International Competition in Services:

Banking, Building, Software, Know-How...

July 1987

NTIS order #PB87-212403
Recommended Citation:

U.S. Congress, Office of Technology Assessment, International Competition in Services, OTA-ITE-328 (Washington, DC: U.S. Government Printing Office, July 1987].

Library of Congress Catalog Card Number 87-619820

For sale by the Superintendent of Documents

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

(order form on p. 403)
——

Foreword

As the nearly 100 member nations of the General Agreement on Tariffs and

Trade (GATT) head into the Uruguay Round trade negotiations, the United States—

chief advocate of an open international economy—finds many of its manufacturing industries less than competitive in that international economy. The Nation’s

trade deficit remains at unprecedented levels, our international debts exceed our

credits, and living standards are headed downward. Few signs point toward a return to the comfortable position the United States enjoyed with respect to its trading partners and competitors 10 or 15 years ago.

Most simply, the U.S. dilemma can be put as follows. The international competitiveness of American firms in most manufacturing industries has been in decline, in large part because of growing competence in other parts of the world.

As this assessment shows, the United States remains highly competitive in many

service industries, But trade in services will remain small compared to trade in

goods, and many of the benefits from foreign investments by American service

firms accrue to the host nations where U.S.-based banks, insurance companies,

accounting firms, and other suppliers of services do business, Services cannot right

the Nation’s trade balance, even granting the many ways in which a strongly competitive service sector benefits the competitiveness of American manufacturing firms.

As the U.S. negotiating strategy in the Uruguay Round emerges, the Nation’s

policy makers will have to balance the needs of service industries and manufacturing industries. These coincide some of the time, but not always. They will also need

to decide in what ways and how strongly to press for measures that would strengthen

GATT and further open the world trading system. Most importantly, Congress and

the executive branch will have to continue seeking domestic policies that can help

U.S. firms compete effectively, prepare Americans to work in the knowledge-based

industries that will remain a major U.S. strength, and develop an approach to policies for economic adjustment suited to U.S. traditions and the Nation’s political

system. Past OTA assessments—as well as this one—show that the situation of U.S.

industries has changed fundamentally over the last 15 years. The policymaking

system has not caught up.

This assessment was requested by the Senate Committees on Governmental

Affairs and Foreign Relations, and the House Committee on Small Business. OTA

is grateful for the assistance provided by many individuals, inside and outside the

Federal Government during the course of this assessment and in particular the cooperation of the Office of the United States Trade Repersentative and the Departments of Commerce, State, and Treasury. Full

with OTA.

responsibility for the contents rests

. . .

Ill
International Competition in Services Advisory Panel

Robert Gilpin, Chairman

Princeton University

C. Michael Aho

Council on Foreign Relations, Inc.

Mark Anderson

AFL-CIO

John Bowles

Public Policy Analysis, Inc.

Robert B. Cohen

New York State Urban Development Corporation

Richard L. Crandall

Comshare

Ronnie L. Goldberg

United States Council for International Business

George Kohl

Communications Workers of America

Stephen D. Krasner

Stanford University

Robert Kuttner

Brookline, MA

Martin Mayer

New York, NY

William Nolen

Highlands Insurance Co.

Hugh O’Donnell

Crocker National Bank

K. Nagaraja Rao

Wentworth Institute of Technology

Cathy A. Schoen

Service Employees International Union

Jeffrey J. Schott

Institute for International Economics

Ronald K. Shelp

Celanese Corp.

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: International Competition in Services

Lionel S. Johns, Assistant Director, OTA

Energy, Materials, and International Security Division

Audrey Buyrn

Industry, Technology, and Employment Program Manager

John A. Alic, Project Director

Kenneth L. Conca W. Wendell Fletcher Jeffrey Hart

Kenan P. Jarboe Jameson R. Miller Mary Ellen Mogee

Philip A. Mundo Douglas R. Ostrom

Contributors

Clare Delmar Martha Caldwell Harris Jeffry H. Taylor John Sullivan Wilson

Contractors

Eileen Appelbaum, Peter S. Albin, Ross Koppel, and Farrokh Hormozi

Susan Christopherson

Gunter Dufey and Adrian Tschoegl, University of Michigan

H. Peter Gray

Daniel W. Halpin

Larry Hirschhorn, Wharton Center for Applied Research

Louis Jacobson, The W.E. Upjohn Institute for Employment Research

Jarl G. Kallberg and Anthony Saunders

George E. Lindamood

Robert R. Miller

James A. Orr

Clyde B. Tatum

Martha E. Williams

Administrative Staff

Edna Thompson, Administrative Assistant

Andrea Amiri Diane White Joyce Wills
Workshop on International Banking, January 1986

Robert Z. Aliber

University of Chicago

James Ammerman

Department of the Treasury

Serge Bellenger

Credit Industrial et Commercial

Robert Bench

Office of the Comptroller of the Currency

Detlef Bindert

Deutsche Bank AB

George J. Clark

Citicorp

Gunter Dufey

University of Michigan

Jarl G. Kallberg

New York University

Martin Mayer

New York, NY

Hugh O’Donnell

Crocker National Bank

Priscilla Rabb

Department of the Treasury

Kim Steking

General Accounting Office

Adrian Tschoegl

University of Michigan

Ronnie L. Goldberg

United States Council for International

Business

vi
Contents

Chapter Page

I. Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

2. Services in the World Economy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34

3. International Competition in Banking and Financial Services . . . . . . . . . 81

4. International Competition in Engineering and Construction. . , . . . .. ...119

5. Information Technology Services: Software, Telecommunications,

Data Processing, and Information Services . . . . . . . . . . . . . . . . . . . . .. ...157

6. Technology Trade: Licensing by U.S.-Based Firms . .................,191

7. Jobs in the Services. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .225

8. Moving Toward a High-Skill Economy: Computer Applications

and Work Organization in the Services. . . . . . . . . . . . . . . . . . . . . . , . . . . . .259

9. Foreign Government Policies . . . . . . . . . . . . . . . . . . . . . . . . . . ...........295

10. U.S. Government Policies: Issues and Options. .

Appendix A: Glossary. . . . . . . . . . . . . . . . . . . . . . . . . .

Appendix B: Analyzing Competitiveness in the Serv

Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

. . . . . . . . . . . . . . . . . ,., 329

,..,, ,,..., ..,.,. ,,. 379

ces . . . . . . . . . . , . . . , . , 383

,,.., ..,.., ,.,.,, .,, 391

vii
Chapter 1

Summary

.
CONTENTS

Page

Principal Findings . . . . . . . * . ! . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

Services and the U.S. Economy ................. . . . . . ........ 5

The U.S. Competitive Position . . . . . . . . . . . . . . . ....... . . . . . ....... 6

Negotiations on Trade in Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

Trade and Competition by Sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

Domestic and Labor Market Implications . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

Federal Policies . . . . . . . . . . . . . . . . . . . . . . . . . . ....... . . . . . . . . . . . . . . . . . 22

Evolving Industrial Structure: Services and Goods . . . . . . . . . . . . . . . . .... 31

The Services and Manufacturing: Synergies and Interdependencies . . . . . 32

Multinational Expansion and Integration . . . . . . ........ .......... 34

Thinking About the Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. ...... 35

Using Technology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .............. 37

Boxes

Box Page

A. Services in the New Trade Round. . . . . . . . . . ........ . . . . . . . . . . . . . . . 4

B. The Technology/Science Base for the Services . . . . . . . . . . . . . . . . . . . . . . . 38

C. Computer Applications in the Services . ............ . . . . . . . . . . . . . . 40

Figures

Figure No. Page

l. U.S. Service Exports.. . . . . . . . . . . . . . . . . . . . . . ............... . 5

Z. U.S. Trade Balance According to Official Government Figures . . . . . . . . . 6

3. U.S. Trade Balance by Region, 1985 . . . . . . . . . . . . . . . . . . . . . . . ........ 8

4. International Assets of Major Banks by Country . . . . . . . . . . . . . . . . . . . . . . 11

5. Construction Contracts Won by Foreign Firms in the United States... . . 15

6. Characteristics of Firms and Industries ............. .. .. ........ 41

Tables

Table No. Page

l. Business-Funded R&D as a Percentage of Gross Domestic Product . . . . . . 19

2. Summary Guide to Policy Options . . . . . . . . . . . . . . . . . . . . . . ........ . . 24

3. issues and Options for Congressional Consideration . . . . . . . . . . . . . . . . . . 25

4, Classification of Service Providers by Markets . . . . . . . . . . . . . . . . . . . . . . . 36

5. Characteristics of Knowledge-Based Compared to Tertiary Services . . . . . 37

6. Examples of Knowledge-Based and Tertiary Service Industries . . . . . . . . . 37
Chapter 1

Summary

Domestically as well as internationally, services and manufacturing depend on one another.

Given the size and diversity of the U.S. economy, any view of the future that sees the services taking the place of manufacturing has

pushed the distinctions between them too far.

As this assessment shows, there is no choice

to be made between a manufacturing economy

and a service economy. The choices concern

the pace of change and the kinds of skills that

Americans will need to work productively in

emerging industries. They also concern Federal policies to aid and assist the adjustments

involved, and an international trade regime that

will permit the synergies between domestic and

foreign production, goods and services, American know-how and foreign know-how, to multiply. Among the most critical policy choices

will be those affecting Americans who lack the

skills for full participation in the kind of economy that will emerge over the next 30 years.

The international infrastructure for services

has become critical for the long-term competitiveness of U.S. firms in many industries. More

than 70 percent of all Americans work in the

service sector of the economy (table 32, ch. 7).

In nations otherwise as different as the United

States, Japan and the United Kingdom, more

people find jobs in service industries than in

manufacturing, and services account for more

than half of gross domestic product. Many governments have instituted policies, often including trade protection, to encourage growth in

the intermediate or business services that form

a primary subject of this assessment.

Still, while the services make a significant

contribution to the U.S. balance of payments,

direct trade in manufacturing remains much

larger. The share of services in total world trade

has remained more-or-less constant at 17 to 18

percent over the past 15 years. Thus the dominance of services domestically—in terms of employment and share of gross output—does not

carry over to the international trade arena. Even

so, beginning in 1982, the U.S. Government

made reductions of trade barriers in services

the centerpiece of its proposals for a new round

of multilateral trade negotiations (box A). These

proposals were opposed in parts of the developing world. As preparations continued, the

emphasis on services receded only slightly; the

Uruguay Round, initiated in September 1986,

gives them a prominent place. Why did the

United States raise the negotiating stakes so

high? Why did other nations react as they have?

Does it make sense to press for international

agreements on services at a time of deteriorating trade relations generally? As this report will

show, the answers to such questions depend

as much on the interrelationships of the services and manufacturing as on the magnitude

of service exports themselves.

This assessment, requested by the Senate

Committees on Governmental Affairs and Foreign Relations, and by the House Committee

on Small Business, looks with particular care

at four services:

banking (ch. 3);

engineering and construction (E&C, ch. 4);

information technology (IT) services, including most services related to data processing and communications, but not equipment (ch. 5); and

technical licensing (a source of revenues

for manufacturing firms almost exclusively,

ch. 6).

Beyond specific expressions of interest by the

requesting Committees, the reasons for choosing these four sectors included dependence on

technology and its significance for international

competition, and dollar value of transactions

as recorded in the U.S. balance of payments.

All four have strategic importance, in part because they are intermediate services provided

mostly to other businesses. This means that

competitive strength can create a powerful if

indirect stimulus for other parts of the U.S.

economy—as when multinational manufacturing companies make use of international com3
4 ● International Competition in Services

Box A.-Services in the New TradeRound

In September 1986, trade offidab from most of the QO#us membe~ ofth~ General Agreement

cm Tariffs and Trade {GATT, the principal mg~zation within which ~mrnmmts negotiate the rubs

for world trade] agreed on plana far a naw round of multilatmd trad~ negbtiatioas (MTN)-to be

known as the Uruguay Round. Since 1$!M, the United States had ken prewing for an MTN round

that would address barriers to services trad~ [ch. $]. Other “xww Mm” r-in promimmce SS preliminary discussions continued. Respite ~soing opposition from a group af developing naticms, led

by Brazil and Iqdia, must of the new imwes raisad by th~ United $tptas will ba put of tho Uruguay

Round negotiations, akhough nut nec~ssarfiy as prominent as the t.Mt.ed Mates might hava wished.

In admtion to $ervic~, tlmse include restrictions on foreign direct immtnmnt tit m@Y di*o~ bade

flows (most simply, performance requiqmmnte that make txporting a cxmdition far inward investment) and protection fo~ intellectual property (strengthening of patents md copyrights, stiffer enforcement of laws prohibiting ~ountetfkiting of goods).

To begin the process of liberalizing tzwie in services, the United States has sought the foiiowing:

● Agreement that “natbmd troatrnent” should, in general, govern services trade. For most of

the services, this principle-that foreign firms should be treated the s~me as domestic (national)

firms-implies the right of establishment.

● “Transparency” in regulations and barriers that affact services trade--i.e., explicit rather than

hidden rules.

● GATT procedures for resolving disputes concerning trad~ in services.

Given a satisfactory umbrella agreement incorporating such provisions, GATT parties might (or might

not) lnove on to negotiations dealing with particular service industria during the Uruguay Round.

While the United States got most of what it wanted in the 1986 Ministerial Statement, services

negotiations will take place in parallel wi~, rather than as part of, n$gotiatitms on goods trade. This

concession to the developing countries—which argue that services do not belong in GATT at d, but

should be discussed in other international bodies--may make it nwre diffiqdt to eventually integrate

whatever agreements are reached into the structure of GATT codes end adjudication rnechani$ms.

on the other hand, theze ae good reasons, as discussed later in tMs repro% for pur$~i~ negotia~on$

on services in other multilateral forums as a supplement to the GATT talks, and also for biiateral

discussions on services.

The Uruguay Round is scheduled to run though %990, but it seems quite possible, given the complexity of the issues to he negotiated, th@ 4 years wfll not be enough to reach meaningful agreements;

this set of trade talks could easily continue well into th~ 19$0s. The prdmss of bringing services trade

under GATT discipline wiil be a difficult one, for ~0 C~Q~lY m~~ P-W” Fir~tt many Of the *rvices in many countries have been heavily regulatad far years (examples include bankinq sind insurance). State ownership has also been common [air travel, telacomrntmication$). Second, almost all

the trade and inve@ment restrictions are non~ariffin nature. M~y govmnments design their regulatory and supervisory policies to exclude fordgn firms or ftwor domestic firms. The preceding Tokyo

Round took up non-tariff barriers affadt.ing trade in goods; progwss proved painf@y slow. When

it comes to many of the services, sensitivities will be wan higher, if only kxmse openness to trade

implies rights of establishment and hence inward investment.
Ch. 1—Summary • 5

munications networks to manage global oper- terests of other groups or the Nation as a whole,

ations. Because this assessment deals with sometimes not, But it is business organizations

international competitiveness, most of the anal- that compete internationally—not governments,

ysis centers on businesses, Sometimes the in- not people (as consumers, as workers), not enterests of U.S. companies correspond to the in- tire economies.

PRINCIPAL FINDINGS

Services and the U.S. Economy

1. OTA’s estimates show that services make

a greater contribution to the U.S. balance of

payments than the official figures imply—a surplus of perhaps $14 billion in 1984, rather than

only $2.3 billion. Services account for about

one-quarter of U.S. exports, substantially more

than the 17 percent indicated by official government statistics (figure 1).l But while services help the U.S. trade position more than had

been realized, OTA finds no reason to expect

that exports of services will grow more rapidly

than exports of goods; the ratio of service exports to total exports will probably not change

very much over the next decade or two, Trade

in services will remain considerably smaller

than trade in goods; services may have a dominant place in domestic employment and production, but not in international trade (figure 2).

2. Relatively few American jobs depend directly on trade in services, Not only does domestic production of services greatly exceed

exports and imports of services, but U. S.-based

service firms do more overseas business through

foreign affiliates than through direct exporting,

Investment abroad means jobs in foreign countries. (And foreign investment in the United

States means jobs here,) Almost certainly, services embodied in U.S. goods exports contribIThe $14 billion figure corresponds to the middle of the range

of OTA’S estimates. For 1984, OTA places U.S. exports of services, excluding banking, at $69 billion to $9 I billion. Mercbanclise exports that year came to $220 billion, The ratio of the

midrange figure for ser~’ices to all exports equals 0,27. Based

on the official Federal Government figure for 1984 service exports, $43.8 billion, services come to only 17 percent of all exports. See Trade in Services: Exports and Foreign Revenues

(Washington, DC: Office of Technology Assessment, September

1986), p, 38.

100

10

Figure 1 .—U.S. Service Exports

65

0

1982

—42

.

1983

91

84

67

42

J

69

44

—

1984

Year

OTA high OTA low

estimate estimate D

BEA estimatea

aBureau of Economic Analysis, Department of Commerce

SOURCES: Trade In Serwces” Exports and Fore/gn Revenues (Washington, DC

Off Ice of Technology Assessment, September 1988), p 39, R C Krueger, “U S International Transactions First Quarter 1986, ” Survey of

Current Business, June 1986, pp 3670

ute more to U.S. employment than do exports

of services,

The need to produce services at the point of

consumption limits growth prospects for exports,

in contrast to goods, which can be shipped and

stored. Although advances in communications

and transportation have made it easier and

cheaper to supply services at a distance, the

changes are incremental, with no real prospect

of radical transformation. In general, when

U.S.-based firms establish overseas affiliates in

the services, these affiliates are staffed by local people and purchase in the local market,
6 • International Competition in Services

Figure 2.— U.S. Trade Balance According to

Official Government Figures

Investment

/-’” w

Year

SOURCE R.C. Krueger, ‘W S International Transactions, First Quarter 1986, ” Survey of Current Business, June 1986, pp 42-43

3. While overseas investments may not contribute very directly to U.S. jobs, exports, or

international competitiveness, the indirect and

strategic benefits to the Nation economy can

be substantial.

American multinationals—whether they produce services, goods, or both–stand to benefit

from further opening of trade and investment opportunities in the services. These benefits will

come in part from a better developed global infrastructure for supporting their business activities: deeper and more integrated capital markets; well-established and comfortable working

relationships with the overseas affiliates of the

accounting firms, advertising agencies, insurance companies, and law firms that they deal

with at home; cheap and reliable communications networks. The synergies and strategic benefits flowing from such an infrastructure can

aid U.S. economic growth and competitiveness,

and create new domestic jobs, even though impacts within the United States may be hard to

trace.

4. International competitiveness in high-valueadded manufactured goods (e.g., computers or

commercial aircraft) depends on knowledgebased services—computer software, engineering, banking and finance, business services of

all kinds, To maintain a society with high living standards and large numbers of well-paying

jobs, the United States must remain competitive in both high-value-added goods and knowledge-based services; this, in turn, requires a

well-educated and highly skilled labor force,

one that can adapt to changing competitive conditions.

5. Government policies, particularly regulatory policies, have greater impacts on many

service industries than on goods-producing industries. Sometimes these policies help the international competitiveness of American firms,

sometimes they hurt. But impacts on competitiveness seldom get much attention from policymakers. Given the increasing integration of

the U.S. and world economies, Federal agencies with regulatory or supervisory authority

over the services will have to begin paying consistent attention to international competitiveness. If they do not, the competitive ability of

American service firms may begin to suffer. If

U.S. service industries suffer the same kinds

of competitive declines as U.S. manufacturing

industries, the Nation’s living standards will

be in even greater danger,

The U.S. Competitive Position

1. Internationally, the United States maintains a position of competitive advantage in

most services—although U.S. competitiveness

varies a good deal among these industries. Some

—e. g., engineering and construction—have been

slipping. Others, notably the information-related services, remain highly competitive. (Industry-specific findings appear later in this

chapter.)

Figure 3 compares the U.S. balance of payments in services, according to the official

figures, with that in goods, The chart shows

that the United States ran large deficits in goods
Ch. 1—Summary ● 7

—

Phofo credlit: Lufthansa

American jetliners, part of Lufthansa’s fleet, at Frankfort airport

trade with almost all regions of the world in

1985, coupled with surpluses in services—albeit

small—everywhere but Latin America (where

tourist travel by Americans pushes the balance

to the deficit side). The official figures underestimate U.S. exports and imports of services,

but are the only source of comprehensive geographic detail; more accurate data would disclose somewhat larger surpluses with most

regions.

2. The U.S. surplus on services trade has

fallen–according to OTA’s midrange estimates,

from about $20 billion in 1982 to $14 billion

in 1984. As for trade in goods, some of this decline reflects the strength of the dollar, but in

many of the service industries, as in manufacturing, continuing economic growth and development have helped other countries narrow the

gap with the United States. For example, E&C

firms in both the newly industrializing and less

developed countries (NICs and LDCs) have

made substantial strides in their technological

and managerial capability over the past 15

years.

3. As in so many manufacturing industries,

many of the future competitive threats in the

services will come from Japanese firms, Japan

has already proven its competitive ability in
8 • International Competition in Services

Japan

Latin America

Canada

Western Europe

Rest of world

Other developed

countries

Figure 3.–U.S. Trade Balance by Region, 1985

t

/

-

d

a

I 1 I I I I

–50 –40 –30 –20 –10 o 10

Current account balance (billions of dollars)

❑ Goods ■ Services

asewlce~ balance with “otfler developed countries” = $026 billion

NOTE The sum of the balances In the figure does not equal the 1985 current account deflc ”+ because the current account

Includes other Items not I n the chart (investment income, government transactions, and unilateral transfers)

SOURCE: R.C Krueger, ‘(international TransactIons, First Quarter 1986, ” Survey of Current f3uslness, June 1986, pp. 36-70.

computer hardware and in telecommunications

equipment. Improvements in services ranging

from software products to computer and communications networks will follow, if at first only

to meet Japan’s own needs and to take advantage of the country’s expanding hardware base.

This coming thrust into information-based services promises to boost Japan’s international

competitiveness still further in manufacturing.

Japanese E&C firms have long since demonstrated their competitive ability. The banks, as

discussed below, have been following Japanese

manufacturers into international markets, aided

by the capital reserves accumulating as a result of huge trade surpluses; if Japanese banks

succeed in taking competitive advantage of their

asset base, they could quickly take on still more

prominent roles in world financial markets.

Finally, Japan’s policymaking system seems

more attuned than those of Western governments to the needs and consequences of the

shift toward an information-centered economy.

To this point, policy makers and bureaucrats in

Japan have tended to view competitiveness in

services as flowing from competitiveness in

manufacturing, But they also recognize that the

Japanese economy faces an eventual transition

from mass production of consumer durables

to a structure centered on information technologies. Government officials in Japan are doing
Ch. 1—Summary . 9

their best to lay the groundwork for a competitive set of industries in the future, as their economy emerges from this transition.

Negotiations on Trade in Services

1. The United States has made reductions in

barriers to services trade a primary goal in the

Uruguay Round trade talks, Although immediate payoffs in terms of U.S. jobs and U.S. exports will be small, the long-run strategic importance of services makes the goal a vital one.

The negotiations promise to be lengthy and difficult: far more often than in manufacturing,

trade (and investment) barriers in the services

—almost always non-tariff in nature—have domestic policy rationales.

Governments regulate banking and insurance

to protect consumers; many countries view

telecommunications as having elements of natural monopoly. Such factors raise sensitivities

several notches above those associated with

non-tariff barriers (NTBs) affecting trade in

goods. It is easy for governments to tilt the regulatory and supervisory policies that affect service industries to make life difficult for foreign

firms. Past GATT negotiations aimed at reducing NTBs affecting goods have proved less successful than hoped. With a great deal of room

for maneuver and for ambiguity, it will take patience and persistence to reach meaningful

agreements on barriers to services trade, inside

or outside of GATT.

2. No matter the perspective from which the

service industries are viewed, differences seem

to outweigh similarities, even among the knowledge-based intermediate services that form the

primary subject of this assessment. Generalizations concerning the international competitiveness of U.S. service industries cannot be

pushed too far. Government policies, here and

overseas, affect them in different ways; measures that help one may hurt another. Liberalization would benefit some U.S. industries more

than others. The lists of those helped and those

harmed will differ among countries.

Any negotiating strategy for the service industries, in either a bilateral or a multilateral

framework, must be based on a well-founded

analytical grasp of the differences among them.

Lacking such a grasp risks outcomes that, on

balance, would do more harm than good to U.S.

interests. Even given such an understanding—

difficult to develop, if for no other reason than

the gaps in the data from which analysis must

begin—a multilateral trade agreement embracing the services will almost certainly mean

diminished competitive prospects for some U.S.

service industries, along with brighter prospects for others.

3. U.S. policy makers will be faced with decisions on which topics will be most appropriate for GATT and which for other venues (e.g.,

the Organization for Economic Cooperation

and Development, bilateral negotiations, specialized organizations). Longstanding international arrangements exist for services including

shipping, air travel, and telecommunications.

Bodies like the World Intellectual Property

Organization will continue to provide a forum

for negotiations on intellectual property protection, Decisions on international technical

standards could have considerable impact on

trade and investment in the decades ahead,

Choosing the right mix of topics in the right

mix of forums would be a major step toward

a trade policy that is forward-looking rather

than reactive.

The process entails more than monitoring foreign government actions (and seeking to learn

from foreign experience). The United States

also needs to monitor and adjust its own policies, As chapters 9 and 10 make plain, the list

of policy issues that affect trade and competition in the services is a long one. The issues

range from very general—the ability of the Federal Government, as currently organized, to

cope with economic interdependence, new patterns of international business, and continuing pressures for domestic adjustment—to quite

specific, such as illegal copying of computer

soft ware.

4. Other governments, particularly in the developing world, have often viewed the U.S.

push on services as forcing them into a battle

they will probably lose. They will seek conces-
10 ● International Competition in Services

sions on trade in goods in return for liberalization in services.

Given a massive U. S. deficit in goods trade,

which a falling dollar will help but not eliminate, policy makers and trade negotiators will

have to balance priorities, not only among the

services, but between services and goods. Trade

agreements always lead to winners and losers,

if for no other reason than that some nations

and some industries benefit more than others;

in a very real sense, services and goods compete with one another. To get agreements that

it wants in services, the United States will undoubtedly have to make concessions elsewhere.

U.S. negotiators will need to seek advice and

guidance from a wide range of potentially affected interests, particularly if the Uruguay

Round negotiations go beyond an umbrella

agreement to sector-specific issues. New advisory mechanisms may be needed to bring services-related negotiations to a satisfactory conclusion. Government agencies charged with

conducting the negotiations, notably the Office

of the U.S. Trade Representative (USTR), may

well require added resources.

5. OTA finds no compelling reason, at this

time, to give either bilateral or multilateral

negotiations in particular service sectors unusually high priority. Of those services with

clear strategic importance for leveraging U.S.

exports and spurring economic growth, telecommunications services and computer software come closest to meriting special consideration.

In some contrast, international banking, alone

among the services, seems to carry the potential for severe disruptive impacts, and hence

for economic dislocations potentially comparable, say, to the oil shocks of the 1970s. Here,

however, continuing steps aimed at preserving stability are likely to take place quite independent of GATT.

6. In part because more nations have been

evading the intent and sometimes the letter of

GATT codes, the ability of the system to manage trade in goods has deteriorated. The strains

will probably continue to build. Countries with

heavy debt burdens need to find foreign markets for their goods, but face new restrictions

in many industrial nations, including the United

States. At the same time, many of these developing countries see their relatively small service sectors as vulnerable to foreign competition and in need of protection. They may feel

there is little to be gained from agreements on

services trade, unless accompanied by an opening of markets for their goods,

With the United States and other industrialized nations, as well as the developing countries, more heavily dependent on trade in goods

than services—and with the United States already having large shares of many service

markets—aggressive pursuit of services agreements could harm prospects for improving the

ability of the trading system to cope with strains

over trade in goods. U.S. negotiating objectives

may have to adapt to this reality as the Uruguay Round continues. Unless GATT as an institution can be substantially strengthened, its

disciplinary force will continue to wane; GATT

could become irrelevant.

Trade and Competition

Banking and Financial Services

International banking (ch.

similar to the retail financial

by Sector

3)—only loosely

services familiar

to most Americans—has been growing rapidly,

fueled by deregulation and new products, many

of them possible only because of developments

in computer and telecommunications technologies. Examples range from 24-hour securities

trading to the lightly regulated offshore markets for products like Eurobonds. With lending less profitable in recent years, banks have

turned to new and largely unregulated products in part to earn fees for services. The offshore markets—in essence, operating outside

the regulatory reach of national governments—

have been expanding at literally explosive rates.

Growth in securitization means that almost any

financial instrument—e.g., commercial paper,

bundles of mortgages–can now be traded.

Larger corporations can market their own secu-
Ch. 1—Summary ● 1 1

Photo credit: Steven Weissman, NYT Pictures

Stock exchange in India

rities, manage their own short-term assets.

When they do so, they are in effect competing

with their banks, Taken together, these developments raise new questions concerning the

safety and stability of the international banking system.

Figure 4.— International Assets

1984

United Kingdom

8.00/0 —

West

Germany

6.20/o -

France A

8.70/o

Total: $2,236 billion

NOTE Figures are for September of each year

Deregulation means more competition, driving down profits. Banks seek new products and

new international markets in part to maintain

their profit margins. Deregulation becomes contagious. When one nation relaxes its supervisory authority, others must follow, else risk losing business. But deregulation cannot go too

far without threatening the stability of the

system,

In the United States, regulatory and supervisory authorities find that more of their decisions have international ramifications. Impacts

on international competitiveness must be built

into decisonmaking processes.

This is an industry, then, with intense competition among financial institutions in many

countries, one where substantial advantages are

hard to come by. American banks have done

well, in part because of their accumulated experience in a relatively open market. Only Japanese banks, with their rapidly growing financial muscle—in large part a legacy of Japan’s

vast trade surplus in manufactured products—

have mounted a real challenge (figure 4),

1. Internationally, a great deal of momentum

drives the technology that leads to innovations

of Major Banks by Country

1986

United Kingdom

6.6 ”/0

West

Germany

7,80/o -

France J

8.20/o

Total: $3,238 billion

SOURCE A NICOII Japanese Bank Lending Surges Ahead F/nanc/a/ T(rnes, Jan 20, 1987 p 22 Orlglnal source Bank for International Settlements
12 ● International Competition in Services

in financial service products, to market growth,

and to pressures for deregulation. The changes

taking place raise new concerns for the safety

of the international banking system. Electronic

networks move huge sums of money around

the world almost instantaneously. Where once

regulatory authorities could expect to see warning signs days or weeks before a bank failed,

now the process could be over before the authorities charged with safeguarding the system

are able to react. Innovation in financial services will continue, in rather unpredictable

directions. Regulatory and supervisory bodies

will have to cope with dynamic, rapidly changing conditions, nationally and internationally,

for the foreseeable future.

2. Despite the bad loans they have made internationally, U.S. financial services firms, as

a group, remain highly competitive. Banks in

other countries have their share of problem

loans, while American firms have been leaders

in new financial services and innovative applications of technology—many of the latter

helping them escape the regulatory thrusts of

national governments. As other countries deregulate, American banks will continue to take

advantage of their learning and experience here

to penetrate foreign markets. Nonetheless,

some U.S. financial services firms will make

mistakes and find themselves in competitive

difficulty; some may fail or be purchased by

more successful rivals.

3. Among national banking industries, only

the Japanese have mounted a real threat to the

United States in financial services. Japanese

banks followed Japanese manufacturing firms

onto the world stage. Japan now can claim most

of the biggest banks in the world, as measured

by assets. The speed with which Japanese financial institutions turn new opportunities into

competitive reality—and the magnitude of the

competitive threat to U.S. banks—depends first

of all on the speed of deregulation in Japan’s

domestic financial markets. The faster Japan’s

Government liberalizes at home, the freer Japanese banks will be to compete overseas.

4. While U.S. financial services firms have

been moving into overseas markets, foreign

banks have moved into the United States. In

both retail and commercial banking, some foreign banks will be quite successful in the United

States, but this in itself should not be taken as

a sign of flagging U.S. competitiveness. It is,

rather, a natural consequence of an open and

attractive market, with fewer regulatory restrictions than in the past. Foreign banks come here

in part because of the size of U.S. markets, in

part because their corporate clients have invested in the United States, in part because they

seek experience in a deregulated and highly

competitive environment.

5. To considerable extent, U.S. banking regulations have been overtaken by events. Many

of the regulatory barriers—e. g., those separating commercial from investment banking—

seem bound to crumble further. While regulations will continue to have significant effects

on competitive outcomes internationally, most

of these are secondary and indirect—hard to

trace and hard to predict. This real but less than

obvious influence is precisely the reason that

policymakers and regulators in the United

States will have to take far greater account of

the ramifications of their decisions for international competitiveness in banking. Financial

services is plainly an industry that, in its domestic as well as its international dimensions,

will challenge the creativity of regulators as well

as bankers.

Sometimes U.S. regulations give foreign banks

advantages, and in other cases American banks

come out ahead, but there are few cases of major asymmetries and little cause for wholesale

reassessment of U.S. banking policy because

of international competition. Rather, given the

expansion and growing integration of world

financial markets, U.S. policy makers need to

build international considerations into their

routine processes.

6. Governments and banks have special relationships all over the world. Regulatory and su-
pervisory policies aim at ensuring stability and

protecting depositors. Governments implement

monetary policy through the banking system,

and, in some countries, use it to allocate credit

and guide economic development.

With new technologies and new products

making it easier for banks to circumvent the

regulations that remain, and with competition

inducing financial institutions to take greater

risks in order to maintain their profit margins,

continued movement toward international

coordination of banking regulations seems

necessary to ensure stability. The competitive

trends analyzed in chapter 3 point to a need

for ongoing discussions aimed at harmonization and coordination of regulatory and supervisory policies among major banking nations.

The international regime for banking looks

markedly underdeveloped compared with that

for service industries like telecommunications.

Indeed, despite the sensitivities raised by the

special relationships between banks and national governments, it maybe time to consider

supranational regulation of financial services,

rather than simply coordinated national policies.

Engineering and Construction

While international banking has been growing, the international E&C market has been

shrinking (ch. 4). Falling oil prices and Third

World debt burdens marked the end of a period

of vast international projects, one that brought

abundant opportunities for both American and

foreign E&C firms. Today, foreign contractors

often have technology as good as—in some

cases, better than—American firms, European

and Japanese contractors have pioneered new

approaches to tunneling and reinforced concrete construction. South Korean construction

companies learned their trade in Vietnam and

the Middle East during the 1960s and 1970s,

often working alongside American firms.

The result? More competition for fewer projects, and a difficult environment for U.S. contractors, who no longer have outstanding technological advantages to set against their high

labor costs. Foreign government subsidies—

notably tied aid credits—aggravate the situation. Major international contracts often turn

on financing packages. Many foreign governments participate in assembling these packages;

by and large, the U.S. Government does not.

For the E&C industry, the competitive future

resembles that for the Nation’s smokestack

manufacturing industries more than that for

most other traded services.

1. Since the 1970s, U.S. E&C firms have been

losing ground steadily in international markets;

they will probably continue to suffer from gradually declining competitiveness.

During the Middle East construction boom

of the 1970s, U.S. firms did well, but nonetheless saw their share of international projects

fall. Other countries took growing shares, and

continue to do so. Third World debt means

fewer of the large and complex projects for

which American companies have had competitive advantages. Growing technical capabilities

in the Third World mean fewer jobs for outsiders. E&C firms with headquarters in the

LDCs and NICs as well as other industrial nations offer stiffer competition for projects that

do come onto the international market. As a

result, U.S. market share has declined faster

in the 1980s. Indeed, foreign firms have begun

to make startling inroads into the U.S. E&C market; figure 5 shows the rise in new U.S. contracts of foreign construction firms—a rise that

has taken place during a period when the value

of new construction in the United States has

declined somewhat.

2. As in many manufacturing industries where

U.S. competitiveness has slipped, the reasons

begin with economic growth elsewhere, coupled with improvements in overseas technology and managerial ability. That is not to say

the U.S. industry is problem-free; in general,

U.S. E&C firms—and construction companies

more than engineering and design firms—have

yet to come to grips with their shifting competitive circumstances, Adjustments to new

realities have been slow, responses more reactive than proactive; differences in attitude and

outlook between managements in American
14 • International Competition in Services

Photo credit: Bechtel Power Corp.

Construction on the $1 billion Ok Tedi Gold and Copper project in Papua New Guinea

E&C firms and those in banks or data process- computer and communications technologies—

ing companies have been striking. these skills no longer suffice for competitive

3. Better utilization of existing technologies,

and aggressive development of new technical

know-how, could help American E&C firms

maintain their competitive standing. The United

States is no longer a leader in a surprising number of technologies relevant for large-scale construction projects. While many U.S. firms retain a deserved reputation for skills in design

and in the management of complex projects—

aided by the broad U.S. lead in applications of

advantage in bidding on many international

projects.

Given high labor costs (which U. S.-based contractors try to reduce by hiring foreign nationals

whenever possible), and limited assistance from

the U.S. Government in arranging financing,

American E&C firms appear to have little choice

but to move aggressively in rebuilding their industry on a base of high technology. Thus far,

however, few firms have taken decisive steps
— .

Ch. 1—Summary . —

Figure 5.—Construction Contracts Won by Foreign Firms in the United States

1980

❑ All others

1981

❑ British

SOURCE Engineering NewsRecord, various issues

1982

in this direction. The Federal Government

could help by encouraging cooperative and

joint R&D to strengthen the technology base for

the construction industry, as well seeking more

effective methods for transferring the results

of government-sponsored R&D to industry.

Cost-sharing by Federal agencies would help

extend time horizons for R&D projects.

Construction remains craft-based and laborintensive, with vast scope for productivity improvement through better technology, Given the

size of the domestic industry, better productivity would have far-reaching impacts within

the United States as well as internationally.

1983

Year

1984 1985

French ❑ Japanese ❑ Germa n

15

4. Project financing has always been an important element in international E&C projects.

Many foreign governments help arrange financing packages, not only to assist their E&C firms

but to attract follow-on export business, Favored techniques include tied aid and mixed

credit subsidies, which the United States normally avoids. U.S. efforts to limit subsidies have

included negotiations in the Organization for Economic Cooperation and Development (OECD),

along with new mechanisms intended to help

Federal agencies match foreign financing in an

effort to keep other governments at the bargaining table, To the extent such efforts bear fruit,

as they appear to be, U.S. firms will be on a
16 . International Competition in Services

more even competitive footing. But, while a significant step toward equalizing the terms of

competition, this by itself will not be sufficient

to revive U.S. competitiveness in the E&C industry.

Other policy initiatives at the Federal level

can also help U.S. firms—e. g., set-aside programs for U.S.-funded projects overseas (military construction, as well as construction for

embassies and consulates). But the shifts in

competitiveness visible in the international

E&C industry are deeply rooted in technological change and international economic currents. Federal policies can, at best, provide

support for new strategic thrusts by the U.S.

industry—thrusts that have yet to take shape—

they cannot reverse the forces leading to change

in international E&C markets.

Information Technology Services

Along with banking, the cluster of sectors including telecommunications, data processing

(DP), information services, and computer software—the IT services—has the greatest impacts

on competitive prospects of other U.S. industries (ch. 5). Cheap and reliable international

communications mean that an American engineer on site in a foreign country can tap into

the piping design layout for a petroleum refinery, change a hanger, and calculate the seismic response in a few minutes, One set of computer programs manages the functions of the

communications hardware; other software carries out the calculations. Some applications of

IT services cut costs, as when a DP service bureau handles another company’s health insurance claims, Strategic applications of IT services help firms create new products and enter

new markets—for instance, a chemical manufacturer may tie customers into its computer

network so they can place their own orders.

1. Of the IT services, telecommunications and

computer software are most important for U.S.

competitiveness in other industries. Multinational integration depends on global communications. Computer software helps firms in all

industries control costs and develop new business strategies; software tools will be particularly vital in building a high-technology base

for U.S. manufacturing. Today, engineers in

many industries rely on software aids for design and development of new products; software then controls the factory equipment that

makes these products.

Both the telecommunications and software

sectors are growing rapidly. So is information

services (e.g., electronic databases)—a relatively

small and specialized sector today, but one that

will take on much greater importance in the

future. In contrast, the DP services industry has

already matured; growth has slowed, in part

because many companies that once purchased

DP services now take care of much of their own

computing.

2. Currently, American firms are highly competitive internationally in all four IT sectors,

Their positions appear generally secure over

the short to medium term, particularly in DP

and information services, Telecommunications

and software, for differing reasons, will be a

good deal more volatile, and may demand the

attention of policy makers.

Value-added data communications networks

(VANs–including the computer networks that

link banks together, and that tie airlines and

travel agents) will grow rapidly. Commercial

VAN services will become important tools for

businesses both domestically and internationally, particularly smaller companies that cannot afford their own networks, Larger U.S. companies will want their own VANS, but will use

services supplied by independent vendors for

some purposes as well. Development paths will

depend in part on regulations here and overseas. To the extent that policymakers can shape

regulatory environments that will speed the expansion of VANS, ensure the availability of

VAN services to small businesses as well as

large, and guarantee U.S. firms access to overseas VAN markets as both suppliers and users,

American businesses of all types will be in a

better position to compete internationally.

U.S.-based software firms remain undisputed

leaders in world markets. Indeed, other gov-
Ch. 1—Summary • 17

ernments have viewed the U.S. lead in software

with a good deal of concern. Nations like West

Germany have shifted government support

from hardware (e.g., microelectronics) to software. Developing countries like Singapore and

Taiwan emphasize software in their programs

for catching up technologically. And of course

Japan, with its heavily publicized fifth-generation computer project, seeks software that will

help its computer manufacturers penetrate

world markets more deeply. Why the focus on

software? First, because of the cost-cutting and

strategic applications for users almost anywhere in an economy, Second, because productivity in the generation of software itself has

been nearly stagnant, Raising software productivity y holds enormous promise for multiplying

the productivity increments in other industries.

Moreover, U.S. competitiveness in computer

hardware, and indeed in all high-technology

industries, increasingly depends on software.

Today, software needs and availability often

shape the design of hardware; indeed, software

is often integrated into hardware (e.g., through

functions embedded in semiconductor chips).

Rapid progress in automated software development could lead to shifts in international

competitive standing. So could unexpected success in foreign projects such as Japan’s fifthgeneration effort. But the more likely outcomes

of future competition will be gradual slippage

in the U.S. position, particularly as foreign software firms move away from custom programming. Specially tailored software is expensive,

and no longer a good solution to many customer

needs. Cost pressures will drive countries like

Japan toward the standardized applications

packages pioneered by American suppliers. As

foreign software companies begin producing

standardized products, they will be able to compete more effectively with American suppliers.

The Japanese, in particular, will become more

competitive, if only because their rapid progress

in hardware will force them to do better in software. A narrowing gap between U.S. and foreign industries could prefigure a challenge in

computer software not unlike past challenges

in microelectronics. Furthermore, better software in Japan—and in particular, programs that

can deal efficiently with the complex character set of the Japanese language—will lead to

major productivity increases throughout

Japan’s economy. Office automation is only the

most obvious example.

3. Neither the fragmentation of responsibility for U.S. international telecommunications

policy, nor foreign government policies—including the much-discussed possibility of restrictions on transborder data flows (TBDFs)

—have, as yet, had major competitive impacts

on U.S. businesses operating internationally,

But with American firms of all kinds increasingly dependent on telecommunications, Federal agencies with both domestic and international responsibilities will have to make impacts

on competitiveness a normal and routine,

rather than extraordinary, element in the policy process.

As more American companies do business

in more parts of the world, negative impacts

of NTBs affecting telecommunications and related IT services become a more serious prospect. TBDF restrictions, onerous rate structures

within particular countries, discriminatory access to network facilities—any of these could

harm U.S. competitiveness in a broad range of

industries. That the impacts have not been major ones in the past does not mean they could

not become so in the future.

4. The next generation of telecommunications technologies—Integrated Services Digital Networks, or ISDN—will provide end-to-end

digital communications for voice, data, and in

some cases video signals. New services—e. g.,

computer networks—will be cheaper; eventually, any home or office that now has a telephone should be able to tap an information utility with a very broad array of available services.

ISDN as an information infrastructure could

parallel the Interstate Highway System in its

impacts on the Nation’s economy,

The capital costs of ISDN, however, will be

enormous—hundreds of billions of dollars by

the time, well into the next century, when international ISDN coverage becomes widespread.

Technical standards will influence the costs,
18 . International Competition in Services

as well as the outcomes of competition involving equipment manufacturers, service suppliers,

and users. The stakes are very high. Vast expenditures, and commensurate rewards to successful suppliers of equipment and services,

will generate a great deal of conflict, both within

and among the nations that design and build

ISDN networks.

With different firms and different governments beginning to implement ISDN, the U.S.

Government will face continuing decisions in

international forums concerning technical standards, as well as questions of domestic regulatory policy. Given the tight control exercised

by PTTs (post, telegraph, and telephone authorities, generally functioning as government monopolies) in many countries, negotiations over

issues such as TBDFs and the international implementation of ISDN will probably go on for

years. The costs of incompatibility in ISDN

standards could be high, while the interests of

equipment suppliers and user groups may differ substantially. As the U.S. position evolves,

Congress may wish to review procedures for

coordination among the many Federal agencies

involved, and the specific preparations for standards-setting and related negotiations internationally. Regulatory decisions in telecommunications, as in banking, have seldom reflected

considerations of international competitiveness;

in the future, they will need to do so.

Before the AT&T breakup, many of these matters could be left to technical experts; today,

with numerous companies competing to find

an edge in the marketplace, matters of commonality, harmonization among systems, and

standards demand high-level policy attention.

The next several years could well be critical,

with discussions planned within the International Telecommunication Union (ITU) that

may have substantial implications for trade in

telecommunications services as well as equipment. Congress, at several junctures, may wish

to review efforts to develop and coordinate the

U.S. position at these meetings and in GATT

among the agencies involved (which include

the Department of State, the Federal Communications Commission, USTR, and others).

5. The United States might learn a good deal

from close observation of foreign government

policies affecting the IT services, Both France’s

Teletel/Minitel system (which has put simple

computer terminals in more than 21⁄2 million

homes and offices), and Japan’s very ambitious

plans for ISDN, hold considerable promise for

stimulating development of new business activities—among both service suppliers and equipment manufacturers. Even if the U.S. Government continues to leave developments such as

videotex totally to the private sector, insight into

policies and outcomes overseas could help inform the regulatory decisions that will always

be necessary here.

Technical Licensing

For years, the United States has been a source

of technology for the rest of the world. Many

American companies, mostly manufacturers,

license not only patents, but knowledge and expertise (ch. 6), By value, most of these licenses

go to affiliates—foreign joint ventures as well

as the overseas divisions of U.S. multinationals

—where control of proprietary know-how is

easier than with an independent foreign firm.

In years past, many U.S. companies took their

emerging Japanese rivals too lightly. Few would

do so today; there is little evidence that American companies license their technology too

cheaply—that is, that they continue to underestimate the risks of future competition from

their licensees, But just because firms look out

for their own interests does not mean they look

out for their competitors’ interests (or their suppliers’ or customers’ interests, or the national

interest).

Today, the United States can also learn from

the rest of the world. With overseas technology often as good as American, many more U.S.

companies could benefit from seeking out and

licensing foreign technologies. A more balanced two-way flow would be a positive sign

for future U.S. competitiveness. Indeed, growth

in U.S. licensing revenues has slowed since the

beginning of the 1980s, This is one of many

symptoms indicating that the vast base of technology underlying the Nation’s commercial
Ch. 1—Summary ● 1 9

—

industries—particularly sectors well removed

from defense needs—no longer adequately supports an economy as large and diverse as that

of the United States. Coupled with indications

of declining productivity in U.S. R&D, OTA’s

analysis suggests a real need for overhauling

the Nation’s technology policy.

1. U.S. companies license their technical

knowledge primarily when other opportunities

for exploiting it–exporting goods from the

United States, direct investment in overseas

manufacturing plants—have been cut off. Today,

foreign governments use policies such as import barriers, investment incentives, and performance requirements more effectively than

in the past to encourage transfers of technology to their own firms. American companies

have increasingly been forced into licensing

agreements and joint ventures as substitutes for

exporting or wholly owned foreign plants.

U.S.-based multinational corporations (MNCs)

have responded, in part, with integrated worldwide strategies in which licensing becomes an

option to be bargained over from the beginning.

The multinational may, for example, try to lock

foreign partners into its proprietary technology through licensing, so that it will have at

least a piece of the market, even though it cannot sell its exports. Or it may seek arrangements

in which licensees will depend on purchases

of components from the United States (e.g., advanced microprocessor chips). This is one of

many examples of shifts in the international

business strategies of U.S.-based firms where

a sound analytical grasp by Federal agencies

would aid in the development of negotiating

positions during the Uruguay Round.

2. Given shrinkage or loss in the technological leads that so many American industries enjoyed a decade or two ago, some U.S.-based

companies have become notably more aggressive in locating and acquiring foreign knowhow through exchanges, joint ventures, or outright licensing agreements. Many others have

yet to take such steps. Federal policies—e.g.,

evaluation of foreign technical capability, critical reviews [as well as translations) of foreign

technical literature, support for personnel exchanges—that encouraged inflows of foreign

technology could help support the long-term

competitiveness of many U.S. industries. So

could continued efforts by the Federal Government to ensure that the overseas affiliates of

American firms have the right to participate

in government-supported R&D programs, and

equitable access to results.

3. Rough parity among major industrialized

nations has become the norm in many industries and many fields of technology. Increased

inward licensing paints much the same picture

as other indicators: U.S. technology is no longer

broadly superior to foreign know-how. Indeed,

American firms have fallen behind in a surprising variety of cases (as ch. 4 outlines for the

E&C industry). Attributable as much to improved technical abilities in other parts of the

world as to slow-down in the United States, this

relative shift is most evident in industries wellremoved from military needs and defense funding—in steel rather than computers, autos not

aerospace. Many of the indicators, indeed,

point to priorities for the development of commercial (i.e., non-military) technologies that are

markedly higher in countries like Japan and

West Germany than in the United States; table

1, for example, shows that both Japanese and

German companies spend relatively more on

R&D than American firms.

Given the breadth of the technology base that

supports commercial industries, the services

as well as manufacturing, Congress may wish

to consider major changes in U.S. technology

Table 1 .—Business-Funded R&D as a Percentage of

Gross Domestic Product

1972 1981 1983 1985 1986a

United States . .0.99 °/0 1.22°/0 1.32°/0 1.39°/0 1.42°/0

Japan . . . . . .....1.15 1.73 1.99 2.09 2.14

Federal Republic

of Germany . . .1.08 1.46 1.56 1.64 1,69

aEstlmated

SOURCES’ 1972: Science and Technology Indicators Basfc Sfatisf/ca/ Ser/es —

Volume B Gross MWmal Ex’pendlture on R&D GEF?D 79697982

(Paris Organ! zat!on for Econom!c Cooperation and Development,

1985), table 16, 1981-1988: “FRG Institute Compares German, U S ,

Japan Research Expend itures, ” Europe f?eport-Scfence and Technology, Joint Publlcatlons Research SewIce JPRS-EST@&033 Nov

6, 1966. pp 25, 28, 31 Translated from Techrrolog/e Nachnchfen, May

15 1986 Orlglnal source, Battelle Institute, Frankfort
20 ● International Competition in Services

policy. Such a reassessment might begin with

the recent turn toward Federal support for basic

research almost exclusively. In the past, government agencies provided a mixture of support for basic and applied research. But the path

from basic research to the marketplace is long

and tortuous; Federal support, if restricted to

basic work (and particularly to research in science rather than engineering), may not aid U.S.

competitiveness for many years, perhaps decades. Policy initiatives such as support for

generic technologies (those that can help all

firms in an industry), and better mechanisms

for diffusing commercial technologies to the

vast majority of American companies that are

not technologically self-sufficient, could make

a significant difference. The costs would be

small relative to total Federal R&D expenditures.

4. Although Japan has licensed U.S. technologies extensively in the past, and NICs like

South Korea are currently seeking U.S. knowhow as part of their development strategies,

OTA has found little evidence that licensing

by American firms has, in recent years, been

counterproductive from the perspective of individual firms—i.e., that license fees have been

too low. Nor does it appear that U.S. companies have, with rare exceptions, licensed at any

price technologies critical for their own longer

term competitiveness. But firms look out for

their own interests, not those of their competitors; moreover, in earlier years, many American companies plainly underestimated the capabilities of Japanese manufacturers.

Finally, when foreign governments combine

restrictions on imports and investment to pressure U.S.-based MNCs into licenses either at

arms-length or with joint venture partners, they

may be able to help local companies buy technology more cheaply than would otherwise be

possible. Regulating technology outflows holds

scant promise as a U.S. policy alternative. It

is corporations, not governments, that develop

and control proprietary technologies. But government policies aimed at helping American

companies learn from foreign know-how could

aid in bringing inflows and outflows into better balance.

Domestic and Labor Market Implications

Despite the many differences among the services examined in this assessment, international

competitiveness in all of them depends heavily on human capital. Production of knowledgebased services (and goods) requires skills and

abilities, know-how and judgment, that will be

supplemented but not replaced by emerging

computer and telecommunications technologies

(ch. 8).

Automation and productivity improvement

cut into job opportunities in industries that utilize computer and telecommunications systems

intensively. Nonetheless, to the extent that firms

in industries ranging from shoes to chemicals,

insurance to modular housing, can apply such

tools effectively, “dematuration” processes will

help preserve job opportunities for Americans

over the medium term and beyond. Both domestic employment in better paying, more

highly skilled jobs, and the position of U.S. firms

in world markets, depend on the maintenance

of a comparative advantage in the production

of knowledge-based goods and services.

1. To the extent that the U.S. labor force remains a source of well-educated employees

with skills needed by service firms, the Nation

is likely to remain internationally competitive

in most of the knowledge-based services. This,

in turn, will help U.S. manufacturing industries

maintain their competitiveness. It will also help

support a tertiary service sector that can continue to create jobs for Americans who are badly

educated or lack specialized skills—jobs that

will, however, pay little and provide no more

than limited opportunities for advancement,

To maintain their international competitiveness, American firms in many of the service

industries, as in much of manufacturing, must

be able to respond quickly and effectively to

changing market needs (in terms of output level

or product mix), new technological opportuni-
Ch. 1—Summary ● 2 1

ties, the twists and turns of foreign government

policies. Flexibility can come from new technologies, mostly computer-based. But it ultimately rests on a work force with broad and

deep skills. Both new technologies and a more

highly skilled labor force will be needed if

knowledge-based service industries are to adapt

successfully to new competitive realities,

2. In most of the service industries, exports

and imports remain small compared to domestic consumption (or sales through foreign affiliates). Employment levels in the services,

therefore, do not depend very directly on trade.

Nonetheless, indirect effects can be important

—e. g., employment created in service firms that

sell to exporters (of goods or services). There

are no good estimates for the value of services

embodied in goods exports, or the numbers of

jobs created. But it is possible to state that such

jobs will, on the average, be relatively highly

skilled and well paid—particularly for hightechnology manufactured products, with their

heavy inputs of knowledge (regardless of whether

manufacturers produce these knowledge inputs

internally or purchase them from service companies). Likewise, most of the direct employment benefits of foreign investment in the

services accrue to the host country; thus investments in the United States by foreign service

firms–e.g., Japanese or French banks with

offices in New York or San Francisco—create

jobs for Americans.

3. In searching for low costs and flexibility,

American firms are increasingly turning to temporary and/or part-time workers. By supplementing a core staff with contingent employees, companies can adjust quickly to shifts in

demand. (Temporary help services has been

one of the fastest growing U.S. industries.) Parttime employees help firms with labor requirements that vary predictably to minimize costs—

e.g., banks that need more tellers on Mondays

and Fridays, or retail stores open evenings and

weekends.

The steady rise in people taking part-time jobs

involuntarily—because that is the only work

they can get—suggests that underemployment

is joining unemployment as a persistent U.S.

economic problem. But greater numbers of

Americans are also working voluntarily in parttime or temporary positions. This reflects,

among other things, a labor force with increasing levels of education and skill and a greater

number of largely autonomous people who can

pick and choose their work (graphic artists,

computer programmers, auto mechanics). With

Americans starting as many as a million new

businesses each year (including those that are

unincorporated), self-employment and new

small-business startups have become more

popular choices, So has work in the underground economy.

4. As the rise in involuntary part-time work

suggests, together with the growing numbers

of jobs that require credentials such as a college degree for entry, stratification in terms of

income and career prospects will continue to

increase within the U.S. labor market. Restructuring and applications of new technologies in

many service firms have knocked the rungs out

of internal promotion ladders. No longer can

high school graduates enter an insurance company or a chain retailer and hope to move steadily upward in pay and responsibility. At least

some college will be required for entry into

many positions with prospects for upward mobility. Despite the rise of higher education over

the last 25 years, then, many Americans will

find themselves stuck in low-paying service jobs

with limited chances for advancement. There

seems little prospect that low-skilled, entry-level

service jobs will ever lead to the long-term career earnings patterns characteristic of blue-

-collar manufacturing employment in the earlier

postwar period.

5. Many recent immigrants into the United

States, especially those entering illegally, take

low-paying jobs in the tertiary services. But immigrants also cluster in skilled occupations

such as nursing and engineering (service functions even if in manufacturing companies). U.S.

industry has come to depend on a suppIy of

foreign-born employees—notably, engineers

and scientists who choose to stay after com-
22 ● International Competition in Services

pleting their education at an American university. To some extent, foreign nationals with

technical training—who generally cannot qualify for security clearances—help balance the

flow of U.S. citizens into defense-related industries.

Capable, well-trained people—regardless of

field—will always be in demand. To the extent

that immigrants add to the pool, they help U.S.

industries compete.

6. Will the U.S. economy be able to draw on

the human capital–the knowledge and skills–

needed to create good jobs and support high

living standards in the future? New technologies and new ways of doing business demand

high-level skills—not only reasoning, problemsolving, and creativity, but interpersonal and

FEDERAL

In the services even more than in manufacturing, government policy makers have seldom

paid much attention to international competitiveness (ch. 10). This is changing, slowly. Congress has called for better coordination among

the dozens of Federal agencies whose policies

and regulations affect the services, and the

Administration has begun to respond. Antitrust

enforcement reflects the realities of international competition more strongly today than 10

years ago. U.S. persistence in GATT demonstrates that the highest levels of government

have endorsed the goal of liberalizing trade in

services,

Still, the United States has a long way to go

to put its own house in order. Many of the impacts of regulatory and supervisory policies on

international competitiveness occur indirectly;

service industries ranging from insurance to

air travel will remain more heavily regulated

than typical manufacturing industries. Given

the deregulatory fervor of the past dozen years,

the policy shifts affecting competitiveness in

sectors like banking or telecommunications

have emerged from confused and confusing

debates (such as that over non-bank banks, or

deregulation/re-regulation of the telephone syssocial skills. And learning itself is a skill. In the

emerging knowledge-based economy, people

will need to learn to work effectively in fluid

and ambiguous environments, to accept responsibility individually and in groups—in many

respects to behave more like managers even

though they may not have jobs that are explicitly

managerial.

Higher-order problem-solving, good judgment,

learning from experience–schools often pay

lip service to these skills, but seldom try systematically to develop them. OTA’s analysis suggests that preparation for work in the 21st century may demand a fundamental rethinking of

the Nation’s education and training system, Despite the attention focused on education over

the past several years, there is little indication

that such a reexamination has begun.

POLICIES

tern). The complexity of technology and business practices in such industries makes it difficult for policy makers to grasp the issues;

indeed, deregulation, falling back on the magic

of the marketplace, has sometimes been little

more than an admission of this failure. But withdrawal as well as intervention has competitive

consequences, and good policy choices demand

insight into these consequences. American

business, with some exceptions, has adapted

relatively quickly to immersion in a world economy rather than a national economy. American

government, which remains primarily attuned

to domestic needs and domestic interests, has

not.

Other governments face the same problems:

linking domestic policies and foreign economic

policies; linking the problems and needs of service industries and manufacturing industries.

Some have responded better than the U.S. Government, some worse, The more successful

governments—and particularly those that have

learned to shape market outcomes with some

effectiveness—pose yet another test for the

United States. When other countries take this

tack, the stakes go up in trade negotiations. Yet

the lack of planning capability and institutional
Ch. 1—Summary ● 2 3

Photo credit: Walt Disney ProductIons

U.S. travel and tourism exports came to

$13 billion in 1986.

memory in Federal agencies mean that sometimes U.S. policy makers may not even realize

what is at issue.

Tables 2 and 3 summarize the policy options

discussed in chapter 10, with table 2 providing an abbreviated guide to the 33 options and

table 3 treating them in more detail. (Both appear in chapter 10 as well. Table 2 is the same

as table 55, while table 3 condenses material

found in tables 56, 57, 59, 60, and 61.) While

many of the options deal with the specifics of

particular government programs, the overall focus is on the capability and effectiveness of the

policymaking system as a whole.

The first group of options (l-11) are concerned

with U.S. trade policy. The subjects range from

negotiating approach and objectives during the

Uruguay Round, including the resource needs

of the agencies involved, to the United States

and Foreign Commercial Service (which looks

understaffed alongside export promotion efforts by competing nations). In this group of

policy options, OTA stresses the need to adequately support the Uruguay Round negotiations, which promise to be more involved and

complex than previous MTNs, and beyond this

to build better analytical capability into the

structure of U.S. policymaking. Deeper engagement in world trade brings greater needs for

coordination and planning among agencies, for

clear thinking about U.S. interests and U.S. negotiating objectives.

The analysis underlying the next set of options (12-17) draws on the banking and telecommunications industries to illustrate the need for

linking domestic policies—particularly regulatory decisions—with international competitiveness. Many agency policies affect the competitiveness of U.S. firms, but the system contains

few mechanisms for taking account of potential impacts. Specific options here range from

new Industry Sector Advisory Committees (for

providing input to U.S. trade negotiators) to an

office on banking competitiveness in the Treasury Department (or in another Federal agency

with responsibilities for financial services).

OTA’s analysis of competitiveness in the services, like past analyses of manufacturing, shows

that international competitiveness has deep domestic roots, and that domestic policies—for

example, dealing with education and training

—have a great deal of influence over competitive outcomes. The human resources policy options (18-24) focus on adult education and training—covering questions such as educational

technologies that might help build a more flexible and better-skilled work force. OTA also

stresses the need to seek answers to questions

such as: Will tinkering with the education and

training system do the trick? Or must the United

States seek fundamental changes in its educational practices to maintain competitiveness in

high-value-added services and goods during the

next century?

When it comes to technology development,

policy choices spread well beyond the service
24 . International Competition in Services

Table 2.—Summary Guide to Policy Options

Issue Area Option Relevant service sector

1. The Services and U.S. Trade Policy

A. NEGOTIATING OBJECTIVES

—Congressional guidance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

B. COORDINATION OF SERVICES POLICY

—Oversight on coordination of trade negotiations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

C. TRADE ANALYSIS AND DATA

—Long-term analysis for trade policy and planning . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

–Oversight on collection of services trade data (also see Option 12) . . . . . . . . . . . . . . . .

—Improving the data on trade in services and on technical licensing . . . . . . . . . . . . . . . .

D. SUPPORT FOR THE NEGOTIATIONS PROCESS

—Staff and budget for USTR and other agencies. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

—Service sector advisory committees (also see Option 16) ... , . . . . . . . . . . . . . . . . . . . . .

—Continuing evaluation of U.S. and foreign regulations that act as non-tariff barriers . . . . .

E. OTHER TRADE-RELATED ISSUES

—Overseas promotion of exports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

—Tied aid and mixed credits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

—Trade and Development Program (TDP) ... , . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Il. Linkages Between Domestic Policies and International Competitiveness

A. EXAMPLES FROM BANKING AND FINANCIAL SERVICES

—Data on international trade in banking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

—Office on international impacts of banking policies . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

—International coordination of regulations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

B. EXAMPLES FROM TELECOMMUNICATIONS

—Negotiating objectives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

—Advisory committee on telecommunications negotiations . . . . . . . . . . . . . . . . . . . . . . . .

—Institutional mechanisms for addressing impacts of domestic policies on

competitiveness . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Ill. Human Resources

A. EVALUATION

—Fundamental reexamination of human resources policies as they affect

competitiveness . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

B. ADULT EDUCATION AND TRAINING

—Demonstration projects for training/retraining of the active work force . . . . . . . . . . . . .

—Increasing the national commitment to education and training of active workers . . . .

—Postsecondary vocational/technical curricula . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

C. INSTRUCTIONAL TECHNOLOGY

—Inventory of federally developed training materials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

—Transfer of federally developed training methods, procedures, and course materials . . . .

—Funding for research, development, evaluation, and dissemination of instructional

technologies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

IV. Technology Development

A. R&D IN THE SERVICES

—Improving Federal Government data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

B. THE U.S. TECHNOLOGY BASE

—Federal support for commercial R&D ., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

—Technology diffusion to industry . . . . . , . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

—Implementation of Japanese Technical Literature Act. . . . . . . . . . . . . . . . . . . . . . . . . . . .

—International exchanges of technical personnel . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

—Equitable access to foreign technology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

—Analysis of impacts of defense-related R&D on U.S. competitiveness . . . . . . . . . . . . . .

C. TECHNICAL STANDARDS

—Federal testing and demonstration facility for ISDN . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

—Preparation for upcoming meetings of the International Telecommunication Union . . . . .

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

29

30

31

32

33

all

all

al I

all

all; licensing

all

all

all

primarily E&C

primarily E&C

primarily E&C

banking

banking

banking

telecommunications

telecommunications

telecommunications

al I

all

all

all

potentially all

potentially all

all

all

all; E&C

all

all

all

all

all

information and

telecommunications;

indirectly all

information and

telecommunications;

indirectly all

SOURCE Office of Technology Assessment, 1987
Ch. 1—Summary • 25

Table 3. —Issues and Options for Congressional Consideration

This table (which condenses material from tables 56.57, 59, 60, and 61 in ch. 10) presents the 33 policy options in self. contained form Ch.

10 discusses them in detail

Issue Options for Congress

ISSUE AREA i—THE SERVICES AND U.S. TRADE POLICY

A. Negotiating Objectives

While negotiators need flexibility, close con- OPTION 1: While the Uruguay Round is in

tinuing contact with Congress IS essential its early stages, Congress could provide

if the Administation IS to secure a trade specific guidance to the Administration

agreement acceptable to the Iegislativewe on the outcomes it views as most critical

branch to U S interests This could take forms includlng:

● informal congressional consultations

with USTR;

● requiring formal consultation and

reporting at several junctures before the

Administration seeks congressional approval of new GATT agreements;

● legislative statements of U.S. negotiating objectives, possibly including objectives for specific service sectors. This

could involve amending the relevant

portions of the Trade Act of 1974 (e.g.,

Sec. 104A, added in 1984 to define

broad goals dealing with services trade,

foreign direct Investment, and trade in

high-technology goods).

B. Coordination of Services Policy

Developing trade policies for services will

require effective coordination among more

than 30 Federal agencies (including

numerous regulatory bodies) with responsibilities for services

C. Trade Analysis and Data

Better analytical support would make for

better U S trade policy Long-term policy

planning is a particular need

The current database on trade in services is

seriously deficient

Many of the needed Improvements in services data would entail changes in procedures of the Bureau of Economic Analysis

(BEA), the Commerce Department unit

that compiles trade statistics The Administration has failed to approve some

BEA proposals Without a congressional

directive, delays may continue

OPTION 2: Also at an early point during the

Uruguay Round, Congress could conduct

oversight (and provide guidance and direction where needed) on executive branch

coordination of services trade policy, under Title Ill of Public Law 98-573 In particular, Congress might use the oversight

process to determine whether coordination is adequate for ensuring consistent

U.S. positions in GATT and the other international forums where sector-specific

and specialized issues (e.g., Intellectual

property protection) will be discussed.

OPTION 3: Establish a new office for trade

policy analysis, to provide continuing analytical support and institutional memory

for executive branch decisionmaking. The

office could focus on support for day-today decisions, on longer term policy development, or both.

OPTION 4: Conduct oversight on implementation Of the International Investment and

Trade in Services Survey Act (as amended

in 1984) to determine whether some of the

discretionary provisions for data collection should be made mandatory.

OPTION 5: Direct the Commerce Department

to take specific action to Improve data on

trade in services. Possible steps include:

● surveying service transactions between

unaffiliated firms (by proceeding with

the BE-20 survey or a modified version);

● expanding the Census of Service Industries,

• altering BEA procedures for presenting

royalties and license fee data to distinguish technology from other categories

of Intangible property, and to provide

data on numbers of Iicense agreements

by year, and on receipts and payments

on new Iicense agreements in a given

year

Comments

The new GATT round raises fundamental

questions concerning the U S role in the

world trading system—matters going far

beyond possible GATT coverage of the

services:

● I n what ways would a stronger GATT

serve U.S. interests?

● Will U.S. Initiatives in services trade

and other new Issues—and in agricultural trade—serve to strengthen GATT

as an institution? Will some of them

and not others?

● Other nations will inevitably seek concessions in exchange for agreements

that U.S. policy makers view as important. What sorts of trade-offs IS the

United States likely to face as we move

into the Uruguay Round?

● How will U.S. negotiators assign relative priorities to goods and to services

when conflicts between the two arise

during the discussions?

Title III of Public Law 98-573 gave USTR

responsibility for developing and coordinating services trade policy, using the

interagency Trade Policy Committee

Negotiations affecting trade in services may

take place in other forums as supplements to or in parallel with GATT. Examples include OECD, the World Intellectual

Property Organization, and the International Telecommunication Union

The primary reason for creating a new trade

policy analysis unit, rather than simply

providing more resources to an existing

office, would be to place the new group

close to policymakers —and to staff and

structure it accordingly

In Sec. 306 of Public Law 98-573, Congress

amended prior law to give clear authorization to the President to collect data on

trade in services However, Congress left

collection of services data discretionary

OTA discusses further steps for Improving

the database on services trade in its special report, Trade in Services Exports a n d

Foreign Revenues Also see Option 12 on

financial services
26 • International Competition in Services

Table 3.—issues and Options for Congressional Consideration —(Continued)

.

Issue

D. Support for the Negotiations Process

Despite the growing number of issues on

the Nation’s trade agenda, budget and

staff resources for negotiations remain

modest.

If discussions on services trade move beyond the umbrella stage to sector-specific

topics—and for such talks elsewhere —

U.S negotiators will need more input

from service industries and their employees, and from users of services

Regulatory policies lie behind many of the

barriers to services trade and investment,

lncluding regulations that serve Important

public purposes. Progress in reducing barriers will depend on willingness by countries to acknowledge and identify

regulations that unnecessarily discriminate against foreign firms.

E. Other Trade-Related Issues

Compared to many of its trading partners

and competitors, the United States devotes only modest resources to export

promotion abroad

For years, the United States has sought to

tighten a loophole in OECD guidelines on

export credits that permits tied aid subsidies. In 1986, Congress authorized a tiedaid war chest as part of the Export-Import

Bank Act Amendments (Public Law

99-472) Substantially tighter OECD guideIines followed in 1987

The Trade and Development Program (TDP)

finances feasibility studies and planning

services by U.S. firms for projects in

LDCs Some of these studies lead to fur.

ther work for U S firms, or to exports of

goods

Options for Congress

OPTION 6: Expand USTR’s budget and staff

to meet not only the heavy continuing

work load expected over the course of the

Uruguay Round, but also to carry on planning and preparations for subsequent

negotiations, including those in other international forums.

OPTION 7: Direct the Administration to establish several more Industry Sector Advisory Committees (I SACS) to speak for

particular service Industries, and several

additional labor subcommittees to speak

for their employees, To prepare for sectorspecific talks—indeed, to help determine

whether these would be desirable from

the U.S. point of view—Congress could

direct the Administration to establish and

consult with the new advisory groups at

an early date.

OPTION 8: Direct USTR (in cooperation with

other agencies) to give high priority to

evaluating both U.S. and foreign regulations that act, intentionally or incidentally,

as non-tariff barriers to trade and investment in the services By taking the initiative, the United States could encourage

other major trading nations to examine

their own regulatory barriers.

OPTION 9: Increase support for the overseas activities of the United States and

Foreign Commercial Service (US&FCS),

which is responsible for most of the overseas export promotion undertaken by the

Federal Government, Raising the number

of US&FCS officers overseas from current

levels—about 200—to a complement of

300 or more would aid U.S. exporting in

general Congress could also direct the

Service to provide training for its employees in the special needs and

problems of the service industries.

OPTION 10: Since other governments can always find ways to subsidize exports that

they judge Important for national interests, Congress could make plain U S

resolve to keep such practices under control by continuing the authorization for

the tied-aid war chest—and by funding It

to match foreign subsidies, if this seems

needed to get other OECD members to

hold to the new agreement

OPTION 11 Increase TDP support from its

current level of about $20 million annually

—much smaller than similar programs in

several other nations. Congress could

also direct TDP to raise the number of

feasibility studies conducted by U.S. firms

on a reimbursable or cost-sharing basis

As part of this process, Congress could

direct the Administration to compile and

annually update a statement listing the

contributions of all Federal agencies to

U S. trade negotiations.

The trade advisory committee system

authorized by Sec. 135 of the Trade Act of

1974 provides a mechanism for private

sector input into trade negotiations. While

an overall Services Policy Advisory Com.

mittee exists, only one ISAC (or two,

counting that for wholesaling and retailing) represents the services at the sectoral level, compared with 14 for goods (See

Opt Ion 16 for discussion of telecommunications )

USTR reports annually to Congress on foreign trade barriers The agency made a

start on Identifying U S regulations affecting trade in services when it prepared

the U.S. national study on services, submitted to GATT in 1983 To reach agreements on reducing barriers to services

trade, nations will first have to decide

what topics are appropriate for discussion.

Japan has about 5,000 overseas commercial

officers, the United Kingdom and France

each have 400 or more

TDP has particular relevance for the E&C industry.
Ch.

Table 3. —Issues and Options for Congressional Consideration—( Continued)

Issue Options for Congress Comments -

ISSUE AREA II–LINKAGES BETWEEN DOMESTIC POLICIES AND INTERNATIONAL COMPETITIVENESS

A. Examples from Banking and Financial Services

Current data collection procedures fall to

provide a clear picture of banking exports

and imports

Decisions made by the many Federal and

State agencies that supervise and regulate banking can affect International competitiveness, creating a need to build

cons! deration of these impacts into

policymaking processes

Domestic authorities, here and in other

countries, have been hard pressed to

keep up with rapid changes in international banking and financial services. Greater

international coordination of bank supervision and regulation may be needed, along

with an expansion to cover securities

markets

B. Examples from Telecommunications

Restrictions on trade in both telecommunications equipment and services have hindered or halted the efforts of U S. firms

seeking to enter foreign markets

To prepare for sector-s specific negotiations

on telecommunications. policymakers will

need input from the fulll range of stakeholders

Because telecommunications IS a vital portion of the infrastructure for the world

economy, government policies have competitive Impacts not only for equipment

manufacturers and service providers, but

also for users (including many U S -based

firms)

ISSUE AREA III–HUMAN RESOURCES

A. Evaluation

Despite numerous commissions and task

force reports, no consensus has emerged

on adapting education. training, and other

human resources policies to the new circumstances resulting from U.S. immersion in the international economy

OPTION 12 Direct the Commerce Department’s Bureau of Economic Analysis to

improve its database on international

banking and financial services, in consultation with the Federal Financial institutions Examination Council, and its

member agencies (e g , the Federal

Reserve Board)

OPTION 13: Direct the Administration to provide an explicit mandate for an office of

International competitiveness in banking

to serve as a focal point for such issues,

in particular the International ramifications of domestic policies

OPTION 14: Use oversight and reporting requirements to begin evaluating alternatives for greater International coordination

of banking policies One possibility would

be to direct U S. agencies that serve on

the Basel Committee to explore ways of

expanding the Committee’s present activities

OPTION 15: Congress could establish formal

U.S. negotiating objectives for GATT and

other forums dealing with telecommunications services and equipment

OPTION 16 Direct USTR and Commerce (in

cooperation with other Federal agencies

involved in telecommunications policy) to

establish an Industry Sector Advisory

Committee on telecommunications The

ISAC should include representation for

users of telecommunications services and

employees of telecommunications firms,

as well as service providers and equipment manufacturers

OPTION 17” Direct all Federal agencies with

responsibilities for telecommunications to

take into account in their regulatory and

other decisions the Interests of U S. firms

which are users of international telecommunications services, as well as suppliers

of equipment and services. If Congress

restructures the Nation’s regulatory apparatus (e.g., by returning more authority

to the FCC), it could take that opportunity

to provide such directions

OPTION 18: Call for a fundamental reexamination of human resources policies, and

an evaluation of specific steps to enhance

the ability of Americans to adjust to

shifts in labor market and workplace conditions resulting from International competition.

1—Summary . 27

—

Congress could direct the Administration to

establish a new group, or to expand

Treasury’s existing Office of International

Banking and Port follow Investment

Congress could also direct Federal agencies

to examine and report on the desirability

of creating a new international body for

addressing issues of International coordination and harmonization of regulatory

and supervisory policies.

Examples of possible objectives include:

that U.S. firms be allowed to compete on

an equal basis with host-country firms

where foreign governments permit competition in telecommunications services,

that, as users of foreign telecommunications services, U S -based firms not be

subject to discriminatory terms, rates, and

conditions

Because the Interests of equipment

producers, suppliers of services. and

users often diverge, it might be desirable

to create three subcommittees reporting

to a telecommunications ISAC

It will be up to Conqress, in the end, to

redefine the roles- of Federal agencies I n

telecommunications policy Whatever the

choices, it will be critical that the new

structure give questions of International

competitiveness high priority Congress,

for example, might give particular attention to the prospective role of the FCC.

as an Independent agency, in dealing with

foreign governments and International

bodies concerned with telecommunications

Congress could charter an Independent

council or Institute to report and make

specific policy recommendations. Or it

could ensure that human capital issues

get a prominent place in the mandate of

any council or other body established by

Congress to examine and make policy

recommendations on International competitiveness
28 ● International Competition in Services

Table 3.—issues and Options for Congressional Consideration —(Continued)

Issue

B. Adult Education and Training

A work force with good skills IS essential

for maintaining U.S. competitiveness

While some companies provide broadbased education and training for their employees, others do little or nothing.

Demonstration projects alone will not lead

to major increases in training for employed adults

General vocational curricula that would provide a foundation for continuing (restraining could help people in the

knowledge-based Industries adapt to future workplace changes,

C. Instructional Technology

The Federal Government has developed a

great deal of technology and instructional

material for training, Some of this could

be useful to the private sector and the

schools, but only limited Information has

been easily available to educators and private sector trainers,

Transfer of training technology from the

government to schools and to the private

sector may involve several agencies, as

well as requiring modifications to course

materials.

Realizing the long-term potential of instructional technology will require continuing

research on teaching and learning, Beyond R&D and the development of new

teaching and training materials, dissemination of new methods—including

computer-based training—will require ongoing Federal support.

Options for Congress

OPTION 19: Direct the Administration to undertake pilot and demonstration projects,

in cooperation with business and industry, on new approaches to training and

retraining of active workers. Involvement

by organized labor would also be desirable. Such programs would not require new

authorization.

OPTION 20: Consider alternatives to increase the national commitment for training and retraining of the adult work force,

Including incentives for employer-provided

education and training and new sources

of funding.

OPTION 21: Direct the Department of Education, in cooperation with the Department

of Labor, to fund demonstration projects

for broad-based vocational curricula,

focusing on generic skill development for

the knowledge-based services. Grants

could be made available to both public

vocational-techntcal schools and

proprietary (trade) schools.

OPTION 22: Direct the Administration to

give priority to timely completion of the

feasibility study for an inventory of federally funded training software called for by

the Federal Technology Transfer Act of

1986. Should it seem appropriate once the

feasibility study has been completed,

direct the Administration to proceed with

the inventory.

OPTION 23: Instruct Federal agencies to

place more emphasis on transfer of training technology and course materials to

public institutions and corporations, initially through technology transfer mechanisms as authorized in Public Law 96-480

Congress could follow with oversight to

determine whether new mechanisms

should be created specifically for diffusion of training technologies.

