DOE’s Applied

Energy projects are usually planned with commercial application as an integral part of their mission,

and it is on the whole accomplished effectively.

However, Applied Energy has a small and declining

share of DOE lab funding.

Funding-Technology transfer does not come

cheap. Identifying technologies with commercial

possibilities, finding firms that might be interested,

and exchanging information with those firms take

time and effort, but are necessary parts of aggressive

technology transfer. Negotiating terms with firms

interested in licenses—and fighting through red tape

back at the lab or agency—takes still more effort,

indeed probably requires some full-time technology

transfer staff. Encouraging startup firms can also be

expensive. Patenting is also expensive, especially

outside the United States. And if the labs go in for

collaborative R&D projects with industry, the labs’

share must be funded--often a a level greater than

could be justified by the labs’ defense or basic

research missions.

On the whole, DOE’s technology transfer effort

has been underfunded. Collaborative R&D has

rarely been funded outside the Applied Energy

programs and technology transfer offices have been

thinly staffed. DOE is not alone in this. DoD, for

example, has required its labs to fund technology

transfer activities out of overhead.48

Lab directors and agencies can hardly be expected

to embrace technology transfer enthusiastically if

they have no money to pay for it, or have to rob Peter

to pay Paul. Low spending is also a signal. Skimpy

funding leads companies to question the labs’

commitment. 49 Dependability is important too. Delays in expected funding have caused industry to

view the labs as unreliable collaborators. 5o I n

addition, firms may hesitate to pledge themselves to

multi-year projects when the government will commit funds only year by year.

Incentives—Incentives for collaboration in the

labs are sometimes weak or even negative. Time

spent answering a fro’s questions is usually time

spent away from research; and help to industry does

not always count in a researcher’s performance

evaluation, even though the law specifically directs

46Enera RexMch Adviso~ B~~d, op. cit., pp. 21.22. @Iy 45 indus~ re~~chers visited the DoD labs in 1986, while 291 visited the much Smidler

NIST (then called NBS) labs; U.S. General Accounting Office, Technology Transfer: U.S. and Foreign Participation in R&D at Federal Laboratories,

RCED-88-203BR (Gaithersburg, MD: U.S. GeneraJ Accounting Office, 1988), p. 20.; Rees L. Dwyer, III, Executive Assistant to the Assistant Secretary,

Management and Administration, Department of Energy, personal communication, Jan. 4, 1990.

d?David fi~er, “TriVelpl~e: Visits Give Rise to Tech Transfer,” McGraw Hill’s Tech Transfer Report, March 198~, p. 5.

48u.s.~p~ment of ~fe~, Office of tie ~swtor Gener~, Report on be Audit of the DOD Domestic Technology Transfer ~ogr~, Report No.

90-006, Oct. 19, 1989, pp. 8-9.

dgJo~ Whetten, act~g dir~t~, LOS Almos National Laboratory, testimony at hearings before the House COmmitti on Science> SPace~ and

Technology, Subcommittee on Energy Research and Development, July 27, 1988, Serial No. 100-122, p. 90.

s~llli~Black, Jr,, Senior Vice President, Biomagnetic Technologies Inc., testimony at hearings before the House COmmittw on scie~e~ SP~el

and Technology, Subcomrni tt= on Energy Research and Development, June 23, 1988, Serial No. 100-118, pp. 79-80; William Gallagher, manager,

Exploratory Cryogenics, Thomas J. Watson Research Center, research division, International Business Machines Corp., testimony at hearings before

the House Committee on Science, Space, and Technology, Subcommittee on Energy Research and Development, June 23, 1988, Serial No. 100-118,

p. 156; Harold Hubbard, Director, Solar Energy Research Institute, testimony at hearings before the House Committee on Science, Space, and

Technology, Subcommittee on Energy Research and Development, July 27, 1988, Serial No. 100-122, p. 97.
192 ● Making Things Better: Competing in Manufacturing

that it should.51 Collaborations with industry maybe

unattractive if the work is proprietary and the

researcher cannot publish his results. In addition,

time that researchers spend on sabbatical in industry

is often not counted as pensionable.

Recently, researchers and their labs have been

permitted to keep portions of patent royalties paid

for their inventions. While the amount of money is

often modest, it does offer recognition for work that

is useful to industry .52 Some agencies and labs

provide added incentives. At least one lab (Oak

Ridge National Laboratory) sets aside an extra 4

percent of royalties to reward lab researchers other

than those named as inventors on licensed patents

for extraordinary contributions to technology transfer.53

Slow Negotiations--Speedy negotiations for licensing of technology, and also for collaborative

R&D (which typically includes licensing provisions), are important to fins. They have to fit

innovations into their product development schedules and hold on to earmarked funding (their own or

investors’). Delays can cause deals to collapse as the

firm’s strategic situation changes, or the people

involved move on. Startups are especially vulnerable.

Negotiations with labs can often take many

months. Some delay may be hard to avoid but some

is caused by bureaucratic slowness and government

reluctance to grant exclusive rights. Both are largely

avoidable. Reviews by agency headquarters that

convert two-way negotiations between a lab and a

firm into three-way negotiations have often been the

culprit.54 For GOGO labs, agency review of collaborative R&D agreements was in principle shortcircuited by the Federal Technology Transfer Act of

198655 and an Executive Order in 1987,56 which

respectively permitted and required agency heads to

delegate to lab directors the authority to negotiate

collaborative R&D agreements, subject to agency

veto within 30 days. However, many agencies have

been slow to implement this delegation.57 Moreover,

these provisions did not apply to DOE’s GOCO labs.

After complaints by labs and industry about DOE

red tape, Congress in November 1989 amended the

law to permit similar delegation of authority to

GOCO labs.58 DOE will probably make such a

delegation. 59

Exclusive Rights—Many delays revolve around

the companies’ desire for exclusive rights, to help

recover the cost of expensive R&D efforts. Exclusive rights may also carry certain social costs,

including higher prices and reduced use of the

technology by others.60 These costs and benefits

must be balanced case by case. 6l This sort of

decision might be made by the labs themselves,

subject to agency guidelines and audits. However, in

many cases the labs’ hands are tied.

slThe F~er~ Technology Transfer Act of 1986 directs lab directors tO “ensure that efforts to transfer technology are considered positively in . . .

evaluation of. . . job performance.” 15 U.S.C. 3710(a).

s2The F~er~ T~~ology Tr~sfer Act of 1986 ~lo~s re~~chers in GOGOs to collect 15 percent of the roy~ties from their patf311tS, Up tO $]~,ooo

per year. Many agencies, including DoD, voluntarily give inventors a greater share. The lab gets much of the rest. Many of DOE’s GOCO labs also give

the inventors a share of patent royalties. U.S. Congress, General Accounting Office, Technology Tram~er: Implementation Status of the Federal

Techno@yActof 1986, op. cit., pp. 37-38; Energy Research Advisoxy Board, op. cit., p. 44; U.S. Department of Energy, Technology Transfer Summary,

July 1988, p. 5.

Ssclyde HwfiM, ~sident, M~in M~ena Energy Systems, Inc., testimony at hearings before the House COmmitw on science, Space> and

Technology, Subcommittee on Energy Research and Development, Mar. 25, 1988, Serial No. 100-136, p. 45.

54JoWh ~len, &=tor, Offiw of F~er~ T~~oloa Management, U.S. ~p~ment of Commerce, ~rson~ communication, MM. 9 ~d 21, 1989.

55Se 15 u,s.c< qTIOao ~s au~ori~ applles o~y to projats in which the lab contributes only personnel, se~ices, facilities, quipment or other

in-kind resources; the lab cannot pay money to its industrial partners.

sGEx~utive Order 12591, Apr. 10, 1987.

s~.so Congess, ~ner~ ~comung office, Techno~gy Trawfer: Implementation Status of the Federal Technolou Tra~fer Act of 1986, oP. cit.,

pp. 23-30; U.S. Department of Defense, Office of the Inspector General, op. cit., p. 10.

58Nation~ Comwtitiven=s ‘r’~hnolow Transfer Act of 1989, fib~ic Law 101-189, SCC. 3133 (amending 15 U.S.C. 3710a).

59D0E h~ ~Eviou~ly ~upW~~ ~ bill which ~o~d have made s~h delegation mandatory for the nation~ labs. (The bill Wm not enacted.) btter

from John Herrington, secretary, U.S. Department of Energy, to Senator Pete Domenici, Sept. 28, 1988, supporting S. 1480, as reported in Senate Report

No. 100-544, Sept. 23, 1988. See Sec. 205.

~hese costs and benefits apply to intellectual property protection (patents, copyrights, trade secrets) in general, not just in lab-industry agreements;

see the section below entitled Intellectual Property,

61ExcluS1ven@~ c~o~n~ liml~ to ap~c~~ applic~on of We t~hnology. For ex~plc,~engine manufacturermight be gh%tt the fSXChlSk

right to use a patented alloy in engines, but be given only a nonexclusive right, or no right at all, to use the alloy in other products.
Chapter 7—Where We Stand: Public Policy and Technology ● 193

. Patents. In order for DOE labs to give firms

patent rights, DOE must generally first waive

those rights. In the past few years, labs have

experienced long waits in obtaining waivers. It

appears that it typically took 6 to 12 months

from the lab’s application until DOE approval.

In early 1989 DOE’s patent counsel worked to

eliminate any backlog of applications over 6

months old, but the waiting times have again

grown longer pending resolution of policy

issues. Some labs have complained about the

paperwork DOE requires for waivers. DOE’s

view has been that it is required by statute to

consider certain factors in granting waivers.62

In the Bayh-Dole Patent Amendments Act of

1984, Congress tried to cut this red tape for

DOE’s labs with non-profit operators. The Act

provided that, with certain exceptions, these

labs need not apply for waivers but can simply

claim the right to government-funded inventions.63 Congress specifically exempted inventions that are classified for security reasons (for

which DOE rarely if ever grants waivers

anyway), and also unclassified inventions at

defense-oriented labs that relate to weapons or

naval nuclear propulsion. Congress also permitted DOE to exempt other inventions under

“exceptional circumstances.” 64 After DOE

implemented this provision in its operating

contracts with these laboratories,65 DOE had

disagreements with the Commerce Department

and the University of California over the proper

scope for DOE’s ‘exceptional circumstances”

exemption.

DOE has supported extending the BayhDole approach to national labs with for-profit

●

●

operators, 66 and also to unclassified weapons

inventions unless they are designated as sensitive technical information-all subject to guidelines and safeguards such as restricting the use

the operator may make of royalties.67 However,

this legislation was not enacted.

Proprietary Rights. The right to keep data

proprietary may be as important as patent rights

to firms. Until recently, the Freedom of Information Act (FOIA) was a major obstacle, at least

calling into serious question an agency’s ability

to keep secret the results of collaborative R&D.

This discouraged firms from participating.68

However, Congress recently largely removed

this obstacle, exempting the results of collaborative R&D from release under FOIA for 5

years-usually enough time to get a head start

in the market.69 DOE’s organic statute (the

provisions that set up DOE and its predecessor

agencies) provides that DOE should not hinder

the dissemination of technical data.70 The

courts have not ruled on how this might apply

to results of collaborative research. DOE believes that the Act might apply, but only to data

actually in the custody of DOE or the lab.

Copyright of Software. Firms that develop

government software into a commercial form

or who collaborate with the government to

create software are also likely to insist on

exclusive rights. Often secrecy is not practical,

as software can be duplicated once it exists.

Copyright could provide effective protection.

However, it is generally not possible in collaborations with or licenses from a GOGO, because

material developed in whole or part by govern6~e law ~~nc. ~E t. follow the ~o~~ of ~romot~g Commercialization, fostefing competition, making tie benefits of R&D widely available

in the shortest possible time, and encouraging fiis’ participation in DOE research, and to consider such factors as the firm’s investment, ability to

contribute to research or commercialization, and the need to grant rights as an incentive to participation. See 42 U.S.C. 5908.

6335 UOS,C. 202(a). Al~ou@ AT&T T~~ologies, tie AT&T subsidi~ that ~s Sandia, takes no management fee, it is considered a fOr-prOfh fi~

for this purpose. .

~35 U.S.C. 202(a); see also 35 U.S.C. 200.

65s~ Energy Rese~ch Advisory Board, Op. cit., p. 49.

@These include Martin Marietta Energy Systems, Inc., which operates Oak Ridge; AT&T Technologies, which operates Sandia; and EG&G Idaho,

Inc., Westinghouse Idaho Nuclear Co., Inc., and Rockwell-INEL, which operate Idaho National Engineering Laboratory.

67~~er from Jo~ Hern~gt~n, s=re~, us, ~p~ment of Ener~, to senator Pete ~menici, Sept. 28, 1988, suppofiing S. 1480, as reported in

Senate Report No. 100-544, Sept. 23, 1988. See Sees. 207,209.

MU,S, Congess, Gener~ ~comting office, Tech~~gy Transfer: lrr@ementation Status of the Federal Technology Tra~fer Act of 1986~ OPO CitOI

p. 49; US. Congress, General Accounting Office, Technotbgy Transfer: Constraints Perceived by Federal Laboratory and Agency ~ciah, op. cit.,

pp. 15-17.

69Nat10~ Competitiveness Tw~o~on Transfer Act of 1989, ~blic Law 101-89, &x. 3 133(a)(7) amending 15 U.S,C. 3710a.

T~e law stites, for exmple, that ~mgements for conducting research shall not “contain any provisions or conditions Which Prevent the

dissemination of scientific or technical information except to the extent such dissemination is prohibited by law. ” 42 U.S.C. 2051.
194 ● Making Things Better: Competing in Manufacturing

ment employees is not copyrightable.71 Hence,

officials at several labs and agencies favor

changing the law.72

This problem does not arise in GOCO

collaborations, since GOCO lab staff are not

government employees. However, DOE initially permitted firms to copyright software

created partly by a lab only if the firm agreed to

deposit the source code for public inspection—

which firms were sometimes unwilling to do. In

1989, DOE changed its policy to permit fins,

on a case-by-case approval, to make public

only an abstract of the software.73

Additional Concerns—Even if labs and parent

agencies make it a part of their mission to put

government research at the service of industry, and

if they get funds for the purpose, other concerns still

can stop efforts to promote commercialization unless a strong voice within the agency favors such

efforts. Moreover, balancing other concerns, such as

U.S. national security, against the benefits of commercialization is likely to require intra- and interagency coordination and indeed Presidential leadership.

One concern is fairness. In offering licenses to

technology and opportunities for collaborative work,

labs and parent agencies try to avoid favoring

particular fins. The practical matter of avoiding

lawsuits or complaints to Congress is involved, as

well as the ethical issues of fairness. But attempts to

be fair can slow commercialization.74

Also, lab-industry collaboration has the potential

for conflicts of interest. For example, the collaborating lab researcher may also have done private

consulting for the firm, may have once worked for

the firm, or may seek royalty payments for himself

or the lab from the firm. Guarding against conflicts

of interest takes careful planning and judgments.

Agencies without a strong commitment to technology transfer might prefer to avoid the whole

problem.

Some labs, such as NIH, place a high value on free

exchange of ideas within the lab and with people

outside. This poses problems for collaborations

involving proprietary research with industry .75

National security needs may also clog the free

flow of information out of the labs. In response to

this problem, DOE’s Defense Programs office assigned responsibilities for information security and

technology transfer to the same staff, thus helping to

ensure that the two concerns are fairly balanced.

Sandia did the same.76

Finally, there is the tricky double problem of

defining a U.S. firm and determining Federal lab

policy toward non-U.S. firms.

General Applications

The story of the DOE labs has implications for all

the Federal labs, despite the differences among

them. One is simply that technology transfer can be

done. There are some success stories from DOE,

most of them rather unpublicized. Technologies did

emerge from the labs and were exploited by U.S.

fins, often with help from the labs. On the other

hand, the story also suggests that even the DOE labs,

which have faced considerable congressional scrutiny on this issue in recent years, have a long way to

go in improving their performance.

The HTS pilot projects illustrate both sides of the

story. DOE took significant steps forward in setting

up the projects and committing to apply the lessons

that may emerge from them to other lab programs.

However, the process is likely to be a slow. The

experiment lasts 2 years, evaluation will take time,

the development of DOE-wide policy will take

longer, and implementation of that policy will take

longer still. This is in the nature of the beast, and

DOE should not be faulted for working methodi7117 LJ.s.c. 105, 101.

72u.so Congess, Gener~ ~comting office, TechM~gy Transfer: Implementation Statu of the Federal Technolou Tra~fer Act of 1986* oP. cit. >

pp. 4849; U.S. Congress, General Accounting Office, Technology Transfer: Constraints Perceived by Agency ~icials, op. cit., pp. 11-12.

73~cording t. DoE’s ~oul, it is Wsslble hat a cow wo~d nevertheless compel disclosure of tie entire source code under the NE’s OrgaIliC

statute. Richard Constant, Assistant General Counsel for Patents, U.S. Department of Energy, personal communication, Feb. 23, 1989. However, DOE’s

position is that publication of the abstract satisfies the agency’s dissemination requirement.

WU.S. ConHess, Gener~ Accounting Office, Technology Transfer: Implementation Statw of the Fedemf Techhv Tra~fer Act of 19~6~

RCED-89-154 (Gaithersburg, MD: May 30, 1989), pp. 49-50. In general, collaborative R&D agreements contracts are not subject to the stringent fairness

requirements of government procurement contracts.

75u.s. Congess, Gener~ Accounting C)ffice, Technology Tran@er: Constraints Perceived by A8enV o~ic~~~ oP. cit.> P. 17”

76Ad Report: Tec~~~ Tramfer, Sa&’a Natio~l ~boratorles, Flsc~ Year 1987, op. cit., ~. 9.
Chapter 7—Where We Stand: Public Policy and Technology ● 195

cally. However, the process could easily take 4 to 5

years-the equivalent of two generations of products in some high-technology sectors.

Attitudinal barriers need to be further dismantled

as technology transfer becomes an organic element

of most programs, rather than remaining the province of isolated specialists or even special programs

(like Applied Energy at DOE). Commercialization

needs to be supported with funding, which includes

funds for appropriate people. For example, the

recent Inspector General’s report on the DoD labs

highlights the paucity of patent lawyers, leading to

a backlog of applications and hence of technology

transfers that cannot be made until applications have

been filed. Legal obstructions need to be addressed,

such as the problems surrounding software copyrights and DOE’s ability to maintain proprietary

information. Also, authority must be delegated to

levels low enough to get the job done. DOE’s labs

have suffered long delays at agency headquarters

and, according to the Inspector General’s report, the

DoD has not delegated sufficient authority or given

policy guidance to a low enough level in the DoD

hierarchy.

There are many reasons-financial, legal, practical, and philosophical-why the gears still grind

slowly in bringing new technologies out of Federal

labs and into manufacturing companies. It is much

easier for both labs and parent agencies to go on

doing things the traditional way than to tackle new

problems in government-industry interaction— such

as justifying extra funding for technology transfer,

wrestling with conflict of interest issues, or negotiating collaborative research. It is also evident that real

difficulties stand in the way of making the necessary

changes. The labs’ success in transferring technology will depend very much on funding for this

purpose and on the will and attitude of senior lab

managers and top officials of parent agencies, along

with continued leadership from Congress and the

President.

ENGINEERING RESEARCH

CENTERS

The idea of creating university-based, multidisciplinary engineering research centers (ERCs) came

out of discussions in 1983 between the National

Science Foundation (NSF), the National Research

Council, and the President’s Office of Science and

Technology Policy. 77 It was hoped that these center%

would help the performance of U.S. industry by

strengthening some of the weak links in American

engineering: the link between engineering education

and the real world of manufacturing, the link

between university engineering research and industry engineering problems, and the links between the

engineering disciplines.

NSF began to setup the program in 1984, and by

1988 had funded 18 ERCs at an average of about $2

million per center annually .78 (Box 7-C lists the

ERCs and their areas of research.) The NSF funds

cover about half the costs. Industry contributes about

one-third, and the rest comes from university, State,

and local finds. Each center gets NSF funding for an

initial 5-year period, with a review after the third

year. If the evaluation is positive, the ERC gets 5

more years of funding, starting with year four.

Another review after the sixth year leads (if it is

positive) to a final 5 years’ funding from NSF—a

total of 11 years, after which the ERC has to compete

for new funds with proposed centers or else find

some other source of money.

For an innovative n-year program that was

deliberately planned with a long time horizon, it is

too early to draw definitive conclusions about the

program’s success in meeting its goals. A few

observations based on experience so far are in

order. 79

Overall, the centers have attracted impressive

levels of financial support and participation from

industry—a crucial element in their success. Individual centers get from 9 to 61 percent of their

funding from private companies, and about 420

companies are taking part. However, most of the

TTMuCh of tie material in this section is drawn from ~hp Shapira, “The National Science Foundation’s Engineering Research Centers: Changing

the Culture of U.S. Engineering?” contract report to the Office of Technolo~ Assessment, March 1989. Additional material is drawn from David

Sheridan, “The Engineering Research Centers,” contract report to the Office of Technology Assessment, June 1989.

T81n January IW th.rtx more ERCS were established.

T~ew ob~ryations we b- on inte~iews with NSF officials, and site visits to ERCS at four universities, including interviews with fac~ty

members, students, and industry participants in the ERCS. The universities were Carnegie-Mellon, the University of Illinois at Urbana, the University

of Maryland, and Purdue. For more details of the visits and interviews, see Philip Shapira, op. cit.
196 ● Making Things Better: Competing in Manufacturing

Box 7-C—The National Science Foundation Engineering Research Centers

In June 1984, the National Science Foundation (NSF) invited proposals for the creation of Engineering

Research Centers (ERCs). The Foundation received 142 proposals from over 100 universities. Six centers were

selected in 1985:

. Columbia University, telecommunications

 Massachusetts Institute of Technology, biotechnology process engineering

● Purdue University, intelligent manufacturing systems

● University of California-Santa Barbara, robotics systems in microelectronics

* University of Delaware, composites manufacturing

● University of Maryland/Harvard University, systems research

Another round of 102 proposals was evaluated in 1986; NSF awarded five additional ERCs:

● Brigham Young University, University of Utah, advanced combustion

. Carnegie-Mellon University, engineering design

Q Lehigh University, large structural systems (for construction)

. Ohio State University, net shape manufacturing

. University of Illinois, compound microelectronics

In 1987 three more centers were designated:

. Duke University, emerging cardiovascular technologies

. University of California-Los Angeles, control of hazardous wastes

* University of Colorado/Colorado State University, optoelectronic computing systems

in the fourth round, 1988, four more centers were awarded:

. North Carolina State University, advanced electronics materials processing

● Texas A&M University, University of Texas-Austin, offshore technology for recovery of oil and other

resources

* University of Minnesota, interracial engineering

● University of Wisconsin—Madison, plasma-aided manufacturing

In 1988, the third year review of the first generation of ERCs resulted in decisions to phase out two

centers-Delaware and Santa Barbara--over the following 2 years. The other four original centers were continued

for another 5 years.