OPTION 24: Increase funding for research,

development, evaluation, and dissemination of instructional technologies—

including adult education and training,

One approach would be to direct the

Department of Education to establish and

provide partial funding for a research

center concerned specifically with adult

Comments

In its 1986 amendments to JTPA (Public Law

99-496), Congress authorized the Secretary of Labor to fund pilot projects for

training, while the Carl D. Perkins Vocational Education Act of 1984 (Public Law

98-524) provides for a special State grant

program for adult education and

retraining.

Proposed alternative funding mechanisms

have included tax credits for firms that

provide certain kinds of training, and a

payroll-based tax to fund retraining services for workers,

Business and industry should be actively involved in any such experimental and

demonstration projects. The Carl D. Perkins Vocational Education Act of 1984

provides a suitable vehicle for this option

Congress called for the feasibility study in

the Federal Technology Transfer Act (Public Law 99-502), which amended the

Stevenson-Wydler Technology Innovation

Act of 1980 (Public Law 98-480).

Examples of executive branch efforts to

transfer training technology include a

computer-assisted reading program developed by the Navy and transferred to

some libraries.

Federal funding for such a program could

be kept modest by requiring matching

grants from foundations and the private

sector, which stands to benefit substantially. Congress, in the Higher Education

Amendments of 1986 (Public Law 99-498),

called for a national program of research

on adult learning—without, however,

Iearning, and including R&D on instruc- authorizing funding

tional technologies,

ISSUE AREA IV–TECHNOLOGY DEVELOPMENT

A. R&D in the Services

OTA finds U.S. R&D related to services to OPTION 25: Direct Federal agencies— Services R&D has been underreported for

be much greater than reported in the specifically, the National Science reasons similar to those for the underusual Federal Government data series. Foundation—to develop new criteria for reporting of services trade in the U.S. curidentifying and collecting information on rent account—outdated and unexamined

R&D and technology development related procedures, many of which simply omit

to the services, service activities.
Issue

Ch. 1—Summary ● 2 9

— -—

Table 3.— Issues and Options for Congressional Consideration—( Continued)

B. The U.S. Technology Base

The services depend on much the same

technology base as manufacturing Leaving aside national defense, the Federal

Government provides relatively little funding for technology development

Congress has called for more emphasis on

diffusion of technology to American industry through such laws as the

Stevenson-Wydler Act (Public Law 96-480)

The Administration, however, has only implemented parts of the legislation

The United States, no longer the unquestioned leader in technical knowledge, will

need to do a better job of Iearning from

foreign technology in years to come

Policy adjustments may be needed to

capitalize on the potential of defense

spending for enhancing the competitiveness of commercial Industries

C. Technical Standards

Before the AT&T breakup, a single company

dominated the process of setting technical standards. Today, the process involves

many firms in competition with one

another

Opt Ions for Congress

OPTION 26: Increase Federal R&D support

for commercial (i e., non-defense) technologies by expanding initiatives such as

NSF’S Engineering Research Centers, and

ensuring continued funding for existing

programs such as the Center for Building

Technology at the National Bureau of

Standards

OPTION 27 Alternatively or in addition to

the steps in Opt Ion 26, Congress could,

under the 1986 Federal Technology Transfer Act (the 1986 amendments to Public

Law 96-480), authorize, provide funding

for, and direct the Administration to offer

grants for Centers for Cooperative

Research For greatest effectiveness,

these centers should be charged with

technology diffusion as well as development.

OPTION 28 Emphasize congressional commitment to implementation of the

Japanese Technical Literature Act of 1986

(Public Law 99-382) through early oversight and full funding If Congress wishes

to place more emphasis on screening and

evaluation, or to direct the Administration

to fund translations of Interest to

university-based researchers. it could

direct the Commerce Department to share

responsibility with agencies having more

experience in technology and science—

e g the National Science Foundation

OPTION 29 Increase support for exchanges

of U.S. technical personnel with those of

other nations Congress could fund fellowships that would send graduate students in engineerlng to countries Iike

Japan, as well as considering programs

that would provide partial support. in conjunction with employers, for Industrial engineers and scientists working abroad

temporarily (in industry or in universities)

OPTION 30: Make equitable access to foreign technology a formal U S negotiating

objective, and calI for reductions in restrictions on access for U S citizens to

publicly supported R&D projects in other

countries

OPTION 31 Investigate and evaluate policies for maximizing the positive impacts

of defense-related R&D and procurement

on the international competitiveness of

American industries.

OPTION 32: Direct the National Bureau of

Standards (in cooperation with the Nation.

al Telecommunications and Information

Administration) to set up an ISDN testing

and demonstration laboratory to help

government agencies make purchasing

decisions and take advantage of emerging

technical capabilities. and to help pave

the way for a smooth transition to ISDN

in the United States

Comments

Should Congress choose to create an Advanced Civilian Technology Agency or National Technology Foundation—as has

been proposed in a number of bills introduced in recent years —cooperative

technology centers would fit naturally into

its role and function Technology diffusion programs could be cost-shared between the States and the Federal

Government

Sending more engineers and scientists to

work temporarily abroad could help

change corporate attitudes in the United

States, and would give American industry

more rapid access to foreign technologies

as they emerge

Pursuit of this objective (included in H.R. 3

as passed by the House in May 1987)

would need to be consistent with U S

policies on foreign access to results from

government-supported R&D projects here.

Analysis of the linkages between the military and civilian sides of the economy

might also lead to policy changes making

it easier to adapt commercial technologies to military systems

NBS’s Institute for Computer Sciences and

Technology already has related work underway. An ISDN laboratory could provide

independent assessments to support Federal procurement decisions, and also disseminate information to private sector

users of telecommunications services
30 • International Competition in Services

Table 3.—issues and Options for Congressional Consideration—( Continued)

Developing U.S. positions at the ITU has be- OPTION 33: Congress could anticipate the The State Department coordinates and

come far more complex since the AT&T possibility that incompatible standards for presents U.S. positions at the ITU. The

breakup Future ITU deliberations may ISDN will be proposed both internationally Department relies heavily on the private secwell define a global framework for ISDN, and within the United States, and begin to tor, through committees, for advice on U.S.

with Impacts on equipment sales as well take preparatory steps to address such is- recommendations concerned with standards

as services sues. Specific actions might include:

● oversight to review U.S. preparations

and negotiating positions for upcoming

ITU meetings (e.g., WATTC-88), and the

Implications for U.S. positions at GATT

and in other trade negotiations dealing

with telecommunications;

• requesting a comprehensive study to

review prospective ISDN standards and

implementation, with a view to Iaylng

groundwork for future policy decisions

(e. g., if it appears that U.S. telecommunications carriers might adopt dissimilar approaches that would be costly for

users).

SOURCE Off Ice of Technology Assessment, 1987

industries (Options 25-3 1). Competitiveness in

the services springs from a technology/science

base much the same as that for manufacturing.

This fact alone—which has not been widely

recognized—means that strengthening the infrastructure for development and diffusion of

a wide range of technologies could help both

sides of the economy. Higher priorities for commercial technologies seem needed, Governments in countries like Japan pay much more

attention to pre-competitive technologies that

can help all firms in an industry, Indeed, Federal policies aimed at encouraging inflows of

technical know-how from countries like Japan

could help U.S. competitiveness.

Achieving a better balance between science

and technology, and finding ways to maximize

the benefits of military R&D and Federal procurement for commercial technology development would also help American companies in

many industries maintain and strengthen their

competitive ability. Among the services, the

need for better technology is most obvious in

E&C firms, but certainly not limited to them.

The last two options (32 and 33) reflect the significance of technical standards for international competition. The standards set in international bodies sometimes shape competitive

outcomes quite directly, Other governments frequently try to influence these decisions. ISDN

standards, for example, could have far-reaching

implications for future competition in both services and in sales of computer and telecommunications equipment.

Standards-setting activities provide one of

many examples of issues that often become lost

in the fragmented structure of U.S. policymaking, Of course, dispersal of authority has been

intentionally built into the U.S. system. The immediate problem is whether the system as currently structured can respond to the new needs

of the U.S. economy, These needs are plain

enough, Over two decades, even less, a broad

array of American industries has lost competitiveness internationally. With continued movement toward an interdependent world economic system, the pressures on U.S. industry

will continue to build. Firms and industries adjust, because they must. Some companies have

failed, Others have moved abroad. Many have

adopted new technologies, reduced their employment levels. But will the policymaking system adjust? The stakes are high: U.S. living

standards have already begun to decline.

Certainly there are signs of change in Federal agencies. Deregulation has been one response, the services initiative in GATT another.
Have the policy adjustments been fast enough?

Has the system changed in the right direction?

Will our rather disorderly apparatus, with many

agencies sharing overlapping responsibilities,

continue to prove adequate? If other nations

follow the U.S. lead, deregulating more than

regulating, opening more markets than they

close, then the answer is probably yes. If, on

the other hand, other nations rely more heavily on national industrial policies to guide development, learn to use these policy tools with

some effectiveness (as the Japanese have already done), and pay only lip service to GATT

discipline, the answer will probably be no, In

the latter case, the U.S. system—where structural adjustment as a policy goal has never been

legitimated, and trade policy remains an appendage—will be a grave handicap.

If other nations do take the route of greater

government involvement in economic affairs,

then the United States may have little choice

but to follow. If we do not, many of our remaining advantages-for example, in the information technology services-may slowly dissipate,

Other governments will continue to extract concessions from U.S. businesses, and help their

own firms chip away at U.S. markets. Telecommunications services and equipment illustrate

many of the problems. Trade friction has been

high for years. Repeated efforts to reach agreements on subsidies and ‘‘targeting” have come

to little. Disputes will certainly continue. The

European nations—where government ownership of PTTs is the rule—have embarked on

extraordinary measures to promote technological development in computing and communications systems, while simultaneously trying

to limit competition and protect jobs. Trade friction with Japan over telecommunications will

continue as well, with the difference that Japanese policies have been more far-sighted than

those in Europe–easier, given low unemployment rates, a single dominant political party,

Ch. 1—Sufnfnary • 31

and a huge trade surplus. Meanwhile, the stakes

have been going up, as the next generation of

telecommunications technology—ISDN—begins

to materialize. Thus far, some of the European

nations, as well as Japan, have taken at least

tentative steps toward deregulation, following

the U.S. lead. Yet this primary difference remains: the United States has deregulated for

domestic reasons; other countries have made

their choices for reasons including international trade and competition. Leading exporters

like West Germany and Japan have built consideration of impacts on trade and competition

into their policymaking structures. They have

many years of experience, often painful, in

learning to use government policies to aid their

country’s businesses internationally. The United

States has never had such a trade (or competitiveness) policy. Through most of the 1970s, at

least, there seemed no need.

Over the postwar period, the United States

sought, in many ways, to help other nations develop economically. By and large, these efforts

have been successful. U.S. leadership helped

ensure open international markets for trade and

investment. Seven rounds of multilateral trade

negotiations have left tariffs at low levels; although NTBs have replaced many tariffs, the

world economy is more open today than ever

before, Technology has diffused widely; many

nations have moved steadily up the ladder of

development. The United States has achieved

much of what it sought over the past 40 years.

Unfortunately, many American industries are

having trouble competing in the world U.S.

leadership created.

* * *

The following section, the last in the chapter, expands on the introductory paragraphs

of this summary, and prefigures portions of the

analysis in the body of the report.

EVOLVING INDUSTRIAL STRUCTURE: SERVICES AND GOODS

To some, the service economy is an informa- pervasive electronically based media. Other imtion economy, symbolized by communications ages center on more personalized service prodsatellites, computerized financial transactions, ucts—psychotherapy, schooling, fast foods.
32 ● International Competition in Services

Looking at the U.S. economy in 1987, some observers would predict a de-industrialized future, in which too many Americans will take

in each others’ laundry, while U.S. manufacturing industries continue to decline internationally. Others, looking at the same picture,

see a high-technology, post-industrial future—a

future filled with smart machines helping produce knowledge-based services as well as the

familiar tertiary and personal services, and with

other smart machines revitalizing the manufacturing side of the economy.

Despite the examples of satellites or cheaper

overseas air fares, most of the images have a

domestic context. Few people know much

about markets for Eurobonds, or the technical

licensing transactions through which U.S. corporations exploit their know-how overseas. Internationally, trade in goods gets far more attention than trade in services—no surprise,

given the huge U.S. deficit in goods trade.

Much the same is true in other countries.

Some countries opposed inclusion of the services in the Uruguay Round negotiations because

they saw nothing to be gained. Others—including NICs like Brazil and India, the leaders of

the group opposing the U.S. initiative—see

more clearly the importance of services for continuing economic development, but think they

will lose if forced to open their markets. Some

countries have been more receptive, but the

LDCs and NICs in general—most with relatively

small service sectors—have been slow to recognize ways in which liberalization might work

in their interests.

The Services and Manufacturing:

Synergies and Interdependencies

In 1986, the invisibles account—direct exports of services plus income from U.S. investments abroad—contributed 38 percent of total

U.S. exports. Within the invisibles account,

however, investment income (e.g., remittances

from foreign affiliates of U.S. firms) outstrips

exports of services (e. g., banking services provided from the United States for customers

abroad). The official U.S. balance of payments

lists direct exports of services at some $49 billion in 1986, compared with $91 billion for investment income, and $222 billion for exports

of goods.

OTA’s own estimates, summarized in chapter 2, show that the official statistics seriously

understate both imports and exports of services, While OTA’s estimates indicate a surplus

on services trade substantially greater than the

official figures—$14 billion compared to $2.3

billion for 1984, the latest year for which data

are available—even this surplus looks small

compared to the Nation’s deficit on trade in

goods, $113 billion in 1984 (and $148 billion

in 1986).2 And sales by overseas affiliates of U.S.

service firms exceed the Nation’s service exports, probably approaching $100 billion in

1984. A foreign presence will continue to be

more important for selling services than for selling goods, for reasons that lie in the nature of

service products—many of which must be produced at or near the point of consumption. Easier and cheaper global communications will

change this aspect of the services only slowly.

Trade in goods, which can be shipped and

stored, will remain much larger.

Still, many of the conventional distinctions

between goods-producing and service sectors

are breaking down, domestically and internationally, While the national accounts may draw

a line between goods and services, companies

need not, Many produce both, and sell them

bundled together (although distinctions by division or line of business remain common). The

firms that have emerged as major competitors

in world markets for computers have succeeded

largely because of their skills in providing services to customers—services that include systems integration, user training, and support and

maintenance for software as well as hardware.

2

0TA places 1984 service exports at about $80 billion, with

imports of $66 billion—figures that exclude banking and represent the midpoint of a relatively wide range. These estimates,

like the official statistics, take no account of services embodied

in goods shipments, which cannot be approximated even roughly.

See ch. 2, as well as Trade in Services: Exports and Foreign Re\’-

enues, op. cit., p. 38. Service sales of foreign affiliates of U.S.

firms for 1984 could not be estimated because the data were lacking, but OTA’S midrange estimates for 1982 and 1983 came to

$97 billion and $92 billion, respectively (p. 41).
Ch. 1—Summary ● 3 3

Software, arguably a service and now accounting for the major share of user costs in large

computer systems, also comes from a rapidly

growing independent industry, And of course

the computer itself produces nothing tangible;

its function is service—whether helping process a company’s payroll or designing airplane

wings.

Competitive ability in producing services has

thus become a powerful factor in determining

international competitiveness in manufacturing. Service revenues may give a manufacturing firm a broader range of strategic options.

The productivity of people within an organization who perform service functions helps determine the ability of a firm to compete in world

markets. General Motors’ competitiveness depends on its assembly line workers, and also

on its engineers, accountants, and truck drivers.

GM bought EDS because of the latter’s expertise in data processing services. Finally, GM—

along with other U.S. automakers—gets substantial profits from financing new car purchases. To take another example, RCA—once

but no longer a computer manufacturer—owns

the NBC television network, while also making TV sets and communications satellites (and

marketing the services of its satellites). GE,

which likewise withdrew from computer markets years ago, builds locomotives and also markets information services to banks; GE bought

RCA more for its service businesses than its

manufacturing capability. Other examples:

large corporations raise their own funds on the

commercial paper market, bypassing their

banks. Meanwhile, banks and accounting firms

develop and sell computer software. E&C firms

occasionally take equity positions in facilities

they design and build. Multinational enterprises

compete in some realms, cooperate in others,

through vehicles that include international joint

ventures, co-production agreements, licenses

and technology sharing agreements; for years,

RCA received some $50 million annually in

licensing revenues from Japanese manufacturers of color televisions—a sum comparable

to RCA’s profits from the manufacture of consumer electronic products.

Market linkages between services and manufacturing often drive expansion in both, Production and sales of video-cassette recorders

(VCRs), almost all made in Japan, have expanded at high rates; much of the growth has

been fueled by U. S.-produced “software” in the

form of pre-recorded tapes, As the time lag between release of motion pictures in theaters and

sales or rentals of cassettes has dropped, VCRs

have become a more attractive purchase. Thus

sales of hardware and software, one imported,

the other produced domestically, grow hand

in hand. Software likewise drives sales of personal and home computers (ch. 5).

The lines separating service occupations

from manufacturing occupations blur just as

do those separating service firms from manufacturing firms. Growing numbers of employees in goods-producing industries perform service functions—nurses, company librarians,

machine repairers, inventory clerks, computer

programmers—in support of others in the parent organization or customers on the outside.
34 ● International Competition in Services

Almost by definition, high-technology goods

embody high service content in the sense of

knowledge and expertise (an integrated circuit,

a jet engine, a newly invented biological organism). Knowledge-based services (in contrast to

the traditional or tertiary services—a later section outlines the distinctions) provide a critical part of the foundation and infrastructure

for the production of high-value-added manufactured goods, where U.S. export strength has

been greatest.

In their domestic operations, manufacturing

companies rely on service firms not only for

familiar business services like advertising,

accounting, contract engineering, and public

relations, but to operate cafeterias and clinics,

provide security guards for offices and factories, and temporary employees to help meet

surges in demand. Downstream from the factory, they depend on distributors and dealers.

Japanese automobile manufacturers penetrated

the U.S. market so deeply in part because they

built up and nourished, over a considerable

period, dealer networks which today are not

only extensive but highly profitable for their

American owners. In the steel industry, too,

growth in distribution through service centers

has helped change the terms of competition;

much of the foreign steel sold in the United

States moves through these independent suppliers. Finally, service firms not only sell to the

manufacturing sector, but the Nation’s manufacturing base provides much of the necessary

support for a standard of living that leads to

high consumption of personal services (restaurants, entertainment, travel), thus creating additional service-related jobs.

Service exports also create new export opportunities for goods: American E&C firms

operating overseas often specify American capital goods (power generating equipment, industrial process control systems). Likewise, exports

of goods lead to exports of services: contracts

for training and maintenance may accompany

sales of Boeing jetliners (with engines made by

GE or Pratt & Whitney). More subtly, for U. S.-

based multinationals to take advantage of new

opportunities on a global scale, they must have

reasonably open access to foreign markets, not

only for sales of goods and services, but for direct investments. And to capitalize on the things

they do best, American firms need an infrastructure that can support globally integrated

business activities–an infrastructure supplying telecommunications services, financing, advertising, insurance, and the host of other concomitants of international business. This is

equally true for multinationals that are primarily manufacturers (IBM, Caterpillar) and those

that are primarily service providers (Citicorp,

American Express). It is also true for those that

are both: given the forces operating in the world

economy, managers of many U.S.-based manufacturing companies are seeking to steer their

organizations toward service activities (one of

the factors behind the GE-RCA merger).

Multinational Expansion and Integration

At the end of 1985, U.S. direct investment

abroad stood at about $235 billion. Motives for

foreign direct investment range widely. Small

manufacturers seeking low labor costs establish plants in Mexico or Malaysia. Global giants like Citicorp and IBM seek new and growing markets, Sometimes investment is reactive,

as firms search for an accommodation to competitive pressures (e.g., rising imports at home);

sometimes it is outward-looking and strategic,

At one extreme, American manufacturers may

respond to import competition by subcontracting production to local firms in low-wage countries. Logistical problems—communications,

coordination, transportation—often bedevil these

arms-length arrangements. At another extreme

—multinational integration—companies can

use data processing and communications networks to link farflung operations, solving many

of the logistical problems of dispersed business

operations. Today, it remains easier for large

companies than small to put together well-integrated multinational organizations, but this

will become more practical for smaller companies as the range of marketed services expands, experience accumulates, and costs come

down. Already, many relatively small high-technology firms—e.g., software suppliers—operate

on a multinational basis, seeking to expand at

home and abroad in parallel. When U.S. soft-
Ch. 1—Surnrnary • 35

ware firms carry out product development in

the United Kingdom, they do so not only to cut

labor costs, but to be close to overseas markets.

Later chapters explore the meaning of integration, and the implications for competition and

competitiveness, in more detail.

Many U.S. Government policy makers, as well

as corporate executives, see substantial benefits for the United States in multinational

integration—benefits to which international

agreements on services trade (and foreign investment) could make valuable contributions.

In this view, such agreements, in GATT and

elsewhere, emerge as highly desirable and perhaps essential for building U.S. competitiveness. Whether the businesses involved export

from the United States or operate through overseas affiliates, services such as international

telecommunications and data processing networks, or the foreign operations of American

banks, seem vital. Indeed, some who take this

view would argue that multinational integration

provides the only feasible path for a country

like the United States in an era of intensifying

low-wage competition and rapid international

diffusion of technology. OTA’s analysis, in any

event, suggests that maintaining high living

standards in such a world requires a leading

position in knowledge-based industries, services as well as manufacturing.

Despite their strategic significance, U.S. exports of services will continue to lag well behind goods exports (ch. 2). Continuing progress

toward cheaper and more reliable telecommunications systems will alter processes that require production at the site of consumption only

slowly. Nor can services, with few exceptions,

be held in inventory, stored, or shipped overseas. Two implications follow:

Employment in U.S. service industries

does not depend heavily or directly on

trade (either on exports, or on competition

from imports).

Foreign investment and sales through affiliates abroad will remain relatively more

significant in the services than in manufacturing.

Nonetheless, rising service content in U.S.

goods exports will help create new jobs for

Americans, as will investment hereby foreign

firms seeking to sell services in the lucrative

U.S. market. And, if most of the direct benefits

(e.g., employment) of foreign investment accrue

to the host country, services provided by U.S.

affiliates abroad lead to indirect sources of

advantage for other American industries. Moreover, many of the jobs created domestically in

support of overseas investments tend to be relatively skilled and well-paying (e. g., technology

development, financial analysis), For such reasons, U.S. international competitiveness in the

services—and particularly in knowledge-based,

high-value-added services–brings substantial

benefits to the U.S. economy, though these may

be indirect,

Thinking About the Services

In practice, lines are usually drawn so that

the category labeled services includes nearly

all economic activities except production of tangible goods. Regardless of the sharpness of the

lines, or just where they are drawn, the service

industries comprise a group at least as heterogeneous as the goods-producing industries, and

perhaps more so; certainly, production of legal services differs as much from tourism as

production of paper differs from production

of computers. The categories in table 4 illustrate something of this heterogeneity.

The services listed in table 4 demand a wide

range of inputs. The competitive ability of a

given firm in a given country will depend on

those inputs and their costs (see app. B, at the

end of the report). A country like Mexico, with

ample low-cost labor in addition to its beaches

and sun, is well-placed to capitalize on tourist

travel. Medical services, in some contrast, rely

on highly skilled and highly paid workers, along

with expensive capital equipment. Internationally, perhaps the most significant difference between goods-producing and service industries

is this: goods can be exported, while service

firms must generally maintain a foreign presence to sell in foreign markets. Foreign direct
36 ● International Competition in Services

Table 4.—Classification of Service Providers

by Markets

1. Intermediate markets (i.e., for services purchased

primarily by business and industry)

Financial services

● Banking (including investment banking and brokerage)

. Insurance

● Leasing

Shipping and distribution

. Ocean

● Rai l

● Trucking

. Air freight

● Warehousing, distribution, wholesale trade

Professional and technical

● Technical licensing and sales

● Architecture, engineering, and construction (including

engineering design services, architectural design,

construction management, and contracting)

. Management services

. Legal services

. Accounting

Other intermediate or business services

• Information technology services (including software,

telecommunications, data processing, and information services)

● Franchising

● Advertising

● Other (commercial real estate, business travel, security, postal and courier services, contract maintenance, . . . )

Il. Services provided largely in final markets to private

citizens

● Retail trade (including restaurants)

. Health care

. Travel, recreation, entertainment

● Education

. Other social services, including government

• Other Personal services

SOURCE Off Ice of Technology Assessment, 1987

investment may be desirable in manufacturing;

it is essential in many of the services.

In this assessment, intermediate or business

services (category I, services produced and sold

to other businesses) get most of the attention.

With some exceptions in “other” services, as

well as in shipping and distribution, most of

the intermediate services in table 4 are knowledge-based and skill-intensive—i. e., they depend on technology. The second category (services provided largely in final markets to private

citizens) also includes high-skill, high-wage, and

technology-dependent industries such as health

care, along with a variety of “low-technology”

Plainly, all such distinctions remain arbitrary,

Banks employ many tellers with relatively low

skills and low pay. Familiar industries—retailing and advertising, tourism and transportion,

architectural design—depend on a continuous

stream of technology-intensive innovations

[automated inventory and ordering systems,

computerized reservations and ticketing, computer-aided drafting, database management systems for engineering changes and bills of materials). American banks move funds around

the country and around the world via electronic

networks. Computer systems provide analytic

support for decisions made by air traffic controllers and bank officers. In many of these applications, computers enhance human skills

(e.g., by helping people deal with complexity

in rapidly changing environments). In other applications, computer systems rationalize production in far more mechanistic ways–examples

include automated warehouses and the back

offices of banks, where huge volumes of checks

must be processed quickly and cheaply. Here,

the systems tend to replace human skills, as well

as augmenting them in the sense of helping people do straightforward jobs faster.

Broadly speaking, technology is so pervasive

in advanced economies that most foreign sales

by U.S.-based companies, whether provided

through exports or foreign affiliates, depend

in some sense on technical expertise. Moreover,

the services provided in conjunction with sales

of goods such as commercial aircraft, or computer and telecommunications systems, follow

directly from the technology embodied in the

goods—e.g., training in servicing procedures

for jet engines, or in maintaining systems software. At various points in this assessment, then,

knowledge-based services are distinguished

from more traditional or “tertiary” services, the

latter including such industries as trade and

distribution. Table 5 summarizes the distinctions between knowledge-based and tertiary

services, while table 6 reclassifies service industries on this basis.

Like the classification by markets in table 4,

ambiguities and exceptions can be found in taservices, ble 6, but the distinction between knowledge-
Ch. 1—Summary ● 3 7

— —

Table 5.—Characteristics of Knowledge-Based Compared to Tertiary Services

Knowledge-based services

High ski// levels (as measured, for example, by years of

education) and relatively high pay. Many professional

and paraprofessional jobs. Continuing learning often important,

Either the product or the production process, or both, depends on relatively advanced technologies. In many

cases, digital computers have become integral to the

production of the service (data processing itself,

computer-assisted architectural drafting). Typically, computers are used to enhance people’s skills. Control over

the system (and the production process) may be distributed through the organization.

Often though not always an intermediate service, supplied

to other businesses.

Provision of the service often demands rapid response to

shifting customer needs. (It may begin with the elicitation of those needs.) Flexibility (in volume of output, in

design of that output, hence in response to customer

needs) may become a major competitive weapon. Both

product and process can involve substantial customization to meet market requirements, implying high information/knowledge content.

Tertiary services

Low ski// levels and educational requirements; low pay. Upward mobility may be quite limited.

While advanced technologies may have a prominent role in

the product/process environment, in general neither the

nature of the service nor the nature of the production

process is affected by the technology in a fundamental

way (electronic cash registers as direct replacements for

electro-mechanical; food preparation using preprogrammed equipment). Typically, the computer serves

to rep/ace human skills, with control concentrated at

management levels.

Frequently a service provided in final markets to individuals, sometimes to businesses (custodial services, private

security guards).

The service tends to be standardized, the production

process more-or-less fixed and routine,

SOURCE Off Ice of Technology Assessment!, 1987

Table 6.— Examples of Knowledge-Based and

Tertiary Service Industries

Knowledge-based - Tertiary -

Banking Leasing - -

Insurance Shipping and distribution (all, in -

Professional and technical (all) cluding wholesale trade)

Information technology services Franchising

(all) Retail trade

Advertising Travel, recreation, much enter

Motion pictures tainment

Health care Social services (some)

Education Personal services (most)

based services and the traditional or tertiary

services helps identify sectors where a highwage, high-skill economy like that of the United

States can expect to be competitive internationally. At the same time, given the heterogeneity

of the services, it makes little sense to speak

of an economy being competitive in the services as a whole. Over time, just as in manufacturing, some service industries will gain internationally, while others lose.

Using Technology

U.S.-based service companies have often had

technological advantages that translate into

competitive advantages. Today, protecting

those advantages is harder than ever. Goods,

services, people—all carrying technology—

migrate with relative freedom through a world

economy that is largely open, with national

economies interpenetrating one another, primarily through the activities of international

businesses.

The technology and science base underlying

the service industries, which centers on modeling of product designs and production processes, overlaps that for manufacturing (box B).

While products and processes differ greatly between the services and manufacturing (and

among the services), many of the techniques

remain similar, Computer-based decision models

for buying and selling stocks, to take a widely

publicized example, find parallels in factory

automation, as well as in management of telecommunications networks, When it comes to

applications of computers and communications
38 ● International Competition in Services

BOX B.—The Technology/Science Base for the Services

Narrowly defined, the technological foundation for the service industries begins with models,

the more useful of them mathematical. These models abstract from systems, both simple and complex

(the system could be a food store or an international currency market), helping people predict their

behavior. For a simple example-which is not to say the modeling is simple--consider a retail clothing

store, whose owner might want to determine desirable inventory levels and reorder intervals, staffing

needs, whether it pays to open on Sunday. Seasonal selling patterns, predictions of local and national

economic growth, even long-term weather predictions, might help him decide how many winter coats

to order, whether to hire and train new staff in expectation of booming business, and whether to

negotiate a 6-month bank loan to finance inventory or rely on a revolving line of credit. A related

problem might be to locate a new store within a growing urban area. Predictions of growth patterns

and concentration of future shopping activity would help the owner decide where to put the store,

and how much rent he could afford.

Only in the simplest cases could the store owner expect a full and immediately useful answer

to his questions, yet imperfect information and heavily quaified results, provided he understood their

limitations, would help him guide the business. Mathematical modeling based on knowledge of the

physical sciences normally gives more accurate results. When a manufacturing company relies on

engineering models to predict the performance of a newly designed home air-conditioner-e. g., its

energy consumption-the predictions will be close to actual performance. But they not be the

same, and critical decisions (whether the new design performs enough better than the old) will always

depend on actual tests. Note that the air-conditioner manufacturer will also rely on models like those

useful to the retailer-consumer buying habits, the economic outlook, seasonal weather forecasts,

optimal inventory levels.

Technology, then, in the services as in manufacturing (and mining and agriculture), begins with

a science base, eclectically assembled to meet the needs of the industry. The science base underlies the models. The next and critical steps consist in knowing which models use for a given purpose, how to use them defectively, when to accept their predictions and when to disregard them.

Thus there is much more tlm~ modeling to technology in Rs bro?dar dimensions: only in simple

cases will the decisicm be autonmtie $he atom will rm out of cann~ peas n@ Saturday unless we

reorder now]. People make decisions based on what th~y know and can articulate-which inchdes

the output of amdytical proced~ornbined with tacit knowledge instinct, and intuition, some

of which theywillnot evenbe awareofcalling on. This is part ofteclinolo too, viewed as know-how

and expertise. In this view, people mbody technology, both individuJ?’ y and collectively.

In most of the servkxw, knowledge trmxmb~e to tho science base will be less reliable as a guide

for decisions than in goods-producing indus@es. What people “know” but cannot neceasariiy explain becomes correspondingly more important. I!@reover, it is collective know-how and institutional

decisionmaking that count in tbtmninin$ mrnpetitive outcomes-while a bade will depend more

heavily on the collective knowiedge, much of it intangible, of its staff than a con@ruction company

or a manufacturer of air-conditioners (which does not by any means make tacit know-how unimportant for the lattar).

Many of thenmddsdeveloped inthapast fordealiti” @h@ries

could be handled with ~pet+md-penqil rnathmimtics. &s w~@e$@@@ for a IX-3, owm

a nuclmlr powerplant; fxmlpk$x cdcdatiims” that can alify be on di@taltmrnput@s bring

refinements, but @rdy O@X@Ona@ ti techntctd’ .XrJthesel%kxis, mare Ofth$”inodels

wili axceed the limits of papar and penkil M th@y ard &$ b4 @a#@. Many of the to be

modeied-e.g., Peep!@’s behavior+nust htr@4ted st@$tk@ly. ‘1’ypiwdiy , thts requihs processing

a good deal of empirical data-mm of tha things compwtem do best.
Ch. 1—Summary •

—

Computers excel at storing and manipulating large volumes of data and information—orders and

inventory levels in a chain of retail stores, financial transactions in banks. They can also implement

complex algorithms for recognizing print or simple spoken language. Beyond these transactional applications, new analytical uses of computers, primarily for supporting managerial decisionmaking,

are rapidly becoming important for competitiveness in the service industries (as discussed in box

C). Companies that utilize such techniques effectively-i.e., rely on them when appropriate, disregard

them when not—will come out ahead. As always, appropriate use of technology will depend on judgment and experience.

The Federal Government—for instance, in its compilations of R&D statistics, and in policies for

R&D tax credits—has not fully recognized the technology/science base for the services. But that lack

of recognition, and the perception that service companies do market research rather than R&D, should

not be allowed to hide the extent to which service industries depend on the tools of mathematics

and other sciences. Estimates in chapter 9 suggest that annual U.S. R&D spending related to the services totals perhaps $26 billion, more than 10 times the figure published by the National Science Foundation as representing U.S. nonmanufacturing

systems, the contrast between analytical applications, such as computer-based stock trading,

and transactional applications, in which the

system does little more than keep track of large

volumes of information, yields further insights

into the place of technology in the services. Box

C amplifies on this contrast.

As box C suggests, new technologies change

the ways in which firms organize work, Digital data—sometimes information, sometimes

meaningless noise—already permeates firms in

the advanced industrial economies. Even quite

small companies depend on electronic databases, automated production control systems,

telecommunications services. Software itself,

a service by some criteria, a good by others,

symbolizes many of the ongoing shifts. Sitting

between the system and the people who use it,

software tells the computers what to do, controlling the interactions between people and

machines. Software and system designers help

shape corporate organizations, the contours of

jobs, the channels of power and influence

within the firm. But software no longer consists exclusively of pre-determined programs

with a fixed logical structure. With distributed

computing and fourth-generation languages,

software—and hence the system as a whole—

becomes more fluid. As these new approaches

evolve, computer-literate experts will lose some

of their control over the configuration of the

R&D.

39

system; in principle, many people could gain

at least limited ability to modify and customize

the software they work with.

Given this ability to use computer technology—either to enforce conformity with rigidly

structured work procedures, as in the back office of a bank (analogous to an assembly line),

or to enhance people’s independent problemsolving capabilities, as in the bank’s front office or in a computer-aided design laboratory—a

“new” manufacturing enterprise may look

more like a knowledge-intensive service firm

than an “old” manufacturing enterprise. A

modern steel producer, utilizing ladle refinement, vacuum degassing, and argon gas stirring, followed by continuous casting, to produce

high-strength steels with lean alloy content, will

be heavily dependent on sophisticated control

models to regulate melt chemistry, mold levels,

and rolling practice. In a sense, such a facility

may have less in common with a steel manufacturer still relying on 1960s-era technology

than with a hospital laboratory that uses automated sensors, analytical instruments, and

recording devices to perform an individually

specified test series on blood samples. Two

basic dimensions to the use of computer technologies in business organizations follow:

● information/knowledge content, the extent

to which the firm depends, in its products
40 ● International Competition in Services

Box C.-Computer Applications in the Services

As noted in box B, the service industries use many of the same technological tools as manufacturing. Structural design for bridges, dams, and buildings-undertaken by E&C firms-does not differ

fundamentally from structural design for aircraft or for artificial hip joints. In both, the laws of physics

provide the starting point for design methodologies that, today, often include finite element codes

for stress and deflection analysis-codes that can only be run on powerful computers. Designing an

office building to minimize operating costs (e.g., for lighting, heat, and cooling), given constraints

on floor area and construction costs, means calculations for heat transfer and thermal management.

In the telecommunications industry, computers help find optimum solutions for network design

problems.

But what about services like banking and insurance, not to mention retailing and fast foods? Today,

not only may the corner grocery do its bookkeeping on a personal computer, but supermarket chains

use simulations to find the right number of check-out lines for a given store. An international construction company can manage an onsite inventory of piping, valves, and fittings worth millions of

dollars, with large savings in its costs. Of these three examples, the first and last can be considered

transactional, meaning that the primary task for the computer system is to keep track of large volumes

of data. While arithmetic and simple logic will be part of this—e.g., in bookkeeping—mostly the computer is managing information flows. The second example differs; it is an analytical application, meaning that the computer performs calculations using a mathematical model (box B). None of the simplifications typical in such models are allowed in bookkeeping, although analytical applications might

well be part of the software for managing onsite construction inventories (e.g., procedures for minimizing materials handling costs).

Transactional applications as part of ongoing business operations tend to be simple in principle

but demanding in practice, particularly when databases are large and rates of information flow high.

Although originally developed to reduce costs and increase productivity by automating existing jobs,

transactional applications also yield strategic advantages through better customer support and service. For example, some companies are beginning to locate terminals on the premises of their customers. Not only can the customers place orders at their convenience, they can use the system to track

shipments and otherwise manage their inventory levels. Other examples include fundamentally new

products such as the cash cards used in automated banking.

Analytical applications, which can be replete with empirical data representing human behavior

in at least some of its random messiness, stem more directly from the technology/science base underlying the services. Drawing in some cases on social and behavioral sciences, the unifying element

once again is mathematical modeling, Whether it is queuing theory (as in the supermarket example),

linear or nonlinear programming (as in the well-known traveling salesperson and warehousing problems), or economic modeling (e.g., business forecasts), the models run on computers, often some of

the most powerful machines available.

Like transactional applications, analytical applications of computers open up strategic alternatives but may also simply cut costs. The supermarket can predict not only how many check-out lines

it needs, but how many checkers to call in as a function of the day of the week and the time of day.

In many service industries, future international competitiveness will depend on both transactional

and analytical applications of computer systems, and on telecommunications systems for linking these

computers.
Ch. 1—Summary • 41

●

and/or its production processes, on technical expertise, know-how (whether wellcodified, as in a computer program, or

tacit, as in people with experience, wellhoned skills, good judgment), and inputs

of data and information (e. g., from process control sensors); and

work organization, ranging from rigidly

programmed or rule-based, as for telephone

operators, to flexible and adaptive, as in

the groups of more-or-less autonomous professionals who work in investment banks

or R&D laboratories. (Note that, today,

computer technologies may be indispensable at both ends of the work organization

spectrum, but they are used to regulate

and/or replace human abilities at the one

end, to support and enhance people’s skills

at the other).

Figure 6 includes examples of both manufacturing and service industries ordered on such

Adaptive,

Flexible

I

Organization

of

work

Rigid,

Pre-programmed

dimensions. In essence, the horizontal axis

takes the distinctions summarized earlier in table 5 between tertiary and knowledge-based industries, spreads them along a continuum, and

adds a similar distinction between “old” and

“new” manufacturing. Information/knowledge

content cannot be measured precisely, but is

closely related to customized production—

whether of legal services, computer software,

or a batch of low-sulfur, low-phosphorous steel

with high resistance to lamellar tearing. (These

distinctions are examined in more detail in ch.

8, as are the work organization and computer

utilization dimensions along the vertical axes.)

Moving from lower left to upper right in figure 6 corresponds roughly to the direction of

change in the U.S. economy since the close of

the Second World War. These changes will continue; indeed, as the figure suggests, an ongoing shift seems necessary if the United States

is to remain competitive in high-skill, highFigure 6.— Characteristics of Firms and Industries

dynamic

comparati

advantag

Tertiary / Old New i KnowledgeEnhancement

of human

skilIs

1

Computer

utilization

Replacement

of human

skills

/

(traditional) manufacturing manufacturing

/

basedservices services

SOURCE Office of Technology Assessment, 1987
42 ● Infernational Competition in Services

wage, high-value-added industries—with the of internal attributes in each sector to another.

higher living standards this implies, The move- The United States does not need to evolve toment is not so much from manufacturing toward ward a service economy. It does need to move

services as from one set of manufacturing and toward a high-skill economy.

service industries to another, and from one set
Chapter 2

Services in the World Economy
CONTENTS

Page

Summary . . . . . . . . . . . . . . . . . . . . . . ....... .. . . . . . . . . . . . . . . . . . . . . . 45

Competing in Service Industries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47

What Determines Competitiveness Internationally? . . . . . . . . . . . . . . . . . . . . 47

Multinational Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52

Services and Goods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. .... 55

Measuring Services Trade . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57

U.S. Government Balance of Payments Figures . . . . . . . . . . . . . . . . . . . . . . . 58

OTA Estimates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61

World Trade in Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65

What Can Be Gained Through Liberalization? . . . . . . . . . . . . . . . . . . . . . . . . . 70

The U.S. Position Relative to Other Nations . . . . . . . . . . . . . . . . . . . . . . . . . . 71

Trade Barriers in the Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73

Concluding Remarks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75

Appendix 2A: The Service Industries in Economic Adjustment . . . . . . . . . . . 77

Boxes

Box Page

D. Innovation and Product Development in the Financial Services

Industry . . . . . . . . . . . . . . ........ .. ... ... .. .... . . . . . . ....... . 50

E. Benefits From Liberalization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72

Figures

Figure No. Page

7.

8.

9.

10.

11.

12.

13.

14.

15.

16.

17.

18.

19.

U.S. Exports. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59

U.S. Imports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60

Composition of U.S. Exports, 1986 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61

Composition of U.S. Imports, 1986 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61

U.S. Invisibles Receipts . . . . . . . . . . . . . . . . . . . . . ., .. . ~ . . . . . . . . . . . . . . . 62

U.S. Service Exports by Region, 1985 . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63

U.S. Invisibles Payments ............ .......... .... 6 4

U.S. Service Imports by Region, 1985 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65

U.S. Service Trade Balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ........ 65

OTA Estimates of U.S. Service Exports by Industry, 1984 . . . . . . . . . . . . 66

Foreign Revenues of U.S. Firms by Service Industry, 1983... . . . . . . . . . 67

World

World

Service Exports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68

Service Exports by Type, 1984 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69

Table No.

7.Major

Page

Influences on International Competitiveness in the Service

Industries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49

8.

9

10

Examples of Product Innovations in Banking . . . . . . . . . . . . . . . . . . . . . . . 51

Disaggregated Categories in the U.S. Invisibles Accounts . . . . . . . . . . . . . 58

Leading Exporters and Importers of Services, 1984 . . . . . . . . . . . . . . . . . . 69
Chapter 2

Services in the World Economy

The international competitiveness of any industry depends on the ability of firms in that

industry to design, develop, produce, and market their output. This is just as true for Eurobonds or a database on organic chemicals as

it is for soybeans or 747s. The ability of individual firms to compete effectively depends on

a broad range of factors, some of which the firm

can control (the people it hires), some of which

it cannot (the labor pool from which it hires

them). Government policies affect competitive

ability at many points: tax rates here and abroad;

tariffs and other trade barriers; export assistance. Policies in the United States and elsewhere, in turn, affect corporate decisions—

whether, for instance, a firm will seek international business through exports or overseas investments.

Together, the competitive ability of the firms

in an industry will determine the international

competitiveness of that industry. But it makes

little sense to talk about the international competitiveness of an economy. Rather, the competitive rankings of the industries in the U.S.

economy—relative to one another and relative

to their counterparts elsewhere in the world—

determine what the Nation will export and import. In turn, the goods and services that the

United States exports and imports affect U.S.

living standards.

Simply put, the United States exports the

products of the industries in which it is most

competitive: if, over time, the U.S. banking industry becomes more competitive internationally, its exports may increase while U.S. exports

in, say, the computer industry may decline (or

rise more slowly than they otherwise would).

In this sense, industries compete with one

another for export sales as well as domestically;

when some industries grow more competitive,

others will probably become less competitive.

But services and goods also depend on one

another. The more efficient and more competitive the U.S. financial services industry, the

more competitive their customers in other industries can be. The same is true for any service industry that sells to business customers.

And the more competitive these customers, the

better the opportunities for growth by their suppliers.

Companies buy some of the inputs they need

to produce their end services and goods, do the

rest themselves. U.S.-based service companies

have followed their customers in other industries overseas, in many cases successfully exploiting advantages that come with multinational integration—ranging from lower costs

to name recognition and reputation. Today,

many American manufacturing firms purchase

services they once produced internally. At the

same time, they may sell services alongside

their goods (or through another arm of the company). As many examples illustrate, structural

and technological changes, in both services and

goods, within the U.S. economy and internationally, have become extraordinarily rapid

over the past two decades. Within this setting—

one of constant flux, and a good deal of uncertainty—companies make the decisions that cumulatively determine their competitive ability.

Governments face the same uncertainties as

they make decisions that reflect their policies

towards trade and industry—or, where no clear

policy exists, the decisions that constitute their

de facto policy. The U.S. Government makes

choices every day that affect the international

competitiveness of U.S. firms and industries,

in both the services and manufacturing. Because the competitive ability of an industry depends fundamentally on what the companies

in that industry do at home—and on the relative rankings of domestic industries—Federal

4 5
46 ● International Competition in Services

policies with domestic aims and objectives

often have even greater impacts on the international competitive ability of American firms

and industries than do trade and foreign economic policies.

In the services, the United States runs a positive balance of trade in almost all sectors with

almost all regions of the world. OTA’s estimates

of services trade indicate that the official Federal Government statistics underestimate both

exports and imports of services, as well as the

net U.S. position on services trade. More complete and accurate data would probably show the

U.S. competitive position to be even stronger,

Together with the evidence in other chapters

of this report, the services data give a reasonably clear picture of the structure of U.S. comparative advantage. Diminishing competitiveness in manufacturing has meant a relative shift

in U.S. strength toward knowledge-based services. Export markets for these services, however, remain modest in size. Foreign markets

must often be served through foreign affiliates—

with exports of capital rather than exports of

products—sometimes because of foreign government trade barriers, but more commonly because service products must be produced at the

point of consumption. Because of this dependence on a foreign presence, and for other reasons (including, as later chapters show, strong

challenges from some foreign service industries), exports of services have not increased

to compensate for the huge U.S. deficit on trade

in goods. Nor is there any reason to expect that

world trade in services will expand much more

rapidly than trade in goods, whether or not governments agree to reduce trade barriers: taken

as a whole, the available data on services trade

suggest that the direct benefits of liberalization

for U.S. interests, though real, may not be as

great as sometimes assumed. At the same time,

some of the countries that have opposed discussions on services in the General Agreement

on Tariffs and Trade (GATT) may have more

to gain than they recognize. The data themselves reveal little about indirect and strategic

benefits, but much other evidence suggests that

this is where the real advantages for the United

States will lie, with liberalization, for example,

helping U.S.-based multinationals hold on to

advantages accruing through worldwide integration of business operations.

For the world economy as a whole, reductions in barriers to trade and investment in the

services should lead to greater economic efficiency and more rapid growth, for two primary

reasons: 1) when each country specializes in

the services it is best at, all can, in principle,

gain through trade; and, 2) competition can

serve as a spur to domestic service industries,

forcing them to become more efficient. Of

course, as for trade in goods, liberalization may

help the world economy as whole without aiding each and every country; some will gain

more than others, and some may lose.

From its beginnings in 1947, negotiations and

agreements within GATT have centered on

trade in tangible goods, with limited attention

to foreign investment. A 1982 Ministerial Statement initiated a process of discussion and negotiation culminating 4 years later in agreement

to begin the Uruguay Round, where GATT

members will discuss services for the first time.

Finding an effective path to liberalization in

the services poses difficult problems for negotiators. In the service industries, most of the barriers are non-tariff—often part of long-established

domestic regulatory structures. Resistance to

change will be high; some governments will

prefer the certainty of what they have to the

risks of new rules. Some nations view the Uruguay Round negotiations in North-South terms,

with the United States attempting to exploit one

of its few remaining advantages. To these countries, going along with U.S. demands that they

open their markets may seem tantamount to

giving up hope of developing a competitive

service sector. At the same time, as pointed out

in chapter 9, much of this resistance arose before countries thought these matters through:

the fact that so many services must be produced

where they are consumed means that local economies will get many of the benefits.

Beyond this, when it comes to the knowledgebased services, countries that attempt to limit

imports or prevent foreign investment may end

up harming their own economies by cutting off

access to superior technology and expertise.
Ch. 2—Services in the World Economy • 47

Sheltered banking and insurance industries in guay Round negotiations on services promise

the developing world have been notoriously in- to be lengthy and contentious, But if successefficient; a sound telecommunications infra- ful, they could mark the beginning of a new

structure helps an entire economy, The Uru- stage in world economic integration.

COMPETING IN SERVICE INDUSTRIES

The United States grows little coffee; some

Brazilians travel to the United States for a university education (which counts as the export

of U.S. services to Brazil). Through trade,

whether of services or goods, all nations can

benefit–if the conditions are right–by specializing in the things they do best. American companies export computers and wheat, motion

pictures and technology. The United States imports small cars, clothing, and reinsurance

services.

What Determines Competitiveness

Internationally?

But if the United States is more competitive

in technical licensing than in reinsurance, why?

Chapter 6 explores the advantages of U.S. firms

in licensing—advantages that stem quite directly

from past spending on R&D. Here, as in goodsproducing industries, competitiveness depends

on the value for money that U.S. companies can

offer compared to foreign firms. Likewise, Japanese automakers have been able to build small

cars of a given design at lower cost than American manufacturers—put another way, design

and develop superior cars to sell at the same

price, a competitive advantage with multiple

sources. Reinsurance works quite differently.

Here, the United States typically runs a deficit

because American insurance firms seek to

spread risk internationally.

Appendix B summarizes the analytical framework for this assessment—as in previous OTA

studies of competitiveness, an approach rooted

in notions of comparative advantage. Just as

for goods, relative costs of production will be

primary determinants of competitiveness in

service industries. If a South Korean steelmaker

can purchase the coal, ore, labor, and other inputs for making a ton of steel for less than an

American firm, and if this production cost advantage exceeds the cost of transporting a ton

of steel from Korea to the United States, Korean producers will be able to sell here at lower

prices than American steelmaker. If a U.S.

insurance company can write an $80 million

policy covering the loss of a communications

satellite at a lower premium than a British company, the U.S. company is more competitive.

As the second example suggests, transportation

costs can be ignored for many service products.

Reliable, high-speed data transmission has often

reduced or eliminated transportation as a significant expense—a major force in the spread,

particularly, of financial services across national boundaries. In other cases, a service firm

must send people overseas in order to supply

its products. Alternatively, the customer may

come to the site—as when a foreign national

flies to the United States for treatment at the

Cleveland Clinic. Here, as for goods, reductions

in travel or transportation costs spur growth

in trade—with cheaper international air fares

in recent years a particular stimulus to tourism. Still, there may be relatively little trade

even in services where the United States has

a marked competitive advantage. American

physicians may be among the world’s best (and

most costly), but other characteristics of the industry mean they cannot provide care to large

numbers of foreign patients.

For meaningful cost comparisons, goods (a

bushel of soybeans) or services (an advertising

campaign) must be similar in a qualitative

sense, Such comparisons will be far more difficult for some products than others. It is easier to compare the characteristics of steel

produced in South Korea and the United States

than computers made by Unisys and Fujitsu

or aircraft made by Boeing and Airbus.
48 . International Competition in Services

Photo credit: Humana, Inc

Interpreting X-rays

Qualitative comparisons become still more

difficult for services, given their intangible and

time-dependent nature; purchasers rely heavily on reputation as a guide to the future. A company planning to buy a $5 million computer

can run trial programs to benchmark competing machines, and ask past customers if they’ve

been satisfied. In the end, judgment will be involved (if only in deciding what kind of benchmark tests to run, and how to interpret the results), but judgments of a different kind than

for comparisons of the health care provided by

two clinics or the services of two law firms.

Statistics may help (mortality rates for medical operations, won-lost records for cases tried),

but the next product is always in the future,

Who can compare advertising services, and reduce this to cost terms? Only time reveals how

good a campaign will be. Much the same is true

for engineering and construction services, although the many stages of feasibility study and

design specification in construction projects

offer intermediate checkpoints (ch. 4). Even so,

large-scale international construction shares

this characteristic with open heart surgery: by

the time unambiguous evidence of problems

arises, it may be too late.

For almost all services, then, it is impossible

to tell at the time of purchase how good the

product will be. Anheuser-Busch can return a

shipment of hops that does not meet standards,

but the firm’s managers will never know if they

made a good decision in rejecting a proposed

series of television commercials. Consumers

have much better sources of comparative information for buying toasters or automobiles

than for buying dental care (a major reason for

the historical spread of licensing in the professions). For the seller of differentiated service

products, this means a variety of factors besides

costs come into play, Selling services, like selling some kinds of goods, may depend heavily

on reputation or on established linkages between the supplier and the purchaser. Most corporations will stick with their investment

banker as long as they remain satisfied (but may

shop for commercial banking services based

on price). Successful firms in intermediate service industries can often expand by building on

their reputations, as when advertising agencies

move into market research, accounting firms

sell management consulting services, and banks

seek to become financial supermarkets.

Many other examples illustrate some of the

factors that ultimately affect trade figures and

competitiveness. For Bostonians, a winter vacation may involve a choice between Florida

and Mexico. A week in Miami would remain

an entirely domestic transaction, a week in Cancun creates U.S. travel imports and perhaps imports of passenger fares, But the ultimate choice

might be the attractions of a week in the sun

versus some entirely different good or service.

Purchasing a video-cassette camera and recorder

instead would mean a balance of payments entry reflecting a goods import from Japan. As

such examples illustrate, services compete with

one another and also with goods for both domestic and export sales. Everything else the

same, relative costs of developing, producing,
Ch. 2—Services in the World Economy • 49

and distributing service products will determine international competitiveness. But everything else is seldom the same; it is easy to compare air fares between New York and London

on U.S. and British carriers, but far from easy

to compare the range of services New York and

London banks offer to multinational corporations.

To some extent, a company—whether an advertising agency, an airline, or a construction

firm—controls its own destiny. It can hire people, invest in a computer system or in a new

product line, change its management style. In

other respects, the firm operates in an environment that it can influence little if at all, An

American company may lobby Congress and

the Administration for changes in the tax code

that would help it with respect to other American firms, but it will be only one voice among

many. And any one company has even less

influence over interest rates or antitrust enforcement.

Table 7 lists some of the factors that affect

competitiveness—in the knowledge-based services particularly—under two primary categories: those that individual firms can control, at

Table 7.— Major Influences on International

Competitiveness in the Service Industries

Factors subject to considerable control by individual firms:

Strategic decisions: to develop, market, and export new

service products; to invest in some overseas locations but

not others; to develop a corporate data processing and

communications network.

Staffing patterns, including corporate training programs,

labor-management relations, mechanisms for employee

participation, management priorities, attitudes, and value

structures.

Factors subject to considerable control by governments:

● Market structure—e. g., as influenced by antitrust or competition policy, price controls, public investment.

. Human resources and labor force characteristics, as affected by education and training policies, attitude toward

labor unions.

• Infrastructural support—e. g., the public communications

system, government funding for research and development.

• Business and economic conditions as affected by macroeconomic policies, regulations, political stability.

. Foreign economic policies, including trade policies (and

trade barriers), foreign aid and assistance, support for organizations such as the General Agreement on Tariffs and

Trade.

SOURCE Off Ice of T~chnology Assessment 1987

least in part; and those that governments control or influence, Of course, some competitive

factors—natural resources, labor market size—

remain beyond the reach of either firms or governments.

Appendix B includes an expanded treatment

of factors affecting competitiveness, while box

D discusses innovation and product development in financial services. As the box illustrates, and later chapters show in more detail

and for other sectors, technology—interpreted

broadly to include knowledge and expertise—

is a major competitive weapon in the services,

Much of the task of analyzing competition

in the services becomes a matter of determining which among the factors affecting competitiveness have the most weight in a given industry. Major questions for the U.S. Government

center on the impacts of policies, positive and

negative, on international competitiveness and

on U.S. employment, and the leverage offered

by alternative policies. As chapter 10 points out,

because trade and competition in the services

have been secondary concerns in the past, Federal agencies seldom consider the impacts of

their actions on international competitiveness.

Today, however, even routine rulemaking and

policy implementation can have significant

ramifications internationally. Another question

follows: Given the way the U.S. policymaking

system works, is it possible to do more than

make a series of individual decisions constituting a de facto policy? OTA’s findings for the

services replicate those in earlier reports dealing with manufacturing: in order to pursue a

more coherent policy, the Federal Government

must develop a better understanding of the

forces that affect international competition.1

Lacking this—a grasp of what government can

do and what it cannot do–attempts t o develop

such a policy will, more likely than not, be based

on wishful thinking.

OTA’s past studies of international competitiveness demonstrate that the shifting positions

of U.S. industries have no single, simple cause
50 . International Competition in Services

Box D.-Innovation and Product Development in the Financial Services Industry

In 1980, Merrill Lynch applied for a patent on its Cash Management Account, later suing Dean

Witter for patent infringement–one example among many of the institutionalization of R&D by financial services firms.1 Major commercial and investment banks have created new product groups, much

as found in manufacturing firms. Seeking to turn R&D to competitive advantage, banks search for

new products that can differentiate their services in a highly competitive market. They also seek better production methods that can reduce their costs.

Interactions of the macroeconomic environment, regulations, and technology drive innovation

in banking:

●

●

●

The Macroeconomic Environment–Inflation in the 1970s made it profitable for mutual fund

companies to offer money market accounts. Banks, which still faced regulatory ceilings on deposit interest rates, could not compete and lost business. Eventually, the banks were able to

convince government regulators to relax interest rate ceilings on some accounts. Inflation was

the first step in a process that led to a broad array of new financial products. Rapid swings

in exchange rates have likewise created new demand for products that hedge or exploit currency risks.

Deregulation—Today, banks have far more freedom to offer new and different products than

15 years ago. So do firms outside the industry, now permitted by regulators to offer many banklike services.

Technology—Back-office automation has lowered the costs of processing financial data. New

services can be offered at attractive prices. Lower prices have increased demand for old as

well as new services.

At least since the first transatlantic cable, advances in communication technologies have brought

national capital markets closer together. Today, differences in rates of return are almost instantaneously arbitraged. Morgan Stanley can transmit its entire “book” of outstanding investments from

London to New York at the end of the London trading day; still later, the book can be transmitted

to Morgan Stanley’s Tokyo offices.2 New analytical capabilities reduce some banking activities to

a set of rules (lending to individuals, foreign currency trading) that can increasingly be automated,

sometimes with the aid of expert systems (see chs. 3 and 8). Program trading on stock exchanges

reflects the development of new products such as stock index futures, and a new ability to quickly

find arbitrage opportunities.

Table 8 lists some recent developments in financial products, focusing on those important in international banking. Chapter 3 discusses several of these in detail, while the glossary in appendix

A defines the less familiar terms. Given the volatile behavior of both exchange rates and interest rates,

demand has grown for price-risk-transferring products that tie the prices of financial assets more

closely to market indicators. With the widespread perception that creditworthiness has declined generally, markets for credit-risk transferring instruments have expanded. Liquidity-enhancing products

are a consequence of high interest rates, which make highly liquid investments more costly, coupled

with worries about the creditworthiness of banks. Credit-generating innovations follow from increased

IThe lawsuit was eventua]]y settled Old Of COUH.

For examples of R&D by a bank, see K.J. Freeze and R.S. Rosenbloom, “Bane One Corporation and the Home Information

Revolution,” Harvard Business School Case Study 9-682-091, 1982. This bank has been budgeting 3 to 5 percent of earnings

for R&D for many years.

For a broader survey, see “Recent innovations in International Banking,” Bank for International Settlements, Basel, Switzerland, April 1986, p. 184-86. Box FF in ch. 9 summarizes services-related RkD spending, while ch. 3 examines competition

in international banking.

~J. Maranoff, P. Tate, and B. Whitehouse, “Around the World in 24 Hours, ” Datamatim, Jan. 15, 1987, p. 75. While this

might seem a technologically simple step, it has only recently become feasible. Other large firms, including Citicorp and Merrill

Lynch, do not yet have the capability to manage a global inventory of financial instruments in real time and multiple currencies.

The huge dollar amounts involved in financial communications make reliability and security critical. Some banks have

established their own communications networks, others have hired experts trained in security, intelligence, and encryption

away from governments.
Ch. 2—Services in the World Economy • 51

demand for credit, especially in the United States. Many of these products are possible only because

of deregulation in the United States and abroad, and practical only because of new communications

and data processing capabilities.

Innovations in the payments process have also been rapid—-for both small transactions (credit

cards) and large (funds transfers between banks using national and international computer networks—

see box G in ch. 3). Here, competitive advantage for any one bank will be limited; because payments

by definition involve transactions between two or more financial institutions, new developments must

be shared. Thus banks have found it in their interest to link their automatic teller machines.

Changes such as those outlined above have profoundly affected the nature of competition over

the past 15 years. Cheaper, more reliable, more pervasive communications systems mean that local

banks face competition from money center institutions. Restrictions on interstate banking have crumbled. Non-financial firms–including retailers like Sears and diversified corporations like General Electric (through its GEISCO subsidiary, ch. 5)—have drawn on capabilities and experience developed

in internal data processing operations to compete with banks. New products and proprietary technology have given American firms like Citicorp a competitive edge in markets abroad, but internationalization of capital and financial markets has led to increased competition from foreign banks here.

Table 8.— Examples of Product Innovations in Banking

———

Function

Price-risk- Credit-risk- Liquidity- “ Credittransferring transferring enhancing generating

Floating rate loans . . . . . . . . . . . . . . . . . . . ......... . . . . . . . . . . . . . . . . . #

Back-to-back loans . . . . . . . . . . . . . . . . . #

Securitized assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . / /

New cash management techniques . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P

Negotiable money-market instruments . . . . . . . . . . . . . . . . . . . . . . . . . . . /

Zero coupon bonds. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . /

Junk bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . /

Futures . . . . . . . . . . . . . . . . . . . . #

Swaps . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ti /

Forward rate agreements. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ti

Note issuance facilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . x Y /

SOURCE Adapted from Recent Innovations In Internal !onal Banking, Bank for International Settlements Easel, Switzerland A-~rIl 1986 p 172

(such as the strength of the dollar). Nor do shifts

in competitive standing have single, simple consequences. For the United States, a strong dollar during the first half of the 1980s, combined

with ongoing structural shifts in the U.S. and

world economy, led to seriously declining competitiveness in major industries. Many of these

structural shifts can be traced back to the 1960s;

in the steel industry, for example, worldwide

overcapacity—creating strong incentives for

price-cutting and subsidies—has had greater

impacts on the plight of the large, integrated

American firms than exchange rates, Other generalizations concerning international competitiveness, typically underappreciated, include:2

1. When a nation such as the United States

engages in international trade, some of its

industries must by definition be competitive, but some will likewise be uncompetitive, Over time, in order to export, a nation must import; if it imports, it must

export. This suggests that increasing competitiveness in some industries will nec-
52 ● International Competition in Services

2.

3.

4,

essarily be accompanied by declining competitiveness in others.

If, as has been true of the United States for

several decades, a nation’s overall rate of

productivity growth lags compared to its

competitors and trading partners, the result need not be losses in competitiveness

for all industries, provided exchange rates

are free to adjust and trade barriers do not

intervene, But if overall productivity in the

United States were to increase faster than

in other countries, some formerly competitive American industries might become uncompetitive. The productivity increase

would make U.S. exports more attractive.

Domestic customers would also choose

U.S. products as substitutes for imports.

In the normal course of events, the dollar

would appreciate compared to other currencies. This, in turn, would make some

industries—probably those with relatively

low productivity growth-less competitive.

When industries experience relatively rising costs in world markets, and lose market share both at home and abroad, the

price system may be signaling that resources should be reallocated internally,

Prominent examples in the United States

include shrinkage in the domestic steel industry, and in textiles and apparel, Because

the services and manufacturing compete

for export sales, expansion in the services

will interact in complex fashion with declines in the international competitiveness

of U.S. manufacturing industries.

Almost any policy adopted by the Federal

Government may affect, directly or indirectly, the competitive standing of U.S.

industries: all Federal policies that affect

business and industry must be assumed to

result in winners and losers, In an economy open to imports, it is not possible to

simultaneously help all sectors compete internationally. The Federal Government

makes choices among industries all the

time, explicitly or implicitly.

Multinational Operations

During the postwar period, many American

corporations have concluded that successful

competition against other U.S. and foreign

firms requires a multinational presence; when

a U.S.-based company sets up manufacturing

operations in a new country, American banks

and accounting firms often follow. Spreading

investments by multinationals over the past 35

years have led to rapid growth in international

trade among affiliates. Microelectronics provides one of the more dramatic examples; up

to three-quarters of U.S. imports have consisted

of intra-firm shipments, primarily from subsidiaries in Asia. Overall, the interdivisional shipments of U.S.-owned firms account for about

20 percent of the nation’s goods imports,3 Most

of the same motives operating in manufacturing have driven multinational integration and

intra-firm trade in the services. But there is a

major difference: many services cannot be supplied in a foreign market without an on-theground presence,

The Need for a Foreign Presence

Goods can be shipped from place to place and

held in inventory; most services cannot. Of

course, there are exceptions. Construction can

be viewed as a service (or not); if designing a

bridge or a hospital seems less ambiguously a

service than carrying out the construction, the

plans, drawings, and bills of materials are quite

tangible—they can be stored, transmitted from

place to place, and modified during building.

The package of information constituting a “design” (or a computer program or an advertisoBased on B.F. Brereton, “U.S. Multinational Companies: Operations in 1984, ” Surve~r of Current Business, September 1986,

table 2, p. 28. Thirty percent of U.S. exports go to overseas affiliates (both figures are for 1984). Other estimates have been as

high as 40 percent on the import side and 3.5 percent for U.S.

exports—J. S. Little, “Intra-Firm Trade and U.S. Protectionism:

Thoughts Based on a Small Survey, ” New England Economic

Reviewr

, January-February 1986, p. 42. On microe]ect ronics, see

International Competitiveness in Electronics, op. cit., p. 136.
Ch. 2—Services in the World Economy ● 5 3

ing campaign) has a permanent physical existence quite unlike the services provided by a

trial lawyer or a banker. But regardless of such

distinctions, exporting means selling to a foreign customer (the importer) a service produced

by factors of production (inputs) located in the

exporter’s country. This may not be possible

for intangible and nonstorable services, If it is

possible, it may still require a physical presence

in the importing country, with some of the value

added there. Direct investment in a subsidiary

corporation or joint venture may be essential,

particularly in view of foreign government regulations. Other possibilities include branches,

franchises, sales agents, and marketing or distribution affiliates.

A commercial bank or an accounting firm

will not get many sales in foreign countries

without foreign offices. In some contrast, businesses such as reinsurance and investment

banking operate in what amounts to a global

market. The primary buyers and sellers not only

know one another, they tend to be less parochial

than smaller firms; to a multinational corporation (MNC) seeking to insure its risks worldwide, it will make little difference whether the

carrier has offices in all the countries where

the MNC operates.

Even tourism depends on advertising and

representation in the importing country (i. e.,

the home country of travelers). National tourism industries staff promotional offices in major importing countries, They advertise, cultivate ties with travel agents, seek favorable

publicity in the media. Similarly, airlines need

reservation/information offices in the major cities and countries they serve. Hotel chains provide marketing/reservation networks for their

members, For manufacturing companies, on

the other hand, services like technical licensing may simply be an occasional business, and

thus an exception to the need for a foreign presence. Even so, some American firms with high

volumes of overseas licensing have established

offices to help their licensees; RCA opened a

laboratory in Japan for this purpose in 1954.

In some cases, communications technologies

may reduce or eliminate the need for a foreign

presence, in others not; 24-hour securities trading, with exchanges always open somewhere

in the world, will probably mean stationing

brokers overseas. While a trader in New York

could place an order on the Tokyo exchange

in the middle of the night, most transactions

will probably be made by people in Tokyo who

are wide awake.

Integration

Vertical integration implies sequential operations under common management. A chain

of fast-food restaurants that raises its own

chickens has integrated vertically. When two

firms competing in the same market merge,

they have integrated horizontally, Other forms

of integration include geographic expansion—

as when a hotel chain or financial institution

enters another country, Citibank offers much

the same range of services in many nations (ch.

3). A foreign branch or subsidiary gets advantages from the parent bank’s expertise, international linkages, reputation, and visibility in

the marketplace. Engineering and construction

(E&C) firms that utilize proprietary knowledge

at home and abroad have likewise integrated

across technologically related markets. Diversification of a firm’s product lines can lead to

integration; when United Airlines merged with

Westin Hotels and Hertz, it could capitalize on

its existing relationships with travelers and

travel agencies. Finally, a firm can expand into

totally unrelated areas, as ITT did with its purchase of Sheraton,

Vertical integration especially—raising one’s

own chickens—can be a source of competitive

advantages that accrue over both short and long

time periods, Internal transactions usually

carry lower costs for information and control

(purchasing, negotiation and monitoring of contracts, quality assurance), These advantages

hold for geographic integration as well, A firm

that manages its own production chain may be

able to maintain lower inventory levels as protection against supply interruptions, with savings

in inventory and transportation costs particularly attractive for an MNC that can effectively

coordinate production and shipping in many
54 ● International Competition in Services

parts of the world. When the MNC relies on

a telecommunications network to capture these

benefits, the result may be intra-firm trade in

data-processing services as well as in the firm’s

end products. Cost savings and quality improvements in day-to-day management accrue through

established working relationships, similarities

of attitude and outlook, and other characteristics of an established (and exported) corporate

culture. Indeed, many American MNCs go to

considerable lengths to transplant their cultures

overseas, seeking the benefits of improved communications, shared goals and commitments,

common jargon. Networks of acquaintances

among employees, and mutual trust among people who must deal regularly with one another,

can be of real importance to a multinational,

even though precise benefits may be hard to

pin down in terms of costs or other measures

of competitive ability. a

Because companies can protect their technology more effectively, they will normally be

more willing to pass on learning-by-doing

knowledge to an overseas subsidiary or jointventure partner than to an unaffiliated concern.

Efficient markets seldom exist for proprietary

technology, particularly technology based on

tacit knowledge and experience (ch. 6). Nor can

a bank or an E&C company sell or lease its

know-how as easily as a hotel chain or manufacturing firm, If a company cannot readily

market its experience, however, it maybe able

to transfer it internally—for instance, by sending employees abroad to train local peoples For

services, where no blueprint can describe the

product, integration under a common manageqConsider Vernon’s vision of the ultimate multinational:

Picture an MNC with an innovating capability that has developed a powerful capacity for global scanning Communication

is virtually costless between any two points on the globe; i nformat ion, once received, is digested and interpreted at little or no

(est. Ignorance or uncertainty, therefore, is no longer a function

of distance; markets, wherever located, have an equal opportunity to stimulate the firm to Innovation and production; and factor} sites, wherever located, hate an equal chance to be weighed

for their costs and risks.

“The Product Cycle Hypothesis in a New International Environment, ” Oxford Bulletin of Economics and Statistics, vol. 41

(November 1979), p. 261.

‘See R. K. Shelp, J .C. Stephenson, N .S. Tru itt, and B. Wasow,

Ser[’ice Industries and Economic Development (New York: Praeger, 1984). Firms can also exploit proprietary technology through

management consulting contracts and turn-key plants.

ment structure makes it easier to achieve consistency and quality of output. Examples include

accounting, the hotel industry, and consulting

services. Through franchising arrangements

which include training programs for overseas

employees, Holiday Inns can exploit its knowhow and reputation without the need for equity investments. Advertising campaigns that

build brand recognition work to the advantage

of all franchisees.

Service firms with widespread name recognition have a head start in expanding into new

geographic areas or product lines; Hertz and

Hilton rely heavily on reputation to get the business of harried travelers just arrived in Munich

or Manila. But for name recognition to be a useful marketing tool, consumers must believe that

products differ among firms. When all firms

in an industry produce services that are essentially the same, competitors try to differentiate their output, seeking to build brand allegiance, Airlines do this, along with Caribbean

islands. On balance, reputation and name recognition (and track record) have been advantages for American service firms operating internationally. When they have followed their

U.S.-based customers abroad, their reputations

have helped them sell to foreigners as well,

American E&C firms like Bechtel benefited

from heavy foreign direct investment (FDI) by

American firms in the 1950s and 1960s. American Express grew rapidly during the years

when U.S. tourists could more readily afford

to travel than those from other countries,

U.S. firms continue to be leaders in global

integration. American franchisers have more

than 27,000 overseas outlets; by comparison,

foreign franchising has been almost nonexistent in the United States. G But American companies have never been alone as multinationals;

some large European firms (Shell, Unilever)

have operated in many parts of the world for

years. Since the end of the 1970s, Japanese firms

have been expanding rapidly through direct inOTrade in SerL’ices: Exports and Foreign Revenues (Washington, DC: Office of Technology Assessment, September 1986], p.

69.
vestment, with trade friction and the threat of

protection a powerful driving force, In manufacturing industries, Japanese FDI in Europe

and North America has doubled since 1983.7

With Japanese manufacturers becoming true

multinationals (rather than simply exporters),

Japanese service firms–banks, E&C companies,

and others—have been following them overseas.

Japan’s trading companies are there already.

As firms based in other countries follow the

example of American MNCs that began expanding abroad in earlier years, the competitive advantages U.S.-based multinationals have

enjoyed through worldwide integration will

“’jCi[)c~II(J\~: l)ire[. t ln\(;stl~]ellt,” /rI~)aI) F,’(ot]omj(” ,SIlfI f’~ , J:ir)-

IId r}’ 1 !)87, ~), 1 (i Ilesplt[; t Il(; rai)id rise in manu fa(; turi ng i rl\’est -

rl]t; n t 5, J a pd n‘ \ total forf; ig n I rl kcst m (1 rl t p[)s i t io rl r-em a i ns hea\-

I I j c (j rl(. (’ n t r{i t (I( i II) red 1 [;st a to a n(l f i n a rl ( ial scrlr i(. (JS.

probably diminish. At present, U. S.-based MNCs

have an edge in managing globally integrated

organizations, in part through the application

of technologies such as the computer and telecommunications networks discussed in chapters

5 and 8. Maintaining this source of advantage

will be vital for future U.S. competitiveness,

Liberalization of trade and investment in the

services will help.

Services and Goods

Goods and services compete with one another.

Market forces and flexible exchange rates imply that an increase in exports of one good or

service may lead to a decrease in exports of

others. Sometimes, of course, success in exporting services will lead to new exports of merchandise—most obviously, when E&C contracts
56 ● International Competition in Services

result in exports of capital goods, B When an

American E&C firm designs, say, a petroleum

refinery, it will ordinarily specify Americanmade equipment. Likewise, selling goods overseas may lead to new service exports; as the

installed base of computers grows in other

countries, markets for software and for data

processing and information services expand.

In still other cases, services may be bundled

with manufactured goods—software goes with

computers, maintenance and training contracts

with capital equipment (commercial aircraft,

power-generating equipment). These linkages

magnify the importance of maintaining international competitiveness in the services or

goods that lead to secondary exports.

Manufacturing industries, furthermore, rely

heavily on services as inputs–engineering,

sales, accounting, finance, management consulting. Companies produce some of these services internally, while buying others on the outside, Even when a firm’s output consists wholly

of manufactured goods, more of its employees

may be performing service functions today than

in the past—in support of others in the organization, or customers on the outside (ch. 7).

Knowledge-intensive or high-technology manufacturing firms employ substantially higher

fractions of white-collar personnel than firms

in more traditional industries; production workers account for about two-thirds of U.S. employment in consumer electronics, only a little over

a third in the computer industry (where many

more people work in R&D or in company-owned

marketing and service organizations).

Advertising and other marketing-related services have traditionally been purchased externally, along with banking and some kinds of

accounting services. These patterns can change

quite rapidly. As noted in the next chapter, large

corporations have begun to take care of many

sWhile quantitative data are sparse, the U.S. International Trade

Commission’s report on the subject includes many examples.

See The Relationship of Exports in Seiected US. Ser~’ice industries to U.S. Merchandise Exports, LISITC Publication 1290

(Washington, DC: United States International Trade Commission, September 1982). For 1982, the 67 U ,S, serkrice industrj’

firms responding to the Commission’s voluntary sur~rejr estimated

that their ok’erseas activities generated $3.4 billion in merchandise exports (p. 4).

of their own financing needs—e. g., by floating

bonds and commercial paper themselves. At

the same time, companies in manufacturing industries like automobiles and steel have begun

purchasing more technical services on the outside. Even those with vast technological resources, like General Motors and Daimler-Benz,

have contracted out engineering services—for

instance, the design and development of cylinder heads. Contract design services easily

shade over into contract manufacturing, particularly when volumes are low; Cosworth

Engineering (a British firm) not only designed

a specialty cylinder head for one of DaimlerBenz’s car lines, but produces them.

Reasons for external purchases include the

following:

External specialists may be able to supply

services, ranging from software maintenance to plant security, more cheaply. By

selling to many customers, they can develop expertise and achieve scale economies that users cannot match within their

own organizations. An outside firm may

be able to provide hazardous waste disposal

services more efficiently both because it has

experience with available technologies and

because it knows the government regulations. Airline deregulation has led to shifts

in cost structures that may make it cheaper

to contract out services such as refueling,

baggage handling, and pilot training to specialist firms.

Companies may turn to service firms for

temporary personnel or contract production to meet peaks in demand without expanding their own work force or investing new capital (ch. 7); when the aerospace

firm Grumman hired 20 free-lance software engineers on a temporary basis, it

avoided both several months of recruiting

and subsequent dismissals at the end of the

year-long project.9

gThe engineers were needed for work on a new a i rplane’s (:omputer system- 1,. Reibstein, “More Companies Llse Free -I.ancers,

A\oid Cost, Trauma of [.ajroffs, ” It’a)] ,Street ]ournal, Apr. 18,

1986, p. 23.
Ch. 2—Services in the World Economy ● 5 7

• Firms may license or purchase technology

to save on R&D costs (ch. 6), or hire management consultants to help with new or

unusually complex problems (including international operations].

The more competitive the service industries

that provide inputs to American manufacturers,

the easier it is for those manufacturing companies to compete; the more competitive the manufacturers, the greater the market opportunities for suppliers of services. Both the service

provider and the customer may benefit if the

former follows its customers overseas. An

American accounting or advertising firm that

has dealt with an American client previously

should be able to provide services more quickly

and cheaply than a potential competitor, because its employees are already familiar with

the client’s business. It follows that restricting

exports and investment in the services harms

the competitive postures of both sets of firms.

To the extent that the process of buying services on the outside has moved the furthest in

this country, American suppliers may also find

new opportunities in less-developed markets

overseas—e. g., in hospital management or dataprocessing services. In this, they would be following a common pattern in which firms offering new services or goods develop domestic

markets first, then expand abroad. Management consulting, for example, is a relatively

new business, one that got its start in the United

States; today, most of the large American management consulting firms operate on a worldwide basis, On the other hand, as it becomes

easier for local firms to procure business services (such as those listed in table 4) in their home

markets, U, S.-based multinationals may lose

some of the advantages they once gained from

their internal knowledge and expertise.

Manufacturing companies not only supply

services bundled with goods, they sell services

directly, The major automobile manufacturers

operate subsidiaries that provide financing. So

does Sears. Some manufacturing firms own

commercial banks. Many sell technology overseas. Aerospace and accounting companies

have branched out into computer services (ch.

5). Outside purchase of services once produced

internally can be viewed as part of a larger trend

toward decentralization, smaller corporate

units, and dispersed decisionmaking—a trend

visible in corporate organizations in many parts

of the world. Decentralization is not inconsistent with the movement toward greater global

integration stressed above and in other chapters of this report; indeed, the goal of multinational integration is to couple the units of a

sprawling, decentralized organization so that

they can be left autonomous in some respects

but not others. Integration and disintegration

go on dynamically as firms seek greater efficiency and competitiveness.

MEASURING SERVICES TRADE10

The United States exports services when a

firm located here makes a direct sale to a foreign buyer; domestic resources must be used

to produce services sold to foreigners (including the overseas subsidiaries of American companies). When a tourist from Japan rents a car

in Los Angeles, or buys a ticket at Disneyland,

the transaction counts as an export of services

just as for shipments of computer software. But

if an overseas affiliate of an American company

sells a service, exports from the United States

take place only to the extent that value is added

to the service here. Otherwise, the transaction

simply involves domestic parties in the foreign

country; any impacts on the U.S. economy, positive or negative, would then be indirect. These

indirect impacts can be considerable. Data on

exports and imports of services, even if accurate, do not fully reflect the significance of service exports that may, for example, lead to merchandise exports.
58 • International Competition in Services

U.S. Government Balance of Payments Figures

The Bureau of Economic Analysis (BEA) in

the Department of Commerce estimates U.S.

imports and exports of services, and uses these

in its calculations of the Nation’s balance of

payments. Table 9 gives BEA’s categorization

for invisibles (services plus investment income),

representing the maximum level of detail possible with BEA’s current database. BEA figures

for exports and imports of services are subject

to large errors and uncertainties, as discussed

below.

Table 9.— Disaggregate Categories in the

U.S. Invisibles Accounts

— —.

Travel

● overseas travel

• Canada and Mexico

Passenger fares

Transportation

● ocean freight

● air freight

. other freight

. air port services

● ocean port services

● other port services

. other transportation

Fees and royalties”

● royalties and Iicense fees between affiIiated firms

● other affiIiated fees and royalties

. royalties and Iicense fees with unaffiIiated firms

• other unaffiIiated fees and royalties

Private miscellaneous receipts and payments

•

●

●

●

●

●

●

●

●

●

contractors’ fees (net receipts only)

reinsurance

communications

foreign governments/international organizations

(receipts only)

Canadian affiliate trade unions

temporary resident wages

temporary resident expenditures

film rentals

commissions (receipts only)

other private miscellaneous services

Investment income

● direct investmenta

● other private receipts and payments

● U.S. Government receipts and payments

U.S. Government transactions

● defense agencies

● other government agencies — - — .

aRecel pts and payments by Industry or Industry group available

SOURCE Service Transactions In the U S Ifrternat(onal AccourIts 19771983

(Washlrrgton, DC Department of Commerce, Bureau of Economic Analysis no date)

Figure 7 compares U.S. exports of services

with investment income and trade in goods over

the period 1960-85, according to the official statistics, with figure 8 the corresponding chart

for imports. (In these charts, and throughout

the chapter, all values are given in current dollars.) Over many years, the current account remained roughly in balance, as indicated by figure 2 (ch. 1), but the picture changed radically

in the middle 1970s. Earlier in the 1970s, the

balance on trade in goods had dipped into the

negative region; after 1975 it plummeted. Imports of goods grew much faster than exports.

During the 1970s, rapidly rising oil prices led

to much of the imbalance, but the causes had

shifted by the end of the decade; a strong dollar and declining U.S. competitiveness in manufactures lie behind the steeply negative trend

during the first half of the 1980s.

As late as 1983, surpluses on investment income and services approximately counterbalanced the goods deficit. But in 1984, the (official) surplus on services vanished, while the

overall U.S. current account deficit reached the

unprecedented level of $106 billion (and increased to $141 billion in 1986). Nonetheless,

while it has been several years since the surplus on invisibles exceeded the deficit on goods,

invisibles in total continue to be in surplus [figure 2, ch. 1); they represent a major source of

strength in the overall U.S. trade position.

Figures 9 and 10 give the 1986 shares of total

U.S. exports and imports accounted for by

goods, services, and investment income. Invisibles–services plus investment flows-totaled

38 percent of U.S. exports, but only 27 percent

on the import side; more accurate data for services would raise both percentages.

Exports

U.S. service exports expanded steadily over

the period covered in figure 7, from $5 billion

in 1960 to a BEA estimated $49 billion for

1986—an average annual increase of 9 percent.

The growth rate for receipts of investment income was even higher, averaging 12 percent

per year. Over this same period, exports of
Ch. 2—Services in the World Economy ● 5 9

Figure 7.—U.S. Exports

50

0

1960 1965 1970

Yea r

r

1975 1980 1985

❑ Good s ❑ Investmen t ■ Service s

SOURCES 1960.85: R C Kruecjer ‘U S International Transact Ions First Quarter 1986 Survey of Currerrf Bus/ness June 1986

pp 4243

goods increased at an annual rate of only 7 percent. Even so, it would take many more years

of greater relative expansion in the services to

change the overall proportions of goods and

services in U.S. trade by very much.

Figure 11 breaks down the investment and

service components of the invisibles account

for the years 1977-85. BEA estimates 1985

receipts of investment income (exports) at $90

billion, 67 percent of total exports of invisibles.

As the figure indicates, transportation (i. e.,

freight) has been the single largest export category among the services, followed by travel.

(The travel category includes all expenditures

by tourists and other foreign travelers except

passenger fares.) The totals in both categories

are considerably larger than for passenger fares,

while both private miscellaneous services and

royalties and fees make substantial contributions to U.S. exports. Passenger fares have grown

the fastest over the past few years, followed by

transportation, private miscellaneous services.

travel, and royalties and fees, Note that most

of the intermediate services discussed in this

report fall into the miscellaneous category, with

little detail available—an indication of the need

for better data on services trade.
60 • International Competition in Services

—

Figure 8.—U.S. Imports

500

450

400

350

300

250

200

i

1975 1980 1985

I

❑ Goods ❑ Investmen t ■ Services

SOURCES 1980-85: R.C. Krueger, “U S International Transactions, First Quarter 1986, ” Survey of Current Bus/ness, June 1986,

pp 4243

Figure 12 gives the distribution by region of

U.S. service exports, 60 percent of which have

gone to other advanced industrial nations (a

similar percentage of U.S. service imports come

from these same countries). In 1985, the European Community (EC) accounted for nearly

one-quarter of U.S. service exports, followed

by Canada and Japan.

Imports

Investment income is the largest item among

U.S. invisibles payments–at $65 billion in 1985,

coming to well over half of all private invisibles imports (figure 13)—just as among receipts.

As figure 13 also shows, spending by Americans traveling overseas heads the list of service imports, followed by transportation. As for

exports, passenger fares have grown the fastest,

Other categories remain small by comparison.

Figure 14 shows that U.S. service imports are

heavily weighted toward Latin America and

Europe—much of this associated with travel

and tourism. Deficits in passenger fares and

travel grew steadily during the first half of the
Ch. 2—Services in the World Economy ● 6 1

Figure 9.–Composition of U.S. Exports, 1986

Total” $361 billion

(preliminary, excluding military transfers)

SOURCE C L Bach U S International Transact Ions, Fourth Quarter and Year

1986 Survey of Currerrf fllus~ness, March 1987, p 4 4

Figure 10.—Composition of U.S. Imports, 1986

Total: $484 billion

(preliminary, excluding military transfers)

SOURCE C L Bach, ‘U S International Transact Ions, Fourth Quarter and Year

1986,”’ Survey of Current Bus/ness, March 1987, p 44

1980s (figure 15) in part because the strength

of the dollar made overseas travel attractive to

Americans.

OTA Estimates

OTA has reviewed BEA’s services data elsewhere, and presented independent estimates

of U.S. services trade .11 These estimates dem11 f.’or se(:t or. b].. se(; t o r ~;st 1 m a tes o f 22 sertri(; e i ndost rles, ‘+(’[’

Trade in Sertice.s; L“yport,s and Forf~ign Re\enues, op. { it , (,]1,

h. C)’ I’, A’\ estimates In thi~ spcc ial report do not pro~i(le K[:(Jgraphi[ (Ietai] com~)ardhle to figures 12 and 14,

onstrate that current government procedures

for reporting services in the balance of payments lead to large errors and uncertainties.

The errors, much greater than for trade in goods,

stem in part from difficulties inherent in measuring production and trade in service products.

The historical origins of the services categories in the current account—as a residual for

items that did not appear elsewhere—also contribute. Some service transactions are simply

omitted from BEA’s coverage. Other categories

commingle services and investment income.

Some services are misclassified. Uncertainties

in assigning values, extrapolations from past

surveys—some in the quite distant past—and

incomplete coverage of sample surveys all contribute. Even using the best available data

sources, private as well as government, the uncertainties remain large; therefore OTA has presented its estimates as ranges. (The special report cited above discusses means for improving

the data on services trade, as does ch. 10 of this

report.)

Export and Import Figures

Excluding banking (and services bundled

with goods), OTA estimates that the U.S. balance of payments understated exports of services by $25 billion to $47 billion in 1984, with

non-banking imports of services underreported

by an estimated $16 billion to $33 billion. Because OTA’s figures include only those service transactions that could be estimated with

some reliability, they do not reflect the full impact of services on the balance of payments.

Banking, in particular, has been excluded from

the summary figures in this chapter because

the data are so poor.

Figure 1 in chapter 1 compared the OTA and

BEA results. Even basing comparisons on the

lower bound of the range of OTA’s estimates,

BEA’s figures show substantial underreporting

—36 percent for exports, 28 percent for imports;

actual underreporting by BEA is almost certainly a good deal larger. While OTA’s estimates

span a wide range, they do make it plain that

the Nation’s balance of payments surplus in

services has been considerably larger than officially reported.
62 • International Competition in Services

Figure 11 .—U.S. Invisibles Receipts

—

I I

I—

1980 1981

Year

1984 1985

U Incom e

❑ Private

services

SOURCE R C Krueger, ‘U S

pp. 36-70.

~ Fees and

royalties

International Transact Ions, First Quarter 1986, ” Survey of Current Bus/ness, June 1986,

Figure 16 presents the OTA high and low estimates for service exports by industry, including a number of sectors for which no corresponding BEA figures exist, While confirming the

importance of transportation and travel, the

OTA special report shows many other industries to be considerably more significant as exporters than the official figures suggest. Insurance and investment banking/brokerage, for

example—both largely omitted from BEA’s

coverage—emerge as comparable to or larger

than technical licensing, and considerably

greater export earners than, say, telecommunications,

Sales by Foreign Affiliates

Services provided through overseas subsidiaries or affiliates do not count in the balance

of payments unless value has been added by
Ch. 2—Services in the World Economy ● 6 3

Figure 12.—U.S. Service Exports by Region, 1985

[

Rest of world

22.2 % I Western Europe

30.3 % \

Other developed

nations

4.6 %

NOTE Excludes Investment Income and government transactions Rest of

world also Includes the unal located port Ion of total service exports and

Imports, most of {t flag of convenience shlpplng.

SOURCE R C Krueger ‘U S International Transact Ions, Ftrst Quarter 1986, ’

Survey of Current Bus/ness, June 1986, pp 36-70

residents of the United States. In services as

in manufacturing, foreign affiliates may purchase most of their inputs, including labor, on

the local market. Nonetheless, as pointed out

above, integration across national boundaries

can be a significant source of competitive

strength for American firms, Thus, measures

of foreign activity broader than direct exports

have a place in any assessment of the international competitiveness of U.S. service industries,

The measure adopted by OTA in its special

report—foreign revenues—consists of direct

services trade (exports and imports) plus sales

through affiliates (less any intra-firm trade that

would otherwise be double-counted). The primary drawback of this measure lies in the broad

definition of foreign affiliates used by the U.S.

Government-it) percent or more ownership

interest. In the normal course of events, the control of American firms over minority-owned affiliates will be limited, and these affiliates will

not have a great deal to do with U.S. economic

interests, Note that affiliate sales will be zero,

by definition, for services like travel.

Figure 17 compares OTA estimates for exports and for affiliate sales by industry, based

on the mid-points of estimated ranges. A large

percentage difference between direct exports

and foreign revenues warns that a focus on either of these in isolation could be misleading.

In the past, given the spotty data on trade in

services, confusion between exports and foreign revenues has been common, far more so

than in goods-producing industries. Sometimes

this confusion has extended to policy discussions. Foreign revenues in retailing, for example, consist almost entirely of sales by U.S.

affiliates located abroad. Trade in retailing services is very small; when U. S.-owned retailers

abroad sell goods originating in the United

States, these are counted as merchandise exports. Foreign revenues in retailing—more than

$25 billion in 1983 (figure 17)–have little to do

with U.S. competitiveness.

Foreign service revenues of U.S. firms in

1983, the latest year for which data are available, totaled $152 billion to $169 billion, compared with direct exports of $61 billion to $75

billion. Total foreign revenues in commercial

banking, for which no direct export figures are

available, came to about $9 billion. (OTA estimates place service revenues of foreign firms

operating in the United States at $113 billion

to $131 billion in 1983, with imports accounting for $44 billion to $56 billion of this. ) As figure 17 shows, much U.S. international activity

in the services, whether measured by exports

or the more inclusive foreign revenue figures,

comes in traditional or tertiary services (table

6). Notable examples include transportation

and travel. Knowledge-based services-e.g.,

accounting, legal services, and information

services-remain small by comparison.

Any and all measures of services trade continue to be subject to substantial errors and

uncertainties—as figure 1 showed. Current BEA

practice leads to serious underestimates of the

value of trade in services. OTA has estimated

the impact of services on the U.S. balance of

payments only for the years 1982-84; more than

anything else, the results should be taken as evidence of the deficiencies of the existing database (and as an indication of the need to improve it). The data on services trade are poorest

for precisely those industries-the knowledgebased services-where the United States should

have the greatest dynamic comparative advan -
64 ● International Competition in Services

110

100

90

80

70

60

50

40

30

20

10

0

Figure 13.— U.S. Invisibles Payments

—

—

.

4

—

i

1977 1978 1979 1980

Year

—

❑ Travel

.

❑ Private ■ Fees and

services royalties

SOURCE R C Krueger, “U S. International Transact Ions, First Quarter 1986. ”Survey of Currer?f Bus/ness, June 1986,

pp 36-70
Ch. 2—Services in the World Economy ● 6 5

Figure 14.— U.S. Service Imports by Region, 1985

0

NOTE Excludes Investment Income and government transactions Rest of

world also Includes the unal located portion of total service exports and

I reports, most of It flag of convenience shipping

SOURCE R C Krueger, U S International Transactions F[rst Quarter 1986, ”

Survey of Current Bus/ness, June 1986 pp 36-70

Figure 15.— U.S. Service Trade Balance

Passenger fares

K

\

\

,

Year

SOURCE R C. Krueger, ‘“U S International TransactIons, First Quarter 1986, ’

Survey of Current Business, June 1986, pp. 36-70

— — . —

tage, and where the greatest strategic benefits

for other American industries lie,

World Trade in Services

Total world services trade—the sum of all

countries’ exports or imports—grew at an annual rate averaging 6 percent during the period

1978-84, although, at $360 billion in 1984, still

below the 1981 peak (figure 18).12 Investment

income has grown even faster, along with trade

in goods—the latter at a bit over 10 percent annually during the 1978-84 period. World exports

of services (excluding investment income) have

remained a little less than one-fifth of world

merchandise exports—a proportion unlikely to

change much over the rest of the century, The

“other services” category in figure 19, accounting for about 40 percent of world service exports,

includes such diverse items as construction,

insurance, telecommunications, and technical

licensing,

Together, the United States and the other

members of the Organization for Economic Cooperation and Development (OECD) account

for nearly three-quarters of world service exports (figure 18). Since 1978, the share of total

service exports originating in the advanced industrial nations has fallen slightly—from 81 percent to 76 percent in 1984—but the U.S. share

has gone up from 10 to 11 1⁄2 percent. Asian nations other than Japan (an OECD member), and

1 Zwhen expressed i n U.S. dollars, i~or] d t>\ [)() ri \ of go{ )(] ~ hll \ (’

also dropped since 1981, but these dcx: 1 i nc \ (i r~’, i N (ISW n{. v, a rtifacts caused hy the strength of th~ dollar. L1’ht’n {’x[)res~txi, w},

in SDRS (Special Drawing Rights], totals for Ix)t h w:rk i( m and

goods have continued to rise, although not at tlie r,ite~ [)~ thr

late 1970s.

Worldwide trade data come from thl> 1 ntern,lt I( )nal Al[jneta r}

Fund, which relies on figures supplied b} indi~l(lua] count rl(’>.

The quality of the data, and the basis for the scrl i(w t r,](l~: figures

reported, differ considerably among count rle+: ,] \ for tljf~ [‘n it[’d

States, most of the services data ar~’ prohahl~ qu}tr [x)or. (,~1~()

see the footnote to table I O, p. 69 )
66 ● International Competition in Services

.- —

Figure 16.–OTA Estimates of U.S. Service Exports by Industry, 1984

Tertiary industries

Transportation I a

Travel a

Miscellaneous

Franchising

Leasing

Knowledge.intensive

Investment banking/brokerage

Construct ion

Licensing a

Information b

Computer software

Education -

1

Health 1

Legal b

Motio n a

Management/consulting _ 1

Engineering

Telecommunicate ions a

Data processing

Accounting

Advertising

I

a

I I I I I I I I

o 2 4 6 8 10 12 14 16 18 2

Value of exports (billions of dollars)

oo OTA low estimates ❑ OTA high estimates

aHlgh and low est!mate Identical

bLow estimate equals zero

SOURCE Trade In Serv(ces Exports and Fore/gn Revenues (Washington. DC Off Ice of Technology Assessment September 1986), p 38

)

to a lesser extent the Middle East, also increased

their shares of service exports over the 1977-

84 period.

Much the same picture emerges from examination of the performance of individual countries. Although rankings vary from year to year,

the United States has remained at or near the

top—leading al] service exporters in 1984 (table 10), the latest year for which data are available. (Note that the United States heads the list

even though the rankings depend on the official BEA figures; while more accurate values

for U.S. exports and imports would be much

larger, the figures for other nations are probably understated too.) OECD nations fill the top

10 export positions in table 10, and 15 of the

top 20. Among importers, the 6 largest—and

16 of the top 20—come from the roster of OECD

members, Trade in services, then, occurs mainly

among the developed economies, but just as for

trade in goods, newly industrializing countries

—Singapore, South Korea—are becoming more

prominent. India and Brazil, however, the most

vocal opponents of liberalizing services trade,

appear far down on both lists.
Ch. 2—Services in the World Economy ● 6 7

Figure 17.— Foreign Revenues of U.S. Firms by Service Industry, 1983

(OTA mid-range estimates)

Tertiary industries

Transportation 1

Retailing 1

Miscellaneous

Leasing

Franchising

Knowledge-Intensive

Insurance 1

Investment banking/brokerage

Construction

Computer software

Engineering

Licensing

Accounting

Data processing

Motion pictures

Health

Information

Telecommunications

Management/consulting

Education

Legal

‘advertising 

o

~

5 10 15 20 25

Value (billions of dollars)

Export s ~ Affiliate sales

)

SOURCE Trade (n Serwces Exports and Fore/gn Revenues (Washington DC Off Ice of Technology Assessment September

1986) p 41
68 ● International Competition in Services

400

30(

200

100

Figure 18.—World Service Exports

o

1978 1979 1980 1981

Year

1982 1983 1984

❑ OECD

other than

United States

NOTE Excludes Investment Income

■ United States

SOURCE Yearbook of Balance of Payrner?fs Stat/st/cs, Part 2 (Washington, DC. International Monetary Fund, 1985), pp

42-59
. —

10.

20.

30.

Ch. 2—Services In the World Economy ● 69

—.

Figure 19.— World Service Exports by Type, 1984

NOTE Excludes Investment Income

SOURCE Yearbook of Ba/arrce of Payments .Stat/stms, Part 2 (Washington,

DC International Monetary Fund, 1986), pp 42-59

Table 10.— Leading Exporters and Importers of Services, 1984

Value of exports Value of imports

(billions of dollars) (billions of dollars)

.

United States . . . .

France . . . . . . . . . . . . . . . . . . . . . . .

Federal Republic of Germany .

United Kingdom . . . . . . . . . . . . . .

Italy ... ... . . . . . . . . . . . .

Japan . . . . . . . . . . . . . . . . . . . . . .

Netherlands . . . . . . . . . . . . . . . . . .

Spain . . . . . . . . . . . . . . . . .

Belgium/Luxembourg . . . . . . . . . .

Canada . . . . . . . . . . .

Singapore . . . . . . . . . . .

Austria. . . . . . . . . . . . . . . . . . . . . .

Switzerland . . . . . . . . . . . . . . .

Norway . . ..., . . . . . . . . . . .

Sweden . . . . . . . . . . . . . . . . . . . . . . . . . . .

Egypt . . . . . . . . . . . . . . .

Mexico. . . . . . . . . . . . ..., . . . . . . . . .

South Korea . . . . . . . . . . . .

Denmark . . . . . . . . . . . . . . . . . . . . . . .

Saudi Arabia. . . . . . . . . . . . . . . . . . . . . . . . .

Australia . . . . . . . . . . . . . . . . . . . . . . . . . .

Yugoslavia ..., . . . . . . . . . . . . . . . . . . . . .

India . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Israel . . . . ..., . . . . . . . . . . . . . . .

Greece. . . . . . . . . . . . . . . . . . . . . . . . . . . .

Taiwan . . . . . . . . . . . . . . . . . . . . ..., . . . . .

South Africa . . . . . . . . . . . . . . . . . . . . . .

Finland . . . . . . . . . . . . . . . . . .

Malaysia . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Philippines . . . . . . . . . . . . . . . . . . . . . . . . .

Thailand . . . . . . . . . . . . . . . . . . . . . .

Brazil . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Panama . . . . . . . . . . . . . . . . . . . . . .

Venezuela . . . . . . . . . . . .

Subtotal . . . . . . . . . . . . . . . . . .

Rest of world . . . . . . . . . . . . . .

Total . . . . . . . . . . . . . . . . . . . . . . . . . — — —

$41,4

35.5

27,0

26.2

21,3

20.9

14.4

12,6

11.3

8.0

7,7

7.7

7,6

7.1

6.4

6.4

6.2

6.1

5.1

4.3

3.7

3.3

3.1

3.0

2.8

2.7

2.5

2.4

2.0

2.0

1.9

1.8

1.1

0.8

United States . . . . . . . . . . . . . . . .

Federal Republic of Germany . . . . . . .

Japan . . . . . . . . . . . . . . . .

France . . . . . . . . . . . . . . . . . . . . . .

United Kingdom. . . . . . . . . . . . . . . .

Italy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Saudi Arabia. . . . . . . . . . . . . . . . . . . . .

Netherlands . . . . . . . . . . . . . . . . . . . . . . . . .

Canada . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

IO. Belgium/Luxembourg . . . . . . . . . . . .

Norway . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Australia . . . . . . . . . . . . . . . . . . . .

Sweden . . . . . . . . . . . . . . . . . . . . .

Switzerland . . . . . . . . . . . . . . . . . . . .

Taiwan . . . . . . . . . . . . . . . . . . . .

Mexico. . . . . . . . . . . . . . . . . . . .

Spain . . . . . . . . . . . . . . . . . . . . . . .

Austria . . . . . . . . . . . . . . . . . . . . . . . .

Denmark . . . . . . . . . . . . . . . . .

20. Malaysia . . . . . . . . . . . . . . . . . . . . . . . . . . .

India. . . . . . . . . . . . . . . . . . . . . . . . . .,

South Africa . . . . . . . . . . . . . . . . . . . . . . . . .

South Korea . . . . . . . . . . . . . . . . . . . . . . .

Singapore . . . . . . . . . . . . . . . . . . . . . . .

Israel . . . . . . . . . . . . . . . . . . . . . . . . . .

Brazil ., . . . . . . . . . . . . . . . . . . . . .

Kuwait . . . . . . . . . . . . . . . . . . . . . . . . .

Yugoslavia . . . . . . . . . . . . . . . . . . . . . . .

30. Venezuela . . . . . . . . . . . . . . . . . . . . . . . . .

Finland . . . . . . . . . . . . . . . . . . . . ., . .

Egypt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Thailand . . . . . . . . . . . . . . . . . . . . . ...,

Greece . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Philippines ..., ..., . . —

$41.5

40,1

35,0

27,1

20,7

15.2

14.4

13,9

11.4

10.2

7.0

6.7

6.6

6.5

5,2

5.0

4.8

4,7

4.4

4,3

4,1

4,0

4,0

3.9

3.4

3.3

3.1

2.8

2,6

2.6

2,1

1.9

1.2

1.1

$316.3 (88%) Subtotal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $324.8 (84%)

$ 43.3 (12%) Rest of world, . . . . . . . . . . . . . . . . . . . . . . . . . . $ 62.9 (16%)

$359.6 (100%) Total. ..,... . . . . . . . . . . . . . . . . . . . . . . . $387.7 (100%)

aStatlstlcal dlscrepencles In aggregated world trade statistics such as here between total Imports and exports of serv!ces tend to be relatively large, reflecting errors

and om!sslons m the data reported by !ndlwdual countries

SOURCE kVor/cf/nv/sfb/e Trade (London Bnttsh Invlslble Exports Council July 1986L pp 14-15 Basedon data compiled by the lnternat!onal Monetary Fund
70 ● International Competition in Services

—

WHAT CAN BE GAINED THROUGH LIBERALIZATION?

The U.S. Position Relative to Other Nations

What do the trade data summarized above

imply for probable negotiating positions and

possible outcomes during the Uruguay Round?

While the OECD nations account for most of

the world’s exports and imports of services, not

all these countries show surpluses. Japan, for

one, had a $14 billion deficit in 1984. West Germany’s deficit was almost as large. Both nations

have been running large surpluses on trade in

goods, suggesting a comparative advantage

over services.

How about the United States? Does this country currently have an underlying comparative

advantage in services? The question cannot be

answered with any precision, especially at

present. Effects on trade of the Federal deficit,

rapid shifts in the strength of the dollar, and

continuing inflows of foreign capital have created a situation without real precedent. But the

data as a whole–and the OTA estimates much

more than BEA’s figures—suggest that American firms remain generally competitive in services. OTA’s estimates show continuing surpluses

in most of 22 service industries independently

examined. 13 That surpluses continue to be recorded during a period of massive deficits in

goods trade points, at the least, to considerable

underlying strength in services, and suggests

an ongoing comparative advantage in most

sectors.

Does this mean that further opening of international markets for services will bring big dividends for U.S. service industries, and help the

Nation’s trade balance? Or does it mean that

American industries are doing so well already

that reductions in barriers to trade and investment would make little difference? The paragraphs that follow examine such questions on

several levels.

lsAt the same time, the data on trade in services are so poor,

the uncertainties so large, that it cannot even be demonstrated

conclusively that the United States has a net surplus on services

trade. See Trade in Sert’ices: Exports and Foreign Retenues, op.

cit., p. 38.

Who Will Benefit?

Along with countries like Japan and West

Germany, many developing nations have deficits that are uncomfortably large compared

with their overall volume of services trade and

net balance of payments position. Brazil’s 1984

deficit on services trade came to $1.5 billion

(table 10), while the country had a surplus of

something over $13 billion on trade in goods,

together with net payments on direct and indirect investment of $9 billion, reflecting past

borrowing. 14 Should it be a surprise that Brazil

has been a leading opponent of GATT negotiations on services? From Brazil’s perspective,

liberalization could be quite damaging if it led

to a greater deficit in services; after all, the country needs to maintain a surplus on goods and

services in total in order to meet its debt repayment obligations. Indeed, it is not obvious that

opening Brazil’s services markets would be in

U.S. interests. Brazil owes much of its debt to

American financial institutions; a greater Brazilian deficit in services trade, leading to a worsening overall trade position, could make the

repayment of these loans even more problematical.

Furthermore, the aggregate figures in table

10 conceal differences that often reduce still

further the enthusiasm of developing countries

for negotiations. Latin America does well in

net tourism receipts, where liberalization will

have little effect—tourism being relatively free

of restrictions. Conversely, the United States

runs surpluses in those sectors slated to be subjects of discussion during the Uruguay Round:

financial services of all kinds; informationrelated products; licensing and other business

and professional services.

But OTA’s estimates also indicate that intermediate and business services account for a

relatively small fraction of trade. No geographic

breakdowns exist for trade in knowledge-based

14 World /n vislb]e ‘rrade, (London: British Invisible Exports

Council, 1986), pp. 14-1 6; Balance of Pa~~ments Statistics.’ Yearbook, Part 1 (Washington, DC: International Monetary Fund,

1985), pp. 84-85.
services as a class. Nonetheless, it seems likely

that much of this trade takes place among

OECD countries–and probably among affiliates. (The data show this to be the case for the

United States, and it is probably true for other

OECD nations as well.) Where detailed information is available—as for technical licensing

(see ch. 6)–the pattern is clear: intra-firm transactions within the OECD nations predominate.

Two quite different conclusions follow:

1,

2.

Foreign investment may benefit recipients,

particularly developing countries, through

transfers of know-how and technology

without doing serious damage to their balance of payments positions because direct

trade in these services will remain small.

Liberalization will not make for much of

a difference, directly, in the overall U.S.

trade balance. Unless reductions in barriers lead to unexpectedly rapid expansion

of total world services trade, U.S. firms will

continue to exploit their competitive

strength in the knowledge-based services

primarily through foreign investment and

transactions with affiliates. Exports to affiliates will continue to be concentrated

within the OECD, These exports will probably grow at about the same rate as in the

past, because—granting exceptions such

as insurance—OECD nations have seldom

imposed severe restrictions on trade in

knowledge-based services.

A further implication follows: although an increase of a few billion dollars in the U.S. surplus on services would certainly be helpful, the

argument that liberalization of trade and investment in the services will work in the interests

of the United States rests primarily on the indirect and strategic benefits, rather than on

short- or medium-term improvement in the U.S.

balance of payments position.

Over the past few years, as the stage has been

set for the Uruguay Round, the positions taken

by both the United States and the developing

countries generally mirror the structure of comparative advantage as suggested by the data

summarized above. The available statistics imply that developing countries have not been maCh. 2—Services in the World Economy • 71

jor factors in international services trade—and

will not become so in the near to medium-term

future, Although some depend heavily on industries like travel and tourism, to the extent

that typical developing nations trade in services at all, they tend to have deficits. Few seem

to have thought through the implications of

opening their markets to foreign service firms.

They commonly take the view that the risks of

wider deficits outweigh possible benefits from

greater imports of services embodying advanced

technology—or from foreign investment that

would bring them knowledge and expertise (see

box E–ch. 9 explores these positions, and the

motives underlying them, in more detail). The

developing world seems to have overemphasized narrow balance of payments considerations, while minimizing the possible gains from

increased trade in services. But the available

data also suggest that the United States may

have exaggerated the benefits of liberalization,

at least the direct gains.

Sectoral Questions

At the sectoral level, the concerns become

more specific: Are there service industries

where international expansion by U.S.-based

firms has been slowed, or competitiveness

dampened, because of foreign government

trade barriers? Are these conditions subject to

change through initiatives of the U.S. Government? Most important, are there particular service industries where liberalization could bring

especially large gains for the United States,

gains that might escape the generalizations

above? Indeed, there are two—computer software and telecommunications—as outlined

below and discussed in more detail in later

chapters.

The computer industry can serve as a reference point, American firms have led the world

in computer hardware and software. More specifically, they have led the world in applications

of computer systems, In sectors ranging from

agriculture to banking, computer applications

have enhanced U.S. competitiveness. Software

—treated as a service in this report—embodies

these applications, helping American firms cut
72 ● International Competition in Services

Box E.-Benefits From Liberalization

There is more to the argument for trade liberalization than gains from specialization (as predicted

by theories of comparative advantage). When a country opens its markets to imports and foreign investment, domestic companies forced to confront new competition may take steps to improve their

own efficiency-steps that can constitute a two-edge sword. Under the spur of Japanese competition,

American automobile manufacturers redesigned their product lines and improved their manufacturing methods. They also cut their overhead by firing white-collar workers as well as production employees, and moved some production to foreign countries. In many U.S. manufacturing industries,

rising import competition over a period of years has dampened wage increases in unionized industries and led to givebacks and two-tier wage systems—to some observers, evidence of earlier distortions in the form of union-induced wage premiums. As many such examples show, when a company

reorganizes to meet new competition, its employees often bear heavy adjustment costs. But reorganization may be essential for survival.

Sheltered industries often lag in introducing new products. One of the primary arguments for

deregulation in telecommunications, nationally and internationally, has been that regulation slows

the adoption of new technologies. As the United States has deregulated financial services, Britain

has been forced to follow suit [ch. 3]. With easier entry for foreign banks, some British institutions

may be unable to meet the new competition. At the same time, Britain’s insurance companies have

been pressing for admittance to the West German market, in part because they believe that government protection in Germany has bred inefficiencies there that they can exploit.*

Developing economies where service industries have been sheltered from outside competition

should get significant benefits through greater efficiency.** While some governments have learned

to steer economic growth and development with at least modest effectiveness, other countries—trying

to accomplish the same thing-do more harm than good. Trade protection has been one of the standard tools in such efforts, but even among more traditional services, protection can be directly counterproductive-a developing country that restricts landing rights to support a national airline stands

to hurt its tourism industry. And, while reducing barriers to services trade will help some countries

more than others, the benefits in terms of world economic growth and efficiency improvements should

be greater than for lowering barriers to trade in goods. Why? Most fundamentally, because international transactions in services are more likely to involve the transfer of technological knowledge, in

all its dimensions. In the services,- on-tariff barriers (NTBs) can easily and invisibly slow the diffusion of knowledge and learning that lead to increases in productivity and efficiency through organizational learning and a better-trained work force. MNCs contribute to global efficiency in large part

through such dynamic effects: aiding in the spread of know-how, both product-specific (judging risks

for loans to developing countries) and technology-specific (computerized systems for accounts receivable). Because services-related technologies must be brought to the location of production, they add

directly to the storehouse of knowledge in countries lacking home-grown technical expertise. Moreover, exchanges of patents, copyrights, and other forms of proprietary technology often entail direct

transfers of tacit know-how by people with experience that cannot be put down in words (how to

debug a computer program, when a bank should risk a loan that does not meet its formal criteria).

While the gains cannot be measured directly, trade and investment in services clearly helps economies that need such knowledge, including managerial skills, in order to develop and expand. As

a result, the total gain to the world economy from international exchanges of services, per dollar

of transaction, probably exceeds that from international exchanges of goods.

*J. Csrr and C. Taylor, “Ibtwds Futs Faur Membtw States in Dock An EEC Trade in Services Case is Corning Up for

Close Scrutiny Today,” F’fnandd ~es, Nov. 6, 1$8!5, p. 8; W. Dawkins, “Court Judgcmwnt Opens Door to Lucrative European

Market,” Financial ?Ymes, Dec. 5, 1986, p, 2.

**A.F. E~w, $~why ~~r Trade in WI+CM IS In the Interest of Developing COUIltik?S,” /OU1’~~ Of’ ~0~~ ~~~~~~!

vol. 18 (March/April 1985), p, 147.
Ch. 2—Services in the World Economy ● 7 3

—

Beyond specialization and competition, is it possible that lower barriers to services trade could

help in a third way—by easing adjustments to dislocations or disturbances originating elsewhere in

the economy? Economic growth and new competition brings change, often wrenching. Companies

merge, go out of business, enter different markets; new firms create new jobs. Industrial sectors prosper or decline, cities and regions follow. People who lose jobs in the steel industry may (or may not)

find work in the services. The processes–normal and unavoidable-bring pain to some, prosperity

to others. If the services have characteristics that make them unusually good buffers, that would add

extra force to the argument for liberalization. But are the services in any sense special in their ability

to cushion adjustment? Appendix 2A examines this question, finding that the answer is no. Thus

liberalization of services trade has no added claim on this basis.

costs, raise productivity, and pursue new business strategies. In a very real sense, software

provides the brains of the system, International

competitiveness in the computer software industry is vital for U.S. economic interests. So,

by similar reasoning, is competitiveness in

telecommunications (in part because the worldwide telecommunications infrastructure is rapidly becoming a network of computers),

Of course, when U. S.-based companies sell

software abroad, they help the foreign firms that

use this software compete more effectively. But

this is also true when American manufacturing companies transfer technology through

licensing agreements, or when E&C firms undertake projects overseas. In fact, system-wide

applications of digital data processing and communications technologies should greatly enhance global economic efficiency,

For different reasons, the financial services

industry will also remain critical for U.S. interests (and those of other countries). Companies

look to financial markets for the capital they

need to grow, Governments rely on the financial sector to implement macroeconomic policy. All countries have an interest in efficient

capital markets. All countries have an interest

in world financial stability. Liberalization by

itself—particularly in the sense of deregulation

—would not necessarily enhance stability, but

the analysis in the next chapter stresses the need

for negotiations aimed at harmonizing regulatory and supervisory practices internationally,

Trade Barriers in the Services

Given a fluid competitive environment for

U.S. firms, affected by forces as different as the

strength or weakness of the dollar today and

the fruits of R&D investments made 20 years

ago (for instance, research in artificial intelligence, sponsored for many years by the U.S.

Department of Defense and just now finding

its way into the civilian economy), a primary

question for trade negotiators becomes: In

terms of overall impacts and significance—and

in terms of effects on the U.S. economy—how

important are barriers to trade and investment

in services compared to goods? In other words,

given an international trade regime that seems

to be slowly deteriorating even in its ability to

maintain reasonably open trade in goods, does

it make sense to place a high priority on services in the Uruguay Round, particularly if this

may mean slower progress elsewhere?

The starting point is to acknowledge that,

without much question, freer trade in services

will work to the benefit of the United States;

the gains may not be that large or that immediate, but foreign government restrictions handicap any American industry with an underlying

comparative advantage, At the same time, for

reasons discussed in box E, countries that restrict trade in knowledge-based services risk

depriving their own economies, But it will not

be easy to reach meaningful agreements on

services trade.

Today, as discussed in chapter 9, barriers to

international trade and investment are typically
74 ● International Competition in Services

higher for services than for goods. Protection

remains the norm in agriculture, but seven previous rounds of multilateral trade negotiations

have left tariffs on manufactures at low levels.

Of course, governments bent on protecting

goods-producing industries have many tools for

doing so, and NTBs such as quotas have become widespread as tariffs have fallen. Nontariff barriers—whether explicit (quotas on imports of Japanese machine tools) or implicit (the

difficulties faced by foreign firms seeking to

buy a Japanese company have been called

NTBs)—create new problems for trade negotiators and for international bodies such as

GATT.

With few exceptions, all barriers to trade in

services are non-tariff in nature. But NTBs in

the services differ fundamentally from those

affecting goods. While governments can close

their borders to imports of goods, rely on uncooperative customs inspectors to harass importers, or otherwise restrict entry, services—

except for those embodied in a tangible object

(motion picture film, magnetic disks or tape)–

do not pass through a port of entry. Given the

need for a foreign presence to supply services,

governments limit the operations of firms from

abroad through controls on inward investment

or discriminatory regulations. The regulations

need have no obvious protective intent: typi-
Ch. 2—Services in the World Economy • 75

cally, governments supervise industries like

banking and insurance to protect consumers

and ensure stability. Some countries have

sought to control international telecommunications traffic in the name of safeguarding personal privacy—steps that could, at the same

time, raise prices or hinder the operations of

foreign-based MNCs. In many countries, service industries function as government monopolies, with legal restrictions on entry by any

firm, foreign or domestic. Public ownership exists in manufacturing as well, but a list of service industries where it has been common—

banking, telecommunications, airlines, ocean

shipping, railroads, health care facilities, education, radio and television—suggests the dimensions of the problem. (Still other industries are

organized as private near-monopolies, like insurance in Japan and South Korea. )

Barriers in the services, then, range from outright prohibitions on trade (quotas set at zero)

or investment, to subtle discrimination against

foreign-owned firms. Whenever regulations

with a nominally domestic thrust have been tailored to make life difficult for foreign-owned

firms, they function as NTBs.

What, then, is to be considered “fair” and

what “unfair” in the services? The problems

posed by NTBs affecting trade in goods have

proven difficult enough, Given the intangible

nature of service products, NTBs, in a very real

sense, will remain less visible than for trade

in goods. And, with patently obvious NTBs rare,

progress in negotiations implies efforts to reduce barriers that have some measure of justification in terms of domestic policies. This will

be difficult, Such regulations–e.g., in banking

—typically have a wide range of indirect impacts, few of them clear-cut. Tariffs raise prices

directly; negotiators can agree to cut tariffs on

wheat in exchange for reductions on computers.

Many NTBs have uncertain quantitative effects;

discussion can bog down in debates over the

respective magnitudes of barriers. For just these

reasons, the Tokyo Round had only modest success in dealing with NTBs for goods. Adding

another layer of complexity, services such as

shipping, air travel, and communications have

long been regulated internationally on a more

or less ad hoc basis. Agreements have grown

up with little consistency from sector to sector, and little relationship to codes of conduct

covering trade in goods,

Chapters 9 and 10 discuss the kinds of progress that may be possible. Here, the primary

point is this: given the predictable difficulties

in moving quickly towards liberalization, there

seems little reason to give the services unusually

high priority in the U.S. negotiating strategy.

Liberalization in the services deserves to be a

long-term goal, but other objectives are at least

as important. For instance, if the United States

is serious about strengthening GATT as an institution, logical priorities begin with efforts

to create effective enforcement mechanisms

and to close the loopholes that have permitted

NTBs for goods to proliferate. In such a context, an umbrella agreement establishing a general set of rules governing services trade (see

chs. 9 and 10) fits quite naturally, particularly

if it could be coupled with extension of GATT

coverage to foreign investment.

CONCLUDING REMARKS

The discussion above points to a number of to market so many services, Given the imthemes that recur in the remainder of this portance of foreign investment, justificareport: tion for placing a high priority on international negotiations concerning services

• Direct exports of U.S.-produced services trade must depend to considerable extent

will remain relatively small compared to on indirect gains to the U.S. economy.

exports (and imports) of goods, if only be- s Major sources of indirect benefits from

cause of the need for an overseas presence more open trade and investment in the
76 • International Competition in Services

●

●

●

services include an infrastructure and environment internationally that: 1) can aid

American exporters of goods as well as

services, and 2) provide strategic support

for efforts by U. S.-based multinationals to

build globally integrated organizations.

An open international economy—with relatively free flows of technology and knowhow, vast pools of low-cost labor, more and

more-capable competitors—will mean

greater uncertainty and less stability for

American firms. Given such an environment, U.S.-based firms will find themselves

moving towards more flexible organizational structures, in part simply to adapt

and survive—but in part also to capitalize

on evolving applications of computer and

communications systems.

Flexibility and adaptiveness carry many

shades of meaning, among them: heavier

reliance on technology (broadly defined);

decentralization and delegated decisionmaking; greater dependence on communication channels, both horizontal and vertical; continuing learning; rapid adjustment to competitive pressures (which may

mean utilization of part-time and temporary employees to cope with fluctuating

demand). In both the services and in manufacturing, new approaches to integration

—geographic, and in terms of products and

production processes—will help companies

develop and market products with, for example, a greater degree of customization,

hence higher value-added. For at least some

companies, the boundaries between production of services and goods will continue

to blur. Many companies will purchase

more services on the outside.

For the U.S. labor force, continued job creation in the services, coupled with a stagnant or declining manufacturing sector

●

and new demands for flexibility, will mean:

1) relatively large numbers of new jobs in

the traditional, tertiary services, 2) but also

many new jobs in knowledge-based services. The former will remain at the bottom

of the pyramid in terms of skill requirements and wage levels. The latter will demand high skills, rewarding them in many

cases with high pay. Greater stratification

within the U.S. labor market could sharpen

policy-related conflicts over issues of education, (restraining, and mobility, not to

mention income distribution.

Effectively utilizing the capabilities of the

U.S. labor force, and the potentialities of

new and emerging technologies, will remain critical for international competitiveness in both services and manufacturing.

Well-integrated organizations, making effective use of people’s skills, as well as technology, will have better prospects for competitive success, for growth, and for the

creation of new jobs, High value-added

products, depending on high skills and able

to support a high-wage economy, will in

many cases result from applications of computer-related technologies that enhance

rather than replace people’s skills.

How can Federal Government policies support the knowledge-based industries, so dependent on human capital, that will lie at the core

of a high-skill, high-wage economy in the 21st

century? This report suggests that commitment

to open international trade and investment, in

the services as well as in manufactured goods,

and commitment to economic deregulation,

must carry a significant corollary: commitment

to policies that help individual Americans take

advantage of the opportunities created in such

an economy.
Ch. 2—Services in the World Economy ● 7 7

APPENDIX 2A: THE SERVICE INDUSTRIES IN ECONOMIC ADJUSTMENT

Adjustment Processes

The international compctit i~c cntrironment for

U.S.-based companies seems less stable toda~ than

et’en a decade ago. AS other nations climb the technology}’ ladder, compet itit’e pressures on the United

States will continue to build. Nc\\ technology, shifts

i n domestic demand, i report competition-all these

f’orce adjustment, Big changes within a short time

period-in 1979-80 ~~hen the U.S. automobile industr}r ~vas hit sir~lLlltiirleoLlsl~r \\rith recession, a shift

in consumer demand to~t’ard small cars (resulting

largelj from gasoline shortages), and rising competit ion from Japan-can o~erwhelrn the economy’s

c apacit]’ t o adjust IJ} rc-deplo}’ing resources no

longer needed in [ie{:lining sectors. ’ This capacit}rthe cconoml’s resil ien(:} or robustness-depends

on ~o~rern m(!nt [)01 i(:ies as t~’ell as economic structure. t$’hen peo~)}e ~lho lose their jobs remain Llnem plo~’ed for long periods, and other resources remain u nderut i 1 i zcd, this is e~ridence that change is

being f’or(:ed c)n an econorn~ faster than it can

respon(l.

Rapid shifts in one sector mean adjustment else-

~~’here. I n the (:omputer industr}r, technological impro~rcments hate ]Mi to huge increases in price/performance ratios and an e~er-expanding range of

applicat ions-~~ith impacts that ~i’ash through the

entire e(; onom~, A giien disturbance can hurt a

s ma] 1 or less (1 i~’ers i fie(l e(:ono In}’ more: if’ A meri -

cans sto~) spencii ng tourist dollars in Nlexico, for

~~hate~er reasons, the adjustments ~~’ill be painful.

Agrarian nations are susceptible to drought The

!vIi(ldle East ~~’ill eventually run out of petroleum.

The U.S. economy, in contrast, has the advantages

of’ both size and d i~’ersity —sources of resilicnc~’

\\’hether disturbances are domestic (bank failures)

or global (energj shock). Beyond this, adjustment

\\’ill be easier if the mix of resources released b~r

declining industries resembles that needed by expand ing sectors: the shift from lo~~r-skilled factor}

~iork to ser[rices taking place since the mid-l 97os

(:reates a substantial source of d ist urbances, if OIIIJ

be(;ause the social environment of the ser~rices

(ii f’fers so great 1}’ from that of the factor}’. As chap-

)l)l\I 111111011< { ,111 ll(i\ (, (Iltl(, [ ( ,11 I\(, \ ‘f ”} It’ 1 ‘)85 Nl(,~II II ( ;lt\ [’(lrtt)q~ic]kf,

( If, (l ((,() ,1 tl(,,l \ \ })(! r (11. rl {Ii ,I(j ]ll\}lll 1,]]1 101 41 l,\ I( ( )’\ IJl ( 1 1)( )Illt of ( (111 1 ‘,( ,

[11( 1s1 (1 I \l II I t), ! Ill l,\ ()[)(,1 ,1[(, 011 1[ 11) :1,1 I I 111(~ s{ {i 1(,~ \\’)1(,11 ( 11,11) :1, 1~ S]( )Jl

[ )1 1) ,1s 1 11) ])(1( t \ 1\{ )1 ,It tvi \\ 11 II 111 \ll),1 II ] )( II t II 11)\ ( Ii t 1)(, (,( ( )1)( )ll}\ <i! { ]11 \l 1111~1) 1

1)1 ()( (,\\ f,\ ( (ill Ill, 1 l,l<lt l\ t,l\ t 11111:11

[ [)1 <1 II ,1 Il,ll\ >)\ of I(il)( )1 [II(I f hlf ,1( I ] (1 \t fIIIllt I 11 I }1( [ II 1 II(I\t,ll l,\ \l, ( ,

‘/ (,( hllo/og\” df)(l \/r 11( (Ilf,// [ ‘/)(, fll/)/()\/1)(,11( h’(>(,/Tl/J/(f\ If]: /)1 \/)/,1{ (’(/

1(/(///$ [\\’< i\tllll~l(l Il I )( : ( )f\I{ {, (II I I,( IIl)(Il~)qL \\st,\sl]]f,]]t f 1,111 II,lr \

1 (11{() ~

ters 7 and 8 suggest, the rapidly growing kno~\ledg(~-

based services, in particular, need people ~irith bot h

technical skills and social skills quite unlike those

of many of the Americans who earlier found lobs

in traditional manufacturing industries

Adjustment Policies

Lower trade barriers also create dist urban(:~?s and

force adjustment—a problem recogn izc(] in the

GATT escape clause mechanism (Article XIX). The

escape clause permits go~rernnlents t o g i~’c t cnl -

porary protection to industries injured i)}r re(lu(:-

tions in tariffs or NTBs; governments (:an (:all on

temporary protection or a varietjr of other ~)oli(:~

tools to ease adjustment (retraining progranls, relocation assistance, tax incenti~’es for ex pa n(i i ng sectors that might soak up displaced resou r(:t;s, I<K D

support for sectors expected to gro~f’ rapidl}).

Many go~~ernments have ~’ie~~’ed in f’ant in(iustries

as worthy of protection or subsid~. be(:a u sc of their

future potential (e. g., electronics in Japa II during

the 1970s]. On the other hand, gro~~lb rates that turn

negative often call forth sector-speci fi(: I.CS])(IIISCS

intended to arrest or manage dec Ii ne (t ra(i e ] )rot e(:-

tion for steel in the United States and t hc F;u ro[)eiin

Community). Whether or not adjustment is the ~)rimary mot i~’e, governments choose from a In(l II(: () r

less standard list when seeking policies to ai(l a

given industry: financial subsidies; protect ion: regulation; government procurement; funds for R&L).

Direct, sector-specific intervention has seldom

worked very well in the United States or i n J\’est -

ern Europe, u’ith most of the failures st [!nl m i ng f’rom

attempts to counter deep and poilerf’u ] e(:o nmnic

trends. Government aid can seldom enable industries suffering from mounting (:0111~):~1’ilti[’(; (disadvantage t o maintain customar~ output le[rels;

such policies easily become cou n ler-ad j ust ment

measures.

Are Services Special?

Pressures for adjustment can start an)’~~rhere:

service industries are potential dist urtxin(:cs. as ~~’ell

as potential buffers. While some dist (lrba rices or iginate abroad (o i] price increases in 1973-74 {i I]ci

1979-80, rising imports of steel and automobiles

from ]al)an), differential] ,grolvth rates ~~ithin tht)

U.S. econom}, as well as surging foreign in\’estments b}r A meri(: a n corporations, ha~’e created s[!-

~’ere stresses i n t hc past. So ha~e L1 .S. Go\rern ment
78 ● /international Competition in Services

— .

initiatives—e. g., President Nixon’s renunciation of

the gold-exchange standard in 1971, following the

breakdown of the Bretton Woods Agreement.

Within an economy as large as that of the United

States, only the banking industry among the services seems to carry the potential for major disturbances. The international banking system links national economies; any shock from the collapse of

a large U.S. (or foreign) bank, perhaps resulting from

too many bad loans, could spread through the system’s network of interlocking deposits and credits.

If other banks were to fail in a domino effect, instability in national financial markets would be only

a short step away.

If only the banking industry among the services

carries the potential for severe disruptions, what

about the potential of service industries for facilitating adjustment? Do any of the services enhance the

robustness and resiliency of the U.S. economy out

of proportion to their size and their contribution

to economic diversity (by, say, quickly adapting to

new conditions, soaking up resources displaced

elsewhere, using a shifting mix of inputs or changing their rates of output in response to new conditions)? Here, the services show no outstanding advantages compared to goods-producing industries.

At the same time, the services (other than banking)

should generally be able to respond to disturbances

without aggravating adjustment problems. The implication: if none of the service industries have unusual potential for offsetting adjustment pressures,

then none has much claim on government policies

that would favor it over other industries in the name

of smoothing adjustment.
Chapter 3

International Competition in Banking

and Financial Services
CONTENTS

Page

Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81

Growth and Competition in International Financial Services . . . . . . . . . . . . . 85

Market Dynamics. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85

Onshore and Offshore Banking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87

Securitization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89

International Banking Strategies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94

New and/or Rapidly Growing Product Markets . . . . . . . . . . . . . . . . . . . . . . . 94

Movement Into Investment Banking. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99

Finding Profitable Market Segments in Commercial Banking . ..........100

The Future . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ................101

Japanese Competition: Two Scenarios . . . . . ............................103

Constrained Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .............104

Rapidly Mounting Competitiveness . . . . . . . . . . . . . . . . . . . . . . ........ ..106

Policy Issues... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ....................108

Domestic Regulations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ..............108

Future Policies; Negotiating Objectives . . . . . . . . . . . . . . . . . . . . . . ........111

Concluding Remarks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. ...113

Box

F. Foreign Banks

G. Technology in

Systems . . . . .

Boxes

Page

in the United States . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90

Banking: Electronic Networks and Cash Management

... ..... . . . . . . . . . . . . . . . . . . . . . . . . . . . . ● .* 91

H. The Role of the Dollar . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97

Figures

Figure No. Page

20.

21*

22.

23.

24.

25.

Relative Asset Shares of the World’s Largest Banks . . . . . . . . . . . . . . . . . . 86

Lending in the United States by Foreign-Owned Banks . . . . . . . . . . . . . . . 88

Growth in Fee Income Relative to Interest Income for U.S. Banks . . . . . 93

Return on Equity in Banking, Five Countries . . . . . . . . . . . . . . . . . . . . . . . 94

Growth of the Eurobond Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96

Sources of External Financing for Japanese Corporations . . . . . ........102

Tables

Table No. Page

11. Growth Rates of International Banking Compared to World Trade . . . . . 85

12. Companies With Shares Traded on Foreign Markets,

by Home Country . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88

13. Eurobond Issue Managers by Country . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97
Chapter 3

International Competition in Banking

and Financial Services

SUMMARY

Over the postwar period, few international

businesses have grown as rapidly as banking.

For 20 years or more, rates of expansion on

many measures have been in the range of 20

percent per year. National capital markets have

become more tightly integrated, mirroring linkages among banks and other financial institutions. More than 150 U.S. banks maintain

branches overseas; Citicorp alone operates in

more than 90 countries. Foreign banks have

reciprocated, opening new offices throughout

the United States.

Truly international capital markets have led

to a broad range of new financial products,

some of them listed in table 8 in chapter 2. Many

of these new products have been introduced

in the so-called Euromarket. This offshore or

external market, relatively free of the restrictions and regulations that governments normally

place on financial transactions, has become a

highly desirable alternative for businesses seeking to place or to raise funds. Because the Euromarket is efficient, costs for both lenders and

borrowers are low. Firms can issue financial

instruments (e. g., bonds, notes, commercial paper) in dollars or almost any other currency.

In a typical transaction, the London office of

the U.S. securities firm Prudential Bache raised

a total of 4.3 billion yen (about $16,7 million)

early in 1985 for the Japanese robotics manufacturer Dainichi Kiko through placements with

seven institution] investors in Europe.l

Two primary forces lie behind much of the

growth and change in international banking:

deregulation, and new technologies. The United

States has been a leader in both, with generally positive impacts on U.S. international com-

‘11’, 1)~ t~ ~ i ns a II [~ }’. Sh iba t a, ‘‘.) ~ l~lPan~~s~? L’pS[;t for \’~;[lt~] r~:

(;a~)it~il i~t ~,” F’in[infi:f) ‘l”imf’~, ()(:t. 28, 1986, p 28.

I)aln 1(.t] I KIkIJ ~;rltcrc[l barl kr{];)![ \ tllf~ rl[:~t year.

petitiveness in financial services. (While this

chapter focuses on companies that identify

themselves as banks, boundaries between banks

and other financial firms have blurred; OTA

has not attempted to maintain hard and fast

distinctions by firm or by product.) Laws and

regulations constraining banks have been relaxed

or repealed. Looser regulation means opportunities for new products. Deregulation, by increasing competition, also drives down profit

margins, inducing some banks to take greater

risks in the hope of maintaining profitability.

Governments everywhere stand behind the

safety and stability of their banking systems;

plainly, deregulation will only go so far. Governments will also continue to influence banking activities as they pursue macroeconomic

policy and control of the money supply. The

relationships between public and private sectors in banking are unique among industries.

Financial service firms have been major users,

but not originators, of postwar advances in

computer and communications systems, Thus

technology—the other major driving force—

has been an independent factor. Deregulation

permits firms to broaden the scope of their financial activities; technical advances make it

possible to do so efficiently, and on a global

scale. Banks turned to computer technology,

first, to help manage their vast flows of paperwork. Strategic applications came later, complementing back-office automation (ch. 8), with

banks looking to technology for help in escaping from government regulations; offshore Eurobanking, perhaps the preeminent example, began in the early 1950s, but it was electronic

funds transfers that freed offshore markets from

fixed geographic locations, opening them to

worldwide participation.

Today, a large American company can arrange a loan in Tokyo or place a security denom81
82 ● International Competition in Services —

inated in yen and swap the currency into dollars to be spent in the United States (or marks

to be spent in Germany), at the same time swapping a fixed interest rate for a variable rate—a

transaction that, while not unheard of, would

have been unusual as recently as 1980. Funds

flow across national boundaries as never before, and national financial systems have become tightly interwoven. Once, the effects of

a major failure would have been isolated within

the bank’s home country; today, they could ripple around the world. While steps taken in the

past few years have allayed much of the immediate concern over stability of the world financial system, future developments could easily

lead to renewed fears of worldwide banking

collapse.

This chapter examines competition in international financial services, in both offshore and

onshore markets. (Onshore banking refers to

operations in national markets by foreignowned banks—for instance, Japanese banks in

the United States.) With the need to focus on

international banking, and the competitiveness

of U.S. financial services firms, OTA has not

been able to give much space to the well-publicized changes taking place in domestic retail

banking, although many of these have also been

driven by the twin forces of deregulation and

new technologies; in U.S. retail banking, the

half-dozen standard products of a decade ago

have given way to a hundred or more.

The sections that follow highlight four major points:

1. The maze of U.S. banking regulations—

implemented by the States as well as by

Federal agencies—exerts wide-ranging impacts on the international competitiveness

of the U.S. financial services industry.

Rapid expansion of international banking

makes these impacts much more important

than just a few years ago, but policy makers

give them little consideration. OTA’s analysis indicates a need for the policymaking

process to reflect, on a routine rather than

exceptional basis, the impacts of Federal

policies on the international competitiveness of the U.S. financial services industry.

2,

3.

4.

Regulators confront moving targets as technological change and competitive pressures lead to continuous restructuring in

world financial markets. Increasingly integrated but decreasingly regulated markets pose greater dangers of instability and

world banking collapse. National regulations intended to protect depositors and

ensure stability have self-limiting effects;

in a competitive world, they drive banks

to seek unregulated markets and unregulated products–a dynamic that can lead

to greater risks. U.S. leadership in seeking

greater international coordination of banking supervision and banking regulation

could help move the system toward a more

stable footing. (To some extent, the decrease in regulation has been accompanied

by an increase in supervisory oversight by

government bodies—i. e., by monitoring

rather than control.)

External markets have grown as providers

of capital search for higher returns, while

corporate borrowers seek lower financing

costs, Not long ago, corporations went to

the Euromarkets for bank loans to support

their foreign subsidiaries. Today, they look

to these markets for securitized financing

—bonds and stocks, commercial paper that

can be traded in secondary markets—to finance domestic as well as foreign operations. Securitization—the replacement of

loans by marketable securities—has permanently changed the environment for international competition. The consequences

make competitive life more difficult for

U.S. banks.

Only the Japanese seem in a position to

challenge American financial services firms.

As Japan’s financial markets become more

fully integrated into the world system—in

part as a result of prodding by the U.S.

Government—Japanese financial institutions will mount major competitive challenges. While it is too early to predict the

outcomes, it is not too early to take account

of this new source of competition in implementing Federal policies. For example,

it is not at all clear that U.S. pressure aimed
Ch. 3—international Competition in Banking and Financial Services • 83

at opening up Japan’s capital markets is

in the longer term interest of the U.S. financial services industry.

In such a world, can the Federal regulatory and

supervisory system continue to cope? This chapter suggests that, at the very least, the system

needs modification to bring national and international considerations into better balance.

As they have evolved since the 1930s, U.S.

banking policies, at both State and national

levels, have generally been focused quite narrowly on the particular problems of a particular time. The policies themselves emanate from

a bewildering assortment of State and Federal

authorities (including, at the national level, the

Comptroller of the Currency, the Federal Reserve Board, and the Federal Deposit Insurance

Corporation (FDIC)). Rarely have either State

or Federal agencies examined the possible impacts of their actions on the international competitive standing of U.S. banks, even though

in many cases these impacts are real and apparent. The FDIC, for instance, establishes premium levels with little effort at coordination

with other governments; yet international differences in these premiums alone could place

U.S. banks at a competitive disadvantage.

One of the policy options in chapter 10 (option 13) would establish mechanisms for monitoring and coordinating the actions of Federal

agencies as they affect the international competitiveness of the U.S. banking industry. This

is not to suggest that these impacts should dictate policy, but that they should take their place

with other considerations as a normal part of

the policymaking process.

National banking regulations exist in part to

foster confidence in the security of deposits and

in the continuing viability of the system as a

whole. But continuing restructuring of world

financial markets, driven in part by advancing

technology, can quickly make the regulations

of any one country obsolete. New products,

many of them securities, continually stretch the

boundaries of the permissible. With sources of

interest income remaining more heavily regulated than fee-earning services, banks develop

new products that replace loans with other

sources of earnings. As banks and other institutions develop new forms of financing, regulatory officials find themselves chasing moving targets. When the regulatory agencies react

to their innovations, the banks move off in

another direction.

In the United States, the responsibility for

monitoring and for implementing regulatory

policies shifts between agencies as new forms

of financing spring up, with ultimate authority becoming diffused and confused. The problem is little different in other national markets.

Internationally, the situation is still messier; regulatory structures, where they exist, remain

poorly developed. The growth of offshore markets makes regulations in any and all countries

less effective because financial institutions have

more ways of avoiding them. Although the

banks themselves benefit from a stable international environment, they have been more

concerned with narrow questions that affect

their ability to compete with one another. Banks

and national governments are in similar positions: individually, they can do little to preserve

stability internationally.

In this climate, governments have begun to

consider methods for coordinating and harmonizing their regulatory and supervisory practices.

The Federal Reserve and other U.S. authorities

have opened discussions on the possibility of

international rules for external markets. Recent

proposals for a bilateral agreement with the

United Kingdom (U. K.) on capital requirements

may be a first step towards broader arrangemerits. 2 OTA’s analysis points not only to the

need for continuing such talks, but to the need

for a thorough study of sources of possible instability.

If coordination of regulations might help, national interests will inevitably differ and widespread agreement may be hard to achieve. At

this point, it is not even clear that appropriate

international forums for negotiation exist. Over

the past few years, the Basel Committee, an

advisory group of central bankers and super-
84 ● International Competition in Services

visory officials from fewer than a dozen major

nations, has provided a place for discussion,

but the Committee would not necessarily be the

proper setting for negotiations among governments. In chapter 10, OTA suggests steps that

would help focus attention on questions of international coordination and the further development of an international regime for the supervision of financial services.

what then of U.S. international competitiveness in banking? Securitization—replacement

of bank loans by securities as preferred sources

of corporate financing—has made deep and permanent changes in the competitive environment, Investment banks have become much

more prominent in international markets because of their experience in structuring new

securities issues; rapid growth has led U.S. investment banks, which remain small compared

to commercial banks, to seek new capital—

sometimes foreign—in order to keep pace with

market expansion. At the same time, where permitted, U.S.-based commercial banks have

plunged into investment offerings (regulations

restrict this in the United States). U.S. commercial banks have also sought other sources of income to supplement their international lending, Some of these fee-based products—e. g.,

foreign exchange trading, interest rate swaps—

could turn out to be riskier than anticipated.

OTA’s analysis suggests that the competitive

changes caused by securitization threaten the

competitive position of individual banks more

than that of the U.S. industry as a whole. Indeed, relative to foreign industries, the American financial services industry has done well

in the rapidly shifting competitive environment

of the past few years. American banks have

been able to take advantage of learning and

experience in their deregulated home market

ahead of major foreign competitors; some of

latter have invested in the United States primarily to gain experience. From all recent signs,

U.S. international competitiveness in banking

and financial services will remain strong. This

does not mean, of course, that all American

banks will do well internationally. This is an

industry with many competitive firms. Some

do well in some markets, some do well in others.

Products are similar, technology—though not

the expertise to use it—easy to come by. New

financial services arise in part as banks struggle to differentiate themselves and become

something other than purveyors of commoditylike products. No one can count on decisive

sources of advantage or sure success in the

future.

There seems only one real threat to the competitive rank of the U.S. financial services

industry—Japan. Japanese banks, almost invisible 15 years ago, have become major players

on the international stage, Because of continuing and massive bilateral trade surpluses with

the United States and other industrial nations,

Japan has become a huge international creditor,

particularly in dollar-denominated financial

assets. Japanese banks now hold more international deposits than their American counterparts, and far surpass any other national industry. The competitive thrusts of Japanese banks

show greater sophistication today than even 2

or 3 years ago,

Yet Japanese competition has thus far made

few major differences for U.S.-based financial

institutions. American banks have been aggressive, innovative, and efficient—qualities that

have enabled them to maintain their international position in an increasingly deregulated

global environment, Could all this change, in

the way it did for manufacturing industries like

automobiles or consumer electronics? Could

the Japanese exploit new competitive opportunities to carve out ever-larger shares of international markets? Do their onshore investments

in the United States represent competitive strategies aimed at the home markets of American

banks? while not impossible, and while some

signs point in this direction, parallels between

markets for financial services and manufactured goods can easily be overdrawn.

Banking has been a highly competitive international industry for decades, with many firms

from many countries competing in a least some

parts of the market. In such industries, few of

the forces affecting competitiveness, in isolation, make a big difference (the way technical

skills do in the commercial aircraft industry,
Ch. 3—International Competition in Banking and Financial Services ● 8 5

or scale economies once did in automobile pro- bound to intensify, with the pace largely conduction). American banks have not been insu- trolled by Japan’s willingness to liberalize its

lar or insulated; they have capitalized effec- financial markets. The competitive threat is

tively on advantages where they could find real, but careful monitoring of relative positions

them, just as foreign banks have, Competition seems the appropriate response for the moment,

between the United States and Japan seems

GROWTH AND COMPETITION IN INTERNATIONAL FINANCIAL SERVICES

Banking—the second-oldest service—was also

one of the earliest to be traded internationally.

Trade in goods still requires financing, but international banking today hardly resembles the

industry of even a decade ago. Looser regulatory structures have bred greater competition

among more banks in more parts of the world.

No longer can banks live comfortably within

sheltered regional or national markets. Protective barriers offered one of the few sources of

decisive advantage in a business with many able

competitors, quick to copy good ideas. Although

much of the business continues to revolve

around trade-related instruments like letters of

credit and banker’s acceptances, new products

—particularly those sold in lightly regulated or

unregulated external markets—have grown at

an explosive pace, Here, the banks that have

gotten in first have generally been able to maintain leading positions.

Market Dynamics

International banking deposits (as defined in

table 11) have grown much faster than world

trade [i.e., total world exports of goods and services). In most countries, international banking

Table 11 .—Growth Rates of International Banking

Compared to World Trade

Annual rate of growth

1966-73 1973-80 1980-84

Total international banking

deposits a . . . . . . . . . . . . . . . . . 30.0% 24.4% 6.6%

Total world exports . . . . . . . . 9.2 25.2 – 1.5

aEqual t. the sum of domestic and foreign currency Ilablltttes to nonresidents

of all banks world wide, plus their foreign currency ha bllltles to residents

SOURCES Annua/ I?eporl Bank for /n(emaf/ona/ Sett/ernenK (Basel, Switzerland

Bank for International Settlements. various years], /nternatmna/ F/nan

c~al Staf/st/cs (Washington, DC International Monetary Fund vari

ous years)

has also grown more rapidly than domestic banking; for the nations of the Organization for Economic Cooperation and Development (OECD),

the ratio of foreign to domestic liabilities more

than doubled during the 1970s, and has continued to rise, albeit more slowly,3 During the

1970s, banks everywhere found their profitability slipping in traditional markets, Early responses included heavy lending to newly industrialized and less developed countries (NICs

and LDCs), and to Eastern Europe. Rising oil

prices meant large trade surpluses in some

countries and large deficits in others; banks

could get funds from oil exporting countries,

extend loans to importing countries, and expect handsome profits. These loans grew to become a significant part of the portfolios of many

major banks before the shortcomings of the

strategy became clear to all.

During this period, American banks did about

27 percent of the total syndicated lending to

these countries, about the same as their percentage of worldwide assets.4 Worldwide reces3R, M. Pecchioli, The internationalization of Banking: The Polic~’ Zssues (Paris: Organization for Economic Cooperation and

Development, 1983), p, 16.

To take a different kind of indicator, the number of major banks

having offices in banking centers outside their home countries

increased from about 300 in 1970 to 550 in 1980— The Bankers

Almanac and Yearbook, 1970-71 and 1980-1!38 ] (New York: I.P, C,

Business Press Limited).

4“International Bank Lending Trends, ” L1’or/cj J’jnan(;jaj A~arkets (New York: Morgan Guaranty, July 1985), pp. 5, 7,

By the end of 1986, Brazil’s foreign debt stood at about $108

billion and Mexico’s at $100 billion. Among countries seeking

rescheduling, these two are followed by Argentina ($50 billion],

\~cnezue]a ($35 billion), and the Philippines ($27 billion]. Major

lenders to these countries include Citicorp (the largest single

lender to Brazil and Mexico), Manufacturers Hanover,

BankAmerica, and Chase; each of these banks has loans outstanding to Brazil that total more than half of its shareholders’ equity.

Ten or more U.S. banks have outstanding Latin American loans

totaling more than their equity. See P. Truell, “Citicorp’s Reed
86 ● International Competition in Services

sion and falling oil prices, along with less than

prudent loans, make repayment of principal

and in some cases the interest on many of these

obligations uncertain. In worst case defaults,

the capital of even large money-center banks

could be wiped out, leading to a crisis at the

lending bank or banks; beyond ongoing risks

of defaults, the major implication for competitiveness is that banks with high levels of risky

international debt will have limited strategic

options.

Big banks take most of the business in international financial services; perhaps two dozen

firms with headquarters in the OECD nations

account for more than half of all cross-border

lending, and some 60 percent of lead managements of bonds and other securities issues. s

Among these banks, positions have been changing. As figure 20 shows, the assets of the largest

Japanese banks have been growing steadily, and

now exceed those of their American counterparts. The relative shifts visible in figure 20 reflect macroeconomic factors such as differing

economic growth rates and currency exchange

values, among other things, with the increase

in U.S. asset share between 1980 and 1984

largely a consequence of the strength of the dollar during that period.

Cross-border assets paint much the same picture. At the beginning of 1986, Japanese banks

for the first time held more international deposits than U.S. banks—a gap that widened

quickly during the year as the dollar weakened.

As figure 4 (in ch. 1) showed, banks from other

countries trail far behind. The rapidly rising

assets in the Japanese financial system stem in

large part from Japan’s consistently high trade

[continuf)(i from prf?~fou,s page]

Takes Firm Stance on Third-World Debt, ” Wall Street journal,

E’eb, 4, 1987, p. 6; “Risks of Foreign Banks in Latin America, ”

Financial 7’irnes, Feb. 25, 1987, p. 4; E,N. Berg, “Brazil’s Debt:

A Key Juncture, ” Newr York Times, Mar. 3, 1987, p. D1.

U.S. banks are particularly affected by Latin American debt

problems, with Western European banks exposed in Eastern Europe, and the Japanese in Indonesia. In lending to Brazil, Japan

follows the United States, with outstanding long-term loans of

$8.8 billion, compared with $18.6 billion for American banks.

5P. Mentre, “The Fund, Commercial Banks, and Member Countries, ” Occasional Paper 26, International Monetary Fund, April

1984.

Figure 20.— Relative Asset Shares of the World’s

90

80

70H

1970

Largest Banksa

4v

1984 1985

Year

.

—

U Another. E Japanese bank. ■ U.S. banks

a300 largest banks for 1970-84; 500 largest fOr 1985

SOURCES 1970.84: The Banker (var!ous Issues), 1985: “30th Annual Survey of

the World’s Top 500 Banks, Part 11, ” Arnerlcan Banker, July 30, 1986,

pp 36-44

surpluses over the past half-dozen years. It is

this growth in assets that, more than any other

factor, points toward greater competitive challenges by Japanese banks,

in 1984, the latest year for which comparable data are available, Citicorp remained the

largest financial institution in the world as

measured by assets, with $190 billion, followed

closely by five Japanese banks, the largest of

which was Dai-Ichi Kangyo, at about $170 billion.6 Measured in this way the dominance of

Japanese banks as a group appears overwhelming. When measured by profits, however, Citicorp was far ahead, earning almost a billion

dollars, compared to runnerup Barclays (British) at $600 million. National Westminster

(another British bank), Chase Manhattan, and

Manufacturers Hanover all reported greater

84’ International Banking: Wooing the Customer, ” The Economist, Mar. 22, 1986, p. 6; “30th Annual Survey of the World’s

Top 500 Banks: Part I I,” American Banker, July 30, 1986, pp.

36-44. In 1985, Dai-Ichi Kangyo became the biggest bank in the

world as measured by assets, and in 1986 the biggest bank holding company as measured by assets, surpassing Citicorp.

AH measures of bank size and profitability reflect dramaticall~

shifting exchange rates, as well as differing accounting principles and banking practices.
Ch. 3—International Competition in Banking and Financial Services . 87

profits than the Japanese leader, Sumitomo

(which earned less than $400 million).

American banks have generally moved the

fastest into fee-based services, many of which

generate profits that do not translate into assets, This accounts for some of the disparity

between asset and profit measures. Data presented later in the chapter show that U.S. financial institutions have large and often increasing shares of markets for major international

banking products, American banks also tend

to have many more foreign branches: by Sumitomo’s count it has only 40 foreign branches,

compared with over 1,800 for Citicorp. In summary, the big U.S. banks, while certainly not

dominant, remain competitively strong,

Competition among banks is only part of the

story. U.S. banks have new rivals who have entered from outside the financial services industry—not only corporations that place their own

commercial paper, but companies expanding

into financial services from other industries.

Some, like the major department stores with

their charge cards, and automobile companies

with their financing subsidiaries, have been extending consumer credit for years—and earning healthy profits from these parts of their businesses. More recently, companies like Sears

—which purchased Dean Witter in 1981—have

sought to use their marketing skills and network

of outlets to enter retail markets for financial

services. Thus far, entrants from other industries have not had much impact internationally, nor have mergers between financial and

nonfinancial firms been outstandingly sucessful; frequently, profits of the merged units have

fallen,

Onshore and Offshore Banking

Funds move internationally in two kinds of

markets, onshore and offshore. In an onshore

transact ion—e. g., when an American corporation arranges to borrow yen in Tokyo—foreigners participate through national markets. Onshore banking also takes place when foreignowned financial institutions enter domestic

markets—when a Japanese bank opens offices

in San Francisco or New York, or buys an

American bank. In offshore markets, financial

transactions take place largely beyond the regulatory reach of the government issuing the currency of the transaction—the case when an

American corporation borrows dollars (or yen)

in London. Offshore markets, often called Euromarkets because much of the activity continues to take place in European financial

centers, tend in practice to be largely free of

regulation by any and all governments; they

need have no fixed geographic location, and

today could almost be viewed as existing in the

telecommunications infrastructure.

In either onshore or offshore markets, flows

of funds can be direct or intermediated. In the

first case, a broker brings together a buyer and

seller of securities (e. g., stocks or bonds). Direct flows of funds in the foreign sector of national capital markets mostly involve bonds, In

intermediated transactions, a financial institution, usually a bank, borrows by issuing its own

liabilities and lends the money to others.

Today, onshore markets for foreign bonds,

concentrated in Switzerland, the United States,

and Japan, total about $30 billion; continuing

regulatory constraints have slowed growth,

contributing to expansion in other financial instruments. Onshore markets for equity (stock)

have begun to expand rapidly, although remaining small compared to foreign bond markets.

While the shares of relatively few corporations

are listed on exchanges outside their home

countries—table 12—the numbers have been

headed steeply upward, especially among the

biggest companies; the 400 firms traded on foreign markets as of mid-1985 may have represented a quarter of the total capitalization of

their home-country stock markets, ’ It should

soon be possible to buy or sell any major stock

at any time of day or night through an exchange

in Europe, North America, or Asia, The emer7’4The (~orporate List ,“ EUrorr]one~, f-’ehrui+r~, 1986, [)1). 168- 1(;!1,

In 1983, [;or~)oratiorls raised $83 milllon throl~~t) nt:~t {~qu]t}

i~t~l[~s i 11 nlarkc)f~ outsi{~e their htJnltI ([)untries-a financing nlc(:h-

~ n i \ Hl ;] I m ost u nhca r(i o f 1) re~ i [)us] ~’, Ne\~’ E u roeq u it } issues t ()-

t,] l[~d $30(; m i] 1 ion i n I ~8q, $3,2 Ill 11 Ion in 1985, a n(i the ~a nl[:

a m c) u n t i n t h c first (j nlo n t hs () f I g8[j, See Q. II. I,i m, ‘‘ [{(] u i t i[l~

t+jnt[’r the [iurohontj ,+!gc, ” f~urom~jr]f;~, (){;t()tl[:l, I ~~~, 1), Z(;Z:

a n (1 ,S, 1 ,() h r, “rl’urning to Europe for Equit),” .\’et~f l’or~ 7’jJHfIs,

AUg, 21, 198(j, [), I) 1.
88 • International Competition in Services

Table 12.—Companies With Shares Traded on

Foreign Markets, by Home Country

Number of companies

Headquarters location of December December June

issuing company 1983 1984 1985

United States 84 85 85

Japan 49 65 81

United Kingdom 13 25 33

Federal Republic of Germany 17 22 26

Other 73 131 175

236 328 400

SOURCE Eurorrroney various Issues

2

20

1 5

10-

5

0

gence of foreign markets for stocks promises

to be a big step toward fuller integration of capital markets internationally, with dramatic consequences for the underwriting business.

Onshore banking through direct investment

has also been expanding, spurred by a loosening of regulatory constraints in countries including Japan, Canada, Sweden, Taiwan, and

Australia. Figure 21 shows the steady expansion of foreign bank lending in

Figure 21.— Lending in the United States by Foreign-Owned Banks

—

—

—

1975 1980

Year

❑ Total loans ❑ Business loans

1985

the United

NOTE. Percentages for December of each year, except June 1988.

SOURCE Federal Reserve Board, unpublished data, November 1986
Ch. 3—International Competition in Banking and Financial Services ● 8 9

—

States. New York, as a major international banking center, has been home to many foreign bank

offices for years: Bank of Tokyo’s New York

office was founded in 1880. But expansion elsewhere, and particularly in retail banking, is a

newer phenomenon; Japanese banks have become much more visible in California (Sumitomo Bank of California, California First, Bank

of California). In 1975, the foreign assets of U.S.

banks (outbound banking investment) greatly

exceeded the assets of foreign banks in the

United States (inbound); since then, outbound

growth has been slow compared to inbound,

and today inbound and outbound banking investment are about equal.8 Box F summarizes

reasons for the growing foreign bank presence

in the United States, while a later section looks

more closely at the strategies of Japanese banks.