And in January 1990, three more centers were added:

* University of Montana, interracial microbial proves engineering

. Mississippi State University, geometrically complex field problems

● Carnegie-Mellon University, data storage systems center

companies are large (over 500 employees). The operation for more than a couple of years can all cite

program does not reach many small or medium-size

firms. 80

Industry participation ranges from short-term help

with specific problems, to recruitment of welltrained engineering graduates, to collaborations in

long-term strategic research (e.g., several firms are

participating in the optoelectronics program with the

two Colorado universities, as a way of getting into

future generations of semiconductor manufacture

and application). The centers that have been in

specific examples of technology transfer to industry.

For instance, an advanced engineering design system developed at the Carnegie-Mellon Center is now

being used by General Motors. Most of the technology transfers so far. though, have tended to be highly

specific technologies. For example, a performance

analysis workstation developed at the University of

Maryland center has been commercialized by AT&TSUN. NSF hopes that the centers will develop

‘‘whole new technology systems rather than pieces

of systems. ’

‘ao~ ~xception is MT’s biot~hnology program, In this field, many of’ the leading ~ornp~lcs we Srnal!
Chapter 7—Where We Stand: Public Policy and Technology ● 197

While comments by industry representatives on

the ERCs were nearly all favorable, observations by

university faculty members on industry’s involvement were more mixed. Many faculty members

emphasized that contacts with industry had a positive influence on their own research, and that the

program had established new relationships or enriched existing ones. On the other hand, some

faculty members criticized industry’s short-term

outlook and unstable participation. Some (not all)

companies seemed interested only in getting immediate answers to particular problems and avoided

risky or long-term research. More generally, ERC

faculty were concerned about the constant turnover

of industry representatives, which obliges them to

keep training new industry people. Said one: ‘There

is a constant educational process. ’

The evidence so far shows the ERCs are making

good progress in educating engineers in new ways.

They are giving students opportunities to work with

industry while they are in training; exposing them to

an array of engineering disciplines and methods;

giving them access to sophisticated research facilities; and fostering an interest in manufacturing. ERC

graduates seem to have little trouble finding jobs,

and in several cases corporate sponsors have actively

recruited students before they graduated. Some of

the students fear, however, that they will not be

properly recognized by industry since their education has broken the mold of traditional disciplinary

boundaries.

The number of students affected by the program

is still small. In most of the universities with ERCs,

only about 1 percent of engineering undergraduates

are taking part in the ERC program (MIT, with

nearly 14 percent undergraduate participation is a

notable exception); between 2 and 14 percent of

engineering graduate students in universities with

ERCs are participating. And only 18 of the 280-plus

U.S. colleges and universities offering engineering

education have ERCs.

The ERCs have far less funding from NSF than

originally planned, and this has caused problems for

some of the centers. Individual ERCs are getting

$300,000 to $1 million less per year than expected.

Some have been able to makeup the difference from

industry contributions, but others have had to reduce

the scope of research and cut funds for equipment

and students. One ERC director said that the

shortfall in funding had curtailed efforts to build

relationships with smaller businesses, and forced

him to spend more time in fund-raising and less in

research. It is possible that the industry share of ERC

funding will continue to rise. However, companies

tend to emphasize short-term projects, and their

support over the long term is uncertain. In a survey

by the General Accounting Office of companies

sponsoring ERCs, 85 percent of respondents said

they would continue support for the following year,

but only 41 percent were willing to commit support

4 years in the future. Thus, it is likely that with

greater industry funding would come less stability

and more pressure for short-term results.

The ERC program is mostly at the research end of

the R&D spectrum in industry. Whether it will lead

to successful commercialization of new products or

manufacturing processes is unknown. On this point,

there is some skepticism within the program itself.

As one ERC program manager with NSF said: “I

think the ERCs will make clear the next generation

of technology systems in their particular areas of

research, but who in the United States will be

capable of manufacturing those new technologies?’

A faculty member at the University of Illinois ERC

said: “It will be Sony, Toshiba, and other Japanese

companies that will commercialize it. ’

Possibly the ERCs’ biggest impact on industry

will be the caliber of the engineering students turned

out. ‘‘When they move into industry,” said one NSF

official, “those engineering students will be well

prepared to take on the engineering problems of

industry in a real world industrial context. ” He

added: “I look for them to move into management

eventually where they will make their greatest

contribution. About half the managers in Japan have

a technical background, but the proportion in the

U.S. is much lower. I’m hopeful the ERCs will play

an important role in correcting this imbalance. ’

TAPPING INTO JAPANESE

TECHNOLOGY

Until recently, U.S. industry gave rather scant

attention to research results and new technologies

developed in Japan, for several reasons. First, many

people in U.S. industry were hard to convince that

Japanese technology had much to offer. This skepticism is now rare. Second, much of the Japanese

superiority stems from excellence throughout the

manufacturing process, and this involves things that

are hard to copy. It is no easy matter to imitate a
198 ● Making Things Better: Competing in Manufacturing

whole interrelated system of organizing work and

managing people. However, many U.S. managers

are trying to adopt various aspects of Japanese

manufacturing practice, and some are making headway.

Today, interest in Japanese technology goes

beyond the factory into the laboratory. Japanese

engineers and scientists are adding strength in

research to their proven abilities to adopt foreign

technologies and improve on them. Thus, keeping

up with research results from Japanese labs is taking

on new importance.

People-to People Technology Transfer

The Japanese have long been adept at keeping up

with foreign scientific and technological research by

sending people to study in other countries. For years,

a great many Japanese scientists and engineers have

undertaken graduate studies in American universities, attended scientific meetings in the United

States, visited U.S. national laboratories, and won

fellowships in U.S. Government laboratories. But

the flow has mostly been one way. For example, in

1988 there were over 6,700 Japanese scientists and

engineers working in U.S. Government and university facilities. The number of Americans working in

Japanese labs was probably 800 at most.81

Several factors account for the meager presence of

technically trained Americans in Japan. First, U.S.

engineers have not been particularly eager to work

in Japan. Not many speak Japanese and until quite

recently, few were interested in learning it. For those

engineers and scientists who do want temporary

assignments in Japan, high living costs and the

difficulty of finding jobs for spouses are other

important obstacles. Moreover, very few U.S. companies or institutions have wanted to send technical

people to Japan for extended stays, nor do they

especially reward scientists and engineers who have

experience in Japan. For example, MIT graduate

engineers who take MIT-sponsored internships in

Japanese Government, industry, or corporate labs

usually find on their return that they are hired on

much the same terms as engineers with no Japanese

experience or Japanese language.82 However, the

personal relationships the interns form in their year

or two in Japan may prove of great importance over

the years in learning about the latest Japanese

advances in technology. One company manager said

that these young people may well turn out to be the

industry leaders 25 years later.

The nature of Japanese institutions also deters

U.S. researchers from doing work there. Much R&D

in Japan—including some of the best—takes place

in private industry, and since a good deal of this

work is proprietary, acceptance of outsiders in

corporate labs can be difficult. In government and

university labs, the quality of basic research has been

uneven, very good in some fields but less so in

others. Furthermore, foreign researchers’ access to

government labs was rather limited until recently. In

the United States, university and government labs

have the reputation for consistently high-quality

work. Positions in the United States interest foreign

researchers, and foreigners are generally welcome.

Japanese scientists win many of these positions on

merit, often drawing stipends from the U.S. Government.83

Since 1962, the United States and Japan have had

bilateral exchange programs in the field of science

and technology. The U.S.-Japan Cooperative Science Program, established by executive agreement

that year, has supported hundreds of joint seminars

and short-term cooperative research projects ever

since. In the late 1980s emphasis in these bilateral

exchanges shined to longer term projects and more

research by American scientists and engineers in

Japan. A new agreement signed in 1988 reflected

this changed emphasis.84

81Nation~ science Fo~ation, $Jt&tic~ Rese~ch s~ices.

swn~r its Japan Scienw and Technology program, the Massachusetts Institute of Technology has sponsored 1-or 2-year internships in Japan since

1983. Returning interns reported to an OTA-MIT workshop in 1988 tiat, while employers took a positive view of the interns’ Japanese experience, they

were not always interested in making immediate use of that experience, or able to do SO. Representatives of American companies that support the MIT

program confirmed the point; the interns are treated like other newly hired engineers and are expected to fit into existing patterns of work assignment

and rewards. (U.S. Congress, Office of Technology Assessment, Techwlogy Transfer to the United States: The MIT-Japan Science and Technology

Program, background paper, April 1989).

83For exmple, 327 Jap~e~ did ~mh at the Nation~ Institutes of Health in 1986-87, compared to 72 West Germans and 68 French. StiWnds for

five out of six Japanese werepaid by the NIH, at a cost of $6,8 million; fewer than half of the Germans and two-thirds of the French got NIH stipends.

See Marjorie Sun, “Strains in U.S.-Japan Exchanges,” Science, July 31, 1987.

~The A~ment BetW~n the Uniti States of America and Japan on Cooperation in Research and Development in Science and TNhnoIogY, first

signed in 1980 and revised in 1988.
Chapter 7—Where We Stand: Public Policy and Technology ● 199

One goal of the U.S. negotiators in the new

agreement was “equitable contributions and comparable access to each Government’s research and

development systems.”85 In 1988, the Japanese

Government established two award programs to

bring as many as 100 young (under 35) post-doctoral

or master’ s-degree American scientists and engineers to Japan each year for research lasting 6 to 24

months. Placements are in university and government labs, some of which rank as world leaders (e.g.,

the Institute for High Energy Physics at Tsukuba).

The awards pay for airfare to Japan, travel within

Japan, a stipend, housing and family allowances,

medical insurance, and Japanese language instruction. Each award is worth about $50,000 per year;

100 awards would amount to about $5 million per

year.

In addition to founding these two programs, the

Japanese Government also made a one-time gift of

$4.8 million in 1988 to enable U.S. investigators to

do research in Japan.86 The National Science Foundation administers the fund, using it mostly for

long-term visits for U.S. researchers (of any age, not

limited to post-docs) in all kinds of Japanese

labs—university, government, or corporate-with

whom NSF concludes agreements. For example,

NSF has an arrangement with the Japanese Ministry

of Industry and International Trade (MITI) to offer

U.S. applicants up to 30 research spots per year in the

16 laboratories directed by MITI’s Agency of

Industrial Science and Technology.

NSF also provides awards covering tuition, fees,

and a stipend for researchers undertaking intensive

study of the Japanese language. The program is

primarily for graduate or post-doctoral scientists and

engineers, but is also open to senior researchers,

including people in industry; it can accommodate

about 50 people per year. In addition, NSF supports

programs at four universities to improve the teaching of Japanese, and about 50 more individual

students get tuition and stipend awards in connection

with these programs. Altogether, NSF set aside

$800,000 in fiscal year 1988 for its Japanese

Initiative programs, and $725,000 in 1989; spending

in 1990 is expected to stay at the 1989 level. Most of

the NSF funds are spent for bilateral seminars,

short-term visits, and the Japanese language programs.

In late 1989, NSF spokesmen said that the

Japanese language programs were oversubscribed

and ‘‘competitive, ” and that qualified people are

being turned down. Participation in the new programs for long-term visits and research in Japan was

spottier. NSF estimated that of the 100 places

available from April 1989 to March 1990 in the two

Japanese Government programs, about 60 to 65

would be filled. NSF’s own program supporting

long-term visits to Japan has had 18 participants

since May 1988, but some seemingly attractive spots

have had few takers. For instance, only one of the 30

slots offered in the MITI labs was occupied in 1989.

None of a possible three posts in the Fifth Generation project was filled (one was the previous year).

Only one researcher so far has been posted to a

Japanese corporate lab.

The reasons mentioned above—the high cost of

living in Japan and ignorance of the Japanese

language—are still important deterrents to many

potential candidates. The age limitation may be

another; American researchers find it easier to take

a year abroad when they are already established in

academic or research positions than when they are

just starting out. But a major factor may be

unfamiliarity. These programs are barely more than

1 year old. As their reputations grow, they could fill

up, as have some of private programs that sponsor

placement of U.S. engineers and scientists in Japan.

One of these is the Japan Science and Technology

Program of the Massachusetts Institute of Technology, which sends MIT graduate engineers and

scientists to corporate, government, or university

labs in Japan for 1- or 2-year internships. In its first

6 years, 1983-89, the MIT program had 53 participants (an average of fewer than 10 per year). In

1989-90, it sent 47 interns to Japan.

Even assuming fairly rapid growth, all these

programs together, public and private, will send only

a few hundred researchers to Japan per year. Adding

in those who go on their own, the numbers are still

small compared with the thousands of Japanese

85~~er from~e HO~O~~bl~Gw~~~p. ShUltZ, swretw of Smte of the Ufited States of America, to His Excellency, Soustie Uno, Minister for Foreign

Affairs of Japan, June 20, 1988; letter from Mr. Uno to Mr. Shultz, June 20, 1988. See alSO the Omnibus Trade and Competitiveness Act of 1988, which

directed that federally supported international science and technology agreements should ensure “equitable and reciprocal” access to technological

research, to the maximum extent practicable (Public Law 1O(M18, Part II, Sex. 5171, ‘‘Symmetrical Access to Technological Research”).

We gift was arranged by then Prime Minister Takeshita.
200 ● Making Things Better: Competing in Manufacturing

scientists and engineers who study and work in the

United States. Moreover, relatively few Americans

in other fields related to industry and technology—

economics, business administration, current business experience-spend time in Japan acquainting

themselves with Japanese management and business

practice. A few university programs (e.g. Stanford’s)

encourage exchanges of this kind by offering

intensive training in the Japanese language.

Scanning Japanese Technical Literature

U.S. acquaintance with written research results

from Japan does not begin to match Japanese

knowledge of U.S. research. One reason is the idea,

still current in some companies, that anything

important will be published in English.87 A more

important reason is the scarcity of technically

trained Americans able to read Japanese. Companies

that want to keep up with Japanese research often

cannot find someone to do it.88 Job-seekers who

offer this skill may be highly valued. For example,

one American specialist with experience in scanning

Japanese journals, translating titles and abstracts,

and using on-line Japanese databases was hired by a

high-technology company that told her to name her

own price. The experience of this information

specialist contrasts with that of the MIT engineers

returning from Japanese internships, whose experience in Japan and knowledge of Japanese were

usually not much used or specially rewarded in their

first jobs back home. Companies may set a higher

value on knowledge of Japanese in a full-time

information specialist than in a freshly minted

engineer, whose main value to the company is

technical competence.

Government and private efforts to provide services that scan and translate Japanese technical

literature have been only modestly successful so far.

In the Japanese Technical Literature Act of 1986,

Congress directed the U.S. Department of Commerce to set up an office to provide such services.

The office established to do the job is small, staffed

by two people and funded at less than half a million

dollars per year, reprogrammed from other department funds. Initially, the office arranged for translations, but the service was so expensive ($60 per

page) that there was little demand for it. Services still

provided by the office include a directory of

translation and monitoring services, a listing of

important Japanese documents available in English,

and a yearly report on important Japanese advances

in science and technology.

A more direct and focused effort to learn about

Japanese accomplishments in high-technology

fields is JTECH, managed by the National Science

Foundation in collaboration with other Federal

agencies and funded at $600,000 in fiscal year 1990.

JTECH sends teams of leading scientists and engineers to Japan to evaluate R&D in areas such as

computer-assisted design and manufacturing of

semiconductors, complex composite materials, and

supercomputing. Workshops at NSF discuss the

teams’ preliminary findings, and the panel reports

are distributed by the National Technical Information Service. In 1989, JTECH published reports on

the much-discussed topics of superconductivity

applications and high-definition television.

Learning the Japanese Language

For the long run, broader knowledge of Japanese

among Americans is the best assurance that scientists, engineers, and business managers will be able

to keep up with technological advances in Japan.

And the best way to learn Japanese is to start early.

Japanese school children get 10 years of instruction

in English, from the elementary grades through high

school. (Though the instruction is weak in conversational skills, most Japanese professionals learn to

read some English.) It is the rare American high

school that offers Japanese courses, and instruction

in the elementary grades is practically nonexistent.

R&D CONSORTIA

Traditionally, consortia have played a much

greater role in technology development in other

countries, such as Japan and Korea, than in the

United States. Antitrust law and the prevailing free

sTone yougen@nWr, a formermA Japan fellow who now works for Hewlett-Packard, told the OTA-MIT workshop that he reads Japanese twhnicd

articles on his own, but few of his colleagues see the need. The company does not use his Japanese beyond asking him to translate occasional messages.

U.S. Congress, Office of Technology Assessment, Technology Transfer to the United States from Japan, op. cit., p. 11.

ssIt mi@t be thought hat ~me Of tie JapaneW scientists and engineers who study in the United States would stay and work for U.S. ftIIIKS (SS Komn

and Taiwanese researchers have done in large numbers), thus providing a source of technically trained people able to read Japanese. However, most

Japanese have been little inclined to stay in America and work for American companies, and some Korean and Taiwanese are returning to their home

countries even after many years of working for U.S. firms.
Chapter 7—Where We Stand: Public Policy and Technology ● 201

market ethos combined to make cooperative research appear inefficient or even illegal.

When American technology led the world, means

of improving not just the technology but the process

for creating it had little place in the public policy

agenda. Yet as America’s competitive position has

deteriorated, and a state of crisis has emerged,

especially in certain high-technology sectors like

semiconductors, some now argue that R&D consortia are a critical element in the return to international

competitiveness. The argument contains the following points.

First, as manufacturing processes become more

complex and the technology more sophisticated, the

cost of R&D rises. In particular, the sheer size of the

investment necessary to advance to new generations

in microelectronics implies risks unacceptable to all

but a few large firms. For example, developing

X-ray lithography technology runs into hundreds of

millions of dollars. Such investments are beyond the

reach of smaller firms, and even IBM is balking at

that on its own. Consortia can allow the maximum

leveraging of resources, by giving a company access

to substantial R&D returns for a relatively small

outlay. Companies can also ensure that they are in a

position to appropriate the results of the research in

that field-reducing a different risk, that they will be

frozen out of a key development.

Second, U.S. industry is known for short-term

thinking-which is a particular handicap in developing new technology. Consortia can reorient the

perspective of participants toward longer term investment.

Third, there are externalities. Single firms may not

be able to capture benefits from research that would

nonetheless benefit the community as a whole. If a

number of firms join together to do the research, the

risks are spread and diluted.

Fourth, research consortia often have an important training function, even when they do not reach

the technological goals they originally aimed for.

Fifth, consortia may improve the diffusion of new

technologies by increasing the speed or the breadth

of diffusion or both, a very important attribute. This

may be especially true for consortia designed to help

companies to catch up in areas of technical weakness.

Sixth, the creation of significant alliances and

even a consensus among participants in the face of

foreign competition can be useful. In textiles, for

example, the Textile and Clothing Technology

Corporation (TC2

) is credited with developing

inter-and intra-industry linkages that have strengthened the domestic industry, even though the original

technological goal of the project was not achieved.

All these benefits are important. If they were the

only side of the story, strong backing for R&D

consortia would bean obviously appropriate goal for

public policy. But three main sets of drawbacks have

been put forward. Some have stressed an anticompetitive and hence antitrust element of cooperative R&D; this argument becomes more telling for

consortia that are further downstream toward manufacturing. Alternatively, some argue that R&D

consortia have minimal effects-they simply don’t

work and are not a useful means of furthering

competitiveness. Finally, there are questions about

the relationship of the government to R&D consortia.

The problem of antitrust is discussed in the last

section of this chapter and in chapter 2. However,

since R&D consortia are under discussion here, the

antitrust argument is not very relevant; few people

see antitrust problems in nonproduction cooperation.

The second criticism is more cogent. Not all

consortia are successful, but some are. The problem

is to identify the circumstances that make for

success, rather than offering simplistic generalizations. Some of the key questions are:

●

●

Goals. Are consortia designed to attain some

goals more successful than those aimed at

others? For example, is basic research a more

appropriate goal than research closer to commercial application? Does a consortium do

better trying to produce new technology or

should it simply focus on catching up with

technology that exists elsewhere?

Players. Who needs to be involved? Must the

biggest firms in an industry be part of the

consortium? Should all participants be roughly

the same strength or size? Should the industry’s

technology leader participate? Do consortia

with vertical participation fare better than those

involving only firms from a single stage of the

production process?
202 ● Making Things Better: Competing in Manufacturing

●

●

●

●

Financing. Are there optimum forms of financing? Should the government help? How much?

Technology transfer strategies. R&D consortia

have two primary purposes-the creation of

new technology, and the diffusion of technology. Can successful diffusion strategies be

defined?

Personnel. Firms are typically reluctant to send

their best people to consortia. Does this matter,

given that in some consortia most scientists are

hired directly rather than being seconded from

participants? How does this affect technology

diffusion to participating companies?

Structure. Does the structure of the consortium—

timeframe, forms of participation, location of

research labs, accrual of patent rights to insiders and outsiders, etc.-affect its success?

The third set of criticisms concerns the role of the

government. In particular, the use of government

money for R&D inevitably means that the government will have a say in which technologies to

support. Critics argue that the U.S. Government in

particular lacks the institutional capacity to make

such choices.

This section examines some of the more important cases involving R&D consortia, focusing on the

United States and Japan. It then offers some possible

guidelines for cultivating successful consortia.

Collaborative R&D in U.S. High Technology:

Electronics

The electronics industry accounts for the majority

of joint R&D activity in the United States as well as

in Europe and Japan. In the United States, most joint

activity has occurred in the last 10 years. Early joint

R&D efforts in this country were centered in

universities, mainly because of antitrust concerns.

Over time, and with relaxation of antitrust prohibitions, more joint efforts have been undertaken by

private companies and those tend to be targeted

further downstream.

This section looks at three different types of joint

R&D in electronics: basic research (industryuniversity collaboration), long-term strategic research (MCC), and manufacturing R&D (Sematech). The following section looks at collaborative

R&D more generally in Japan.

Basic Research: Industry-University Consortia

This form of research collaboration has grown

rapidly in the microelectronics industry during the

1980s. 89 Usually, the projects focus on basic research and on training students in subjects that fit the

industry’s needs. Member firms are granted access

to all research findings. They are also encouraged to

send technical people to the university to do research

for extended periods. They often use their university

access for recruitment; this may be the most

important aspect of cooperation for the firm. Universities benefit because the extra research funding

helps them to attract and keep faculty and graduate

students and to upgrade their laboratories and

equipment. Also, it encourages interdisciplinary

teaching and research-something that is hard to

accomplish with the university’s own resources.

Some programs are designed to promote regional

development. An example is the North Carolina

Microelectronics Center (NCMC), which draws on

university faculty from the Research Triangle to

conduct R&D in a center constructed and operated

in part with State funds. Member firms work

together in vertically integrated teams: NCMC's

initial sponsors included a semiconductor manufacturer (General Electric), a telecommunications equipment maker (Northern Telecom), a semiconductor

manufacturing equipment firm (GCA), and a supplier of manufacturing process gases (AIRCO).