The external or offshore markets function

quite differently. Eurodollar bonds, to take an

example, are denominated in dollars but bought

and sold outside the United States, typically in

London. Most Euromarket transactions involve

the U.S. dollar, but participants (buyer, seller,

underwriter) need not have their main businesses in the United States. Likewise, an American bank might underwrite a corporate bond

in London denominated in yen that is sold to

a French bank and raises money for a Brazilian firm; U.S. laws prohibit commercial banks

from underwriting such an issue here.

While London has traditionally been the center of the offshore market, Singapore and New

York have seen rapid growth in recent years.

Fierce competition has led to reduced operating costs and rapid expansion. In 1965, the Eurodollar market was less than 10 percent as

large as the domestic U.S. financial market–

$12 billion versus about $170 billion. By 1983,

the Eurodollar market had surpassed $800 billion, more than half the size of the U.S. domestic market. Direct financing, mainly Eurobonds,

has been growing considerably faster than the

intermediated transactions that also take place

in external markets. (Lack of regulations and

reporting requirements in offshore markets

means that their size can often be estimated

only roughly.)

eFederal Reserve Board, unpublished data.

Expanding external markets go hand in hand

with newer banking products that facilitate international flows of capital (table 8, ch. 2).

Telecommunications links (box G) have spurred

growth in interest rate and currency swaps,

(Swaps, explored more fully later in the chapter, involve the exchange of one financial asset or obligation for another. ) The annual volume of outstanding interest rate and currency

swaps has grown beyond $300 billion, With

these and other new banking products (e.g.,

standby letters of credit, also described later),

banks earn fees for their services rather than

interest. As figure 22 shows, fees have been

growing relative to interest as a source of revenues for U.S. banks. The shift toward fees is

probably greater for international banking than

for domestic operations.

Securitization

Perhaps the most striking and most significant change in financing practices—a change

that has accompanied the rise of external markets, and contributes to the growth of fee-based

services—stems from securitization. A company seeking financing can, in general, do so

either by borrowing from a financial institution or by issuing a security such as a bond or

stock. Likewise, those with money to invest can

deposit funds in a financial institution or buy

Figure 22.—Growth in Fee Income Relative to

Interest Income for U.S. banks

28

27

26

25

24

23

22

1981 1982 1983 1984 1985

Year

SOURCE. Federal Reserve Bullet/n, September 1986, P 627

63-527 0 - 87 - b
90 ● International Competition in Services

Box F.—-Foreign Banks in the United States

Figure 21 shows that foreign banks increased their onshore business in the United States quite

rapidly during the 1970s. Some of this growth has followed naturally from rising international trade

and expansion in foreign economies. Have competitive shifts played a part? Answers to this question

begin with the reasons that foreign banks invest in the United States.

The first of these, as in so many industries, is the size and lucrative nature of the U.S. market.

New York City is the world’s largest center for financial services. Any bank that sees itself as multinational will seek customers among American corporations, along with access to a base of dollar deposits and the discount window of the Federal Reserve System. Not only is the banking infrastructure

more advanced here than elsewhere, but financial services have been deregulated ahead of other parts

of the world. Foreign banks establish or expand U.S. operations in part to gain experience in a comparatively deregulated environment, one they expect to spread to their home country and to other

markets within which they do business.1 Differences in national regulations also create strategic opportunities; for instance, the mix of U.S. and foreign regulations that apply to branches and agencies

in the United States may result in lower costs for some financial service products-e. g., business loans—

for some foreign banks. Other reasons for investing in the United States include the following:

●

●

●

●

●

Foreign banks, many of which operate on a nationwide basis in their home markets, may feel

that they will have advantages over less-experienced U.S. institutions as interstate banking

spreads.

Until passage of the 1978 International Banking Act and subsequent legislation, foreign banks

were treated differently than American banks, arguably to their benefit. Moreover, U.S. antitrust policy has made it easier for foreign banks to purchase troubled financial institutions,

or bank units sold for strategic reasons—a quick and easy entry to fundamentally profitable

markets. For example, when Bankers Trust decided to reemphasize retail banking in the New

York City area in 1979, it sold most of its 106 branches to three foreign banks.2

Some foreign banks, less burdened by risky debt in developing countries than their American

competitors, have greater strategic freedom.

Just as American banks followed American corporations overseas, Japanese and some European banks have moved into the United States to serve their corporate clients.

Finally, entering the United States will make sense for any bank with reason to believe it can

compete; initial-entry into the U.S. market serves as a test. Rapid expansion can follow if the

bank finds itself to be highly competitive, or if the fluid environment here should shift in its favor.

Despite the possible sources of advantage mentioned above, the U.S. operations of foreign banks

have seldom been particularly profitable.3 While there are many reasons for foreign banks to seek

an onshore presence in the United States, there is little evidence that the expansion illustrated in

figure 21 points to competitive advantages over U.S. banks. And of course these banks are not selling

services supplied from overseas, but services produced here with the aid of U.S. workers, the U.S.

banking infrastructure, and, often, U.S. capital.

%s, for example, KA. Groeeberg, “’Japan Chaokhxg Out U.S. Banking Revolution,” Wall Street ]otrmd, Feb. 0, 1S88, p. 24.

zBank Leumi Trust National Bank of North America, and Bamiays-E. Compton,Inside Comnerdd flanking, Zd ed. (New York: Wiley,

1983), pp. 93-04, 1~,

%ee, for example, N. Gilbert, “Foreign Banks in America: They’re Still CorninS,” Ewwnoney Ausuat 1985, pp. 150-156. Of course, banke,

like firma in any industry, sometimes choose to sacrifice profits to buy market share.
Ch. 3—international Competition in Banking and Financial Services ● 9 1

Box G.—Technology in Banking: Electronic

As in so many of the services, new technologies

in banking mean, first and foremost, applications

of digital computers and telecommunications

systems. Banks have been leaders in applications

since computers began to spread in the business

world. Today, back-office paperwork functions

—e.g., check processing—are highly automated;

transactions processed overnight a few years ago

can be handled immediately. Larger financial

service firms continue to invest hundreds of millions of dollars annually in new software and

hardware, with much of the investment now

going to support new products rather than the

automation of existing operations. Fault-tolerant

systems cut down on errors, with some banks

investing millions of dollars for backup systems

that may never be used—but if needed, could save

far greater sums (see the Bank of New York example below).1

Banks are also learning to use computers analytically–for risk analysis and decision support

—as well as for routine transaction processing.

Simple computer programs can calculate a range

of possible repayment schedules for proposed

loans; complex programs analyze price trends

of thousands of Eurobonds each day. Software

developed by Bankers Trust reputedly gives the

company’s foreign exchange traders a 10 second

advantage over the competition, enough time to

execute four or five trades. Soon, expert systems

will be available in the form of computer programs that embody the decision rules followed

by experienced foreign exchange traders. The expert system will never be as good as the true human expert, whose storehouse of experience

leads to judgments and intuitions that cannot

be reduced to rules the computer can follow (ch.

8). But expert systems will help the inexperienced

to learn, the inexpert to perform better, and the

true expert to avoid errors. Among those recently

surveyed, about 20 percent of American financial institutions had already begun to install expert systems, with another 40 percent planning

to do so over the next few years.2

IOn backup systems, and applications mentioned in the next paragraph, see R.B. Schmitt, “’The Technology Gamble,” Wd StreetJourmd, Sept. 29, 1986, p. 10D.

New technologies used in retail banking-e. g., automatic teller machines (ATMs)—have more visibility but little to do with international

competition. Their main effect is on the price and quality of retail

services domestically.

Z“The Future of Technology in the Financial Services Industry, ”

American Banker, Apr. 14,1986, p. 14. Coopers and Lybrand, which

Networks and Cash Management Systems

Networks. -Banks communicate and transfer

funds through computers linked to form value-

-added networks (VANS, ch. 5). Member banks

can transmit messages both domestically and

across national borders via SWIFT (Society of

Worldwide Interbank Financial Telecommunications), which began operations in Europe in

1977 and now links nearly 2,000 locations in over

50 countries. Jointly owned by more than a thousand banks, the SWIFT system currently handles

almost a million messages each day.

SWIFT transmits messages between banks, but

not funds. These are the province of other computer networks. Normally, any international

transfer involving dollars will make use of CHIPS

(Clearing House Interbank Payments System),

controlled by a dozen large New York banks (the

clearinghouse banks) and connecting 140 U.S.

and foreign-owned institutions, all in New York

City. (Three of the clearinghouse banks—Marine

Midland, National Westminster Bank U. S. A.,

and European American Bank—are subsidiaries

of foreign companies.) CHAPS, a similar network

in the United Kingdom, serves the large London

banks. In a typical transaction:

Bank A in London has a correspondent relationship with Bank B in New York and

wishes to transfer funds to Bank Din Tokyo

which has a correspondent relationship with

Bank C in New York. B and C are CHIPS

members.

After message traffic between A and B concerning the transaction, perhaps over SWIFT,

B enters codes for itself and for the receiving bank C into its CHIPS terminal, along

with the sum to be transferred and the identity of bank D.

The message goes to the central CHIPS computer, where it is stored temporarily.

The sending bank B must next transmit a verification for the release of funds. The cenconducted the survey, found that rnorebanks than insurance campaniee, brokerage firms,ar investment houses expected to use new technologies like expert syatems as competitive weapons. An analyst at

Arthur D. Little has estimated that 35 percent of the largest U.S. financial institutions will install prototype expert systems during 1987,

compared with 5 percent in 1986-W.M. Bulkeley, “Computers Take

on New Role As Experts in Financial Affairs,” Wall Street Journal,

Feb. 7, 1986, p. 23. For further examples of expert systems applications, see B.J. Feder, “The Computer As Deal Maker,” New York

Times, Aug. 14, 1986, p. D2; also, L. Kehoe, “White Collar Robots

Go To Work,” Financial Times, Aug. 5, 1986, p. 9.
92 ● International Competition in Services

tral computer then debits the CHIPS account

of B, and credits the account of the receiving bank C (retaining a permanent record).

Bank C informs Bank D that the transaction

has been completed.

Normally, each of the 140 banks will settle its account with CHIPS at the end of the business day.

Final settlements use FedWire-another network,

this one operated by the Federal Reserve System.

FedWire, which links about 6,300 financial institutions in the United States, nets transactions

immediately.

Many other networks also provide electronic

funds transfer services, with about 66 automated

clearinghouses (ACHs) currently operating in the

United States. In contrast to CHIPS, most ACH

transactions are relatively small. They also provide services to firms outside the banking industry-e. g., direct deposits of employee paychecks.

Other computer networks provide quotations

and execute trades of commodities and securities. Non-financial firms can tap into almost any

of these systems with an electronic cash management system, as discussed below.

Multinational banks commonly operate private

international networks for communications between branches—e.g., Manufacturers Hanover’s

Geonet. A common pattern consists of service

centers in major financial markets, from which

further spokes fan out. Hongkong and Shanghai

Bank, for instance, operates a telex network linking more than 100 offices in over 60 countries

based on leased lines (cable and satellite) and

switching centers in Hong Kong, Britain, the

United States, Bahrain, and Australia. The company also has a newer computer network, only

partially completed, which operates at much

higher speeds. Independent vendors such as

GEISCO, Telenet, and Tymnet-all of which offer specialized services for banks-provide a further set of alternatives for message communications and securities transactions.

The greater the speed with which message,

clearing, and settlement systems function, the

greater the opportunities for banks to make profits on certain kinds of transactions. On the other

hand, when the time lags between messages,

clearing (transactions booked), and settlement

(payment made) decline, financial institutions

have less chance to take advantage of floats, the

de facto interest-free loans made possible by these

lags.

Implications for Stability.-Computer networks

are never foolproof. A highly publicized failure

cost the Bank of New York about $5 million during a 2-day span in November 1985. The bank,

which does a very large business in government

securities, normally receives and makes payments

on these securities almost simultaneously. A software error in the firm’s system left it liable for

payments without receiving the corresponding

credits. Before discovering the problem, the bank

ran up a $32 billion overdraft with the Federal

Reserve. The $5 million in interest charges came

to about 5 percent of the bank’s annual earnings.3

As message, clearing, and settlement networks

evolve toward greater complexity and greater

speed, the probabilities of system failures may

not rise, but their consequences certainly will.

When, for instance, payments moved through the

mail, failure of a bank might be a process taking

weeks. Regulatory authorities could monitor the

situation and intervene if appropriate. Now a

bank could fail almost instantaneously.

Cash Management.–For many years, banks

provided services to corporations in exchange

for the interest-free use of funds on deposit. With

rising interest rates, corporations began to view

this as a bad bargain; today, corporate treasurers

manage their cash balances and short-term assets much more aggressively, as they have always

managed long-term finds. Banks have been faced

with the loss of more than the interest income.

Many of their traditional customers now have

the ability to manage their own cash, should they

choose to do so. Typically, the banks have restructured their products and accounts in response, and introduced new computer-based

technologies to offer corporations a package of

cash management services that can handle not

only currency, collections, and disbursements,

but transactions in commercial paper, short-term

notes, and foreign exchange.

For a multinational corporation (MNC), the

cash management system will aggregate information from, and move funds among, branches

*J.M. Barry, “Cornputar Sxmrled N.Y. Bank,” t%’ushington R@, Dac.

13, 1S85, p. D1. Trading in government aacuritiaa averagaa about $200

billion daily.
Ch. 3—International Competition in Banking and Financial Services • 93

and subsidiaries around the world. In effect, the

bank helps the corporate treasury operation improve its efficiency—for instance, by sweeping

all idle cash into an investment account on a daily

basis.’ The bank gives up the use of the higher

balances the corporation once maintained, but

gets fees for the-new services it provides. The

corporation gets an integrated package, without

having to put the system together itself (although

some do). Already, cash management systems

may provide direct access to market quotations

and execution of buy and sell orders. In principal,

a company can centralize almost all its cash management functions at a single treasury work station (a computer terminal or PC). Thus far, perhaps a thousand treasury workstations have been

installed worldwide—most of them in the United

States; as experience accumulates, they will probably become much more popular.

MNCs and other large corporations deal with

many banks, most or all of which must participate for a cash management system to function

efficiently. The major U.S. commercial banks pioneered integrated cash management services,

at home during the 1970s and internationally beginning in the early 1980s. Differences in tax laws

4RJR Nabisco (formerly RJ Reynolds) says it saves $2o million annually through cash management techniques. For instance, the company can now match a need for Deutsche marks 6 months in the future to pay for German tobacco machinery with an expected inflow

of marks from overseas subsidiaries. Previously, it would have purchased a forward contract from a bank to lock in the price of the machinery in dollars, See “How the Last Became First,” Euromoney,

February 1986, p. 39.

securities directly. Securitization refers to the

growing tendency for those on both sides—

funds seekers and investors—to choose securities, and for these securities to be traded in

secondary markets. Banks can securitize existing loans by selling the right to collect the interest and principal. Individuals securitize

when they purchase shares in a money market

mutual fund as an alternative to demand deposits.

Securitization reduces the demand for traditional financial services, particularly by larger

customers; a corporation that once borrowed

and banking regulations, as well as restrictive

telecommunications policies, have led to complications abroad, with many foreign banks reluctant to participate. At present, for example,

Japan’s Ministry of Finance permits a computer

link between a corporation and a bank, but prohibits electronic funds transfers; the Ministry

plans to remove this restriction once Japanese

banks have become more competitive in cash

management technologies. While the larger European banks have also begun to develop their own

systems, their software remains far behind the

best U.S. practice. A survey of 60 large multinational banks, with headquarters in Japan, North

America, and Europe, revealed that many depend

heavily on American cash management technology.5

“’New Directions in European Cash Management, ” Business International, 1985. While most banks in most countries, including the

United States, had developed their own software, 16 of the 60 worldwide chose Chemical Bank’s BankLink. Outside the United States,

software from National Data Corp., also an American firm, was the

second choice to BankLink. Of the four Japanese banks surveyed, none

had developed their own software, all looking instead to U.S. suppliers.

The survey painted a similar picture for network services. GEISCO,

a CeneraJ Electric subsidiary, supplied VAN services to half the overseas banks, and more than half the American banks. Overseas, local

post, telegraph, and telephone authorities (PTTs) were second to

GEISCO, with other U.S. firms, such as ADP, also providing services

both in the United States and abroad. Four U.S. banks maintained

private networks, but only 2 of 34 foreign banks.

A survey of corporate treasurers internationally ranked Citibank

at the top of commercial banks providing electronic cash management services, followed by three other U.S. banks—BankAmerica,

Chase, and Chemical. See “Corporate Finance,” Euromone~, March

1985.

from a bank may now issue commercial paper

directly. And in some cases, the bank’s intermediary role—bringing together investors and

those looking for financing—declines, But in

other cases, even with securitization the bank

continues its traditional functions, particularly

those of managing the sizes, risks, and maturity of assets and liabilities; financial intermediaries collect small deposits and make large

loans (and use demand deposits to fund term

loans), and substitute their own creditworthiness for that of the borrower.
94 ● International Competition in Services

INTERNATIONAL BANKING STRATEGIES

Profitability in banking has been dropping—

figure 23.9 While competition has intensified

in lending, the traditional core of the business,

loans have been diminishing relative to feeearning services as a source of earnings. Regional and national markets, once comfortably

segregated, have been opened to new entrants,

domestic and foreign. Securitization has cut

‘No comparative data more recent than that in the figure is

available. Both the largest and the smallest U.S. banks showed

further drops in profits during 1985; although average profit levels

for all U.S. banks rose in 1985, reversing a 5-year decline, Continental Illinois’ return to profitability accounts for the entire

gain. See D.J. Danker and M.L. McLaughlin, “Profitability of

U.S.-Chartered Insured Commercial Banks, ” Federal l?eser~re

Bulletin, September 1986, p. 618.

Because of differing accounting rules, absolute \’alues of return on equity acros5 countries have little significance.

Figure 23.— Return on Equity in Banking,

Five Countries

18 ~

16

4

2

r

1981 1982 1983 1984

Year

SOURCE The EconornIst, Mar 22, 1985

into customary sources of profit. With more intense competition, particularly in familiar lines

of business, banks have searched for new strategies that might help them earn profits at accustomed levels.

Broadly speaking, deregulation has pushed

financial institutions into riskier endeavors as

they have sought to avoid the devolution of

banking into a commodity-like service. They

have developed new products, sought out new

onshore and offshore markets, and, where possible, tried to move from commercial banking

into related services—notably, securities trading and investment banking. In an industry like

this, with many able competitors, competitive

success normally comes through the accretion

of small advantages. How well U.S. banks do

in finding new and profitable markets will be

perhaps the single most important factor in determining their future competitiveness. Regardless of whether the industry as a whole rises

or falls relative to others in the world, some

American banks will probably do quite well,

and some might do quite poorly.

New and/or Rapidly Growing Product Markets

Banks that can identify and develop new

products ahead of the competition can often

generate relatively large returns, at least until

their rivals catch up. Even then, product differentiation may offer continuing competitive

advantages. Thus innovative financial products

have been central elements in the strategies of

American banks. Most of these products are

not so much new ideas as existing products that

have seen rapid growth because the combination of market conditions (inflation, exchange

rate instability, deregulation, the Euromarkets,

securitization—see box D inch. 2) and new technologies (computer networks, telecommunications) makes them attractive both for financial

firms and their customers.

The pervasiveness of regulations complicates

innovation in this industry. Government policies in both the United States and Japan, for

instance, have restricted the spread of ATMs.
Ch. 3—lnternational Competition in Banking and Financial Services ● 9 5

Photo credit Hong Kong Trade Development Council

Hong Kong’s financial district

U.S. regulations generally allow withdrawals

in two or more States, but deposit-taking across

State boundaries has been limited by restrictions on both bank holding company activity

and interstate banking. Japan permits ATM use

only during certain hours, thus curbing one of

their principal attractions—around-the-clock

access. In both cases, regulations limit the advantages that innovating banks can expect.

Other innovations have come in direct response to regulation. In the 1970s, high U.S.

interest rates, combined with regulatory limits

on the interest banks could pay on deposits, led

to the creation of money market mutual funds.

Reserve requirements on deposits in the United

States, and restrictions on capital movements

here and elsewhere, contributed to the expansion of the Euromarket relative to more regulated capital markets during the 1970s and

1980s,

When new banking products circumvent existing regulations, national governments may

respond by reinterpreting legislation or passing new laws. Alternatively, regulatory authorities may view the innovation as desirable, and

perhaps liberalize the rules further. Internationally, deregulation has proved contagious: MNCs

and other major bank customers can often

choose the country and the banks—thus the

regulations—they wish to deal with. National
96 ● International Competition in Services

governments that fear the loss of valued customers then must liberalize their own regulatory structures. After fixed commissions were

abolished on the New York stock exchange,

trading volumes rose; the London exchange

was eventually forced to follow suit. Liberalization of the London financial market, in turn,

has brought in new business from Paris and

elsewhere on the continent, with liberalization

in many parts of Europe following.

Deregulation has also spread to Japan. Until

recently, Japanese corporations could not issue Euroyen bonds (bonds denominated in yen

and sold in the Euromarket). Japanese corporations seeking to participate in the Euromarket were forced into other currencies, where

Japanese banks tended to be less competitive.

The government’s decision to permit a Euroyen

market (corporations still must meet certain financial tests) represents a concession to this

reality. Still later, the authorities permitted an

offshore market to develop in Japan (operations

began in December 1986).

Eurobonds and Euronotes

Eurobond issues grew at about 30 percent per

year between 1975 and 1985—figure 24. New

Eurobond and Euronote issues totaled about

$136 billion in 1985 and an estimated $180 billion in 1986.10 Lack of regulation in the Euromarkets means lower issuing costs for the

banks, and lower margins for customers. Customers as well as banks maybe able to bypass

domestic constraints; South Korean firms, for

instance, have sought medium-term financing

in the Euromarket because inflation, uncertainty, and government restrictions have prevented the development of a medium-term domestic bond market in Korea,

Eurobonds come in three varieties: 1) traditional fixed rate bonds; 2) floating rate notes

(FRNs–issued with maturities up to 7 years and

paying interest at rates periodically adjusted

to reflect prevailing short-term rates); and 3)

1O’’Key Figures, ” Euromoney, February 1986, p. 170; “International Bonds: A Profitable Year for Borrowers, ” Financial

Times, Dec. 29, 1986, p. 13.

Shorter maturity bonds are known as notes.

Figure 24. —Growth of the Eurobond Market

’

120

40 

~

100

80

60

40

20

0

1975 1980 1985

Year

SOURCES Euromoney, various issues, “Recent Innovations in International

Bank!ng,” Bank for International Settlements, Basel, Switzerland, April

1986, p, 163

convertible Eurobonds (which bear fixed rates

but can be converted into equity shares of the

issuing firm—in recent years these have never

exceeded about 10 percent of the total market).

As figure 24 indicates, new FRN issues have

grown especially quickly; first marketed in

1978, by 1984 they accounted for 40 percent

of the Eurobond market,

Table 13 shows that U.S. financial services

firms have had by far the greatest share of the

Eurobond issue market, doing even better in

the rapidly growing FRN segment, American

firms manage nearly 60 percent of issues denominated in dollars, and about two-thirds of all

Eurobond issues for U.S. corporations, (Box H

expands on the significance of the dollar as the

primary currency of international trade,)

Trade Financing and Other Fee-Earning Services

One of the oldest international services provided by commercial banks, trade financing,

continues to expand, Such traditional busi-
Ch. 3—international Competition in Banking and Financial Services ● 9 7

Table 13.—Eurobond Issue Managers by Country

Percentage share of new issues, 1984

Floating Fixed

rate notes rate notes Overall

United States ... . 53 0/0 35 ”/0 440/0

Federal Republic of

Germany . . . . . 3 20 12

Switzerland . . . . . . 11 8 11

United Kingdom 13 6 10

France . . . . . 11 4 8

Japan ... . . . . . . . . 2 10 8

Subtotal . . . . . . . 93 0/0 830/o 93%

Others a

. . . . . . . . . . . 7 % 17 ”/0 7%

alncludes smaller Issue managers from countries Ilsted. as well as countries not

on the list

SOURCE Eurornoney various Issues

nesses as letters of credit (LCs), whereby banks

endorse their customer’s creditworthiness, are

now carried out largely through the telecommunications infrastructure. Clients can request

LCs electronically, using standard formats, with

many of the communications handled via SWIFT

or such U. S.-based data processing organizations as GEISCO and ADP. Paperwork costs

have been cut, and the process is now much

quicker—a matter of hours rather than weeks.

(Citibank claims it can issue a letter of credit

in a matter of minutes.) While the United States

led in automating this process, some European

banks, especially in Scandinavia, have developed competitive systems.

Box H.—The Role of the Dollar

Many of the world’s financial transactions are denominated in U.S. dollars, even when the parties

have no relationship to the United States. Trade between Japan and North Korea, for instance, has

commonly been conducted in dollars. While the continuing importance of the dollar creates competitive advantages for U.S. banks, these advantages are small, and will no doubt decline further in the

years ahead.

Why is the dollar so commonly used? Many of the reasons are historical. Before World War II,

the British pound had been the world’s primary currency for international transactions. But the major

European currencies did not return to convertibility until 1957. The dollar has kept its role since,

in part because the United States provides an unmatched banking infrastructure, with well-developed

markets for holding short-term balances, in addition to political and economic stability. Moreover,

the volume of international capital flows involving American companies, particularly during the 1950s

and 1960s, also made it natural to continue using dollars. But decisions by residents of other countries

to use the dollar—or any currency other than their own—depend on relative attractiveness, and most

of these factors have less weight today than in earlier years. As market participants have diversified

across currencies, the Deutsche mark (DM) and the yen have slowly gained in market share. Indeed,

the yen has become almost as popular as the DM, one among many signs of the integration of Japan’s

financial system into the world system.

What advantages, if any, accrue to financial institutions doing business in their home currency?

The first point is this: the more open and better developed the market, the less the advantages for

domestic banks. Even in such countries as the United States, however, regulatory/administrative factors tend to tip the scales a bit. A second factor, related but distinct: domestic banks normally dominate the clearing (payment) system in their currency. Other banks bear costs (through their balances

with members of the clearing system, as well as the fees they pay for services). For such reasons,

domestic banks tend to have a competitive edge-small but potentially significant—in transactions

involving their home currency. Even in the free-for-all external markets, U.S. ownership helps in

attracting U.S. dollar deposits, while German bank branches do better in attracting DM deposits.

With continuing deregulation, and movement toward globally integrated financial markets, such advantages will probably continue to erode. Even so, as pointed out at many places in this chapter,

banking is a highly competitive business; a superior position must be built piece by piece, and each

piece counts.
98 . International Competition in Services

Standby letters of credit (SLCs) also substitute a bank’s credit standing for that of the client. The market for SLCs—agreements to lend

money should other prospective lenders refuse

to do so—grew from almost nothing in the early

1970s to nearly $150 billion by 1984. Five large

banks—Citicorp, Manufacturers Hanover,

BankAmerica, Chemical, and Bankers Trust—

account for more than a third of the U.S. total,

Foreign banks, too, have been quite active in

SLCs, with Barclays’ New York branch reporting that in some months its letter of credit business exceeds its loans,

The fees a bank can charge for SLCs depend

in part on market judgments of the bank’s riskiness; if a bank has a high credit rating, its guarantee will be worth more. Because of their exposure in developing countries, U.S. banks have

been viewed as relatively risky; many have been

hard-pressed to compete with their Japanese

and European counterparts. (Of the major U. S.-

based banks, only Morgan Guaranty still has

the coveted AAA rating.) Indeed, Japanese

banks have recently backed tax-exempt State

and municipal bonds in the United States, including issues by Michigan, and by the cities

of Chicago and Philadelphia.

A banker’s acceptance (BA) guarantees payment of a trade debt, These time drafts can be

traded in a secondary market which, in the

United States, amounts to about $80 billion annually. More than half of this represents thirdcountry BAs, involving neither U.S. imports nor

exports, The third-country portion of the market reflects, not only the prominence of the U.S.

dollar in international trade, but the ability of

U.S. financial institutions to capture business

from banks in other nations also willing to deal

in dollar obligations. Thus, the recent announcement by the Japanese Government that it will

allow a yen-denominated acceptance market

may or may not represent much of a threat to

American banks. To the extent that the yen

makes inroads on dollar-denominated BAs,

banks based in Japan will have something of

an advantage. Still, even in a yen acceptance

market, U.S. banks might be able to remain

competitive because of their accumulated experience.

Financial swaps enable two parties with advantages in different segments of the market

to exchange (swap) their obligations. Banks

earn fees for arranging these transactions—

another example of the growing importance of

non-interest income. New variations have fostered enormous growth in the market. Recently,

much of the expansion has been in cross-currency interest rate swaps, For an example, consider that a Japanese firm seeks fixed rate

financing in dollars, while an American company wants floating rate financing in yen. If

the Japanese firm can borrow yen relatively

cheaply, and the American firm dollars, they

will be able to swap their interest rate obligations to their mutual benefit. The bank serving

as intermediary absorbs the credit risk of each

party. Many actual transactions become much

more complicated than this example, involving three or more currencies and other complexities.11 Because these transactions involve

only a contingent liability on the part of the

bank, they remain off the balance sheet, although some larger banks have begun to take

swaps onto their books by offering a swap to

one party even if no counter-party has yet been

found.

U.S. commercial and investment banks have

been leaders in the market for swaps, where

success depends on efficiency, inventiveness,

and quick response. Citicorp alone accounted

for some $25 billion in swaps in 1985. Only one

British investment bank (SG Warburg) and one

French bank (Paribus) have established positions comparable to even the smaller U.S.

players. Banks have developed the swap market largely in response to the needs of their

clients. For commercial banks, these are mostly

corporations. The leading investment banks—

which include Salomon Brothers, First Boston,

and Goldman Sachs—often arrange swaps for

other financial institutions, especially savings

and loan associations.

llIn March IWM, American Express raised 20 billion yen in

the Euroyen market, which it swapped into $109 million and

then into securities denominated in eight different currencies,

some of these securities at floating rates and some at fixed rates—

L. Wayne, “New Broader Role for Finance Officers, ” New York

Times, Oct. 20, 1986, p. D6.
Ch. 3—international Competition in Banking and Financial Services ● 9 9

Many of the financial products discussed

above--banker’s acceptances, SLCs, swapsshare a common characteristic: they do not appear on the books of the bank, but the bank

guarantees the credit of other parties. Regulators have been concerned over the growth of

these possibly risky activities; governments require banks to maintain reserves of capital

against their assets (mainly loans, but also treasury and other securities), in part to protect consumers and other depositors. To the extent that

banks develop and market financial products

without creating assets on their balance sheets,

they avoid these requirements (and the associated costs). A bank that guarantees a loan may

be able to collect a fee almost as large as the

interest it could have earned if it had made the

loan itself. Likewise for a swap, the bank

guarantees payment of interest by both parties

but neither of the swapped instruments becomes an asset or liability of the bank.

Regulatory authorities have looked askance

at this de facto loosening in control. In most

cases where governments have begun to count

such items against capital requirements, they

have viewed SLCs, swaps, and other guarantees as much smaller risks than loans. But the

fact remains that, at this point, no one is in position to judge the real risks: growth in many

of these markets has been very rapid; experience remains limited. In general, the United

States has been slower than other industrialized countries to extend capital adequacy requirements to off-balance-sheet items. U.S. policy, therefore, seems to have had the effect of

inducing American banks to market off-balance-sheet products more aggressively than

their foreign competitors. So far, the result has

been to help U.S. banks capture large shares

of these markets,

Movement Into Investment Banking

Many commercial banks see attractive strategic opportunities in investment banking—

trading in securities, underwriting stock and

bond issues, arranging mergers and acquisitions. Investment banking holds out the prospect of recovering lost profitability: commercial banks do well to earn 15 percent on equity,

while rates of return above 30 percent are far

from unknown among investment banks (which

do not take deposits or make loans). An American commercial bank contemplating a move

into investment bank faces two sets of obstacles, the first legal and political, the second organizational.

The Glass-Steagall Act and other U.S. legislation bars firms from engaging in both commercial and investment banking in the United

States (although American firms can do so overseas). While Japan maintains restrictions similar in some respects to those imposed in the

United States, few other foreign governments

maintain this regulatory separation; in countries including the Federal Republic of Germany, Switzerland, and the Netherlands, socalled universal banks underwrite corporate

securities, offer mutual funds, and engage in

the full range of stock brokerage activities. The

freedom granted U.S. commercial banks to

function as investment banks aboad has been

one of the factors spurring expansion of the Euromarket (where, however, American investment banks have performed better than commercial banks in managing Eurobond issues,

products similar to those investment banks

work with at home).

In recent years, commercial banks have

moved into new businesses domestically that

test the limits drawn by U.S. law. Often, the

courts have been asked to decide the merits of

the arguments for a liberal interpretation of the

restrictions, as put forward by commercial

banks, versus the stricter standard suggested

by investment banks. (The much smaller investment banks have not sought to move into commercial banking.) Two current examples:

1. Should Bankers Trust be permitted to

broker commercial paper for its corporate

clients? A Federal Appeals court in December 1986 ruled in favor of Bankers Trust,

overturning a district court finding that

had reversed a Federal Reserve decision.

The Securities Industry Association quickly

signaled its intent to appeal to the Supreme

Court.
100 • International Competition in Services

2. The Federal Reserve is expected to decide

in 1987 whether commercial bank holding

companies will be permitted limited underwriting of municipal revenue bonds

and certain other securities.

As these examples suggest, and as discussed

in more detail in the section on “Policy Issues”

below, the separation of commercial and investment banking in the United States has been

slowly breaking down, in part because new

banking products blur some of the traditional

distinctions, But if the erosion of Glass-Steagall

and other restrictions continues, as it no doubt

will, U.S. commercial banks face another obstacle in moving into investment banking—differences in organizational patterns and managerial style suggested by the saying that “bankers

live off their assets, merchant bankers [i.e., investment bankers], live off their wits.”12 In the

United States, managing a combined organization means reconciling such differences, a process that will take time and during which other

opportunities might slip by. Plainly, greater

freedom from legal restrictions would lead the

larger commercial banks to venture further into

investment banking. Some would probably be

successful. Others might have trouble mastering new and unfamiliar lines of business, perhaps eventually withdrawing to more familiar

territory.

‘%ee P.L. Zweig, “Some Big Banks Find Entering New Fields

A Tough Transition, ” Wal] Street Journal, Aug. 13, 1986, p. 1.

Unlike manufacturing companies, financial services firms depend on no raw materials or manufactured inputs to produce

their end products. They do depend on people—the bank’s employees. In international banking especially, the skills that employees bring to and develop on the lob-—and the ways in which

the organization deploys these people and their skills—can make

a great deal of difference for competitiveness. In this, banking

is not unlike other knowledge-based service industries.

In recent years, banks have sought greater numbers of specialists in fields like bond trading, currency transactions, and swaps,

Increasingly, they have hired in people from graduate schools

of business to fill such positions, rather than promoting from

lower positions within the bank–O. Bertrand and T. Noyelle,

“Changing Technology, Skills and Skill Formation in French,

German, Japanese, Swedish and U.S. Financial Service Firms:

Preliminary Fin dings,” report to the Center for Educational Research and Innovation of the Organization for Economic Cooperation and Development, August 1986, pp. 47-48.

Finding Profitable Market Segments

in Commercial Banking

Onshore Retail Banking

Overseas retail banking has seemed a relatively conservative choice for banks seeking

greater profits. Here, size by itself seldom provides much of an advantage, but new products,

good service, and aggressive marketing hold

out the promise of substantial rewards. Indeed,

foreign banks have moved into the United

States no doubt feeling they could offer better

quality services and/or undercut their rivals’

costs. The rapid spread of credit card services

(e.g., Visa, Master Card), now offered around

the world through joint ventures owned by participating banks, provides another example of

international expansion in retail banking,

Particularly in countries with stable regulated

markets, nominally competing banks have often

been happy to fall into patterns of peaceful

coexistence. When American banks have been

able to enter such markets, their efficiency advantages have sometimes led to profit levels

well above those of their local rivals.13 On the

other hand, U.S. banks have not done very well

since being admitted to the Canadian market

in 1980. Earlier government restrictions barred

foreign banks from establishing subsidiaries,

branches, or agencies in Canada, and limited

them to a 10 percent holding in a chartered

bank, The result was high prices and profits

for Canadian banks.14 Since 1980, foreign banks

have been permitted to expand in Canada, but

with restrictions—e.g., on the number of

branches permitted—that continue to limit their

ability to compete with Canadian banks;

Citicorp, the largest foreign bank in Canada,

has only eight branches. Foreign entrants have

lsFor example, Citibank has reportedly earned a substantial

portion of its worldwide profits in Brazil—20 percent in 1982—

where a grandfather exception permitted it to remain after the

Brazilian market was closed to other foreign entrants. See I.

Walter, “International Competitive Distortions in Banking and

Financial Services,” draft for Trade Policy Research Centre, I.ondon, March 1984, p. 112.

lqAfter-tax return on capital to Canadian banks averaged 12.9

percent, compared to 9.1 percent for eight large New York

banks-Efficienc~r and Regulation: A Studbv of Deposit institutions (Ottawa: Economic Council of Canada, 1975].
Ch. 3—international Competition in Banking and Financial Services ● 101

been largely denied access to a low-cost deposit

base; U.S. banks have not been able to earn the

high profits that might be expected in a protected retail market. Nor is Canada the only

country in which liberalization has been structured in such a way as to limit the opportunities available to U.S. and other foreign banks.

Citicorp, Chase, and a few British and Japanese banks have been the only entrants pursuing retail banking on anything approaching

worldwide scale. Citi has major efforts underway in Europe and elsewhere, and has been

quick to introduce new retail banking products

in seeking greater market share. In Britain, Citi’s more efficient systems help it process mortgage applications in 10 days, compared with

a month for local competitors; Citibank claims

to undercut the costs of its rivals by 50 percent

in some lines of business .15 Other U.S. banks

have been quite selective in entering retail markets abroad; Citicorp has been alone in expressing interest in acquiring a small Japanese bank

as a wedge into Japan’s retail market. Citi’s

strategy is predicated in part on technological

superiority leading to lower costs. But to succeed in retail banking, a foreign entrant must

also develop a detailed knowledge of local conditions–knowledge at least equal to that of the

competition. This is a task that demands a

strong commitment over time, even if the new

entrant begins by buying an existing bank or

hiring experienced people locally. Citicorp gets

advantages from being a major commercial

lender in many countries. This appears to be

one reason it has been able to expand in overseas markets despite being perceived as a foreign presence—a far more serious disadvantage

in retail than in commercial banking.

Commercial Lending to Small and

Medium-Sized Firms

In recent years, banks both in the United

States and overseas have been placing much

more emphasis on lending to smaller companies (see, for example, the MetroBank case

.

‘

5

’’ Citicorp’s GutsY Campaign to Conquer Europe, ” Business

il’cck, Julj 15, I!185, p 47. Also see P.1.. Zweig, “The Elusi~e

(:onsurner, ” Ilra)l Strfmt }ourna), Sept. 29, 1986, p. 341). Citicorl)

has retail hanking operations in 34 countries, Chase in 25.

study in the appendix to ch. 8). Foreign banks

in the United States lend to small businesses

here; Citicorp’s branches in many of the 90-

some countries in which it operates are said

to be eagerly pursuing the loan business of firms

with sales in the $25 million and up range. The

reasons begin with securitization, and the increasing self-sufficiency of large corporations.

When these corporations go directly to the capital markets, banks may still provide guarantees, and sometimes distribution services, but

margins tend to be thin. Smaller companies,

less known and perceived to be more risky, still

need the services of a bank to raise money,

Financial institutions in different countries

have developed this portion of the market differently. In Japan, businesses depended much

more heavily on bank loans after the war than

on equity, But by the 1970s, as Japanese economic growth continued, larger corporations

could finance much of their expansion through

reinvested earnings; Toyota, admittedly an extreme case, has generated so much cash the

company has sometimes been called the Toyota

Bank, As figure 25 shows, the drop in bank lending in Japan compared to other sources of corporate funds has been dramatic. Faced with

rapidly declining demand for loans from their

major customers, Japanese banks have sought

to lend to the small businesses they once

ignored.

The Future

Competitive strategy for any commercial

bank seeking to expand internationally will

hinge on its view of the coupling among its services. Will a bank that offers a broad range of

products be able to reduce its costs? Will it reap

marketing advantages, perhaps be able to lockin its clients? Will a corporation that uses Morgan Guaranty as a lead manager in the Eurobond market also borrow money from Morgan

domestically? If the answers to these questions

turn out to be yes, then banks able to offer a

comprehensive package of services will be wellpositioned to grow and compete in international markets. By the same token, a bank with

an extensive worldwide network of branches,
102 . International Competition in Services

Figure 25.—Sources of External Financing for

Japanese Corporations

Average, 1981 1982 1983 1984

1970-75

❑ Equity issues ■ Bonds

❑ Bank loans

SOURCE: “Survey of Japanese Flnanclng and Banking, ” The EconornIsf, Dec

8, 1984, p 21

agencies, representative offices, and subsidiaries will be better placed to develop and market a wide range of financial products. On the

other hand, no matter the efforts of banks to

maintain ongoing “relationships” with clients,

customers all over the world seem to be shopping for banking services more extensively than

in earlier years. Relationship banking is in part

simply a reaction to such trends, including

securitization, While some U.S. banks will no

doubt have success in locating profitable areas

of foreign commercial banking, this is plainly

not a strategic route open to all. Those that already have a broad and deep foreign presence

—notably Citicorp—seem most likely to prosper through continued penetration of new onshore banking markets.

Furthermore, any strategy aimed at finding

and exploiting unusually profitable lines of

business depends on doing so before other financial institutions seize the same opportunity.

Banking expertise is widespread, particularly

in the OECD countries. The history of LDC

lending demonstrates the point. Many regional

U.S. banks, deciding there were profits to be

made in loans to the developing world, set up

offices overseas for the first time. Even without the Third World debt crisis, lower returns

would have followed simply from the increase

in competition. Lending to medium-sized businesses in Canada holds a similar lesson: after

the market opened to American banks, fierce

competition among Canadian, U. S., and other

foreign banks kept profits low. While they lobbied hard and ultimately with some success for

greater access to the Canadian market, American banks have been disappointed with the results. They have also won concessions from

Japan’s Ministry of Finance. This will enable

U.S. banks to expand their activities in Japan,

but here as well, competition promises to hold

down profitability. The point is a general one:

in an era of deregulation, profits will be low

in many or most of the markets seen as new

opportunities for American financial service

firms,

Moreover, concessions overseas often go

hand in hand with losses of previous advantages. Onshore foreign banks in Japan recently

won the right to enter the trust business. The

Japanese Government has granted licenses to

six U.S. and three other foreign banks. These

foreign banks now have a strategic option not

open to the biggest Japanese banks. But other

recent policy decisions—e. g., permitting Japanese corporations to issue Euroyen bonds—

mean that, in at least some cases, Euroyen

bonds placed by Japanese banks will supplant

Eurodollar bonds that would otherwise have

been handled by American banks.

Future competition in international banking

promises to be fierce, with many entrants having similar capabilities seeking to establish

themselves in new and growing markets (geographic as well as product), American banks

do have sources of competitive advantage, primarily their experience in a deregulated and

competitive environment, and in applications

of technology. Foreign institutions have advantages of their own—e.g., the financial clout of

the big Japanese banks—to set against them.
.

Ch. 3—international Competition in Banking and Financial Services ● 103

Photo credit: Arthur Lavine Chase Manhattan Bank N.A.

Currency trading room

JAPANESE COMPETITION: TWO SCENARIOS

Over the past decade, U.S.-based financial institutions have grown rapidly, In terms of assets, however, Japanese banks have grown

much faster, as figure 20 showed, The astounding expansion of Japanese manufacturing industries has pulled Japan’s financial institutions

onto the world scene, with banks following

their corporate customers abroad. Although

banks from countries like Britain and West Germany are strong in some parts of the market,

only the Japanese pose a real threat over the

foreseeable future to the U.S. position in financial services.

This section sketches out two possible scenarios for the rivalry between U.S. and Japanese banks. In the first, regulatory constraints

and other factors built into the Japanese system slow international expansion, blunting

many of the competitive thrusts of Japan’s

banks. In the second scenario, more rapid deregulation by Japan’s Government leads to concerted attacks on international markets by

financial institutions largely free to pursue strategies of their own choosing, and with the financial muscle to succeed more often than not.

On balance, OTA views the second scenario

as more likely, but the critical decisions will

be made within the Japanese Government,

where they will emerge from the interplay of

political and bureaucratic forces. Liberalization

in Japan means still more intense competition
104 ● International Competition in Services

in international banking, competition to which

U.S. and Japanese banks bring differing sets

of strengths. At the least, competitive life for

U.S. firms will be more difficult.

Constrained Growth

Japan’s large continuing current account surpluses have been accompanied by rapid growth

in international assets, both financial and nonfinancial. Management of these assets has become the responsibility of Japanese financial

institutions, especially the banks, which have

grown proportionately. But despite their size,

the sense has remained, in some circles, that

Japanese banks, while undeniabably major

players, have not yet become fully competitive

with European and American banks internationally. Some of their rivals do not perceive

the Japanese to be good bankers, claiming that

they lack the skills and experience that are the

strengths of U.S. and European financial firms.

Japanese banks, for instance, must compete for

the best graduates of the best universities with

other industries and with government ministries—a sharp contrast with the United States,

where investment banks, especially, can often

pick and choose, competing only with one

another. All this could change, but in the constrained growth scenario the change will come

slowly.

Japan also has a currency that has not been

widely used to denominate international transactions. The dollar remains the currency of

choice in offshore financial markets, and, to

a lesser degree, in trade (box H). To the extent

that these patterns continue, American financial services companies have a source of ongoing if modest advantage, while Japanese banks

face a competitive hurdle. The Japanese, of

course, understand this. Why have they not

taken steps to make the yen more acceptable

in international business circles? That is, given

Japan’s presence in world commerce, why

hasn’t the Euroyen market developed faster?

Only in 1986–although the relative asset growth

of Japan’s banks has been visible for years—

did the Ministry of Finance (MOF) permit an

offshore Euroyen market in Tokyo.

The reluctance of Japan’s Government is understandable. An open door for Japanese financial institutions to participate in international

markets, and for the yen to become more widely

used, necessarily implies opening Japan’s domestic financial markets to foreigners. Indeed,

this move would have to come first. For the yen

to be a major currency internationally, both foreigners and Japanese must have greater freedom to move funds into and out of Japan, to

maintain accounts of all kinds, and to otherwise enter Japanese financial markets—as has

been the case in dollars in the United States

for years.

The MOF, one of the most powerful agencies in the Japanese Government, although

slowly loosening its grip on financial and monetary affairs, has no wish (at least in this scenario) to take liberalization nearly as far as it

has gone in the United States. Japanese officials view “guidance” of the banking system

as one of the critical elements in their country’s postwar economic boom. With the postal

savings system an important source of financing for Japan’s budget deficits and outstanding debt—at interest rates low by world

standards—the MOF has little enthusiasm for

liberalization, which would raise the cost of

servicing that debt. Furthermore, a wholesale

loosening would make domestic monetary policy more difficult to implement, and leave the

Japanese economy more vulnerable to ill-conceived monetary and fiscal policies elsewhere

in the world—a decidedly unpleasant prospect

to MOF officials.

Large Japanese corporations see things differently. Regardless of their view of the past, today

most would argue that the closed nature of Japanese financial markets limits their strategic

opportunities and competitive prospects. Corporations want to control their own financing,

without interference from the government. The

constrained growth scenario, therefore, hinges

on the MOF surrendering its authority only

grudgingly, and more often than not prevailing over corporate interests and other government agencies—e. g., the Ministry of International

Trade and Industry—that favor liberalization.
Ch. 3—international Competition in Banking and Financial Services ● 105

—

Indeed, the MOF appears to be split internally on this issue, with some factions advocating more rapid change. But the interplay of

forces within the Japanese Government, and

the policies that emerge, will tell only part of

the story. Even assuming more freedom for

Japan’s banks, will they be able to increase their

competitive presence as rapidly as Japanese

manufacturing firms? Analogies do exist between

Japan’s growing competitiveness in financial

services and past successes in manufacturing.

But none of the analogies is particularly close.

The constrained growth scenario treats the

competitive precedents with skepticism, emphasizing the differences between financial

services and the typical Japanese strategy in

manufacturing (build scale at home; find attractive market niches overseas; export from a secure base in Japan, seeking greater market

share; invest in foreign markets only when

forced by political pressures and the threat of

trade barriers).

In the constrained growth scenario, two key

differences weaken the parallels with Japan’s

past competitive successes. First, U.S. banks

will not easily be outflanked. These are not steel

companies, domestically oriented and comfortably ensconced behind barriers created by

transportation costs thought high enough to

keep out foreign products. Nor automakers,

with an international perspective and many foreign investments, but with domestic products

perceived as uniquely suited to U.S. market conditions. Nor even computer companies, with

technological leads that shrank much faster

than expected.

Banking was an international business before

Columbus; Japanese banks have been participants for more than a hundred years. For several decades, American financial firms have

won out in world markets against able foreign

competitors through aggressive strategies and

innovative products. Moreover, American banks

compete strongly among themselves. Those that

survive domestic competition are well-placed

to compete internationally. Even more, an increasingly permissive U.S. regulatory environment has taught them how to maintain high

levels of customer satisfaction without compromising efficiency, Finally, the U.S. industry benefits from a home market that is the center for new applications of computer hardware

and software technologies, as well as telecommunications. Thus, to successfully attack the

U.S. banking industry, any competitor must put

together a coordinated strategy that can be effective on multiple dimensions (e.g., offshore

markets, business lending, retail banking, investment and brokerage activities, applications

of new technology). Those accepting the constrained growth scenario see little indication

that the Japanese (or anyone else) have the capabilities to succeed in such an endeavor,

There is a second difference. The structure

of this industry differs markedly from manufacturing sectors, where Japanese companies

could begin by creating efficient production

systems to supply domestic markets. When they

identified market niches abroad—e. g., small,

black-and-white televisions—Japanese firms

could export and sell at low prices, taking

advantage of their domestic base and local labor force. This is decidedly not the case in a

service like banking. To compete, Japanese financial firms must maintain operations in

world banking centers such as London and

New York, They have to rely on the same labor

pool and confront the same cultural traditions

as others. They cannot depend on their strength

at home, but will have to develop competitive

advantages in markets not only far away, but

in the backyards of their strongest competitors,

This is a new and different competitive environment for the Japanese, one in which success promises to be elusive.

For all of these reasons, then, in the constrained growth scenario, Japanese competition

will be slow to develop. Competitive thrusts by

Japanese banks will be isolated, with little

cumulative effect. U.S. financial service firms

will maintain their international leads. The

MOF, a conservative force within the Japanese

bureaucracy, will not abandon the tools that

it believes responsible for a favorable macroeconomic environment. Japanese financial

markets will open only slowly. Meanwhile, the

U.S. regulatory climate will remain conducive

to American success.
106 ● International Competition in Services

Rapidly Mounting Competitiveness

What would it take to invert the picture

above? More than anything else, ways in which

Japan’s banks could turn the enormous increase

in Japanese-held financial assets to competitive

advantage. Although this overseas asset growth

cannot be attributed solely to the efforts of Japanese banks, the fact is that the assets are there,

and Japanese banks (and others) have the opportunities (or problems) of managing them.

Not only have the largest Japanese banks

grown bigger, more Japanese banks are now

powerful enough to be serious players internationally; by some measures, Daiwa, ninth

among Japanese banks, is larger than Chase.

With expansion come new sources of competitive advantage: Japanese banks can pursue

more strategies simultaneously, undertake more

activities independently, without the need for

correspondent banks or syndicates. Moreover,

their asset holdings will continue to grow, at

least for the next several years, Although Japan’s

exports have slowed somewhat, her trade surplus remains large; Japanese financial claims

on the world will continue to mount.

Thus far, however, the Japanese approach to

their overseas assets has been a conservative

one, emphasizing safety. Funds have been held

in foreign bank deposits, or invested in Treasury bills and notes, denominated in local currencies. While prudent, such strategies sacrifice many opportunities for greater earnings,

A number of signs now point to a more active

posture by the Japanese.

Almost any scenario that sees a rapidly expanding Japanese presence in international

banking must begin with foreign direct investment in manufacturing. For 30 years, Japanese

manufacturers have been very aggressive in

seeking out export markets and in guaranteeing their supplies of raw materials (e. g., iron

ore) and energy (coal and petroleum). Until recently, most of their other international ventures have been tentative and small in scale.

Japanese investments in Western Europe remain a small fraction of U.S. investments there

(a cumulative $11 billion, versus $107 billion

for the United States),” Until the last few years,

both business and government in Japan have

directed their attention to internal development; electronics and automobile firms, for example, began building plants in the United

States only after trade-related political pressures built to very high levels.

Now, of course, the picture is changing rapidly. As pointed out in the preceding chapter,

Japanese manufacturing firms have stepped up

their foreign investments and begun to establish truly multinational operations. In this, they

are following in the footsteps of American

firms—footsteps 30 or 40 years old. Just as

American firms invested in Europe to assure

continued access to markets there, Japanese

companies now find themselves seeking to

avoid incipient trade restrictions in both Europe and the United States. And, again like

American firms before them, Japanese companies now see stronger ties with their foreign

customers as a competitive necessity.

Expansion abroad has inescapable consequences for the Japanese financial system, and

for the government. Historical parallels suggest

that Japanese banks will seek to expand overseas, following on the heels of manufacturing

investments. U.S. banks moved abroad to service customers setting up offices and factories

around the world. American companies preferred, and still prefer–all else equal–to deal

with American financial institutions. But if the

banks do not offer their services overseas, companies will find alternatives in foreign banking industries, American banks had little choice

but to follow their customers. Japanese banks

have the same choice–or lack of choice. They,

too, will follow their customers into foreign

markets.

But providing familiar services to familiar

customers in a foreign setting does not make

an international bank, or an international in-

‘“’’Japanese Investment in Europe, ” Financial Times, Nov. 13,

1986, sec. 111. Department of Commerce estimates placed U.S.

foreign direct investment at 41 percent of the world total in 1981,

compared to 7 percent for Japan. International Direct Investment: Global Trends and the U.S. Role [Washington, DC: Department of Commerce, 1984), p. 45.
Ch. 3—international Competition in Banking and Financial Services ● 107

dustry; much more is necessary, beginning with

accommodating government policies in both

home and host countries. In general, favorable host country policies already exist. Japanese

manufacturers are moving into markets where

other foreign firms—financial firms included—

have been comfortable for years. Japanese Government policies, as discussed above, seem a

different matter. Indeed, the future policies of

the MOF and other Japanese agencies will be

perhaps the single most critical factor in determining rates of international expansion by

Japanese banks.

With trade friction and political pressure

mounting on many fronts, financial liberalization is but one of a series of policy questions

facing Japan’s Government. For years, other

countries have objected to export-led growth

in Japan, and demanded reciprocal access to

markets there. Beyond this, other countries

have begun pressing the Japanese to behave

more like a major world power. Japan’s corporations, meanwhile, face stronger competition

in their traditional export markets from developing countries—South Korea, Taiwan, even

Brazil. With Japanese manufacturers responding to new pressures in part through rapid increases in foreign investment, financial institutions, by every indication, wish to become

more active not just in financing for Japanese

corporations, but in the entire range of banking services supplied internationally. Both manufacturing and banking sectors will press their

views on the Japanese Government—arguing

that financial liberalization is necessary, and

must come quickly. The real questions, then,

concern the government’s response.

As yet, the MOF has not been willing to move

very far on domestic matters—a precondition

for international expansion, for reasons outlined above. Still, many signs in both official

reports and in the Japanese press indicate that

the Ministry will not try to stall liberalization

indefinitely. MOF officials, like their counterparts elsewhere in the government, have many

times acknowledged—to be sure, in vague and

noncommittal ways—the need for Japan to take

its rightful place among the world’s economic

powers.17 Given changing attitudes elsewhere

in Japan’s Government (and in some parts of

the MOF), it is a reasonable presumption that,

although the Ministry may be able to fight a

rear guard action, ultimately it will have to give

way. In this second scenario, the MOF gives

way sooner rather than later.

The major Japanese banks, foreseeing the

eventual outcome on the policy front, clearly

plan to be ready; they are attempting to gain

experience, as quickly as possible, in the somewhat arcane ways of international banking.

They still have a good deal to learn. Will Japanese banks be able to establish foreign branches

and subsidiaries that can compete head-to-head

with long-established and aggressive rivals? On

such matters, the jury will be out for a number

of years. But few today would underestimate

the ability of Japanese firms in any industry to

master the intricacies of international competition. And of course, the banks will not be

alone. With the new foreign investments by Japanese manufacturing firms, Japanese financial

institutions have a ready-made customer base,

solid ground on which to build.

This leaves, finally, the question of whether

the world will continue to rely on the U.S. dollar, The answer, in this scenario, is that it makes

little real difference. The primacy of the dollar

is not all that important for American financial firms. Non-U.S. banks compete effectively

in offshore dollar markets already. Indeed,

banks from quite a large number of countries

compete successfully in whatever markets they

choose to enter, even if they cannot manage

a presence across the board. Beyond this, the

dollar will not necessarily retain its dominance

over the longer run. Other currencies—notably

the yen—could make inroads. This would, once

again, require policy changes in Japan, but Japanese economic strength makes growing prominence for the yen inevitable.

17F0 r example, “International Ilanking’s Pending Issues Suddcnl~ Unfold /aparr Report, Joint Publications Research Ser\’-

ir:e ]PRS-JAR-86-018, 13ec. 19, 1986, p. 58—an inter~riew with

Takotorno Otsu, International Finance Bureau, Ministr} of Finan[; e, translated from Ginko ]ih}o, Sept. 16, 1986,
108 . /international Competition in Services

In this scenario, then, Japanese competitiveness in international financial markets steadily increases. Japan’s Government raises its profile internationally, making clear its intent to

protect the interests of Japanese banks should

an international debt crisis arise. Major U.S.

banks, vulnerable because of their exposures

in the developing world, find the competitive

balance tilting toward the largest holders of international deposits in the world.

It is too early to predict outcomes. But competition between the United States and Japan

in financial services will certainly intensify. The

competition will differ in many ways from that

in manufacturing industries, but past experience suggests that it would be better for U.S.

bankers and U.S. policy makers to err on the

side of overestimating rather than underestimating the Japanese threat. Policy makers in the

U.S. Government tempted to urge their Japanese counterparts to liberalize rapidly might

first think through the full range of possible consequences,

POLICY ISSUES

Governments everywhere regulate banking;

in some places they own the banks. Rules set

by governments determine the products offered, and, indirectly, the profits that are possible. Banking is a very special industry. Banks

provide the mechanisms for creating, transferring, and storing money—essential for the exchange of goods and services. All industrial

market economies have relatively complex and

sophisticated banking systems. Banks are also

special because of their role as depositories of

savings and other financial assets. All governments take steps to protect consumer deposits, Finally, governments implement monetary

policy through the banking system—in the

United States, a process centering on the Federal Reserve Board (FRB), The special nature

of banking means deregulation—permitting

banks and bank-like firms to respond more

directly to market incentives—will not go too

far. Deregulation tempts banks into riskier lines

of business. But customer safety, and public

perceptions of safety, will keep governments

involved in the banking industry, just as governments will continue to regulate some aspects

of the airline industry.

Given the special relationship between government and the banking system, should Federal agencies support U.S. banks internationally? If S O, when and how? Or should the

primary concern of policy makers be domestic

financial services? In reality, such distinctions

are false. As the scenarios for Japanese competition suggested, competitive ability depends

in part on domestic policies—a fact of life in

this and many other industries, although one

that the U.S. Government has seldom acted on,

or even acknowledged,

Domestic Regulations

Separation of Commercial and Investment Banking

Although administrative and judicial decisions have widened the scope of activities permitted commercial banks, and the bank-like

businesses that compete with them, the GlassSteagall Act and other U.S. laws and regulations continue to enforce a separation between

investment and commercial banking. Few other

countries divorce these two activities.

The argument for following much of the rest

of world in permitting universal banking begins with the steadily increasing integration of

national capital markets, and the growth of hybrid products such as floating rate notes that

combine features of commercial and investment banking services. With securitization, investment banking products tend to replace commercial banking products, To be competitive

in investment banking, moreover, now demands

large amounts of capital–capital that U.S. commercial banks have, and U.S. investment banks

need, Mergers and acquisitions involving U.S.

investment banks—including the recent purchase by Sumitomo of a share in Goldman
Ch. 3—International Competition in Banking and Financial Services . 109

Sachs—have been driven by these requirements

for capital. Finally, say the advocates of relaxation, the view that combining commercial and

investment banking leads to potential conflicts

of interest—the original reasoning behind GlassSteagall—is no longer true, if it ever was (as

shown in part by the lack of such problems in

universal banking in Europe) .18

The case for maintaining the separation with

little or no change rests on a different logic.

Removing the restrictions would work to the

benefit of large commercial banks–many of

which have made major errors in judgment in

recent years. The implication? Relaxing GlassSteagall and other restrictive policies might simply give big banks more room to make big mistakes, perhaps requiring new government interventions to resolve.

Whether one likes it or not, however, the walls

between commercial and investment banking

are crumbling. policy makers must first ask,

given continuing efforts by commercial banks

to expand into these activities, whether it will

be possible to continue enforcing the separation indefinitely. After all, commercial banks

seek to move into investment banking in part

to counter the thrusts of other financial and

non-financial firms into their own territory—

thrusts made possible by deregulation in the

United States over the past decade.

In a climate of contagious deregulation, can

the barriers between commercial and investment banking hold? OTA’s analysis suggests

that, in the long run, they cannot. The analysis

also suggests that the regulatory separation has

had only limited significance for the international competitiveness of the U.S. financial

services industry (helping in some ways, hurting in others)—but that a policy of attempting

to preserve the separation indefinitely could be

inefficient if not counterproductive.

U.S. banks will continue expending effort and

resources in finding ways to circumvent the

rules—effort that might better be directed elseIfIFor th[; hl$tor i~ a] I)ackgro{] n(i, see 1. ~Valter, Barriers to Trad(’

in BanLIng and Finanfia] Sert’icf;s ( Imndon Trade Po] ic~’ Re-

~ea rch (Jentre, I !]85 ].

where. The questions then become: When and

how should the rules be relaxed? Should policymakers permit gradual and selective entry

by commercial banks into some but not all currently prohibited businesses? Or should the prohibitions simply be dropped at some agreed

time? It may be time for Congress to confront

these issues more directly.

Regulation of Interstate Banking

The other major division imposed on the

banking industry by U.S. legislation, in the form

of the McFadden Act, together with subsequent

laws restricting bank holding companies, has

been geographic: banks were not to expand

across State lines. Here, judicial rulings, legislative changes, and technological developments

have combined to undermine many of the prohibitions written into the law, as these affect

wholesale and international banking,

Indeed, at this point, permitting unlimited interstate banking would make little difference

for the international postures of U.S. banks,

with one exception. In several parts of the

United States, existing small to medium-sized

banks have begun to merge into super-regional

firms—often taking advantage of legal provisions that favor their expansion over existing

money-center banks, Although few do much

overseas business currently, some will probably

grow large enough to support operations in, say,

London—in doing so, recapturing customers

lost to correspondent and money-center banks.

(NCNB, of North Carolina, is one of only six

U.S. banks with membership on the London

Stock Exchange.)

While the emergence of these super-regional

banks will take time, they could eventually provide a source of new vitality, helping the U.S.

industry maintain its competitive position, In

sum, there seems little reason based on international considerations for Congress to consider changes in the laws governing interstate

banking.

The Banking Infrastructure

The FRB, along with agencies such as the

FDIC, maintains a dual relationship with the
110 • International Competition in Services

U.S. banking system. On the one hand, as a regulator, the Board sets rules under which banks

must operate. On the other hand, the FRB also

supplies banking services—notably clearing

and settlement for member banks, a critical part

of the Nation’s banking infrastructure. How

well government agencies fulfill their functions

as intrinsic parts of the banking system helps

to determine the competitive position of the

U.S. industry.

When a Korean firm borrows dollars, the

transfer of funds from the lender’s account

to that of the borrower normally takes place

through the CHIPS system, while the net settlement between banks involves FedWire (box

G). FedWire, CHIPS, and the other elements

in an efficient transfer system have played key

roles in maintaining the dominant position of

the dollar in world commerce. By legislation,

the FRB’s FedWire system is to be a break-even

service.19 In recent years, the Board, in its role

as regulator and provider of net settlement services, has acted in ways that insulate FedWire

from competition. For instance, the Fed has imposed caps on daylight overdrafts regardless

of whether the overdrafts are on FedWire or

a competing service. Banks, needing to carefully monitor their overdrafts, have tended to

give more of their business to FedWire, at the

expense of private competitors. 20 Fewer rivals

for FedWire could mean less pressure to keep

prices low and reliability high—the principal

issue for policy makers.

The possibility of conflicts between the Fed’s

concern for its own profitability and its regulatory responsibilities will exist so long as the

FRB acts both as competitor and regulator;

given the importance of FedWire and other

portions of the banking infrastructure for the

Nation’s competitive position, maintaining the

efficiency of this infrastructure becomes an onIg]n Ig8LI, the Board reported that FedWire had become largely

self-supporting, and that its wire transfer services as a whole

had made a $3.5 million profit. SeLenf~-firsfAnnual Report, Board

of Go L’ernors of the Federal Reserve Board (Washington, DC:

Federal Reserve Board, 1985], p. 194.

%ee ].W. H. Watson, “Fed Drives Out Competitors in Bank

Fund Transfers,” Wa)~ Street ]ourna], Mar, 13,1986, p. 30. Bankwire, founded in 1952, and by 1971 jointly owned by some 200

U.S. banks, ceased operations in Febuar} 1986.

going policy issue of some significance. If anything, the Monetary Control Act of 1980, which

requires the Fed to cover its costs, may encourage the Board to use its regulatory power

to reduce competition, and, with it, the efficiency of the payments process.

Safety and Stability of the Financial System

Like the Fed, the FDIC provides services to

the U.S. banking industry—deposit insurance,

for which banks pay an annual premium—

while also functioning as a regulatory body. In

practice, the FDIC may act to protect all deposits, even those in overseas branches, given

its overriding concern with preventing bank

failures in the first place. The FDIC’s policy

of protecting banks in order to protect depositors means that new financial products may,

like overseas deposits, get the benefits of the

FDIC umbrella even though in principle outside its coverage (and even though no premiums

are paid). Standby letters of credit, for example, create contingent liabilities for the bank.

If the borrower fails, the liability becomes a real

one. A deposit insurance program that prevents

bank failures has the effect of insuring SLCs

as well, even though the FDIC’s legal obligations may not extend this far (a question at

present unanswered).

SLCs are only one of many examples where

the FDIC’s nominally domestic guarantees can

affect international competition. But it would

be wrong to suggest that FDIC protection creates major competitive advantages for U. S.-

owned banks. Other industrialized countries

are no more likely to let their large banks fail

than is the United States. The issues revolve

around the implicit subsidies provided by such

guarantees.

Governments everywhere stand behind their

financial systems. In doing so, they help their

banks compete. Unless governments collect

fees or premiums reflecting the risk of failure,

they are subsidizing these banks. Subsidies may

well be justified, considering the benefits to the

public at large, but they nonetheless raise the

question of distortions internationally. Movement toward standardizing practices across

countries—e. g., tying premiums to the protec-
Ch. 3—International Competition in Banking and Financial Services • 111

tion actually provided, thus reducing subsidy

levels, or reducing uncertainty as to the immediacy of payment in the event of a failure—

would be a significant step toward a level playing field. Another step would be to pursue international agreements aimed at coordinating

regulatory and supervisory practices, thereby

reducing the need for either implicit or explicit

insurance. Put another way, international coordination of regulatory practices can reduce

the potential for distortions in financial markets. International agreements aimed at standardizing such practices, although they might

take years to achieve, merit high priority as a

U.S. negotiating objective (see below and also

ch. 10).

Problem loans to developing countries raise

similar issues. Some of these loans pose potential threats to the solvency of large U.S. banks.

How far should the Federal Government go

toward lessening these threats? The Baker

Plan—a U.S. initiative proposed by Treasury

Secretary James Baker, calling for joint action

by the banks, the borrowing countries, and multinational lending institutions (e.g., the World

Bank) —would help the borrowing countries

service their debt, thereby reducing risks for

the banks, But perhaps more effective government policies could have kept the banks out of

the trouble they’re now in. LDC loans also raise

the question of coordinating policies toward

loss reserve requirements—currently stricter in

the United States than in Japan, for example.

Given the trends outlined in this chapter, policymakers may wish to consider risk-related insurance premiums as an alternative to other

forms of regulatory interventions in the financial services industry. The Third World debt

situation provides perhaps the strongest argument for such an approach, The problem, of

course, lies in making the judgments about riskiness, particularly for new or different ventures.

Still, that is what insurance is all about.

Does the United States Need a New Approach

to Banking Regulations?

The U.S. deposit insurance system, the regulatory separation between investment and

commercial banking, and restrictions on interstate banking all stem from legislation passed

in the aftermath of the banking collapse of the

1930s. The laws have been modified over the

years, but with no fundamental shift in philosophy. In the practice of banking, however,

change has been sweeping—both internationally and domestically (e. g., the rise of non-bank

banks). Perhaps it is time for Congress to consider comprehensive new banking legislation,

Reasons for considering a new approach begin with interactions between spheres of regulatory and supervisory practice once largely independent, but no longer so. For example,

lifting the Glass-Steagall restrictions would

force changes in FDIC insurance; otherwise,

the insurance umbrella would, in effect, be

stretched over a wide range of risky activities

for which it was never intended. Banks with

FDIC coverage would be competing with uninsured non-banks, who could legitimately protest unfair competition. One alternative would

be to switch the basis for regulation from an

institutional focus (i. e., regulating what a particular type of institution can do) to functional

regulation. Commercial banks might then be

permitted activities currently denied them under Glass-Steagall (and other current laws), but

in turn directed to treat funds from different

sources differently. For example, individual

depositors could be protected by requiring

banks (and non-banks) to invest funds from

small depositors only in short-term Treasury

securities, and to give such depositors priority

in the event of a voluntary or involuntary

liquidation—thereby reducing or eliminating

the need for insurance to protect consumers,

Future Policies; Negotiating Objectives

Data for Analysis

The Federal Government collects a great deal

of data on international banking compared with

other service industries; unfortunately, none

of it measures international banking activity

in ways that correspond to exports and imports

in other industries. 21 Because existing data can
112 • International Competition in Services

offer little guidance for policy makers on probable consequences of changes in either foreign

or domestic policies, banking and other financial services deserve high priority in any effort

to improve data collection and analysis relating to trade in services. In the absence of such

information, policy makers might, in fact, wish

to reemphasize liberalization of trade in financial services simply because the consequences

for the U.S. economy cannot be predicted.

Dealing With Restrictions Abroad

U.S. financial services firms face severe restrictions in many foreign countries .22 Some

governments simply deny entry to foreign banks,

or limit the businesses they can pursue; until

recently, Sweden prohibited any foreign bank

office from accepting deposits or making loans.

Some countries deny foreign-owned banks full

access to the central bank discount window;

foreign banks must often use clearing systems

controlled by their local competitors.

There are cases in which U.S. banks can engage in activities denied to local banks. Until

the early 1980s, only foreign banks in Japan

could make foreign currency loans to Japanese

borrowers—a lucrative business. Opening the

market to Japanese banks has hurt the onshore

firms, But in general, foreign government policies limit U.S. banks compared to their local

rivals, with restrictions on the type of foreign

presence—branches, subsidiaries, agencies—

making it difficult for U.S. banks to operate as

integrated multinationals. Australia, Canada,

(( [)r711r]IJtd Irwn] prt~t iou.s Jhfgt’)

spw: ial problc ms posed b~’ measuring trade i n fi niinr: ial ser\’-

ices are summarized on p. 40, with OTA’s own estimates for

foreign rekrenues in commercial banking on pp. 56-58. These mtirnates suggest that the foreign re~’enues (not exports) of U.S. banks

probably exceeded $12 billion in 1984, but the underlying data

are too weak to place a great deal of con ficlenc e in this or an}

figure.

~~~’[) 1. detai 1s, see ‘‘ Nationa] Treat ment Study: Report to CO ngress on Foreign Government Treatment of U.S. Commercial

Banking anc] Securities Organizations, 1986 IJpdate, ” Department of the Treasury, Washington, DC, December 1986, Also:

earlier Treasury Department national treatment studies (in 1979

and 1984); lnternatiorla] Trade in Ser\”i[;es: Banking (Paris: Organizat ion for Economic {Xmperat ion and De\relopment, 1984]; and

‘‘ I)ire(:t Sources of Cornpet itii’eness in Banking Ser\i(:es, ” pre-

~)ared for OTA bj J .G. Kallberg and A. Saunders under contract

No. 533-5640, pp. 5.5-5.47.

Finland, New Zealand, Norway, and Sweden,

among others, permit foreign banks to establish subsidiaries but not branches. This imposes

more of an arms-length relationship than other

organizational forms. Some countries limit

transfers of funds across their borders. Negotiations that would help American banks integrate their worldwide operations deserve high

priority,

Unfortunately, the 1978 International Banking Act removes a potential lever for U.S.

negotiators. So long as the law is in place, the

United States cannot really threaten to reciprocate when other countries place burdensome

restrictions on U.S.-owned institutions, A credible threat of reciprocity in banking regulations,

even if never called upon in practice, could be

a negotiating advantage for the United States.

Congress may wish to consider amending the

International Banking Act to this effect.

International Coordination

Each country has its own banking regulations, with many differences. South Korean

companies seeking to expand have a difficult

time raising money in part because of restrictions on Korean banks. And if a Korean bank

tries to float bonds in the United States for a

Korean corporation, it will face restrictions that

limit the foreign portfolio holdings of American purchasers. For such reasons, the Korean

company will more than likely go to the Euromarket, where neither Korean nor U.S. regulations apply. Similarly, a multinational corporation will do business with banks wherever

it can make the best deal. U, S.-based MNCs will

borrow from European or Japanese banks if

lower capital ratio requirements permit better

terms than American banks can offer. European banks and governments, meanwhile, argue that their tighter supervision of off-balancesheet activities handicaps them unfairly in markets for, say, floating rate notes.

The dilemma is plain. Asymmetries in regulations induce banks to move their operations

elsewhere—e.g., to offshore markets. If national

governments maintain their regulations unchanged, their domestic banking industries lose

business and their regulatory agencies lose con-
Ch. 3—international Competition in Banking and Financial Services ● 113

trol. They can either try to extend their regulatory grasp to the offshore market or liberalize

domestically. Offshore markets cannot be unilaterally regulated, but U.S. policy makers have

nonetheless sought at times to have it both ways.

The FRB’s decision in 1981 to permit U.S. and

foreign banks to establish international banking facilities (IBFs) in the United States represents an attempt to compete with offshore markets by permitting lightly regulated Eurodollarlike markets here. But in part because IBFs still

must live with more regulations than competing offshore establishments, growth has been

slow. Attracting more of this business to the

United States would mean relaxing regulations

that the FRB considers important for the stability of the U.S. banking system.

Where banks and their customers meet in international capital markets, then, banks will

press their governments for treatment at least

as lenient as their foreign rivals, or seek agreements that will impose tighter standards on

those rivals. U.S. banks argue for higher capital ratios elsewhere or lower ones in the United

CONCLUDING

International banking has grown very rapidly in the postwar period. U.S. financial services firms have been pre-eminent over much

of this time, although banks from other countries have often grown faster. These strides by

foreign banks do not mean that the competitive abilities of American financial institutions

have diminished so much as that other economies have been expanding rapidly, and their

banking industries becoming stronger.

Banks compete not only with one another,

but with their customers. Businesses turn to

banks for financing needs ranging from cash

management and short-term revolving credit

to the structuring of complex financial packages for capital expansion and overseas investment, Large corporations need financial institutions relatively less than smaller companies.

Multinationals have the capability to manage

States. But the function of such regulations is

to preserve stability—an objective difficult to

question so long as regulations do not unnecessarily sap efficiency, All this suggests that,

difficult as it maybe to achieve, international

coordination of policies toward banking should

be a paramount goal—that this is one industry

where the hoary notion of a level playing field

has real meaning as a policy objective; there

is no reason to permit large financial institutions or large MNCs to play off governments—

each with good reasons for regulating financial services—against one another.

U.S. policy makers will need to continue balancing the need for safety and stability in the

Nation’s banking system—and the ability to pursue monetary policy—against the benefits of a

more liberal and presumably more efficient

banking system worldwide. Policy makers may

also find it time to begin considering whether

to move beyond coordinated national policies

toward supranational supervision and regulation of financial services.

REMARKS

their own cash and market their own commercial paper, although they may need banks for

access to the clearing system or for insuring

their paper. As a corporation’s own cash management system improves, its banks must maintain an edge or lose business; if the banks get

better, the corporate treasury operation will too.

Electronic cash management is possible only

because of developments in computer and communications systems; data processing and

telecommunications technologies help integrate world capital markets, make new banking products possible, and provide faster and

cheaper delivery of traditional banking services. As electronic messages have replaced paper and the telephone, the amount of information available to bankers making decisions on

loans or currency transactions has increased

enormously.
114 ● International Competition in Services —

Innovations in financial products and in the

technology for delivering services have helped

American banks maintain their competitive positions. U.S.-based institutions have dominated

in markets for new products such as interest

rate swaps and Eurobonds. They have adapted

rapidly to securitization; when it comes to technologies used in trading securities, American

firms lead the rest of the world by substantial

margins. In many markets, U.S. banks have

been successful despite inherent disadvantages;

examples include banker’s acceptances for

third-party trade, and securities underwriting

in foreign currencies.

At the same time, foreign banks have dramatically increased their presence in the United

States (although expansion has slowed in the

last several years). Does this imply lagging competitiveness by U.S. banks in their home market? OTA has found little evidence to suggest

such an interpretation; foreign banks come here

in part to gain experience in a highly competitive, deregulated, and technologically advanced

industry; the very fact that U.S. financial services firms remain highly competitive internationally attracts foreign banks seeking to learn

from U.S. experience. As in other industries,

the size and wealth of the Nation’s economy

attracts foreign firms.

Many of the forces that have worked to the

advantage of U.S. competitiveness in the past

promise to continue to do so. But competitive

patterns can and will change. Americans—both

as individuals and as corporate officers—may

think first of Merrill Lynch or Chase Manhattan when it comes to financial services, whether

domestic or international. Japanese feel the

same way about Nomura Securities and Fuji

Bank. Nonetheless, U.S. automakers, who once

bought all their steel from American steelmaker,

now purchase overseas as well. Today, American corporations increasingly seek financing

on the world market.

Competition among the world’s major banks

has tended to keep differences in the price and

characteristics of services relatively small. Still,

banks differ in corporate strategy, in marketing skills, in production efficiency. Seldom are

these differences large enough to enable banks

from one country to quickly or easily take business from foreign rivals who have comfortable working relationships with major customers. Over time, they do have a cumulative

impact on market share and other indicators

of competitive success.

But the financial institutions in the advanced

industrial economies will probably not diverge

very much in terms of the factors that determine competitive outcomes. Market forces will

keep them close together (in the absence of massive changes in the world economy). Innovations in banking products and in back-office

production technologies diffuse with considerable speed. Other governments are following the U.S. lead in deregulating financial markets. Both forces—technology and deregulation

—point toward increasing convergence. If anything, the competition that already exists in the

United States and in offshore markets—and the

multinational character of U.S. banks—will give

them ongoing opportunities to attract customers based in foreign countries. American banks

that take advantage of these opportunities

should continue to do well internationally.

The forces at work in financial services will

also lead to greater cross-penetration of major

markets, both domestically (in the form of regional and perhaps nationwide banking) and

internationally. Moves by banks like Citicorp

and Chase into regional U.S. markets find their

analogs in competition in Tokyo and London,

as well as New York, among banks and securities houses from many countries. British banks

are moving in the same directions as American

banks—and for many of the same reasons. The

deregulation of the London stock exchange, the

Big Bang of October 1986, will surely speed the

convergence of financial services offered by

U.S. and British firms (although London is currently behind in technology).

Deregulation in Japan has been slower, with

Japanese banks less willing than their American counterparts to test the limits of existing

laws and regulations. Even so, banks in Japan

have been pushing for greater freedom of action for some time. In 1979, for example, argu-
Ch. 3—International Competition in Banking and Financial Services • 115

ing that restrictions on managing issues overseas only applied to public offerings, the wholly

owned Swiss subsidiary of Fuji Bank took the

lead role in managing a Swiss franc private

issue for a Japanese construction company.

These and subsequent thrusts by Fuji and other

Japanese banks led to the de facto reinterpretation of parts of Section 65 of the Japan’s Securities and Exchange Law, which controls the

separation of commercial and investment banking in Japan .23

Internationally, with so many players in each

market, price competition will continue to be

intense. Customers will be able to switch easily among competing banks; the banks will be

under constant pressure to hold down prices.

Real or threatened competition will keep margins low, making financial services unprofitable by the standards of the late 1970s—not only

in major world markets, but in many markets

previously viewed as local or regional. In this

competitive milieu, the leading banks from each

country may well change, The big banks in the

major industrial countries will be carrying the

burdens of past mistakes for years to come; loan

portfolios weighted down with Third World

debt limit their strategic options. Emerging

super-regional banks in the United States, with

stronger balance sheets, may be able to take international business away from larger banks

that must avoid new risks. At the same time,

regional banks—in the United States, Japan, and

elsewhere—will face much stronger competition in their traditional markets. As a result,

the high profit levels of regional and superregional banks will probably diminish.

Governments affect competitive dynamics in

this industry through regulatory and supervisory policies, directly and indirectly. All governments view banking as a special industry.

In seeking to protect depositors, particularly

individuals (and for political reasons), they inevitably have an interest in the fortunes of individual banks. But national regulations have

~ ‘Ii. ~t’ [~ ;l}’(h;Il , “ 1 nt ernat ionalizing }apan’s Financial S\stcm,”

):fp~in “f Ef.onc)mJ: f,’c)~)il)g Itrith L’hangy ir] ~he lntf>rn;]tionai ErItJronmt~r] t. 1). 1. okl m[jt(} ({; (I. ) [ Bould[’r, ( ;(): 11’est~irw. SII[:( la 1

Stu(lic\ Scrlcs, 1 982], 1)1). 99-100.

become increasingly difficult to maintain; when

one country deregulates, others may have little choice but to follow. With national regulatory structures growing more porous, real

dangers of instability on a global scale follow,

Given ongoing integration in world financial

markets, it may be time to seriously consider

supranational regulation of those markets.

Governments not only regulate, some own

and operate financial institutions. While postal

savings banks, for example, may have no direct presence internationally, they can nonetheless affect competitiveness indirectly. Japan’s

postal savings system—the largest depository

institution in the world—makes the Japanese

Government cooler than it might otherwise be

toward liberalization. By increasing competition for deposits—and, in effect, giving Japanese savers access to the higher market interest rates set internationally —liberalization

would force the postal savings system to pay

out more in interest.

As Japanese manufacturing firms continue

to invest in other countries, Japanese banks will

follow. As they do, they will mount more substantial and more sophisticated competitive

challenges to the leading American financial

firms, in this aided by Japan’s very large holdings of foreign assets—a legacy of many years

of trade surpluses. At this point, many of the

decisions that will determine the pace and force

of this challenge remain matters of domestic

Japanese politics: if those advocating rapid

change in Japan’s own financial markets win,

further penetration of Japanese banks into international financial markets will come quickly;

if the conservative Ministry of Finance manages

to hold onto most of its control over Japan’s

domestic markets, the pace will be slower.

What then of the outlook for U.S. financial

service firms? Deregulation and new competition will, as always, make for winners and

losers. Some foreign banks may continue growing faster than American banks, if only because

they service faster-growing economies, Japanese firms like Nomura Securities will continue

expanding in the United States to serve Japa-
116 • International Competition in Services

nese (and American) clients. Leading U.S. institutions will report profits below traditional

levels, some of the super-regional banks will

flounder, some large banks may shrink dramatically. Mergers, possibly involving some of the

biggest banks–U.S., Japanese, European–will

continue,

By several measures, particularly in terms of

asset size, U.S. banks have lost ground in recent years. Given the ongoing shift in international banking from lending to fee-based services, these losses—and the gains by Japanese

banks–are not so serious as they would otherwise be. But a major competitive challenge to

the American financial services industry is

coming from the Japanese. The outcomes may

be in doubt, but not the gravity of the threat

to U.S. competitiveness.
Chapter 4

International Competition in

Engineering and Construction
CONTENTS

Page

Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ...........119

Industry Structure and Trade . . . . . . . . . . . . . . . . . . . . ....................121

The Industry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .....................124

Downstream Linkages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .............127

The International E&C Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. ...128

Competitive Strategies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ...............136

Financing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ..........136

Technology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ...........138

The Future . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ...................144

Policy Issues: Technology Development and Diffusion, . . . . . . . ...........148

Concluding Remarks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ...151

Boxes

Box Page

I. Examples of International Design and Construction Projects of

American Firms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ..................122

J. Piping Design and Construction Management Technologies . ..........125

K. Technical Knowledge in the E&C Industry: Three Examples . . . . . . .. ...140

L. Federal Government R&D Support for Construction-Related

Technologies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ..............149

Figures

Figure No. Page

26. New U.S. Construction, 1985 . . . . . . . . . . . . . . . . . . . . . . ...............126

27, Total Billings, Domestic and Foreign, for 500 Largest U.S. Design

Firms by Type of Project, 1984 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ......126

28. New Contract Awards of the 250 Largest International Contractors ....129

29. Economic Growth in the Developing World. . . . . . . . . . . . . . . . . . . . . . . ..130

30. Foreign Construction Awards of the 400 Largest U.S. Contractors .. ...131

31. New Contract Awards of the 200 Largest International Design Firms ..133

32. Foreign Awards of the 500 Largest U.S. Design Firms. . ..............134

Tables

Table No. Page

14. Leading International Contractors, 1980 and 1985 . ..................126

15. Typical Examples of U.S. Goods Exports Resulting From an Overseas

Energy Project. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ...........128

16. New Contract Awards for the 250 Largest International Contractors,

1985 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ....131

17. Revenues of the 500 Largest U.S. Design Firms . ....................132

18. Billings of the 200 Largest International Design Firms, 1985 . .........134

19. Foreign E&C Firms in the United States . . . . . . . . . . . .................135
.—

Chapter 4

International Competition in

Engineering and Construction

Through the mid-l970s, American engineering and construction (E&C) firms won far more

international contracts than competitors from

other countries. For many of the larger U, S.-

based contractors-Bechtel, Brown & Root,

Fluor-international projects came to account

for half Or more of revenues and profits. But

as international (construction boomed and U.S.

firms did well, others did better. [J. S. market

share gradually slipped.

The 1980s brought a new era to the world

construct ion industry. Like so many of their

counterparts in U.S. manufacturing industries,

American E&C firms found themselves in a

world w i t h many more quite able competitors,

A second factor accelerated the slide in U.S.

market share: declining economic growth rates

in the Third World, plus the collapse of oil

prices, meant fewer international projects.

Over the past two decades, the E&C firms of

the less developed and newly industrializing

countries (LDCs and NICs) have matured.

Meanwhile, the Europeans and Japanese pursued strategies based largely on the development

of technological advantages, first in construction methods needed to deal with conditions

in their home markets, So long as Third World

growth was strong, and Middle East oil revenues high, there were enough international contracts to keep many companies busy. U.S. market share gradually fell, but for practical

purposes American companies had all the business they could handle,

Today, deteriorating economic conditions

mean fewer of the big construction jobs—dams

and water projects, airports and electric generating plants—that have been a staple of U.S.

(and European) E&C firms. Third World debt

burdens mean that developing countries cannot

afford new projects. Falling oil prices have cut

sharply into new construction in the Middle

East and other oil-exporting regions. The oilexporting nations already face overcapacities

in petrochemical production; they have neither

the money nor the need of earlier years. At the

same time, these countries can now handle

many projects on their own that a decade ago

would have been contracted to a foreign E&C

company.

Moreover, contractors from NICs including

South Korea, Brazil, and Turkey have begun

to compete against firms from the developed

nations in the international market, With the

NICs pushing from below, E&C firms from the

other developed countries have invaded markets once the province of American contractors, often with the aid of subsidized financing

packages put together with government help,

Companies based in Britain, France, and West

Germany—major players in the international

construction game for many years—have been

joined by aggressive competitors from Japan,

Italy, and elsewhere.

Three primary factors affect international

competitiveness in the E&C industry: costs,

financing, and technical capability—the latter

including managerial expertise as well as engineering skill. Generally uncompetitive in laborintensive construction, American companies

have concentrated on the professional services

portion of the industry-architecture, engineering, construction management, and operations

and maintenance. But with rising competence

elsewhere, U.S.-based firms have had trouble

competing on a cost basis even for the more

sophisticated jobs; despite hiring growing numbers of foreign nationals for work on international projects—engineers and supervisors, as

well as people in lower skilled positions—

American companies continue to lose contracts

to foreign competitors with lower costs overall.

119
120 • International Competition in Services

—. —

With more competition for fewer projects,

U.S.-based firms will increasingly find themselves members of international consortia. To

survive internationally, they must rely more

than ever on strengths in putting together

financing packages, and on their managerial

and technological expertise. The alternatives?

Withdraw from the market, or operate internationally only in protected segments created

by U.S. Government set-asides (e.g., military

projects). With other governments participating in financing—to support exports of materials and equipment as much as E&C services—

American companies have been actively seeking joint ventures with foreign partners, in part

to tap the financial resources of the latter. This

pattern will probably continue even if U.S. efforts to wean other countries away from subsidized financing succeed.

The picture is not all grim. American companies still have excellent and deserved reputations in engineering and project management.

If not, as they once were, broadly superior, U.S.

firms lead the world in technologies such as

computer-aided design and drafting (CADD),

and in know-how for designing petroleum refineries and some kinds of power stations and

chemical plants. They also retain a lead in

managerial expertise—which remains a significant though diminishing source of advantage,

given the shift in the market away from massive projects demanding skills in logistics and

coordination on jobs involving hundreds of subcontractors and suppliers. Even so, management tools such as computerized inventory control systems and scheduling methods can help

cut costs and increase productivity on projects

of all sizes, as can advances in construction

technologies such as automated earthmoving

equipment and pipe bending machines. These

technologies can help to reduce the labor cost

disadvantages of U.S. construction firms, as can

techniques for offsite fabrication of major components and designs that are easier and cheaper

to construct.

Taken together, advances in construction

technology will, over the next two or three decades, lead to huge increases in productivity.

Currently, however, it is foreign companies, not

American, that have the lead in fields like tunneling, reinforced concrete construction, and

some applications of new materials. Overseas

firms—especially the Japanese—do much more

research on basic construction processes. Most

U.S. R&D has been directed at managerial and

design technologies, and at industrial process

engineering. While American E&C firms have

been seeking to position themselves to take

advantage of growth in emerging industries like

biotechnology, the common strategy—serving

as a broker who can put together a turn-key

package of process technology for the customer

—today can compensate only partially for lack

of a proprietary technological position in the

sense of firm-specific know-how.

American companies have begun to adapt to

new competitive realities, somewhat hesitantly.

The years ahead promise further painful adjustments, Broadly speaking, loss of competitiveness in engineering and construction has

implications for the entire economy. Even

though only a small portion of U.S. E&C firms

seek international business, and even though

the linkages between exports of E&C services

and exports of goods have been weaker in the

United States than in other nations, loss of competitiveness in the E&C industry translates into

reductions in the export potential of industries

that sell capital goods internationally. These

range from computer systems for air traffic or

industrial process control, to steam generating

units and turbo-alternators, to mining, earthmoving, and construction equipment itself.

Furthermore, as E&C markets have dried up

elsewhere, foreign firms have turned their attention to the United States. Using skills honed

abroad, some of these companies have begun

to make substantial inroads into the huge domestic U.S. construction market; American

E&C firms could begin to find themselves uncompetitive at home as well as overseas.

The most immediate government policy impacts in this industry come through financing.

Progress in matching or eliminating foreign

government subsidies—e.g., mixed credits—

would be a real help to U.S. firms internation-
Ch. 4—international Competition in Engineering and Construction ● 121

ally, not only in winning contracts they might

otherwise lose, but in permitting them to avoid

some of the joint ventures with foreign partners they have been forced into. Beyond this,

Federal support for R&D that underlies the E&C

industry—including new applications of existing technologies, and diffusion of results—

could help American companies rebuild their

technical prowess. Even in the absence of foreign government subsidies, American firms

will need better technology over the medium

and longer term to compete. The evolutionary

transformation of construction into a hightechnology industry, already underway, means

new opportunities for American firms that can

innovate and establish strong technological positions. While Federal procurements could help

the industry, an aggressive strategy based on

strengthening the infrastructure for technology

development offers the best hope for maintaining competitiveness over the longer run,

INDUSTRY STRUCTURE AND TRADE

Some firms do business in both the design

and construction portions of the industry,

others specialize in one or the other. Box I includes examples of typical projects of both

types, drawn from recent or current international projects won by American firms. Design

activities, encompassing both architecture and

engineering, include:

●

●

●

●

●

project feasibility studies, ranging from

economic analyses to environmental impact assessments;

conceptual design, for appearance as well

as function;

cost estimating;

engineering, including site planning, structural analysis and design (foundations, calculations of loads and strength), and—for

buildings—heating, ventilating, and airconditioning, as well as other building systems (e. g., electrical power); and

preparation of detailed drawings and specifications to guide construction.

The construction phase involves procurement and tracking of materials and supplies,

mobilization of labor and equipment, site preparation, earthmoving, onsite materials handing,

and fabrication and erection. Contractor and

purchaser may each have their own inspection

and quality control personnel. Development of

operations and maintenance (O&M) procedures, and training of the client’s work force–

while not normally considered part of the E&C

industry-fits logically as a part of the engineering process; moreover, a number of E&C firms

now undertake ongoing O&M work on a contract basis.

Many E&C firms specialize in certain types

of projects—Fluor in energy-related work and

petrochemicals, Ebasco in power generation.

Other firms specialize by technical function-T.

Y. Lin in structural engineering, Louis Berger

International in planning, design, and construction management. Some companies choose to

diversify, and compete for many types of jobs.

Even so, a company that builds, say, communications networks would seldom be found putting up residential buildings.

Contract opportunities typically emerge at

four stages during large international projects:

feasibility studies; design and engineering; construction; and startup, including O&M training. The earlier an E&C firm becomes involved,

the better the chances of further contracts. As

a rule-of-thumb, feasibility studies account for

about 1 percent of the eventual project cost,

with design and engineering about 10 percent.

Construction management can run between 2

and 6 percent of total costs, while lifetime expenses for operations and maintenance may

amount to several times the design and construction cost, depending on the type of facility. E&C firms may make little if any profit on

feasibility studies—indeed, because they provide an opening wedge for future design and

engineering contracts, may treat them as loss

leaders.
122 ● International Competition in Services

●

●

●

●

●

●

●

●

Box I—Examples of International Design and Construction Projects of American Firms

The Guy F. Atkinson Construction Co. leads an international consortium that is building the Guri

Dam in Venezuela, the second largest hydroelectric development in the world. With the firm Eulogio Grodo y Cia, Atkinson is also responsible for the Colburn Dam in Chile, which will be that

country’s largest.

A group of U.S. firms helped build the 1.8 million square foot Taipei World Trade Center in Taiwan. Bechtel International served as consultant for construction supervision and project management, Hellmuth, Obata & Kassabaum as lead architect, T.Y. Lin International as structural engineer, and William Tao & Associates as the mechanical engineering contractor.

Saudia Arabian Bechtel Co., Ltd,—the local subsidiary of the Bechtel Group-serves as planner,

designer, and project manager for the King Fahd International Airport. Minoru Yamasaki & Associates, of Troy, Michigan, won the contract for architectural design of the terminal complex.

A joint venture of three American firms—Paul N. Howard Co., Harbert International, and Sadelmi,

Inc.—has begun the first stage in what will be a $2.6 billion rehabilitation of the Cairo sewer system.

Local subcontractors will do most of the physical work.

AEGIS Construction has won a contract to design and build 125 units of family housing at the

U.S. naval base at Guantanamo, Cuba.

M.W. Kellogg’s British subsidiary recently won a contract for engineering, procurement, and construction supervision for an ammonia plant in Hull, England.

Scientific-Atlanta has a contract to procure equipment for and build 12 satellite Earth stations in

Gabon.

Morrison-Knudsen International designed and is constructing a $2 billion coal mine and port on

the Guarjira Peninsula in Colombia—the Cerrejon Mine/Puerto Bolivar project. This is Columbia’s

largest development and the world’s biggest award to a single contractor. Most of the labor force

was hired locally, with 380 Americans in a work force that reached a peak of 11,000.

Contracts take two common forms: designbid-build, and design-construct. Under the

design-bid-build sequence, design and construction take place under separate contracts.

Specifications developed in the design phase

form the core of a request for bids on the construction work. (Typically, the client selects the

design firm based on an evaluation of qualifications.)

Design-construct procedures eliminate the intermediate bidding stage, so long as the client

is satisfied with the earlier work. One contract

covers the entire project—design and engineering, construction, and perhaps even installation of equipment (for a turn-key project). The

lead contractor might later provide O&M services. Turn-key or total package approaches have

the benefit of simplicity for the client, who need

deal with only one firm,

The design-construct process aims for better cooperation between the design and construction teams; the design-bid-build system

fosters separation, even antagonism, between

designer and builder–a tradition that persists

in the American E&C industry, even within integrated firms. Current policies at both the

World Bank and the Inter-American Development Bank permit clients funded through bank

programs to award design contracts as followups to earlier feasibility studies without reopening the bidding process. If the client has been

satisfied with the feasibility study, the presumption of this “continuity of work” principle is

that sticking with the same firm will be more
Ch. 4–International Competition in Engineering and Construction • 123

efficient and less disruptive during the design rounds of bidding. Other nations have negoti -

phase, given that the E&C firm has developed ated selectively with or invited bids from indian understanding of the client’s needs. Like- vidual companies.1

wise during construction, continuity of work For large and complex projects, which may implies that staying with the same firm will be broken down into thousands of individual eliminate the cost of learning and mobilization

that a new firm would incur and charge to the work packages, site management becomes a

critical factor in controlling costs and meeting client.

Many bidding variations exist. For example, IA. Demacopoulos and F. Moavenzadeh,

United Arab Emirates picks the lowest five bids

“ I nterniit l[]na] (;(]nstruction Financing, ” l’DP Report 85-3, hlassa{:husctts Institute

for a rebidding process, or negotiates down to of Technology, Tec hnologj’ and De\wlo p men t l)rogra m, ] one

the lowest price offered. Indonesia awarded the 1985, pp. 73-74.

Information in this chapter not otherwise cittxl ~(’nerall~ (:onl(;~

contract for the Jakarta Airport after three from interviews,

Photo credit: Bechtel Power Corp.

Construction project under U.S management in Southeast Asia.
124 ● International Competition in Services

schedules, and hence in the ability to put together a winning bid. Tasks such as tracking

incoming supplies, onsite warehousing, releasing drawings (and preparing as-built drawings

when changes must be made in the field) on

a large project can be overwhelming. For example, Morrison-Knudsen’s Cerrejon Mine

project involved 200 subcontractors and 2,100

suppliers. In order to control costs, construction companies have begun using onsite computer systems (box J). American firms have been

leaders in software for onsite management, and

in the use of personal computers in the field,

The Industry

Domestically, construction is one of the

largest sectors of the U.S. economy. Well over

a million firms, most of them small, employ

more than 5 million Americans. New construction in the United States during 1985 accounted

for nearly 9 percent of the gross national product. But only a few thousand American E&C

firms do business internationally.

Residential building comprises more than 40

percent of domestic construction (figure 26),

with industrial plants and civil works of all

types (roads, bridges, dams, irrigation systems,

water and sewer systems, pipelines, ports) making up another 30 percent. Commercial and

other nonresidential buildings account for most

of the rest. z Residential housing remains the

domain of local firms, both in the United States

and overseas. The international E&C market

consists mostly of design and construction for

industrial facilities, civil works, and, to a lesser

extent, nonresidential buildings.

Of the 400 largest contractors in the United

States, only 60 gained new contracts for foreign work during 1985.3 A few big companies,

in turn, dominate this small export-oriented

2

See Traffe in St?rlrices: E~ports and Foreign Relrenues (Washington, DC: Office of Technology Assessment, September 1985),

pp. 58-61 and 65-67. Also 1986 Lr.S. Industrial Outlook [Washington, DC: Department of Commerce, February 1986), cbs. 1

and tj7.

“’U.S. Reco~er} Fuels Work Again, ” Engineering NeiisKecord, Apr. 17, 1986, p, 98. The figure was 6[j in 1984. This

group got 21 per(:vnt of its total contract ii~~rar(ts oi’erwas (lurin~ 1985,

group, with eight construction firms accounting for more than 80 percent of new foreign

awards by value. Similar patterns hold in other

countries, with international contracts making

up a substantial part of the total revenues of

the largest firms and/or those that specialize

in this part of the business (table 14). For the

[J. S. industry as a whole, foreign revenues—

although totaling $7.7 billion to $8.1 billion in

1983—account for only a few percent of total

receipts (3 percent in 1983).4

Relatively more design firms do business

internationally than construction companies

(many of the large E&C firms offer both design

and construction services), Of the 500 largest

U.S. design firms, 258 reported foreign billings

in 1985. 5 Figure 27 gives the breakdown by type

of project, including both domestic and foreign

awards, for 1984 (the latest year for which such

data are available), Small design firms, particularly, are more likely to be active in the international market than small construction companies. Nevertheless, of more than 45,000

establishments providing engineering, architectural, and surveying services in the United

States, only about 4 percent report foreign

receipts. However, those that do have foreign

sales get, on the average, more than 20 percent

of their revenues overseas.6 For the design portion of the E&C industry, OTA estimates that

foreign revenues came to about 14 percent of

domestic revenues during 1983 ($5.1 billion to

$5.6 billion, compared with $37.3 billion domestically), with affiliate sales considerably

more important than in construction.7

4These figures are (ITA estimates—Trade in 5’ert’ices, op. c it,,

p 60. Of the $7.7 billion to $8.1 billion, $4,8 billion consisted

of direct export s—e. g., construction services produced in the

United States for Lustorners ot’erseas; OTA estimates place the

sales of foreign affiliates of U.S. construction firms at $2,9 billion to $3.3 billion in 1983.

5“Designer Billings Reachecl Record of$11 Billion, ” Engine(;ring Ne}t’s-Recortf, Nlay 15, 1986, pp. 32-50,

‘1982 Census of Ser\7ice Industrit?s: A!isce]]aneous Subjects

(Washington, DC: Department of Commerce, 1985), p. 5-142,

‘Trade in Sert’ices, op, cit., pp. 65 and 67. OTA places direct

exports of design ser~’ices at $1,1 billion to $1.6 billion in 1983,

m ~](:h less than the estimate(l $-I billion in sales by. o~’erseas a ffiliates of U.S. design firms.
Ch. 4—International Competition in Engineering and Construction • 125

Box J.—Piping Design and Construction Management Technologies

For refineries, petrochemical plants, and power stations, fabrication and installation of piping may

be the single most expensive part of the construction process. With miles of pipe of many different

sizes, thousands of sensors, valves, and pipe hangers, and tens of thousands of welds, the design

process itself is laborious and expensive. In earlier years, three-dimensional models were needed to

check for clearances; today, much of the spatial design can be done with CADD systems. Particularly

in nuclear powerplants, piping systems must be designed so that neither expected nor unusual loads

(e.g., earthquakes) will cause ruptures; both piping runs and hangers will affect vibratory modes and

the loads at each point. Calculations are very complex; today, they are carried out on large computers.

The pipe itself is expensive, particularly when specialty metals (e.g., nickel-base alloys) must be

used to resist corrosion or high temperatures. Welds must be checked, often with X-rays. Pipes may

need to be insulated after fabrication. For a large power station, conventional or nuclear, the materials and labor for the piping can run to half a billion dollars or more. Piping may account for 40 percent

of total labor hours on the job site. Mistakes leading to scrappage or extensive rework can cost millions.

Piping fabrication—e.g., cutting and bending —normally takes place in an onsite shop. As an alternative to using elbows, induction heating following by bending under computer control can greatly reduce

the number of welds and hence cut both fabrication and inspection costs; savings maybe 20 to 40 percent. * While U.S. construction companies have begun to use induction bending, the technology has

been developed in Europe and Japan, and continues to be controlled by firms outside the United States.

Offsite fabrication can also lead to savings, particularly for projects in countries with limited pools

of skilled labor. For the A1-Jubail refinery, in Saudi Arabia, a Japanese firm built modules weighing

up to 2,500 tons at its home facilities. After shipment from Japan by sea, the modules were moved

6 miles on a specially constructed roadway to the refinery site.

Other sources of future savings in piping-intensive construction will include direct control of pipe

bending equipment from CADD databases, greater use of automated welding equipment and robotics

during installation, and automated real-time inspection of welds (ultimately, closed-loop control of

the welding process may obviate inspection except on the most critical welds).

Electrical wiring—also involving many components and labor-intensive installation—presents an analogous set of opportunities for automation and costs savings. Bechtel, for example, has scaled down

a mainframe computer program for cable and raceway scheduling to run on PCs at the construction

site, Designers enter data on each electrical component into the system at the home office. When

parts, components, and subassemblies are delivered, warehousemen log them in using optical scanners

to read bar codes and computer-generated control cards. As the job progresses, workers enter discrepancies and field changes into databases maintained both at the home office and the construction site.

Far more can still be done to improve productivity in construction through improved management

systems. On some large projects, workers maybe idle as much as two-thirds of the time while waiting

for the materials or tools for the next task.** Such examples suggest the potential of computer-based

construction management systems, now in their infancy, for smoothing the flow of work and cutting

costs. They will be extensively developed and applied over the next 10 to 15 years, not only for piping

and electrical wiring, but for many of the other tasks commonly found in complex construction projects.

In principle, components can already be coded and tracked from the design phase (engineering specifications), through fabrication (material lots, delivery and warehousing, construction and inspection),

and a database maintained over the life of the plant or facility. In practice, however, most companies

still work with a number of independent databases, handing control from one to the next at successive

stages in design and fabrication. The companies that develop and apply computer-based construction

management systems most effectively will have substantial advantages on large international projects

in the future.

*“Final Report, Tasks 1/2, Technology in Architecture, Engineering, and Construe. tion. ” prepared for OTA h} Il.\\’ Ha]pin under contract

iNO, 633-1970, p. 42.

The A1-Jubail example below comes from p. 32, the information on Bechtel’s computer management of elwtri(a} wiring from pp 26-27.

* *“Final Report, Task 3, Technology in Architecture, Engineering, and Construct ion,” preparwl for (3TA h} 1). VI’ Halpin under contract

633-1970, p. 2.
126 • International Competition in Services

Figure 26.— New U.S. Construction, 1985

Other private

nonresidential -

$56.1 billion (16.50/.) ~

\

$75.8 billion (22.1%

Total: $342,4 billion

SOURCE “Annual Value of New ConstructIon Put In Place In the Un!led States

In Current Dol Iars and 1977 Dollars, ” U S Department of Commerce

News, Apr 1, 1966

Figure 27.—Total Billings, Domestic and Foreign,

for 500 Largest U.S. Design Firms by Type of

Project, 1984

Water supply

70/0

Sewer and waste

12 ”/0

Total: $9.6 billion

SOURCE “Design Billings Gain 12 Percent In 1964, ” Ertg/neerirrg NewsRecord,

May 16, 1985, pp 36-66

Table 14.–Leading International Contractors, 1980 and 1985

1980 1985

New contracts New contracts

(billions of dollars) (billions of dollars)

Foreign Domestic Foreign Domestic —

American firms:

Bechtel Group . . . . . . . . . . . . . . . . . . . . . . . $8.5

Parsons. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8.3

Fluor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.0

Foster Wheeler . . . . . . . . . . . . . . . . . . . . 2.8

C-E Lummus . . . . . . . . . . . . . . . . . . . . . . . . 2.7

Japanese firms:

Chiyoda . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1.3

JGC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.7

Toyo Engineering . . . . . . . . . . . . . . . . . . . . 0.5

European firms:

Philipp Holzmann (West Germany) ., . . . $2.5

Bilfinger & Berger (West Germany) . . . . . 2.4

Davy (Britian) . . . . . . . . . . . . . . . . . . . . . . . . 2.4

Korean firms:

Hyundai . . . . . . . . ... . . . . . . . . . . . . . . $1.4

Daelim. . . . . . . . . . . . . . . . . . . . . . . . 0.8

Daewoo. . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.8

Other:

Mendes Junior (Brazil) . . . . . . . . . . . . . $1.5

Solei Boneh (Israel) ... , . . . . . . . . . . . . . . 1.3

SOURCE E~g/neer/r?g News-Record, various tssues

$2.1 M.W. Kellogg . . . . . . . . . . . . . . . . . . . . . . . $6.2

1.1 Parsons . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.0

4.1 Bechtel Group . . . . . . . . . . . . . . . . . . . . . . 3.6

1.8 Brown & Root . . . . . . . . . . . . . . . . . . . . . . . 2.9

1.6 Lummus Crest . . . . . . . . . . . . . . . . . 2.4

0.3 Kumagai Gumi . . . . . . . . . . . . . . . . ... . $2.2

0.4 Mitsubishi . . . . . . . . . . . . . . . . . . . . . . . . . . 1,4

0.1 JGC . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.0

1.2 Philipp Holzmann (West Germany) . . . . . $1.9

0.6 SADE/SADELMl (Italy) . . . . . . . . . . . . . . 1.8

0.1 John Brown (Britain) . . . . . . . . . . . . . . . . 1.7

$0.2 Hyundai ., . . . . . . . . . . . . . . . . . . . . . . . . $2.0

0.3 Daewoo . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.9

0.1 Daelim . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.5

$1.4 Enka (Turkey) . . . . . . . . . . . . . . . . . . . . . . . $1.1

. Joannou & Paraskevades (Cyprus) . . . . . 0.5

$0.6

3.6

3.8

2.7

1.1

$2.5

3,0

0,4

1,3

—

0.4

$0.5

0.4

0.4

$0.5

—
Ch. 4—International Competition in Engineering and Construction • 127

Relatively few Americans work overseas on

projects carried out by U.S.-based E&C firms;

generally, they fill only the higher level

managerial and technical positions. In the past,

it was more common for skilled jobs—surveyors, heavy equipment operators—to go to

Americans, but most of these are now filled in

the host country, or by people from third countries who get lower wages. Laborers and semiskilled workers come almost entirely from host

and third countries; U.S. firms with contracts

in the Middle East, for example, have hired

large numbers of South Koreans. In 1983, U. S.-

based E&C firms employed 45,000 Americans

on international projects and 99,000 foreign

workers, exclusive of subcontracting.8 Of the

Americans, about 19,000 worked outside of the

United States and 26,000 at home. In recent

years, U.S.-based firms have also tended to let

larger numbers of subcontracts to foreign companies, taking advantage of their lower labor

costs.

Downstream Linkages

While E&C firms may underprice their feasibility studies in hopes of landing a follow-on

design contract, and may hope that a design

contract will carry over to the construction

phase, this happens only some of the time. And,

while a design contract by one U.S. firm may

raise the probability that it or another U.S. firm

~“’1’he Conlr]bution of Architectural, Engineering and Con-

~tro(:tion Exports to the U.S. Economlr, ” prwpare(l h} f]rice \l’aterh{}use for the International Engineering an(] Construe. ti[]n lndust ries Council, V/ash ington, 11(;, April 1985, [). 17. (;oinpa ri ng

total payroll costs, including fringe benefits, tor U.S. and [oreign worker-s demonstrates the mutl~’es for hiring foreigners: p,i}.-

roll costs for the 45,000 America ns totaled $2.2 hi] I ion (an a\er -

,ige o f $49,000], costs for the 99,000 foreign ~~.orkers o n 1 y’ $1.4

hil]ion ($14,000, on the average).

Direct exports prokide about 1 percent of total (J. S. E&C Indust r}’ employment. Assuming a 11 45,000 Americans mrcre Ill-

~.ol ~’ed i n industrial or civil w() rks, the}’ made up perhaps 3 i)e rcent of U.S. employment in this sector of the E&C illdustr}’. ,4

higher fraction of emplo}’rnent can bet raced to exports in many

of the capital goods sectors that depenci in part on construction

propx.ts for sales, For example, according to the [1 .S. lnt[’rnat lorral ‘trade (:nrn mission. 4.3 per(, ent of [” .S, lohs I n the heat -

I ng, plu rnh ingl and structural metal produ(:ts i n(lust r~ (I f:[]t}n(ltxl

() n cxpurts i n 1982, 31 I)e r(; e n t i n (;on st ru (. t io n a n ( 1 m i n i n g m dc h i nery, and 34 per(: e nt 1 n e n~ i nes and t LI rh i n e-[ ‘..$. TrcI~lt?-

~e]ate{l ~mp/oJ ment, USITG ~)ublication 1445 (tt’ashington, 11(;:

1“,S. International ‘I1rade (;olnn~ i~~ion. ()(,tohcr 1983], I)p. 49-50.

will get the construction contract-perhaps because the design calls for construction technologies in which American firms specialize—one

study of large projects during the 1970s found

only 43 percent of projects with U.S. designers/

consultants subsequently going to U.S. construction firms.9 Thus, exports of design do not

automatically lead to exports of construction.

A second set of downstream linkages also begins at the design stage. Merchandise sales—

e.g., capital equipment—often follow quite

directly from exports of E&C services. Part of

the reason is simply that design firms tend to

specify equipment they are familiar with, so

that American E&C firms turn naturally to

American-made goods (table 15). Furthermore,

American-made equipment commonly demands

American-made spare and replacement parts.

Contracts for O&M training and management

services also follow logic all}’ from the export

of design services and equipment.

Today, with comparable equipment available

in a greater number of countries, this set of linkages is not so strong as a decade ago, and will

probably continue to weaken. Under continuing pressure to cut costs, American firms have

been purchasing or specifying foreign materials and supplies more frequently than in earlier

years. Still, in a survey by the U.S. International

Trade Commission, 33 of 38 American E&C

firms said that they specified or recommended

U.S. equipment.10 Sometimes, of course, the

purchaser (rather than the E&C firm) specifies

American (or other foreign) equipment for reasons of price or reputation. Nonetheless, most

‘K. J. Mu rph~’, hfacroproject De}relopmen t iII the Third [ lr(~rl(i

(Boulder, CO: West\riew, 1983), p 138. Other’ (Downstream IIn Aage percentages: !Vest German y., 80 percent; J a pa n, (j 3 per( c n t:

France and Italy, 50 percent; Britain. 13 per[:ent.

IO The Rela tionshlp of ~’,~ports Irr h’cle(,’tf?ti [ ‘.,5’, i~’( ‘rt ”l[, f‘ ]1) (/ll.$-

tries to U.S. hfercharrdi.w Exports, LISIT(; Puhli(at lon 1290

(Washington, DC: U.S. International ‘1’radf’ [;omm ittion, I !]82),

p. 62.

.4 survey of projects with financing from the L’S F;\l)(Jrt-lllll)ort

13ank found that, when the design firm mas Amerlcdn, t)o ~x;z

cent of imported equipment ~t’a~ purchased from American (onl-

~)anies. \}’ith des]gn engineerirl~ firms from other foreign ( ()\lnt ri(:s (not the host (:OU nt r~’), the percentage (Iropped to 43 p~’r(. ent.

See (~, Becker an(l F’. L1’ilsorl, “’ Addendum to Architectural an(l

Engineering Serx ices Sector StudJ-]une 1 984, ” Export-l nlport

Bank of the ( 1nited States, Jt’ashington, 1)(;, July 27, 1:184.
128 ● International Competition in Services

Table 15.—Typical Examples of U.S. Goods Exports

Resulting From an Overseas Energy Project

Likelihood of U S goods purchases relative to foreign goods

Above average Average Below average

Fired heaters, including furnaces,

ovens, boilers,

flues, and related

products

Pumps and drives, all

types

Vacuum equipment

(vacuum pumps,

ejectors)

Sawmill and planing

mill equipment

Equipment for refining

petroleum, and miscellaneous products

of petroleum and

coal

Miscellaneous plastic

products

Heating and refrigeration equipment

Switchgear and

switchboard apparatus

Wiring devices

Pressure vessels and

columns, Including

towers, and

reactors.

Heat exchangers, including condensers

and evaporators

Instruments, including safety valves,

Indicators, and

panels,

Electtric motors, motor

controls, and transformers

Compressors and

drives, including

blowers and fans.

Crushers, pulverizers,

and blenders,

Water and waste

treatment equipment, including

clarifiers, chemical

feeders, mixers,

and agitators.

Paints and allied

products

Nonferrous wire

drawing and insulating equipment

Lighting fixtures and

equipment

Fabricated plate

work

Fabricated piping

of all types

Tanks, bins, and

hoppers,

Materials-handling

equipment–

e.g., bucket

elevators, conveyors, cranes,

hoists, weighing

devices.

hoppers

Plywoods and

veneers.

Plumbing fixtures,

fittings, and

trim,

Fabricated structural metal

products

Pipes, valves, and

fittings.

SOURCE E C Stokes Vice President Procurement Bechtel Power Corp

of the total project budget on a large international project normally goes for non-U.S. goods

and services, even when the contractor is based

here. A 1983 survey of American firms by PriceWaterhouse found that only about a quarter of

their spending on international projects went

to cover expenses incurred in the United States,

On the average, about 11 percent went for salaries and fringe benefits of U.S. employees (excluding employees of U.S. subcontractors), 10

percent for the purchase of equipment and materials from other American firms, and 5 percent for subcontracts to U.S. firms .11 Most of

1 I Sllc h figures (;a n va r}~ a good deal from year to ~fea r, with

a fe~l’ major pro je(:ts producing large swings in the proportions

spent her-e and abroad. Those quoted are from ‘‘The Contributhe remaining 74 percent paid for goods and

services purchased overseas,

When comparable goods (or subcontract services) are available from many sources, price will

usually be the determining factor. Basic building products—lumber, cement, and fabricated

steel—tend to be purchased in the host nation

or from low-cost third-country suppliers,

Today, American firms will also normally specify standardized or commodity-like products—

e.g., many kinds of piping and materials-handling equipment—based largely on price. In addition, protected markets for host country construction and supplier industries may limit an

E&C firm’s ability to specify foreign goods and

services, with local procurement requirements

often written into contracts. As table 15 suggests, American suppliers begin to have advantages where proprietary technology makes a

difference, as for refinery equipment, In other

countries, E&C firms may work more closely

with suppliers, particularly where one or both

are publicly owned, or when governments participate by providing export credits; the president of Italy’s state-owned industrial group, IRI,

has said, “The first priority . . . is to promote

the work of Italian suppliers. ”12

The International E&C Market

Figure 28 summarizes conditions facing American construction firms: a shrinking world market, caused in large part by economic problems

in the LDCs, coupled with intense competition

as firms from many countries strive to maintain hard-won positions. Economic growth

rates have been declining in the developing

world—figure 29. At the same time, the extertion of Ar[; hitectura], Engineering and Construction Exports to

the [J .S. Economy, op, cit,, M’ it h corrections supplied by PriceW’aterhouse to OI”A, This sur~.ey found that, in 1983, foreign

contracts to U.S. E&C firms totaling $19.6 billion resulted in $2.2

billion in U.S. salaries and fringe benefits (excluding subcontractors), $1.9 billion in pur(:hases of U.S. goods, and $1,4 billion in U.S. subcontracting. A total of$13,4 billion went for goods

and ser~’i(;es purchased in the host nation or in third countries

(foreign expenses), with the remainder for miscellaneous items

such as tax pa~’rnents. For 1982, $21,7 bil 1 ion i n con tra(; ts resulted in purchases of $2.8 billion in U.S. materials, $2.2 billion

for U.S. salaries and fringe henefits, and onlj $800 million for

L’. S. subcontracting, with $15,3 billion for [orei~n expenses.

l’” Italian Engineering & Cnnst ru(; tion 1986, ” Engjne(,rjl],q

,\T(?\\’s-R(;(; (][$(i, )UI1(; 12, 1986, p. 1-6.
Ch. 4—international Competition in Engineering and Construction ● 129

— —

Figure 28.— New Contract Awards of the 250 Largest International Contractors

1980 1981 1982 1983 1984 1985

Year

Headquarters location of contractor:

❑ All other ❑ Japan ❑ Korea ❑ Europe ■ United

States

SOURCE Eng/neer/ng News-Record, various issues

nal debt of the LDCs has grown—from almost

$400 billion in 1978 to an estimated $1 trillion

in 1987.13 Many developing countries cannot —-—. IJ~~~Or/~ ~Co~omjc out100k (Washington, DC: International

Nlonetary Fund, October 1986J, p. 100. For the current account

figures for oil exporting countries, below, see p. 78.

in 1977, 15 percent of revenues that the indebted developing

nations earned through exports went to debt payments: by 1982,

debt sert’ ic, e pa~’rnents had peaked at 24,6 per(; ent of total e\-

ports. For man} indi~’idual countries, the situation was much

worse; in the Llrestern Hemisphere, o~er half the exports of tht:

indebted de~eloping nations In 1982 went to~i’ard debt payments,

(An indebted nation has external debts greater than e~ternal assets; in practice, this i nc]udes all I,DCs ~t’ it h the exception o f

Ali(i(ile Eastern oil f;x~xjrters, )

service their existing debt, much less contemplate expensive new construction projects.

Among the reasons for the deteriorating economic picture illustrated by figure 29, perhaps

the most significant has been the fall in prices

for non-oil commodities–particularly food and

primary metals, For the Middle East, of course,

the problem has been declining oil exports, and,

more recently, falling prices, leading to economic slowdown; the current account of the

oil exporting nations as a group shifted from

a surplus of $95 billion in 1980, to an estimated
130 . /international Competition in Services

—

Figure 29.— Economic Growth in the Developing World

\ 1

\

I 1

ige 1978 1979 \ 1988-77

t

s

\

2 Middle East+

k“~’

–41

SOURCE” World EcorIormc Outlook (Washington, DC. International Monetary Fund, October 1986), p 37

$39 billion deficit in 1986. Given their debt servicing problems, and the fall in commodity

prices (including oil), developing nations have

generally been unwilling or unable to borrow

capital to finance major development projects.

This is the context for viewing the declining

U.S. share of international E&C projects.

Construction

American construction firms (design and

engineering are treated later) get much of their

international business in Asia and the Middle

East. Figure 30 shows the extent to which the

Latin American market, large in the early 1980s,

has dried up—a casualty of the economic problems summarized above; since 1982, U.S. firms

have done as much or more business in Canada as in all of Latin America.

The dropoff in the Middle East has also been

severe. Nonetheless, table 16—which gives new

contract awards by region during 1985 for construction firms from different countries—shows

that the Middle Eastern market continues to

be particularly important for American contractors. European firms do especially well in

Africa, a result in many cases of continuing ties

with former colonies. In 1984, the 41 U.S. firms

among the 250 largest international contractors (in that year) had a share of the international market slightly greater than that of the

European firms (38.1 compared to 37.1 percent).

In 1985, however, the U.S. market share fell

below that for the Europeans, as the table indicates. Indeed, it has been dropping steadily for

15 years. Over the period 1966-71, American

firms captured nearly 70 percent of the foreign

construction orders won by companies from
Ch. 4—International Competition in Engineering and Construction ● 131

Figure 30.— Foreign Construction Awards of the 400 Largest U.S. Contractors

50

40

30

20

10

0

1980 1981 1982

t

1983

Year

I

I1

1984 1985

Source of contract award:

❑ Canada and ❑ Europe ❑ Africa ❑ Latin

America

Asia ~ Middle Eas t

SOURCE Errg/neerlrrg News.l?ecord, various Issues

Table 16.— New Contract Awards for the 250 Largest International Contractors, 1985

Total new awards by region (billions of dollars and percentage) ‘-

Number Country Total Latin – - ‘North

of firms of ownership awards Middle East Asia Africa Europe America America

43 United States $282 34.6% $ 78 36.0% $7.1 39.9% $ 4.5 29.1% $4.2 $4.2 42.3% $2.3 34.8% $ 23 23 0°10

116 Europe 326 399 61 284 43 24.3 75 487 55 55.3 3.6 53.2 5.5 542

39 Japan 11.6 143 19 88 54 306 1 6 108 02 23 05 7.1 20 19.2

17 South Korea 48 58 34 156 04 21 10 6.5 —a — —a 

35 All other 44 5.4 2.4 11. 2 05 30 07 05 03 49 04 36

250 A l l $81 .6 100% $2.1 6 100% $178 100% $153 1 100% $100 100% ‘$6.6 100% $1 0-

2700”/(0

‘{L e!~ Ihar $50 mllljon

—

FJ() I [ Totals may n~l ~dc hfrdd<c O’ rourc ng

SOIJ RCE E ng(neerlnq ‘ie~ + 8e:orl ) J I ~ 11 198EJ P ~ 1
132 . International Competition in Services

six major industrialized nations.14 By 1980, the

U.S. share of new contracts going to these six

nations had dropped to 60 percent, and 1984

saw a still smaller share of 49 percent.

Why did the U.S. share drop? Largely because

exports of E&C services from other countries

grew faster, With the rapid increase in new construction projects in the Middle East during the

1970s, U.S. E&C exports jumped, rising from

about $3.6 billion in 1972 to some $22 billion

in 1975. However, this growth did not necessarily translate into a larger share of the international construction market for U.S. firms;

construct ion exports from other nations rose

as fast or even faster during the peak years of’

the Middle East building boom. South Korea’s

rise was especially striking; Korean construction exports rose from $83 million in 1972 to

$8 billion by 1978, peaking at $13,9 billion in

1981.15 Meanwhile, for American firms, 1975

marked the beginning of a plateau, although

exports from countries like Korea continued

to climb.

U.S. market share has been sliding ever since.

As figure 28 indicated, the U.S. share of all international contracts was 35 percent in 1985;

it had been 45 percent in 1980, While the United

States continues to export far more construction services than any other nation, the relative slide has been rapid. Foreign firms have

14R. Bah Nw, lnternatj~n~j Construction [;OI]tractjI]g (Eppirlg,

Essex: Gower Press, Bowker Publishing Co,, 1976), p. 38, “1’he

shares o~’er the I ~66-~ I period were:

[ ‘rlltf’d ,Sfiit(’.$ l’r<tn(:t> Hrltdfn [t81J” 11’c’lt (;(~rmall) /(ipdrl

b8.9% I 1. I % 9 1‘% 6 3% .$,~C,/,, 1 ,:3’’/11

Historical data on the international E&C market are hard to

(:ome bj’, and not necessaril~’ comparable from year to ~’ear. I n

general, the annual surveys conducted b~ Engineerjn,g Ne\\rsRecorcf (EN R), drawn upon where possible in this cbapter, pro-

\ride the most useful data. Nonetheless, these surveys are of quest ionable accuracy: some firms in some years, for instance, may

understate their business, while others ha~’e reasons for o\’erstating tbeir awards. EN R’s surveys of the top 250 international

contractors did not begin until 1980, while their co~erage of international design firms only became standard ized at 200 firms

in 1982.

15R (;ortirlc~,ls and M, Co]ombard-prout, La Coree dU .$od et

la Questjon des Eyportatjons de BTP ( Paris: Centre Experimental

de Recherches et d’ Etudes du Batiment et des Travaux Publics,

1982), p. 150.

More recentl}’, tbe collapse of the hliddle East market has hadl~

hurt the South Korea construction industr}, E:xports of South

Korean firms ranked among the largest 250 international firms

declined from their 1981 peak to $4,8 billion in 1985.

been continually nibbling area} at the U.S. position. With a growing number of competent

firms, and increasing} homogeneous technologies, the pattern is one of convergence in Competitiveness; particularly since 1982, price competition in a shrinking overall market has been

very intense. As in so many other industries

where the international standing of U.S. firms

has been threatened, many of the causes lie as

much in improvements elsewhere as in problems here.

Foreign government policies have contributed to this convergence. Governments dictate

the conditions under which foreign-owned E&C

companies do business within their borders.

In the 1950s and 1960s, an American firm could

bid on and win contracts calling for most of

the engineering and design work to be undertaken in the United States. Today, many governments insist that the work take place locally.

They also seek transfers of proprietary technologies. In many cases, this means that U. S.-based

E&C firms station a small nucleus of highly

skilled specialists in the host country, where

they supervise and train local residents.

Through such policies, developing countries

have nurtured their own E&C capability, and

today depend less heavily on foreign expertise.

Design and Engineering

overseas work for American design firms has

remained relatively stable, in contrast with the

slump in construction. Foreign billings of U.S.

design firms fluctuated between $1.1 billion and

$1.4 billion over the first half of the 1980s (table 17). Figure 31 shows the market shares of

the top international design firms. U.S. design

firms have been, by and large, holding their own

internationally, The Middle East has been a maTable 17.— Revenues of the 500 Largest

U.S. Design Firms (billions of dollars)

Foreign revenues Domestic revenues

1980 . . . . . . . . . . . $1.1 $6.1

1981 . . . . . . . . . . . . 1.2 7.1

1982 ... . . . . . . . . 1.4 7.1

1983 . . . . . . . . . . . . 1.3 7.3

1984 . . . . . . . . . . . . 1,1 8.5

1985 . . . . . . . . . . . 1.3 9.7

SOURCE .Eng/neer/ng News-Record, various Issues
Ch. 4—international Competition in Engineering and Construction • 133

Figure 31 .— New Contract Awards of the 200

Largest International Design Firms

1982 1983 1984

Year

Headquarters Iocatlon of firm:

❑ All other ❑ i Canada ~

~ Europe ■ United States

SOURCE Eng(neenng NewsRecord. var!ous issues

1985

Japan

jor international market for U.S. design firms

(figure 32]. While the recent drop in opportunities in the Middle East has hurt, U.S. design

firms—unlike their counterparts on the construction side of the business—have been able

to find replacement markets in other parts of

the world—e. g., Latin America.

As table 18 indicates, the industrialized

nations—basically the members of the Organization for Economic Cooperation and Development (OECD)—continue to monopolize the

international market for design and engineering contracts. None of the NICs has carved out

an international position comparable to that of

the Koreans in construction. This does not

mean that the NICs are not active. Engineering News-Record’s listing of the 200 largest international design firms includes companies

from South Korea, Taiwan, Brazil, and Venezuela. But as table 18 shows, the international

billings of the four Korean firms making the

1985 list totaled less than $50 million.

Outlook for the Future

Given the past importance of the Middle Eastern and Latin American markets, f’ailing oil

prices and increasing LDC debt have drastically

affected the competitive fortunes of American

E&C companies. Is it possible that the deteriorating U.S. position outlined above is temporary, subject to reversal with improving economic conditions in the developing world?

Certainly an economic upturn would bring new

demand for construction and help American

firms. Nevertheless, the international E&C market has changed fundamental}’, and in ways

that make it unlikely that American companies

will return to the positions they held in the early

1970s.

The primary reason has already been mentioned: rising competence elsewhere, as demonstrated most spectaculary by the rise of the

South Korean construction industry during the

1970s. And it is not only the E&C firms in the

NICs that have matured, but those in the LDCs

as well, aided by participation alongside U.S.

and other foreign firms on past projects. (Man}’

South Korean firms learned their trade on

projects in the Middle East and Vietnam, often

under the supervision of American companies. )

Developing countries can nowr handle many

construction projects on their own that once

would have been opened to foreign bids. From

1980 to 1985, World Bank disbursements within

host nations nearly doubled (this covers both

goods and services for civil works projects);

only one-quarter of these expenditures now go

to outside firms.

Improvement in local E&C capability, of

course, has been a major goal of the development process, and a cornerstone of industrialization. 16 In countries with low per-capita in16’jT’he construction Industry: Issues and .~’tra tf>~~ie,s in ])f> L’Plopin~ f,’ountrif~s (lVashington, DC: W’orld Bank, 1984]; P.G. Al]-

hott, ‘rcchnolog~r Transfer in the Construction lndustr~, Spmial

Report ,No. 223 (I,ondon: Economist lnte]]igence Unit, 1985). on

the examp]e~ later in the paragraph, sw “Third Saudi A ir[mrt

Flt for Kings, ” Engineering Ne~t’s-Record, Dec. 19, 1985, II. 48:

and ‘‘ Disne}’ Park To Smooth Weak F’r[’nrh \larket, ’ Enginecrin,g Ne\%’s-Record, Jan, 2, 1986, p. 14.
134 • International Competition in Services

Figure 32.— Foreign Awards of the 500 Largest U.S. Design Firms

., ---

1,200

1,000

800

600

400

1984

—

1981 1982 1983

‘ear

1980 1985

Source of contract award:

❑ Canada and ❑ Europe the Caribbean

❑ Asia/Pacific ❑ Middle East

Latin

America

SOURCE Ertg/neer/rrg News-Record, various Issues

Table 18.—Billings of the 200 Largest International Design Firms, 1985

Foreign billings by region (millions of dollars and percentage)

Number

of firms

59

96

13

12

4

16

Country

of ownership

United States

Europe

Canada

Japan

South Korea

All other

Total Middle Latin

foreign billings East Asia Africa Europe America

$1.1645 32.0% $3036 31.1% $267.6 29.1% $127.6 16 1% $1499 41 .9% $2944 64.6%

1,7094 47.0 5023 51. 6 3670 40 0 501 5 63,3 199,0 55 6 102,7 22,5

2658 7, 3 162 1,7 71,4 78 787 9.9 2.1 06 279 6.1

2622 6 2 154 1.6 151.2 16 5 443 56 1.9 05 134 29

46.6 1,3 244 2.5 16.4 1 8 58 07 —a — — —

2272 6 2 1123 11, 5 455 50 34.2 4,3 4,9 1.4 172 3.8

North

America

$21.5 15 2%

37.0 262

695 493

—a —

— —

13.1 93

200 All $3,675.7 100.0% $9741 100% $9190 100% $792.0 100% $3577 100% $455.5 100% $141 0 100%

a[ ess than $100000

NOTE Totals may not ~dd because of rounding

SOURCE Engmeer/r?g News .f?eco(o August 7 ~986 p 28
Ch. 4—international Competition in Engineering and Construction ● 135

comes, the World Bank gives bids from local

contractors a 71⁄2 percent preference. Many

1,1X governments have protected their supplier

and E&C industries, following infant industry

strategies. Regulations may require subcontracting to local firms, as well as local purchases

of’ materials and supplies, In Indonesia, by

presidential decree, subcontracting to domestic companies must accompany all awards to

foreign E&C firms. The aim is to speed technology transfer. Saudi Arabia’s Government

hopes to see three-quarters of the contracts for

the King Fahd International Airport go to Saudi

companies. In pursuing such approaches, developing countries are simply following the lead

of the First World, When it comes to military

and other federally funded projects, the U.S.

Government maintains its own set of preferences for American firms, as discussed in chapter 10 (see box II). In France, over 90 percent

of’ the work on the new Euro-Disneyland-to

be built outside Paris at a cost of more than $3

billion-has been promised to French architects, engineers, and construction firms.

Beyond the growing capabilities of indigenous firms, three decades of Third World development also mean that many of the large infrastructure and industrial projects are already

in place. A resumption of economic growth will

certainly bring new opportunities, but not on

the scale of the past, In the petrochemical industry, for example, overcapacity in commodity

products means movement toward high-valueadded specialty chemicals. New plants will be

smaller in scale, the contracts less lucrative.

The success of the green revolution has likewise reduced the immediate need for massive

irrigation and other agricultural projects. As

many in the industry put it, the era of the megaproject is past, (China’s $20 billion Three Gorges

hydroelectric station, if it goes forward, may

prove the outstanding exception.)

Structural change in this industry means

more than stronger competition in overseas

markets, For American E&C firms, as for American manufacturing firms, it means new competition at home. With the slowdown in the

Third World, foreign contractors have begun

Table 19.— Foreign E&C Firms in the United States

Number of U.S. affiliates

1978 1980 1983

Design and engineering services

(including architecture) . . . . . . . 40 53 58

Construction . . . . . . . . . . . . . . . . . . 45 70 82

U.S. receipts of foreignowned E&C firms

(millions of dollars)

Design and engineering

affiliates . . . . . . . . . . . . . . . . . ..$ 669 $ 594 $ 892

Construction affiliates:

European . . . . . . . . . . . . . . . . . . . . $1,142 $3,896 $5,394

Canadian . . . . . . . . . . . . . . . . . . . 61 243 144

Japanese . . . . . . . . . . . . . . . . . . . 24 50 81

Other . . . . . . . . . . . . . . . . . . . . . . . 317 415 1,308

Construction total ... ... ... .$1,544 $4,604 $6,927

SOURCES: Fore(gn Drect Investment In the Un/ted Stafes Operaf/ons of U S

Affi//ates 1977.80 (1985); 1980 Benchmark Survey (October 1983) and

Pre//rn/nary 1983 Est/mates (December 1985), tables 5 and E 5 All

Department of Commerce, Bureau of Economic Analysls

to view the United States as the next major

growth market. Companies with headquarters

in Europe, Japan, and South Korea have announced plans to expand into the U.S. E&C

market. Many already have operations here—

table 19. The rapid rise in U.S. revenues of

foreign-owned E&C firms indicates that they

have been taking market share from Americanowned competitors (also see figure 5 in ch. 1).

In some cases, foreign E&C firms have purchased American companies. One of Britain’s

largest construction companies, the Davy

Corp., bought Arthur G. McKee & Co. of Cleveland in 1978 to form Davy-McKee. ” The German firm Philipp Holzmann acquired a large

American company, J.A. Jones Construction,

of Charlotte, NC, in 1979, and later added Lockwood Green Engineers. The South Koreans and

Japanese seem to prefer to establish their own

subsidiaries and branch offices (Samwhan

American, Kajima International), rather than

purchase American competitors or enter joint

ventures. As both table 19 and figure 5 show,

European E&C firms had a greater presence

1“’()~erseas Firms Closing In on U.S.,” ,!311gineer”ir]g .\k;Ji.5-

Recor[i, I%llg, 2, 1984, pp, 10-11.

Nlorc recent]}, a Norwegian compan}’ purchased a majority

share of E.W, Howell of Port Washington, N’}r, the 162nd lar~est

LI, S ~~ntract~r—’’Nor\tegia ns BU}I N.}”. contra(;tor, ” ~x]gir]f>t>rin~ .\’ettrs-Record, Jan. 23, 1986, p. 158.
736 ● International Competition in Services

in the United States than the Koreans or Japa- for 1983 to $700 million in 1984, and $1.8 bilnese in the past. But recently the Japanese have lion for 1985.18

invaded the U.S. market with startling success;

their construction contracts in the United States

1%. H. Farnsworth, “Japanese Accused On Bidding, ” New York

Times, Jan. 6, 1987, p. D2; also R. Koenig, “Toyota Learns TO

jumped from the $81 million shown in table 19 I.ive With U.S. Unions, ” Wall Street Journal, Feb. 25, 1987, p, 21.

COMPETITIVE STRATEGIES

Competitive advantages in the international

E&C industry hinge on three interrelated factors: costs, financing, and technology (including management expertise). In part, technology determines costs, but a bidder that can

assemble an attractive financial package may

get a contract despite direct costs for construction higher than for the competition.

Labor is a big part of construction costs,

regardless of the type of project. In the developing world, labor costs for roadbuilding can

range up to 70 percent of total project costs,

depending on construction method. With

wages in the LDCs far lower than in the industrial countries, extensive hiring in host country labor markets is a fact of life. The average

construction wage in the United States in 1983

was $12 per hour, while laborers in Ecuador

earned less than $2 per day.19 In the United

Kingdom, the 1983 figure was $4.47 per hour;

in Mexico, $0.65 per hour, Large wage differentials exist at technical and managerial levels

as well, helping contractors from the NICs undercut those based in industrial nations. A Korean engineer or project manager working on

an international project earns less than half the

salary of an American in a similar job.20

As a result, American E&C firms seeking

overseas business not only hire local workers,

l~The (j’onstructjon lndustr~r: Issues and strategies in Det’eloping Countries, op. cit., p. 41; Year Book of Labour S’tatistics—

2985 [Geneva: International Labour Office, 1985), table 1499.

ZOEy,en S0, i n the early 1980s, a Korean manager or engineer

could expect a salary of more than $35, ooo per year on an overseas project, Plumbers and welders could earn about $15,000

per year, and bricklayers about $6,000—double what a worker

could make in South Korea. Nonetheless, these costs are low

compared to salaries for Americans stationed overseas; indeed,

U.S. firms complain that the $70,000 tax exemption for Americans working abroad is too little, and raises their wage costs

even higher. See R. Cort inc~’is and M. Colombard-Prout, op. cit.,

p. 227.

but often establish subsidiaries in low-wage

countries. A great deal of scope remains for improving labor productivity through automation

of construction processes, and high productivity—hence management skills and technology—can offset high wage costs. But at present,

E&C firms from the industrialized world can

generally compete for Third World projects,

even hiring local labor, only in special circumstances: 1) when projects are too demanding

technically for local firms; or 2) where they can

offer attractive financing packages. Such financing, often arranged with the help of the

E&C firm’s home-country government, may include loans with below-market interest rates

or unusually long payback periods.

Financing

Currently, few nations (or enterprises) in

those parts of the world where the majority of

international contracting takes place can

assemble the necessary financial packages for

large projects on their own. To be successful,

bidders must offer not only competent engineering, but access to financing. This is not a

new problem for the major U.S. E&C firms,

which, since the 1960s, have accumulated much

experience in working, not only with international lending agencies, but with aggressive private U.S. financial institutions. Nonetheless,

with Third World governments strapped for

cash, and with governments in other OECD

countries often willing to help their own firms

win contracts, the U.S. E&C industry has been

operating under a considerable handicap.

Today, LDCs commonly ask foreign contractors to submit financing proposals along with

their bids; Bechtel Financial Services has been

involved in well over 50 major projects since
Ch. 4—International Competition in Engineering and Construction ● 1 3 7

1977. 21 In cash-poor countries, outside financing may be necessary to create a market. For

those American firms which, unlike Bechtel

and other very large companies, have quite limited financial resources of their own—and no

more than peripheral experience in the mechanics of international financing—the competitive difficulties will prove severe. Many

commercial banks already have unacceptable

exposures in countries that otherwise would

offer attractive opportunities. Winning new

jobs will mean assembling imaginative financing packages on a project-specific basis. This,

in turn, will call for much greater familiarity

on the part of E&C companies with the intricacies of rapidly evolving international financial

markets (ch. 3), At the same time, banks and

other players in global capital markets will need

to develop a better grasp of the financing problems peculiar to international construction.

Managers of American E&C firms face a related strategic problem, one partially outside

their control: the roles taken by other OECD

governments in project financing. In countries

including France, Italy, and Japan, government

agencies have stepped in, not only with development aid, but with export credits at belowmarket interest rates. The objectives have been

not only to support their own E&C firms, but

to secure orders for materials, supplies, and

capital goods. A Japanese-led consortium, for

example, won a major contract from the Turkish Government to build a bridge over the

Bosporus with a package including a $205 million Japanese loan at 5 percent, at least $130

million in Italian export credits at 2 1⁄2 percent

to 7 3⁄4 percent, and commercial loans totaling

$230 million.22

‘–~ 1 ~~(jre than 4(I COU nt ries sought contractor part icipat ion i II

financing during 1984–’’Foreign Contracts Slump Further,”

Engineering Nen’s-Record, July 18, 1985, p. 55. On Bechtel, see

“Financial Engineering Wins Jobs, ” Engineering New’s-Record,

~Ug, ~, 1984, p, 30,

ZZI.. Ingrassia, “HOW Japan Sealed Deal To Build Big i3ri(l~(’

Spanning the Bosporus, ” tt’aff Street journal Ylaj 29, 1985, p. I.

Ch. I(I discusses po]ic~ issues raised b}’ subsidized financing,

in{;] ud in,q mixed credits, a spe(; ia] case oft ied aid. Tied ai(l refers

to de~’eloprnent grants or loans that require purchases of spe(:ified goods and ser~ices, generall~ from the donor nation; mix[~(j

(:redits combine de~elopment aid with export (;rtxiits.

While the U.S. Government has sought international agreements to limit the use of financial subsidies, especially mixed credits, progress has been slow—not surprising, given the

indirect as well as direct benefits that governments expect from their financial participation,

Aside from appeals to the U.S. Government for

assistance in combating foreign government interventions (or in matching foreign subsidies),

American companies are not entirely powerless in pursuing offsetting strategies. They can,

for instance, enter joint ventures with foreign

firms that have access to subsidized financing;

while such a strategy may not be ideal, it helps

preserve some international business. American E&C firms can also use existing forms of

assistance, including the services of the U.S.

Export-Import Bank. Furthermore, the major

American E&C firms are among the largest and

financially strongest in the world; this has permitted them, in some cases, to take equity positions in new projects. Bechtel Power Corp.,

for instance, recently signed a protocol with

the Turkish Electric Authority to build a $1 billion coal-fired powerplant. Bechtel and its partners will not only design, build, and finance

the project, but will also enter a 15-year joint

venture with the Turkish Government; some

of their revenues will come from the sale of

power. 23

In the last analysis, if a foreign government

wants one of its firms to get a particular contract, and if financing is a critical part of the

bid package, there will be little that other bidders can do without aid from their own governments. Realistically, U.S. E&C firms will

continue to have trouble competing wherever

government-supported financing comes into

play. Progress in the OECD toward moderating

the use of mixed credits and other forms of subsidies will help, but subsidies will not disappear in the foreseeable future,

27’’ Buying Into Turkey, ” Engineering .Ve~i.s-Kec:ord, Nlar. 13 ,

1986, p. 17; D. Barchard, “Ozal Mode] Sets l)attern for the Future. ” Financial ‘rimes, Dec. 18, 1985, p. 6.

h“ot man} E&C firms (;an vf:nture into such arrangements,

tthich not onl~’ demand an unusual commitment of capital, but

ma} force the contractor into an uncomfortable entrepreneurial 1 role, Few’ firms h a~’e the ski] 1s, and even fewer would ~’ i (~ti’

the role of owner/operator as a desirable strategy (rather than

a recourse a ftc r other opt io IIS were c Iosed ).
138 ● International Competition in Services

Technology24

In contrast to many of their foreign competitors, American E&C firms have seldom operated their own R&D laboratories or invested

heavily in proprietary construction technologies. Although successful companies provide

their clients with highly competent engineering advice, most U, S.-based E&C firms have

seemed content to adopt construction technologies pioneered elsewhere. Even in the area of

process engineering—e.g., for petrochemical

plants—where American firms excel, not all

have wished to develop proprietary technical

positions. Although control of chemical engineering technologies has meant construction

contracts in the past, managers typically rationalize this choice by pointing out that a clientoriented E&C firm should scan the terrain,

maintain a high level of technical knowledge,

and select the best available technologies for

each client’s particular needs. Independent development of proprietary technologies would,

in this view, compromise the interests of clients.

Indeed, most U.S. R&D relevant to the E&C

industry takes place outside the industry—in

university civil engineering departments

(where industry funding has been rare), in Federal laboratories (notably those of the Department of Defense and the National Bureau of

Standards), by owners of large facilities (e.g.,

utilities, through the Electric Power Research

Institute), and in firms that supply equipment

and materials (Caterpillar, DuPont, Monsanto).

A later section treats Federal Government support for R&D in more detail.

While world leaders in petrochemical and

other process technologies, American companies start out behind in construction methods,

In contrast, proprietary technical positions in

construction have been a mainstay of competitive strategies in Europe and Japan for years,

with E&C firms from these countries now wellentrenched. They have invested in R&D in conZAThis section, and most of the detailed information on E&C

technology, comes from “Final Report, Tasks 1/2, Technology

in Architecture, Engineering, and Construct ion,” op. cit., and

“Final Report, Task 3, Technology in Architecture, Engineering, and Construct ion,” op. cit.

struction and also in the development of specialized equipment. The German firm Dykerhoff & Widmann holds many patents covering

pre-stressing and post-tensioning of reinforced

concrete. The company gets a substantial share

of its earnings from licensing its patents and

know-how. Another German company, Philipp

Holzmann, controls a set of proprietary techniques for tunneling in frozen ground, while

Japanese firms are leaders in boring where geological conditions are unstable.

The Role of Technical Expertise

Traditionally, many American E&C firms

have specialized: T.Y. Lin in structural engineering of pre-stressed concrete; Guy F. Atkinson in heavy construction; Brown & Root in

offshore oil projects; M.W. Kellogg in petrochemicals. Some have continued with such

strategies, while others have diversified.

Bechtel, with its past experience in heavy construction, including the Hoover Dam—augmented by expertise in process engineering and

management—has moved into design and construction management for all types of projects,

Specialized expertise determines which firms

will compete for contracts. Before turning to

the firm’s bid and the details of financing packages, a client is likely to ask: Can this firm do

the job? In fact, under design-bid-build procedures, technical qualifications become the primary criterion for awards to the design firm,

Construction companies may have to pre-qualify before bidding on a job. Clients must often

judge the capabilities of prospective bidders

based on past performance.

Technical expertise in engineering and construction, then, stems in considerable degree

from the accumulated experience of the firm.

Even companies that depend heavily on international contracts tend to remain strongest in

technologies important in their home market.

It is no surprise to find American companies

leaders in offshore drilling technologies, simply because much of the original work took

place in the Gulf of Mexico. And, while American firms have a great deal of experience in

telecommunication projects, they would have

trouble competing with French or Japanese
Ch. 4—International Competition in Engineering and Construction ● 139

companies for work on high-speed railroads.

The Swiss and the French have well-honed

skills in bridges and tunnels for mountainous

terrain. So do Japanese firms, while the additional pressures of high population density in

Japan have led to unusual emphasis on underground construction. Many other examples

(box K) illustrate the point: E&C expertise comes

in large measure from experience in solving

problems of a local nature. Thus U.S. capability in construction management stems from

past experience with large and complex projects at home as well as abroad, and the U.S.

lead in applying computers to management

tasks throughout the economy.

Computer Applications

With many more computers installed in the

United States than in any other country, American E&C firms have a good deal more accumulated experience than their foreign competitors, They can hire people with the latest skills,

and draw on the know-how of a large independent software and services industry (ch. 5). In

common with other American corporations,

U.S. E&C firms have already automated standard business functions like payroll and accounting. They are leaders in applications of computers to construction management and in

computer-assisted design and engineering.

Firms like Bechtel, Fluor, and Ebasco have

developed proprietary CADD software, generally starting with packages available from vendors. Compared with manual drafting, CADD

systems cut labor hours by factors of three or

more. Interactive CADD, with software that

maintains an online database and automatically

issues change notices, revised drawings, and

updated bills of materials will lead to further

savings. With integrated databases, CADD systems will be tied directly into construction processes, where U.S. firms already take advantage

of the best software for estimating, project

scheduling, cost accounting and control, and

materials tracking (Box J). Computer-assisted

engineering calculations—for structural analysis, foundation design, slope stability, earthquake resistance—have also become routine for

American E&C firms.

The next step will be to apply expert systems

(a form of artificial intelligence) to the more

standard design calculations (and to other E&C

applications—cog., operations and maintenance). Stone & Webster, for instance, has developed expert systems for optimizing welding

parameters, and for diagnosis of operating

problems with pumps. Eventually, computerassisted automation of many construction processes will become practical.

Field use of small computers will accelerate

the trends outlined above, and multiply the benefits. Today, the larger American E&C firms

typically operate with two levels of computer

support: mainframes or powerful minicomputers for complex design, engineering, and

management packages, with PCs for running

smaller programs both at the head office and

on the job. Where once a scheduling problem

caused by, say, late delivery of materials would

have been referred back to the home office,

today a revised production plan can be prepared in a branch office or in the field.

Foreign E&C firms make use of some of the

same techniques, but the American industry

remains the leader, notably in integrating engineering and management databases—a critical

step for cutting costs, and one with great potential for further savings. While Japanese and

European firms have been developing computer-aided systems for management, as well

as design and engineering, most fall well behind the U.S. state-of-the-art. Nor can foreign

firms match the Americans in the intensity with

which they use computers; Bechtel, for instance, has more than 10 times as many CADD

work stations installed as the large Japanese

E&C firms. For the time being, with American

firms continuing to develop applications such

as three-dimensional CADD, the U.S. lead

should remain secure. But without continuing

investments, these sources of advantage could

quickly shrink or vanish.

The U.S. edge in computer-based technologies has helped American design firms hold

their own in the international market, and also

works to the benefit of large integrated E&C

firms that offer turn-key projects. Nevertheless,

when it comes to projects less demanding tech-
140 ● International Competition in Services

Box K.-Technical Knowledge in the E&C Industry: Three Examples

1. New Austrian Tunneling Method

The so-called New Austrian Tunneling Method

(NATM), developed more than 20 years ago for

projects in the Austrian Alps, has more recently

helped foreign firms penetrate the U.S. market.

With NATM, shotcrete-a fast-drying concretebased mixture-is sprayed onto tunnel walls to

stabilize them as boring proceeds. Temporary

supporting structure can be minimized, with the

shotcrete replacing steel or reinforced concrete

tunnel liners. Polyvinyl chloride (PVC) sheeting

between the layers of shotcrete provides waterproofing.

Widely used in Europe, NATM was introduced

into the United States in 1983 for the Wheaton

station portion of the Washington, DC subway

system. The lead contractor, the Austrian firm

Ilbau, won the job with a lowbid of $51 million,

and then submitted a proposal to use NATM at

a cost of only $45 million; the job had been estimated at $84 million based on conventional methods.* This is only one example where U.S. firms

appear to be well behind foreign competitors in

ground stabilization techniques and tunneling

technology generally.

2. Up/Down Construction**

The Up/Down construction process provides

an example in which U.S. firms adopted a technique first developed in Europe. As used in the

Rowes Wharf project in Boston, the Up/Down

process entailed excavation of five below-ground

levels while simultaneously erecting a building

above. In a conventional project, the foundation

would first be excavated and the below-ground

structure put in place, with the building erected

last. With the Up/Down process, the contractor

digs a trench for the perimeter walls, while sinking interior columns to provide the foundation.

Then the building goes up, while at the same time

the below-ground levels are dug out around the

columns. At Rowes Wharf, as each below-ground

level was excavated, a floor slab was laid, and

anchored to the pm-sunk columns. The floor

slabs were complete except for a 30-square-foot

access hole, through which the earth excavated

below could be removed. In essence, the structure is built upward and downward at the same

time.

On the Rowes Wharf project, the developer was

willing to pay an extra $2 million in construction costs to save 4 to 6 months in schedule time.

The architect, who had previous experience with

the necessary design techniques, originally suggested the Up/Down method, which was independently proposed by an English construction

firm. After reworking the project design, schedule, and cost estimates, the client decided to proceed. Resign and construction plans were further refined by several pre-qualified construction

firms. After a good deal of consultation among

client, designer, and the construction firms, the

developer chose an American contractor for the

job, even though this firm had no previous experience with the Up/Down method. The client

took out a largo insurance policy.

3. Partially Automated Fine Grading

Here, the innovation came from an American

company. Grading in preparation for paving

roads, highways, parking lots, and airport runways must be carried out to tolerances of 1/8 inch

or less. Surfaces must be accurately contoured,

not only for drainage, but to minimize consumption

of expensive paving materials, Given tight tolerances, grading typically begins with a crawler

tractor (bulldozer)that makes a rough cut to bring

the surface to within about an inch of the required elevation. Then, in the fine grading step,

a highly skilled operator uses a motor grader to

cut the surface to the required specification. The

operation is slow and expensive. A surveying

crew places stakes every 10 feet or so to guide

the grader. With this conventional approach, a

crew can grade about 30,000 square feet [or about

two-thirds of an acre) in an 8-hour shift.

Grade-Way Construction Co., a small contractor in San Francisco, began work on automating

this process in 1977. Unable to interest US.

equipment manufacturers, Grade-Way’s employees designed, built, tested, and refined a system

that permits a bulldozer, rather than a more ex-

*S. Neuatadtl, “Tbe New Underground,” Hfgh Technology, February 1SS$, pp. 46-s2.

● *WA on ‘lExa@~ of l~ova~on On En@nWring and Ccmatruction k%o@cte and Impiicatione for the construction hmovation system,”

prepared for OTA by C.B. Tntum under contract No. S33-2725. TM report ia &o the eource for the fine grading example, below.
Ch. 4—International Competition in Engineering and Construction ● 141

pensive motor grader, to carry out fine grading.

A rotating laser beam defines the plane of the

cut, replacing the surveying stakes. The bulldozer

carries a sensor that registers the laser beam and

signals a microprocessor-based control system

tied into the bulldozer’s hydraulic system. Manual control of the blade in response to an operator read-out is also available, and has proved useful for training purposes.

It takes about 8 years’ experience for an equipment operator to master the art of manual fine

grading, but the laser-based system can be used

by an apprentice. Productivity has gone from

30,000 square feet per shift to 200,000 square feet,

costs from 80 per square foot to 1¢. (Despite this,

few of Grade-Way’s competitors have sought to

automate their own grading operations.) Since

developing its system for bulldozers, Grade-Way

has adapted it to graders, bucket scrapers, comically, and for much construction, the cost

savings from computer applications have generally been insufficient to counter U.S. disadvantages in labor costs. Nor, with few exceptions,

does the United States lead in computer applications for engineering and management extend to construction processes themselves.

Productivity in Construction

In sharp contrast to factory production of

standardized manufactured goods, construction remains a craft-based industry. Automation will change this on the job site, just as

CADD has changed it in the drawing office. The

eventual payoffs in the field will be enormous,

although they may take many years to realize.

Those companies that master computer-aided

construction processes—e. g., automation applied to earthmoving or steel fabrication—will

be able to carve out strong competitive positions. Some of these technologies will lead to

advantages even for projects in the LDCs, most

of which have abundant labor but lack skilled

workers; automated construction equipment

will greatly reduce the need for skilled operators (see the third example in box K).

pactors, and trenching equipment. As of mid1986, the company had eight laser-based systems

in use. Grade-Way’s annual revenues have grown

from about $1 million when development began,

to more than $80 million, despite a declining local market.

Grade-Way now plans to integrate its grading

system with a CADD database. At present, a design firm specifies the grade, frequently using

a computerized drafting system. The resulting

drawings are passed along to Grade-Way, which

must enter the specifications in its own database,

first for estimating, and then, if the company

wins the job, for carrying out the work. GradeWay produces a new set of drawings for use in

setting up the rotating laser guidance system.

Cutting out this step would lower costs still

further.

Two paths, broadly speaking, lead to greater

productivity: 1) better techniques on the job site,

including automation and onsite prefabrication

(e.g., using mobile shops); and 2) offsite prefabrication, With some exceptions, the United States

is behind in both; indeed, productivity in the

American construction industry has changed

little since the 1960s. Examples of productivity

improvements through better techniques include slipform construction for high-rise buildings and onsite precasting of concrete, While

continuous pouring of concrete using slip forms

has been adopted by U.S. companies, the Europeans continue to push into more sophisticated

applications. The vast majority of U .S. companies still use manually constructed forms, while

universal formwork has begun to penetrate job

sites elsewhere. To take an example of onsite

precasting, Ilbau, an Austrian contractor, recently built an arch bridge in Bavaria by setting in place two half-arches, fabricated on site,

with the aid of a computer-controlled cable

support system. Notable examples of off site

prefabrication include ocean drilling platforms

—generally built in drydocks, then floated to

their final destinations. Similarly, the steel caissons and parallel strand cables for the Bisan
142 ● International Competition in Services

Photo credit: Beloit Corp.

Two generations of engineering design, turn-of-the century and 1960s era.

Today, computer-based graphics systems are taking over

much of the drafting and design work.
Ch. 4—International Competition in Engineering and Construction ● 743

Straits suspension bridge in Japan were prefabricated in their entirety, with the caissons

towed to sea and sunk in place. In many parts

of the world, structures such as high-tension

towers can now be prefabricated and placed

by helicopter.

Major productivity improvements often require new approaches to design. The European

lead in concrete technologies begins with design experience and extends to the manufacture of high-capacity concrete pumps; the Japanese have begun testing still more advanced

methods, with automated booms for pouring

and for spreading and finishing concrete. The

Danes and Swedes, especially, have become

known for high-quality precast concrete. Both

Japanese and European firms are working to

automate the highly labor-intensive tasks of cutting, bending, and placing reinforcing bars and

cables. At one time, the United States led the

world in bridging, especially suspension

bridges. This is no longer true. With concrete

replacing steel for many bridges, the Europeans

have gained the advantage. The Saudi ArabiaBahrain causeway, built by the Dutch firm Ballast Nedam, made use of piles and spans cast

on site for most of its 73⁄4 mile length. Ballast

Nedam’s experience with heavy lifting barges

for assembly made this approach possible.

If U.S. firms generally lag in technologies for

concrete construction, they have thus far remained at the forefront in fabricated steel structures. Here, however, the Japanese have been

making considerable progress in automation,

exemplified by their well-publicized robots for

spraying fireproofing insulation onto girders

and columns. Japanese firms have also spent

heavily on R&D for automated earthmoving

equipment, a technology that Komatsu has been

pursuing in its efforts to win sales from U.S.

heavy equipment manufacturers like Caterpillar. The Japanese are also clear leaders in soft

ground tunneling, while European firms have

superior technology for hard rock tunneling.

Although the Japanese have successfully developed modular prefabrication methods for piping, electrical wiring, and industrial control

systems—e.g., for portions of the A1-Jubail refinery in Saudi Arabia—U.S. firms have also

been quick to pursue these techniques, As a final example, improvements in construction

materials—e.g., synthetic fibers for use in pavement bases and drains—have again often originated overseas. While the United States has

been generally strong in materials R&D, relatively little of this work has been directed

toward construction, Few American E&C firms

have pursued innovative applications of materials, or pushed their suppliers to develop new

products.

Implications for Competition

Poor showings by U.S. firms in construction

technologies can be traced back to the common

strategy of seeking a position as technology

broker or service provider, rather than technology originator, and also to bidding procedures

in the United States. The design-bid-build system splits the responsibility for design and construction. The result? Weak incentives for E&C

firms to adopt cost-saving design features, or

to move toward a design-for-cost or design-forconstructability approach. Under design-bidbuild, the contractor will be constrained by

specifications typically established by another

company, Not only may superior construction

methods be precluded, but the system rewards

conservative choices. Once the contractor has

won a job with a fixed-price bid, there is little

incentive to do anything but follow the specifications the bid was based on. In contrast, engineering firms in Europe must often submit

proposals covering construction methods; with

evaluation of alternative construction techniques an explicit part of the competition, they

have incentives to design projects so as to take

advantage of new, low-cost methods.

In focusing on the services portion of the industry, U, S.-based E&C firms have stressed

management of complex projects rather than

construction techniques themselves. Instead of

developing their own technologies, American

companies have preferred to serve as technology brokers, relying on their ability to match

available knowledge with their clients’ needs.

This brokering strategy does sometimes lead

to acquisition of technologies through licensing or joint venture agreements, but U.S. E&C
144 ● International Competition in Services

firms—except for some that have specialized

in fields like petrochemical processing—have

seldom invested their own funds in proprietary

developments. European and Japanese E&C

firms spend more heavily on R&Din construction methods, with the larger Japanese companies maintaining substantial R&D programs. In

Japan, research staffs of several hundred people working on construction technologies, with

annual budgets of $10 million or more, are not

unknown. In contrast, few of the large U.S.

firms have anyone at all working directly on

new construction methods, although staff engineers do monitor developments elsewhere. 25

R&D undertaken by U.S. E&C firms generally focuses on the computer applications outlined earlier, or on petrochemical and other industrial process technologies, rather than

construction. In industrial process technologies, a small group of relatively specialized

companies—e. g., Kellogg Rust in ammonia,

Lummus Crest in ethanol—have developed

strong proprietary positions. When a firm owns

the process technology for, say, production of

ammonia, it maybe able to insist on a turn-key

contract, avoiding the need to bid separately

on design and construction. Even when the

firm does not control the process technology,

it can trade on its skills in process engineering. But the position of technology broker can

be dangerous when it comes to construction

methods such as tunneling or bridge building.

Here, an E&C firm without a proprietary position may find itself forced to rely on its competitors for know-how, with predictable results—

having to settle for second best. Technologies

do diffuse to the United States–e. g., tunnel boring techniques from Europe—but foreign firms

will try to protect their position through continuing refinements in methods and by maintaining a work force well-trained in the latest

techniques.

American E&C firms plainly have access to

the expertise necessary for designing projects

Z5Dur ing a visit to a Japanese research laboratory, a vice pt’es 1-

dent of a major U.S. construction firm has been reported as saying that, if he were in charge, he would fire all the R&D staff

and save the company $25 million a year— ’’Final Report, Task

3, ‘1’echnology in Architecture, Engineering, and (construct ion,”

0[). cit., pp. 6-7.

that would make greater use of industrialized

production techniques—offsite fabrication of

subassemblies, automated construction (as

much a function of design as of construction

equipment), innovative uses of new materials.

But U.S.-based E&C firms will need to reshape

their corporate strategies before they can hope

to take the lead in reshaping construction processes; over the past several decades, American

E&C companies have adopted and adapted, but

have seldom been innovators.

The Future

Battered by rapid decline in traditional markets abroad, an overvalued currency during the

early 1980s, and stiffer foreign competition,

large U.S.-based E&C firms have undertaken

agonizing reappraisals of their strategies. Some

have retrenched, scaling back business development programs aimed at overseas contracting—a choice that means participating in the

international market as opportunities arise, but

at a much lower levels than before. MorrisonKnudsen, for instance, has closed its foreign

offices and consolidated its international sales

force in San Francisco. Other companies have

begun rethinking their sources of competitive

strength, and how these might be nurtured or

extended. Another response—common among

industries threatened by foreign competition—

has been to appeal for Federal assistance. In

particular, American firms have sought help

in matching foreign financing packages. This

and other steps the Federal Government might

take, as discussed below, could help the industry, But the long run ability of U.S. E&C firms

to maintain a competitive position internationally will depend on their own responses to

changing conditions in markets here and

abroad. Different firms will choose different

directions, within a range of strategic possibilities that has already become apparent. This

range is not a broad one, The nature of international competition leaves few real choices.

American E&C firms face four primary constraints:

1. For projects with a heavy component of

relatively unskilled labor (which may in-
Ch. 4—international Competition in Engineering and Construction ● 145

elude supervisory labor), competition is already stiff; it will grow still more intense

in the future,

2. Many foreign E&C firms, including those

3

in the Third World, can now adapt and apply a relatively broad range of technologies

as needed. Once the backbone of the U.S.

industry, technologically based strategies

are now open even to firms from the NICs,

many of which have become quite competent in design and engineering.

When it comes to innovation, particularly

in construction processes, European and

Japanese firms are ahead in some technologies. No matter the counter-efforts of U. S.-

based firms, it will be difficult to regain

useful leads.

4. Governments will continue to intervene in

competition for international E&C projects,

with this involvement taking two primary

forms—aid for domestic firms seeking foreign contracts (e. g., through subsidized

financing), and protection of markets at

home.

Perhaps needless to say, these conditions are

not unique to the E&C industry. They can also

be found in many sectors of manufacturing.

American E&C firms, which dominated international markets into the 1970s, have joined

other U.S. companies in facing new foreign

competition. This, in turn, suggests that the strategic responses in engineering and construction will show parallels with industries ranging from steel to electronics?

Technologically Based Strategies

What, then, are some of the possible strategies? First, and perhaps most obvious, American E&C firms could develop new product

offerings for the international market, much as

American banks and financial service firms

have been doing. Second, they could put more

resources into management technologies and

construction methods that will reduce costs and

improve productivity.

In this industry, most new product development begins with existing technologies that can

be applied in new ways—e.g., computer-controlled heating, ventilating, and air-conditioning systems for buildings. Operations and maintenance services provide many other examples;

M.W. Kellogg forecasts that 15 percent of its

revenues and 30 percent of its gross margins

over the next 5 years will come from maintenance and training. In other cases, new industrial processes—and new industries, like biotechnology—mean new opportunities for E&C

firms. American companies are attempting to

adapt their expertise in chemical process engineering to scale-up in biotechnology. Japanese

and German firms, however, may have a head

start in bioengineering techniques for the production of specialty chemicals. 26

O&M services have the great advantage that

the work does not end when construction has

been completed (although ongoing contracts

will normally be small compared to construction contracts). By making use of skills available in the United States—ranging from remote

sensing to computer-based process control, production scheduling, and database management

—American firms can hope to maintain competitive advantages in contract O&M services.

Training local personnel offers complementary

opportunities. It may even be possible for American firms to adapt training methods originally

developed by the U.S. military; the problems

of teaching poorly educated Americans to

maintain high-technology military systems are

not unlike those of training unskilled workers

in LDCs.

U.S.-based E&C firms can also turn their

know-how toward renovation and rehabilitation of existing facilities—in part, an extension

of the O&M strategy. At some point, equipment

becomes obsolescent; replacement, rather than

maintenance or modification, will be called for,

Particularly for complex industrial plants,

many companies look to external contractors

when redesign and renovation are called for.

Once again, most of the contracts will be small

relative to those for new facilities, but opportunities will grow faster.

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146 ● International Competition in Services

New technologies—mostly originating in

other industries—create another set of opportunities for American E&C firms to develop new

products. Developments like fiber-optic communication systems or bioengineering stimulate capital investment, with one of the consequences greater demand for E&C services.

While many of these opportunities will depend

on technical advances beyond their control,

E&C firms with the expertise to apply new

knowledge should be able to establish competitive margins. Such abilities have been a traditional U.S. strength, but the technology broker

strategy will not be as effective in the future

as in the past. With other nations—notably

Japan–moving into fields like optical communications and biotechnology as rapidly as the

United States, it will be harder for American

E&C firms to capitalize on new opportunities

arising from new technologies.

To be competitive in the future, American

E&C firms will probably have to make their own

investments in proprietary know-how ranging

from control of hazardous wastes to the design

and construction of clean rooms for manufacturing integrated circuits. Thus far, international markets for many of these specialized

design and engineering projects have been slow

to materialize. At some point they will, and the

companies prepared to take advantage will reap

the rewards.

It will take more than success in developing

new E&C products—whether O&M services or

knowledge of bioengineering—for U.S. firms

to rebuild their competitiveness in engineering and construction. They will need to continue building on their strengths in computer

applications and in management, while seeking ways to keep up in construction methods.

Expertise in engineering and design gives

American firms something to trade: while the

United States imports construction technologies, foreign firms come here seeking software

and management know-how. So long as they

stay ahead in these fields, American E&C firms

will have leverage for negotiating joint venture

deals and technology transfer agreements. In

particular, American companies will need to

extend their managerial advantages beyond the

large and complex projects in which they excel. With fewer such projects internationally,

management skills on smaller and more routine jobs will take on greater significance. There

is no reason why U.S. firms should not be able

to move from skills in the management of complexity to equal reputations in management for

increased productivity and reduced costs.

While they have not yet done so, their lead in

computer applications gives them a powerful

weapon.

Management for productivity and constructability will plainly take on greater importance

in the future. With construction know-how

widely available to firms in the NICs and LDCs,

the grounds for competition will shift from technology itself to the management of technology.

In the past, for example, earthmoving in the

LDCs depended on cheap labor and simple

equipment that relatively unskilled operators

could use. Meanwhile, cost pressures in the developed nations led to capital-intensive methods. Contractors turned to very large pieces of

equipment, with which a few skilled operators

could achieve high levels of output. They also

sought specialized equipment for small jobs or

for work in congested areas (e.g., laying pipelines). Similar cost pressures lie behind the R&D

on automated earthmoving procedures mentioned above—automation that will eventually

make it possible for an unskilled labor force

to use advanced machinery and equipment. Already, partial automation—e, g., laser-guided

grading (box K)—has reduced skill requirements. When companies anywhere can lease

or purchase the same equipment, management

ability, in the sense of tailoring operations to

local conditions, will become a prime source

of competitive advantage—one that American

firms may still be able to exploit.

The demands of customers and the innovations that emerge elsewhere in the U.S. economy will help shape the future strategies of

American E&C firms. In the longer term, the

more successful companies will be those willing to invest their own resources in adapting

technologies from other industries to the problems of engineering and construction. American firms should be able to do well, given the
Ch. 4—International Competition in Engineering and Construction ● 147

U.S. position at or near the forefront of so many

technologies, but they will have to put money

into R&D. E&C firms in other industrialized

countries face the same choices and the same

opportunities. As in manufacturing, part of the

task for U.S. E&C companies will be to more

aggressively monitor and learn from their foreign competitors.

International Contracting Practices

American E&C firms enter into international

consortia not only to take advantage of the

strengths that foreign firms can bring to such

ventures, but to meet bidding requirements;

U.S. companies contribute management and

technical skills, while foreign firms may provide less expensive labor, access to low-interest

financing, and their own specialized expertise.

A recent example saw Bechtel team with the

Japanese firm Kumagai Gumi to build a $l70

million dam in Canada .27 Such arrangements

seem bound to increase, given the current realities of global competition.

Among these realities, government intervention looms large: often, the formation of international E&C consortia follows quite directly

from government policies that permit foreign

participation in local projects only through joint

ventures with domestic firms. In this way, governments seek to speed technology transfers—

e.g., by requiring that engineering and design

work be shared. Where they do not seek joint

ventures, governments may require local hiring by foreign contractors. In other cases, domestic firms receive preferences on contract

awards—common in industrialized countries

as well, where employment has been a primary

motive. In the United States, construction

projects paid for with public funds have often

been restricted to U.S. companies, while Buy

American clauses may cover materials and supplies. Canada places restrictions on foreign architects. The United Kingdom requires that

engineering contracts for North Sea oil projects

go to firms with majority British ownership.28

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What do government pressures for local participation mean for corporate strategy? Primarily this: any foreign firm that resists government pressures to join with local companies

will lose out, in the absence of literally enormous advantages in technology or financing,

One or a few foreign firms may decline to participate, but others will be only too happy to

take their places. While the United States certainly needs to continue pressing Third World

countries to abandon such policies, LDC governments will continue to seek advanced technology in one guise or another—leaving American managers seeking ways of remaining

responsive to these requests while also preserving technically based competitive advantages,

a dilemma E&C firms share with those in hightechnology manufacturing. At the same time,

the nature of the international E&C business

often makes it necessary to have a local partner, regardless of government involvement.

Beyond entering joint ventures and consortia with foreign companies, American E&C

firms have begun to explore joint development

with manufacturing firms as a route to proprietary technologies and possible competitive advantages. For example, Bechtel and Varian

Associates have combined to supply clean-room

facilities for the microelectronics industry,

while Fluor has joined with the Allen Group

to offer a package of services for the design and

construction of automated factories. Although

these efforts are in their early stages, they will

probably expand in size and scope. If hardpressed American firms in several industries

can join, taking advantage of the technical poCorrstru(:t ion Servic es,’ memora II(I II m, 1)tI~)CI rt nlt~nt of

Commerce, Washington, DC, Fet)ru,]r\ I {][][,.

I n pre~)ardt ion for the [ lruguay Rol]n(l t ra(]t~ rl[~~( )[ I~tt ioI]\, t h[~

[ 1,s, ~o\(31.11n lent has [;omp iled a long 1] \t of l]{]lati[)n~ of I):it ional treat merit —the principle that (i[)nl[)~t I{ :1 I){ I I ( )r~; igr) f i In)\

I]t: treated the same—in the a~var(lin~ oi Ii&(; ( ( ]I]t ra( t~ S[;[J

“’1’ri](le Issues in the Engineering an(] (;onst I U( ! ]or) ,111(] R~Jl,lt(vj

(;(]nsl]ltancj Ser\ices 1n(lustry,” hackgrol]r](i l), Il)fII, ofi I( [I of

thf: [ J nit[x] States ‘I”ra(l[; Represe I)tat ii (I. L!’,1 \lI I II XI ( )11, I )( [ II( I

[iatr),

\fanj I n the L 1,S, E&(; industry hat e strong reser~atlorls (:on-

{ e r n I rlg t h (I nt;ll t ra d (; IOU n d, N 1 a 11 a~c r~ fear the (” n It C( 1 St,1 I [’s

nla \ ha( L a~~’a}” from (’lIrrent polI[ i[’s that iupport the industr? —

{’. ~., p I’(; f [’ rc n (:tl~ d n d set-as I (1 [’s (In fort: i~n pro j ects such as m 11 itary t)a~[~~—in [J\(.hdnge for lih[;ra]izat ion t~ls[~where. ‘rh(t in[lust r}

() i) [)( I if’\ t h (’ (Jxt (~n \ i( ) n of t h t’ (;:1 ‘[”1’ I ) r-()1 u r(~nl (In t (:()(1[> t () IJI] g i

n IIt’r’l n g ,! n (i ( I ) n st rl~ [t io n ~f’ ri ] ( (>i f ( ) r >] m i 1 a r I-t>a >( ) ns,
148 ● International Competition in Services

sitions that each retains, they should fare better internationally. For the E&C industry, these

joint endeavors suggest somewhat belated recognition that a continuing technological edge

depends on advances in other sectors of the U.S.

economy.

Finally, American firms have the option of

eschewing international markets entirely, and

retrenching inside the Nation’s borders, Although the size of the U.S. market makes this

option potentially attractive, the choice is a

risky one, as the experiences of American manufacturing corporations demonstrate. While

foreign penetration of U.S. construction markets has thus far been minor relative to the overall size of the industry, firms in Japan and Europe clearly see in the overseas problems of

American contractors evidence of vulnerability at home, With foreign E&C companies making penetration of the U.S. market a major element in their own strategies, American firms

that pull back internationally may quickly find

the competition following them here. So long

as the U.S. economy remains a relatively open

one, the home market will not necessarily be

a safe haven for American E&C firms.

Moreover, abandoning the international market carries implicit costs. First of all, reentry

in later years—e.g., when the world economy

has picked up—will be difficult, Reputations

will be tarnished if not lost, along with critical

stores of overseas experience. Mobilization of

resources will be difficult once foreign bases

have been abandoned; companies will face new

expenses. Furthermore, a corporate view

limited to the United States could cause E&C

firms to overlook potential sources of competitive advantage valuable, not only in international competition, but at home—e.g., technologies pioneered overseas. Again, the analogy

with U.S. manufacturing, where many purely

domestic companies remain ignorant of foreign

innovations, seems appropriate. Today, a

provincial view of technology development is

an invitation to competitive obsolescence. And

ultimately the real worry is that inability to compete abroad may foreshadow inability to compete at home.

POLICY ISSUES: TECHNOLOGY DEVELOPMENT AND DIFFUSION

As earlier sections of this chapter suggest,

the major policy issues for the U.S. E&C industry center on financing and technology. When

it comes to financing, success in U.S. efforts

to combat foreign government subsidies would

be a major step toward equalizing the terms of

competition. The Export-Import Bank’s Engineering Multiplier Program, through which the

bank extends loans to foreign purchasers of

U.S. architectural and engineering services, has

also provided some help, as has the Trade and

Development Program. Chapter 10 discusses

these and other topics related to financing, including specific policy options. This section focuses on technology.

As noted earlier, U.S. E&C firms do little

R&D. Most of the support for research related

to construction comes from the Federal Government (box L), from suppliers to the industry, and from the owners of large facilities.

There are no authoritative figures on total U.S.

expenditures for construction R&D, but spending is probably in the range of half a percent

of construction revenues; Japan’s construction

R&D, in contrast, has been put at 3 percent of

total industry revenues, 29 Not only is spending

in the United States low, but the military focus

of federally supported R&D contrasts sharply

with the typical approach in Japan and Europe,

Many European governments have ministries

of construction. Among their other activities,

these ministries sponsor and coordinate R&D,

In the United States, as box L indicates, the Department of Defense accounts for most government R&D related to construction. Much of the

money goes toward the water and port projects

of the Army Corps of Engineers; technology
Ch. 4—International Competition in Engineering and Construction ● 149

Box L.—Federal Government R&D Support for Construction-Related Technologies

While a good deal of Federal support goes toward technologies tangentially related to the E&C

industry —e.g., new materials, robotics and automated manufacturing—directly relevant work outside the military totals less than $30 million per year. Spending by the National Bureau of Standards

(NBS, part of the Department of Commerce) accounts for about $20 million of this total.

Civilian Agencies

The fiscal year 1987 budget for the NBS Center for Building Technology (CBT) comes to $12 million.

The Center for Fire Research, also part of NBS, gets another $8 million. (Both figures include work

undertaken on a reimbursable basis for other agencies.) In past years, the Reagan Administration

has sought to eliminate both NBS centers, arguing that their activities could be undertaken by State

and local governments; the current Administration proposal for fiscal year 1988 calls for merging

the two centers and reducing funding.

Consistent with NBS’s overall mission, the CBT develops measurement techniques, databases, and

testing methods—a set of technologies with broad and general relevance to the construction industry.

Because of this, support at State and local levels seems unlikely. Why should one State pay for R&D

that the other 49 will also benefit from? Although Congress has kept the CBT’s programs going, funding has declined from a high point of $14.7 million in 1980 to the 1987 level of $12 million, while

man-years have fallen from 199 to 126 over the same period. With two-thirds of the Center’s work

undertaken on a reimbursable basis for other organizations (mostly government agencies), a continued

decline in direct appropriations means that more of CBT’s research will reflect the narrow missions

of these agencies, Congressional appropriations—some $3.4 million in 1987—provide most of the support for generic R&D at the Center.

The National Science Foundation (NSF) funds construction-related research in civil engineering,

almost all of it at universities. Three programs account for most of the relevant NSF grants. The Structures and Building Systems program funds research on construction processes, including automation, at a 1987 level of $3.8 million. A program focused on infrastructure and on existing buildings,

entitled Systems Engineering for Large Structures, has a 1987 budget of $2.7 million. NSF’s Earthquake Hazards Mitigation program ($14.4 million) funds some R&D related to construction. In addition, NSF has awarded a grant for an Engineering Research Center on Advanced Technology for

Large Structural Systems to Lehigh University; this center is scheduled to receive $10.4 million over

5 years, with additional support from the Pennsylvania State Government.

Finally, the Federal Highway Administration spends something less than $1 million per year on

research, development, and technology transfer related to highway pavements and bridges. Some

State highway departments also maintain research programs. Currently, the National Research Council’s Transportation Research Board is coordinating the Strategic Highway Research Program, with

a 5-year budget from several State and Federal organizations of $150 million. About half the budget

will be spend on materials-related research; little will go to R&D on construction processes.

Defense-Related R&D

Military projects at six Federal laboratories run to much higher levels—a total of about $270 million

in 1986. The Army maintains a combat engineering laboratory at the Belvoir Research and Development Center, while the Army Corps of Engineers operates three facilities—the Construction Engineering Research Laboratory, the Cold Regions Research and Engineering Laboratory, and the Waterways Experiment Station. The total R&D budget for the Corps of Engineers came to $67 million in

1986, with 1987 estimates of $62 million to $75 million. The Air Force and the Navy each maintain

civil engineering laboratories of their own, while the Department of Defense began in 1986 to fund

Centers of Excellence on Advanced Construction Technology at MIT and the University of Illinois.

Some, though not all, of the military research is relevant to civilian construction problems—most

commonly, the work of the Army Corps of Engineers, which is responsible for heavy construction

on many U.S. dams and waterways. But work that could be used in the civilian E&C industry finds

its way only slowly and sporadically to the one million-plus American E&C firms.
150 • Intemational Competition in Services

transfer from the Corps’ laboratories to industry has been occasional.

The analysis in earlier sections of this chapter indicates that, to be competitive in the future, U.S. E&C firms will have to rely heavily

on advanced construction technologies. Over

the next several decades, construction will

gradually emerge as a high-technology industry, with extensive automation replacing the

craft-based methods in current use. Rapid

productivity gains will cut costs for firms that

lead in applications of high technology; the

need is as much for creative use of tools and

techniques that already exist (perhaps in embryo form) as for new research. At present,

American firms do a good job of applying computer-based technologies during the design

stages of E&C projects, and for construction

management, but they are well behind in construction methods, automated and otherwise.

That is where most of the costs are incurred,

and where the big payoffs lie.

That future international advantages for the

U.S. E&C industry will be based in part on technology could, in itself, justify higher levels of

Federal funding for construction research. But

the potential domestic impacts—through greater

productivity y and lower costs for projects ranging from residential building through infrastructure improvement (roads, waterworks) to

heavy construction—argue much more powerfully for higher levels of R&D. But why should

government pay? Because much of the work

required falls in the category of generic or

precompetitive R&D. For reasons explored in

greater detail in chapter 6, private firms in the

United States seldom pursue such R&D very

extensively. Simply put, no one firm can expect to capture the rewards from R&D that benefit’s an entire industry.

For the U.S. construction industry, the immediate opportunities lie in utilization of existing knowledge, including technology from

other industries and know-how originating

overseas (e. g., European approaches to reinforced concrete construction). Institutionally,

perhaps the most pressing need—given the vast

size and fragmented character of the industry—

is for better-developed mechanisms for diffusing technology, and the lessons of experience

in applications of new technologies. so

Again, note the parallels with U.S. manufacturing. The Nation’s base in scientific research

and in high technology is unmatched in the

world. Much of this research, in principle, can

be applied to industrial problems. But relatively

few of the firms, in construction or in manufacturing, that might draw on this research base

have staffs capable of picking and choosing

what is needed for a particular problem. Nor

do that many firms have the strategic vision

at executive levels necessary for reshaping their

operations over periods of years (which would

include recruiting and training the right kind

of employees) to take advantage of new technological opportunities. Such difficulties exist

around the world. But particularly in the United

States—where the gap between advanced research and applications is widest—attempts at

technological solutions to problems in either

construction or manufacturing too often fail

because of a mismatch between the company’s

real needs and the means brought to bear (technology for the sake of technology), because of

an inappropriate mix of people and machines

(integrating the work force out of the process

rather than into the process), or for lack of commitment (management backs out after initial

failures, rather than seeking to learn from experience). In essence, U.S. E&C firms have not

been very good at appropriate technology.

A positive Federal role, then, would be to help

create infrastructural mechanisms for: 1) conducting R&D on construction methods; and 2)

transferring know-how and results to the E&C

industry, in part through ongoing company involvement in the R&D projects themselves.

NSF’s Engineering Research Centers provide

a possible model (although one center for construction might fill 1 percent of the need); other