Although NCMC’s success at economic development has been questioned, it appears to have been

effective in achieving technical goals.90

In microelectronics, the Semiconductor Research

Corp. (SRC) is a key case.91 It plays the role ‘f

broker for the semiconductor industry’s basic research activities. An early goal was to stem the

proliferation of expensive and duplicative university

facilities for R&D on integrated circuits, and in this

SRC had some success. Through the SRC’s technical advisory boards, member firms have also approached some consensus on the main technologies

to push for rapid advance. In addition to shaping the

research agenda in microelectronics, this team8!?Much of the ~aten~ ~this ~tion is b- on David C. Mowe~, ‘ ‘Collaborative Research: ~ Assessment of Its potenti~ Role k the ~veh)pment

of High Temperature Superconductivity, “ contract report prepared for OTA, January 1988.

wan Dirnancescu and James Botkin, The New Alliance: America’s R&D Consortia (Cambridge, MA: Ballinger, 1986), pp. 9-10; 75.

glIn 1989, SRC had 28 mernbm companies and a budget of about $30 million, $20.4 million of that from indusn.
Chapter 7—Where We Stand: Public Policy and Technology ● 203

building exercise helped lay the groundwork for

Sematech.

SRC has had less success in transferring results of

the research it funds to member firms. The reasons

are not altogether clear, but a likely one is the typical

difficulty companies find in making immediate use

of basic research. Another is the separation between

R&D and manufacturing in many member companies, and a third is the lack of a reward system within

companies for adopting ideas developed outside.

Long-Range Strategic Research: MCC

The Microelectronics and Computer Technology

Corp. (MCC) was founded in 1982 by leaders of the

computer industry, galvanized by the threat of

Japan’s Fifth Generation computer project.92 The

idea was to share resources and risks, and to

undertake mid to longer term R&D where individual

companies might not venture. More than at its

founding, MCC today conducts numerous specialized projects tailored to the needs of its members,

and it is putting more effort into meeting the needs

of smaller companies and into technology transfer.

However, it has so far kept the ability to do some

core, longer range R&D projects.

MCC funding is almost entirely private. It was the

first U.S. industry consortium in a non-regulated

industry, and is a large one, with a staff of 430 and

an annual budget of around $65 million. It currently

has 20 member firms (shareholders), drawn largely

from the computer, semiconductor, and aerospace

industries .93 MCC’s five research programs are

application-driven; they are in advanced computing

technology, computer-aided design, packaging and

interconnect, software technology, and hightemperature superconductivity. They operate on 6-to

10-year horizons, with an increasing emphasis on

spinning off interim products.

MCC originally expected to draw staff from its

shareholders but the firms were reluctant for competitive reasons to assign their best people. Admiral

Bobby Ray Inman, the first CEO of MCC, initially

rejected 95 percent of the researchers sent by the

member companies, instead hiring highly respected

outside scientists who were attracted by the large

R&D budgets, high wages, and the central mission

of long-term R&D.94 These direct hires now comprise 85 percent of MCC’s staff.

The structure of MCC is also an accommodation

to competitive rivalries. Each of the five main

research programs is operated independently, and

there have been strict rules (recently somewhat

loosened) about information exchanges among scientists across programs. Shareholders can pick from

among the programs, joining as few as one. This

cafeteria structure allows member firms to work in

areas where they are weak and keep their strengths

to themselves.

Both MCC’s structure and the large percentage of

directly-hired staff have impeded the transfer of

technology, particularly within the consortium. Inman

noted that although these factors made managing

MCC much more difficult, they also helped MCC to

attract and maintain a sufficient number of shareholders.

The Six-Year Mark—As MCC ended its sixth

year, evaluations were mixed. Membership was

holding steady, and MCC managers believed that

existing shareholders represent a generally solid

core of supporters. But shareholders continue to

withhold their best people and their best ideas from

MCC: virtually every good research idea pursued by

MCC has come from within the consortium. Moreover, member firms are demanding a more immediate bang for their buck, and some have said they are

looking to lower their contribution to MCC. (Most

of the shareholders pay at least $1.5 million per year;

some 20 associate members pay annual dues of

$25,000 for limited access to MCC research.)

For members, a basic problem is the dearth of

clearly usable research results. Only three commercial products have resulted from MCC technology .95

However, some firms also use MCC technology less

directly, as Honeywell did to develop an internal

product designed to place components on a multilayX2The ~dW~ gl~~, ~M and AT&T, did not join, possibly fOr antinst re~ns.

g3Me~r accomt for one.h~f to t~o-~irds of ~1 firms in Mose industries, ad most have R&D budgets of $100” million or more. Merton J. P~k,

“Joint R&D: The Case of Microelectronics and Computer Technology Corporation, “ Research Policy, 15, 1986, pp. 224-225.

gdInterview M* ban, NOV. 1, 1989.

9SNCR cow. rwently in~~uc~ ~sl= Advisor, an Cxwfi system for ~tegrat~ circuit designers b- on MCC’S work in artificial intelligence.

The consortium has also licensed its laser bonding technology, a technique for comwting the leads of semiconductor chips to the circuit board. Most

recently, the Digital Equipment Corp. (DEC) amounced plans to use MCC’S tape-automated bonding technology in one of its VAX computer systems.
204 ● Making Things Better: Competing in Manufacturing

ered printed circuit board. Boeing has set up four

labs in Seattle to develop technologies that it takes

from MCC.96 Other benefits are apparent but hard to

measure. For example, access to MCC has allowed

member firms to delay capital investments and then

make the right ones when the time comes. And even

negative results help shareholders to avoid blind

alleys.

Nevertheless, MCC members and executives

alike feel that the consortium should be spinning off

immediately usable technology even as it pursues

long-term projects. This pressure for results has been

intensified by a change in the corporate level of

interaction with the consortium; MCC executives

refer to this as the ‘‘kings, dukes, and barons

progression. In place of CEOs with long-range

visions (the founding members, or kings), responsibility for interacting with MCC has migrated downward to the managers of profit-and-loss centers

(dukes and barons) in many member firms. These

managers have much more immediate needs, and

generally press for nearer-term payoffs.

A few shareholders--Digital Equipment Corp.,

Control Data Corp., and Boeing, for example-have

made major technology transfer efforts. DEC spends

half again its investment in MCC seeking ways to

use the consortium’s results.97 But others largely

ignore MCC. Scientists at MCC describe some

shareholders as “black holes’ because of the

difficulty of locating-and then maintaining contact

with-the appropriate recipient for a particular

technology. “Too many [shareholders] are waiting

around for a virtual product design to emerge before

they examine what’s happening and why they might

use it, ” Inman observed after he left MCC.98 In

addition to diverting MCC resources away from

long-term research, this demand for neatly packaged

results creates tensions, according to one program

manager, because ‘the weak sisters want us to bring

the technology damn near to market,” while the

strong ones don’t.

Some technology transfer problems arise in strong

firms as well as weak ones. For example, MCC’s

CAD program serves a group of semiconductor

manufacturers who have become increasingly dependent on the emerging software vendor industry.

When MCC gave CAD members research algorithms instead of completed software tools, it was

“like feeding grass to tigers,” according to MCC’s

chief scientist, John Pinkston.99 The CAD program

director stepped down and the program was substantially reorganized. A similar problem occurred with

MCC’s much-praised laser-bonder. Most MCC shareholders could not use the technology in ‘raw’ form.

It was eventually licensed to a non-member firm

with the sophisticated capacity to make use of it.

Mid-Course Corrections-MCC has changed its

structure to combine shorter with longer term

projects. l00 The CAD program and two others were

each reorganized into a core unit working toward

long-range goals, plus several satellite projects,

designed to produce ongoing results for shareholders. In these programs, shareholders must buy into

the core project and at least one satellite. However,

MCC’s Advanced Computing Technology (ACT)

program (by far the largest) recently eliminated the

core structure altogether. A shareholder can now

select from 12 medium-term projects—including

neural networks, optical computing, and artificial

intelligence—at an annual price of $125,000-

$700,000 apiece plus a one-time fee of $250,000 for

access to the program. Although some of ACT’s

$1.5 million contributors are sure to trim their

investment, MCC hopes that new participants will

more than offset that loss.

MCC has begun to seek government money in

cases where shareholders fail to exploit its research

or where the government funds complementary

research. For instance, the shareholders did not pick

up the parallel processing work of the advanced

computing program, so MCC instead attracted a $6

million DARPA contract. Toward the end of 1989,

MCC estimated that government contracts would

WMamgemeti Review, February 1989* P“ 26-

~~ong o~er ~ngs, DEC rwufies hat evew MCC project it supports have an individual sponsor within the company. BY including tie funding

for external R&D in the budget for internal research projects, DEC encourages managers to pay close attention to the work of consortiums. Scientific

American, May 1989, p. 100. DEC also works hard to put researchers returning from a tour with MCC into positions where they can help the company

the most.

g~r~ Guterl, “MCC: The Dilemma of Joint Research,” Business Month, M~ch 1987, p. 50.

991ntetview with Pinkston, MCC, May 12, 1989.

l~m ~ discmsion of MCC’s rargafization, ~J. Robefi Lineback, ‘ ‘Mcc, After Five yews Of R&D, Refocuses To Em Its K&p,’ E/ectrom”cs,

December 1988.
Chapter 7—Where We Stand: Public Policy and Technology ● 205

grow from 2 or 3 percent of its budget to 10 to 15

percent in 1990. MCC now also does proprietary

work for individual member firms. The packaging

and interconnect program (MCC’s most successful)

runs such projects for five of its seven shareholders.

These projects exploit other ongoing research and

currently total less than 20 percent of the program’s

effort.

MCC is putting more resources into transferring

its results. In 1988, for example, there were some 80

technology transfers to shareholders compared to a

handful in 1985. Fully a quarter of MCC’s budget

now goes into technology transfer activities. Other,

more qualitative changes include relaxing the barriers between programs, formal voting on program

research to increase shareholder commitment to

MCC’s work, and attempting to increase the shareholder portion of MCC’s staff to 35 percent. On the

members’ side, most do keep some people on the

premises in Austin-and not just to see what other

shareholders are up to, as in the early days, but to do

real work. Although staff seconded from shareholders are still a small minority, those who are assigned

there could be used to transfer technology back to

the company.

MCC’s Future—The shift in MCC toward more

client-centered and more immediate results is in part

a response to the needs of weaker members. One

function of MCC is to help C companies become B

companies, or help A and B companies strengthen

weak areas. Thus the trend toward shorter term,

more specialized R&D has positive aspects. At the

same time, the trend could upset the balance between

MCC’s original goal, to take on long-term and

relatively risky research, and the need to generate

products that are more immediately or more narrowly useful to members of the consortium. It is this

balance that distinguishes MCC from institutions

that are devoted mostly to serving individual customers with proprietary R&D.

Manufacturing R&D: Sematech

SRC and MCC notwithstanding, microelectronics

industry observers were skeptical about the 1987

announcement of a proposed manufacturing research consortium to be funded equally by industry

and government. Twenty years of intra-industry

competition would not be easily set aside. The

newfound cooperation was partly based on fear, as

Japanese inroads into the market for dynamic

random access memory (DRAM) chips—the workhorse of the chip business—threatened U.S. firms’

very existence.

Despite the similarities between MCC and Sematech, including a handful of common members,

there are major differences. The Federal Government, consciously excluded from MCC, is a full

partner in the 5-year chip consortium: DARPA is

contributing $100 million per year, roughly half of

Sematech’s budget.lO1 More important, Sematech’s

focus is narrower and more applied; it goal is to

develop 0.35 micron manufacturing technology by

1993. Sematech’s membership is relatively homogeneous: 14 semiconductor manufacturers, both merchant and captive, which together represent 80

percent of U.S. chip production capacity. Sematech’s

15th member is Semi/Sematech, an organization of

U.S. equipment and materials producers.

Sematech’s members include IBM and AT&T,

the industry giants that have stayed away from

MCC. Sanford Kane, then IBM’s vice president for

industry operations, explained his company’s rationale for supporting Sematech:

The survival of the U.S. semiconductor industry

was critical to us for several reasons. Number one,

we were one of the largest purchasers of chips in the

world. We liked to source locally, and we didn’t

want to be in a position where we had no choice but

to be dependent on our competitor. Second, IBM was

the largest manufacturer of chips in the world. We

produced in-house those chips that gave us a

technological edge. In order to stay state-of-the-m%

we needed to have sophisticated equipment to make

the semiconductors. If the U.S. chip makers go, so

would the U.S. equipment companies. We knew it

would be difficult to establish close relationships

with the Japanese, especially since most of their

firms are associated with chip companies. We would

be forced to share information and it would be

doubtful whether we could get access to state-of-theart equipment as quickly as our Japanese counterparts.l02

IOl~D’S SUm~ is sCh~Ul~to end in 1993, Ro~~ Noycc anticipates ~at, if Sematwh is successful, kdus~ will continue to fund the effOll ~lhOUl

government support, albeit on a smaller scale. If industry is unwilling to fully fund Sematech after 1993, he maintains, it should be ended. “I’m a fmn

believer in sunset provisions,’ says Noyee. Interview with Noyce, May 11, 1989.

lm’’semat~h,” Harv~d Business School Cm #N9-389-057, 1988, p. 10.
206 ● Making Things Better: Competing in Manufacturing

So important is Sematech’s success to IBM and

AT&T that the two firms shared their respective 4

megabit (M) DRAM and advanced 64 kilobit (K)

SRAM processing technologies to the consortium,

along with the engineering support necessary to get

them into operation. These contributions have allowed Sematech to establish baseline manufacturing

with 0.7 and 0.8 micron technology less than a year

after moving to its Austin facility. Although Sematech’s fabrication facility (fab) will turn out only

a few hundred wafers a day, just a fraction of a

commercial fab’s output, the consortium considers

that sufficient to achieve rapid process learning.

Sematech’s strategic plan calls for high-yield, pilot

application of 0.35 micron processing technology an

estimated 6 to 18 months ahead of leading foreign

chipmakers. 103

Three strategic objectives are central to achieving

this goal: 1) improving suppliers’ technologies, 2)

improving chip makers’ manufacturing skills and

techniques, and 3) strengthening the manufacturing

technology base for semiconductor production.

Objectives-First of all, Sematech must strengthen

U.S. materials and equipment suppliers. The industry includes hundreds of small supplier fins, most

with sales of less than $10 million per year. These

firms have traditionally had an arm’s-length, and

often adversarial, relationship with semiconductor

producers, who preferred to keep their chip designs

and manufacturing processes secret. A recent report

describes the industry’s situation:

Compared with captive equipment makers in

integrated Japanese and European electronics firms,

U.S. equipment makers lack the advantages of

predictable internal markets, access to broad scientific expertise, and deep pockets for high-cost R&D.

They also lack the opportunity for joint development

and internal site testing of new equipment, and the

benefit of systematic high-quality feed-back on

product performance.l04

Sematech represents an attempt to overcome

some of these structural handicaps. Through competitive R&D contracts to selected suppliers, it will

try to promote long-term alliances between chipmakers and suppliers. Although chip producers are

the source of two-thirds of the innovations in

semiconductor equipment, they have traditionally

kept these innovations secret, so as to preserve their

competitive advantage in process technology.l05

The consortium structure encourages chipmakers to

reveal their secrets to equipment producers.

By awarding contracts to multi-company teams,

the consortium is also trying to promote cooperation

and consolidation among suppliers. For example, a

team composed of three rivals in high purity gas

technology was recently awarded a contract to

develop gas pipelines, filters, and other technology

for Sematech.

The R&D funds awarded to selected suppliers

will also be important, although probably less so

than the knowledge it generates and improved

relationships with chipmakers. Sam Harrell, president of Semi/Sematech, expects over half of Sematech’s budget to filter down to equipment and

materials firms in the first few years of the consortium.lO6

Finally, Sematech will provide a high-quality beta

test site, where suppliers can test run their new

equipment and processes under realistic manufacturing conditions. Currently, a supplier firm must test

its equipment on an actual production line; since it

can take weeks to debug a new piece of equipment,

chipmakers are understandably reluctant to act as

guinea pig. This test facility will also serve to certify

the quality and composition of chemicals and other

inputs.

Sematech’s second objective is to improve manufacturing skills and techniques among chipmakers

themselves and, in so doing, to change the very

culture of semiconductor manufacturing in the

United States. Sematech’s director of strategic

planning, A. S. Oberai of IBM, describes the problem

this way:

In Japan, engineers spend 70 to 80 percent of their

time on “continuous improvement programs. ” The

process operator is king-the first line of attack. It is

he who keeps the equipment in order and decides

when to call in the engineers. In the United States,

engineers spend 70 to 80 percent of their time on

crisis management as opposed to crisis avoidance.

1~’lle consortiums interim goal is to apply 0.5 micron manufacturing technology by 1990, roughly even with leading fomi~ chipmakers.

1~’’sem~h: ~o~esws and prospwts,” Re~rt of the Advisory Council on Federal Participation in Sematech, 1989.

IOS~c Von Hip@, The SoWce~ of Innovation (New York, NY: Oxford University Press 1988).

1~’’sema~h,” Harvard Business School, op. cit., p. 12.
Chapter 7—Where We Stand: Public Policy and Technology ● 207

The system encourages that by rewarding doers—

problem solvers—rather than problem avoiders. [In

contrast to Japan, in the United States] process

operators do no maintenance or planning-they just

push wafers.107

Sematech should also provide an arena for the

cooperative development of standard equipment

interfaces-a key problem up to now—and members will be able to use their substantial market

power to get those standards accepted industry wide.

The ultimate goal is a computer-integrated manufacturing system, which will provide diagnostic information about chip manufacturing to a computer in a

standardized format.

Sematech’s third objective is to strengthen the

manufacturing technology base. Through expert

workshops, the consortium tries to identify the most

promising paths to its various technical goals. In

addition, 10 percent of Sematech’s budget is going

to 11 university centers of excellence,108 whose

activities are being directed by the SRC. The centers

are conducting research in a limited number of areas

that will be critical to Sematech’s post-1990 activities: for example, contamination/defect assessment

and control, and advanced plasma etch processing

technology.

Preliminary Assessment—Sematech got off to a

rocky start. Member firms clashed over the kinds

and volumes of chips to produce.l09 There were

problems in recruiting a CEO, and DARPA rejected

the consortium’s first operating plan. However, after

a year-and-a-half of operation, Sematech has made

significant progress. It has built a world-class clean

room and fab in less than half the normal time and

at lower cost. In March 1989, several days ahead of

schedule, the consortium produced its first chips,

using AT&T’s SRAM technology.

Member company assignees to Sematech are

generally high caliber, and the consortium has,

unlike MCC, achieved its goal of balance between

assignees and direct hires. 110 There is other evidence

of members’ commitment. National Semiconductor

has built a pilot production line to apply the tools

that Sematech is developing.lll And some supplier

firms appear to have made preliminary plans to

locate R&D and production facilities in Austin.112

According to Sematech officials, members’ commitment went ‘from casual to urgent” following the

Federal Government’s decision to participate.113

Whether or not DARPA’s financial contribution is

critical, 114 Federal participation is certainly important symbolically: it gave Sematech credibility and

encouraged industry members to believe that government officials will take seriously their concerns

about unfair Japanese trade practices.

The participation of IBM and AT&T is at least as

important. Their contribution of leading-edge technology represents an enormous benefit to merchant

firms-one that has probably outweighed any costs

to them of Sematech membership. However, the real

test of commitment will come only later, when

merchant firms will receive much less relative to

their contributions, financial and otherwise.

Even now, not everyone would agree that Sematech is a conditional success. One concern is with

Sematech’s decision to limit actual production of

chips in its fab, in keeping with strong opposition

from IBM and Texas Instrument to high-volume

lm~temiew with A. S.Oberai, May 10, 1989.

10SAS of January 1990.

109Sme ~~ysts ~We that, in Choosing hi@.volWe Chips, Sematech is attacking the ~ong problem. mey see the indus~’s fUtUR h

application-specific integrated circuits (ASICS), which are custom-made in small quantities.

11OAccording t. LW Novak, a Texas ~s~ents assign= and sema[~h’s dir~tor Of l~hnology ~ansfer, an msignmenl to sematech iS .CXXn a.s

“career enhancing. Slow growth of the industry has kept many employees from moving up the career ladder in their home companies. Sematech

provides an alternative ascent route<

lllN~ York Times, July 2, 1989.

1 lz’’sema~h: %o~ess and Prospects,” Op. cit., p. ESA$.

113~id,

114claUde B~le]d, Americ-nEnt@se ~tltute, inte~fiony ~fore the Joint ~onomic committ~, J~e g, 1989, argued that industry was pEpWd

to fund Sematech on its own. However, Robert Noyce argues that semiconductor companies can ill afford the $100 million per year they conrnbute, since

their profits are among the lowest in manufacturing.
208 ● Making Things Better: Competing in Manufacturing

production. 115 Some critics believe that a highvolume operation is essential for testing yield and

reliability, and that frictions between design and

manufacturing teams can otherwise be swept under

the rug.

High-volume production would require attention

to every step in the process chain instead of the

current selective emphasis, principally on lithography. That would cost considerably more money than

Sematech has available. Some believe that the

consortium’s budget is too small to ensure success.

Financial constraints do force Sematech to place its

bets on a limited number of technologies aimed at

achieving 0.35 micron circuitry. If those bets prove

wrong, as one member company liaison said,

“Sematech will have bought the farm.”

Even if Sematech’s technology wagers pay off, as

most experts expect, the consortium still faces major

problems. Technology transfer is one: Will member

companies actually adopt the manufacturing tools

that Sematech develops, let alone the new ‘culture’

of semiconductor manufacturing? Similarly, will the

new closer relations between chipmakers and their

suppliers be sufficient or lasting? Finally, will all of

Sematech’s work translate into significantly greater

U.S. market share?

Cooperative R&D Ventures in Japan

In a nation where corporations are famous for the

ferocity of their competition, the continued use of

cooperative research ventures could not have come

about by accident. Several factors have combined to

produce the level of joint research activity seen in

Japan.

ll6

First, the nation has a tradition of government

efforts to promote cooperation between competing

firms that dates back to the beginning of industrialization in Japan. This history has conditioned firms to

accepting joint R&D.117 Second, the stability of

firms within industries fosters the development of a

certain level of trust. Wakasugi describes membership in a research consortium as ‘effectively perpetual."118 Third, firms want to participate because

they are afraid of letting rivals gain a competitive

edge. 119 Companies do not invariably join R&D

consortia when invited; 120 however, reluctance to

flout powerful, respected government agencies such

as MITI, combined with fear of missing the bus,

usually win out.