~~~loor attendance at meetings on technology’ transfer or~anlmj

b} militar~ laboratories that conduct construction-related R&Ll

shows, not that there is no problem, but how deep-seated the

problems are—” Military R&I] Up for Grabs, ” Engineering Ne\*rsRecord, Nfar, 6, 1986, p. 11.
Ch. 4—International Competition in Engineering and Construction ● 151

models also exist, both here and overseas .31

Given the size of the E&C industry, and the

range of applicable technologies (including

those originating in other industries), a robust

and self-sustaining infrastructure for developing and transferring construction-related technologies might involve dozens of such centers.

Certainly there appears to be room for one

or more industry-cooperative R&D consortia on

the lines of Microelectronics& Computer Technology Corp. The Federal Government could

facilitate the creation of such consortia by contributing seed money and/or incorporating

some of the ongoing activities of the existing

NBS Center for Building Technology. Furthermore, ongoing Federal funding of some percentage of the work conducted by R&D consortia could serve the public interest. For example,

government support for testing and commercialization of new construction technologies

would help ensure the safety and long life of

structures built with public funds. (NBS, the

31 See “I)(3\(;lcJ[Jnl[;nt ~il(l I)iff L]sion of Commercial T~(;hnOlog ie>: Should the F’e(l era [ ~o~’crnrncnt Redefine Its Ro]e?’ staff

rnf}nlo ra Ildll m, of fl( f> Of ‘1’[)[, hnnlogy ASS f? SSITlf311t, w~Shi Il~to Il,

1)(;. Nlar(; h 1984.

CONCLUDING

Into the 1970s, developing countries looked

to U.S.-based E&C firms to design and build

electric generating plants and power distribution networks, refineries and petrochemical

complexes, pipelines and offshore oil platforms,

steel mills and cement plants. American companies, with a great deal of experience from

work in the U.S. energy industry, were able to

transfer their skills quite directly to competition for international projects in the Middle

East. In the poorer LDCs, much of the work

consisted of infrastructural development, often

financed by international lending agencies.

Here, U.S. advantages were based on domestic experience with large water and highway

projects and on political and economic ties with

Latin America.

These once comfortable patterns have broken down. In part, the shrinking U.S. share of

Federal Highway Administration, and the Army

Corps of Engineers do some of this already,)

Government agencies might also help speed

innovation by experimenting with contract procedures that would permit bidders to propose

alternative techniques, following the European

model, to be evaluated by an independent board

of experts. Alternatively, government agencies

could move toward design-build contracts, or

greater use of performance-based specifications, Congress has already directed the Department of Defense to pursue nontraditional approaches to construction projects in an effort

to reduce costs.32 Related needs and mechanisms range from a national system for information exchange on construction technologies

to upgraded teaching equipment in trade

schools and university engineering departmerits .33

32 Mi]i(ary cons(rll~(ion Appropriations .!3i]], 1987, Report

99-648 to accompany H.R. 5052, Committee on Appropriations,

House of Representatives, June 19, 1986, p. 13.

u Tech no]og\r and f]l~ Future of the [‘, h’, ~’[)IJ.Str U[:tlOn Indli ~-

tr.t;, Proceer i inks of the Pane] on Technical Change an{] the [ 1,S.

Building Construction Industry, Office of Technology A\w;\\-

ment and the American Institute of Architects (tlrashin~t[jn. 1)(::

AIA Press, 1986), p. 75.

REMARKS

international markets has been a consequence

of Third World debt and declining oil prices.

So long as developing countries face demands

for austerity programs to qualify for additional

loans—often needed simply to service their

debt–new construction undertaken by outsiders will be the exception rather than the rule.

But much more is at work than the credit

crunch and declining oil revenues. E&C firms

in the developing world have themselves matured technologically; taking advantage of low

labor costs, they can now win some kinds of

contracts in competition with companies based

in the advanced nations. Government policies

in the LDCs and NICs have helped the process

along. Viewing construction as a vital industry for development, governments have protected local entrants and forced international

contractors to enter joint ventures and trans-
152 ● International Competition in Services

fer technology. And when it comes to construction methods, American contractors generally

lag behind competitors in Europe and Japan,

while typical U.S. contracting procedures discourage innovation. With financing a major element in winning new contracts, and a troubled

world economy, competition will remain stiff,

and the U.S. share of E&C markets will probably continue to decline.

Nor can the U.S. industry afford to feel that

its current lead in management expertise will

be secure. With O&M contracts accelerating the

spread of expertise, any strategy based on superior managerial skills will probably fail unless complemented by a major effort to make

up lost ground in construction technologies.

Indeed, U.S. firms need to catchup in construction know-how simply to protect their domestic markets from foreign incursions.

Today, the competitive environment facing

American E&C firms resembles that for many

manufacturing companies. Some E&C firms

have reacted much like those manufacturers

that have called for government assistance

while retrenching or withdrawing from international markets. But reactive strategies will

not rescue this industry, although government

preferences and set-asides might help provide

needed cash flow (while also meaning higher

construction costs for Federal agencies). On the

other hand, those American firms that take the

initiative in technology development, and in

tapping the skills of U.S. financial institutions,

will—when they cannot win projects on their

own—often be able to enter international consortia and joint ventures on favorable terms.

Certainly, these international combinations will

become more common; to the extent that such

consortia become standard features on the competitive landscape, firms that can bring distinctive advantages to them will do better, while

those that cannot will lose ground.

Relatively few American E&C firms are active in the international market, and loss of competitive advantage internationally, in and of itself, would not be a devastating blow to the U.S.

economy, Greater dangers come from possible

losses of downstream sales by suppliers of

materials and equipment. While exports of

American E&C services do not automatically

translate into exports of goods, such linkages

continue to benefit the Nation’s balance of payments, as well as U.S. employment. By encouraging the formation of cooperative ventures between E&C companies and other American

firms–e.g., trading companies–the Federal

Government could help strengthen these linkages. Team America, a consortium assembled

to bid on China’s huge Three Gorges project

offers a suggestive model (the group includes

U.S. E&C firms, suppliers, and banks).

In terms of Federal policies, however, the

greatest short-term need is simply to force other

OECD nations away from subsidized financing for international projects. For years, the major industrial economies have used export

credits to sweeten deals, particularly those with

developing countries. When it comes to E&C

projects, most of the industrialized nations offer generally similar development assistance

and export credit packages, Several of the NICs,

notably South Korea, also provide financing

assistance to support their E&C industries. s*

Once some governments began offering subsidized financing packages, others followed suit

to avoid losing sales. While an agreement

within the OECD (see ch. 10) established consensus interest rates on loans, with lower rates

and longer maturities on credits for the poorest

developing countries, the agreement did not

cover tied aid or mixed credits, leaving a loophole exploited by France and other European

nations, along with Japan. Congress approved

a $300 million mixed credit war chest in 1986,

with the intent of creating leverage for negotiations aimed at moderating the use of mixed

credits by other nations. A revised OECD agreement, in the spring of 1987, promises to be a

step in the right direction. But the United States

will probably have to keep the pressure on,

Over the longer run, Federal support for innovation and technology development carries

34] n ~(jc] it jon S[)u t h K ~r~~ ‘S co~rf;rn mf)n t of f’f?rs tax 11) cent i Y’flS

tu en(;ourage R&I) hy constru(:t ion firms-~lr. Arnold, “Rcscuc

pt]ckage for (;~nstruf;tl~n %;tOr,” Det’fkpment Forum, JUn(’

17! 1985, ~). 1.
Ch. 4—International Competition in Engineering and Construction ● 153

the greatest promise for helping this industry

rebuild its competitiveness. Currently, American E&C firms do almost no R&D. Meanwhile,

the larger European companies have many

years experience in turning proprietary construction technologies to competitive advantage. precasting, pre-stressing, and posttensioning techniques for concrete, for instance, have been developed mainly in Europe.

Given the continuing inability of American

companies to compete on costs for routine international projects, successful strategies will

necessarily entail technological leadership beyond that already achieved in design and management. American E&C firms are in much the

same position as countless manufacturing companies. Without strenuous and continuing efforts in R&D and technology development, U.S.

contractors can look forward, first, to further

deterioration of their competitive positions

abroad. This will almost inevitably be followed

by an increase in competitive pressures at

home. The pattern has long since become clear

in other industries.

Renewed technical leadership will depend in

considerable measure on developments elsewhere in the U.S. economy. Much as they have

done in the past with computer-assisted construction management techniques, E&C firms

will have to draw on other American industries

in building proprietary technical positions.

Most of these companies have avoided strategies based on proprietary technologies in the

past. For that reason alone, long-term efforts

will be necessary.

Future international success will probably

also require more diversification than American E&C companies have preferred. Narrow

expertise tied to the energy industry or to power

generation carries high risks in a period of slow

economic growth and volatile energy prices;

specialized firms will be vulnerable to both cyclical (or secular) decline in their clients’ industries, and to the competitive thrusts of targeted policies by foreign firms and foreign

governments, Diversification can reduce the

vulnerabilities only too evident over the past

few years among E&C firms that depended

heavily on energy projects.

While new corporate strategies are evolving

in some American E&C firms, old habits will

die hard in others; for those in the latter camp,

international competition will be harsh and potentially devastating. Many companies still appear at sea, unable to home in on new strategies suited to new competitive conditions.

While some U.S.-based E&C companies have

begun to place more emphasis on R&D, they

are in the minority. Those that aggressively seek

and adapt technologies from other industries,

and from foreign E&C firms, will be better positioned to gain with respect to competitors both

at home and abroad. Eventually, prefabrication

and automation will be common in the construction industry. Productivity will jump. If

American firms take the lead in developing new

approaches to construction methods, they may

be able to renew their competitive ability internationally. If they fail, their markets within

the United States could be deeply penetrated

by able foreign competitors.
Chapter 5

Information Technology Services:

Software, Telecommunications, Data Processing, and Information Services
Page

Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ...................157

Computer Software . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ..................160

Hardware and Software Costs: Productivity in Software Generation .. ...161

The U.S. Industry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .................162

Japan’s Software Industry and Market . . . . . . . .................,......163

Europe . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ..........166

Competitive Dynamics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ......168

Telecommunications Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .........169

The Competitive Environment . . . . . . . . . . . . . . . . . . . . . .................169

The Telecommunications Infrastructure . . . . . . . . . . . . . . . . .............175

Value-Added Services . . . . . . . . . . . . . . . . ..................,.,........176

Videotext . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ....................180

Data Processing and Information Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . .181

The DP Services Industry . . . . . . . . . . . . . . . . . . . . . . . . ..................181

Database and Information Services . . . . . . . . ..........................183

Concluding Remarks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ..............,186

BOXeS

Box Page

M. International Telecommunications . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. ...170

N.

o.

P.

Q.

R.

s.

T.

Regulation and Deregulation in Foreign Telecommunications Markets ..l72

Integrated Services Digital Networks (ISDN) . .......................177

EDS and General Motors’ Planned Corporate Network . ..............178

Telenet . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ...................179

Societe Internationale de Telecommunications Aeronautiques (SITA) ...179

Data-Processing Service Firms: Two Examples . .....................182

Moving Into New Information Markets: InfoBase Corp. . .............185

Figure

Figure No. Page

33. Projected Worldwide Revenues of U.S.-Based Software Suppliers .. ....162

34. Projected Sales of Packaged Software in Western Europe . . . . . . . . .. ..,167

35. Publicly Available Databases Worldwide.. . .........................183

36. On-line Database Searches. ..,... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ...184

37. Publicly Available Electronic Databases by Country of Origin, 1985....186

Tables

Table No. Page

20. Three Phases of Telecommunications Technology . ..................176

21. Data-Processing Services Markets, 1986 . ...........................183

22. Electronic Information Service Revenues in the United States... .. ....183
Chapter 5

Information Technology Services:

Software, Telecommunications, Data Processing, and Information Services

SUMMARY

The cliche comes easily: information technology is to modern industrial societies what

steel was to the industrial societies of the late

19th century, automobiles to the first half of

the 20th. Computer hardware and software,

telecommunications, embedded and invisible

processors deep inside other equipment—these

aid banks in processing huge flows of transactions, make factories more productive, help

airplanes fly. The logic built into software tells

the processors what to do, while telecommunications systems permit computers as well as

people to talk to one another over thousands

of miles.

This chapter deals not only with software and

telecommunications, but with marketed data

processing and information services. The cluster of industries covered—the information technology (IT) services—includes both new applications (database services and videotex, defined

below) and businesses that are already relatively

mature (data processing). All depend on the

ability to store, process, and transmit great

volumes of information at ever-lower costs.

Software, something like a service (computer

programs have no necessarily fixed form) and

something like a good (programs can be reproduced, stored, and shipped) makes the rest of

the IT services possible, All the products of digital systems technologies depend on computing capability in one way or another, and computing capability depends on software. Today,

for instance, the central switching systems that

route telephone calls between distant cities are

giant computers; 80 percent or more of the $2

billion-$3 billion cost for developing a new generation of these central office (CO) switches

goes for software.1 Software development costs

Ij, Rippetcau, ‘*GTE’s Planned 1,ink L1’it h Sicmens Worries CIIstomers, ” Financial Times, A~; r. 22, 1986, p 18.

( :ompanic~ IJrotluc ing (;() switches can [;x]]c(t to spen(] se~=

eral hundred million (iollar-s annuall! simply on malntaln i ng an(i

are likewise becoming a larger proportion of

total development costs for both microprocessors and their embedded applications. Very

large-scale integrated circuits, the building

blocks of computers and communications systems, can only be designed using software for

computer-aided design; the same is true of computers themselves. Software, which embodies

the logic of complex systems, epitomizes high

technology for the latter part of the 20th

century.

While computer hardware manufacturers

(and users) continue to develop a great deal of

software, a rapidly growing independent industry had emerged by the 1970s. The firms in this

industry develop and market programs for offthe-shelf sale or lease to customers—packaged

software—along with custom products tailored

to user requirements. Generally the software

company will also provide training, documentation, and at least some software maintenance;

over the life of a package, maintenance costs—

e.g., updating and error correction—may exceed the cost for developing the original program by several times.

In 1985, U.S. firms had about 70 percent of

a world software market worth some $30 billion, with many of their overseas sales through

affiliates. 2 The largest portion of these revenues

come from the sale of operating systems and

applications software for large mainframe computers—much of this software supplied by the

original equipment manufacturers—but sales

of software for small systems, notably PCS, have

been growing rapidly. An applications package for a large system can easily cost $1 million, while many PC programs retail for under

impro~ing the softltare, partlcularl}f on soft If’are updates for prok’ id i ng ncw sf; rk’i(; cs,

2

1.986 1‘. S’. Industrial OutlooA- (Washington, I)(:: I)epa rt m (’n t

of (;ommercf;, ]anuarj’ 1 986), p. 28-3.

157
158 ● International Competition in Services

$100, The custom software business consists

largely in putting together complex and specialized applications packages for relatively

powerful machines.

U.S.-based firms have been market leaders

for a long time, but their share of the world market seems bound to shrink in the years ahead.

With much of the future growth in other countries, where computer use does not come near

to levels now common in the United States, foreign software firms will probably be able to improve their relative positions, particularly as

they follow the American lead in switching to

packaged, as opposed to customized, software.

In particular, the U.S. industry can expect a

strong challenge from suppliers in Japan, as that

country continues to build its computer industry. With software increasingly influencing or

determining the design of hardware, the Japanese realize they need major advances in software; both government and industry have made

strong commitments to improvements in software productivity and to new generations of

software technology, with the goal of leapfrogging the United States.

Providers of telecommunications services

give their customers access to an infrastructure of public switched telecommunications

networks, along with private leased lines for

voice and/or data communications. Developments including microwave systems, communications satellites, fiber-optic links, cellular telephones, and cable TV networks have made

possible not only new services—e.g., videotex—

but conventional voice and data transmission

bypassing the regular telegraph and telephone

network. One of the newest elements in this

evolving infrastructure, local area networks

(LANs), link computers within an office, a building, or similarly restricted setting, while wide

area networks (WANs) tie together systems that

may be on different continents.

Over the next several decades, many countries will begin building Integrated Services

Digital Networks (ISDN) that can handle voice,

data, facsimile, and video signals over a common grid—a development that promises rapidly declining costs for transmission, although

the worldwide capital costs of building ISDN

networks will run into the hundreds of billions

of dollars. New services will be possible, if only

because most data communications still move

over telephone lines, which were never intended

for this purpose; ISDN will be much faster, and,

for a given volume of data, much cheaper.

Choice of technologies for ISDN both internationally and within the United States will have

far-ranging impacts on competitiveness (chs.

9 and 10). Should the United States find itself

with an ISDN system different from the rest

of the world, or with several different ISDN systems, American firms in many industries could

be placed at a competitive disadvantage.

Technological changes over the past two decades have already had major impacts on the

competitive environment in the United States.

Microwave transmission made it possible for

new entrants to challenge AT&T’s monopoly

on long-distance telephone service. MCI and

other companies prevailed in the courts and

later in Congress, arguing that competition

would provide better service, stimulate innovation, and avoid the regulatory confusion

stemming from the blurring of boundaries between voice and data communications. The series of administrative, judicial, and congressional decisions establishing the right of other

firms to offer services through the AT&T network culminated in the breakup of the Bell System, a process that has had enormous impacts

worldwide.

Domestic telecommunications revenues greatly

exceed the value of international services; in

1986, only $3.6 billion of U.S. revenues estimated at some $117 billion represented international telecommunications services.3 Although

Japan, and to some extent Great Britain, have

begun to follow the U.S. lead in deregulation,

telecommunications remains a government

monopoly in most countries, with little oppor3

1987 U,S, Industrial Outlook (Washington, DC: Department

of Commerce, January 1987), p. 31-1. Negotiated formulas divide the charges for international services between the carriers

in the countries involved—Tracfe in Services: Exports and Foreign Revenues [Washington, DC: Office of Technology Assessment, September 1986), pp. 91-94.
Ch. 5—Information Technology Services: Software, Telecommunications, Data Processing, and /formation Services ● 159

tunity for competition in traditional telephone

and telegraph services. Rather, most of the international opportunities lie in network services that add value to data communications by

providing file storage, message switching, protocol conversion, interfaces for different types

of terminals, and access to database and other

information services. Value-added networks

(VANS) providing some or all of these functions,

mostly to business customers, have grown rapidly. While maintaining tightly regulated basic

telecommunications markets, a number of countries have moved to liberalize value-added services provided over the public infrastructure, enabling American firms to compete in some

VAN markets abroad.

In effect, almost any computer network can

be viewed as a VAN—the SWIFT (Society of

Worldwide Interbank Financial Telecommunications) system for electronically linking banks

described in chapter 3; airline reservation systems (some 50,000 terminals in 12,000 travel

agency offices worldwide are tied into American Airlines’ Sabre system); even ARPANET,

designed for the U.S. Department of Defense

in the 1960s to link computers in R&D laboratories, and the original source for much of the

technology used in current computer and communications networks. a

Videotext/teletext services, known collectively

as videotex, consist essentially of VANS providing access to multiple information services;

examples include The Source and Dow Jones

Information Retrieval, which offer a variety of

personal and business information services, including electronic mail, stock market quotations, and airline directories. (Videotext and

teletext differ primarily in that videotext services tend to be highly interactive, and to be provided over the telephone network, while teletext

is broadcast to television receivers. ) Originally

targeted at households, videotex services have

also sold well to businesses, Outside the United

States, government PTTs (post, telegraph, and

telephone authorities) or other monopoly telecommunications carriers have generally sup40n Sabre, see S. (Ja re}’, “ Europe Bristles at ( 1 ,S. -Airl ine Computers, ” tValf Street Iournal. No\’, 21, 1986, p. 36.

plied videotex services; the most successful has

been the French Teletel/Minitel system, with

21⁄2 million terminals in service at the end of

1986 and 6 million projected for 1990. Monopoly control of videotex services in other countries will limit the ability of U.S. firms to compete, but they may be allowed in when they have

specialized services to offer that would otherwise be unavailable.

Firms providing data-processing (DP) services were among the first to take advantage of

the telecommunications infrastructure for transmitting digital data. Starting with batch processing, when data were physically transferred

(e.g., as coding forms or on magnetic tape) to

a facility owned by the processor, DP services

quickly expanded into remote processing, with

data transferred via telephone lines. DP services firms sell computer time (including time

on supercomputers), handle payrolls and accounting for other companies, and in many

cases provide facilities management under contract; systems integrators help customers design their own DP facilities (e. g., choosing and

packaging hardware and software). OTA places

the 1984 foreign revenues of U.S. DP services

firms at $2.7 billion to $5.1 billion, while total

revenues, domestic plus foreign, came to about

$15 billion.’

DP services firms grew rapidly by providing

computing capability to companies that did not

have equivalent internal capabilities; today,

with computing power cheap and widespread,

this part of the business is mature. While DP

services firms can still provide many specialized functions cheaply, growth will come in

new lines of business; many DP services companies are now pursuing strategies that emphasis VANS or information services.

If growth in the DP services industry has

slowed, information services and electronic

databases are poised for rapid expansion. In

essence an old industry taking on a new form,

electronic databases can supplement and extend print media in many ways. Information

ranging from bibliographic citations to the text

5 Trade in Ser\’ices: E\ports and Foreign Re\’en UP.S, ()[), (: i t,,

p. 62.
160 ● International Competition in Services

of legal decisions to remote sensing data American companies have also had considergathered by satellites can now be delivered to able success in Japan; with English in nearly

the customer on a floppy disk or directly over universal use among business customers, the

the telecommunications infrastructure. U.S. in- U.S. industry will have a continuing source of

formation services firms had 1985 revenues of advantage in international competition.

about $1,9 billion, with 20 percent coming from

foreign sources; American vendors supply half

or more of all database services in Europe. B

e 1986 U.S. industrial Outlook, op. cit., p. 48-6.

Much of the information in the rest of this chapter not other.

wise cited comes from interviews.

COMPUTER SOFTWARE

In the early years of the U.S. computer industry, customers purchased hardware and

software bundled as a package from one of the

half-dozen or so companies that made computing equipment. Customers could create their

own applications software, but normally relied

heavily on programming languages and implementation routines developed and supplied by

the manufacturer. As early as the 1950s, independent software and systems houses emerged

to meet specialized programming requirements.

Through the 1960s, as user needs became more

specialized, independent firms continued to

expand.

A major turning point came in 1969. IBM,

already the largest computer manufacturer in

the world by far, was forced under intense antitrust pressure to unbundle software, changing its pricing policy so that customers were

charged separately for hardware and for programs, The independent software industry

gained new credibility, while more customers

began to evaluate software purchases independently of hardware. For the smaller computer

firms striving to compete with IBM, and particularly the emerging manufacturers of minicomputers, such as Digital Equipment Corp.

(DEC), this was an important development.

DEC still markets 30 to 40 percent of its hardware to systems houses which assemble integrated hardware/software packages to the specifications of particular customers.

Many businesses continue to do some of their

own programming. Banks and accounting firms,

for example, maintain large staffs of computer

specialists. But for relatively standardized

needs, the benefits of purchasing software on

the outside, particularly packaged software,

have become steadily more compelling. These

benefits include:

Availability.—Software already on the market can be quickly evaluated, purchased,

and put to work.

Lower Risk.—A firm choosing to develop

its own programs may not achieve its functional goals; even if it does, the development effort may cost more and/or take

more time than planned.

Manpower Savings .—Purchasing software

minimizes the company’s internal staffing

requirements.

Better Documentation.—Packaged software includes documentation, which can

be evaluated as part of the purchase decision. Few companies that do their own programming seem able to enforce high priorities for documentation. 7

Against these points, a company must weigh

the prospects of arriving at better solutions to

its particular problems. It must also consider

the possible strategic advantages (ch. 8); unique

7W. 1.. h’ rank, Critical Issues in Software (New York: Wiley

Interscience, 1983], p. 166.
Ch. 5—information Technology Services: Software, Telecommunications, Data Processing, and Information Services ● 161

software can, like other forms of proprietary

technology, be a potent competitive weapon.

Fourth-generation languages, which make it

easier for end users with relatively little training to create their own applications packages,

sharpen the trade-offs between in-house and

off-the-shelf software. Also called end-useroriented packages, examples of fourth-generation languages include FOCUS (Information

Builders Inc.), ADABAS (Software AG), and

Ramis-II (Martin Marietta).8

Hardware and Software Costs: Productivity in

Software Generation

Cost/performance ratios for computer hardware have been declining steeply for years, with

no end in sight; today, even the smallest businesses can easily buy and use surprisingly

powerful desktop machines. More than ever,

purchase decisions for hardware—small systems and large—depend on software availability. Indeed, software has begun to dictate the

design of hardware. Computer manufacturers

find themselves spending the majority of their

R&D dollars on software. Given the decline in

prices for equipment, they seek to increase their

revenues from software sales; at IBM, software

and services have grown from less than 20 percent of total revenues as recently as 1983 to

about 30 percent in 1986.9

Falling hardware prices, leading to a larger

user base, increase the demand for software.

This, in turn, means that software suppliers can

charge lower prices because they can amortize

their upfront development costs over larger unit

sales. But at the same time, productivity in developing software has increased only slowly—

perhaps 5 to 10 percent per year, far less than

Wln the advantages of fourth-generation languages, see J. Martin

and C. McClure, Software Maintenance: The Problem and Its

Solution (Englewood Cliffs, NJ: Prentice-Hall, 1983), ch. 11; also

J. Martin, Fourth Generation Languages (Englewood Cliffs, NJ:

Prentice-Hall, 1985). With a third-generation language like Basic

or COFIO1, the programmer’s instructions tell the computer i n

step-by-step fashion how’ to proceed, With a fourth-generation

language, the (applications) programmer tells the s}stem what

tl~e output should be, but not how to achie~’e that output.

‘M. Schrage, “III M Reprograms Its Strategy to Sell Software,

Servir; es, Lt’ashington Post, Au~. 3, 1986, p. FI.

rates of productivity increase on the hardware

side of the business. Skilled programmers must

still write and debug software on a line-by-line

basis. While improvements in computer languages and programming aids, including automation, have helped, longer and more complex

programs continue to stretch the capabilities

of the best people and the best tools. Software

maintenance—upgrades as well as debugging—

typically accounts for well over half of life-cycle

software costs.10 Documentation is also expensive, while the spread of computing power to

new and nonexpert users has made good documentation ever more important for success in

the marketplace. The result? A productivity bottleneck in programming, with software now

accounting for a far greater percentage of total system costs than in earlier years.

With demand for skilled programmers and

systems developers high, American universities have struggled for a decade to keep up, as

more and more students sought to study computer science and software engineering. While

some kinds of routine software development

can be handled by programmers with modest

skills, marketplace success often depends on

the insights of a few unusually creative people

—those who can devise a fourth-generation language, make progress in automating the generation of software itself, or develop expert systems (a form of artificial intelligence, or AI),

The growing dependence of hardware design

on software places still heavier demands on the

conceptual skills of those responsible for the

overall design of software packages.

Given the dimensions of the productivity bottleneck, a great deal of software R&13 has been

directed toward tools for cutting costs and

speeding common programming tasks. In the

near term, fourth-generation languages, which

IOSome estimates indicate that as much as 8(I percent o f maintenance costs go toward adapting software to customer needs

that were not fully understood when the de~reloprnent process

began, or that have shifted over time. See Software &/airztenance.

The Problem and Its Solution, op. cit., p. 4. For an idea of the

scope of maintenance requirements, note that the worldwide

in~entor~ of programs written in COBOL, still popular for business applications, reaches perhaps 75 billion lines of code—” Engineering an End to the Software Nightmare, Financial Times,

NOV. 20, 1986, p. 14.
162 ● International Competition in Services

can give 10:1 to 100:1 productivity improvements, seem to offer the best hope. Related efforts in the United States include AI techniques

for training programmers, as well as expert systems to help them generate new software.

The U.S. Industry

The American software industry is the largest

in the world and the biggest exporter. U. S.-

based firms reportedly hold more than 70 percent of the global software market, with worldwide revenues of about $21 billion in 1985.11

As many as 10,000 American firms, the vast

majority quite small, develop and market computer software. As figure 33 shows, in recent

years hardware manufacturers and independent software firms have accounted for roughly

equal sales volumes, with projections suggesting that the share of the independent firms will

grow. Contract programming is expected to

drop from over 20 percent of the market currently to a projected 12 percent, a consequence

of the continuing trend away from custom

soft ware.

Most of the software supplied by hardware

manufacturers consists of operating systems

and applications software—e.g., for database

management—designed specifically for the

firm’s machines. This is a big market in dollar

terms: while mainframes and minicomputers

sell in the hundreds or thousands to tens of

thousands of machines per year, compared with

millions of PCs, software for the more powerful systems costs much more. The sales of the

II 1986 U.S. ]ndustrja] Outlook, op. cit., p. 28-3. Western Europe, Canada, and Australia have been major markets for U. S.-

based firms.

The most recent figures on market share, for 1982, show the

U.S. industry far ahead of other national software industries:

.%1C5 Pt,r( f,nl Ilrorld rntirkt>t

(bI//I[)IIs 1)/ (/()//drs/ Emp/[Jj mer]t for(,]gr] sales ~h,ir~,

[ lrr,t(y~ s(~tf,~ $10 :1 224,000 5[1-00%

P’ran( t, 13

70%

40,000 24 5-7

[+pan 12 :18,000 + 1 5.7

Llnlted K]ngdom 07 25,000 + 7 2-3

See A Competitive Assessment of the U.S. Software Industry

(Washington, DC: Department of Commerce, December 1984)

p. 35; the employment figure for the United Kingdom comes from

IIo]icy for the UK information Technology Industry (I,ondon:

National Economic Development Office, 1982), p. 61.

The expert systems market is currently in the $140 million

range—J. Mead, “Building a Bridge to Expert Systems, ” Datamation, Jan. 1, 1987, p. 17.

Figure 33.— Projected Worldwide Revenues of

U.S.-Based Software Suppliers

90 

I I

1984 1986 1988 1990

Year

and system design

SOURCE: “Review and Forecast The Software and Services Market place,” international Data Corp , March 1985

largest of the independent PC software firms,

Lotus Development, came to about $225 million in 1985; IBM’s software revenues totaled

$4.2 billion, and Hewlett-Packard’s $500 million. 12

With few exceptions, foreign firms lag well

behind their American competitors in software

technology, as well as in sales, The factors responsible for U.S. leadership begin with the vast

domestic market, driven by a hardware base

that is the largest in the world by far, American software firms can expect to cover their

design and development costs at home, giving

them latitude in setting prices overseas. Because even a product that is not a great success may sell enough copies to cover fixed costs,

IZP. Archbold and P, Hodges, “The Datamation 100, Datamation, June 15, 1986,
Ch. 5—Information Technology Services: Software, Telecommunicatlons, Data Processing, and Information Services • 163

r

‘f

.

T

Photo credit Cray Research

Cray X-MP supercomputer, one of the most powerful

machines available.

the risks of new product development are lower

here than in foreign countries–one reason why

foreign firms like Software AG have invested

heavily in the United States.

While all signs point to continued competitive strength for U.S. suppliers, their world market share seems bound to slowly decline. Foreign industries where custom programming is

still the rule will be forced, sooner or later, to

move into the design and production of standardized software. As firms overseas negotiate

this transition, some will emerge better able to

compete with American suppliers.

Japan’s Software Industry and Market

While European software firms have been

more visible internationally than the Japanese,

over the longer run Japan will emerge as the

primary U.S. competitor in software. Today,

the major Japanese computer manufacturers

sell hardware that compares well with that from

American firms. But Japan remains substantially behind in software, with poor applications

packages—along with limited sales and service networks—a major handicap in selling hardware internationally, particularly in the office

automation and PC markets. In contrast, Japanese systems software, which is based on technology originating in the United States, is usually considered to be quite good.l3

The Japanese recognize their deficiencies

quite clearly, and have embarked on a massive

effort to catch up. A few years ago, Hitachi

spent only 10 percent of its R&D money on software; now it is spending more than 30 percent.14

Toshiba has established a “software factory”

employing 3,000 programmers to work on products for business and industry. NEC spends

$400 million annually on software development.

Still, leaving aside these efforts by hardware

manufacturers, and leaving aside the government-sponsored fifth-generation project, the

Japanese software industry resembles that in

the United States perhaps two decades ago—

small and not very visible. The independent

software houses remain weak. As in many countries, skilled programmers have been in short

supply. About 90 percent of Japanese applications software continues to be undertaken on

a custom basis, often by firms for their own use;

meanwhile, customized programs have already

fallen below 40 percent of the U.S. market, and

to about 60 percent in the United Kingdom.

Custom programming is inefficient (often

costing 10 to 100 times more than packaged programs), and will not persist indefinitely, if only

because the burgeoning software needs of the

13H ,J, We]ke, Data Processing in ]a~)an (Amsterdam: NorthHolland, 1982), ch. 6; D, Brandin, et a]., “J”rIi(:H ])anel Rcl)ort

on Computer Science in Japan, ” Scien(:e Appli{ at Ions 1 nternationa] Corp., La Jolla, CA, under contract N’o, TA-8:1-SA[:-(X?254

from the ~epartment of Commerce, December 1984, p. 3-1, Both

Fujitsu and Hitachi continue to make 113 hl-compatible (,om[]~lter~,

while N EC operating s~’stems trace their a IIC t:st r} t{) 1 { o II [?\

well products. The operating systems de~’eloped b~ t h ese companies may have U.S. origins, but today in at least some (:ase~

the Japanese versions are superior. One of the objec,tl\res of Japan’s

heavily publicized fifth-generation coml)ut cr project, discussed

later, is to help Japanese companies take the neit stel] in breaking free of their long-standing (dependence on American so ftttrare.

14] 11 the ~)a St acc ~r~ing to H isao I sh i ha ra, hl a n agi ng Director

of the Japanese So ft\\’are 1 ndustr} Association, “Hardware nlarl -

ufa[turci-s ha~’e been laz~r about de~eloping so ftware, ” See “Soft-

~~’a re: The New Dr i~’ing Force, ’ Business 11’ee~, Feb. 27, 1985,

p, 96.
164 • International Competition in Services

Japanese economy can only be accommodated

through greater adoption of standardized applications packages; the rapidly growing hardware base in Japan, now second in the world

after the United States, will force change. Over

the next 10 to 15 years, as they respond to these

pressures, Japanese software suppliers will

markedly improve their competitive positions.

Software Technology

Their overwhelming reliance on customized

software contains the seeds of the Japanese industry’s future development. In software, as in

manufactured goods, Japanese companies have

elevated process engineering to a high art. Software factories like Toshiba’s reportedly produce large volumes of code with levels of quality (as measured by freedom from errors) and

productivity (as measured by lines of code per

man-year) substantially higher than in the United

States or Europe. These software factories typically specialize in programming for particular

classes of applications—e.g., process-control

packages for nuclear powerplants and steel mills,

aircraft flight control systems—making it easier to re-use blocks of code, as well as to train

the programming staff narrowly but deeply. 15

Thirty percent or more of a given package may

be recycled from past programs, helping both

quality and productivity; Toshiba’s Software

Workbench claims an error rate of 0.3 bugs per

thousand lines of code, a factor of 10 below typical U.S. error rates.

When the Japanese software industry moves,

as it must, toward prepackaged applications

programs rather than custom and semi-custom

products, the software factory experience should

prove of considerable value. But releasing a

bug-free program means little if the software

fails to meet user needs. For general-purpose

applications packages, with design requirements that will be fuzzy and ill-defined compared with custom-tailored programs, market

success depends first of all on conceptual delsThe Specialties given are those of the Software WorkBench

of Toshiba Fuchu—’’JTECH Panel Report on Computer Science

in Japan, ” op. cit., pp. 3-3 to 3-4. Also see Information Techno]-

og~’ R&D: Critical Trends and Issues (Washington, DC: Office

of Technology Assessment, February 1985), p. 85.

sign. Japanese software firms generally lack experience in developing and marketing programs

that can satisfy mass markets. Their strengths

lie in the steady improvement, often through

painstaking and expensive trial-and-error, of

existing products and processes. (Recall their

improvements on U.S.-developed operating systems.) On the other hand, if the ideas become

available—perhaps from American firms or

American software designers hired by the

Japanese–Japan’s experience base could provide the foundation for future cost advantages

in software. Indeed, this is part of the Japanese

strategy: a Toshiba executive has said, “To overcome Japan’s language problem and compete

with the United States, we have to have productivity double that of the U.S.” 16 To help surmount their handicaps in conceptual design,

Japanese software suppliers will not hesitate

to follow electronics firms and automobile manufacturers in establishing design centers in the

United States.

At the same time, the generally poor reputation of Japanese applications programs hides

real strengths. Efforts over the years to develop

Japanese language input/output terminals, and,

more recently, word processing software, may

help Japanese firms gain the lead in some kinds

of applications packages. In manufacturing,

many Japanese companies have implemented

simple but sophisticated factory automation

systems, with software already well-proven in

practical applications; Japanese software for

numerically controlled machine tools, for automated inspection, and for statistical quality control may be less than innovative—perhaps even

derivative of American technology–but it works,

and works well. Other examples of successful

applications software lie hidden inside many

Japanese corporations. In the future, Japanese

software suppliers will be able to build on these

achievements.

On the other hand, their language will create ongoing difficulties for Japan’s software

suppliers, particularly when it comes to overseas sales. Japanese programmers, not surprisingly, prefer to work in their own language

‘e’(Software: The New Driving Force, ” op. cit., p. 98.
Ch 5—Informatlon Technology Services: Software, Telecommunications, Data Processing, and Inforrnation Services ● 165

where possible. To export software, they must

translate not only codes (commands, prompts

and comments) into English or some other language acceptable in the foreign market, but also

the accompanying documentation, including

training materials. (At present, the U.S. firm

Lotus Development supplies software packages

in seven languages, ) Given the long-term vendor-customer relationships and the turn-key

environments typical in Japan, documentation

has not been up to Western standards.

There is another side to the matter of language differences, however, one that may eventually have effects on competitiveness in many

industries. Because written Japanese uses some

2,000 kanji characters, typewriters have been

expensive and difficult to operate, Likewise,

computer terminals have been beyond the capabilities of people lacking special training.

Business communications in Japan depend on

handwritten documents to an extent unheard

of in the West for decades. Now, with Japanese

language capability becoming available in computer systems, Japan’s companies, no matter

what industry they compete in, will be able to

tap a major new source of productivity improvement. During 1985, production of Japaneselanguage word processors increased from about

30,000 per month to nearly 250,000 per month,

while average prices dropped by a factor of 5.17

Moreover, Japanese word processing software

is in some respects already quite advanced; the

system must interpret keystrokes representing

phonetic combinations, “guessing” the operator’s meaning based on context and expressing that meaning in kanji. Programs that do this

become, in effect, applications of AI. The Japanese companies that have developed this software should be able to transfer some of the

techniques to other types of programs, with subsequent competitive advantages.

1“’Output Outlook by Sector, ” Iapan Report-science and Technolog~’, Joint Publications Research Ser\rice JPRS-JST-86-070 -I.,

oct. 30, 1986, p 47. Translated from Nikkei Electronics, Apr.

7. 1986.

The Fifth-Generation Project

When it comes to technologies like AI, it is

the fifth-generation project that gets most of the

attention outside Japan. Begun in 1982 under

the auspices of the Institute for New Generation Computer Technology (ICOT), the goal of

the fifth-generation project is to extend applications of massive computing power to ordinary users by harnessing AI, natural language

input capability, and very large databases. The

intent is to leapfrog existing—i.e., American—

computer technologies. This is not the first time

that joint government-industry R&D, a process

refined in Japan over several decades, has been

turned to the “software gap.” 18

The fifth-generation project’s budget, averaging less than $50 million per year, is not large

compared to internal corporate R&D spending,

or, for example, to the Strategic Computing program of the U.S. Department of Defense. This

by no means makes the project unimportant.

The technical goals will be very difficult to

achieve. But as many other joint projects in Japan have demonstrated, focusing exclusively

on technical objectives misses the point. Such

projects serve many other functions in Japan’s

industrial policy system, ranging from consciousraising and consensus-building to training technicians and engineers, In Japan, where concerted efforts to build an “information economy” go back to the 1960s, the government

looks to computers (and communications) as

the centerpiece of the nation’s future economic

structure, a structure emphasizing knowledgeintensive, hence software-intensive, goods and

Inon Japan’s approach to joint gokrernnl[;I~t-irldL] str}’ R& f), including the objectives of the fifth-generation project, see international Competitiveness in Electronics {L\’ashington, DC: Office of Technology Assessment, November 1983), pp. 416-419,

One of the more important of the early sc)ft~t:ire-irlterlsi~e efforts, the Pattern Information Processing S~’stenl [PIPS) project,

helped Japanese companies develop technologies for input devices that could accept kanji characters. The recent SIGNIA

project (Software Industrialized Generator and hlaintenance

Aids), initiated in 1985 by the Information Technology}’ Promotion Agency, seeks increased productivity in progr~rnming

though software engineering techniques and automation. This

effort, scheduled to run through 1989, has a planned bud,get of

more than $150 mill ion and involves nearly 130 companies. See

A, Cane, “Japan’s $100m Software Boost, ’ Financial Tin?e.s, %pt.

18, 1985, p, 14; also S.K. Yoder, “Automating Soft\i’are, ” L1’a)l

S(reet Journal, No\. 10, 1986, p 33D.
166 ● International Competition in Services

services. The fifth-generation project is one part

of this larger effort.

Trade Barriers

As in other industries, direct and indirect barriers have made it difficult for U.S.-based firms

to sell software in Japan. For example, many

American companies contend that Nippon Telegraph & Telephone [NTT), potentially a huge

customer for U.S. software, gives preferential

treatment to Japanese companies. After lengthy

negotiations and much pressure from the U.S.

Government, NTT—now partially privatized—

has begun to show signs of opening up its procurement process, with software one of the

areas of progress, Time will tell whether this

concession represents the first step in what

would inevitably be slow progress toward more

open procurement, or whether it represents no

more than a token concession by the Japanese.

U.S.-Japan friction over copyright protection

for software has been as heated as that over

NTT’s procurement practices. A 1983 bill prepared by MITI and introduced in Japan’s legislature, the Diet, called for compulsory licensing of software where the Japanese Government

deemed this in the national interest. The intent

was clear: MITI wished to aid Japanese firms

by making it easier for them to use existing

programs, particularly the IBM software that

Japan’s plug-compatible hardware manufacturers

continue to depend on. Lengthy negotiations

between the U.S. and Japanese Governments

followed; other countries also protested the Diet

bill, which was eventually shelved. Finally,

Japan’s Government promised to implement

copyright provisions for software more acceptable to foreign interests.19 If the Japanese continue to keep out American software firms, and

otherwise aid their domestic industry (by, for

example, allowing reverse-engineering of U.S.

programs), a strong group of competitors could

eventually emerge in this industry—from behind barriers much like those that earlier helped

1“S. Chira, “Japan Plans TO Provide Protection for Software,)’

,VeMr Y’ork Times, Mar. 19, 1985, p. L)l 3. While the new plan

was proposed in 1985, no action had been taken as of mid-1987.

the Japanese develop their computer, semiconductor, and telecommunications hardware suppliers.

Europe

While American hardware and software firms

have had a much easier time in Western Europe than in Japan, none of the European nations, individually, can compare with Japan as

a potential customer (or potential competitor).

As a whole, the Western European computer

market exceeds that of Japan by perhaps onethird, despite a population roughly twice as

great.

Although custom software does not take as

high a fraction of sales in Europe as in Japan,

customization remains more common than in

the United States; European sales of custom

software and software consulting services came

to $4.5 billion in 1985, compared with $5.2 billion for packaged software,’” By the end of the

decade, standard programs are expected to outsell custom software by a substantial margin.

As figure 34 indicates, West Germany should

continue to be the largest market for packaged

software, followed by the United Kingdom and

France.

If third as a market, France nonetheless has

the strongest software industry in Europe. The

biggest independent European software supplier, the French firm CAP Gemini Sogeti, specializes in mainframe programs, doing nearly

60 percent of its business outside France; still,

the company’s 1985 revenues of about $250 million only slightly exceeded those of the American PC specialist Lotus Development. As in

other countries, French computer hardware

and telecommunications equipment manufacturers—notably Alcatel, Thomson, and Bull—

have been major players in software,

‘“’’European Software and Ser\!ices Market, ” Financial Times,

Sept. 22, 1986, p. [11,

For the 1985 revenues of Cap Gemini Sogeti, below, and other

European firms, see “French Software Firms Strong in Europe, ”

Europe Report—Science and Technolog~’, Joint Publications Research Service JPRS-EST-86-038, Dec. 8, 1986, p. 22. Translated

from Zero [In Znformatique, Aug. 18, 1986.
.

Ch. 5—Information Technology Services: Software, Telecommunications, Data Processing, and /formation Services • 167

Figure 34.— Projected Sales of Packaged Software in Western Europe

8

7

6

5

4

3

2

1985 1991

❑ Federal Republic of Germany ❑ France ❑ United Kingdom

❑ Italy ❑ Other European countries

SOURCE ‘“Software Packages for Business, ” F/r?ar?c/a/ T{rnes June 27 1986, p I

In Germany, the local industry centers on the

hardware manufacturers Siemens and Nixdorf,

the latter specializing in turn-key systems, especially for financial institutions. A strong commitment to customer service has helped Nixdorf win a small but growing share of the

market; the firm has even penetrated French

banks, a difficult feat.

With so much of Europe’s hardware base supplied by American-owned companies, much of

the software, particularly systems programs,

also comes from American firms. U.S.-based

computer manufacturers like IBM, DEC, and

Hewlett-Packard have substantial presences in

Europe. IBM operates half a dozen European

R&D centers, each of which undertakes software or related work; in 1983, IBM alone took

more than one-quarter of all Western European

sales of off-the-shelf systems software. 21 Many

independent U.S. software and services firms

—Cullinet, MSA, Comshare, ADP—have also

invested in Europe. In some cases, their affiliates function as sales offices only. In others,

they carry out R&D and/or production. ADP’s

Dutch subsidiary, for example, has developed

software for auto parts wholesalers and retailers

that is now marketed through ADP offices elsewhere in Europe.

Over the next few years, the fastest growing

portion of the European software market, as

ZI R ~T Gizl,cki and 1. Schubert, Microelectro]] i[:s: A Challen~Te

fur Europe’; lndustrja] Sur~i\al (Munich: R. Oldenhourg, 1984],

p. 93; Financial Times, May 1, 1985, p. 1 II. U.S.-owned firms

account for five of the top six independent suppliers of packaged systems programs, although European-owned firms do better when it comes to custom software.
168 • International Competition in Services

in the United States and Japan, will consist of

business application programs for PCs. About

as many people work in Western European

offices as in the United States—60 million. Yet

businesses in Europe lag well behind in their

purchases of PCs, with fewer than 5 million in

use, compared with about 8 million in American offices. 22 Moreover, the home market for

PCs in Europe has barely been tapped. As a result, both PC hardware and software sales may

grow faster in Europe than in the United States

over the next several years—creating attractive

market opportunities for American firms,

From their beginnings, the newest generation

of U.S.-based software startups, most of whom

specialize in programs for PCs, have sought and

found markets in Europe. U.S.-based software

suppliers invest overseas for two fundamental

reasons: to be close to their markets, and to save

on development costs. Software for applications like accounting must be tailored to each

national market—not only in terms of language,

but, in this example, in terms of accounting conventions and standards. American companies

often set up local offices or subsidiaries to handle the necessary program modifications. Moreover, software development costs less in Europe, largely because salaries for programmers

average about half those in the United States.

The U.S. firm Comshare, for instance, does

about 40 percent of its development work overseas, mostly in Ireland, where the firm’s investments save the company about $4 million per

year. While countries like India, Hong Kong,

and Hungary also offer lower programming

costs, thus far the British Isles have proved most

attractive for American firms (including IBM,

DEC, Hewlett-Packard, and Prime).

European software firms themselves, with

only a few exceptions, remain minor players

internationally. Like Japan, the European nations (and the European Community) have begun funding R&D intended to strengthen their

capabilities in software; chapter 9 describes

22 The ~siness penetration figures come from presentations

at the 4th Professional Personal Computer Conference, London,

Oct. 30-31, 1986, by M. Swavely, Compaq Computer Corp. [for

the United States) and B. Morel, Intelligent Electronics Europe.

both the Community-wide ESPRIT effort and

Britain’s Alvey Program.

Of the developing nations that have sought

to build software industries, India has been perhaps the most aggressive, with software exports

growing at 40 percent annually.23 The country

has the advantage (for this purpose) of many

chronically unemployed or underemployed

university graduates; American firms including Texas Instruments and Citicorp have established software development facilities in India,

while other American companies have contracted out programming to local firms. Countries including Singapore and Taiwan have also

attempted to establish themselves as centers for

software development, but typically face acute

shortages of well-trained people.

Competitive Dynamics

Today, software industries in the United

States and overseas are in a state of flux; the

biggest supplier of PC software, Lotus Development, was founded only in 1983. High-end

software specialists have been seeking to expand into other segments of the market, attracted by the many new customers for small

computers, while also moving to exploit the advantages of fourth-generation languages. In this

environment—highly competitive and technologically volatile—many companies have sought

to expand their product lines through mergers

and acquisitions (more than 200 in 1985, over

300 in 1986) as well as internal product development. Acquisitions can broaden a firm’s

customer base; they can also help expand its

programming staff—a critical need for rapid

growth,

U.S. advantages in the evolving world industry begin with the large domestic market, driven

by a hardware base that is still growing rapidly. With the interdependencies of hardware

ZsThe base for this growth has been small, only $24 million

in 1984. “Showing the Way For Developing Countries, ” Financja] Times Survey, Oct. 4, 1985, p. iii; “India’s Climate Looks

Good to U.S. Software Makers,” Business Week, Oct. 13, 1986,

p. 138-H.

On Singapore and Taiwan, see International CornpetitiL’eness

in Electronics, op. cit., pp. 383-389; also “Asia’s Hi-Tech Copy

Cat Aims for Lion’s Role,” Financial 7’imes, May 17, 1985, p, 3.
Ch. 5—Information Technology Services: Software, Telecommunications, Data Processing, and Information Services • 169

and software design increasing, this should

prove a continuing source of strength for the

U.S. industry, while also serving as a prod to

Japan’s efforts.

At present, France probably has the most

competitive software industry outside the United

States: about half of the 20 largest software suppliers to the European market are French, compared with two British companies, and one

from West Germany. But in the longer run, Japanese firms will emerge as the principal competitors for American suppliers, if only because

of the growth and increasing competitiveness

of the hardware sector in Japan. U.S. software

firms could also face somewhat stronger competition if European efforts to foster innovation and entrepreneurialism in software bear

fruit.

Japan’s Government has begun focusing resources and attention on productivity in the

generation of software, an effort that could have

substantial long-term implications, as could

government-sponsored projects in a number of

countries to speed developments in artificial

intelligence. Nevertheless, the traditional sources

of U.S. strength in software—skilled personnel,

strong R&D programs with substantial Federal

funding, particularly for burgeoning military

applications, and capital markets that are deep

and flexible-will persist. U.S. Government policies that ensure access to foreign markets—including effective intellectual property protection

for software (see ch. 9)—would help maintain

existing U.S. advantages in this industry, one

that is critical for future U.S. economic growth

and competitiveness.

TELECOMMUNICATIONS SERVICES

Although telecommunications is much the

largest of the IT services in terms of revenues

and employment, most of the activity is confined to domestic markets. In 1984, revenues

for marketed telecommunications services,

voice and data, totaled some $109 billion in the

United States, nearly $70 billion in Western

Europe, and $22 billion in Japan.24 By definition, there can be no trade in domestic telephone traffic, by far the largest income earner

of all telecommunications services, nor for domestic leased lines and data communications,

the second largest revenue item for most PTTs.

Governments have closely regulated telecommunications, viewing the sector as a natural

monopoly and the service a public good. For

such reasons, publicly owned PTTs or publicly

regulated private monopolies have been common; most of the world retains the former,

while in the United States AT&T’s regulated

244’ Telecommunications Survey, ” The Economist, Nov. 23,

1985, p. 8.

On satellite communications, including the emergence of fiber optics as a potential rival for international circuits, see International Cooperation and Competition in Ci\’ilian Space Actiirities [Washington, DC: Office of Technology Assessment, July

1985], ch. 6.

monopoly has broken down only in the last few

years. Trade, then, consists largely of crossborder voice, message, and data communications—also regulated (box M). Beyond this,

value-added services, mostly supplied through

VANS, and including videotex, hold attractive

market opportunities. Future competition promises to be heated, both within national markets,

where creeping deregulation has in some cases

meant that American firms have been permitted

to enter VAN markets, and for cross-border

VAN services. Intense competition for sales of

telecommunications equipment complicates

the picture.

The Competitive Environment

Basic telephone service continues to generate most telecommunications revenues .25 However, conventional telephone circuits are illsuited to the rapidly expanding volume of data

ZSR~venueS for other than basic te]ecom m u n icat io ns c a rne to

$8.9 billion in the United States during 1985, including revenues

from leased lines—less than 10 percent of total domestic telecommunications revenues. VANS accounted for only $3OO million.

See P.R. Strauss, “1986 Market Survey: Most Sectors Strong Despite Slowdown Fears, ” Data Communications, January 1986,

p. 73.
170 • International Competition in Services

The market for crow-border telecxmmmnications services is one of reguh%ted competition, with,

for instance, sat81hte8 and undwaea cabka tightly controlkd. Joint ownership by U.S. carriers and

foreign PTTs has been themfor OCmn adkaterminating irithis c~ux@y. With the advent & $8tellite links, Cmnsat [cwnnmnia*ns SaMite Corp.) became the privat81y owned U.S. monopoly carrier and signatory to the Intdsat @ystom (th@Mernational T6&m%tmuhkatitIniJ S@to~iU Organiza~

tion, created by intertiatiqwd treaty in 19ti@i The United Statea, aa thQ;rimV@ force behind Inteisat,

provided QO percent Qfita wp~td in ti edy, ywm; Comsat stifl owns 23 pwcent of the internatiomd

consortium. RQ@atiuns drate$ cm intqmatfomd leased lines vary chqwtiding on the count~ies at

thetwoendsof forI*=tiadTo~ho~dT@~r@ (C(XTT)

of the International Tebmqmunic@km IJnipn IITU) prmddea a framework far bilateral agreements.

Currently, a private Iut~g@ligeb_eenthe Uhited States and BrMahcaE CXMfEOm XNWMY$WOOO

per year to somethi~ over $WXMXXJ, deppnding on bandwidth@ nwasum of capacity).

IntelSat continues to controi nearly all cross-border satellite cmnnmititations, including tdevision.1

AIthough at leaat nine fiimsrww dfertelephone service withinthe Utittd Satesusing satellite }inks,

Comsat continues to provida the only ~cem to Intelsat ~ircnits. But dereguktkm promims change.

Following a 1$84 decision by President Reagan to permit n8w ehtrants in competition with Intdsat,

the Federal Communications Commission (FCC) approved conditional licenses for five American companies seeking to provide international sate~te services. Whh the customers of these new entrants

would be permitted to resell or base lines to third parties, the FCC has prcddbited interconnection

with public switched networka,thereby protecting@ cow of Inte!@’sbusiness. [Congress had directed

the Administration to avoid ewmornic harm to Intdsat.) Mwnwhile, fiber-optic cables have emerged

as costdfective competitors for satellite circuits in many parts of the world. Intelsat has responded

to the threat of cmnpetitkiit by cutting prha and axpmxiing seMces.

Further opening of intwmatioid competition in basic ~mvices would require cooperation from

PTTs co<rollin@ in@rctmxwc@on-at the othm tmds o~ cro$$%mxk links. This i$ not likely. In 1976,

the FCC pqmsedto e-dao~xtio~b~ ?U~Q*@ r~~a O~*~~t~~~a*~ Private lead 1ines–

used by many n@tinationalaorpomtimM (h@lCs) for ~-utications-~nbranches in difbent

countries-as it had done far dmnestic privato lines. The I?~C propod re@e&@ed a direct threat

to PT’1% in Europe {where remit US i!oreigfi iiwestment is Cm-medlt a~~ was IX@ bY me *rea~

of a shift fimrn flat-rate taiiffs to time- or vckune-related tariffs (or even disconnection}. This would

have raised costs far U.S,-based MNCS, while maintaining Mvanua levels for the PTTs. The F(X was

forc~d to retrect its proposal.

Two years later, the FCC again gave notica of its intent to authorize resale ufinternational leased

lines. Other cmmtrie$ com&hwed this a breach of ITU rules bewmso a CCITT recommendation had

stipulated that no resai43 or shared use ofiriternational baead Unes be permitted. Whilo CCITT recom~

mendations do not have the force of treaty obligations, it agqtn became clear that action by the United

States would provoke retaliation. Once more, the FCC backed down.

Such disputes win not disappear, if only because the priv~te satellite aarriess authorked by the

United States will continue chip@ng away at Intelsat’@ motmpdy. ‘13mismws ap essentially the same

as in donuhtic M34mMzation, with tin overitty of forejgn policy qw@iow. Is there * need for specialized cervices that Idtebat doea not now p~ovide? If egber Intalaat or privata carriers provide such

services-i.e., to MNCs-woadd costs for otlwr Int&at swstomers go up? Deregulation in the United

States has meant a move toward cost-based pricing, a choice rationalized on grounds of efficiency.

Corporate customers and some household customors benefited from lower rates and a bigger menu

of services: others had to pay mare. Much tho same policy choice presenta itself internationally, promising to generate controversy for yeara to come because deciduns W be linked to questions ranging

from North&@h relations tq sales of satdites and ground eq@#ment.
—

Ch 5—lnformation Technology Services: Software, Telecommunications, Data Processing, and Information Services ● 171

communications. With digital central office

switches—themselves large computers—replacing electro-mechanical crossbar switches, and

digital circuits replacing analog, the infrastructure is rapidly becoming a network of computers

rather than one of telephones (and telegraphs

and telexes). It is this blurring of boundaries

between computing and communications that

undermined much of the old regulatory structure in the United States, setting the stage for

deregulation,

New communications technologies in a deregulated environment permit corporate users to

bypass portions of the public telecommunications network. With local service bypass, lines

—normally leased from the local service provider—go directly to the long distance access

point in a local switching area. Companies with

a higher traffic volume may find it cost-effective

to invest in local facility bypass, with a link (normally microwave) going straight to the long

distance carrier, bypassing local switching facilities completely. With system bypass, the corporation operates its own dedicated network,

using private satellite, fiber-optic, or cable links

to join its facilities. Total system bypass makes

sense only for large organizations.

The AT&T breakup has had major repercussions internationally. With its manufacturing

arm, Western Electric, freed from earlier restrictions on sales of telecommunications equipment abroad, AT&T has begun seeking alliances with foreign firms and access to foreign

markets. At the same time, Western Electric

can no longer count on the business of the regional holding companies (RHCs) and Bell operating companies (BOCs). Divestiture also meant

AT&T could enter computer markets for the

first time.

The opening of U.S. markets for services and

the new competition for equipment sales created pressures for change elsewhere. Foreign

firms, particularly larger businesses, saw that

following the U.S. lead could result in lower

costs and better service. Many grew concerned

that their national PTTs might hold back introduction of new technology, putting them at

a competitive disadvantage.

Photo credit: DGT/Intelmatique

Terminal for France’s Teletel/Minitel videotex system

As in financial services, then, deregulation

has begun to spread to other industrialized

countries, But, as noted in box N, the pace will

be much slower in telecommunications. Government-controlled PTTs—run by civil servants

and in some cases operating under laws littlechanged since the 19th century—have no wish

to relinquish their hold on basic services. Not

only do many PTTs cross-subsidize their laborintensive mail delivery services with telecommunications revenues, but a great deal of pressure for maintaining public monopolies or private regulated monopolies in telecommunications

services stems from the desire of governments

to protect and strengthen national champions

in the manufacture of equipment,

As indicated in box N, procurement policies,

formal and informal, have been used to buttress

computer and telecommunications suppliers

in countries ranging from West Germany (Siemens), to Japan (NEC, Hitachi, Fujitsu, Oki),

to Brazil (many manufacturers that remain

small by international standards). Import penetration levels for telecommunications equipment range from less than 1 percent in Japan,

and under 3 percent in France and West Ger-
172 ● International Competition in Services

Box N.-Regulation and Deregulation in

Events over dm past decade in the Federal

Ra@d4ic of~y(FRG) illustrate the poten.

43fg0velmw3nt w1.

icies that $helter all aspaQts of tdecmnmunica.

tions, west Gemany% l!mm=’Owned X%konopoty,

the Bud-, maintains a@hmity ov8r mail, tekphon~, t4kgr4kp~, all forma of

data and ratli~ broadcasting; atone so farasta ban

Mickey ~owtha kst remain.

ing major industrialco- with a tatal tahwornmunicatiwM monopoly, pressur~ for chwige

have mounted rapidlyin~ FRG, not only frmn

business leaders m%tical of the fur

putting ro8dbkxk i~ the way of $mw tekwm.

xnunicatiori~ but *am ather parts

of the government, Maanwhila, tlw Ihmdespost

and its political dks h&v8 fiercely resistad

change.

Perhaps the first sign of real loosening in the

German regulatory approach camein %886, when

the Bundespost began permitting manufacturers

of modems @ed far transmitting digital data

over the telephon~ system) to market them dh

rectly.a Nonethelem, a cornmy wishing simply

to Iink computers in two wijoining buildings

must still go through the 13undaspm; usws must

get appruvds fur each modem, along with private switching systems! LANs, and othm hardware installations. Laws governing transb~rder

data flows ~13DF@ also require that some data

processing take place in Germany, restricti~g access to on4ine datsbase$ maintained cmtsida the

FRG, as well M limiting some kinds of VAN

services.

The Germans, therefore, despito their gener.

ally favorable stance toward liberal trade, have

been put in the position of defending a tightly

*P. co@Brl, ‘*Ttkoimnunhxtima in WW Qirmany,*7 Serkeiey

Round@bh O% th Intm+national I?oonomy, Urdvmsity of California,

Serkdoy, 1SSS. Ah G. &i fmtqufamw, “Craad Limn jm an $#x%~

Induatry,’$ l?~mncfd Tjm#, ]* % 1SS5, p. 144 R ?%.U’OW and P,

Gumb& “Big German Monopoly ‘f% Up the Talephmw and Ma

Compti@a,*’ W& $trestjoumaf, O@, 24, 1SS!3, p+ 3.

‘or ~ ‘n prim@Iyin b u- Ratea, see G.W, M& T& Tdwmmnmnitwcw Whwiry: The Dymmics of M!kti fWuc&re Warn-e, MA: Harvard Udvtih

Pma8, 1ss1].

auEu~@x Rea&aa Dew#ath Miiwtone,” Fhmdd Tkw,

]Uly 31, 1sss, p. 6. Pmkmaiy, the Sumbapost, aa de w%urca of *p.

piy, mld rwher printitivta rnothmaat doabbor tripkth prima mm.

mon in otber axmtriea, whh aim prohibiting computer equipment

with buiit-in modmns.

Foreign Telecommunications Markets

regulated tekmmunicatio~ monopoly, an irony

that does not escap$ them. An expert commitim

including represen~tives of business, political,

and technical int8rests has been established by

the governmantt~ examine the question ofreorganizing the Bundwqmst. Further slQw dmegu.

I@icmwilI probably follow in th~ wake of the

modem decision; as a next step, private firms

may perhaps be allowed to resell leased lines md

establish some types of Vtih!s, Several &nericanowned firms, including IBM, are moving to establish limited~r@tM VANS, but the Bundespast

will probably succeed in keeping private firms,

-*8 Qfownership, from supplying servicw

that it expects to offer, such as electronic

messages.

Although slow to deregulate, the FRG has been

in the lead in seeking European agreement on

IM3N, with the J3undespost announcing ambi.

tious plans. Othm countries have tended to see

German efforts to move qui&&tow@ EUrOpWUI

standards far ISDN as an attempt to create advantagm for the FRG’s equipment manufa~re~

—-notably Siexmms, tr~dition~y favored by the

government. Memena, which suppiies nearlyh~f

the equipment purchased by the Bundespast,ha8

made heavy commitments to ISDN hardware design, developi~ an entire line of products from

cmnponenw to mainframe computers and CO

switches to take advantage of its position and experience, As this and other examples suggest, a

goad deal of trade-ralat~d friction concerned

with telecmnmudtition$ over the next few years

will mix questions of equipment and services.

In l%ance, the Direction Generaledm Tekmmrnunications &lGT) maintains a regulated monopoly in basic services, but limited cmnpetition

ha been permitted in vak-added services. Private firms can seak approval to offer services

through the DGT’s Teletel/Minit81 videotex system, which makes use of the public telephone

network.

has quickly become the mos t

succesdid videotex system in the world, thanks

to subsidies providing free termin& for home

WW. The governins~t has akw m8d8 it easy for

private f&m4 tu enter the information services

businass through a vehicje called Kfosque, Approvals are simple, and the DGT even offers programming assistance. Uf the nearly 2,000 sfwv-
Ch. 5—information Technology Services: Software, Telecommunications, Data Processing, and Information Services ● 173 —

ices available, perhaps two-thirds cater primarily

to business and professional customers, with the

rest directed at households; banking and financial services have been especially popular.3

Indeed, the demand for Kiosque services-now

about 50 million calls per month—quickly overloaded the TRANSPAC network (a DGT subsidiary), the primary vehicle for Teletel/Minitel services. Users of the French telecommunications

system had been urging faster deregulation, and

the DGT’s failure to anticipate TRANSPAC’s capacity problems added to the pressures. These

must be counted as the failures of success. Since

most of the Kiosque services bring in revenues

to the DGT (roughly 30 percent of user fees go

for billing services and network access), the

agency has more than recouped the cost of the

terminals it has supplied. Not only has the Teletel/

Minitel system stimulated expansion of private

IT services in France, but the public has been

largely won over, which will reduce barriers to

the further spread of information technology in

French society.

The French Government approved an ambitious ISDN program in 1982, providing, even in

the early stages, for bi-directional videotex service, and has promised liberalization of VANS.

Thus far, however, foreign participation in proposed new services has been limited to joint ventures with French companies.

In Japan, shares in the domestic carrier, NTT,

formerly a public corporation, are being sold to

private investors. Under legislation that took effect in 1985, the government will retain 51 percent of NTT’s stock; foreigners can only buy

shares through joint ventures having majority

Japanese ownership. The government will permit other companies to compete with NTT in the

market for Class 1 or basic telecommunications

services (with foreign interests restricted to minority joint venture-positions). With some halfdozen new Class 1 rivals, NTT may eventually

face substantial competition; like the RHCs and

BOCs in the United States, it will have to adjust

its rates and reduce cross-subsidization to match

the prices of its competitors. However, unlike

$B. Tilge, presentation at CIT-Alcatel sales meeting, Charlottesville,

VA, July 15-18, 1985. Also see “Output Outlook by Sector,” Japan

Reporf—Science and Technology, Joint Publications Research Service JPRS-JST-86-070-L, Oct. 30, 1986, p. 50; P. Betts, “Controls Eased

on Telecommunications Services in France,” Financial Times, tviay

21, 1986, p. 2; J.A. Hart, “The Teletel/Minitel System in France,” IVetwork World, forthcoming.

AT&T in the U.S. market, NTT did not have to

subdivide into regional or local operating companies. This should make it easier for NTT to pursue its goal of establishing a nationwide ISDN

network.

Japan’s Business Communication Law establishes a second category of Class 2 or enhanced

services; these include VANS, whether or not

they make use of Class 1 network services. The

law provides for two types of VANs, General and

Special. Private corporate networks account for

most of the General VANS, which have been left

largely unregulated. Special VANS, including all

inter-firm networks, remain under relatively tight

controls. Because of this, only nine applications

had been made for Special VANS as of the end

of 1985, while more than 175 companies had registered General VANS with the Ministry of Posts

and Telecommunications.4 In a typical application, Nomura Computer Systems supplies ordering and point-of-sale terminal services to more

than 2,500 7-Eleven stores in Japan.

As in Germany, telecommunications equipment sales in Japan were, for many years, the

province of a small group of firms—the so-called

DenDen family, consisting of NEC, Hitachi,

Fujitsu, and Oki. NTT, which did not manufacture equipment, nonetheless spent large sums on

R&D, transferring the results to its favored suppliers. An intense trade dispute with the United

States over the purchase of switching systems

and other equipment led to the resignation of

NTT’s president in 1981. The new president was

reportedly given a mandate to increase foreign

purchases, but progress has been slow: NTT purchased 14 million dollars’ worth of U.S. equipment in 1982, $45 million in 1983, and $130

million in 1984 and 1985. With business users

beginning to express dissatisfaction with NTT’s

services, frustration over efforts to change NTT

practices from within-coupled with a widely

perceived need to respond in some way to the

challenge posed by deregulation in the United

States-set the stage for the market-opening steps

that came in 1985 Liberalization will probably

4“Output Outlook by Sector,” op. cit., p. 50. TEe number of VAN

applications has since passed 2!i0-’’Status of Liberalization of International VAN Reported,” Japan Report-Science and Technology,

Joint Publications Research Service JPRS-JST-86-082-L, Dec. 17,1966,

p. 111. Translated from Nikkan Kogyo Shimbun, Sept. 1, 1986.

For the 7-Eleven example, below, see T. Murtha, “Tokyo Takes

Off–Slowly,” Datamation, May 1, 1986, p. 60.
174 ● Intenational Competition in Services

help Japanese firms compete in international

markets for services, as well as equipment.

The United Kingdom has also begun to deregulate, with the Thatcher Government separating

British Telecom (BT) from the British Post Office in 1981, and, 3 years later, selling 50.2 percent of BT’s stock to the publics The government

also licensed a private telecommunications firm,

Mercury, to compete with BT. Moreover, with

the value-added network services licensing act

of 1982, and later clarifications, Britain has

greatly liberalized its markets for value-added

services. Although licensing procedures for

VANS remain in a state of flux, some 200 plus

had been registered by the end of 1986, more than

in the rest of Europe combined. These provide

services that include teleconferencing, ticketing

and seat reservations for British Rail, theater and

concert tickets, access to databases, accounting

and statistical packages, telephone information

services, credit authorization, real estate information, insurance quotations, and news. Moreover, the rapid pace of deregulation in Britain,

compared with the rest of Europe, has attracted

many MNCs seeking to centralize their European

data-processing and telecommunications operations; EDS, for example, is investing heavily in

the United Kingdom, and expects to employ

4,000 people there by the end of 1967.

In some contrast, Britain’s videotex system,

Prestel, has had little success, in part because

Prestel was based on household TVs equipped

with expensive decoders. Many services geared

to home consumers failed to prosper, although

a few—home banking, news headlines, stock quotation services-have survived.

Mercury, BT’s new competitor, plans to limit

its service to larger urban markets, linking them

via fiber-optic cables laid along the nation’s railway tracks. Mercury will be able to target business customers, taking advantage of the digital

broadband capabilities of its network. BT, much

like AT&T in the United States, has a large existing infrastructure-much of it based on obsolescent technology--but gets advantages from the

geographic breadth of its coverage. Nor is it clear

oF. Bar, “Telecomrowdceti6ns in the United Kin@om” Berkeley

Roundtable on the Internatiorwl ECOWW, University of(M&forth

Berkeley, 1965; G. de J(mquiams, “ThrJ Muddlo That Is Slowing

VANS,’* M?141#lcj&f Tfmes, Sqt, 10, 1S66, p. 19; G. Shw -W

Addrqs at World Telecommunication% 19S6, Londom Dec. 1+2, 19S6.

that Mercury will prove a viable rival. Unlike the

Japanese, the British have placed no restrictions

on foreign ownership of either telecommunications carrier, but given Mercury’s relatively modest plans, and a commitment by the government

to restrict the field to these two firms until 1990,

liberalization in the United Kingdom has something of a cosmetic appearance. Still, BT has already cut its prices to match those offered by

Mercury.

Brazil’s telecommunications and informatics

policies, which quite openly shield Brazilian

computer, software, and telecommunications

equipment firms, have led to considerable friction with the U.S. Government.6 Other developing countries have looked to Brazil’s policies as

a possible model, while the Brazilians themselves

have sought to adapt some features of the Japanese model. Even so, two other relatively industrialized developing countries, Mexico and India,

have recently opened their markets somewhat,

after earlier pursuing policies more like Brazil’s.

As in France, Germany, and Japan, TELEBRAS,

the Brazilian PTT, follows a policy of preferential procurement: only if Brazilian firms cannot

supply the needed equipment does TELEBRAS

turn to foreign sources. Brazil currently imports

perhaps 10 percent of its telecommunications

equipment. When it comes to computers, Brazilian informatics policy likewise has been intended

to strengthen the country’s technological capabilities and reduce its dependence on imports.

Thus the policy includes direct import barriers

as well as preferential procurements-actions

that have been widely supported by Brazilian

hardware manufacturers and nationalist political groups. In 1984, the legislature passed a measure barring foreign firms from producing or selling most micro- or minicomputers. Imports have

dropped precipitously, from about 70 percent of

the market to 20 percent.

%ee Tr#Aord8r A@a Flows and Bmzd (New York Unitsd Naticuts Centre on Tranmu@nal Corporations, 1963). While the title

-~~ narrow f$$oaa, in fact thin study &ala with Bmailian

tedeoommunicationa policy as a whole. Also A. l?idi~ “’Brazil’s

I%lcidy Compu&r Policy,” A%w York Times, Apr. 2% 1Qs4, p. 04;

A, Riding, ‘WrwzU’a ProWWKi Computers,” ivmv Yo& Tim#S, Sept.

16, M?iM, ps a#; ““cMiy Thr$@ountrie8’ ComPWWIndw&ieWan Meet

Even Partof3&adS$ Repo&tsay%’’hzt4mmatfc3md T“Kqx3y&y

21, ISit& p. S9S. R4mnrUy on computers, seQ C. F~

A@tional f%dlcfes for Dtrwhphg High Technology Isdustriw, F.W.

Rushing and C.G. Brown, eds. (BouIder, CO: Westview, 1966), p, 31.
Ch. 5—Information Technology Services: Software, Telecommunications, Data Processing, and /formation Services • 175

Foreign telecommunications firms can offer

services so long as these do not challenge the

PTT’s monopoly. Gateway services like GTE/Telenet operate in Brazil; so do closed user networks

like SWIFT and SITA (the international airline

reservation system described in box R below).

But all leased lines and cross-border VANS must

be authorized, there is virtually no intellectual

property protection for computer software, and

the government restricts access to foreign databases unless a national security need can be demonstrated.

Some users of IT services in Brazil, as well as

subsidiaries of foreign firms, continue to press

for changes in these policies, but to little effect.

many, to 9 percent in Britain, and 14 percent

in the United States. 26 Nonetheless, European

equipment markets have begun to open up

somewhat—in part because high R&D costs for

new generations of CO switches are forcing

firms into joint endeavors. Deregulation of

value-added services has also begun in some

countries, but VANS remain government monopolies in at least five European nations, and

PTTs view them as threats to revenues from

telex services (the electronic mail of an older

technological generation).

The Telecommunications Infrastructure

Basic telecommunications—transmission of

voice, messages, and digital data—provides the

infrastructure for new services as well as those

that have been familiar for years. Most of these

new, or enhanced, services provide additional

data communication functions. Examples include protocol conversions, so that different

computers can talk to one another, message

storage and electronic mail, and on-line access

to large databases. Over the next several decades, current generations of digital equipment

–Phase II in table 20–will be supplanted by

ISDN systems, able to handle higher volumes

of data communications traffic, and, as the

name implies, eventually integrating the broad-

‘“’’(J.S. and Europe Dominate $150bn World Market, ” Financial Times, Oct. 21, 1985, p. 4.

Domestic computer manufacturers matched the

sales of foreign firms for the first time in 1984.

The military supports the telecommunications

and informatics policies, along with nationalists

on both right and left politically. Brazil’s Government has responded to U.S. objections to its

discriminatory policies by pointing to the country’s need to reduce imports and keep the economy growing in order to pay off foreign loans.

The policies have not been cost-free. Prices of

telecommunications services and computers in

Brazil are high, quality of products and services

poor. But the political costs have been small, and

the policies will likely be continued.

band capability needed for video into the

network.

Phase I in table 20 describes the infrastructure in most industrialized countries as of the

early 1970s—a system almost entirely analog

(also see box O), During the 1970s, softwareprogrammable CO switches—in essence large

computers—began to replace electro-mechanical

crossbar technology. At this point, network

functions began to move beyond simple transmission of messages, while—with declining

costs for microelectronic devices—voice transmissions could be sent over digital lines as easily as data originating in digital form. Today,

most local U.S. telephone service continues to

utilize analog circuits, while digital long-distance transmission has become common. Phase

II also brought greater use of satellite links, and

the first installations of fiber-optic cables, which

transmit via light rather than electrical signals.

Satellite and fiber-optic transmission make possible broadband links, capable of carrying video

signals along with voice and data. Packetswitching—which breaks messages down into

short bursts, or packets, that can travel by varying routes, to be recombined at their destination—helps carriers utilize networks to their full

capacity.

With broadband capability, system designers

can contemplate an integrated network, one capable of handling voice, data, facsimile, and

video signals. The spread of such ISDN systems
176 ● International Competition in Services

Table 20.—Three Phases of Telecommunications Technology

Time Switching Physical

Phase period Circuitry system infrastructure Services

I Into the 1970s Analog Electro-mechanical Mostly copper cablea

Telephone, telegraph, telex

crossbar

II Present Analog/ Circuit and packet Above, plus micro- Above, plus high-speed data

digital mix switching wave, satellite, fiber- communications and facsimile

optics

Ill (ISDN) 1990s Digital Virtual routing and Above Above, plus video and broadmessaging

aMICrOWaVe and Satelllte links began com!ng into service during the 1 ~OS

SOURCE Office of Technology Assessment, 1987

will mark the transition to Phase III during the

1990s—a transition that will probably be driven

largely by demand for cheaper data communications (rather than, say, video). The range of

services will continue to expand, as pointed out

in box O, but the transition from Phase II to

Phase III will be very expensive—in the hundreds of billions of dollars worldwide over the

next several decades—the more so if different

parts of the world (or different regions in the

United States) adopt incompatible standards.

Value-Added Services

Both intra- and inter-firm communications

will become easier and cheaper as the telecommunications infrastructure shifts toward a fully

digital system. With ISDN, a customer will be

able to plug any terminal device—telephone or

PBX (private branch exchange), computer or

terminal—into the network and communicate

with any other terminal device. VANS of all

types will expand, both dedicated networks—

as used in banking or for airline reservations—

and those such as Tymnet and Telenet that simply provide network services to many of their

customers. It will also become easier for corporations to establish private networks. Today,

only large companies like IBM and General Motors (whose EDS subsidiary is developing a corporate VAN, box P) can afford these investments. Indeed, as box P suggests, much of the

pioneering technical development for ISDNbased VANS will probably be done by private

companies, some of which will no doubt seek

to use the knowledge gained through internal

projects to market services to other firms.

band data

VAN Markets

Today, most VANS in the United States use

some combination of private lines (often leased)

and the public infrastructure. In other nations,

where PTTs may require that all VAN communications use the basic telecommunications network, costs may limit expansion. Even so, the

VAN market worldwide provides many opportunities for American firms, as does that for

information services (discussed in the next

section).

Fundamentally, public VANS (as opposed to

private networks for intra-firm communications) offer two types of services: 1) system management for data networks; and 2) system applications, such as electronic funds transfers,

videotex, or database access. The first category

of firms—systems managers—offer national or

international telecommunications on a singlesource basis; companies like Telenet (box Q)

sell ease of access. It is the VAN provider that

deals with PTTs in various countries, centralizes billing, and assembles and maintains the

network management software. By leasing lines

on a flat rate basis from a common carrier (normally the PTT), and reselling the capacity on

a volume-sensitive basis, these VANS offer a

package of services at a lower price than customers could provide on their own. Some also

design dedicated private network for particular customers; Telenet, for instance, has put

together more than 60 such packet-switched

networks. Finally, VAN suppliers can create

hybrid networks, interconnecting a customer’s

dedicated network with their public VAN to

save on costs for connection to remote sites,
Ch. 5—information Technology Services: Software, Telecommunications, Data Processing, and Information Services • 177

Box O.—Integrated Services Digital

Networks (ISDN)

As table 20 indicates, the current Phase II

telecommunications infrastructure mixes analog and digital telephone service, along with

digital data transmission, and a telex/telegraph

system (plus local cable TV). Fully digital systems, which require low-cost means for transforming voice communications from their naturally occurring analog form to a string of

digital “bits” (and back) only became practical during the 1970s. While the costs of replacing the Phase I system mean that some parts

of the network will remain analog for many

years, all-digital systems should lead to continuing reductions in data communications

costs, with particular advantages for business

customers. At the same time, the telephone

system will become still more highly automated, while the range of services available

to households will continue to expand.

In the United States, at least one of the Bell

operating companies in each of the seven

RHCs is beginning ISDN field trials.1 Japan’s

ambitious plans for ISDN, termed INS, or Information Network System, have begun with

a pilot project in the Musashino-Mitaka area

of Tokyo, in operation since 1984. Although

the basic outline for ISDN standards has been

agreed upon in the ITU’s Consultative Committee for International Telephone and Telegraphy, negotiations continue over detailed

specifications. As discussed in chapter 9, the

standards-setting process will be contentious,

if only because the stakes are so high. Not only

will new generations of CO switches and other

network equipment be needed, but a wide

range of home, office, and industrial equipment will eventually be marketed in ISDNcompatible form—i.e., ready to be plugged into

the network. Governments and PTTs will seek

an edge for domestic equipment manufacturers.

IFor a brief survey of the status of ISDN trials internationally,

see T. E. Bell, “Technology ’87: Communications,” IEEE Spectrum, January 1987, p. 42.

When it comes to the second category of

VANS, the supplier goes beyond the provision

of network access and management, offering

a package of end-user services. Examples range

from Ticketron, to public VAN suppliers like

GEISCO and ADP that provide funds transfer

services, to networks of automatic teller machines,

SWIFT (ch. 3) links banks for messages, with

the actual funds transferred by other means,

while SITA (box R) provides services for airlines. Most of these specialized VANS use dedicated networks of leased lines, with their own

switching and processing facilities, SWIFT is

currently replacing its original system with a

decentralized SWIFT II version based on regional processing centers. (Ch. 3 described the

scope and function of the SWIFT consortium

in relationship to member banks. ) In order to

provide the end services its members need,

SWIFT has developed standard forms of financial messages that can be sent anywhere in the

world without risk of ambiguity, as well as software packages for terminals from a range of

manufacturers. The consortium maintains as

well as supplies all terminal interface software,

in part because security is critical (given that

much of the network traffic concerns very large

financial transactions),

Growing VAN markets offer U.S. firms strategically attractive—if not yet very profitable—

opportunities, with companies like Tymnet,

Telenet, IBM, and Computer Sciences Corp.

(CSC) already significant international suppliers of VAN services. Some of these firms

have expanded from a base in data processing

or data communications. For DP service firms

such as GEISCO and EDS, and for operators

of public data networks such as Tymnet and

Telenet, services like electronic mail and airline reservations represent straightforward extensions of older lines of business, Likewise,

CompuServe’s videotex service is based on its

existing DP capabilities. Most of these firms

have been seeking to expand internationally.

International thrusts by U.S. VAN providers

has generally come only after regulatory barriers have started to fall. In the past, with resale of leased lines prohibited in most parts of

the world, DP services firms and networks like

Tymnet and Telenet could offer little more than

an international connection to their U.S.-based
178 ● International Competition in Services

Box P.-EDS and General Motors' Planned Corporate Networkl

General Motors paid $2.5 billion for Electronic Data Systems in 1964, even though EDS’s annual

revenues were less than $1 billion. Why? GM felt it needed help in integrating computer and communications services into its sprawling organizational structure, a job that EDS had specialized in for

clients during the years that company was building its 13P services business. When it purchased EDS,

GM, with a hundred computer centers and as many independent data networks, was spending more

than $2 billion per year on its internal data processing and office automation needs.

Founded in 1963, EDS had long been known as a leader in batch and remote processing. Over

the more recent past, the company managed to outgrow all the other large U.S. data processing firms.

EDS has traditionally negotiated contracts giving it extensive control over clients’ 13P functions-in

many respects, providing facilities management. This sometimes put EDS in the unusual position

of an outside firm that had partially penetrated the organization of its clients; the frictions that devel

oped between long-time GM and EDS employees thrown together by the acquisition [GM transferred

more than 7,000 of its employees to EDS) have many precedents.

Under GM ownership, EDS remains an independent operating company-in part, an attempt to

preserve some of the EDS culture, markedly different from that of its new parent. GM gave EDS responsibility for all the automaker’s DP-related operations; EDS will prepare the software for GM’s planned

worldwide data network system (some of the hardware for which is to be developed by another GM

acquisition, Hughes Aircraft, purchased in 1985 for $5 billion). GM aims to integrate all of its computer and telecommunications systems, from vehicle design and engineering through links with dealers.

The company will purchase CO switches, rent or buy satellite circuits, and install cable and fiber

optic links to enable a network of powerful computers with advanced software to communicate with

one another. Eventually, the company’s 16,000 dealers, along with some 35,000 suppliers, will be

part of a single network also embracing GM offices and plants in some 33 countries. Among its other

functions, the network will connect a quarter of a million telephones at GM offices and plants throughout

the United States—an example of total system bypass. EDS will handle data processing needs ranging

from GM’s 40,000 employee health claims per year to a major new generation of automated design

and production equipment. The latter, which has proven particularly difficult-in part because EDS

has little experience in factory automation–includes the development and promulgation of standards

for interconnecting computers, machine tools, robots, and other shopfloor equipment.

This set of standards, termed MAP (Manufacturing Automation Protocol, also see ch. 9), has been

accepted by a large number of outside firms-and not only those wishing to sell to GM-because it

will allow simple interconnection of a wide variety of equipment. EDS, along with other companies

including Boeing (another pioneer in DP services through its Boeing Computer Services division),

is also pursuing an initiative called TOP (Technical/Office Protocol], aimed at standardizing interconnections for office automation equipment.

When complete, the GM/EDS system will handle information including the folIowing:

●

●

●

●

●

●

●

●

●

●

dealer orders, together with customer financing and insurance information;

engineering and design data;

manufacturing data, including software for computer-controlled production equipment;

accounting, financial, and tax information;

personnel and payroll data, including electronic funds transfers for wage and salary deposits;

intra-corporate billings and payments;

employee health insurance and claim information, along with other fringe benefits;

government and financial reporting;

intra-corporate electronic mail; and

voice message and voice storage service,

IS.T, McClalian, The CominS Computer Zndustry Shakeout (New York: Wiley, 1984), pp. 138-145; F. IM?att4, “EDS Building Corn Net for

GM,S9 Rk@ronic l%vs, May 13, 1&5, p. 1; “Large C~rporati MS1OP In+fouse Networks in fWeMum A*~atht” mw-fc ~@ws, May

20, 198!$, p. 1; J. Holusha, ‘“Acquisition Is Expaotad To Aid G.M. Piana for Diversification,” New York Times, June 6, 1035, p. 47; “Survival

of the Fattest,” The Economist, Oct. 12,1985, p. 35; “Electronic Data Systems: Logical Move,” The Economist, Dec. 21, 1985, p. 94; D.E, Sanger,

“E, D.S.’S prospects In the Aftermath,” IVew York Thne8, Dec. 2, 1986, p. D5.
Ch. 5—information Technology Services: Software, Telecommunications, Data Processing, and Information Services . 179

. —

Box Q.—Telenet

Telenet, established in the mid-1970s, was

one of the first public data networks to make

use of technology based on the Department of

Defense’s ARPANET packet switching system.

By 1986, Telenet was transmitting the equivalent of more than a million typed pages each

day. In the United States, users can tap into

the network either through dedicated lines to

a host computer or a local telephone call to

one of Telenet’s dial-up nodes. Telenet also

offers services such as electronic mail and

credit card verification.

The network makes use of dedicated lines

and domestic satellite circuits. With the recent

merger of Telenet, Sprint (both previously

owned by GTE), and U.S. Telecom to form

U.S. Sprint, Telenet will have access to a fiberoptic transmission network that will become

the core of its domestic system. The firm provides international access through PTTs (in

more than 70 countries) or directly to one of

Telenet’s international gateways (in 24 nations). In 1983, the FCC designated Telenet an

International Record Carrier (IRC); as an IRC,

the firm can provide international gateway

and network services directly, without going

through another international carrier.

networks. While this is still the case in most

countries, VAN providers can now compete

directly with PTTs in a few nations—an opportunity that brings with it risks over and above

those of competing with other private firms.

With many government-owned or supported

PTTs entering the data network business—e.g.

the DGT’s TRANSPAC in France—private firms

will need to offer differentiated services, given

that the PTTs will always be able to undercut

their prices. Beyond this, some enhanced services, such as electronic mail, substitute for (and

supplement) regulated services or monopoly

PTT services, such as telex. A number of specialized VANS, notably SWIFT, were established because the PTTs could not cope with

demand; the PTTs permitted SWIFT to bypass

their monopoly telex services only because the

rapidly growing volume of inter-bank messages

Box R.—Societe International de

Telecommunications Aeronautiques (SITA)

A cooperative organization of nearly 300 airlines, SITA operates the world’s largest specialized telecommunications network. Started

in 1949, the SITA network now joins about

16,000 airline offices in more than 1,000 cities. SITA’s major switching centers—in New

York, Atlanta, Los Angeles, London, Amsterdam, Frankfurt, Paris, Madrid, Rome, Bahrain,

Singapore, Hong Kong, Tokyo, and Sidney—

make use of dedicated lines leased from common carriers, as well as satellite circuits. In

addition to telecommunications, SITA offers its

members a variety of data-processing services.

The cooperative’s GABRIEL II passenger

reservation system, centralized at the Atlanta

and London centers, connects with the networks of individual airlines, such American’s

Sabre, while also providing hotel reservation

services, credit card authorizations, baggage

and air cargo tracking, flight planning, and

weather forecasts from around the world.

Some of these services, such as passenger reservations, are indirect competition with those

offered by member airlines—e.g., Sabre and

United’s Apollo. But while the airline networks

serve travel agents, SITA does not. Much of

the general message traffic—flight safety notifications, information on aircraft movements

and lost baggage, reservations and ticket sales

—still takes place via telex/teleprinter facilities,

But with computer-to-computer traffic growing rapidly, SITA has established a new packetswitched network for data communications,

threatened to overwhelm them. Private VANS

threaten PTTs both directly and indirectly, and

some PTTs will no doubt use their power to

control or limit VANS that promise to compete

too effectively.

As box N suggested, U.S. firms will probably

have little choice but to enter many foreign

VAN markets through joint ventures with local companies. Of those countries that have already established legal guidelines for VANS, Japan has gone perhaps the farthest in restricting

foreign firms to minority ownership. Despite

the disadvantages of such arrangements, IBM
180 ● International Competition in Services

has chosen to enter joint ventures with NTT

and Mitsubishi, Tymnet has established a venture with Hitachi, GEISCO with NEC, and

AT&T with a group of 18 Japanese firms.

When it comes to telecommunications, U.S.

trade policy has generally focused on opening

up foreign markets for American equipment

manufacturers. Progress in this arena has been

slow, with governments unwilling to abandon

policies of sheltering domestic manufacturers,

and PTTs to abandon their own ties with these

firms. Markets for telecommunications services, in some contrast, seem to promise greater

openness, particularly for VAN suppliers.

Lacking the deeply rooted obstacles that slow

liberalization in equipment and basic services,

VANS will probably evolve in a relatively lightly

regulated environment in many parts of the

world. At the same time, these services will certainly pose threats to PTTs. With VANS heavily dependent on leased lines, for which they

now typically pay flat rates, the first reaction

by some PTTs will probably be to raise their

charges, or seek regulatory approvals for volume-sensitive pricing. With leased-line policies

crucial to the success of VANS, both tariff

schedules and possible restrictions on entry (or

discriminatory tariff rates) become policies that

the United States will need to monitor. Although some countries may eventually allow

private firms to install their own lines, bypassing PTT facilities entirely, so far only Britain

and Japan (besides the United States) have made

this choice.

Videotex

Videotext and teletext—or videotex, referring

to both—provide information services ranging

from news and weather reports, to business and

financial information, teleconferencing, electronic stock trading, on-line shopping, and even

computer games. In essence, they are specialized VANS.

formation and database services intended for

professional and technical markets largely in

the type of information provided, with the professional/technical products tending to be specialized and expensive. Many videotex systems

provide a single gateway to a wide variety of

services, as exemplified by the hundreds of

offerings available through Teletel/Minitel in

France (box N].

When the videotex business began to grow

in the United States during the early 1980s, Dow

Jones News Retrieval and The Source each

offered a wide range of easy-to-use services,

with CompuServe quickly following. These

three firms now split the great majority of the

U.S. market, continuing to match each other’s

offerings. Videotex, particularly for household

subscribers, has been a domestic business

almost entirely; with the more successful products supplied over phone lines to PCs, foreign

subscribers must be willing to pay high charges.

Because cross-border service will probably continue to be expensive, videotex suppliers that

wish to penetrate foreign markets will have to

invest overseas. In some countries, American

firms will probably be limited to providing specialized services to the PTT’s own monopoly

videotex system.

Teletext refers to one-way transmission of

text—e.g., news information. Typical videotext

services—now available over the telephone to

anyone with a PC—combine text and graphics

interactively, Videotex services differ from in-
Ch. 5—information Technology Services: Software, Telecommunications, Data Processing, and Information Services • 181

DATA PROCESSING AND

As the costs of computing equipment dropped,

companies that once contracted out some processing began doing more of their own. Widespread availability of packaged software for

standardized applications contributed to this

trend. While falling data communications costs

work in the opposite direction, the DP services

industry has nevertheless been suffering from

stagnant or even declining demand. The number of firms in the industry has dropped, along

with their average size. Information and database services have replaced processing as a

growth sector.

The DP Services Industry

With computing applications continually expanding, DP firms have needed to search out

ways of keeping ahead of their customers, offering services that will attract even large and sophisticated end-users of computing equipment.

As the market for more routine processing stagnated, they have sought new ways to capitalize on specialized expertise or equipment. Beginning with batch processing, and later time

sharing, many have diversified into support

activities including system design and management. Early entrants like McDonnell Douglas,

Boeing, and Martin Marietta—primarily aircraft and aerospace manufacturers—began offering services to take advantage of the experience they had accumulated in their primary

businesses. Today, all three are moving, along

with other DP firms, into information and network services. Others train personnel for clients,

write software, install and maintain large government or corporate computer/telecommunications systems, and provide consulting services to companies contemplating purchase of

large-scale systems. Some help firms set up

intra-corporate VANS, or increase the efficiency

with which they use existing equipment. Others

sell time on supercomputers. CompuServe, a

remote DP specialist now owned by H&R Block,

used its spare capacity to become the leading

provider of videotex services to small computer

owners. With the hospital market dominated

by two well-established companies, Shared

INFORMATION SERVICES

Medical Systems and McDonnell Douglas, Amherst Associates carved out a niche by adding

financial planning and modeling services tailored for medical centers, For other examples,

see box S.

The largest DP firms are American, led by

ADP with 1985 revenues of $1.1 billion, EDS

at about $980 million, and Computer Sciences

Corp., $800 million.27 As in the software industry, the more typical DP firm, in the United

States or abroad, is a relatively small company

providing specialized services, but it is the large

firms that account for most of the international

trade and investment. As table 21 shows, the

global market exceeds $26 billion. However,

only 2.6 percent of all U.S. DP establishments

(173 of 6,700) reported export revenues when

surveyed for the 1982 Census of Service Industries. 28 OTA estimates that total foreign DP services revenues of U.S. firms came to $2.7 billion to $5.1 billion in 1984.

The larger DP companies rely heavily on raw

computing and telecommunicating power. To

compete for processing jobs involving the

manipulation of vast amounts of data or very

demanding computational problems takes

clusters of large mainframe computers, perhaps

supercomputers, operating, if possible, around

the clock. This in turn leads to marketing approaches that include reduced prices for offhours business use, and geographical diversification to attract customers from different time

zones. Heavy capital equipment costs in this

part of the business limit the competition to a

relatively small number of firms operating

clusters of networked computer centers.

Most of the new international opportunities

for DP firms will probably be found in VAN

and information services. Companies with an

existing network of computer centers will start
182 • International Competition in Services

Box S.-Data-Processing Service Firms: Two Examples

ADP:1 The world’s largest independent DP services supplier, Automatic Data Processing Inc.

(ADP) has been seeking to adapt to marketplace shifts by developing new products based on its traditional strengths. For more than 35 years, the company has specialized in back-office automation—not

only accounting and payrolls, but counting, labeling, sorting, and otherwise processing documents

including stock certificates, canceled checks, sales receipts, and credit-card slips. Not surprisingly,

their strongest competition comes from the in-house DP departments of large firms—one reason for

a strategy built around many smaller customers (in contrast to EDS, which gets most of its business

from a few big contracts).

ADP began by automating payroll processing for its customers, relying primarily on mechanical

sorting and printing machines; by the early 1960s, the firm had become an intensive user of large

mainframe computers. Today, nearly half of ADP’s revenues come from its Employer Services division: the company handles about 10 percent of all U.S. private sector paychecks. ADP has also been

diversifying into front-office brokerage services, as well as processing data for car dealers, banks (including ATM services), and insurance companies. In 1983, the company purchased the stock quotation unit of GTE’s Telenet subsidiary, and 2 years later added Bunker Ramo Information Systems,

a firm with 30 percent of the on-line stock quotation market. Besides moving aggressively into brokerage services, ADP is trying to win sales in data processing for automobile insurers and repair shops,

by, for example, offering a database containing information on 35 million automotive parts to speed

repair estimates. The company has extensive overseas operations, particularly in Western Europe,

where it has followed generally similar strategies.

GEISCO: 2 General Electric Information Services Co.-established in the early 1960s to operate

GE’s remote processing facilities—has been a major force in the time-sharing market, as well as in

network services. While GEISCO once maintained more than a dozen regional centers and operated

several dozen time-sharing systems to supply services to major customers, decreasing data communications costs have led to a more concentrated system. Like other firms with extensive networks, GEISCO

has moved its remote processing centers from urban areas into regional clusters servicing numerous

cities. Today, the firm operates “supercenters“ in Rockville, Maryland, Cleveland, and the Netherlands, where 35 mainframes have recently been replaced by just 11 still more powerful machines.

Because many companies want to link their own systems so that all offices have access to a common corporate database, GEISCO now offers its customers VAN services. The firm has also become

a major provider of network services to banks (ch. 3). GEISCO has thus evolved from providing a

menu of relatively discrete remote DP services to operating a farflung integrated network with links

to customers available through both private and public telecommunications systems. GEISCO has

recently purchased several smaller companies to add to its capabilities in accounting/financial software, oil and gas company services, and ATM services.

I“A Number-Cruncher Wants Out of the Back Office,” f?usineas Week, Dec. 9, 1985, P. 86; p.w. Barnes and A. Monroe, “Automatic Dab

Processing To Acquire Bunker Ramo From Allied-Signal Inc.,” t%llStreetjournt4 NOV. 18,1985, P. fx p. Archbold ~d p. H@w “The Da@-

tion 100,” Datamation, June 15, 1S86, p. 95.

KITA interviews; also C. Wiseman, Strategy and Computers (Homewood, IL: Dow-Jones Irwin, 1985), pp. 148-151 and “The Datamation

100,” op. cit., p. 93.
Ch. 5—Information Technology Services: Software, Telecommunications, Data Processing, and Information Services • 183

Table 21.— Data Processing Services Markets, 1986

Revenues (billions of U.S. dollars)

United States . . . . . . . . . . . . . . . . .. .$19.5

Japan . . . . . . . . . . . . . . . . . . . 3.5

France. . . . . . . . . . . . . . . . . . . . 1,5

Federal Republic of Germany ... . 1.0

United Kingdom . . . . . . . . . . . . . . . 0.9

$26.4

SOURCE 7987 # S /ndu.sfr/a/ Ouf/ook (Washington DC Department of Corn.

merce January 1987), p 471

with advantages in VAN markets. At the same

time, the technological lead of the United States

in specialized applications—e.g., use of supercomputers—should mean continuing new opportunities for firms choosing to remain active

in this part of the business.

Database and Information Services

This subset of the IT services starts from a

much smaller revenue base than data processing, but has great potential for growth—in part

through close ties with VAN and videotex markets. Indeed, on-line database services—those

available via computer terminals—are simply

one type of VAN service. Once again, reduced

costs for computer hardware and advances in

telecommunications, will make it easier and

cheaper for customers to tap on-line databases

and for suppliers to provide interactive services (for instance, models for predicting economic growth that the client can exercise under differing assumptions). Figure 35 shows the

growth in the number of machine-readable

databases available worldwide, The rapidly increasing installed base of PCs, which provide

cheap and convenient terminals for many of

these applications, has contributed to the swelling demand for database services suggested by

figure 35—and also by figure 36, which shows

the rise in on-line searches of these databases

over the past decade,

With many small computers being purchased

for home use, as well as by businesses, two types

of products dominate the information services

industry:

1. Professional and technical on-line services

(Quotron, Mead Data Central’s NEXIS/

LEXIS, Standard and Poor’s COMPUSTAT,

Figure 35.— Publicly Available Databases Worldwide

4,000

3,000

2,000

1,000

0

—

1985

Year

SOURCE M E Wllllams “Database Data, ” prepared for OTA under contract

NO 633-3210

2.

Lockheed’s DIALOG, Datastream in the

United Kingdom and DATEV in Germany),

which offer such products as business and

economic data, or scientific citations.

Videotex or similar services (CompuServe,

Dow Jones News Retrieval,- The Source),

oriented primarily to small business and

household users.

As table 22 shows, professional and technical

services remain the largest markets, with credit,

financial, and economic information accounting for two-thirds of total industry revenues in

1984.

Table 22.—U.S. Markets for Electronic Information

Services

Revenues

(millions of dollars)

1989 Projected annual

1984 (projected) growth rate

Business and consumer credit $ 447

Financial 389

Economi c 222

Legal and government 184

Scientific 102

Business news 98

Marketing and media 69

Personal and household

Information services 78

$1,589

$1,050

720

320

350

220

330

150

470

$3,610

19%

13

8

14

17

27

16

43

18%

SOURCE E/ectmn/c /nkmMMri /m_7usfry FO%IXSI 1984 f!?89 (New York LINK Resources Corp

Ma/ 19851
184 ● International Competition in Services

Figure 36. —On-line Database Searches

—

1981

—

—

1982

Year

souRcE M E. Wllllams “Database Data, ” prepared for OTA under contract No 633-3210

COMPUSTAT provides detailed firm-specific

information of interest to investors. NEXIS supplies the complete text of news stories. LEXIS

lists judicial cases and decisions, a service

widely used by lawyers and legal researchers.

NewsNet, a relatively new full-text service, provides on-line access to over 250 specialized

newsletters. Such databases must be constantly

updated. They also demand substantial investments in initial design and development. Competitive success depends on understanding the

needs and demands of end-users. Firms that

have grown up supplying information services

in print form have sometimes had trouble moving into electronic database markets, as illustrated in box T. Staff must be retrained and people with new skills—e.g., in computer systems

–hired. The design phase tends to be especially

demanding.

—

1983

-

—

1984

u

.

1985

As figure 37 shows, two-thirds of all databases

available on world markets originate in the

United States. The number of on-line databases

available from U.S. sources grew by a factor

of 10 over the years 1977 to 1985, from 212 to

2016; those originating in the rest of the world

increased more slowly, from 154 to 824.29 Nearly

20 percent of the revenues of U.S. database

suppliers come from foreign sources, threequarters from Europe. The Japanese market for

on-line services, like that in Europe, has been

‘

g

’’ Database Data,” prepared for OTA under contract No. 633-

3210 by M.E, Williams.

On the foreign revenues of U.S. suppliers, see A Competitive

Assessment of the [J.S. information Services industry (Washington, DC: Department of Commerce, May 1984), p. 23. Half

or more of database services in Europe are supplied by U. S.-

based firms. On Japan, see “Info Industry Expanding RapidlY,”

Japan Economic SurveLv, September 1986, p. 12.
Ch. 5—Information Technology Services: Software, Telecommunications, Data Processing, and Information Services ● 185

Box T.—Moving Into New Information Markets: InfoBase Corp.1

InfoBase Corp. (IBC) supplies bibliographies,

indexes, and related services to scientists and

technologists around the world. The company,

established many years ago, has distributed its

products mostly in printed form, selling primarily to libraries in universities, large corporations,

and government agencies.

IBC staff receive some 8,000 technical journals.

Through a systematic pre-editing, coding, and

keypunching process, each article is given a unique

access number and address in the firm’s computer system. For scientific indexes, some of the

critical text abstraction work is performed at

IBC’s Bombay offices. Scientists stay with the

firm longer in India than in the United States,

particularly important to the company because

of the high costs of training in IBC methods.

While the company’s managers do not feel that

IBC has fully exploited the potential market for

its traditional products, they recognize they must

develop new products as well. “Somewhere there

is a company controlling just about every type

of document being published, ” noted one senior

manager. “I don’t think we can only do more of

the same.” Another added, “The new anxiety is

that scientists feel they have too much brought

to their attention already. The need is for a level

of interpretation layered on top of the data.” IBC

has begun to experiment with three new approaches: software search tools that complement

its print and on-line database products; custom

databases; and interpretive or editorial products:

• More Conplex Search Tools-IBC has developed and begun to market a software search

aid that helps users sift through many databases without the need to learn specialized

methods for each. The system contains a file

manager with which the user can create a

personalized bibliography while offloading

references from each database. IBC must develop new ways to sell this product. The

company’s print products were subscription

items, relatively self-explanatory and inexIDrawn from a caaa study prepared for OTA under contract No.

533-597o by L. Hirachhorn. The name of the company, and some of

the details, are fictional.

pensive. Software, in contrast, requires active selling. The package is perceived as expensive; customers must also invest time in

learning to use it. “People lack confidence,”

one manager said. “They know they should

buy the product, but its a major investment.

We have to do a lot of personalized education, which is expensive for us. ” The educational effort does not end with a sale. IBC

has trained a group of customer service representatives to trouble-shoot problems and

help customers use the system.

Custom Databases—IBC has sought to market specially-tailored databases to corporations, academic institutions, and government

agencies. Again, this has posed difficulties.

One IBC manager said, “Our sales force

needs to break out of the library, and begin

calling on other places where research is

done—or where there is a need for information, such as stockbrokers and group health

practices.” But another noted, “We can’t just

send our sales reps out to industry without

retraining. They’re too academically-oriented.”

It has also proven difficult to estimate the

cost of customizing a data tape for a customer,

Interpretive Tools–Here, IBC has introduced

a new series of products—an encyclopedia

of science, Again, the company has been

faced with a good deal of new learning. Its

standard citation indexes are entirely objective in structure. Interpretive work means

that IBC must hire writers with legitimacy

and standing in the scientific community.

The company has set up advisory committees of well-known scientists to help it penetrate the social network of researchers and

scholars.

As these examples suggest, in moving into new,

high-value-added information products, IBC

must:

retrain its sales force so that they can deal

with a broad spectrum of customers, and

with more complex purchase decisions;

put together a new force of customer service representatives, who can help scientists

directly, as well as deal with librarians and

information specialists;

63-5?7 o - 87 - 7
186 ● International Competition in Services

● develop abetter understanding of how and For IBC, this means a new product development

why different end users acquire and utilize and marketing stretegy, one based on deeper uninformation; and derstanding of its customers needs, along with

● extend and deepen the company’s existing a more active and sophisticated sales effort.

ties to the user community, so that its interpretive work will be accepted.

growing rapidly, Currently, almost 80 percent

of the databases available in Japan originate

elsewhere. Continued expansion of videotex

systems will drive growth in markets for dataOther European A

nations— 120 (4°/0) >

European Economic

Community (EEC)– i

542 (18°/0) ,

United StatesSOURCE M E Williams “Database Data,” prepared for OTA under contract

No. 633.3210.

As the costs of international telecommunications continue to decrease, and more countries begin to deregulate value-added services,

further opportunities for American firms will

emerge, Under such conditions, U.S.-based suppliers should be quite competitive, particularly

those that remain sensitive to the more specialized needs of overseas users, The major policy

issues likely to arise center on possible TBDF

restrictions, questions of customs valuation,

and protection for the intellectual property embodied in information services—as summarized

below and discussed in more detail in chapter 9.

CONCLUDING REMARKS

U.S. firms have been highly competitive in

the major IT services. Traditional data processing has become a relatively mature business,

but software, telecommunications, and information services are in the midst of rapid growth

and rapid technological change. In computer

software, the United States leads the world.

Trade will grow as packaged programs take

over from custom software. This shift will help

foreign suppliers, particularly the Japanese, in

their efforts to catch up with American software firms. Liberalization of VAN markets,

reduced costs for telecommunications, and

steadily growing reliance by companies doing

international business on both intra- and interfirm data communications point to growing

telecommunications trade as well. U.S. firms

offering enhanced services—e.g,, VANs—should

benefit. So should American DP firms, which

remain highly competitive even as they seek

new lines of business. Videotex, database, and

other information services—all closely related

to VAN services and likewise a U.S. strength—

will be perhaps the fastest growing of all the

IT services over the next 10 or 15 years.

Still, it would be most unfortunate if the competitive strength of the United States led to complacency, particularly in terms of policy. The

American software industry faces competitors

that benefit from foreign government supports

and subsidies, Weak protection for intellectual

property, making it easier to copy U.S. prod-
Ch. 5—Informatlon Technology Services: Software, Telecommunicatlons, Data Processing, and /formation Services ● 187

ucts, also aids foreign firms. Software is expensive to develop and cheap to produce; illegal

copying and counterfeiting have been endemic.

For reasons outlined in chapter 9, current forms

of legal protection seem inadequate. Indeed,

intellectual property issues cut across many of

the IT services.

A multiplicity of technical standards issues

also emerge in the IT services—for ISDN, for

computer interfaces, for programming languages. Given the PTT monopolies on telecommunications that still exist in most parts of the

world, governments will have a major say in

technical standards for ISDN—standards that

will influence competition in world markets for

equipment as well as services. If different parts

of the world (or different regions in the United

States) adopt different standards, the transition

to ISDN will be more expensive.

TBDF restrictions may become a factor in

more countries, along with pricing that works

to the disadvantage of American firms. In the

United States, congressional decisions on regulation/deregulation of telecommunications

will have international ramifications. Countries

that restrict transborder flows of data, although

they may rationalize such policies in terms of

privacy, typically seek little more than new tools

to influence patterns of trade and investment

(ch. 9). In the absence of major new efforts to

impose TBDF restrictions abroad, the issue has

receded somewhat, but it will probably reappear

—if only as a reaction to continuing growth in

international data communications and the

fears this will create among some people and

groups. Moves toward volume-related pricing

could likewise prove troublesome, if foreign

PTTs continue to propose pricing schedules

based on the volume of data transmitted, rather

than connect-time (ch. 9).

International trade in telecommunications

services remains fairly small in value—seemingly

disproportionate to the policy debates concerned with satellite communications or TBDFs.

One reason for the heat generated by these debates is simply that new services, notably VANS,

will be more tradeable than traditional services,

especially if major industrial nations continue

to liberalize their internal markets. Beyond this,

telecommunications has become a locus of concern for European governments worried that

their high-technology goods and services industries are losing the ability to compete with the

United States and Japan; policy makers in Europe may be willing to pay a considerable price

in terms of efficiency in the name of jobs in

telecommunications.

All the IT services depend on computing capability in one way or another, The global market for computer hardware and software, already well over $100 billion, has, despite a

recent slowdown, been growing at close to 20

percent annually for many years; worldwide

markets for telecommunications equipment are

comparable in size. But IT services (and equipment) have significance for the creation of

wealth and employment going well beyond

their direct impacts: competitive success in

other manufacturing and service industries will

depend heavily on the IT services, The links

are perhaps most obvious for the many consumer and producer goods that embody smart

electronics, and therefore software. Software

development costs are growing as a fraction

of total development costs for applications of

computing power, wherever these are found.

Indeed, software today is the primary determining force in the design of many digital systems.

Other links stem from the growing use of

computing and telecommunications services

for managing dispersed manufacturing and

service activities both within and across nations

—in turn, a function of the greatly decreased

cost of hardware. The General Motors corporate

network described earlier provides one example; chapter 8 includes many others. Finally,

as pointed out in chapter 3, banks now use online databases to help manage risks on investments and currency transactions, while electronic clearinghouses and expert systems for

securities trading are moving swiftly ahead. Although only relatively large companies earl afford many of these applications today, in the

future, marketed VAN services of comparable

power and usefulness will be available to companies regardless of their size. The point is sim-
188 . International Competition in Services

pie: continuing U.S. competitiveness in the IT

services will be critical for maintaining U.S.

competitiveness in a wide range of other manufacturing and service industries.

Nonetheless, although many American companies—as well as those with headquarters in

Europe and Japan—know that adoption of new

information technologies will, in some sense,

be vital for future success, few at present have

a very clear view of which technologies should

get the highest priorities, and of how to integrate new services into their ongoing operations. In the United States, the deregulation of

telecommunications has contributed to the confusion by suddenly increasing the number of

options. over the next few years, any firm operating in international markets will likely feel

pressured to at least match the investments and

innovations adopted by its competitors.

Companies will eventually learn to effectively

use local and wide area networks for linking

geographically dispersed operations; some will

link their computer systems with those of their

customers. In such ways, new information technologies are changing old industries—a process that can be termed dematuration. Take, for

example, the shoe industry. Shoe producers in

industrialized countries now compete with

those in low-wage, less-developed countries by

using computer-aided design and manufacturing systems (CAD/CAM) to speed product development and styling changes, and to reduce

costs; small incremental changes in the design,

say, of athletic shoes can help a firm respond

to or create shifts in demand. Design changes

can be transmitted via data communications

links to a plant in Asia. The firm can quickly

acquire and analyze information on market

trends using data from point-of-sale terminals

in retail outlets. Managers can correlate sales

information with that on shipping and distribution to monitor stock levels. The IT services

play a crucial role in these dematuration processes, in this and other industries.

In U.S. automobile production, to take a different example, perhaps the most vital impacts

of information technology have been in reducing design/development time for new vehicles. so

Sosee the articles in the March 1986 issue of A utomotilre Engineering.

Twenty-five years ago, a new car could be designed and brought to production in little more

than a year; since then, the design cycle has

stretched to 5 years or more. In attempting to

keep up with their Japanese competitors, who

have been flooding the U.S. marketplace with

a seemingly endless stream of new products,

American automakers have turned to computer-intensive design and engineering methods,

as well as computer-aided manufacturing.

These strategies hinge on networking and communications among hundreds or thousands of

terminals having access to common databases.

National security offers a final set of examples illustrating the critical nature of the IT services. During the 1950s and into the 1960s, the

U.S. computer industry gained its position of

world leadership in large part as a result of

spending by the U.S. Department of Defense,

Much of this spending, for R&D as well as procurement, went toward early warning systems,

intended to detect possible attacks by aircraft

and rockets. Today, military systems of many

types—from fire-and-forget missiles, to aircraft

flight controls, to the planning for the Strategic Defense Initiative (SDI)—depend on digital systems technology.

Missiles like the Exocets that threatened the

British navy in the Falklands War, and the laseror wire-guided rockets that are becoming standard equipment for the foot soldier, have already

had major impacts on conventional military tactics and strategy, not to mention nuclear strategy. Strategic command and control, guidance

systems for ballistic and cruise missiles, the

Navy’s submarine tracking systems, military

satellites—all demand advanced IT technology,

including man-machine interfaces and software that can determine what information is

important, how it is displayed, and in some

cases what it means, Pilot’s aids in future aircraft will extend the capabilities of military

fliers, helping them cope with information overload and maneuvers at and beyond their skill

envelopes. Beyond this lie not only the daunting SD I software and hardware requirements,

but the quite different needs of huge dataintensive information systems such as those of

the National Security Agency.
Chapter 6

Technology Trade:

Licensing by U.S.-Based Firms
CONTENTS

Page

Summary . . . . . . . . . . . . . . . . . . . . . . ....... . . ... .. ... . . ..00..191

International Technical Licensing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ..194

Why License? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ......194

U.S. Receipts and Payments. . . . . . . . . . . . . . . . . . . . . . . . ................195

Technological Advantage and National Strategy . . . . . . . . . . . . . . . . . . . . . . ..198

R&D and Technology Development in the United States . ..............198

Foreign Technology Development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ..200

Licensing Strategies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .................208

Integration. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. ...208

Joint Ventures. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ..............213

Acquisition of Foreign Technologies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ..214

Policy Issues... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .....................215

The Policy Environment for Licensing. . . . ...........................215

R&D and Technology Development . ................................216

Foreign Government Policies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .218

Concluding Remarks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ................219

Boxes

Box Page

U. The License Agreement . . . . . . . . . . . . . . . . . . . . . ....................196

V. Have U.S. Firms Licensed Their Technology Too Cheaply? ... ... ... ..202

W. Who Licenses, and Why? . . . . . . . . . . . ..............................210

Figures

Figure No. Page

38.

39.

40.

41.

42.

43.

Geographic Distribution of U.S. Technical Licensing Receipts, 1985....197

Constant-Dollar Growth in R&D Spending by American Companies ....199

U.S. Patents Granted, by Nationality of Inventor . ...................200

Japan’s Technology Imports, 1982 . . . . . . . . . . . . . . . . . ................201

U.S. Receipts of Royalties and Fees by Industry, 1982................210

Royalties and Licensing Fees As a Percentage of R&D Spending in

U.S. Manufacturing Industries, 1982 . . . . . . . . . . . . . . . . . . . . . . . . . . . ....211

Tables

Table No. Page

23.

24.

25.

26.

27.

28.

29.

30.

31.

U.S. International Receipts, Payments, and Net Receipts of Royalties -

and Licensing Fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 191

Foreign Nationals Receiving Doctoral Degrees in Engineering and

Science From American Universities . . . . . . .........................199

Technical Licensing Transactions of Selected European Countries .. ...201

U.S. Technical Licensing With Europe and Japan. . ..................204

Japan’s International Technical Licensing . .................,.......204

R&D Funded by Business and lndustry. . ...........................205

Patent Applications by Domestic Residents . ........................206

External Patent Applications by Nationality of Applicant . ............206

U.S. Technical Licensing With Newly Industrializing Asian Countries. .207
Chapter 6

Technology Trade: Licensing by U.S.-Based Firms

SUMMARY

Corporations trade in technology in world

markets just as they do in other services and

goods—that is, they trade in the knowledge used

to produce other goods and services. Mostly

this is proprietary technology—knowledge that

a firm can control, much of it protected under

U.S. law if not always under the legal systems

of other countries. Traded technology includes

management methods and techniques, as well

as knowledge embodied in equipment, in manuals and specifications, patents, in computer

software. It also includes disembodied knowledge—know-how that exists only in people’s

heads or in organizational routines. Today,

licensing agreements may be part of complex

business arrangements that include equity participation by the licenser, training for the licensee’s employees, and contracts to supply parts

or components and buy back finished goods.

Licensing is becoming an integral part of the

international business strategies of American

corporations, rather than a means of generating incremental profits from a company’s store

of technical knowledge.

Compared with other items in the U.S. balance of payments, international licensing is not

a big business. Foreign technology sales by

American firms, measured by royalties and

licensing fees, amounted to $5.8 billion in 1985

(table 23), By value, transactions between U. S.-

based parent companies and their overseas affiliates exceed those between unaffiliated firms.

Receipts from affiliates account for about 70

percent of U.S. licensing revenues, although

making up only 10 to 20 percent of the number

of agreements.1

1 F, J, Contractor, Licensing in Zn terna tiona] Strategy.. A Guide

ftir Pianning and Negotiations (Westport, (X: Quorum Books,

1985), p. 27, in 1977—the latest ~’ear for u’hich such data are

a\’a i] ahle-A merica n corporations had 23,600 {J\rerseas 1 ice n ses

in force, 3,500 of them (15 percent) with affiliated foreign firms

(those owned 10 percent or more bj an American compan~ –

see table 23, footnote b),

\lur:h of the analysis in this chapter is based on interviews

conducted hy (3TA staff and contractors.

Table 23.—U.S. International Receipts, Payments,

and Net Receipts of Royalties and Licensing Fees

(billions of dollars)a

—

Receipts Payments Net

Licensing between affiliated firms:b

1978 . . . . . . . ., ., $2.7 $0.4

1980 ., . . . . . . . . . . . 3.7 0.3

1982 . ... . . . . . . 3.5 0,3

1984 . . ... . . 3,9 0.6

1985 ... ... ... . . 4.1 0.5

Licensing between unaffiliated firms:

receipts

$2.3

3 4

3.2

3 3

3.7

1978 . .. ., . $1.2 $0.3 $09

1980 ... . 1.,3 0.3 1,0

1982 ... ... ... 1.7 0 3 1,4

1984 . . . . . ... 1.6 0.4 1.3

1985 . . . . . ., 1.7 0,4 1,3

Total, affiliated plus unaffiliated:

1978 . . . . $3,9 $0,7 $3,2

1980 ... ... 5.0 0 6 4,4

1982 . . . . 5.2 0 6 4.6

1984 . . . . . . . . . . 5.5 1.0 4.6

1985 . . . . . . . . . . . . 5.8 0.8 5,0

awh( Ie far from perfect, ! he data CO I Iected by the Bureau of Econorn IC A n alys I S

(BEA part of the Department of Commerce)–summarized {n table 23 and used

elsewhere In the chapter—are the best available Throughout this chapter OTA

utlllzes EEA’s data on ‘royal ties and Ilcensing fees’ as a measure of technical

Ilcenslng The broader BEA category ‘ royaltles and fees though more com

monly used Includes management fees and a variety of other charges that may

have Il[tle to do with technology trade The royaltles and I!cense fees series

as presented I n t h!s table shows slgn!flcantly different trends than for Instanc e

the International technical Ilcenslng sertes publlshed by the National Science

Foundation In their blennlal Sc/ence /rrdIcators OTA s choice conforms with

BEA’s practice, beginning In 1986, of separating ‘royaltles and Ilcense fees

and ‘“other private serwces from afftllated foreigners In the balance of pay

ments statistics.

For BEA’s collection procedures, together with the poss I ble sources of error

and amblgu tty, see Trade In Serwces Exports and fore~gn Revenues (Wash I ngton, DC Off Ice of Technology Assessment, September 1986) pp 29.30, pp 8385

summarize the Impact of Ilcenslng on the U S balance of payments

Net recetpt figures may not add because of round!ng

bu s affll[ates, as defined by the Department of Commerce Include all foreign

firms with 10 percent or more of equity owned by a U S parent The data make

no dlsttnctlon between mlnonty (1 O to 50 percent} and ma)orlty ownershl p

although t h IS dlstlnctlon has Important practical Impl I cat Ions for cent rol over

the affll!ate, and thus for Ilcenslng arrangements

BEA presents affll!ated Ilcenslng data only on a net basis That IS the affdlated

receipts (n the table equal payments by subsldlarles abroad to their U S par

ents ml nus payments by these parents to thel r su bsl dlarles U S af f! I I ated pay

ments equal payments by U S affiliates to their foreign parents ml nus their

receipts from those foreign parents I n 1982, payments by U S parents to the! r

subsldlarles came to less than 2 percent of the recel pts of these parents For

affi Itated payments, the difference is more substantial In 1980 payments flow! ng

from foreign parents to their U S subsidiaries came to about 12 percent of the

payments of U.S subsidiaries to their parent firms

The affiliated payments series were revised for 1980 and agatn for 1982 and

later, and may not be directly comparable with earner years

SOURCES Receipts and unaffiliated payments, 1978 and 1980 Department of

Commerce, Bureau of Economic Analysis, unpublished statistics,

January 1986 table 6— U S International Transactions In Royaltles

and Fees wlfh telephone correct Ions Affiliated payments, 1980 For

e~gn Llrecf /nvestmenf fn fhe Un/ted States, 7980 (Washington DC

Department of Commerce 1983), table L-1 p 198 1982-85 R C

Krueger ‘U S International Transact Ions, First Quarter 19E5’ Sur

vey of Curren f Bus~ness J u ne 1986 p 43

191
192 ● International Competition in Services

Particularly for transactions between majority-owned affiliates, the dollar values in table

23 do not necessarily mean much; intra-corporate charges may have more to do with, say,

minimizing worldwide tax liabilities than with

the market value of the licensed technology. At

the same time, license fees represent only a

small fraction of the foreign sales generated

through applications of the transferred technology, Assuming royalty rates at 5 percent of

sales, not untypical, U.S. technology licensing

would lead to some $116 billion in foreign product sales, a figure more than half of total U.S.

merchandise exports ($214 billion in 1985),

Viewed as an alternative means of exploiting

proprietary technology, then, licensing has

great significance for American businesses.

Many licensing agreements also lead to exports

of capital goods, components, or materials.

As table 23 indicates, American companies

also purchase technology developed overseas,

but in small amounts compared with their exports. This picture is changing, more slowly

than it probably should. Today, few U.S. firms

enjoy technical positions so strong that they

could not benefit from selective acquisitions

of foreign know-how. U.S. advantages in technology have not only narrowed, they have, in

more than a few fields, vanished. Some American companies realize how much they can

learn from foreign technical developments;

others do not. For a growing number of U.S.

firms, acquisition of foreign technology has become an important element of corporate strategy, as a substitute for or complement to internal research and product development. The

steel industry provides many recent examples,

with Nippon Steel, for one, providing technical assistance to USX (formerly U.S. Steel),

Armco, and Inland. Technology exchanges

with Japan have also been common in microelectronics and robotics.

What does international competitiveness mean

in terms of licensing? On one level, licensing

can be viewed as an international business in

its own right; in a very real sense, American

firms compete with rivals abroad in selling technical information. Their ability to compete depends on the U.S. technology base, on relative

rates of technological development in this country and abroad, and on the entire array of factors influencing the Nation’s store of technical knowledge.

At the same time, licensing—as a vehicle for

transferring technical information—can cause

changes in the competitive positions of the industries that buy and sell technology. American firms licensed a great deal of microelectronics technology to Japanese manufacturers

during the 1960s and 1970s, reducing the time

required for Japan to become internationally

competitive. The obvious question follows:

Have American firms licensed their technology too cheaply? Put differently, while 1icensors presumably look out for their own interests, is there any reason to expect them to

account for impacts, possibly adverse, on other

companies in their own industry or in other

American industries? The costs and benefits

for the three fundamental alternatives—licensing, exports, direct investment—may differ considerably from the perspective of the firm with

technology to exploit and from the perspective

of the U.S. economy as a whole. More than one

executive has been moved to accuse his counterparts in other U.S. companies of giving away

the Nation’s technological advantages through

too liberal licensing,

At the same time, in a world of sprawling multinational corporations (MNCs), questions of

national technological position quickly become

fuzzy, Most international licensing (by value)

is carried out between the divisions of such

companies (table 23); licensing has become an

integral part of global competitive strategy for

multinationals, If a U, S.-based MNC has investments in several dozen countries and garners

half or more of its sales overseas, does its store

of proprietary technology count as U.S. knowhow? Some of it does, but probably not all. At

the most fundamental level, it is people who

embody and convey technical knowledge, R&D

carried out by the MNC’s employees in the

United States counts in the U.S. technology

base; R&D conducted overseas may be transferred back to the United States, or may not

be. The real point is that the MNC has a good

deal of control over its technology, nations with

open economies have relatively little; the U.S.
Ch. 6— Technology Trade: Licensing by U.S.-Based Firms • 193

Government can support R&D, adding to the

Nation’s technology base, but, as a government,

has only limited means for retaining that technology within U.S. borders. It may be more important (and more practical) to pursue policies

aimed at drawing in foreign technologies than

to pursue policies aimed at slowing the outflow

of U.S. technology.

Arms-length licensing transactions with both

industrialized and newly industrializing nations raise questions of technological comparative advantage most starkly, The issues concern

the sources of technical knowledge, the ability

to preserve and take advantage of proprietary

technology, including the learning and other

dynamic effects so important in competitive

outcomes, and the Federal Government’s role

in supporting R&D and technology development.

They range from needs for better research

equipment in the Nation’s universities, to international regimes for protecting intellectual

property, to foreign government policies aimed

at inducing American companies to license or

otherwise transfer their technology, In many

countries, trade barriers make it difficult or impossible for American firms to export directly.

Governments may also restrict investment by

American firms, cutting off the option of local

production. Since the 1960s, foreign governments have become far more sophisticated in

bargaining with multinationals; integrated corporate strategies have been, in part, a response

to foreign government efforts to extract technology.

For a variety of reasons, explored in this chapter, the technological leads once enjoyed by U.S.

firms have diminished substantially. This relative decline carries implications both for international licensing, and, from a competitiveness

point of view, for sales of knowledge-intensive

products and services. The evidence also points

to a decline in R&D productivity in the United

States–i.e., that a given expenditure for R&D

yields less in terms of commercial innovations

than in the past. The implication: both industry

and government need to seek ways of improving efficiency —e.g., through better mechanisms

for transferring technologies from laboratory

to marketplace. Furthermore, given that improving productivity in R&D has never been

easy, steady increases in U.S. R&D funding

seem necessary. Although the focus in this

chapter remains on technology development

in the private sector, Federal agencies fund

nearly half of all U.S. R&D; government policy

initiatives offer many opportunities for improving the Nation’s technological competitiveness.

That foreign companies have made relative

gains in their capacity to generate commercial

technologies should come as no surprise. Most

have been and continue to be substantial purchasers of technology from the United States.

While some critics take this as meaning that

American firms remain their own worst enemies, the evidence suggests otherwise. Before

the Second World War, European industries

held the lead in many technologies (ranging

from chemicals to automatic lathes to prestressed concrete). Japan had a well-developed

industrial base by the beginning of the 1930s.

After the war, American firms were much better placed to compete, but as Europe and Japan rebuilt, their companies quickly narrowed

the gap. In newer fields, those that have opened

since the 1960s, the Japanese have been able

to enter on a par with American firms, and to

keep up or even move ahead. Examples include

optical communications and structural ceramics.

Today, companies in Europe and Japan operate with state-of-the-art technologies. Japanese

firms now license out more technology 

than

they license in, although Japan continues to be

a net importer of technology in terms of ongoing agreements. Indeed, the United States may

now have as much to gain as to lose through

freer exchanges of technical information. Improving the climate for such exchanges, so that

American firms can learn more easily from foreign know-how, will require a shift in U.S. attitudes, along with policy changes in other industrialized nations.

The following points, then, emerge most

strongly from the analysis in this chapter:

● In an increasingly integrated world economy, U.S. companies license both at armslength and to their affiliates. The affiliates
194 . International Competition in Services

themselves license—their own technology,

as well as know-how they get from the parent. Technology flows around the world

through many channels. Almost any technology will be available to almost any firm

with the money and skills to make use of it.

With licensing a part of business strategies

in which joint ventures and other intercorporate alliances have become common,

it makes less and less sense to speak of U.S.

technology as compared with foreign technology. Corporations control technology

when they can; certainly they maintain

storehouses of proprietary knowledge. But,

granting some exceptions, nations do not.

Given that many foreign corporations, particularly those in Japan, now have technologies in some respects as good or better

than those of American companies, the

U.S. economy could benefit from greater

inward flows of technical know-how. Access to the world’s stock of technology is

quickly becoming an issue comparable in

significance to the ongoing task of supporting R&D and technology diffusion within

the United States. Some U.S.-based firms

do seek out and license technologies from

overseas, but a broad shift in attitude toward foreign know-how on the part of

American corporations seems called for.

Into the 1970s, many U.S. firms underestimated the capabilities of their potential

●

rivals in Japan, and therefore settled for

royalties that experience shows to have

been too low. While most of these mistakes

are in the past, it remains true that firms

look out for their own interests; they do

not, in general, look out for the interests

of other American companies or for broader

U.S. economic interests. The greatest need,

at this point, is to develop more effective

mechanisms for bringing Japanese technology into the United States.

Finally, the U.S. technology base as a whole

plainly needs attention. Policymakers have

acknowledged many of the problems for

years: obsolete and inadequate university

research facilities; too few American-born

graduate students in engineering (and an

infrastructure for technology development

that increasingly depends on foreign nationals); inadequate mechanisms for transferring technical knowledge from those

who have it to those who need it. Despite

much talk, little has been done. More serious strains also seem to be emerging: recognition that military R&D spending yields

far fewer spillovers on the civilian side of

the economy than once expected; evidence

of slowdown in R&D productivity; realization that corporate and national priorities here put less weight on developing and

using technical knowledge than in other

countries.

INTERNATIONAL TECHNICAL LICENSING

Why License? men. Thus managers tend to be quite careful

A company can profit internationally from

its technology by licensing to firms abroad, as

well as through exports that utilize the technology, or through foreign direct investment

(FDI). Seldom would managers put licensing

at the top of the list for exploiting their technology in foreign markets. If the company’s

about which technologies they will license, and

the conditions for external use. Even when a

company builds a plant overseas, it will often

choose a legal contract to help safeguard proprietary knowledge, rather than transferring

technology informally, particularly with partially owned affiliates.

know-how gives it a competitive advantage, Beyond these considerations, markets for

they will want to retain control—much easier technology do not work as well as product marwithin the firm than outside it. Licensing agree- kets. Buyers and sellers have trouble finding

ments are notoriously difficult to police, and each other. Proprietary technologies may be

unauthorized actions by licensees not uncom- available from only one firm, with a scattering
Ch. 6— Technology Trade: Licensing by U.S.-Based Firms • 195

of near and not-so-near substitutes; with few

buyers and sellers for a given technology, pricing becomes uncertain. Neither party—but particularly the potential buyer—can have a very

clear idea of a technology’s worth. Considerable adaptation and re-engineering may be

needed before technologies developed in one

company can be used in another; these costs—

which may be high and uncertain—reduce the

potential returns. For such reasons, the determining factors in setting royalty levels and the

rest of the compensation package may be rules

of thumb, negotiating skills, and relative bargaining power more than the value of the technology as it would be established in a better

developed market. It should be no surprise that

less developed countries (LDCs) often complain

that they must pay “too much” for technologies,

or that some U.S. firms will not license at all

outside their own organization. Box U summarizes some of the characteristics of typical

licensing agreements.