On the government side, Japanese ministries are

constantly engaged in turf battles. One way for them

to gain size and prestige is to become the promoter

of more and more cooperative R&D ventures. The

Science and Technology Agency established the

Japan Research and Development Corp. in 1961, the

same year MITI started the Engineering Research

Association program (ERA). When MITI announced

a 10-year biotechnology research consortium in

1981, three other agencies responded with their own

cooperative biotechnology projects. Government

agencies provide substantial financial inducements

for joint R&D, including loans whose repayment is

contingent on the venture’s success, rapid depreciation of equipment, R&D tax credits, and outright

grants.

Finally, Japan’s legal climate is extremely favorable to cooperative ventures. One of the clearest

expressions of Japan’s attitude towards antitrust is

embodied in the regulation that, even if the Japan

FTC feels they have a legitimate case, they cannot

act if it would “cause a loss of international

competitiveness” for that firm.121

Private cooperative research ventures are common in Japan, but they usually do not involve

government participation. Although fully one-third

of industrial R&D is collaborative, 90 percent of that

1ls~g~e Plaming ~age5 of Semat=h, may indus~ offici~s argued that a high-volume production operation wfi essential foresting yield and

reliability, but Texas Instruments did not want competition in the DWM market. IBM also opposed high-volume production for a variety of reasons.

Sematech members eventually agreed on a facility capable of high-volume production but with an actual output of only 200 wafers a day. New York

Times, Mar. 5, 1987.

llsThissectiondraws p~fily on the following sources: Mark Eaton, ‘‘MIT1 and the Entrepreneurial State: The Future of Japanese Industrial Policy,’

unpublished monograph, 1987; George R. Heaton, Jr,, ‘‘The Truth About Japan’s Cooperative R&D,’ fssues in Science and Technology, fatl 1988; Jonah

D. I.Awy and Richard J. Samuels, “Institutions and Innovation: Research Collaboration as Technology Strategy in Japan,” MIT Japan Science and

Technology Rogram, WP 89-02, April 1989; Daniel I. Okirnoto, “Regime Characteristics of Japanese industrial Policy,” Japan’s High Technology

Indmtries, Hugh Patrick (cd.) (Seattle, WA: University of Washington Ress, 1986); Richard J. Samuels, ‘ ‘Research Collaboration in Japan,” MIT Japan

Science and Technology Program, WP 87-02, 1987; and Ryuhei Wakasugi, “A Consideration of Innovative Organization: Joint R&D of Japanese

Firms,” Shinshu University, Faculty of Economics, Staff Paper Series 88-05, March 1988.

llT~~ and Samuels, op. Cit. p.%’

l18~@i Wbugi, 1$)87, cited in by and Samuels, Op. Ck, PI 38.

119Kom YmmUa, ‘Joint Rese~chand ~tl~t: Japanese vs. Amefican Swategies, ’ J~an’sHigh Techrwlo~Industries :Lessons andLim”tatwns

of Industrial Policy, Hugh Patrick (cd.) (Seattle, WA: University of Washington Ress, 1986), p. 187.

l~smue~s (op. cit., p- 39) Offem sever~ exmp]e5 of leading fms who shunn~ jo~t re~~ch when they believd they were f~ ahead of their fivdS.

lzlyamua in Patrick, 1986, p. 196.
Chapter 7—Where We Stand: Public Policy and Technology ● 209

is simply two-firm contracts between users and

suppliers (i.e., firms that would not compete anyway). Only one-fifth of all joint research----or about

6 percent of total industry R&D-occurs between

rival firms. These are the cases in which government

participation is most common; because of competitive pressures, such alliances tend to succeed only

with government sponsorship.

The typical vehicle for a joint project involving

rival firms is the Engineering Research Association

(ERA). The kenkyu kumiai ho (Cooperative Research Act), passed in 1961, gave ERAs the same

legal standing as industry associations. Early ERAs

were designed to help small and medium-sized firms

catch up technologically, and so aimed to import and

distribute technology, rather than develop it from

scratch. In the early 1970s, ERAs entered a new

phase. Although technological catch-up was still the

goal, large firms began to play a bigger role and the

focus shifted to more advanced research and product

technologies. Critical to this change was a new MITI

policy encouraged use of ERAs for “large-scale

projects” involving research too extensive for any

single firm to undertake. The projects (31 to date)

were initially designed to meet specific goals,

including creation of a prototype in some cases. The

risk was primarily financial, since the technologies

themselves had almost all been proven in the United

States or Europe. A celebrated example of this kind

was MITI’s VLSI project (1976-79), which helped

Japan’s electronics firms master the manufacture of

large-scale digital integrated circuits.

Around 1980, cooperative R&D in Japan entered

a third phase, as the Japanese Government began to

shift from catch-up to state-of-the-art projects. The

Fifth Generation Computer Project, a successor to

VLSI, is a 10-year national project focused on

artificial intelligence and other leading edge technologies designed to make computers far more

accessible to untrained users. Large-scale projects

have become increasingly risky: for example, optoelectronic elements had not been proven when the

Optical Measurement and Control System Project

began in 1979. Similarly, the Next Generation

Industries Program has turned increasingly to uncertain technologies such as bioelectronic integrated

circuits.

As cooperative R&D in Japan entered its third

phase, new vehicles were set up to promote cooperative research, and existing institutions are evolving

to meet the new challenges. MITI and the Ministry

of Posts and Telecommunications established the

Japan Key Technology Center (KTC) in 1985 to

fund promising proposals from research consortia.

Much like a venture capitalist, KTC buys equity

shares in the new firm-up to 70 percent of total

capitalization. The research group, not the government, retains all patent rights.

Like ERAs, KTC consortia will have initial terms

of 7 to 10 years and budgets for term of around $100

million. Unlike most ERAs, KTC projects must

break new ground in basic or applied research, and

the work is more likely to be conducted in joint

facilities. 122 So far, KTC has provided more than

$250 million in capital to 61 research projects. Eaton

sees the program as a watershed: “It is difficult to

overstate the significance of the KTC . . . It signals

a new willingness by the Japanese, led by the state,

to risk resources for basic industrial research. ’’123

For all its contributions, joint R&D has not been

the primary means of technical advance for Japanese

industry. It has always complemented rather than

dominated the research that companies were simultaneously doing in their own labs. Nevertheless,

cooperative R&D ventures have proved technologically significant, especially in electronics. During

Japan’s period of catch-up, they provided an efficient way to rapidly raise the overall technological

base of Japanese industry. As research consortia

shift their activities to more exploratory research,

success will be less predictable and more elusive,

since uncertainty is the price of doing things that are

really new. However, consortia do have the virtue of

spreading the risks in uncertain ventures.

R&D consortia have also helped to speed the

diffusion of technology between Japanese companies. Getting firms to share technology can be

difficult. Though intellectual property laws are

weaker in Japan than in the United States, they do

provide some protection. The problem of technology

sharing can be avoided if all the major player

participated in its development in the first place.

That way key capabilities are less likely to become

proprietary, and the overall level of technological

l~Eaton, op. cit.

l~Ibid.
210 . Making Things Better: Competing in Manufacturing

competence rises faster. No major firms are left

behind in the technology race, and more firms mean

more competition. (For further discussion of competition and technology diffusion, see the section

Intellectual Property.)

As for the Japanese government’s part in R&D

consortia, the idea that Japan’s technology advance

is driven by a massive, government-directed program--

a view fairly widely held in the West at one time-is

untrue and largely discredited. It is a mistake,

however, to underestimate the government’s influence. Although government’s annual spending per

project is typically rather modest (the $300 million

MITI spent over 4 years for VLSI was unusually

high), the government commitment is steady and

long-term, and this counts for a great deal.

Moreover, the fact that the government enters into

relatively few R&D consortia should not be taken as

a sign that the government’s role is insignificant.

The projects in which government participates are

carefully chosen. Usually they are the upshot of

continuing discussions between government agencies and business councils. They are consistent with

the “vision,” also developed by government and

industry, of what kinds of technologies and industries are essential to the Japanese nation. Projects in

the 1970s and 1980s were chosen for their contribution to the Japan’s becoming a knowledge-intensive

society.

Thus, the government’s choices are both strategic

and symbolic. They also give a signal. Private banks

and financial institutions follow MITI’s lead. And

funding of joint R&D is only one of a whole raft of

tools at the government’s disposal for supporting

strategic technologies. Besides the special loans,

grants and tax breaks companies can get as inducements for joining R&D consortia, they may also get

similar benefits from government programs in the

commercial development that follows.

Making Successful Consortia

The innumerable factors (ranging down to the

personalities of key participants) that affect the

outcome of R&D consortia prevent the development

of a recipe. Nonetheless, it is possible to offer some

guidelines.

Because companies in the same industry are

primarily competitors, minimizing conflict between

consortium participants is critical. It is always

difficult to get participants-often with long histories of competitive relations-to work together on

anything, although successful cooperative research

demands that they do. Consortia which fail to reduce

conflicts to workable levels either collapse during

the planning stages or find their effectiveness

sharply reduced.

Conflicts can be avoided in more than one way.

First, the evidence from Japan suggests that cooperation is more easily established when a technology is

already known. Catch-up consortia have the advantage of avoiding certain conflicts by definition; for

example, the participants need have little fear that

any monopoly-creating technological breakthrough

is at stake. Catch-up consortia also benefit from their

clear goals, which make them inherently more likely

to succeed than new technology consortia. This

comparison by itself is misleading, however. Catchup consortia should be compared with other catch-up

mechanisms, not with new technology consortia.

Likewise, new technology consortia should be

compared with other mechanisms of technological

innovation.

It may also be easier to avoid conflicts when a

cooperative project is aimed at goals far from the

competitive arena. For this reason, some claim that

R&D consortia should be aimed at basic industrial

research rather than applied research. Yet if participants can agree on well-defined areas of precompetitive research, they can overcome the potential for

conflict. Indeed, international competitive pressures

can be so strong in some cases that participants

become exceptionally interested in making major

cooperative R&D efforts that go right through pilot

production (e.g., Sematech) perhaps even into commercial manufacturing (e.g., Airbus). Moreover, the

results of applied research may be more useful to

consortium members than yet another increment of

basic research-in which the United States is

already strong.

Conflict is not the only impediment to success.

Ultimately, success comes only when the products

of a consortium are adapted and integrated into the

mainstream of participating fins’ operations. There

are several ways of encouraging diffusion of the

results from cooperative R&D. Most important, a

substantial financing commitment from participants

seems to be necessary. Firms pay attention when

enough of their own money is at stake. Of course,

defining “enough” is possible only case by case;
Chapter 7—Where We Stand: Public Policy and Technology ● 211

Sematech defined it as 1 percent of each fro’s

revenues. Another funding strategy is to make sure

that the resources given to the consortium are taken

from the budget of the department in the firm that is

responsible for using the consortium’s results.

Another issue is personnel. Firms do not often

send their very best people to R&D consortia. But if

they send fourth-best personnel, the consortium will

have no credibility within member fins. Firms must

recognize the problem and send at least their

second-best people, if the consortium’s results are to

get an attentive hearing. Also, a powerful patron for

the consortium within the member firm helps to

ensure that the results are exploited; without such a

patron, the consortium can easily fall victim to the

‘‘ilot-invented here’ syndrome.

To establish closer links between consortia and at

least some participants, the EC (almost always) and

the Japanese (sometimes) have located their consortia research within the labs of participating firms. In

contrast, MCC and Sematech have their own labs.

Another diffusion strategy is the promotion of

parallel research. Japanese firms taking part in

consortia often have entire research labs devoted to

shadowing the consortiums results.

On a slightly different point, one key reason why

Japanese companies take part in consortia is to keep

an eye on what their competitors, domestic and

foreign, are up to. Technology diffusion is an

acknowledged weakness of U.S. manufacturing (see

ch. 6). If R&D consortia succeed not only in

transferring their own results effectively to members, but also in raising members’ awareness more

broadly of technology advances in their field but

outside their members’ own area of emphasis, then

the consortia will have served a useful purpose.

The Role of Government

Government should try to ensure that consortia it

supports are designed appropriately, taking to heart

the lessons described above. But this is not sufficient

grounds on which the government can make a choice

of projects. For example, it is necessary but not at all

sufficient that the project have enthusiastic participation (including a hefty financial commitment)

from industry. The government—with its inevitably

limited funding-must also have some notion of the

extent to which the projects it supports are important

for the economy as a whole.

Some areas of technological advance offer longterm benefit to society but do not attract sufficient

private investment because they are high-risk activities with uncertain pay-offs, and are very expensive.

In the past, industries and technologies have been

supported by the government on the grounds that

they were vital for the nation’s security. But today

other grounds appear more pressing. Certain industries have vitally important spill-over effects: knowledgeintensive industries have ramifications far beyond

their own (fast-expanding) boundaries; the whole

complex of industries that the Europeans call

‘‘telematics’ directly affects the competitiveness of

many other industrial sectors. And there are other

“key” technologies. It is not an accident that both

Japan and the Europeans have targeted the same key

industries and technologies.

The notion that some consortia are more worthy

of government support than others implies that some

government agency must make that determination

(see ch. 2). It is fair to argue that any large-scale shift

toward cooperative R&D with government support

will, in the end, imply the kind of choices that a

civilian technology agency would be designed to

make. Only such an agency could have the necessary

expertise.

This brings up a final important point. While the

government must seek to ensure that its support goes

to projects that are both valuable and likely to

succeed, government support is itself a factor in the

equation. In Japan and Europe, government support

provides both cash and credibility to a project, and

may make the difference between success and

failure. That, after all, is why these governments’

support for R&D projects can be justified: if

government money did not make the difference

between success and failure, there would be no need

for that spending in the first place.

INTELLECTUAL PROPERTY

Intellectual property rights, once largely ignored

in our Nation’s trade policy, are now an important

issue. Foreign firms skilled at imitation are said to be

stealing our inventions, and weak protection of

intellectual property is held to blame. The United

States is negotiating for stronger rights worldwide

(including better enforcement), both bilaterally and

in multilateral negotiations of the General Agreement on Tariffs and Trade (GATT) and the World

Intellectual Property Organization (WIPO). There is
212 ● Making Things Better: Competing in Manufacturing

also concern to maintain strong protection in this

country-especially against infringing imports.

Attention has been focused on the whole range of

intellectual property rights, including (among other

things) patents for inventions; copyright for books,

records, and computer software; and laws concerning trademarks used to identify a fro’s goods.l24

This section, however, addresses only those intellectual property rights that directly protect technological innovation, including patents and software copyrights. Generally, the term “intellectual property”

in this section denotes only intellectual property of

this sort. (Box 7-D describes those intellectual

property rights and explains how their effectiveness

can vary.)

Inventors do not always need legal protection to

keep imitators out of the market. Sometimes they

can keep the new technology secret long enough to

get a good lead in the market.125 For example, it is

hard for an outsider to determine the exact composition of many chemicals, and still harder to determine

the process used to make them. In other cases,

secrecy is not feasible. Many products are rather

easily examined and duplicated—machinery, for

example. Even computer chips, with their microscopic maze of interconnecting circuits, are surprisingly easy to copy. Information can also leak out

through employees switching firms, and through

suppliers and customers. In many industries, detailed information about new products and processes

often leaks out to competitors within a year after

they are developed.126 When secrecy breaks down,

inventors may turn to the legal protection of

intellectual property rights.

The U.S. interest in intellectual property rights to

protect technological innovation is not surprising.

While other countries have surpassed us in implementing some new technologies, the United States is

still a world leader—perhaps the leader—in discovering new technologies. The inventor of something

new has an obvious interest in keeping to himself the

right to make and sell the thing-or in extracting

royalties if he wishes to sell that right to others.

The case that stronger protection would yield

great dividends is not clear, however. Protection of

inventions is only one factor—by no means the most

important-in competitiveness. Furthermore, the

net effect of stronger protection on the advance of

technology is uncertain. While it might encourage

R&D by rewarding inventors, it can limit the

diffusion of the new technology. Finally, it is not

easy to persuade less developed countries, where

intellectual property protection is relatively weak, to

raise their level of protection. While intellectual

property protection does matter, even the best

foreseeable changes in protection here and abroad

will probably have at best a modest positive effect on

U.S. manufacturing. The most promising avenues of

change are: 1) streamlining enforcement of patent

rights in the United States and Japan, and 2)

harmonizing patent procedures among different

countries.

How Much Can Increased Protection Help?

This section considers whether: 1) stronger protection for technological innovation can prevent

large trade losses to imitators, 2) stronger protection

would make the U.S. economy (and other economies) more efficient by encouraging research and

development, and 3) the United States can convince

other countries to increase protection.

Preventing Losses

It is not known how much the U.S. trade deficit is

increased by gaps in intellectual property protection.

The U.S. International Trade Commission (ITC)

estimated that for 1986 these gaps caused U.S. firms

to lose revenues of $43 to $61 billion.127 This figure

is extrapolated from survey responses by selected

firms with estimated losses totaling $23.8 billion.

The sum includes at least $1.8 billion in sales lost

directly in the United States to infringing imports,

$6.1 billion in sales lost directly abroad because of

l~For a more gener~ ~scussion of in~ll~tu~ property rights, see U.S. Congress, Office of Technology Assessment, fnteffecrud Properfy Righfs in

an Age of Electronics andlr@ormation, OTA-CIT-302 (Springfield, VA: National Technical Information Service, 1986).

l~Tr~e ~re~ 1aw Cm pro~t against competitors’ use of information gained by unauthorized Mcas.

126~wln Mansfield, ‘ ‘How Rapi~y ~s Technolo~ ~~ out?” The Jour~iof/~lr~/Eco~mics, VO1. 34, No. 2, December 1985, pp. 219-221.

Mansfield reported on a survey of 100 fms in 13 industries, chosen at random from those industries’ high R&D spenders. Ibid., p. 217, fn. 2.

12’7UOS. ~ternation~ Trade Comi5sion, Foreign Protection of lntellect~lprope~ Righfiadthe Effect on fJ.S. I&t~and Trade (Washington,

DC: USITC Publication 2065, February 1988), pp. H-2 through H-3.
Chapter 7—Where We Stand: Public Policy and Technology ● 213

Box 7-D-Intellectual Property Rights Protecting Innovation

Intellectual property rights follow national boundaries. They are granted by national (or state or provincial)

governments, and apply only within the national territory. A firm that desires rights in other countries can seek such

rights from those countries, If a firm’s rights are being violated in a foreign country, it must go to that country’s

courts for monetary compensation or an order stopping future violations.

The most important intellectual property right for protecting technological innovation is the patent. Patents are

granted by a national government for inventions of new, useful, and non-obvious products or processes (including

new, useful, and non-obvious improvements of existing products and processes). A patent grants the right for a fixed

period (in the United States, 17 years) to stop others from doing the following things within the national territory:

making covered products; using or selling covered products, wherever they were made; using covered processes;

and (in some cases) using or selling products made abroad by covered processes.

Other rights include copyright, semiconductor mask work protection, and trade secrets+ Copyright is the right

for a fixed period (in the United States, the term varies depending on circumstances but is at least 50 years) to control

the copying and other dissemination of textual, artistic, or other expressions; it is significant for protecting

technology because in the United States and many other countries, copyright protects against the copying of

computer programs and data. Mask work protection, a new form of protection created by the United States in 1984

and since adopted by other countries, protects against copying the layouts of semiconductor chips, which involve

elaborate interconnections and are very expensive to design. Trade secrets law concerns the stealing of a firm’s

secrets, including technical know-how. Depending on the law, a firm which has tried to keep its knowledge secret

may be able to stop other firms which gained unauthorized access to this knowledge from using it.

The scope and effectiveness of protection varies from country to country. For example, Argentina, India,

Brazil, and Mexico do not grant patents for pharmaceutical products, and Brazil does not grant patents for processes

for manufacturing pharmaceuticals. Also, the duration of patent protection varies. The United States generally

grants protection for 17 years from the date of the patent grant, while in India patents concerning foods,

pharmaceuticals, veterinary products, pesticides and agrochemicals last only 5 years from the patent grantor 7 years

from the application, whichever is shorter. Some countries require that, when it is in the national interest, patent

owners must grant a license to a local producer. If the parties cannot agree on a royalty rate, an administrative or

judicial authority will set one.

Thus, the laws vary in scope; but the effectiveness of protection might depend still more on procedures for

enforcing legally defined rights. For example, applying for and enforcing patents can be costly, especially in foreign

counties where companies have to hire foreign patent lawyers and pay to have documents translated. Application

and enforcement proceedings often take several years, during which time others are in most cases free to imitate

the invention. Moreover, the rules of procedure and evidence in some countries might make it difficult to prove that

a violation has occurred.

inadequate protection, and $3.1 billion in lost estimates of their losses. It is hard for a firm to state

royalties. 128 It also includes other items, such as

reduced profit margins, business never attempted

abroad, loss of manufacturing economies of scale,

and the effect of a weakened sales force on other

product lines. The ITC’s report did not quantify

these other items separately.129

As the ITC acknowledges, projecting from the

193 companies that estimated lost revenues to the

whole U.S. economy is problematic. Even for these

193 companies, the ITC depended on firms’ own

confidently how much it has lost even in direct sales,

and even more so for other items such as hypothetical losses from sales never attempted. The estimates

could also be too high if the firms incorrectly

believed that certain goods were infringing. In

addition, the ITC study concerned infringement of

all intellectual property. If losses were restricted to

technology-based intellectual property, the subject

under investigation here, the ITC’s estimate would

probably be at least 10 percent lower.130

l~Ibid,, pp. 4.5, A-c. These Mm fi~res arc compiled from firms tha[ estima[ed these items separately. Other responding firms may have inCUrrd

these losses but did not estimate thcm separately.

1291 bid., p. 4-4.

130Ente~~ent, f~and ~verages, pUbllShlng and ~rlntLng, a[ld textl]es and apparel comprise $2..Q~ billion oftie total losses of$23.8 billion. Ibid.,

p. 4-3. These particular categories probably mvolvc almost exclusively trademarks and hterary or arustic copyright.
214 ● Making Things Better: Competing in Manufacturing

More fundamentally, the existing forms of protection cannot always protect against imitation. Even

when a firm has a patent, others can often invent

around it—i.e., develop alternative technologies to

get the same result.131 The patent does give the

original inventor a headstart while others catch up.

During this time, the inventor might be able to

improve the manufacturing process, expand production to exploit economies of scale, and develop

marketing channels ahead of his competitors. If

competitors are better at manufacturing or marketing, however, they can overtake the inventor. This

has happened many times. A classic example is the

CAT scanner, whose inventor was eventually rewarded with a Nobel prize. The invention was

carried out for the British firm Electrical Musical

Industries (EMI) Ltd. in the late 1960s. Although

EMI produced and sold the CAT scanner successfully at first, the company lost its lead in the U.S.

market half a dozen years after introducing it there;

its biggest, most successful competitor was General

Electric, which quickly developed a somewhat

improved scanner and provided hospitals with

superior training and servicing. A couple of years

later, EMI dropped out of the CAT scanner business.

132

Promoting Economic Growth

The theoretical basis for intellectual property

protection is to promote economic growth by

encouraging research and development—a factor of

special importance to the United States, since U.S.

manufacturing competitiveness depends heavily on

technological superiority. Without strong protection, the argument goes, many innovations that

would benefit society as a whole might never be

made because the innovator could not make enough

profit to recover the costs of research and development and compensate for the risks of failure.133 It

should be borne in mind that not all R&D pans out.

Profits on the successes must be great enough to

cover the costs of the inevitable failures as well. In

addition, the world today is so full of competent

manufacturers that imitation is occurring faster than

ever, making it increasingly harder for innovators to

recover enough profits. If they are to get sufficient

reward for their inventions, they need strong protection of the law.

This argument for intellectual property protection

has some force. However, there is evidence that

many inventions would still be made even if legal

protection were unavailable.l34 In an opinion survey,

100 firms in the United States were asked what

percentage of their patentable inventions commercially introduced in 1981-83 would have been

introduced even if patent protection were not available. The answers, by industry, were: 35 percent in

pharmaceuticals, 70 percent in chemicals, 80 to 90

percent in petroleum, machinery, and fabricated

metal products, and over 90 percent in primary

metals, electrical equipment, instruments, office

equipment, motor vehicles, rubber, and textiles.135

In another opinion survey, 130 firms rated patents as

fairly ineffective in many industries, including

electronics; secrecy and lead time were generally

considered more important.136 Another study also

found that patents provide relatively little protection

131~ven~g ~Omd ~atentS iS relatively emy in elatronics, and relatively difficult in ph~aceutic~s. Rich~d Levh, Alvin Klevorick, Richard

Nelson, and Sidney Winter, “Appropriating the Returns From Industrial Research and Development,” Brookings Papers on Economic Activity, No.

3, 1987, p. 811; Edwin Mansfield, Mark Schwartz, and Samuel Wagner, “Imitation Costs and Patents: An Empirical Study,” Economic Journal, vol.

91, 1981, p. 913. In general, broader interpretation of what a patent covers can make the patent harder to invent around.

lszDavid J. T-e, 1‘Captting Value From Technological Innovation: Integration, Strategic Partnering, and Licensing Decisions, ’ Technology ati

G/obaf Industry: Companies and Nafions in the Wor/dEconomy, Bruce R. Guile & Harvey Brooks, (eds.) (Washington, DC: National Academy Press,

1987), pp. 65-66,85-86.

lssM~t Ofien tie major exwme is not ~ m&ing an invention or discovering a new res~t, but rather in Subquent development work culminating

in commercial production.

l~~e li~ratm on this pint is review~ in Wesley Cohen and Richard hvin, ‘‘Empirical Studies of Innovation and Market Structure, ’ Handbook

o~lndusm”al Organization, Richard Schmalensee and Robert Willig, (cd.) (New York, NY: North Holland, 1989), vol. 2, pp. 1091-1093.

135~~n Masfield, ‘cp~ents and ~ovatlon: An Empficd Study,” Ma~gementScie~e, vol. 32, 1986, pp. 174-175. The firIIIS were dSO askd

what percentage of their patentable inventions made during 1981-83 would have been made even if patent protection were unavailable; the responses

were similar, The fms were chosen at random from 12 U.S. industries (excluding very small firms). Of the 100 fins, 96 responded,

136Richmd ~vin, Alvin Klevorick, Richmd Nelson, and Sidney Winter, op. cit., pp. ‘7~, 792, ‘794, 796-797,811. The flrms d.%) rated process piMeIItS

less effective than product patents. The data suggests several reasons: processes are easier to keep secret and fms prefer to keep processes secret rather

than disclose them in a publi~ed patent; processes are patentable less often than products; competitors can find alternative processes rnon easily man

ahemativeproducts; competitors’ uses of patented processes are harder to detect and prove than competitors’ manufacture and sale of patented products.

Ibid., pp. 794 (table 1), 797 (table 2), 803 (table 5).
Chapter 7—Where We Stand: Public Policy and Technology ● 215

in electronics, compared to drugs and chemicals.137

Yet the electronics industry spends about 8 to 9

percent of sales on R&D, compared to an average of

about 3 percent for all R&D-performing manufacturing industries.138

In addition, the social benefit of encouraging

R&D must be balanced against certain social costs.

One cost is reduced diffusion of new technology—

including technology that would have been developed even without legal protection. By exercising

intellectual property rights, an innovator can prevent

others from using the new technology. Thus, people

wanting to buy products dependent on the new

technology might find the products expensive or

unavailable because competition has been stifled.

Perhaps even more important, other researchers will

be reluctant to build on a protected invention (e.g.,

by improving it or by applying it in a new way), since

the original inventor may try to stop other firms from

using any derivative technology. (And if the inventor is willing to license the invention, the royalties

might be more than most firms would pay.) For

example, the semiconductor industry would have

been slower to take off if AT&T had been able to

keep others from using the key technology covered

by its early transistor patents.139

While all patents to some extent risk inhibiting

technology diffusion, some recent patents with a

broad sweep have aroused particular concern. These

include patents on software to display multiple

windows on a computer screen and to compare the

texts of different versions of a document,l40 and a

patent on a new mathematical technique to solve

problems such as routing of telephones and scheduling of airlines.141 The courts might interpret such

patents narrowly or find them invalid altogether—

but first some firm must have sufficient stake in the

issue to mount a court challenge. In some fields, the

danger of inhibiting technology diffusion might be

relatively low. For example, patents on existing

pharmaceuticals generally do not stop rival firms

from developing and marketing new pharmaceuticals based on different active ingredients (although

patents would stop rival firms from developing, for

example, new dosage forms of existing pharmaceuticals).

Patents can also help diffusion of technology,

because they are published and must explain how to

practice the patented technology. Upon reading a

patent, an expert in the field might think of follow-up

work or might think of a way to achieve the same

result in a different way, outside the patent’s

purview. Many Japanese firms routinely track patent

applications (which in Japan are published 18

months after filing) to learn about new technology.

In the United States, applications are published

when a patent is granted—typically about 2 years

after the application is filed. However, this published information often could be learned instead by

examining the products.

There are also costs of running the legal system.

Patent applications can be expensive for inventors to

file and for the government to evaluate. Lawsuits

between patent owners and alleged imitators are

expensive for the parties and take up valuable court

time. Moreover, in many lawsuits the court finds that

no patent rights have been violated, so the time and

expense was for naught---a, worse, the suit might

even have been brought deliberately to harass

legitimate competitors and scare their customers.

Another cost is that, to the extent the law is unclear

or its enforcement unpredictable, business planning

is hindered for both inventors and possible competitors.

Since intellectual property protection entails social costs as well as benefits, providing ever stronger

intellectual property protection does not necessarily

promote economic growth. The best results come

from protection strong enough to encourage innovation but not so strong as to greatly inhibit technology

diffusion—with some attention to making enforcement predictable and inexpensive. Unfortunately,

determining what level of protection would work

lgT~win Mansfield, Mark Schwartz, and Samuel Wagner, op. Cit., p. 913.

ls8Nation~ Science Fomdatlon, Nafiow/Patterm ~fR&f) Resources: ]989, Find Report NSF 8$)-308 (Washington, DC: U.S. Government finting

Office 1989), p. 65. This source gives ‘‘Company R&D funds as a percent of net sales in R&D-performing manufacturing companies by industry’ for

1986. The percentage for electronic components (SIC 367) is 8.5; for drugs and medicines (SIC 283), 8.8; for other chemicals (SIC 284-285, 287-291),

2.6; and for all industries combined, 3.2.

IWU.SO Congess, office of Twhno@y As~ssrnent, /nternutionu/ Competition in Services, OTA-lTE-328 (Sprinxleld, VA: Nation~ TCX~C~

Information Service, July 1987), p. 216. As part of a 1956 consent decree settling an antitrust suit against it, AT&T agreed to license its transistor patents

to other firms.

I@Lawrence Fisher, ‘‘Software Industry in Uproar Over Recent Rush of Patents,’ The New York Times, May 12, 1989, p. D1.

lqlGina Kiolata, “Ma~ematicia~ Are Troubled by Claims on Their Recipes, ” The New York Times, Mar. 12, 1989, p. E26.
216 . Making Things Better: Competing in Manufacturing

best is largely a matter of guesswork. Empirical

studies of how the level of protection affects the total

amount of innovative activity (both invention and

diffusion) are few and inconclusive.142 Other effects

might also be weighed in the balance. For example,

strong patent and trade secret protection can make it

harder for employees in an established firm to leave

to found their own firm in the same field of

technology.

143 Whether this effect is desirable depends on the characteristics of particular industries.

Another effect is that strong protection at home

can be a bargaining chip abroad. In the 1960s, both

IBM and Texas Instruments gained permission to

produce and sell in Japan only by agreeing to grant

Japanese firms licenses under their key U.S. patents

for computers and semiconductors respectively. In

effect, IBM and Texas Instruments gained access to

the Japanese market in exchange forgiving Japanese

firms access to the U.S. market.l44

Finally, in considering the optimum level of

intellectual property protection, it should be borne in

mind that intellectual property protection is not the

only way to encourage innovation. For example, the

government can fund research and development,

give tax breaks or preferential financing to industry

investing in R&D and in modern equipment, and

collaborate in industrial R&D projects. On the

whole, compared with some other countries, the

United States has chosen to rely less on these other

means of encouraging innovation and more on

protection of intellectual property. This choice

probably arises from the fundamental, widely held

view in this country that government and civilian

industry should be separate. Intellectual property

protection is seen as proper: it simply lets firms

make profits in the marketplace based on their

inventions. The alternative that the United States has

most strongly embraced—support for basic research

and for defense R&D-involves little interaction

between government and civilian industry.

If the United States were to put more emphasis on

various other means of encouraging innovation,

intellectual property protection might become less

important.

Convincing Other Countries

Assuming that stronger worldwide protection of

intellectual property could improve U.S. competitiveness, is there a realistic prospect that other

countries can be persuaded to change their laws?

Generally, the less economically developed a country is, the less it desires intellectual property

protection.

Less developed countries are not much moved by

the argument that imitation is a form of stealing

because it takes the benefits of R&D without sharing

the costs. These countries are apt to reply that they

are already much poorer than we are, and that strong

intellectual property protection would just aggravate

the difference. Stronger protection would benefit

innovators in rich countries while driving prices

higher for consumers and stopping capable local

imitators in poorer countries.

The argument that protection is good for economic development in the long run, because it

encourages local innovators, also falls on stony

ground. Imitation of existing technologies is at least

as well proven as a springboard for economic

development as local innovation. Korea and Taiwan

are modern examples. The United States, as colonies

and as a nation, based much of its own earlier

economic growth largely on imitation of European

technology.

Finally, developing countries are urged to consider that they may not always be able to imitate.

Sometimes they will need to buy technology from

foreign firms, and these firms might refuse to license

or sell technologies in countries that lack adequate

intellectual property protection. This possibility

does not seem to scare developing countries much.

For example, many complaints have been lodged

about unlicensed imitation or “piracy” of inventions in Korea, yet Korean firms have found willing

sellers of technology among U.S. innovators, especially in the semiconductor industry.

Idzwesley Cohen and Richd kin, “Empirical Studies of Innovation and Market StIUChKG” Hana%ook of Industrial Organizatwn, Richard

Schmalensee and Robert Willig, (cd.) (New York, NY: North-Holland, 1989), vol. 2, pp. 1089-90, 1094-95.

143when a ~uent fm sues a spinoff for ~leged patent or trade s~ret vlolations, tie cost of fighting tie suit can intimidate the spinoff, regardless of

the merits of the case. The parent’s motivation is often more to prevent hiring away of employees than to protect intellectual property--as shown by the

terms of settlements. Professor John Barton, Stanford Law School, personal communication, June 12, 1989 and Feb. 1, 1990,

144u.s. Conmss, Office of T~~o]on Asx55ment, /~erMtwM/ co~etitiveness in E/ec~om”cs, OTA-ISC-ZOO (Springfield, VA: National

Technical Information Sewice, November 1983), pp. 193-194.
Chapter 7—Where We Stand: Public Policy and Technology ● 217

If the United States cannot persuade other countries that strong intellectual property protection is in

their own interest, it can resort to carrots and sticks.

The carrot is often exemption from tariffs for certain

imports from that country under the Generalized

System of Preferences.145 The stick can be denial or

withdrawal of such benefits, or flexible retaliation

(often in the form of punitive tariffs on certain

goods) under the recently strengthened Section 301

of the Trade Act of 1974. This approach has

achieved some success. For example, partly because

of sustained U.S. pressure, Singapore strengthened

its copyright protection generally and also applied it

to software.l46 

If other countries under our urging do pass

tough-sounding laws, that does not guarantee their

enforcement. Enforcement requires sophisticated

governmental apparatus. A country that has trouble

feeding its population cannot be expected to spend

large amounts of money to ensure speed and fairness

in processing patent applications and trying patent

suits. Moreover, a country that has been pressured

into granting intellectual property rights might be

particularly inclined to give enforcement efforts a

low priority.

Specific Problems

Efforts to strengthen intellectual property protection are likely to be most effective when aimed at

protection in the United States and in other developed countries. Both have large markets for the

products of U.S. technology; and developed countries have more interest in granting strong protection. The weak spots in these countries largely

concern procedures for administering and enforcing

the law, rather than the law’s substance.

U.S. Patent System

Courts in the United States have ruled more

favorably toward patent holders in the 1980s than in

the 1960s. This applies to rulings on patent validity

(in particular, whether an invention was sufficiently

non-obvious to merit a patent); scope of coverage

(how broad a range of possible imitation is prohibited by the patent grant); permissible conduct by the

patent holder (e.g., whether the patent holder may

impose various marketing restrictions on its licensees); and compensation to be awarded for infringement. The changed legal climate in part reflects a

shift in viewpoint. Traditionally, judges enforced

patents narrowly on the ground that patents created

undesirable monopoly rights. Increasingly, however, judges have viewed patent rights as simply a

legitimate incentive and reward for innovation. In

addition, in 1982 patent-related appeals were consolidated in one court, the U.S. Court of Appeals for the

Federal circuit. That court’s rulings have strengthened and clarified patent law. In fact, some believe

that this court has tilted the law too far in patent

owners’ favor.

The effectiveness of U.S. patent law is limited by

delay in enforcement. It takes over 2 1/2 years, on

average, to bring a patent case through trial for a

ruling. 147 Only then (with fairly rare exceptions) can

the patent owner get a court order to stop the

imitation. 148 A firm whose patent is being infringed

might not make it to the end of the trial, and even if

it does the court might not fully compensate for the

harm.

Delay is particularly troublesome in suits against

imported goods. Often it is hard to trace these

imports back to their source, to find out whom to sue.

Moreover, the U.S. courts have no way of enforcing

a ruling against a foreign manufacturer who has

neither assets nor employees in the United States. If

the manufacturer is beyond the court’s power, the

patent owner must sue domestic distributors instead.

(The same is true for other intellectual property

rights, including copyright, mask work, and trade

secret.) The patent owner might hesitate to sue, for

the foreign manufacturer’s distributor might also be

his own, for the same product or others. Even if the

court rules for the patent owner and orders the

distributor to stop selling the infringing goods, the

Idswhile gant~g such preferences might ~ conson~t with o~ over~l foreign policy obj~tives, ~e~ preferences do m~e foreign ~mpelillOn

stronger in the U.S. market, thus to some extent offsetting the gain in our total competitive position due to stronger intellectual property protection abroad.

146R. ~chWi G@bawmdT1mothy Richads, /nte//e~r~/ProPer~ Rights: G~b~Co~e~~, G/oba/Co@ict? (Bolllder, CO: WestviewPress, 1988),

pp. 313,329.

~41An&RepO~Of tie Director of t~ A~in~trati~e ofice of the United States Courts ]988, p. 221. This report shows a rfldiantilIIC Of 31 mOnl.hS

from filing to disposition of patent cases after trial; the arithmetic mean, or average, would probably be somewhat greater, since 90 percent of the cases

take at least 11 months and 10 percent of the cases take at least 62 months.

1481t is ~ Pficiple ~ssible to get s~h an order ~fore ~i~, c~l~ a prelimin~ inj~ction. However, in practi~ it is very had for a patent Owner

to get such an order unless he has already won a prior lawsuit based on that patent.
218 ● Making Things Better: Competing in Manufacturing

foreign manufacturer need only switch to another

domestic distributor. The patent owner will then

have to start all over again, first identifying and then

suing the new distributor.

The owner of a patent or other intellectual

property right can avoid these multiple lawsuits by

filing a complaint with the U.S. International Trade

Commission (an independent Federal agency) under

Section 337 of the Tariff Act of 1930, as amended.149

If the Commission finds that imports are violating

the complaining party’s intellectual property rights,

it can issue an exclusion order, enforced by the

Customs Service, barring importation of those

goods. Moreover, the Commission is required to

render a decision within a year (18 months in a

minority of cases deemed “more complicated”), a

considerably shorter time than the average a court

suit takes.

The GATT has ruled that Section 337 violates

GATT treaty provisions by providing special, harsher

enforcement of the patent laws where foreign goods

are concerned.150 Section 337 is still in effect.

However, other GAIT members could now retaliate

against future use of Section 337 against their fins.

The GATT decision found many aspects of Section

337 inconsistent with the GATT treaty, and it will be

difficult to amend Section 337 to bring it into line

with the GATT decision while still keeping the core

advantages of: 1) a quick decision, and 2) an

exclusion order.

Japan’s Patent System

U.S. firms have often been frustrated by the

ineffectiveness of Japan’s patent system in protecting their inventions.l5l Part of the problem has

stemmed from U.S. fins’ lack of familiarity with

how the system works. Difficulties have also occurred due to the language barrier. But part of the

problem stems from the nature of the system,

especially from delays and a public policy that

favors granting of licenses to those who improve on

a basic patent.

While precise figures are not available, it seems

that an application for a Japanese patent, if opposed

vigorously by another firm, will generally be tied up

for at least 6 years before an inventor can proceed

with a lawsuit. (Patent applications in the United

States take an average of less than 2 years.) After a

patent is issued in Japan, a firm accused in court of

patent infringement could probably cause the lawsuit to take at least 3 to 4 years.152 (U.S. patent trials

are not much quicker. They average somewhat over

2 1/2 years, and a determined defendant often can add

delay.) This puts an inventor in a poor bargaining

position: grant a license, or wait at least 9 to 10 years

to get anything from a lawsuit.153

In addition, other firms might seek patents for

various improvements. This practice is very common in Japan. After an application is first published

(generally 18 months after the application), firms

frequently file many applications for improvements.

Under Japanese law, a firm that receives a patent for

an improvement can apply to the Patent Office for a

compulsory license under the basic patent, if the

owner of the basic patent refuses to agree on license

terms. The Patent Office has discretion to grant or

deny the request.l54 While this law has never

actually been used, its presence can weaken the

bargaining position of a patent owner.155

The Japanese system, which encourages licensing, might work well for Japan’s economy by

promoting diffusion of technology. However, it

often does not serve U.S. firms well. To succeed at

all in Japan, a U.S. firm might have to be the sole

supplier of the item in question. As discussed

elsewhere in this report, Japanese firms have a

strong tradition and bias in favor of buying from

1491(3 USC. 1337. This ~em~y WM ~~en~en~ by the ~lbus Trade and competitiveness At of 1988, Public Law 1OO-418, SW. 1342.

ISOA GA~di~pute ~e~olution panel ~~ in November 1988, upon the complfit of the EC, that Swtion SST violates the ‘ ‘national Weatnlent” ClaUSe

of the GATT treaty, which requires that a member country treat imports from another member countxy in a reamer ‘no less favorable than that accorded

to like products of national origin in respect of all laws, regulations and requirements affecting their internal sale, offering for sale, purchase,

transportation, distribution, or use. ’ GATT Article H. The United States subsequently accepted the panel’s ruling, making it an officiaI GATT deeision.

151~e Semte Comittm on Comer&, Science, and Transpo~ation, Subcommittee on Foreign Commerce and Tourism, has held hearings on the

Japanese patent system on June 24, 1988 (Serial No. 100-59) and Feb. 28, 1989 (Serial No. 101-19).

152Y01c~ro Yamawhi, patent attorney regstered in Japan, Bevefidge, DeGran~ & Weilacher, personal communication, Jan. 30, 19$X).

lss~erdelays we ~ssible in ~th the Japanese and us- systems. The systems are hard to compare ~rudy. In general, both systems involve Sifik

types of delays (though sometimes in a different order), but the delays are longer in Japan. Ibid.

154Jap~ese Patent Law, IAW No. 121 of Apr. 13, 1959, as amended, SeCS. 7292.

lssyolc~ro Yamaguchi, op. cit.
Chapter 7—Where We Stand: Public Policy and Technology ● 219

other Japanese firms. Japan’s complex distribution

system reinforces the preference for buying Japanese. An exclusive patented technology might be the

only way for an American firm to get into the

Japanese market if it is forced to license Japanese

firms, they might capture the whole market.

The United States has been negotiating with Japan

to fix these and other problems. Already, Japan has

increased the Patent Office staff to reduce delay,

although not nearly as much as the United States

believes is necessary. Japan has also lengthened

various deadlines for non-Japanese parties, to allow

sufficient time for communication and translation.

Because Japan is now producing many inventions, it

might be receptive to granting stronger power to

patentees to exclude competition. The keidanren, an

influential Japanese association of businesses, has

already urged that patent systems worldwide should

provide “effective patent enforcement,” including

“preliminary and final injunctions [i.e., court orders

against infringement] as well as monetary awards

adequate to compensate patentees fully and serve as

an effective deterrent.’’156

Critics of Japan’s patent system might keep in

mind that the U.S. system has its own drawbacks.

Resolution of patent cases that go to trial is slow (on

average over 2 1/2 years). In addition, patent litigation can be expensive, and our patent law is quite

complex. Thus, foreigners may feel that our system

puts them at a disadvantage. While patents are issued

relatively quickly in the United States, they are fairly

often ruled invalid by the courts. Moreover, 20 years

ago the courts enforced patent rights more narrowly

than they do now. It should therefore not be too

surprising that Japan and other countries, following

in our economic footsteps, do not grant as strong

protection as we might wish.

Patent Office Procedures Worldwide

Procedures for issuing patents differ from one

country to the next. This raises the cost of filing

applications in more than one country. The United

States has been negotiating in WIPO and with Japan

and the countries of the EC on terms of possible

harmonization. The negotiations have already borne

fruit. At U.S. urging, Japan in 1988 started allowing

inventors to put multiple claims (in effect, multiple

variants of the same invention) in one consolidated

application, as has long been the practice in the

United States and Europe.

Most of the changes, however, will probably

come only as part of a comprehensive settlement. As

part of any package deal, it is likely the United States

will have to change from a first-to-invent system (in

which the first person to make an invention is

entitled to a patent) to a first-to-file system (in which

the first inventor to file an application is entitled to

a patent). Only the United States and the Philippines

follow the first-to-invent system.

A fret-to-file system has some advantages. Since

patents disclose the invention, early patenting could

increase technology diffusion. A fret-to-file system

also avoids extensive legal fights over who was the

first inventor. However, switching to a first-to-file

system in this country could disadvantage small

inventors (either individuals or startup or small

firms), who are probably more important in the

United States than elsewhere. Having no patent

department, small inventors usually have a harder

time filing applications and therefore prefer to delay

filing, to see if the invention warrants filing and to

have more time to prepare the application. Under a

first-to-invent system, these inventors can delay

filing applications without fear of being preempted.

Under a first-to-file system, a small inventor might

lose out to a later inventor in a large firm that gets its

application filed first. This hardship on small

inventors could be lessened by making initial

applications easier and cheaper to file, as they are in

many fret-to-file countries.

ANTITRUST LAW

Federal antitrust law prohibits a wide range of

business conduct that restrains trade or monopolizes

a market. Its core provisions, Sections 1 and 2 of the

Sherman Act of 1890, as amended, prohibit both

business “combinations . . . in restraint of trade”

and the “monopoliz[ation], or attempt to monopolize," trade.157 The Sherman Act and other antitrust

statutes are worded in general terms, and could by

their literal language prohibit a great deal of

innocent business activity. The courts therefore have

taken the statutes as an invitation to fashion a body

l~e ~~ll=tu~ ~~y mi~~ (USA), Keidanren (Japan), and UNICE (Europe), Baic Framework of cm provisions on l~ellect~

Property: Statement of Views of the European, Japanese and United States Bwiness Communities, June 1988, p. 33.

15715 Uos,c. 1.2.

21-7000- 90- 8
220 ● Making Things Better: Competing in Manufacturing

of precedent to explain more clearly what conduct is

prohibited.

U.S. antitrust law has long been an effective

shield against the power of monopoly and has kept

many fields open to enterprising, innovative newcomers. Today, as foreign competition looms large

in the U.S. economy, some have questioned whether

traditional interpretation and enforcement of antitrust law may need some changes. Antitrust law

could potentially prohibit firms from merging,

forming joint ventures, and cooperating in various

other ways—such as setting industry standards and

conducting joint R&D projects. This section assesses the extent to which antitrust law might

prohibit or discourage such behavior even when it

would enhance the competitiveness of U.S. manufacturers.

While direct evidence is scanty, it appears that

antitrust law does discourage some competitivenessenhancing conduct, and would somewhat impede

government and private efforts to increase such

conduct. In most cases, the law does not actually

prohibit the behavior in question; but because the

law is unclear and involves stiff penalties, businessmen are often afraid to do anything that even looks

like it might be an antitrust violation.

The Changing Interpretation of the Law

●

The types of conduct prohibited by antitrust law,

and the philosophical justification for the prohibitions, have changed somewhat through the years. In

the late 1800s and early 1900s, antitrust law was

aimed in part at keeping businesses small. Small

businesses were seen as more humane and more

responsive to local needs. The Supreme Court, for

example, criticized the transformation of “an independent businessman, the head of his establishment,

small though it might be, into a mere servant or agent

of a corporation, ’’158 and noted the “widespread

impression that corporate power had been and would

be used to oppress individuals and injure the public

generally.’ ’159

In recent years, antitrust law has been aimed not

so much at preventing bigness as such but rather at

ensuring fairly free competition. Under neoclassical

economic theory, a free market-in which many

firms compete and no one firm is large enough to

affect the market for its product—is most efficient

for society. When one or a small number of firms

comes to dominate the market; those firms tend to

reduce output and raise prices compared with free

market levels. This market power is called oligopoly

(if only a few firms are competing) or monopoly (if

only one company sells the product).

Since the 1960s, the primary purpose of antitrust

law has been to promote competition by minimizing

the creation and exercise of market power.l60 Today

both the courts and the Federal enforcement agencies acknowledge that some kinds of cooperation

can often be justified by compensating benefits to

society. l6l For example, suppose several competing

firms with large combined market share in metal

alloys create a joint venture to develop and sell a

particular new alloy. Despite the joint venture’s

market power, society might be better off with the

joint venture than without it because on their own the

firms might have taken much longer to develop the

product.

In evaluating a firm’s conduct, enforcement

agencies and the courts most often use a balancing

test, or “rule of reason. ” Conduct that threatens

substantially increased exercise of market power is

permitted if the societal benefits outweigh the

societal costs (or, as sometimes phrased, if the

pro-competitive effects outweigh the anticompetitive effects). The rule of reason is not always

used. For example, certain egregious conduct, such

as agreements among sellers to fix prices or divide

markets, is deemed to be a per se (Latin for “by

itself’ violation. In such cases no balancing test is

performed, on the ground that the conduct rarely if

ever can have any social benefit.

The wide adoption of the rule of reason by the

courts and the enforcement agencies has made

antitrust law more accommodating than it once was.

lS8Fr~~ck Row, “me ~l~e of ~ti~t ~d tie ~l~ions of Models: The Faustian Pact of Law and ~OnOmiCS,” Georget~n @JOIW@

vol. 72, June 1984, p. 1517, quoting United States v. Trans-Missouri Freight Association, 166 U.S. 290, 319, 323 (1987).

l~~id., p. 1517 footnote 32, quoting United States v. Standard Oil Co., 221 U.S. 1. so (191 ~).

16Dp~llip ma @ ~uis K@oW,A~~frwfAW@~~: frobfe~, Text, c~es, Ah ~. (Boston, w: Little Brown & L’o., 1988), pMS. 111, 130, pp.

13-14, 44-45; Frederick Rowe, op. cit., pp. 1524-1535.

161Reportof the Amrican B@Asso~~tion section ofAntip~t~ T~kForce on the Antitr~tDiv&n of the U.S. Department ofJwtice,hdy 1989,

pp. 8-16.
Chapter 7—Where We Stand: Public Policy and Technology .221

Congress also modified the antitrust statutes in the

1980s because of concern for U.S. manufacturing

competitiveness. The Export Trading Company Act

of 1982162 provided for advance antitrust approval

for firms working together through export trading

companies. In the National Cooperative Research

Act of 1984,163 Congress mandated a rule of reason

approach, and in some cases lessened penalties, for

joint R&D. But whether these recent changes are

enough, or whether further modification of antitrust

law is called for to enhance U.S. competitiveness, is

still an issue.

The Terms of the Debate

There are arguments for maintaining the status

quo. In the past decade very few antitrust lawsuits

have been brought, let alone won, that challenge

activity which arguably should be encouraged on

competitiveness grounds (e.g., joint R&D). 164 Moreover, it is hard to find examples of firms’ giving up

any such activity because of antitrust concerns.

In addition, antitrust enforcement has substantially lessened over the last two decades, especially

in the early years of the Reagan administration. For

example, civil cases filed by the Justice Department,

around 30 per year in the late 1970s, dropped to the

low teens by 1983. Cases against conduct other than

price-fixing and bid-rigging165 have become rare,

and the Justice Department’s guidelines, testimony

and other public pronouncements often express a

strong concern to ensure that antitrust law not

prohibit desirable business activity. Private suits

alleging antitrust conduct have also decreased in

recent years—from about 1,110 cases filed in the 12

months ending June 30, 1984 to about 660 in the 12

months ending June 30, 1988. Further weakening of

antitrust enforcement could send the wrong signal to

business, and invite anti-competitive behavior.l66

There are also arguments for further modification.

One argument challenges the neoclassical premise

that free markets always benefit society. Although

the premise might be true generally, it does not apply

in all cases. Specifically, perfect competition may

not be conducive to innovation in today’s business

and technological conditions.

Firms will perform less innovation than would be

best for society if they cannot capture substantial

benefits of their innovations. In a perfectly free

market, other firms imitate the innovator, take away

some of the business, and drive the price down to a

level that typically does not let the innovating firm

recoup its investment. If the innovator can get

market power, at least for a while, he can recover

more of the value to society of his innovation. In the

long run, a society in which innovators can expect to

gain some market power, at least temporarily, is

probably better off than one in which perfect

competition always prevails.167

The patent system provides one way of gaining

such market power. In fact, patent systems are

usually justified on the ground that they encourage

invention. A patent owner has the legal right to stop

others from using the patented technology for a term

of years (in the United States, generally 17 years),

and this right often yields some market power, at

least until others find a way around the patent.

Sometimes patents are not a very effective way of

getting enough market power to repay an innovator

(see the section Intellectual Property in this chapter). Corning out first with a new or improved

product is an alternative way of achieving market

power, at least for a time. But it is often the case

today that neither patents nor the advantages of

being first to market are enough to encourage

adequate innovation by single companies. Increasingly,

the kind of innovation nations need to enhance

l~pub]ic LSW 97-290, 15 U.S.C. 4001 et seq.

l~~blic ~W 98-4.62, 15 U.S.C. 4301 A305.

1640TA is ~wwe of n. ~~h ~-., exapt hat ~me C=s have ~nfil~ (but not won) against grOUpS of f~s ~tting industry stidards.

16SBid ~%ing involves tie exe~i~ of m~et ~wer by buyers, which has un&sirable eff~~ similar KI tie exerci~ of market power by @kXS.

ltiRePort of t~ Amr&an B~ &50c~twn section of Antitr~t ~T~k Force on the Antitrust Division of the U.S. Department of Jusn”ce, Op. Cit.,

pp. 4-5, 16-18, A7 (source for chart on page A7 is U.S. Department of Justice, Antitrust Division Workload Statistics FY 1978 to F’Y 1987); Annua/

Report cfthe Director of the Ati”nistrativeQ?ice of the United States Courts: Z988 (Washington, DC: U.S. Government printing Office, n.d.)t PP. 181t

185; see also Patrick Marshall, “Do Antitrust Laws Limit U.S. Competitiveness?” Congressional Quarterly’s Editorial Research Reports, vol. 2, No.

1, July 7, 1989, pp. 368-70, The Reagan Administration did file a high number of criminal cases, but largely against small local businesses such as

construction. Report of the American Bar Associatwn Section of Antitrust Luw Thsk Force on the Antitrust Division of the U.S. Department of Justice,

op. cit., p. 17; Patrick Marshall, op. cit., p. 368.

167ThommJordeand DavidTme, “~ov~ion, CwPr~ionand~ti~t: B~ancing ComWtition andc~ration,’ ‘High TechnofogyL.uwJournaf,

vol. 4, No. 1, spring 1989, pp. 8-13,
222 ● Making Things Better: Competing in Manufacturing

competitiveness requires resources far beyond the

means of small companies.168 Even for very large

firms, the expense and risks of R&D may be too

great for the firms to go it alone. For example, both

high definition television and optoelectronics require expensive technology development in several

areas at once.

Capital costs for manufacturing can also be very

high. It costs at least $250 million to build a plant to

produce the present generation of DRAM semiconductors, and for the next generation capital costs will

be much higher, perhaps $500 million per plant.

Such costs may be too great for most U.S. firms to

bear on their own. The manufacture of semiconductors and other high technology products also requires technical expertise in many fields-often

beyond the capability of a single firm.

There are other reasons as well for cooperation

among fins. Small manufacturing firms sometimes

benefit from pooling their resources and bidding

together on large jobs. Voluntary establishment of

industry standards requires cooperation between

firms. Sometimes mergers are necessary to match

foreign fins’ economies of scale.

All of these cooperative activities might run afoul

of our antitrust laws. The law does not invariably

prohibit activities like these. In fact, if firms can

advance technology or otherwise improve their

competitiveness only by teaming up, then courts

may well judge that the benefits to competition

outweigh the harm. Under the rule of reason, there

would then be no antitrust violation. The trouble is

that firms cannot be sure of this ruling in advance.

Because elements of the law are vague, and the

penalties for antitrust violation can be severe, firms

often shy away from cooperative deals out of a

combination of fear and ignorance.

Several factors can make it hard to predict the

outcome of antitrust cases involving cooperation.

Under the rule of reason, the beneficial and harmful

effects of the deal must be compared. The harmful

effects are determined largely by how much market

power the deal creates, but in practice, market power

is often very difficult to determine. For example, a

proposed joint venture might be expected to sell 80

percent of laptop personal computers, but only 10

percent of all personal computers, in the U.S.

market. The venture’s vulnerability to antitrust will

depend heavily on the extent to which laptops and

other personal computers are substitutable. Even if

the products do not readily substitute, some manufacturers of non-laptop personal computers might be

waiting in the wings, ready to produce laptops if the

joint venture tried to raise prices. In that case the

joint venture would have little market power. In

general, the substitutability of products and the

ability and willingness of firms in neighboring fields

to enter a market could be points of contention in

court. Also in contention could be the deal’s claimed

beneficial effects. Will the firms substantially advance technology to develop a new product, or is the

deal really just a front for pooling market shares?

And is it really true that the individual firms could

not profitably develop the product in question on

their own?

How these points are resolved at trial again

depends on several factors. The judge or jury may

understand the need for firms to pool their resources

but they may not. Facts about the market are hard to

determine and are often the subject of conflicting

expert testimony. Even after the facts are resolved,

the weighing of positive and negative effects is not

a precise calculation. It inherently involves the

exercise of judgment.

In addition, while the rule of reason is widely

used, alternative legal tests might in some cases cut

short the full consideration of the activity’s benefits.

Antitrust doctrine contains the per se test (an activity

is condemned without any consideration of its

benefits), the “quick look” test (an activity’s

benefits are considered only if on a quick look it

appears reasonably likely that such benefits exist);

and the “least restrictive alternative” test (an

activity is condemned if the court believes its

benefits could have been achieved by another

arrangement with less restrictive effect on competition). These doctrines might, for example, be applied

to some joint production cases-especially if the

l~~ordingto~e National Science Foundation, 200companies accounted for90percent of all industrial R&D spending in the United Staks in 1986.

The average R&D spending among this group was $273 million. If the average R&D intensity of the firms was 10 percent (a very high figure) the 1986

average net sales for companies in this group were $2.7 billion. William L. Stewart, “Effects of Corporate Restructurings on R&D Support,” testimony

before the House Committee on Science, Space, and Technology, Subcommittee on Science, Research, and Technology, July 13, 1989.

l@Jorde and Teece, op. ci~, pp. 4M2, 47A8.
Chapter 7—Where We Stand: Public Policy and Technology ● 223

court is skeptical that joint production can yield

benefits for society.l69

These are some of the complex issues of fact and

law that make the outcome of a particular case

difficult to predict. They can also make a trial quite

expensive. On the average, antitrust cases take

longer than other cases filed in Federal district court.

For example, of the cases that go to trial, antitrust

cases take a median time of 35 months, compared

with a median time of 19 months for all cases.170

Firms therefore have reason to be cautious about

activities that might be considered antitrust violations. The severe enforcement regime in antitrust

law, which includes multiple enforcers and stiff

penalties, reinforces caution.

Both the Justice Department and the Federal

Trade Commission enforce Federal antitrust laws.

These agencies can file civil suits to stop the

offending conduct. Also, if the Justice Department

establishes that an antitrust violation has caused

economic harm to the government, the defendant

must pay the government actual damages.171 From

1984 to 1987 the Justice Department filed a total of

46 civil suits. Of the 50 civil suits terminated in that

period, the government won 39, lost 2, and negotiated an agreement in the remaining 9.172 For mergers

and some joint ventures above certain dollar thresholds, firms must give the government advance

notice. 173 If the government announces its intention

to challenge the deal in court, the firms involved will

usually either modify the deal to satisfy the government’s concerns or abandon the deal altogether.

The Justice Department can also file criminal

suits with potentially large fines for the corporation

and culpable officers and employees, and imprisonment for culpable officers and employees,174 although criminal suits have been reserved for egregious attempts to fix prices, divide markets, or rig

bids. From 1984 to 1987 the Justice Department

filed a total of 219 criminal cases. Of the 237 cases

terminated in that period, 210 resulted in convictions.175

While the U.S. Government’s civil enforcement

in recent years has not been aggressive, firms are

often reluctant to gamble that government policy

will remain the same. Firms can seek approval in

advance for a particular course of action from the

Justice Department or the FTC,176 but these approvals often take several months and can involve

considerable legal expense. Firms usually save this

process for substantial projects (justifying high legal

fees) that can wait several months. Also, government

approval does not insulate firms against private

suits, though in practice it lessens the likelihood that

private suits will be filed or will succeed.

Private parties can file antitrust suits if they claim

to be threatened or to have suffered some economic

harm caused by an alleged violation. Private suits are

far more numerous than government suits. In the 12

months ending June 30, 1988, private parties filed

about 660 private antitrust suits in Federal court,

compared with 20 civil and 70 criminal cases filed

by the government.177 Private suits are on average

~~~An~ Report of the Direc@r of the A&ninistrative@ice of the United States Courts: 1988, OP. cit., pp. **O, **1.

ITIsee 15 U.S.C. 4, 15a, 25. The F~r~ Tr~e Commission proceeds under 15 U.S.C. 21 (mergers) or under the Federal Trade Commission ~t, 15

U.s.c. 45.

172u.s. Dep~mentofJu~tlce, ~ti~t Division WorNoad Statistics 1978 to ~1987, reprint~ in Reportof the American BarAssociation Section

of Antitrust L.uw Twk Force on the Antitrust Division of the U.S. Department of Justice, op. cit., p. A7 (total civil cases: filed, won, lost, dismissed).

17315 U.S.C. 18a.

17415 u-s-c. 1.

175u.s. ~p~mentof Justice, ~ti~t Division WorkJoad Smtistics ~1978 to FY 1987, repl-int~ in Reportof the~ericanBarAssoc;ation Section

of Antitrust Luw Tmk Force on the Antitrust Diviswn of the U.S. Department of Justice, op. cit., p. A8 (total criminal cases: filed, terminated, won).

In 1987,42 individuals were fined a total of $1,636,(XKI; 15 individuals were sentenced to serve time in jail and 33 more were given probation; 1,994

jail days were served; and 66 corporations were freed a total of $16,265,000. Ibid., reprinted in Report of the American Bar Association Section of

Antitrtat Law Tmk Force on the Antitrust Division of the U.S. Department of Jwice, op. cit., pp. Al I-A13.

176Nei~erJmtice ~p~mentapprov~snor FTC st~f level approv~s ~e bindingon the government, butno firm h~ everbeen SUed for conduct within

the scope of such an approval. Janice Rubin, Library of Congress, Congressional Research Service, American Law Division, “The Impact of U.S.

Antitrust Law on Joint Activity by Corporations: Some Background,” May 1, 1989, p. 7 (Department of Justice); Carl Hevener, Justice Department

Liaison, Federal Trade Commission, personal communication, Dec. 1 and 5, 1989 (Federal Trade Commission). During 1984-87, the Justice Department

received about 25 requests for approval per year and granted roughly 90 percent of them. U.S. Department of Justice, Antitrust Division Workload

Statistics FY 1978-1987, reprinted in Report of the American Bar Association Sectwn of Antitrust Law T&k Force on the Antitrust Division of the U.S.

Department of Justice, op. cit., p. A5 (business reviews),

~77An& Report of the Direc~r of the Administrative Q@ce of the United States Courts: 1988, OP. Cit., pp. Igl, *W.
224 . Making Things Better: Competing in Manufacturing

less successful than government suits, although the

statistics are somewhat unclear.178

Private parties that bring suit are usually either

customers or competitors. If the suit is successful,

the offending conduct must stop and the offender

must pay to the complaining party: 1) treble

damages, i.e., three times the amount of economic

harm the complaining party can show he suffered,179

and 2) the reasonable cost of the complaining party’s

attorneys for the successful claims. These are severe

penalties. In most other areas of U.S. law, a

complaining party, if successful, is entitled only to

single damages, i.e., the actual amount of harm he

shows he has suffered, and is usually not entitled to

reimbursement of the expense of hiring attorneys.

The prospect of treble damage and attorney fee

awards can encourage lawsuits by competitors and

customers. Even if the defendant believes he could

probably win in court, the prospect of paying these

large awards—as well as the time and money needed

to fight the case-might scare him into paying

something to settle the case, and someone contemplating filing a suit knows this.180

Antitrust laws may be enforced by State governments as well. Under Federal antitrust law, State

governments may file civil suits on behalf of their

citizens--e.g., on behalf of a large class of consumers who allegedly paid excessive prices because of

an antitrust violation. The penalties are the same as

if the citizens themselves had filed suit.181 State

governments also can enforce the State’s own

antitrust laws, if the State has any.

In sum, even if antitrust law does not usually

condemn activities outright that could improve

manufacturing competitiveness, it can often discourage such activities. For large firms, able to get expert

legal advice, antitrust risk is often considered as one

factor among many. Cooperative projects have

ordinary business risks as well. Will the technology

work? Will the market be there? Antitrust adds

another risk, and makes the project that much less

desirable. Similarly, the need to pay for a legal

analysis of the antitrust risk and for ongoing legal

supervision adds to a project’s cost at various stages.

For small fins, often unable or unwilling to pay for

legal advice, antitrust fear is more likely to act as an

absolute bar. If a small firm suspects that a project

involves antitrust risk, it might drop the idea

immediately-even if there is no real risk. The

ambiguity and complexity of antitrust law are

therefore particularly troublesome to small firms.

While the chilling effect of antitrust is plausible,

it is hard to tell how important it is compared with

other factors that discourage cooperation. It is

difficult to find examples in which antitrust actually

killed a cooperative project, and the examples given

here are not overwhelming. More telling examples

may exist. Firms might hesitate to offer them

because word of their actual or contemplated activities could provoke suits or give away strategic

information to competitors. More important, business decisions typically depend on many factors, and

it is hard even for those involved to say whether fear

of antitrust changed a decision. A businessman

sensitized to antitrust concerns might even avoid or

quickly abandon ideas for cooperative projects.

Those ideas will never be counted or noticed as

activity discouraged by antitrust.

Some activities-e. g., R&D consortia, joint manufacturing, and resource pooling by small firms—

have only recently received serious attention in

government and industry as ways to enhance competitiveness. Even if antitrust in the past has not

visibly discouraged very much activity, it might do

so more in the future as more of these projects are

proposed.

ITSOf the 891 priv~e anti~st suits termi~ted in the 12 months ending June 30, 1988, 145 are Ikted as “settled,” 434 ss “other dismissed,” @ ss

‘‘other non-judgment, ’ and 248 as going to judgment by the court. Of those 248,67 are listed as “for plaintiff, ” 143 ‘‘for defendant, ” and 38 “other.”

David Germy, Statistical Analysis and Reports Division, Administrative Office of the U.S. Courts, personal communication, Dec. 7, 1989. It appears

that at least 577 cases (“otherdismissed” plus ‘‘judgment for defendant’ went entirely for defendant, and that in 212 cases (’ ‘settled’ plus ‘judgment

for phdifr plaintiff recovered something.

l?g~y @le d~~es M-C @d in stits concerning R&l) projects registered under, and within the scope of, the National Cooperative Resemh At

of 1984, discussed below.

l~smtisucsfm the 12 months end~g Jwe 30, 1988 show 145 private anti~st suits “se~led” out of 891 ~rmina~, or 16 percent. David Gentry,

Statistical Analysis and Reports Division, Administrative Office of the U.S. Courts, personal communication, Dec. 7, 1989. However, some cases where

some settlement was paid might be reported under a different heading.

18115 U.SOC. 1%.
Chapter 7—Where We Stand: Public Policy and Technology ● 225

Effect on Business Activity

Joint Research and Development

Traditionally, joint R&D has posed relatively

little antitrust risk. Such projects offer obvious

potential benefits in spreading risks and improving

firms’ efficiency and competitiveness. Moreover,

member firms are generally free to manufacture and

market products on their own (although there might

be agreements restricting use of the resulting technology). Experts in the field know of no antitrust

case brought against genuine joint R&D, and the

Justice Department acknowledges that “[a]s a general matter, joint R&D activities can have substantial procompetitive effects. ’ ’182

The National Cooperative Research Act of 1984

lessened the legal risks of joint R&D.183 First, the

Act provides that such activity will always be judged

by the rule of reason, balancing its beneficial and

harmful effects.l84 While joint R&D would in

general have been judged by the rule of reason

anyway, this provision did remove some uncertainty

and sent a signal from Congress that cooperative

R&D can yield important benefits. This probably

increased judges’ sensitivity to the benefits in

balancing the pro- and anti-competitive effects of

joint R&D.

The Act also provides that, for joint R&D projects

registered promptly for publication in the Federal

Register, only actual damages (rather than treble

damages) may be awarded in a private lawsuit.

(Attorney fees can still be awarded.) 185 As of

January 1990, 160 separate projects had filed 323

registration statements including amendments.186

Some of these projects probably would not have

gone forward without the 1984 Act.187 Registration

greatly reduces the financial exposure in undertaking joint R&D and by the same token greatly reduces

the incentive for parties to file private suits. The Act

further discouraged indiscriminate private suits by

providing that one who files a private suit breed on

a claim that is “frivolous, unreasonable, without

foundation, or in bad faith” must pay attorney fees

of the accused party.

One consortium registered under the Act is the

National Center for Manufacturing Sciences (NCMS),

which started operations in 1987 and by 1990

included over 100 manufacturing firms.188 The

membership encompassed large firms such as General Motors and AT&T; smaller firms such as

Kinefac Corp., a 70-employee metalworking firm in

Worcester, Massachusetts; and even some firms

with fewer than ten employees. (Many of the smaller

firms joined at the urging of their larger customers.)

It is not clear whether NCMS would have been

formed without the 1984 Act. Even with the Act,

antitrust has been a major concern for present and

prospective members. In its startup period, through

early 1989, NCMS spent about $200,000 for antitrust advice from a law firm. In the organizations’

first months, the director of NCMS spent most of his

time on antitrust issues. NCMS’s early meetings

were devoted largely to antitrust concerns, and into

early 1989 NCMS was still receiving about two

queries a week from members. Antitrust concerns ●

have gradually lessened as 1)NCMS became familiar with the issues and could more easily address

members’ concerns, 2) members noted that no firm

had been sued for R&D registered under the 1984

Act, and 3) competition became more intense and

the benefits of joint R&D became more apparent, so

that members were willing to accept some antitrust

risk.

Before joining NCMS, most members were not in

the habit of sharing technical discussions or R&Dpartly from unfamiliarity, partly from antitrust fear.

NCMS has discovered that its members’ pressing

R&D concerns overlap considerably, so that coopera182u.s. ~~m~t of Justice, Antitrust Enforcement Guidelines for Internutwrud operations, NOV. 10, 1988, P. 56.

l~public LAW 98462, 15 U.S.C. 4301-$305. There are some limitations, discussed below, on what constitutes joint R&D un&r the ~t.

l~The ~t requires that the tie of r-n also be used in judging joint R&D under State antitrust law.

l~~e kt simi]~ly limits damage awards in cases based on State antitrust law.

186u,S. ~@~ntofJu~ti~repre~nt~ive, ~wn~cou~cation, Feb. 1,1990, The first 125 or so proj~ts~descri~ itl “National (kiOpertUiVe

Research Act of 1984 Consortia,” New Technology Week, Special Supplement, June 12,1989.

l~T~GovernentRo/e in~oi~Ve~Wes, he~ngbeforethe Houx committ~ on Science, Space, ~dT~hnology, Sept. 19,1989, serial No, 101-58,

testimony of Mauro DiDomenico, director, technical liaison office, Bellcore, p. 101; and testimony of Peter Mills, chief administrative officer, Sematech,

p. 122.

188Thematen~ on NCMS comes fmm ~ Miller, Dir~tor, NCMS, Wrson~ communication, Apr. 10 ad 27, May 3, Aug. 5, Sept. 6, 1989, ad J~,

29, 1990; and Patrick Ziarnik, counsel, NCMS, personal communication, Jan. 26, 1990.
226 ● Making Things Better: Competing in Manufacturing

tive R&D can yield substantial savings. One example is R&Don laser beam splitting-i. e., how to use

one laser beam for several processes at once. NCMS

also facilitates informal technical exchanges among

members—for example, while discussing whether

to fund proposed projects.

NCMS has sometimes made matches between

companies with complementary abilities. It did so,

for example, in the development of ductile iron as an

inexpensive substitute for structural steel in the

non-moving parts of machine tools. A consulting

professor had recommended the alternative of ductile iron, but NCMS could not find any U.S.

company that could both design the specialized

molds needed for pouring the iron and do the

pouring. NCMS then brought together firms with the

CAD ability to design the molds and a company that

could pour the ductile iron once it had the molds. The

effort cost NCMS about $50,000. It has saved one

NCMS member about $250,000.

Although the 1984 Act lessened fears of antitrust

suits arising from joint R&D, these fears have not

completely vanished—as shown, for example, by

the continuing concern of NCMS’ members. Also,

the Commerce Department has from time to time

- provided a “safe house” in which competitors

afraid of prosecution for merely discussing a possible R&D collaboration could frost come together to

hold discussions under government supervision.189

The concerns are understandable. Even firms that

register their projects may still be sued by the

government or by private parties for single damages

and attorney fees. Firms that prefer to maintain

secrecy and do not register are subject to private

treble damages. Even under the rule of reason the

firms are not necessarily home free. For example, the

Justice Department’s 1980 guidelines for joint

research ventures state that “[a] joint venture

between directly competing companies in a highly

concentrated industry . . . will be subject to very

close antitrust scrutiny."190

In cases where cooperating firms need to exchange cost and marketing information in order to

guide the project in a commercially useful direction,

the 1984 Act covers such exchanges only when

“reasonably required to conduct the research and

development.” If, despite the firms’ belief that

certain communications were necessary, a court

should hold otherwise, then those communications

would not be protected by the Act’s provisions.

Also, the Act covers manufacturing only for

“experimental and demonstration purposes. ’’191 Sometimes sizable runs are needed to demonstrate a

process, and the firms involved would take a

significant loss if they could not sell the items

produced. Yet a court might rule that such sale is not

covered by the Act.

More fundamentally, the Act does not cover

commercial manufacturing. Yet there may be cases

in which the scale of the enterprise needed to

capitalize on R&D is beyond the means of single

fins.

Joint Manufacturing

Joint manufacturing can sometimes make firms

more competitive, for example, by allowing economies of scale in production. This could be especially

important in fields such as semiconductors where a

production facility costs hundreds of millions of

dollars. Firms might sometimes need to share

technical as well as financial resources. Manufacturing, like R&D, often requires expertise in many

fields. Again, semiconductor fabrication offers an

example. Future examples might be devices based

on optoelectronics or high temperature superconductivity. Sharing both financial and technical

resources can mean the difference between being

first to market or being an also ran.

Joint manufacturing can have another sort of

benefit when it follows joint R&D performed in a

central organization. Technology transfer from that

central organization back to the member companies

can be difficult. It might be easier for the central

organization to proceed with manufacturing. For

example, some say that it is unfortunate that

Sematech will not perform commercial manufacture

(see the section in this chapter on R&D consortia).

Innovation ideally consists of repeated feedback

189L~fi~ F~~~~, f)i~~r, ~ufi~ TwhrIo]ogy p~er~ip PK)$JHUII, U.S. ~p~mertt of co~e~e, Prsond comm~ication? 3! 19$9’

IWOSO ~pwment of J@Ce, Gt&fe~~r Research joint ventures (1980), Illustrative Examples, CztW B—red Re=wch and ~vdOPtnent JO~t

Venture in Concentrated Industry, reprinted in Trade Regufatwn Reports par. 13,120 (Commerce Clearing House 1988), While these guidelines might

be somewhat outdated in view of the more liberal tone of the U.S. Department of Justice, Am”trust Enforcement Guideiinesforlnternatwrud Operations

(1988), p. 56, the 1980 guidelines were relied on by NCMS’ antitrust counsel in 1989 in giving cautious advice regarding a proposed project.

19115 U.S.C. 4301 (a)(6)(C).
Chapter 7—Where We Stand: Public Policy and Technology ● 227

between R&D, design, manufacturing, and marketing. Many rounds of feedback between a joint R&D

venture and its members might be much more

difficult than many rounds of feedback would be

within a venture that did both R&D and manufacturing.

In general, joint manufacturing carries more

antitrust risk than joint R&D, because it can directly

reduce competition. When firms manufacture jointly,

purchasers may have fewer choices of products and

suppliers. However, in some risky high technology

ventures, joint manufacturing might be the only way

to encourage new entrants. High-definition television (HDTV) offers an example of antitrust concerns

in manufacturing joint ventures. Starting in early

1989, the American Electronics Association (AEA)

sought to promote R&D and manufacturing consortia for HDTV. During the first several months, AEA

had trouble even getting firms to talk with each

other, largely because of antitrust fears. Antitrust

then became less of a concern—partly because the

firms with AEA’s help were able to think through the

antitrust issues, and partly because the many congressional hearings on possible changes in antitrust

law made it seem likely that Congress would amend

the law, or at least that enforcement agencies and the

courts would interpret the law with more appreciation of the benefits of joint production.192

Some analysts question whether U.S. firms really

need large joint manufacturing ventures, arguing

that Japanese firms have done very well without

them. Even if Japanese firms do not do much joint

manufacturing (and this point is subject to dispute),

the two countries are not the same. Japanese firms

are much better able to finance large manufacturing

projects on their own (see ch. 3). They also

sometimes have a wider range of in-house technological expertise. 193 In addition, Japanese high

technology firms are sometimes protected against

foreign competition-either by the government or

by customers who buy Japanese products preferentially.

Antitrust concerns can also discourage small

manufacturing firms from cooperating in marketing

and in performing jobs that are too big or require too

many specialized capabilities for the firms to handle

on their own. Japanese manufacturing firms cooperate a great deal in this manner, with the blessing and

active encouragement of their government; some

European firms have done so as well (see ch.6). Some

U.S. industry groups, encouraged by the Commerce

Department, are seeking to increase such cooperation in this country. 194 Antitrust concerns seem to

have impeded these efforts somewhat.195

An example comes from the Flint River Project,

Inc., a subsidiary of Efficient Enterprises, Inc., in

Troy, Michigan. In 1988, Flint River began trying to

form a network of small manufacturers of spare parts

for automobiles, heavy equipment, and defense.

Flint River proposed to market the fins’ products

domestically and abroad by finding jobs to be done,

selecting a suitable team of firms for each job, and

performing any needed technical coordination, including design and project management. The network still had not formed as this report was written.

While antitrust was not the only problem, it was a

significant one. The firms were afraid that participating in such a network could be deemed an antitrust

violation--e.g., a conspiracy to fix prices.196

Another example: in the early 1980s, a few

members of the Milwaukee chapter of the National

Tooling and Machining Association discussed a bid

solicitation from the U.S. Department of Defense for

about 40 million dollars’ worth of special-purpose

carts to transport bombs. The members believed that

by combining their production capacities and their

various specialized abilities (such as welding, precision manufacturing, design, and possession of a

large crane) they could do the job as well as and

much more cheaply than traditional large defense

contractors. However, early in the discussions somel~pat Hill Hubbwd, Viu president, EIA, personal communication, Sept. 8, 1989.

193GmgoVTm.

y

,6‘SncW~ ~mge and Competitiveness: The U.S. Semiconductor ~dusv, ‘‘ TechnologicalForeca.stingandSocialChange. vol.

38, 1990 (forthcoming); Richard Elkus, chairman, Promernx Corp., personal communication. Dec. 1 and 7, 1989 (elec~onics ind~m).

l~~~we ~Ues, offiW of T~hnology policy, U.S. Department of Commerce, personal commun.icadon. May 3. Sept. 7* 1989.

195Ro~Fn~m, “FlexibleNctworksand ~ti~st,’ T~En~eprene~i~Eco~myRevi~, VO]. 7, No, $), May 1989(published by t.hecorporation

for Enterprise Development, Washington, D.C.).

l%Mich~l H~ler, president md chief executive officer, Efficient Enterprises, Inc., Troy, ~, PrSOnd communication, Apr. 26* MaY 3? ‘d SePt. 14>

1989, and testimony at hearings before the House Committee on Small Business, Subcommittee on Regulation and Business Opportunities, Sept. 13,

1988, Serial No. 100-74, pp. 125-28.
228 ● Making Things Better: Competing in Manufacturing

one mentioned antitrust, and as a result the idea was

quickly dropped.l97

In neither of these two examples was the fear

based on a legal analysis of the particular circumstances. Rather, the firms’ managers said in effect at

the outset, ‘This might have antitrust problems, and

I can’t afford a lawyer to find out. Unless I somehow

get assurances that there will be no problem, I won’t

proceed.”

Standards-Setting

Voluntary industry standards are necessary for

industrial efficiency. Without them, for example,

light bulbs would not fit into sockets and regional

telephone networks could not exchange information.

However, it is possible for a standards-setting

association to be dominated by a clique of firms that

use the process of establishing standards to shut

other firms out. For example, a clique might develop

standards in secret, so that their competitors would

not be able to conform their products to the standard

promptly. In addition, a clique might pick one

standard not because it is the best, but because it is

difficult for competitors to meet. Such practices

would probably be deemed antitrust violations, as

well they should be.198

However, even if firms perform standards-setting

with no anti-competitive intent, other firms may

nevertheless file an antitrust suit claiming that the

standard somehow unfairly discriminated against

them. A court might take these claims seriously. The

Supreme Court recently stressed that standardssetting can easily be abused to harm competition:

[T]he members of [standards-setting] associations

often have economic incentives to restrain competition and . . . the product standards set by such

associations have a serious potential for anticompetitive

harm. . . . Agreement on a product standard is, after

all, implicitly an agreement not to manufacture,

distribute, or purchase certain types of products.199

To forestall accusations, many U.S. associations

have adopted elaborate procedural rules for setting

standards, including open meetings at which all

firms are free to express their opinion. According to

Bell Communications Research (Bellcore), these

open meetings are cumbersome and can slow down

adoption and implementation of standards. In fastmoving fields such as telecommunications, delay

might mean missed opportunities and reduced competitiveness. Firms could speed up progress by also

meeting informally in smaller groups to iron out

difficult technical problems; however, they are

reluctant to do so for fear of an antitrust lawsuit.200

This problem arose in connection with communication standards for ways in which telephone

networks in different regions or countries can

exchange various information--e. g., route calls

around congested lines, determine whether a called

party’s line is busy, and verify credit card numbers.

These standards are handled by the T1.S1.3 Working

Group (formerly the T1.X1.l Working Group) of the

T1 Standards Committee, which is accredited by the

American National Standards Association. According to Gary Schlanger, that working group’s chairman for 1984 to 1987, U.S. and foreign approaches

to exchanging such information started to diverge in

1986. The working group’s efforts to resolve those

differences and harmonize the U.S. and international

practice were deadlocked for 2 years. Mr. Schlanger

believes that with smaller, informal meetings harmonization could have been achieved. Instead, in

1988, the T1 Standards Committee adopted a U.S.

standard inconsistent with the international standard

used by the rest of the world. Now U.S. equipment

manufacturers and phone companies must cope with

translating between the U.S. standard and the world

standard. 201

Joining Forces Against Foreign Firms

In some cases, a fragmented U.S. industry faces

competition from a much more powerful foreign

industry. By combining forces, the U.S. firms might

achieve similar advantages and hold their own. But

some mergers or joint ventures between U.S. firms,

each of which hold substantial shares of the same

197CUI ~qulst, Resident, c~lson Tixd & Manufacturing Co., Cedarburg WI, Personat comm~ication, APr. 28, 1989,

198se for exmple R~”antBur~rs, Inc., v. People’s Gas, Light and Coke CO., 364 U.S. 656 (1961).

~99Allied T&e & Conduit Corp. v. Indian Head, [rLc., 108 S. ct. 1931, 1937 (1988).

200Joe ~e~, Ge~r~ Atto~ey, Bellcore, ~rWn~ commulcatlon, May 3 and Sept. 13, 1989; Ma~o DiDomenico, director, technical litiSOn OffiCX,

Bellcore, testimony at hearings before the House Committee on Science, Space, and Technology, Subcommittee on Science, Research and Technology,

Sept. 19, 1989, Serial No. 101-58, pp. 106-109.

201GW sc~~nger, DiviSiOn M~ager, c~er Intercomwtions, s@n&@ and Nllm~fing Plm Mamgernent hp~ment, Bellcore, ~rsond

communication, Sept. 15, 1989.
Chapter 7—Where We Stand: Public Policy and Technology ● 229

market, are either blocked or never attempted

because of antitrust law. Under the Justice Department’s Merger Guidelines, the firms involved must

provide a high level of proof of any claimed benefits.

Also, the Department will consider whether similar

benefits could be achieved by other means.202 One

merger blocked by the Department was the attempt

of BTU International, a manufacturer of furnaces

used to produce semiconductor chips, to purchase

Thermco, a subsidiary of the Allegheny Corp. (box

7-E). While the Justice Department in this case may

have simply followed judicial precedent and the

Merger Guidelines, these rules may be out of tune

with the realities of failing U.S. competitiveness.

Overall, the uncertain cost of keeping antitrust

law as it is today must be measured against the

uncertain cost of proposed changes. Several possible

modifications would leave intact the basic doctrine

of antitrust law and the basic enforcement machinery, but would adjust around the edges. For example,

points of law could be clarified; safe harbors and

advance approvals could be provided; and treble

damages could be reduced in some cases to single.203

It is not clear that changes such as these would spark

significant anticompetitive activity, particularly in

light of today’s economic conditions. On the whole,

it is harder to maintain market power today than it

was earlier in the nation’s history. In some fields,

products and processes have shorter life cycles so

today’s monopolist might find his position eroded

tomorrow by competitors’ new technology. Most

significantly. foreign firms are more likely than ever

before to compete against U.S. firms that try to raise

prices above competitive levels.

~u.s. Upwmmt of Justice, “Merger Guidelines,” June 14, 1984, sw 3.5, PP. 35-36.

~~e~and otier proposals are discussed h ch 2.
230 ● Making Things Better: Competing in Manufacturing

IThis SCtim isMon ~foma~on fr~ the following personal communications: Paul van der Wansem, CEO, BTU kterntiiond,

Ncwember2, 1989; Paul CYDonnell (the lawyer representing BTU to the Department of Justice), Ropes and Gray, January 18, 1990; Bob Cole,

President, Varian-TELLtd., Deeember, 1989; Anthony Mtdler, CFO, Sillicon Valley Group, December5, 1989; Ken Phillips, Public Relations,

Motorola, Deeember, 1989; Bob England, Vice-President, Semiconductor Group, Texas Instruments, January 26, 1990; Representatives of the

Department of Justice, December 13, 1989, and January 31, 1990.

2~rding ~ m~ket ~e data ga~e~ by Dataquest and filed by Thermco with the Justice Department, BTU had 46 percent ad

Therrneo 47 pereent+ BTU, defining product categories differently, filed data showing much lower market shares.

3WIe no il~ fi~s arc available, tie estimates by TEL’s U.S. distributor and TEL’s U’S, competitor, B’I’U, agree.

4MUller ~int~ out th~ ThermEO h~ incre~ti its market share since its purchase by SVG, so WG is not re~lY ~aPPY Wiw @

Department of Justice’s ruling. Nevertheless, he concedes that the overall strength of U.S. manufacturers in this field, and their ability to mist

Japanese entry into the American market, would have been greater if BTU and Therrnco had combined foxes.
Chapter 7—Where We Stand: Public Policy and Technology ● 231

old loyalty to TEL equipment did not represent a sufficiently large share of the market to prevent BTU from gaining

a monopoly position.

Immediately after BTU’s takeover effort failed, the Silicon Valley Group approached Thermco and was

allowed to buy the firm without ado. SVG makes other types of semiconductor production equipment and had

previously attempted and failed to enter the diffusion furnace business. Although BTU’s market share in the United

States is currently larger than TEL’s, SVG sees TEL and not BTU as its principal competitor. TEL’s 1988 world

sides of diffusion furnaces were bigger than the combined world sales of BTU and SVG, making it the world giant.

Though it is impossible to know for certain what the results of a BTU/Thermco buyout would have been, the

following seem likely: BTU and Thermco could have combined their current technological strengths, improving

production of the most advanced systems; BTU and Thermco combined could have significantly increased their

R&D by eliminating duplication; and the increased size of a united BTU/Thermco would have allowed the

companies to realize savings in production, marketing, and administration. Whether such advantages could have

slowed or stopped TEL’s penetration of the U.S. market cannot be known for sure. Further, the beneficial effects

of the merger might not have been as great as originally hoped.5 But both BTU’s van der Wansem and SVG’s Muller

think that combination would have been stronger than the current U.S. configuration of BTU on its own and SVG

with Thermco, In this case, the Department of Justice’s refusal to permit the merger seems to have hampered the

competitiveness of the U.S. manufacturers.

5~~C. ~d ~o~ ~mt t. ~ ~CqU~~+& ~=eB~ ~~n an ~ch fiv~ ad~a~ layoffs were bound (O result as tk tWO

operations were mmhed. SVG’S Mtdler suggests that enough key personnel might have quit that BTU would have acquired only the hoilow shell

of ThermCo.
Index
Index

accelerated depreciation (see also investment tax credit)

accelerated cost recovery system 22, 44-46

administrative guidance and signaling 99, 100, 102

advanced computing technology 204

Advanced Manufacturing Research Facility (AMRF) 176

Advanced Manufacturing Technology Initiative (DOE)

187

Advanced Technology Program (NIST) 33,54, 73,77

Advanced Television (ATV) 80-89

agriculture

Cooperative Extension Service 55, 71

technology policy 71, 72

Agricultural Research Service 185

Airbus 72, 210

American Bottlers Equipment Co. (AMBEC) 180

American Electronics Association (AEA) 227

American Telegraph and Telephone Co. (AT&T) 205,

206, 207, 225

analog and digital electronics (see electronics)

antitrust law and enforcement 17, 30-31, 66-69, 219-231

barriers to cooperation 225-228

enforcement 68-69, 223-224

manufacturing 226-228

mergers and joint ventures 67, 228-231

research and development 225-226

small firms 224, 227-228

standards setting 228

treatment of foreign firms 67, 229

apparel (see textile and apparel industries)

Applied Energy Programs (DOE) 185-186, 187

ARCH Development Corp. 189-190

arm’s length relation with suppliers 13-14, 19, 151

automobiles 6-7, 129-135, 158

Europe 131, 157

Japan 129-135

productivity 7

New Unified Motor Manufacturing, Inc. (NUMMI)

133-134, 160

product development cycle, innovation 6, 131-133

suppliers: dependence on, relation to, and cooperation

with 18-19, 25, 129-135

suppliers to Japanese transplants, GAO study 134

vertical integration 129-130

banks

Japan 98, 99-100, 101-104

relationships with clients (see capital suppliers,

relationships with firms)

basic educational skills 50, 117-118

basic research 71

Bayh-Dole Patent Amendments Act of 1984193

Bell Communications Research (Bellcore) 228

Bradhart, Inc. 180-181

Brookhaven National Laboratory 186, 190

Brooks Manufacturing 180

BTU International 230

budget deficit 9, 11,22,39,42-43, 106-107

buffered production system 6

capital costs 9-11, 22-23, 42-46, 93-95, 97, 100-101

budget deficit 9-11, 42-43

in Japan 93-94, 96-105

interest rate 9, 22, 42, 94

savings 22, 43-44

tax structure 22-23, 44-46, 96

capital formation (see capital costs, investment)

capital gains tax 23, 47-48

capital investment (see capital costs, investment)

capital suppliers, relationships with clients 9-11, 46, 93

banks 9-10,42,96, 101-103

hostile takeovers 10-11,23, 106-107

shareholders 10, 103-105

CAT scanner 214

catch-up consortia 89, 209

cathode ray tube (CRT) displays 84, 97

chip on glass 86,

civilian aircraft industry

technology policy 71, 72, 74-75, 79

civilian technology agency 33-35, 73-78

civilian technology policies 32-33, 71-73, 74-75

CNC machine tools (see machine tools, numerically

controlled)

collaborative R&D (see cooperative R&D)

Combustion Research Facility (CRF) 190

commercialization

technology from Federal laboratories 29-30, 61-64,

184-195

Community Development Block Grants 182

computers (see also electronics, cathode ray tube

displays) 80-88

computer-aided design and manufacturing (CAD-CAM)

159, 161, 204

Congressional U.S.-Japanese Fellowship Program 65

consortia (see cooperative R&D)

consumer electronics (see also high-definition television)

importance 83-85, 89, 147

consumers 80, 99, 100

consumption 43-44

consumption tax 43

mortgage interest deduction 43-44

cooperation (see also cooperative R&D)

antitrust problems 17, 30-31

between competitors 210, 226-228

between suppliers and customers 13-16, 131-133

cooperative networks or associations (see small and

medium-sized firms)

-235–
236 ● Making Things Better: Competing in Manufacturing

cooperative R&D

antitrust law 225-226

consortia 16-17, 77-78, 202-211

Federal laboratories and industry 19-20,29-30,62-64

foreign firms’ participation 78-79

government-industry collaboration 78-79

in Japan 88, 208-210

in Europe and the European Community 17, 78-79

industry-university consortia 64-65, 202-203

intellectual property rights 192-194

supplier-customer cooperation 131-133

cooperatives of small firms 29, 61, 167-170

copyright (see also intellectual property)

software 64, 193-194

corporate debt

effect on capital expenditures 47, 110-111

effect on R&D 47, 109-111

corporate finance

debt 101-103

equity 103-105

Cray Research Corp. 147-148, 183, 188

critical technologies (see strategic R&D)

cross shareholding (see stable shareholding)

data compression 82, 86-87

Defense Advanced Research Projects Agency (DARPA)

34, 75-78, 89, 106, 205-207

Defense Logistics Agency (DLA) 177

Defense Programs (DOE) 185, 187

defense-related technology (see also national security)

32, 39,40, 71, 153-155, 187

Department of Defense (DoD) 185-186

commercializing technology from 186

dependence on foreign firms 40, 71

support for technology development 32, 39-40, 71,

153-155

Department of Energy (DOE) and DOE laboratories 62,

64, 184-195

Department of Industry and Technology 73

design for manufacturability 125-126

developing countries

intellectual property 20, 69, 216-217

digital and analog electronics (see electronics)

Digital Equipment Corp. (DEC) 204

digital filters 87

digital modulation techniques 82, 87-88

digital signal processor chips 86-87

Economic Recovery Tax Act of 198145-46

education (see also worker training) 12-13, 24, 50-53,

115-117, 118-120

engineers and scientists 52, 120-126, 198-200

primary and secondary 13, 24,50, 52, 115-117

student loans 51

test scores 116-118

vocational 118-120

electronics (see also computers, semiconductor industry,

semiconductor equipment industry)

analog and digital compared 81-82

overlap or synergism between different fields 80,83-88

endaka 23, 104

Energy Research programs (DOE) 185-186

Engineering Research Centers (ERCs) 64-65, 173, 180,

195-197

engineers and scientists 120-126

career paths 125

education and training 24-25, 52-53

exchange programs with Japan 65

foreign language skills 66, 198-200

interaction between design and manufacturing 52-53

job rotation 125

minority engineers and scientists 52, 120, 122-123

numbers 121-123

on the shop floor 25, 125-126

simultaneous engineering 131

work force demographics 24-25, 52, 120, 122-123

equipment leasing

government-supported equipment leasing programs

28, 57-59

Japan 155

machine tools, including numerically controlled (NC)

58, 155, 181

equity financing (see corporate finance)

equity holders (see shareholders)

Europe and European Community (EC) 9, 21,41,78-79

automobiles 131, 157

industry and trade policy, 79

R&D consortia 17, 78-79

Single Market, 19929

strategic technology policy 78-79

exclusive rights (see also intellectual property) 192-194

Export Trading Company Act of 1982221

extended definition television (EDTV) 83, 84

external or foreign technologies (see also not-inventedhere) 19, 30, 156-158, 197-200

family incomes 39

Fanuc 156

Federal budget deficit 9, 11, 22, 106-107

Federal laboratories 19-20,28-30, 184-195

cooperative research and development (collaboration)

29-30

earmarking funds for technology transfer 63; 191

exclusive rights (patents, copyright, proprietary data)

64, 192-194

red tape 29, 64, 192

technology commercialization 29-30,61-64, 184-195

Federal Laboratory Consortium (FLC) 29,63, 190

Federal technology extension (see also technology

extension) 54-56, 174-177

Federal Technology Transfer Act of 1986186
Index ● 237

Federal Trade Commission (FTC) 223

fiber optic communications 88

fifth-generation computer project (Japan) 203, 209

financial assistance (see small and medium-sized firms)

financial environment 9-11,22-23,41-42,93, 96

stability of 11, 23, 96, 106

financial markets 9-11,96-112

in Japan 96-105

Fiscal Investment and Loan Program (Japan) 161

flat panel liquid crystal displays (see liquid crystal

displays)

flexible manufacturing networks (see small and mediumsized firms)

Flint River Project, Inc. 227

foreign suppliers

components and supplies 15-16, 134-135, 148

production equipment 138-142

Freedom of Information Act 193

General Agreement on Tariffs and Trade (GATT)211,

218

Generalized System of Preferences (GSP) 217

Georgia Tech Industrial Extension Service (GTRI) 55,56,

179-184

Germany, Federal Republic of

financial environment 23, 42

NC machine tools 151, 155, 181

vocational and technical education 118-119, 120, 155

government-industry collaboration (see cooperative

R&D)

government-owned, contractor-operated laboratories

(GOCO) 186, 192, 194

government-owned, government-operated laboratories

(GOGO) 186, 192, 193-194

high-definition television (HDTV) 80-89, 147, 227

high-speed counters 83

high-temperature superconductivity (HTS) 77

pilot centers in DOE laboratories 188, 194

home mortgage interest deduction 43-44

hostile takeovers (see mergers and acquisitions)

household savings 22, 43

human resources (see education, engineers and scientists,

worker skills, worker training)

human resources policy 23-24, 50-53

imitation 8, 69, 212-214, 216

Imperial Cup Co. 181-182

improved definition television (IDTV) 83, 84, 147

Individual Retirement Accounts (IRAs) (see savings)

industrial extension (see technology extension)

industrial policy (see industry and trade policy)

Industrial Technology Institute 184

industry and trade policy 21, 79-80

Inman, Bobby Ray 203

innovation (see also product development cycle)

effect of patents 214-216, 221

institutional investors 23, 47, 106-107

intellectual property 20, 31-32, 211-219

copyrights for software 193

Federal laboratories 64, 192-194

first-to-file and first-to-invent patent systems 219

harmonization of patent systems 32, 70-71, 219

incentive for innovation 214-216, 221

Japan’s patent system 70,218-219

patent rights and enforcement 212-213, 214, 217

protection of patent rights abroad 70, 212-213

relevance to GATT 70, 218

interest rates 42, 97-99, 101, 106

International Business Machines (IBM) 142, 146, 205-

206,216

International Trade Commission (ITC) 212-213

investment (see also capital costs, long-term investment,

time horizons) 9-13,22-23,41-50,96-98

effect of takeovers 23, 46-49

in equipment and facilities 6, 9-11, 41-46

in R&D 9-11, 44, 201

long term 9-11,41-50,93-112

tax measures to promote 22-23,44-46, 96, 154

investment tax credit (see also accelerated depreciation)

22,44-46, 154

Italy

cooperative networks 167-168

Japan (see also other entries beginning with “Japan” or

‘‘Japanese’

automobiles 6-8, 129-135, 158-159

banks 98, 99-100, 101-104

bilateral exchange programs with U.S. 65-66, 197-200

capital costs 10-11, 42, 93-94, 96-105

component and parts suppliers 15-16, 129-135, 148

consignment manufacture 160

consumers 80

cooperatives 169-170

corporate finance (see main entry)

Engineering Research Association Program 208, 209

Equipment Leasing System 57, 155, 163

Equipment Modernization Loan System 155, 163

fifth-generation computer project 199, 203,209

financial environment 9-11, 23,42,46, 94-96

financial markets 96-105

Fiscal Investment and Loan Program 161

Industrial Bank of Japan (IBJ) 99, 102

industrial policy, industry and trade policy 79-80,

100-102

Kanagata 170

Kanagawa Science Park 167

lean production system 6

long-term investment 93, 96-105

main-bank system 96, 101-103

metalworking industry 168
238 ● Making Things Better: Competing in Manufacturing

Ministry of International Trade and Industry (MITI) 88,

100, 163, 199, 208-210

Ministry of Posts and Telecommunications (MPT) 88,

209

NHK 85,88

Next Generation Industries Program 209

NSF-Japan programs 65

oil shock 104

Optical Measurement and Control System Project 209

Ota-ward (Tokyo) 163, 158-159, 166

patent system 218-219

patient capital 93

postal savings system 98

premier competitor 4-5

product development cycle 6, 131-133

productivity growth 3

R&D consortia 88,208-210

rising yen 23, 104

savings rate 43

small and medium enterprises (SMEs) 27, 155, 158-

159, 161-167

Small and Medium Size Enterprise Agency 160, 163

Small Business Finance Corp. 163

small business programs 27, 152, 154, 161-167

SME Upgrading Capital System 169

stable shareholding 10, 46, 96, 104-105

supplier-customer relations 13-15, 129-135, 157, 159,

168, 169

tax incentives for equipment investment, SMEs 155,

162

Technology Experimental Center 166

technology extension services 53, 54, 56, 151-156,

173-174

Temporary Interest Rate Adjustment Law 99

Tokyo Stock Exchange (TSE) 103-104

U.S.-Japan Cooperative Science Program 198

vertical integration 11, 142-145

VLSI Project 139-140, 209, 210, 216

X-ray lithography 15, 78, 142

Japan Development Bank 100, 101, 102

Japan Electric Computer Corporation (JECC) 163

Japan Fair Trade Commission 208

Japan Key Technology Center (KTC) 209

Japan Research and Development Corp. 208

Japan Robot Leasing Co. (JAROL) 163

Japan Science and Technology Program (MIT) 198, 199

Japanese Small Business Corporation 169

Japanese technical literature 30, 65, 200

Japanese language studies 66, 200

joint manufacturing 226-228

joint R&D (see cooperative R&D)

JTECH 200

junk bonds 46-47, 107-108

Justice Department 221, 223, 226

Justice Department’s Merger Guidelines 229

Korea

strategic technology policy 79

lean production system 6

less developed countries (see developing countries)

leveraged buyouts (see mergers and acquisitions)

liquid crystal displays 85-86

long-term investment (see a/so investment) 9-11, 33,

41-50, 93-112

effect of capital cost on 9, 42-46, 94

effect of high debt on 47, 108, 111

in Japan 10-11, 46, 93, 96-105

long-term perspective (see time horizons)

Los Alamos National Laboratory 188, 189

machine tools, numerically controlled (NC) 58, 60,

152-155, 158-159, 160, 161, 181

military role in development 153-154, 155-156

management 5, 12, 20, 50, 52

manufacturing engineering and technology 39, 52-60

definition and importance 5

incremental improvements 125-126, 151, 156

improvement by producing consumer electronics 83,

84, 89, 147

Japanese system 6, 145

manufacturing jobs 3, 5

manufacturing process (see manufacturing engineering

and technology)

Manufacturing Sciences Directorate 53, 65

Manufacturing Technology Centers (NIST) 26, 53-56,

176

Manufacturing Technology (ManTech) program 175-176

Martin Marietta 189

Maryland Technical Extension Service (TES) 178-180,

182-183

Massachusetts Institute of Technology (MIT) 190

mergers and acquisitions (M&A), including hostile

takeovers 23, 46-69, 98, 101, 106, 107-112, 138

causes of increased activity in 1980s 46-47, 107-108

effects in general 23, 47, 108-112

effects on research and development 23, 47, 109-111

junk bond financing 46-47, 108

tax measures to control 23, 47-49

metalworking firms 174

Michigan Modernization Service (MMS) 179-184

microelectronics (see electronics)

Microelectronics and Computer Technology Corp. (MCC)

203-205

military requirements and technology policy 39-40,

153-155

Ministry of Finance (MOF) (Japan) 99-100, 105

Ministry of International Trade and Industry (MITI)

(Japan) 72,77,86,88, 100

visions 77, 199, 208-210
index ● 239

Ministry of Posts and Telecommunications (MPT) (Japan)

88,209

Minnesota Governor’s Office of Science and Technology

177

mortgage interest deduction (see home mortgage interest

deduction)

Motorola 50, 142, 146

Moyco Industries 178, 180

mutual shareholding (see stable shareholding)

National Advisory Committee on Aeronautics (NACA)

71,74-75, 190

National Aeronautics and Space Administration (NASA)

71, 74-75,76, 185-186

National Bureau of Standards (see National Institute of

Standards and Technology)

National Center for Manufacturing Sciences (NCMS)

225-226

National Cooperative Research Act of 1984 (NCRA)

225-226

National Institute of Standards and Technology (NIST)

(formerly National Bureau of Standards) 26,73,77,

176-177, 186

National Institutes of Health (NIH) 76, 185, 186

national laboratories (see Federal laboratories)

National Research Council 195

national savings initiative 22, 43

National Science Foundation (NSF) 76, 77

Engineering Research Centers 64-65, 173, 180, 195-

197

JTECH 200

Manufacturing Sciences Directorate 53,65

NSF-Japan programs 65-66, 197-200

national security

and technology transfer from Federal laboratories, 194

dependence on foreign firms 40, 71

changing definition of 32, 40, 7

National Tooling and Machining Association 227

NC machine tools (see machine tools, numerically

controlled)

NHK (Japan) 85,88

North Carolina Microelectronics Center 202

not-invented-here syndrome 19, 151, 156

Oak Ridge National Laboratory 185, 188, 189, 190

Office of Management and Budget (OMB) 106

Office of Science and Technology Policy (OSTP) 195

Omnibus Trade and Competitiveness Act of 198826,

53-55

parallel processing 87

Patent and Trademark Amendments Act of 1980186

patents (see intellectual property)

patient capital 10,93

Pennsylvania Technical Assistance Program

(PENNTAP) 179, 183

Pennsylvania Technology Management Group (TMC)

179-183

pension funds 106-107

Perkin-Elmer company 141

picking winners 32-34,71-73

pixels 82, 86

Prairie State program 51

product development cycle 156-157

cooperation between suppliers and customers 131-133

Japan 19, 156-157

length of cycle 19, 157

simultaneous engineering 131

productivity and productivity growth 3-4

automobiles 7

Program of Research in Modernization Economics (PRIME)

184

proprietary data rights 193

R&D tax credit (see research and development tax credit)

reporting requirements 105, 107-108

research and development consortia 16-17, 77-78, 200-

211

research and development spending, international

comparisons 44

research and development tax credit 22-23, 44-46

retained earnings 101, 159

robots 152, 159

Sandia National Laboratories 184-185, 189, 190

savings 22, 43-44, 97-98, 106-107

business savings and retained earnings 101

consumption tax 43

household savings 22,43

in Japan 98-99

incentives to raise 43

Individual Retirement Accounts 43

national savings initiative 22, 43

taxation or deferred taxation of interest income 43,

science education (see education)

Section 301 of the Trade Act of 1974217

Section 337 of the Tariff Act of 193031, 218

Securities and Exchange Law 104

securities transfer excise tax 48

Sematech 15,40,71,78, 142, 146,205-208,210-211

semiconductor equipment industry 15, 77, 78, 137-142

GCA 138-141

Nikon 138-141

Perkin-Elmer 141

Sematech 142, 146

SEMI/Sematech 205

wafer steppers 138-141

X-ray lithography 142,201

semiconductor industry 11, 15-17, 142-148
240 . Making Things Better: Competing in Manufacturing

capital costs 11, 141, 145, 146

DRAMs 145, 146, 157, 205,206, 222

Japanese industry and trade policy 145

links with consumer electronics 146-147

links with equipment suppliers 138-142

manufacturing technology 86, 145, 205-208

NMB Technologies, Inc. 145

Sematech (see main entry)

Semiconductor Research Corp. (SRC) 202-203

SRAMs 206, 207

vertical integration, large size 142-145

Service Corps of Retired Executives 175

shareholders 101, 103, 104, 105

stable shareholding (Japan) 10, 46, 96, 104-105

Sherman Antitrust Act of 1890219

Shop of the 90’s 176-177

short-term focus (see time horizons)

Showa Precision Tools, Co., Ltd. 164

small and medium-sized firms (see also other entries

beginning “small”)

cooperative networks or associations of 29, 61, 167-

170

financial aid 18,27-29,57, 158, 161-163, 174-175

financial aid tied to technical assessment 28, 59-60,

166, 182

importance for large customers 25, 130-132

Japanese support for 18,27, 152, 161-167, 168-170

tax incentives for capital investment 60, 155

technology extension services for 25-27, 53-56, 158,

166-167, 173-184

Small Business Administration 60, 163, 174, 175

Small Business Development Centers 175

small business guaranteed loans 57, 60, 174

Small Business Innovation Research Program (SBIR) 57,

175

Small Business Investment Corp. (SBIC) 57

software

copyright 64, 193-194

Federal lab-industry cooperation 64, 189, 193-194

patent protection 215

Solar Energy Research Institute (SERI) 186, 187

Sony Corp. 84,86

Spin-Off 188-189

stable shareholding (see shareholders)

standards setting 228

Stanford University 190

Startup firms 189-190

State industrial extension services (see technology

extension)

statistical process control 51

Stevenson-Wydler Technology Innovation Act of 1980

186

strategic technology policy 32-35, 71-80

picking winners 32-34,71-73

relation to industry and trade policy 79-80

supercomputers 87, 147-148, 188

Cray Research, Inc. 147-148, 188

superconductivity (see high-temperature

superconductivity)

supplier-customer relations (see automobiles,

cooperation)

Synfuels Corp. 72

T1 Standards Committee 228

Taiwan

strategic technology policy 79

takeovers (see mergers and acquisitions)

targeted industries 97-98, 187

tax credit (see investment tax credit, research and

development tax credit)

technical assistance (see small and medium-sized firms,

technology extension)

technology diffusion (see also small and medium-sized

firms, technology extension) 25-32,53-60, 151-

160, 215

stable supplier-customer relationship 14, 131-133,

159-161

technology extension 18, 25-27, 53-56, 166-167, 173-

184, 179-184

Federal assistance to States 55-56, 176-177

Federal programs 26, 53-56, 174-177

Japan 53, 54, 56, 151-156, 173-174

Manufacturing Technology Centers (NIST) 26,53-56,

176

National Institute for Standards and Technology (NIST)

26, 53-56, 176-177

State programs 53-56, 177-184

tied to financial aid 59-60, 182

training 181-182

technology transfer 159-161, 203-205, 210-211

from Federal laboratories 29-30,61-64, 184-195

from Japan to the United States 65-66, 157-158,

197-200

telematics 211

television (see high-definition television)

Tennessee Innovation Center (TIC) 189

Texas Instruments 207, 216

textile and apparel industries 136-137, 169, 177, 201

Dan River 137

Greenwood Mills 137

National Apparel Technology Center 177

Quick Response 136-137

textile machinery industry 15

Textile/Clothing Technology Center (TC2

) 177

Thermco 230-231

Thomson Consumer Electronics 87, 88

time horizons 9-11, 23, 33, 93

R&D consortia can lengthen 16,201,205

Tnemec Co. 179

Tokyo Electron (TEL) 230-231

Toyota 130, 160

Trade Adjustment Assistance 28, 176
Index ● 241

trade and industry policy (see industry and trade policy)

trade deficit 3, 39

importance of manufacturing 3

trade policy (see industry and trade policy)

training (see worker training)

transaction tax (see securities transfer excise tax)

TV (see high-definition television)

wages 39, 133

work force (see engineers and scientists)

worker skills (see also education, worker training)

115-120

changing technology and work environment 12,23-24,

117

foremen 120

worker training 24, 51, 155, 158, 181-182

U.S. International Trade Commission (USITC) 212-213

U.S.-Japan Cooperative Science Program 198

X-ray lithography 15, 142, 201

venture capital 189-190

VLSI project (Japan) 139-140,209, 210, 216

vocational training (see education, worker skills, worker

training) Zenith 84, 88, 147

u. s. Government PRIbTI’ING OFFICE : 1990 0- 21-700