Despite the difficulties of negotiating mutually satisfactory agreements, licensing revenues

continue to increase, as table 23 showed. Why?

For

●

●

three primary reasons:

First and most important, American companies license abroad when this is the only

alternative for exploiting their technical advantages. Trade or investment barriers may

restrict foreign investment to minority positions, or foreclose exporting and FDI entirely. (Licensing in Eastern Europe has

turned out to be a lucrative business for

some American companies. ) For smaller

firms lacking export experience or an international division, licensing may be the

only practical route.

Second, firms may have other options but

nevertheless choose licensing for strategic

reasons. Licensing can be a good way to

test the waters in an unfamiliar market, or

earn revenues in smaller countries or those

where political risks are high. Moreover,

MNCs have come to view licensing as a

valuable tool in crafting complex international strategies. For example, American

firms have licensed manufacturers in South

Korea and Taiwan to help create stronger

competition in the Far East for Japanese

firms, as discussed later in the chapter.

• Licensing within the corporation, finally,

takes place for a variety of reasons—all of

which come down to efforts by the firm

to manage international operations rationally. For instance, licenses help with accounting and management control: the division that develops the technology gets the

credit. Most important, licensing agreements

provide useful mechanisms for transferring funds internationally—mechanisms

that may be available even when governments block other flows of funds, or enforce

unrealistic foreign exchange controls.

U.S. Receipts and Payments

Foreign investments by American companies

have been heavy during the postwar period,

with many firms transferring technology to support their overseas manufacturing operations.

In 1985, payments from affiliated foreign companies accounted for 70 percent of U.S. licensing receipts ($4, 1 billion of the $5.8 billion total, table 23); payments by U.S. companies

totaled only $847 million. But as the table indicates, the Nation’s surplus on royalties and

licensing fees grew only slightly during the

1980s.

Figure 38 shows that licensing with other industrialized countries accounts for the great

majority of U.S. revenues; only 5 percent of

affiliated receipts come from LDCs, and 17 percent for unaffiliated receipts. Payments by Japanese and European firms accounted for threequarters of receipts from affiliates and over half

from unaffiliated companies.

While capturing the general patterns, table

23 and figure 38 do not convey a full picture

of U.S. licensing. First of all, BEA’s data cover

all licensing fees, for both new and ongoing

agreements. With the average length of agreements in the vicinity of 10 years, trends are slow

to emerge; neither the number of new agreements in a given year, nor their value, can be

isolated. Second, BEA does not collect data on

the value of licensing agreements for which no

royalties are charged. In industries like electronics, where cross-licensing is common, com-
196 ● International Competition in Services

Box U.—The License Agreement

When technology is transferred, either domestically or internationally, a formal contract will normally set out the obligations of buyer and seller. The license agreement conveying technology to the

buyer sets the conditions on its use—e.g., requiring the recipient to maintain quality standards, limiting the geographical markets in which the technology can be used, prohibiting resale. Compensation

can take a variety of forms: a one-time fee; royalties set at a percentage of the licensee’s sales; a reciprocal

technology transfer; even an equity shareholding in the firm receiving the technology. With the agreements becoming more thoroughly integrated into the ongoing businesses of MNCs, many contracts

today incorporate combinations of these payment forms.

Most license agreements cover fixed terms, commonly in the range of 5 to 20 years. Royalty rates

vary a good deal, and may be less than 1 percent of sales in the petroleum industry but 15 percent

or higher in pharmaceuticals. Given the poorly developed markets for technology, industry norms

have a good deal of influence over royalties. Typical rates range downward from 10 to 15 percent

in the pharmaceutical industry, to 3 to 5 percent in computers, 2 to 3 percent in chemicals (other

than petroleum), and around 2 percent for many consumer products sectors. The rates also vary with

other contract provisions; automakers may get royalties of no more than a quarter of a percent, but

earn substantial profits from sales of parts and subassemblies to firms that assemble their vehicles

under license.1

In the simplest case, the agreement gives the licensee the rights to a patent, conveying no other

technical information. Because patents are public knowledge, the license amounts to an agreement

that the licenser will not sue for infringement. (While copyright and trade secret law, as well as patents, provide protection for intellectual property in the United States, these protections maybe much

weaker in other countries—one reason so much licensing takes place between companies that share

ownership ties.) The great majority of agreements, however, are designed to transfer technology in

a broader sense: the licensing package may convey knowledge in the form of technical manuals, engineering data, manufacturing specifications, administrative procedures and management techniques,

trade secrets, and—particularly if the licensee is inexperienced or the technology complex—technical

training and assistance. Transferring technology can be a difficult and costly business; often, disembodied or tacit knowledge can only be passed along through experience-based learning, with the licensor’s employees working alongside those from the licensee.

Licensing agreements demand management attention past the point of negotiation and transfer

of technology. Each party has an interest in the continuing technical capabilities, markets, and strategic plans of the other. One former executive of a large American multinational recalled in an OTA

interview a meeting with a group of Japanese representatives to discuss a new licensing agreement

between the two firms. The Japanese came prepared with a report summarizing the 300 existing agreements between the two companies, leading the Americans to conclude that their counterparts knew

far more about the relationship between the two companies, and were in fact managing that relationship in ways the Americans had not begun to think about.

I Most contractual royalty rates probably fall in the range of 1 to 8 percent of sales-Licensing in International Strategy: A (Wide for Planning

and Negotiations (WestPort, CT: Quorum Books. 1985), PP. 9, 75,222. See PP. 1UG109 for survey reaults on the content of licensin8 agreements>

showing, for example, that the great majority of licensing agreements make explicit provision for technical assistance to the licensee.
Ch. 6—Technology Trade: Licensing by U.S.-Based Firms • 197

Figure 38.— Geographic Distribution of U.S.

Technical Licensing Receipts, 1985

4

3

2

1

L

. —

Western Canad a Japa n Australia Other

Europe New

Zealand

~ Unaffiliate d

❑ Affiliated

and

South

Africa

SOURCE R C Krueaer U S International Transactions First Quarter 1986

SurvPy of ~urrent Elus/ness June 1986 pp 65-66

panics may trade a great deal of quite valuable

technology with no money changing hands. Finally, there is little information on technology

transferred by the overseas affiliates of American firms, which themselves license to perhaps

another 10,000 foreign firms. 2

As noted, growth in the U.S. surplus on licensing slowed during the 1980s, primarily because receipts increased by only $800 million

from 1980 to 1985 (table 23). Payments by U.S.

firms for foreign technology, although still

much smaller than receipts, have been rising.

Unfortunately, it is hard to tell how fast inward

licensing has been increasing, because of the

cumulative nature of the statistics; these, as

ZAccording to a 1977 survey, the latest available, U.S. affiliates abroad licensed to another 5,5oo affiliated foreign firms and

to 4,600 unaffiliated enterprises. See U.S. Direct ~nvestrnent

,WrI)ad, 1977 [Washington, DC: Department of Commmcc, 1981],

p. 166. At least 8,000 of the 24,000 o~wrseas affiliates of [J. S. firms

made use of the parent firms processes and patents-p. 1 (13.

pointed out above, lump new agreements together with payments for licenses negotiated

10 or 20 years ago.

Many other indicators do provide evidence

that foreign firms have been catching up technologically. For example, U.S.-based MNCs

now transfer technologies to their affiliates

much earlier in the product cycle than in the

earlier postwar period. q Such trends, together

with past OTA assessments dealing with specific technologies and/or industries, show that

the U.S. lead in technology has already narrowed

dramatically (and in some cases vanished). For

the most part, the reasons lie in steadily improving technical abilities in other parts of the

world, rather than lagging investments in U.S.

R&D. But it seems plain that the United States

needs to look to its technology base. In industries ranging from steel to microelectronics to

automobiles, higher priorities for commercial

technology development could have helped the

United States deal with competitive problems.

private industry did not make these investments.

This suggests, in turn, that if maintaining the

competitiveness of U.S. industries is to be a concern of the Federal Government, then policymakers must seek incentives for encouraging

private sector R&D, as well as for diffusing the

results to American companies. Analysis later

in this chapter indicates that strengthening the

Nation’s technological advantages should be

a high priority for U.S. policy makers.

sE. Mansfield and A. Romeo, “Techrlolog} ‘1’r,ir~\frr I() O~[’r--

seas Subsidiaries by U.S.-Based Firms, ” Quarterl~ )ourn,d of l;conmnics, \’ol. 95, No. 4, December 1980, p. 739. Al S( J E. hlarlsfield, “Market Structure, International ‘Iechn{)log} ‘[’ransfer, anti

the Effects on Productivity of the Cornpo\itiorl of R an(i I) Iixpenditures, ” final report to the National S( lt!rlc.e Fourl(fatlor~,”

1981, p. 51, The proportion of technologi[’~ ll~~s than 5 }(;ar~ 01(I

(as measured by the time since first utilization in tht’ [ !nited Statet)

transferred to subsidiaries in developed countrlos in( rea~ed from

27 percent for the period 1960-68 to 75 perxcnt for 1969-78 [although no such trend emerged for technolo~ies t riinsferred to

subsidiaries in LDCS or through unaffiliated 1](. crlscs and joint

ventures). Mansfield found that technologies t r:] n ~fcrred to affiliates in developed countries were much ne~~(!r’ or) t ht) a\r(lrage

(with a time lag since utilization in the United St at es Of ~.~~ ~ M,->}

than those transferred to subsidiaries i n develol)ing count rit:~

(9,8 years).
198 ● International Competition in Services

TECHNOLOGICAL ADVANTAGE AND NATIONAL STRATEGY

Has the ability of U.S. firms to compete in

technologically based products really declined?

There is no smoking gun, Yet a body of evidence

with impressive cumulative impact supports

such a conclusion, This section examines a

range of indicators bearing on U.S. technology,

before going onto comparisons with Japan and

other nations.

R&D and Technology Development

in the United States

Although resource inputs to technology development increased over the 1970s and into

the 1980s, outputs decreased on several measures. Figure 39 shows that R&D spending by

American companies has grown steadily in real

terms, with the exception of recessionary periods

in 1971-72 and 1975. Expenditures grew by

more than 80 percent in real terms over the

period 1975-1985 (reaching an estimated $22.6

billion in 1972 dollars, corresponding to $52.4

billion in 1985 dollars). The number of engineers and scientists engaged in R&D has increased from about 500,000 in the middle 1960s

to more than 750,000 currently (a period during which R&D engineers and scientists in Japan tripled, as noted below).

Many more engineers and scientists graduated from American universities during the

cyclical upswing of the 1980s than during the

previous decade. Although undergraduate engineering enrollments turned back down in 1984,

bachelor’s and master’s degrees in engineering reached record highs during the first half

of the 1980s—of particular significance given

that engineers and scientists play quite different roles in technology development (transfers

of skills across the boundary between science

and engineering can be far more difficult than

the layperson might imagine]. After rapid growth

during the 1960s, the number of doctoral degrees

in science and engineering peaked in the early

1970s and began to slowly decline. The drop

would have been more rapid—and its consequences more serious—without an influx of foreign students, particularly dramatic at the doctoral level in engineering (table 24). Although

comprising only2. 7 percent of the total student

population, foreign students received 42 percent of all engineering doctorates in 1983. 4

Many of these foreign graduates remain in

the United States and find jobs with American

corporations. In 1984, for example, 87 percent

of foreign doctoral recipients with permanent

visas and 49 percent of those with temporary

visas chose this option, s Because they can seldom get security clearances without citizenship, more foreign-born technical graduates

find their way into American companies that

emphasize commercial rather than defenserelated lines of business. (About 20 percent of

the Nation’s engineers work in defense industries .5) In fact, American industry has come increasingly to rely on foreign nationals to fill

technical jobs. The proportion of the U.S. engineering work force made up of naturalized

citizens grew from about 5 percent in 1972 to

15 percent a decade later, Many high-technology companies in such industries as semiconductors and computer software depend heavily on foreign-born engineers, some of whom

have themselves started entrepreneurial firms;

Tandon Corp., founded by Sirjang Tandon in

4More foreign students enroll each year in American universities (over 300,000) than in those of France (1 10,000), the United

Kingdom [60,000), West Germany (50,000), and Canada (40,000)

combined—S. Kahne, “Does the U.S. Need a National Policy on

Foreign Students?” Engineering Education, October 1983, p, 54.

The greatest numbers of foreign nationals in American universities come from Taiwan (22,600 in 1984-85), followed by Malaysia

(21,700), Nigeria (18,400), and Iran and South Korea (both about

16,500). See Trade in Services: Exports and Foreign Revenues

(Washington, DC: Office of Technology Assessment, September

1986), p. 64.

S“Foreign Citizens in U.S. Science and Engineering: History,

Status and Outlook, ” National Science Foundation, Division of

Science Resources Studies, Washington, DC, January 1985, pp.

168-169.

8At the B.S. level, the 1984 figure for all engineers was 19.9

percent, ranging from 59,8 percent for aerospace engineers down

to 16 percent for materials specialists. About 20 percent of B.S.

level computer scientists, and 40 percent of mathematics majors

were working on Defense Department projects in 1984, The percentages have generally declined somewhat since the Vietnam

War period, and are broadly similar among engineers with graduate degrees. See The impact of Defense Spending on Nondefense

Engineering Labor Markets (Washington, DC: National Academy Press, 1986), p. 74.
Ch. 6— Technology Trade: Licensing by U.S.-Based Firms ● 199

Figure 39.—Constant-Dollar Growth in R&D Spending by American Companies

1965

■

m

.

1970

■

✎

m

.

m

.

1975

Year

m

.

■

✎

,

.

m

.

m

.

1980 1985

NOTE 1983 prellmlnary, 1984 and 1985 estimated

SOURCE Sc/ence /nd/caters 1985 (Washington, DC Nat!onal Sc!ence Board, 1985), p 252

Table 24.— Foreign Nationals Receiving Doctoral 1975 to make disk drives for computers, is one

Degrees in Engineering and Science From

American Universities

Foreign nationals on temporary visas

as a percentage of all doctoral

recipients in engineering and science

Field 1966 1970 1974 1980 1983

Engineering 16 70/o 13.7% 22.4% 34.3% 42.1%

Physics and astronomy 122 11,3 17,2 19,2 24,6

Chemistry 11 1 7.9 102 15,4 16.1

Mathematics 126 10,9 18,5 18,7 29.8

Totala15 .3% 12 .5% 16. 7% 18.8% 15.5%

al nclud~s;he ‘followtng fields not sepa rately tabulated biological earth enwronmental agricultural and medlcaj sciences economics pollhcat science

SOURCE Demographic Trends ano the Sc/en!/f/c and Eng/neer/ng Work Force –4 Techn/cal

Memorandum (Washlngfon DG Off Ice of Technology Assessment Oecember 1985)

o 42

of the better known examples. T”

While resource inputs to U.S. technology development show substantial increases in over

the past 10 to 15 years, this growth has been

neither so rapid nor so consistent as in other

major industrial nations (as summarized below).

7

0n Tandon, see C.L. Howe, “Floppy Fortunes Founder, ” Datarnation, Nov. 1, 1985, p. 60.

In many chemical, electronics, and computer firms, the proportion of foreign-born technical employees has risen to a quarter

or more--’ ’Survey of 300 U ,S, Firms Finds One-Half Employ Foreign Scientists and Engineers, ” NSF 85-336, National Science

Foundation, Division of Science Resources Studies, Science Resources Studies Highlights, Washington, DC, Feb. 28, 1986, p. 1.
200 ● International Competition in Services

Moreover, expansion in U.S. R&D has come

to depend on the willingness of foreign-born

students to emigrate to this country. (Americaneducated engineers from South Korea and Taiwan often return home in mid-career, becoming highly productive employees of firms that

compete with U.S.-based enterprises.) Finally,

resources devoted to commercial technology

development have not grown as rapidly as those

going to defense-related R&D, which attracts

many of the Nation’s best technical people.

If such observations seem troubling, the data

on outputs of the R&D process are more so. Although R&D outputs are much harder to measure than inputs, patents and other indicators

offer proxies. Figure 40 shows that patenting

in the United States by Americans has steadily

declined from a peak in 1970. In contrast, U.S.

patents granted to foreign parties have continued to rise.

Given the greater expenditures on R&D noted

above, why should the rate of patenting by American corporations slow? (Companies, rather

than individuals, file for most patents.) Two

possibilities exist: declining productivity of the

R&D process in the United States, and/or conscious choices by American companies not to

seek patent protection. Taking the second possibility first, a recent survey of U.S. firms found

more reporting an increase than a decrease in

the percentage of developments they chose to

patent.

8 All else the same, this finding of a

greater propensity to patent, coupled with the

drop in total patents granted, suggests that the

number of patentable inventions resulting from

U.S. industrial R&D has fallen. Further evidence pointing in the same direction comes

from a decline in research publications by industrial employees. The number of such publications fell from 12,200 in 1973 to 10,400 in

1980, with most of the drop occurring between

1973 and 1977.9 In sum, there is good, although

*E. IMansfield, “Studies of Tax Policy, Innovation, and Patents:

A Final Report, ” Final Report to the National Science Foundation, October 1985, p, 86, The survey covered patenting decisions over the periods 1965-69 and 1980-82 in 100 U.S. firms,

Whe figures include all articles with at least one author from

private industry in o~’er 2,IOO journals included in the Science

Citation Index of the Institute for Scientific Information. See

Science Indicators 1982 (Washington, DC: National Science

Board, 1983), p. 296.

Figure 40.— U.S. Patents Granted, by Nationality

of Inventor

80.000 (

NOTE 1979 data are spuriously low due to lack of funds In the Patent Of ffce

for prlntlng and Issuing patents

SOURCE Sc/errce lrr~lcafors 1985 (Washington, DC National Science Board,

1985), p 258.

not conclusive, evidence that, despite growing

investment in commercial technology development in the United States, the flow of new technologies from that effort has declined.

Foreign Technology Development

Europe and Japan

Certainly, technology development in the

United States has not matched the surge abroad.

Since the end of World War II, Europe and Japan have rebuilt their technological infrastructures and manufacturing capacities to the point

that many companies now operate at the stateof-the-art in many technologies. As previous

OTA studies have indicated, lagging international competitiveness among European firms

can seldom be attributed to disadvantages in

technology; the sources of competitive difficulty typically lie elsewhere, often in the translation of technology into viable commercial

products. 10 Japan, in some contrast, has applied

IOSee, e.g., ]nternationa] Competiti\’eness in Electronics (Washington, DC: Office of Technology Assessment, November 1983),

chs. 4, 5, and 10.
Ch. 6—Technology Trade: Licensing by U.S.-Based Firms • 201

—

Table 25.—Technical Licensing Transactions of Selected European Countries

Balance of payments position in fees and royalties

(millions of 1975 U.S. dollars)

1972 1982

Receipts Payments Balance Receipts Payments Balance

United Kingdom. . . . . . . . . $561 $508 $+53 $608 $496 $+147

France . . . . . . . . . . . . . . . . . . 301 459 – 158 550 641 – 9 1

Federal Republic of

Germany ... . . . . . . . . . . 269 627 –358 340 675 –335

Netherlands . . . . . . . . . . . . 151 222 – 71 209 351 – 142

Italy . . . . . . . . . . . . . . . . . . . . 81 470 –389 133 496 –363

SOURCE OECD Science and Technology Indicators // Resources Devoted to R&D, Techno/ogica/ Performance and /ndustr/a/

Cornpef/t/veness (Parts Organization for Economic Cooperation and Development, 1985), p. 69,

technology very effectively during its rise as

an industrial power,

Both Europe and Japan have imported technical know-how from the United States, as figure 38 suggested. In Europe, inputs of American technology accompanied heavy direct

investment by American firms beginning in the

1950s. Europe’s technology imports continued

to increase, but more rapid growth in outward

licensing shows that European countries have

become important sources for new technology

as well. Even so, as table 25 indicates, only the

United Kingdom has been a net exporter of

technology. (Indeed, a bare handful of nations

run a surplus in licensing transactions. )

In Japan, where government policies prevented most direct investment by American

companies, the technology transfer channels

differed (box V). About two-thirds of Japan’s

licensing payments continue to go to U.S. firms,

with most of the remainder to European companies (figure 41). In Europe, affiliates of American companies account for the lion’s share of

U.S. licensing revenues (table 26); in contrast,

arms-length transactions—those with unaffiliated firms—have predominated in Japan. Finally, while Japan’s total licensing payments

still exceed receipts (table 27)—reflecting old

licenses—new outward licensing by Japanese

companies has exceeded inward licensing since

1973 (much of this associated with FDI by Japanese companies elsewhere in Asia).

What of R&D spending in other nations? Over

the period 1969-81, real R&D spending by business and industry (rather than government) in

the United States grew at 4.1 percent per year,

Figure 41 .—Japan’s Technology Imports, 1982

From elsewhere

$10 million (1 0

/0)

Total: 6,936 licensing agreements valued at $1 16 billion

SOURCE: Report on the Survey of Research and Deve/opmenf (Tokyo Prtme

Minister’s Office, Statlst!cs Bureau, 1983), p 44

less than half the rate (8.6 percent) in Japan.11

Today, business and industry in Japan spend

more on R&D than in any other country except

the United States—table 28. While the rate of

growth of business spending on R&D in current dollars has been slightly greater over the

I IOECD Scjence and Techno]og\, indicators 11.. Resour(; es

Devoted to R&D, Technological Performance and ln(l[l,~tri~l {,’(I:IE

petitiveness: Annex (Paris: Organization for E[:on[]mic (;oo~)t,r

ation and Development, 1985), table 4, O\’er the ] ~6%8 i period,

the real annual rates of growth in business-funded R&D a\’era,ged 5.4 percent i n West Germany, 5.5 percent in Fra rice, but

on]}’ Z.O percent in Britain. The figure for the European Economic Community as a whole comes to 4.5 percent, and for the

Organization for Economic Cooperation and De\relopment, 5.o

percf~nt.
202 ● International Competition in Services

Box V.—Have U.S. Firms Licensed Their Technology Too Cheaply?

American technology helped fuel postwar economic growth in both Europe and Japan. In Europe, American technology accompanied American investment, but the Japanese Government followed

a strategy of restricting direct investment. With government policies also limiting goods imports, and

Japanese companies aggressively seeking foreign know-how, American companies supplied Japan

with a great deal of technology under arms-length licensing agreements. Only in the late 1960s did

Japan begin opening its economy to foreign investment and imports; after 1967, majority foreign ownership in new Japanese companies was permitted in some industries, with entry into others liberalized

later. As table 26 indicates, U.S. companies continue to receive substantially more in royalties and

license fees from unaffiliated firms than from affiliates in Japan. In contrast, affiliates account for

80 percent of payments from Europe.

Between 1950 and 1980, Japanese firms entered into more than 30,000 technology transfer agreements with American companies, for which they paid an estimated cumulative total of $10 billion.1

With remarkable speed, Japanese companies moved from commodity goods and simple consumer

products to high-technology manufactures, including computers and integrated circuits that often

match or exceed the best products of American firms. Today, many Japanese companies continue

to pay royalties on technologies they have long since adapted and improved upon.

Hence the claim that, into the 1970s, American companies sold technology to Japan too cheaply.

The implication is that an appropriate price for a given package of technology exists, and that, for

one reason or another, bargaining processes between U.S. firms and potential licensees in Japan failed

to identify it. In essence, the underpricing argument suggests that U.S. companies took an overly

simple approach to licensing decisions-that they considered their technology development expenses

as sunk costs, with licensing revenues desirable as extra returns. Because they underestimated the

ability of Japanese manufacturers to challenge them in the U.S. market and in third countries, American companies accepted royalty rates that were too low.

As this suggests, the question of possible underpricing of technology can be discussed on several

levels. Normally, an American firm with proprietary technology will assess the possibilities for exploiting its know-how internationallly, with an eye to maximizing profits. In Japan, government restrictions barred both U.S. exports and FDI. Given these constraints, licensing might seem the best—

indeed only-choice, on the basis that some return from the Japanese market is better than none.

But what of the royalty to be charged? How should it be set? From the licenser’s point of view, almost

any royalty rate might be acceptable, since the R&D had already been paid for. But plainly, such a

calculation depends on the absence of future competition based on the transferred technologies. If

American managers had foreseen that Japanese manufacturers would enter U.S. markets, and compete with them for export sales in third countries, they should have demanded higher royalties. In

the extreme, they might have refused to license at all.

In any case, Japanese companies learned very quickly to innovate on their own; the stream of

new products in consumer industries beginning during the early 1960s shows this quite convincingly, as does the unquestioned technical competence of Japanese firms in industries like iron and

steel productions Help from American companies was useful but seldom essential, and, in later years,

only rarely went beyond that available from Europe. If licensing saved the Japanese time and money,

American firms benefited from revenues that they could invest in their own operations—earnings

that, for U.S. industry as a whole, have approached $1 billion annually in recent years (table 26).

Finally, even with hindsight, the consequences of particular licensing arrangements often remain

ambiguous. In 1960, when Japan’s Government permitted IBM to begin local production of computers,

*J. Abegglen, “U.S.-Japan Technologimd Exchange in Retroapaot, 194S-1S81,” ?’ecbnological Exchange: The U.S,-Japaneae Experience, C.

Uyehara (cd.) (Washington, DC: University Press of America, 1SS2), p. 1.

zFor one of the most WY documented recent accounts, fomming on manufacturing technology aa weil as product development, aae M.A.

Cusumano, The Japanese Automobile Indu@y: TechnolqyandMunagement at Nfsa8n and Toyota (Cambridge, MA: Harvard University Press,

1985).
Ch. 6— Technology Trade: Licensing by U.S.-Based Firms ● 203

the price included licenses for Japanese companies. IBM-Japan quickly gained the lead in the Japanese computer market; although overtaken in sales during the first half of the 1980s by Fujitsu and

NEC, IBM still has the largest installed equipment base in Japan. Both the Japanese companies benefited to at least a modest extent from IBM’s licensing. But if IBM had not granted these licenses,

the company probably would not have been permitted full-scale entry into Japan’s computer market

until the liberalization of the 1970s, by which time its rivals’ installed bases would have presented

a severe obstacle to market penetrations

Today, most American firms would claim to take considerable care in negotiating license agreements to prevent future damage to their own interests—and more care today than in earlier years.

Where once they licensed their microprocessor designs to Japanese firms, American manufacturers—

who remain well ahead in this technology—now refuse to do so.4 In OTA’s interviews, American

managers expressed a clear sense of the strategic risks involved in licensing in Japan (or to newly

industrializing countries, particularly in the Far East). But their evaluations-whether of isolated armslength agreements, or of complex strategic options in which licensing is one part of a carefully designed thrust into overseas markets—will be couched in terms of their own interests, and to a lesser

degree those of their industry, their suppliers, their customers. The bigger picture of U.S. competitiveness will more than likely remain outside their calculations.

When it comes to tightly written licensing agreements recent shifts in antitrust enforcement by

the Federal Government make things easier for American companies. Managers express considerably less concern than half a dozen years ago over possible antitrust litigation, given that the Department of Justice has sent enough signals to convince even the more conservative corporate legal advisers that restrictive licensing provisions, once subject to challenge as anti-competitive, will be viewed

more tolerantly in the future (seethe section on “Policy Issues” later in the chapter). Companies now

feel free to negotiate agreements barring their licensees from a wider range of activities that might

pose direct competitive challenges.

In the end, the original question—whether U.S. firms licensed their technology too cheaply–

seems less significant than the question of how the United States can begin to learn more effectively

from Japanese technology. Regardless of the extent to which Western technologies helped Japan reach

early technical maturity, the fact is that in the future the United States will have to depend as heavily

on Japanese technology as Japan depends on the United States. U.S. licensing payments to Japanese

companies have been steadily increasing, with about a fifth of all U.S. payments now going to Japan.

Rather than seeking to stem technology outflows, U.S. policymakers might make equal access to foreign technology a negotiating objective in trade talks, fund fellowships for American students in engineering and science to work in Japanese laboratories, and seek exchanges of U.S. industrial R&D

personnel with those of Japan (and other countries). (Ch. 10 includes specific policy options.) Direct

participation by Americans in overseas industrial R&D will speed U.S. access; people transfer technology much more effectively than documents. It is time for Americans to go overseas in search of

technology as frequently as foreigners come here.

Slnternational Competitiveness in Electronics (Washington, DC: Office of Technology Assessment, November 1983), p. 154.

qThis refusal is one reason for a new agreement between Fujitsu and Hitachi to jointly develop a family of 32-bit microprocessor designs,

See S.K. Yoder, “Hitachi, Fujitsu Link in Microprocessors,” WaJl Street ]ournal, Oct. 28, 1988, p. 39.

past 5 years in the United States, if adjusted

for inflation, growth would be considerably

more rapid in Japan. Furthermore, the overall

lead of the United States stems from nothing

more than the greater size of the U.S. economy.

In Japan, industry now accounts for more

than three-quarters of all R&D spending, compared with about half here, while businessfunded R&D as a percentage of gross domestic

product (GDP) is much higher in Japan. As indicated in table 1 (ch. 1), business and industry

in Japan spent (a projected) 2.14 percent of GDP

on R&D in 1986, compared with 1.42 percent

in the United States. As table 1 also showed,

in the early 1970s, this ratio did not differ

greatly among the United States, Japan, and

West Germany. Around the middle of the dec-
204 ● International Competition in Services

Table 26.—U.S. Technical Licensing With

Europe and Japan (millions of current dollars)

Affiliated Unaffiliated Total

U.S. receipts of royalties and license fees from Western European

companies:

197 8 $1,482 $448 $1,930

198 0 2,019 476 2,495

1983 2,355 628 2,983

1984 2,467 604 3,071

198 5 2,657 634 3,321

U.S. receipts of royalties and license fees from Japanese companies:

1978 $273 $399 $ 612

1980 —a 347 NA

1983 392 523 915

1984 449 549 998

1985 476 576 1,052

NA = Not available

aoata ~u~~ressed by IJeparfrnerll of Commerce tO preSerVe confldentlallfy

NOTE 1983-85 data are not dlrecfly comparable with that for earlier years because of a new benchmark survey and the Incluslon of non-manufacturing royaltles and fees beginning m 1983

SOURCES 1978, 1980 Oeparfment ot Commerce, Bureau of Economic Analysls, unpublished statlsIICS 1983-85 R C Krueger “’U S International TransactIons First Quarter 1986 ‘

Survey of Currerrf Business, June 1986, pp 64-65

ade, however, both Japanese and German companies began increasing their R&D spending

at higher rates. The increase in Japan since 1980

has been especially dramatic. Everything else

the same, the figures in table 1 demonstrate that

Japanese and also West German companies

have placed substantially higher priorities on

R&D than their American counterparts; the

very high rates of R&D spending by Japanese

companies over the past 3 years demonstrate

their intent to move even more rapidly into high

technology.

Trends in employment of R&D engineers and

scientists paint a similar picture, Since 1965,

the number of engineers and scientists has increased steadily in the United States, as well

as in Japan and in West Germany, Britain, and

France. In 1981, the last year for which data

are available for all five countries, the United

States employed more R&D personnel than Japan and the three major European economies

combined. 12 While impressive, this represents

a much smaller differential than existed in 1965,

when about twice as many people worked in

R&D in the United States as in the other five

countries. Indeed, the number of R&D personnel in the United States actually declined during the early 1970s. U.S. R&D employment

passed its earlier peak by 1977, but none of the

other countries passed through such a slump.

One further input measure stands out as having grave implications for the future: the number of engineering graduates. Japanese universities have been awarding more engineering

degrees at the bachelor’s level than have American schools—74,()()() in 1982 compared with

67,000 here.13 Six engineers graduate in Japan

for every scientist; in the United States, 1.4 science majors graduate for every engineer. Although engineers and scientists share many

IzScience IIldicators: The 1985 Report (Washington, 11[~: National Science Board, 1985), p. 186, The 1981 figures are: United

States, 691,000; Japan, 318,000; Germany, 128,000; Britain, 96,000;

France, 85,000. By 1983, the U.S. figure was 750,000, and that

in Japan, 342,000,

IsScience Indicators: The 1985 Report, Op. cit., p. 6. ‘1’lle number of engineering bachelor’s degrees awarded in Japan has

grown steadily from 10,000 in 1955—1,.S. Hiraoka, “Japan’s Technology Trade, ” Technological Forecasting and Social Change,

vol. 29, 1985, p. 237. For the data on engineering graduates compared to science majors, below, see international Science and

Technology Data Update 1986, NSF 86-307 (Washington, DC:

National Science Foundation, 1986), p, 28.

Table 27.—Japan’s International Technical Licensing

Outward licensing Inward licensing Net receipts

Value Value Value

Number of (Billions (Millions Number of (Billions (Millions (Billions (Millions

agreements of yen) of dollars) agreements of yen) of dollars) of yen) of dollars)

All Japanese technology exchange agreements in force: “- -

1978 . . . . . . . . . . . . . 3,157 122,0 $620 6,573 192.1 $ 985 – 70.1 $–359

1980 . . . . . . . . . . . . . 4,103 159,6 786 7,248 239.5 1179 – 79,9 – 394

1982 ... ... . . . . . . 4,738 184,9 760 6,936 282.6 1162 – 79,7 –402

New Japanese technology exchange contracts:

1978 . . . . . . . . . . . . . 1,063 47,1 $242 936 38.2 $ 196 8.9 $ 46

1980 . . . . . . . . . . . . . . 1,237 74,3 366 919 27.7 136 46.6 230

1982 . . . . . . . . . . . . 1,970 63.3 260 929 44,4 183 18,9 78

SOURCE Report on fhe Survey of Research and Devej;prnerrt (Tokyo Prime Minister’s Of flce~Statlst!cs B~reau, 1983) p 42
Table 28.—R&D

United States;

Billions of dollars .

As percentage of all U.S. R&D

Japan:

Billions of yen . . . . . . . . . . . . . . .

Bill ions of dollarsb 

. . . .

As percentage of all Japanese

R&D . . . .

Federal Republic of Germany:

Billions of deutsche marks . . . . .

Billions of dollar s

b 

.

As percentage of all

West German R&D ., . . . . . . .

aProlected

Ch. 6—Technology Trade: Licensing by U.S.-Based Firms ● 205

Funded by Business and Industry

Business-funded R&D expenditures

(billions of current dollars, yen, or

deutsche marks and percentage of

Average annual

total national R&D spending)

rate of growth,

1981-86

1981 1983 1985 1986a (percent)

.—

$35.9 $43.2 $53.2 $58.2 1o.1“/0

50.0 ”/0 50.0 ”/0 49.9% 49,80/o

4,364 5,451 6,500 7,000 9.9%

$19.8 $23.0 $27.5 $42.9

72.90/o 75.9 ”/0 77.4 “/0 77.80/o

22.5 26.0 30.0 32.5 7.6 ‘/o

$10.0 $10.2 $10.3 $14.9

54.90/0 56.6% 57.6 “/o 58.80/o —

bco~verslon~ t. dollars for year In ques[lon from EconorrrIc Repor( of the President (Washington DC U S Government Prtnt

I n g Of flee February 1986} p 373 except for 1966 where m!d-year values have been used

SOURCE FRG Institute Compares German U S Japan Research Expend itures, ” Europe Repofl-Sc/ence and Technology

Joint Publlcatlons Research Service JPRS-EST-$36033. Nov 6, 1986, pp 25, 28, 31 Translated from Techno/og/e

Nachr~chfen May 15 1986 Or(glnal source Battelle Institute, Frankfort

skills, product/process design and development

—the heart of an industrial R&D operation—is

work for which engineers are trained and scientists are not. The quality of engineering education in Japan is distinctly inferior to that in

the United States, but in numbers—given that

Japan has, for more than a decade, been graduating twice as many engineers per capita—it

would be hard to fault that country’s performance.

14

What have been the impacts of increased inputs to the R&D process in other countries? Patent applications have fallen in the major European nations (table 29), just as they have in the

United States. The implication, again as here:

declining technological productivity. The case

is different for Japan, where companies seem

to have a much higher propensity to patent (in

part because patents are awarded on a first-tofile basis, rather than first-to-invent). This makes

international comparisons of patenting problematic. Even so, the steep rise in domestic pat1~ F I a jc)r Ja pa n~st? (;o rpo ra t ions ha tr[; been fore Cd t o d~~’cl 01)

extensi\.e Internal training programs to compensate for the short-

[:f)m i ngs of Ja pans engineering s(:hoo]s. See In ternationa] Conpctititeness in L’)e(;tronics, 0p. cit., pp. 314-317.

Other r,ount ries graduate engineers in lnuch smaller numbers

than Japan or the United States.

ent applications in Japan—they have more than

doubled since 1970, while patenting in other

countries has declined—probably indicates a

significant increase in the output of Japanese

R&D.

Because patents are only valid in the country granting them, a company seeking to protect its technology must obtain patents everywhere it seeks either to use an invention or to

prevent competitors from doing so. Therefore,

external patenting—filings by residents of one

country in another—become another possible

measure of R&D proficiency. Securing adequate

protection can be expensive, particularly where

multiple patents must be sought to lock up a

new development. Because company managements approach such decisions with care, data

on external patents provide a useful indicator

of the commercial value businesses place on

their technical innovations. These data—table

30—show that American companies file the

greatest number of external applications. But

the figures also show that the number of U.S.

applications fell sharply during the 1970s, before recovering in recent years,

The pattern is similar for Western Europe,

but not Japan, where companies have filed
206 • International Competition in Services

Table 29.—Patent Applications by Domestic Residents (thousands)a

1950 1960 1970 1975 1980 1981 1982 1983

United States. . . . . . . . . . . . . . . . . . . 57.4 63.1 76.2 64.4 62.1 62.4 63.3 59.4

Japan . . . . . . . . . . . . . . . . . . . . . . . . . 14.5 31.9 100.5 135.1 165.7 191.6 210.9 227.7

Federal Republic of Germany. . . . . 31.8 36.5 32.8 30.2 30.6 30.3 31.1 32.1

France . . . . . . . . . . . . . . . . . . . . . . . . 16.2 14.5 14.1 12.1 11.1 11.1 10.8 11.2

United Kingdom . . . . . . . . . . . . . . . . 21.0 22.8 25.2 20.8 19.7 20.9 20.6 20,0

Total b . . . . . . . . . . . . . . . . . . . . . . .178.0 200.6 287.7 299.6 309.3 329.6 350.5 364.5

aThi~ table is ba~~d on ~dj”~t~d ~tati~tics originally compiled by the world lfltellectIJal Propeny organization (WI PO) frorfl

reports of national patent offices The introduction of the European Patent Convention (EPC) system in 1978 and, to a lesser

extent, the Patent Cooperation Treaty (PCT) system in 1970, has made it easier for compan!es to obtain patent protection

in multiple countries Under the EPC, a firm can fi Ie a single application covering some or all of the (European) member na.

tions As companies switched to the EPC system, patenting in the national offices of some of the member countries declined

To correct for this effect, the WIPO statistics have been augmented by EPC “designation” and PCT data for years after 1978

This adjustment ratses external patenting levels for the post-1978 period significantly above the unadjusted levels published

in Science Indicators

blncludes Belgium, Switzerland, Australia, Yugoslavia,Denmark, Norway, Greece, Finland, Portugal, New Zealand, Ireland,

and Iceland, as well as the countries listed separately

SOURCE” OECD Science and Technology Indicators //: Resources Devoted to /?&D, Technological Performance and /ndustr/a/

Cornpet/tiveness” Annex (Paris’ Organization for Economic Cooperation and Development, 1985), table 24

Table 30.—External Patent Applications by Nationality of Applicant (thousands)a

1950 1980 1970 1975 1980 1981 1982

United States. . . . . . . . . . . . . . . . . . . . . . . . . . . 34.5 74.1 123.7 93.0 116.3 127.0 123.2

Japan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . —b 3.0 26.6 27.7 45.5 49.3 56.4

Federal Republic of Germany. . ...........13.3 47.3 70.1 60.8 82.6 82.6 79.5

France . . . . . . . . . . . . . . . . . . . . . ...........11.6 16.2 24.4 23.4 33.0 31.4 34.7

United Kingdom . . . . . . . . . . . . . . . . . . . . .. ..20.5 29.1 33.5 24.4 28.1 31.2 33.2

NA = Not Available.

aFillngs in countries other than that in which the applicant resides. Adjusted statistics, as explained In table 29, footnote a

bNegligible.

SOURCE: OECD Science and Technology Indicators 11: Resources Devoted to R&D, Technological Performance and Industrial

Corrrpetitiveness: Annex (Paris” Organization for Economic Cooperation and Development, 1985), table 24.

steadily increasing numbers of external applications. (The establishment of the European

Patent Convention in 1978 made patenting

across countries in Europe easier, bringing a

sharp rise in external patenting. Under the new

system, a firm can file a single application that

covers some or all of the European member

countries. ) For the United States, the data in

table 30 are rather more encouraging than other

indicators, in that they suggest strong and continuing commitment to international business

by American firms. Yet the data also show a

marked increase in external patenting by Japanese firms; more recent figures, if available,

might well show that Japan has now surpassed

West Germany in external patenting.

Newly Industrializing Asian Countries

Japan, the first industrial power to emerge

in the Far East, has been followed by South Korea, Taiwan, Singapore, and Hong Kong. While

each has pursued its own developmental path,

all have been somewhat akin to Japan in first

concentrating on apparel and other labor-intensive goods before branching into more capitaland skill-intensive industries. Today, some of

these countries, notably South Korea, manufacture integrated circuits not far behind the

state-of-the-art and enjoy expanding shares of

the U.S. market for automobiles, personal computers, and a variety of computer peripherals.

Moreover, as noted in chapter 4, Korean engineering and construction teams went into the

Middle East more than a decade ago, winning

contracts from European and American firms.

In Taiwan as well as Korea, the government

has stepped up support for education and training of technicians, engineers, and scientists.

Like Japan, the newly industrializing countries (NICs) in Asia have licensed technology

from American companies (table 31). But, while

U.S. receipts for royalties and license fees from
Ch. 6—Technology Trade: Licensing by U.S.-Based Firms ● 207

Table 31 .–U.S. Technical Licensing With Newly

Industrializing Asian Countriesa

U.S. receipts of royalties

and license fees

(millions of current dollars)

Affiliated Unaffiliated Total

1978. , . . . . . . . . . . . $ 39 $ 70 $109

1980 . . . . . . . . . . 66 103 169

1982 ... . . . . . . . . . . . . . . . . 67 166 233

1983 . . . . . . . . . . . . . . . . . . . . 99 190 289

1984 . . . . . . . . . . . . . . . . . . . . 121 203 324

1985 . . . . . . . . . . . . . . . . . . . . 115 218 333

aBEA’s categories “developing countries, other” for 1978-82 and ‘other countrles in Asia and Africa” for 1983-85, both of wh Ich exclude Latin America and

therefore reflect primarily Ilcenslng with AsIan NICS Licenses In manufacturing only for 1978-82, all Industries for 1983-85

SOURCES 1978-82. Department of Commerce, Bureau of Economic Analysis, unpublished statistics, January 1966 (Table 6C’ U S. Receipts of Royaltles and Licensing Fees in Manufacturing by Area). 1983-85 R C

Krueger, “U. S International Transactions, First Quarter 1986, ” Survey of Current f3uslness, June 1986 p 66

Photo credit: Bechtel Power Corp.

Cooling tower for nuclear powerplant under construction

in South Korea.

the Asian NICs have been growing at a high

rate, they still account for no more than 7 percent of the U.S. total, Japan has also been a major source of technology for the rest of Asia,

with many licensing deals involving affiliates

of Japanese companies. At the same time, Japanese firms have been notoriously reluctant to

license technology to independent firms in

countries like South Korea that are seen as potential rivals.15 One of the best-known cases has

been the adamant refusal by Japanese firms to

license video-cassette recorder technologies to

Korea. The Koreans developed their own. Japanese steelmaker also raised strong objections

to licensing technology for the expansion of

South Korea’s steel industry. While both South

Korea and Taiwan have set out on a path in

electronics much like that Japan followed—first

consumer products like TVs, then semiconductors and computer equipment—Hong Kong and

Singapore have put relatively more emphasis

on software.

The unanswered question is whether or not

the Asian NICs will continue to expand their

indigenous technological capabilities at a rate

that would eventually challenge other industrial nations. To do so, the NICs would have

to overcome the limitations imposed by small

domestic markets, along with growing trade

friction and import barriers in countries to

which they sell. None of the NICs has been able

to strengthen its science and technology infrastructure as rapidly as Japan did during the

1960s; although technical people have been

returning to South Korea and Taiwan from

overseas in mid-career, all the NICs remain

short of engineers and scientists. They spend

far less on R&D than the advanced nations. Both

domestic and external patenting levels remain

I’M. Schrage, “(Korean) Electronics Industry Seek\ Leading

Edge, ” The Washington Posf, Feb. 9, 1986, p. FI. Also, hl.c.

Harris, “Japan’s International Technology Transfers, ” paper ~repared for presentation at Southeast Region Japan Seminar, Apr.

20, 1985, p. 15.

Still, Japan accounted for 55 percent of more than 3,OOO licenses

arranged by Korean companies betm’een 1960 and 1984—B,

Wysocki, Jr., “Weak in Technology, South Korea Seeks Help From

O\erseas,” M’a]l Street Joornal, Jan. 7, 1986, p. 1.
208 • International Competition in Services

low. 16 For all these reasons, sustained technological challenges from the NICs appear to be

161982 Statistic] yearboO~ [New York: United Nations, 1985),

table 72. Patenting by residents of the four Asian NICS probably

represents less than 1 percent of all foreign-origin U.S. patents

— “All Technologies Report, 1985, ” Department of Commerce,

Patent and Trademark Office, Washington, DC, p. Az.

a long way off. At the same time, these countries have a sound base in a wide range of relatively standardized technologies already, and

seem bound to continue doing well with relatively routine products in quite a wide range

of industries. Perhaps their greatest future

handicap will simply be that they must compete with Japan.

LICENSING STRATEGIES

Integration

Increasingly, American companies view technical licensing as an integral part of their business strategies. Licensing has always been an

alternative for exploiting proprietary technology internationally. But most companies would

choose when possible to maintain a tight hold

over their technical know-how by using it to

produce for export, or transferring it to controlled subsidiaries abroad. Today, these choices

may be less practical than in years past. When

circumstances foreclose possibilities for exports or foreign investment, companies stand

to recoup at least some of their development

costs through licensing. The firm may be able

to earn an incremental return in markets that

it otherwise could not enter at all—for reasons

ranging from its own resource limitations to

foreign government barriers. The situations that

follow are typical:

1.

2.

If trade barriers, small market size, or

management’s lack of familiarity with

overseas markets foreclose exporting from

the United States, licensing a foreign company to make and sell products can provide a means of testing the foreign market

for later investment. Caterpillar Tractor,

for example, often used technical licensing as a precursor to eventual expansion

abroad.

Small companies typically face constraints

on overseas operations stemming both

from financial requirements and limited

managerial experience. Even when they

can afford to invest abroad, many smaller

American firms report that they can’t find

3.

4.

the management talent to expand. Probably for this reason, smaller companies are

more likely to license than larger, integrated firms with a broad range of internal resources to draw on. In interviews,

several executives from small, fast-growing

computer firms cited managerial overload

as a primary reason for weighing foreign

involvements carefully.

Foreign governments may combine import

barriers with investment restrictions (including performance requirements that require high fractions of local value added,

local hiring, or re-exporting), forcing companies to seek alternatives.17 As pointed out

above, Japan barred foreign investment

during the earlier postwar period, while

the Ministry of International Trade and Industry (MITI) carefully monitored inward

licensing. Today, a number of Asian and

Latin American nations emulate this approach.

The U.S. Internal Revenue Service requires

that MNCs allocate R&D expenditures between parent company and subsidiaries.

Managements sometimes choose to formalize this requirement through licenses, even

though no operational need exists.

This list covers only a few examples from the

wide variety of circumstances that can lead

companies to choose licensing as a way of doing business abroad. Generally speaking, foreign market uncertainties, which raise the risks

1 pon foreign government Policies and laws covering licensing, see J.D. Frame, “Political Risk in International Technology

Transfer,” ]ournai of Technology Transfer, vol. 10, 1986, p. 5.
Ch. 6—Technology Trade: Licensing by U.S.-Based Firms ● 209

— .

of direct investment, make licensing more attractive to managements. Such uncertainties

can have many sources: erratic government policies, foreign exchange volatility, lack of information and experience.

The appeal of licensing also depends on the

nature of the technology in question. Most firms

shy away from licensing their core technologies—those on which their primary lines of

business depend—to unaffiliated foreign firms.

Licensing always carries risks of disclosing

knowledge to unauthorized parties; sometimes

the licensee attempts to evade restrictions in

the contract, perhaps using the technology surreptitiously. Because policing agreements is

always a problem, managements seldom take

chances with critical know-how. On the other

hand, a firm that occupies a long-established

competitive niche may well trade even stateof-the-art technologies with others that specialize. Or, a smaller company in a fast-moving industry may simply be unable to exploit every

opportunity that comes along. Both factors are

at work in industries like pharmaceuticals,

where international licensing between competing firms has been common.

Box W amplifies on the circumstances under which American firms license overseas. In

most industries, mature technologies tend to

be licensed relatively freely, but maturity is a

function of the pace of change in the industry.

New developments in electronics—e.g., microcircuit designs—are licensed quickly because

managers know that ongoing R&D will render

them obsolescent in a relatively short time. If

the company is not in a position to exploit these

developments immediately, licensing may help

defray part of the R&D costs.

Of course, licensing agreements themselves

require management oversight; licensees or

joint venture partners must be screened, deals

evaluated, agreements negotiated. Once in

place, the licensee’s operations must be monitored; unsatisfactory performance can harm the

licenser’s reputation, perhaps threatening later

opportunities for exploiting the technology.

Companies go slowly when getting into licensing for the first time. Still, the managerial demands tend to be far less than for an initial foray

into exporting or overseas manufacturing,

As noted in box W, cross-licensing agreements—where firms agree to share each other’s

developments—have become increasingly common, Royalties may or may not be involved,

depending on the match between firms in terms

of development capability. OTA interviews indicate that more and more license agreements

involve two-way flows of technology. A significant proportion of licensing in the pharmaceutical industry, for example, is done on a quid

pro quo basis—i.e., one technology for another.

particularly in industries where few companies

can afford to stay abreast of all relevant technologies, exchanging R&D results helps both

parties. Companies can target their efforts on

quite specific needs, getting complementar y

knowledge elsewhere.

The growing number of international crosslicensing agreements illustrate one way in

which corporate managements have begun

using licensing for strategic purposes. As companies seek to control and apply technical

knowledge to reap longer term rewards, licensing becomes increasingly integrated into the

broader strategic view of upper level managers.

For example, in earlier years, when countries

like Japan closed their markets to exports or

FDI, American companies frequently licensed

unaffiliated companies to manufacture and

market products locally, subject only to the

usual royalty arrangements. Today, the impacts

of such licenses on other aspects of the firm’s

domestic and international business get much

more attention. An MNC might seek to tie new

agreements to the purchase of components

which themselves contain proprietary, but not

licensed, technologies (e.g., a microprocessor

chip set). In this way, the MNC assures continuing product exports, while also controlling

the licensee’s use of the transferred technology. Some know-how might be licensed, with

related information held back. A communications equipment manufacturer might license

a foreign firm to produce fiber-optic cable on

the condition that connectors and amplifiers

be imported. In a very real sense, the licensee
210 . International Competition in Services

Box W.-Who Licenses and Why?

Many of the larger firms from the Fortune 500

list have hundreds, even thousands, of overseas

licensing agreements in force.1 Manufacturing

companies, of one sort and another, account for

the vast majority of the Nation’s outward licensing (figure 42], with most of the rest involving

companies that conduct R&D as a business-not

only contract research firms, but new researchbased enterprises that have not yet reached the

stage of manufacturing. Figure 42 gives the distribution by industry of parent firm for U.S. licensing receipts (affiliated plus unaffiliated) in

1982. Manufacturing accounted for 93 percent

of the total, with two industries responsible for

more than half of all receipts-chemicals (including pharmaceutics] and machinery (much of

which consists of office and computing machines,

although no breakdown is available). Electrical

machinery, which includes electronic components, accounts for another 13 percent.

As pointed out below, a number of biotechnology startups have licensed quite actively overseas-to generate needed flows of cash from their

research, or to trade technology for capital. Often

they cannot afford the scale-up and marketing

IF.J. Contractor, fntamationd TeohnolQgy Licen$iltg: C%mpenaation, Coats, andNe@atk?n(@dn@cm, MA: Laxin@m Book 1981),

pp. 57, S&

Figure 42.-U.S. Receipts of Royalties and Fees

by Industry, 1$82

Petroleum

Other 3%

I

Food manufacturing

7% 3%

5%

expenses needed to utilize the-knowledge flowing from their R&D. A few American companies

develop technology solely for license-e.g., process technologies for the petrochemical industry.

Occasionally, individual inventors license their

patents. Licensing has always been more common in research-intensive industries, where

many companies count on licensing revenues to

help pay for ongoing R&D. Figure 43 shows that,

on average, licensing receipts cover more than

a quarter of the R&D expenses for U.S. firms in

the machinery industry; the fraction is probably

somewhat higher for office and computing machines.

In the pharmaceutical industry, about 20 percent of all new products introduced stem from

licensed technologies rather than internal developments. High product development costs mean

that, worldwide, perhaps 20 to 30 large companies have been able to keep up across a broad

front. Many smaller firms routinely license to

larger companies with more resources for bringing new products to market. The patterns, of

course, are not static: some companies, like

Marion Laboratories, that once licensed all their

new technologies from outside firms have now

begun internal product development programs;

others, such as Lilly, still neither buy nor sell

technology.

Conditions in a particular industry may, in

essence, force a company to license. Most semiconductors are sold to companies making products like computers and communications equipment. When major customers insist on multiple

sources of supply, an innovator may have little

choice but to license a new integrated circuit design to competitors.2 To sell to foreign customers may mean licensing foreign competitors. Ac-

~ln ~ti ~em, formo~ aItarnata eourcing veements have

largdy (but not completely) rttplaced the copying that wee once w

frequent in this induafry. See, for example, “Trade Ethica in Silicon

VaEay,” New York ?%naa, June 25,1082, p. Dl; F.C. Klein, ‘“ ‘Reveme

Engineering $ C)f Microchips 1$ Slow, Cody-and Universal,” Wall

S&eet]ourmd, Aug. 5, M&2, p. 1; M.W. Milk, “Intel Chargea NEC

Illegally Copied Miorochip Deaigns,” Wall Street Jourmd, Feb. 27,

1985, p. 28.

Inotk induatrkw, particularly them ralying on proprietary manUf- ttdid~a, rmmemgiwrhg maY be irnpoedk Given

a oomfdex mibcmrnokuie+s.&, @ POiymor ot genetically engineer.

ingqrgaaiam-therei arm waytndeduce with certainty howit might

have - produced. The more proceaa steps, the more difficult it

i8 to work backwards.
Ch. 6—Technology Trade: Licensing by U.S.-Based Firms • 211

Fiqure 43.— Royalties and Licensing Fees As a Percentage of R&D Spending in U.S.

Manufacturing Industries, 1982

Food manufacturing

m

/

Metals

\

Transportation

equipmentPL

Other manufacturing

I

I I I I I I

o 5 10 15 20 25 30

Licensing receipts as a percentage of industry R&D spending (%)

SOURCE U S Dlrecf Investrnenf Abroad 1982 Benchmark Survey (Washington, DC Department of Commerce 1985)

Pp 338-339

tive assistance to second-sources may help the

innovator establish its design in the marketplace.

Indeed, second-sourcing is one of the few cases

in which an electronics company might license

so-called trade secrets. In the extreme, it may be

the only way to capitalize on a new design; that

is, the innovating company may have to help its

competitors get into production in order to sell

at all. Given the way the semiconductor market

operates, companies may also cooperate in developing the members of a family of chip designs.

In such industries—where the pace of technical

development is rapid, and markets volatile and

hard to predict—arrangements involving licensing, cross-licensing, second-sourcing, and joint

product development function as risk-sharing

mechanisms. Managers may choose a reduced

share of a more certain market, particularly a rapidly growing market, rather than chance going

it alone.

Cross-licensing, in particular, offers further examples of risk-spreading. In industries such as

computers and microelectronics, many companies have opted for cross-licensing—usually covering patented technologies only—with almost

any firm, domestic or foreign, capable of generating knowledge comparable to its own. One reason is simply to gain access to technologies that

can help in filling out product lines. But why

should potential competitors agree in advance

to share all patents? According to OTA’s interviews, perhaps the most important reason is simply to avoid having to perpetually monitor possible patent infringements all over the world;

executives in one company stated that, without

wholesale cross-licensing, they would be engaged

in lawsuits nearly everywhere. By the same token, they avoid worrying about infringing others’

patents.

Litigation can nonetheless follow if cross-licensing relationships break down. Early in 1986,

Texas Instruments (TI) filed process patent infringement suits against eight Japanese and one

Korean firm for selling random access memory

(RAM) chips without licenses under TI patents.

According to TI, the nine companies had been
212 • International Competition in Services

licensed in the past, but the contracts had expired

and negotiations for renewal had not been completed; a company spokesman suggested that the

suit might speed progress toward new agreements. 3 TI asked the U.S. International Trade

Commission to recommend that imports of RAM

chips as well as downstream products using

them, including mainframe computers, be banned

from U.S. markets. In response, one of the Japanese companies, NEC, filed a patent infringement

suit in Tokyo against TI-Japan, while another filed

a patent infringement counterclaim against TI

in the United States. Some of these cases have

now been settled; others remain unresolved.

Like semiconductor manufacturers, new biotechnology firms have often found themselves

forced to license, but for different reasons. These

‘Electronic News, Mar. 17, 1986, pp. 38-41; “Texas Instruments

Reports on Company’s Improvement Into First Quarter of 1986,” PI?

Newswire, Apr. 17, 1966; P. Duke, Jr., “Patent Lawsuits Against Sharp,

Fujitsu Settled,” Wall Street Journal, Jan. 12, 1987, p. 8.

can become integrated into the MNC’s own

global operations.

Still more complicated examples are appearing, Recent reports suggest that some U. S.-

based electronics firms have turned to licensing and joint ventures to help fend off Japanese

competition. By licensing their technologies in

South Korea, they hope to aid Korean firms in

becoming effective competitors in the Far East,

putting pressure on the Japanese in markets that

the latter have regarded as their own. 18 T h e

logic appears to be as follows. Japanese manufacturers have been able to achieve economies

of scale in controlled Far Eastern markets, gainWln joint ventures between Korean and American firms, see

S. Chira, “U.S.-Korea Ventures Strive for Compatibility,” New

York Times, Mar. 28, 1986, p. Dl; also, J.R. Schiffman and M.

Shao, “South Korea and Taiwan: Two Strategies, ” Wall Street

}ourna], May 1,1986, p. 36. In the semiconductor industry, more

than a dozen agreements were signed during 1985 and 1986 between U.S. companies and Korean firms such as the LuckyGoldstar Group, Hyundai, and Samsung. The three Korean manufacturers have reportedly invested nearly a billion dollars in

building their semiconductor capability.

firms may have a competitive advantage in drawing on the pool of research results in genetic engineering, but face difficulties in commercialization. Not only is substantial investment capital

often required, but so is a broad range of scientific and technical expertise. Scale-up from laboratory batches to commercial production has

been a common problem; regulatory approvals

may pose an unfamiliar set of hurdles. Under

such circumstances, a relatively small biotechnology firm may simply find itself stretched too

thin; it might seek partners, consider contracting with another company to undertake manufacturing, or it may license. Under such circumstances, a foreign partner maybe more attractive

because the originator can retain the U.S. market for itself. Further, because of Food and Drug

Administration regulations prohibiting exports

of new drugs before they have been approved in

the United States, a foreign firm maybe able to

get approvals and introduce the product more

rapidly overseas.

ing advantages in production costs that help

them move into the United States (and elsewhere), Korean competition, created in part

through help from American firms, would reduce this source of advantage by attacking the

Japanese in their traditional markets.

Strengthening potential new competitors in

the Orient might seem a short-sighted approach

to an immediate problem, given that the Koreans

themselves are already becoming formidable

competitors in some U.S. markets, as well as

third countries historically served by American

firms. Obviously, U.S. managements know the

strategy could backfire. Evidently, they feel it

is better to face two or more independent competitors than a single set of national firms acting in what many American executives believe

to be concerted fashion. As pointed out above,

Japanese companies have themselves been

reluctant to license technologies in Korea that

might threaten their own international market

positions—evidence that the Japanese will take

this U.S. strategy seriously.
Ch. 6— Technology Trade: Licensing by U.S.-Based Firms ● 213

The primary point, then, is that licensing has

become–not only a means of exploiting technical advantages—but a tool for developing

counter-strategies against international competitors. American managers are coming to

realize that gaging foreign market possibilities

simply in terms of cash flows, the conventional

measure of opportunity, is no longer sufficient.

Entering some markets, even in modest fashion, may force competitors to alter their own

strategic approaches in ways that can benefit

the U.S. position.

Joint Ventures

A number of the arrangements between U.S.

and Korean electronics firms have taken the

form of licensing to a joint venture in South

Korea—an increasingly common pattern. Motives for joint ventures linking companies that

normally compete range from market entry for

one of the partners to efforts to limit exposure

in an unfamiliar setting. American firms have

sought joint venture partners in Japan to get

help in penetrating the mazelike Japanese marketing and distribution system, or to do business with such enterprises as NTT (Nippon

Telegraph and Telephone), which have traditionally purchased from a small family of Japanese suppliers.

Many joint ventures involve technical licensing by U.S. companies, perhaps as an equity

contribution; the American firm Halcon International licensed its ethylene oxide technology

to a Brazilian manufacturer in exchange for a

10 percent ownership interest (beating out

Shell, which had sought its own plant but could

not get approval from Brazil’s Government). In

other examples, AT&T has purchased a 25 percent stake in Olivetti as a means of distributing its computers in Europe, while establishing a 50:50 joint venture with the Dutch firm

Philips in order to enter European telecommunications equipment markets; licensing of

AT&T technology is part of both agreements.

Escalating costs have also pushed firms to

cooperate. International Aero Engines, which

links three European and three Japanese companies with the American firm Pratt & Whitney, is undertaking a billion-dollar development

effort that would be highly risky, if not impossible, for the participants individually. R&D

costs likewise were a major reason for the formation of the Texas-based consortium Microelectronics and Computer Technology Corp.

(MCC). As this example and Japan’s fifth-generation computer project (ch. 5) both suggest,

R&D joint ventures tend to be more common

within nations, but they are becoming familiar internationally as well.19 In a typical arrangement, two or more firms from different countries combine in a new company, jointly owned,

to develop technologies that can be shared

through cross-licensing between the joint venture and each partner. Usually, the technical

agenda is tightly focused, serving to bring to

bear the individual strengths of the partners on

problems of common interest. Thus, Sony in

Japan and Advanced Micro Devices (AMD) in

the United States are cooperating on very largescale integrated circuits. AMD expects to increase its sales to consumer products manufacturers, Sony to benefit from AMD’s experience in chips for computer systems. 20

The success of such combinations depends

on each partner meeting its own objectives

(which may involve matters such as taxes, financing, and risk, in addition to technology).

19A150 see the discussions of European programs like ESPRIT

and Alvey in ch, 9.

A recent survey of cooperative agreements and joint ventures

covering nearly a thousand companies operating in Europe found

that more than half were intended to transfer or share technology—E. Ricotta, “Joint Ventures and Inter-Company Agreements

in High-Technology Sectors, ” mimeo, Dec. 13, 1985, Most of the

agreements had been negotiated between European and nonEuropean (typically American) firms, with the electronics industry accounting for many more than any other sector, 44 percent of the total, Slightly more than one-third were restricted

to marketing/distribution, slightl}’ fewer involved production.

20Each company Wi]] have the right to market the other’s products under its own name. See L.M. Fisher, “Micro Pact With

Sony Is Planned,” New York Times, Feb. 13, 1986, p. D1.

OTA’S interviews offer insights into the pros and cons of joint

ventures. As one corporate manager put it, “The difference between licensing and joint ventures is that in licensing you sell

your product, while in joint ventures there is joint contro], joint

management, and joint risk. There are more revenues ~’ith joint

ventures, but you need more cash up front. ’ Another noted that

“Joint ventures require tremendous on-going care and nurture.

It’s like a marriage; if interests begin to di~rerge, the venture may

flounder. ” Also see L.H, Young, “The Corporate Links Abroad,”

New York Times, Aug. 6, 1986, p. D2.
214 • International Competition in Services

If one partner benefits disproportionately—as

some observers see happening in joint ventures

linking U.S. and Japanese companies—the combination will not last long.21 In OTA’s interviews, managers in smaller American companies, faced with difficulty in keeping up with

new technologies, expressed more interest in

such undertakings. Despite such examples as

International Aero Engines and MCC, larger

enterprises with long-established R&D operations tend to be more skeptical, taking the view

that quite special conditions are needed to make

joint ventures attractive.

Acquisition of Foreign Technologies

As the balance of payments figures on licensing presented earlier in this chapter demonstrate, U.S. companies have sought foreign R&D

results far less often than they have transferred

their own technologies abroad. With comfortable leads, where was the need? Although exceptions have always existed, as when U.S.

firms licensed the Pilkington process for plate

glass, or when DuPont began making polyester

under license from British Calico Printers, the

rule was to ignore technical knowledge developed abroad. Today, the rules have changed—

although some American firms seem not as yet

to have realized it. In industry after industry,

American technology is little if any better than

that of foreign manufacturers. In a surprising

variety of cases, foreign firms have moved

ahead—automobile technologies ranging from

combustion system designs to active suspension control, consumer electronics, some kinds

of steel-making and machine tool technologies,

As a result, American managers are beginning

to view acquisitions of foreign technology as

a necessary part of their own planning, a com- — —— — .-..

‘lSee R. Il. Reich and E.11. Mankin, “Joint Ventures With Japan Give Away Our Future, ” Harvard Business Review’, MarchApril 1986, p. 78, who seem to think that, somehow, American

companies can never win in business arrangements with the

Japanese. For a more balanced view, see D.C. Mowery, Alliance

Politics and Economics: Mul~inational joint Ventures in Commercial Aircraft (Cambridge, MA: Ballinger, 1987),

On some of the broader, strategic aspects of joint ventures,

see K.J. Hladik, International Joint Ventures (Lexington, MA:

Lexington Books, 1985), pp. 27-28, Hladik relates that Egypt

barred Coca-Cola from bottling and selling its products from 1967

to 1977 because the company had franchised a plant in Israel.

The ban was rescinded after Coca-Cola entered a joint \’enture

with Egypt’s Government to grow citrus in the desert.

Photo credit: Unimation

Industrial robot

plement to internal R&D. When General Electric decided to enter the industrial robot market,

the company screened and evaluated technologies globally, eventually selecting know-how

from Japan, West Germany, and Italy.

Greater need to specialize in their development efforts also drives U.S. companies to seek

know-how overseas. With R&D costs rising rapidly in some fields, even companies as dominant in their industries as IBM cannot aspire

to excel in all technologies related to their products. As a result, more and more companies

are seeking to identify the technologies most

important in their primary lines of business—

their core technologies—and concentrate their

resources on them. Other technologies they

shop for, and, increasingly, shop internationally. At the same time, many U.S. firms that

could plainly improve their competitive ability through the acquisition of foreign technologies fail to recognize their needs, the opportunities, or both.
Ch. 6—Technology Trade: Licensing by U.S.-Based Firms ● 215

— .

POLICY ISSUES

The earlier sections of this chapter raise three

rather different sets of policy issues, The first

consists of U.S. Government policies that affect licensing itself—questions such as intellectual property protection, export controls, and

antitrust restrictions on licensing contracts.

The second set of issues, far broader, and dealt

with below in greater detail, concerns the Nation’s technology base, and the policies that contribute to strengthening it (e.g., through R&D)

and to utilizing it (e. g., by facilitating diffusion

of technologies within the U.S. economy).

Third, foreign governments have become much

more sophisticated in their use of policy tools

to encourage technology transfers from U. S.-

based firms, raising questions of the appropriate response by the U.S. Government. Specific

policy options, once again, have been left for

chapter 10.

The Policy Environment for Licensing

Legal rights granted by governments in the

form of patents, copyrights, and trade secrets

underlie international trade in technology, with

patent and trademark licensing particularly important in industries including chemicals, pharmaceuticals, and food products. 22 Becaus e

stronger protection for intellectual property has

become a U.S. negotiating objective in the Uruguay Round of trade talks, it is discussed in that

context in chapters 9 and 10.

Export controls have been a contentious matter for years, with Congress amending the Export Administration Act of 1979 in 1985. The

Act authorizes restrictions on exports, including international transfers of technical information, for reasons of national security. The

major objective of these controls is to prevent,

or at least slow, flows of technology having poZZLjcensjng jn International 5’trategy.’ A Guide for planning

and Negotiations, op. cit., p. 125,

Given the ways in which technology has been evol~ing, piecemeal revisions to legal protections for intellectual property seem

increasingly inadequate, as discussed in more detail in ch. 9.

Also see intellectual Propertj Rights in an Age of Electronics

and Information (Washington, DC: Office of Technology Assessment, April 1986],

tential military applications to the Soviet Union

and its Eastern European satellites, A history

of policy controversy within the Federal Government has meant continuing uncertainty. Delays in the processing of applications covering

proposed licensing agreements have sometimes

been lengthy. Managers interviewed by OTA

claim that foreign companies sometimes avoid

U.S. sources of technology because of the possibility of delays and constraints on their use

of licensed know-how. H.R. 3, the omnibus

trade bill passed by the House of Representatives in April 1987, incorporates further amends

to the Export Administration Act,

Until the late 1970s, the Antitrust Division

of the Department of Justice maintained a published list of nine licensing practices considered per se violations of the law. American companies could not insist on contract provisions

barring foreign licensees from using transferred

technology to sell in the United States. Nor

could they control their licensee’s prices. While

other per se violations pertained only to domestic licensing, business executives and their lawyers could never be sure that the Justice Department would not extend these constraints

to the international sphere. As a consequence,

most American companies steered clear of such

provisions in their contracts with foreign firms.

In the view of most managers, the list of per

se violations discouraged licensing by reducing the firm’s ability to control its proprietary

technology.

Beginning during the Carter Administration,

but especially since 1980, the Justice Department has modified its view of antitrust enforcement, with officials articulating considerably

more tolerant standards.23 In the new view, al-

—23 For instance, “Remarks of Charles F. Rule, 1lePuty Assistant

Attorney General, Antitrust Di\rision, L’. S. 1lepartmen~ of IUStice, ‘The Antitrust Implications of International 1,lc.[’rl\ing: .4 fter the Nine No-Nos, ’ Before the 11’orl(l Trade ~is>u~i~tio~) al>{]

the Cincinnati l)atent 1,aw Association, ’ (let. 21, 1986.

On [j.S. antitrust law in general, see [ ‘.S. lndustria] Competitiireness: A Comparison of Steel, Electronics. and Automobiles

(Washington, DC: Office of Technolog} Assessment, Jul~ 1981),

pp. 184-1 85; and ]nternationa] Competiti~”eness in .E]ectronics,

op. cit., pp. 390 and 465, The National Cooperati\’e Research
216 • International Competition in Services

lowing a licenser to place limitations on a licensee’s freedom of action, domestic or international, can lead to more competitive markets,

greater efficiency, and higher levels of R&D

spending. Restrictive provisions in licensing

agreements, therefore, should not be assumed

anticompetitive per se, but rather be evaluated

on a case-by-case basis. Because of this wellpublicized shift in antitrust policy, managers

express far less concern about inserting restrictive clauses in licensing agreements than during the 1970s. Corporate legal departments,

nevertheless, continue to urge conservatism—

their job as they see it—given that the more

relaxed enforcement attitudes have not yet been

supported by clear case precedents.

The actual impacts of the new policy stance,

as they relate to technology development, remain to be seen. While abandoning per se violations may stimulate technology development

by increasing potential rewards to innovators,

such conjectures remain, for the moment, in

the realm of theory. Caution seems in order,

if only because of examples of past policy shifts

with smaller than predicted impacts (R&D tax

credits, ch. 10). Beyond this, some of the lessons of the past seem to have been overlooked.

Strict enforcement of antitrust laws in earlier

years clearly led to enhanced technology diffusion, and thus greater competition, in some industries. The obvious case is the mandatory

licensing of patents flowing from Bell Laboratories under the AT&T consent decree of 1956,

which helped stimulate the enormously dynamic merchant semiconductor industry. This industry would look considerably different had

AT&T been allowed to hold its technology then

as closely as it does today. Similarly, the independent computer software industry in the

United States—which developed much faster

than in other countries (ch. 5)—owes much of

its rapid start down the learning curve to IBM’s

unbundling of software sales from hardware.

(continued from previous page)

Act of 1984, which explicitly permits certain forms of joint R&D,

has been the only recent change in the statutes to be enacted

by Congress. During 1986, the Justice Department proposed a

series of five bills, including amendments to the Clayton and

Sherman acts, that would relax existing law substantially.

IBM took this action in 1969 only under threat

of antitrust proceedings. Given such examples,

it seems reasonable to ask whether U.S. hightechnology industries would exist in anything

like their present form if today’s antitrust climate had existed during the 1950s and 1960s.

R&D and Technology Development

Earlier sections of this chapter stressed that

competitiveness in supplying technology, or,

more broadly, in trading technically based

goods and services, depends on R&D directed

at commercial technologies—and not only R&D,

but the diffusion of results. Both development

and diffusion depend to considerable extent on

government policies.

In the United States, the Federal role has been

twofold. Government agencies have provided

most of the financial support for R&D related

to national defense and space exploration.

Sometimes this funding has contributed to

strong, internationally competitive industries:

e.g., digital computers, commercial aircraft.

Second, the Federal Government has funded

most research in basic science. Here the justification has been essentially economic: without

government assistance, the private sector would

underinvest from a societal point of view. Government funding enlarges the pool of basic scientific knowledge, which then becomes available to all potential users. The fruits of this

policy have been especially evident in industries that utilize research results flowing from

health-related R&D.

As a rule, many years separate the generation of new scientific knowledge from commercial application. Furthermore, much defenserelated R&D is not only narrowly specialized,

but classified, and not readily available to companies outside the community of aerospace

firms and military contractors. This alone delays commercial applications, even though the

proportion of military funds going to applied

R&D, as opposed to basic research, far exceeds

that in most other Federal agencies. (Basic research, almost by definition, tends to be well

removed from possible incorporation in commercial products.)
Ch. 6—Technology Trade: Licensing by U.S.-Based Firms ● 217

The Federal Government has seldom funded

technology development closely tied to commercial products and processes. Despite exceptions such as energy R&D during the 1970s,

commercial efforts have normally been left to

private firms. In part, this choice reflects a belief that government should avoid competition

with the private sector. In addition, many observers believe that government involvement

would inevitably lead to distortions in the market, hurting some companies while helping

others. Thus, U.S. technology policy has operated on the principle that, since private firms

derive the primary benefit from commercial

technology development, they should foot the

bills.

The gray areas—energy-related research,

some civil aviation technologies, a good deal

of health-related R&D —typically fall in what

has been called generic or pre-competitive technology development: R&D necessary for building a knowledge base to support all companies

in an industry. In this sense, the argument for

supporting pre-competitive technologies is

much like that for basic research. Benefits that

might be elusive and indirect for an individual

firm may nonetheless yield large social benefits.

The Reagan Administration’s policy has been

to withdraw support from the gray areas, and

count on the private sector to support them.

The government has, at the same time, stepped

up defense R&D, which in 1987 will, together

with space, account for nearly 80 percent of

Federal R&D dollars. Federal spending for basic

research in the physical sciences has also been

growing relative to other parts of the government R&D budget, with non-defense applied

research shrinking dramatically. Finally, the

Administration has increased funding for research in engineering, primarily through the

National Science Foundation (NSF), and in part

because of concern over lagging U.S. competitiveness (ch. 10).

Some defense-related technologies have substantial commercial spillovers, For example, the

Department of Defense spends a good deal of

money on computer research and on very largescale integrated circuits, But in other countries,

government support for similar research might

center more directly on commercial product

development (see ch. 9). If past history is a

guide, significant commercial applications of

the results of defense-related research will be

the exception, not the rule.24 Put differently, if

commercial technology development is the

goal, military R&D is not an efficient means to

reach it.

Other governments have often designed special programs aimed at improving national capabilities in advanced technologies of commercial significance. Prominent examples include

Japan’s fifth-generation computer project, and

related software development efforts (ch. 5).

The fact is that most other industrialized nations devote a larger fraction of government

R&D spending to projects directly related to industrial technologies, In biotechnology, for instance, while the United States has the largest

and most extensive basic research effort in the

world, the Japanese Government leads in its

commitment to generic and applied research. 25

Diffusion of R&D results raises a similar set

of issues, Government-sponsored programs in

other countries frequently combine support for

technology development with efforts to transfer technology to industry, seeking to speed

adoption and cut learning costs. Moreover, as

noted earlier in this chapter, given rough technological parity in many fields, American companies now have a good deal to learn from overseas. But, in part because the United States was

ahead for so long, mechanisms for learning

from foreign experience remain poorly developed, Chapter 10 discusses policy options for

strengthening these mechanisms.

24’’ Development and Diffusion of Commercial Technologies:

Should the Federal Government Redefine Its Role-?’ staff memorandum, Office of Technology Assessment, L1’ashington, DC,

March 1984.

Compared with efforts abroad, the impacts of’ greater Federal

funding for NSF’s engineering research will be small. The sums

involved are simply not great enough to make m UC}] d i ff’erence,

given the trends examined earlier in the chapter; NSF’s budget

for engineering during fisca] year 1987 comes to $163 mil]ion

out of a total NSF research budget of $1.62 billion.

~scommercjal Biotechnolog~,: An International .4nai~’si.s (Washington, DC: Office of Technology Assessment, Januar}’ 1984],

pp. 505-510.

63- 5? 7 () - 87 - ~
218 ● International Competition in Services

Foreign Government Policies

Less developed and newly industrializing

countries have been much more likely to restrict

foreign direct investment than the advanced

nations, Broadly speaking, the LDCs and NICs

have sought to control investment in pursuit

of three interrelated goals:

1.

2.

3.

Economic Growth.—Many governments

regulate inward investment, seeking to

steer foreign capital to sectors considered

desirable for fostering economic growth

and development.

Technology Transfer.-By permitting FDI

only if accompanied by transfers of technology, governments have sought to build

their infrastructures and develop a skilled

labor force.

Autonomy .—Closely related to the first two

objectives, many developing countries

wish to limit production and market share

by foreign-based MNCs in key economic

sectors, reserving these for their own companies.

From the U.S. perspective, the policy issue that

arises is straightforward. Foreign government

policies can distort corporate decisions concerning the use of proprietary technologies. The

consequences may be harmful to U.S. interests,

Most obviously, in the absence of foreign government incentives and/or restrictions, American companies might use their proprietary

technologies to produce at home and export.

Of course, such considerations cut two ways.

The U.S. Government has imposed restrictions

on imports, or threatened to, with increasing

frequency since the middle 1970s, As a result,

foreign firms in industries ranging from consumer electronics to automobiles have opened

manufacturing plants in the United States.

In fact, many governments have a schizophrenic attitude toward MNC involvement in

their economies. On the one hand, they may

encourage inward investment through incentives including low-interest loans, tax rebates,

training grants, and tariff and foreign exchange

preferences, Typically, governments offer such

incentives to companies they wish to attract—

i.e., those whose presence is consistent with

policy makers’ views on development needs.

But selective investment incentives may conflict with objectives related to technology transfer and autonomy. An MNC that accepts the

incentives will want to conduct its business

much as it does elsewhere, integrating its local operations into the global enterprise. For

example, the MNC might wish to license a subsidiary, although the government prefers that

technology be transferred to locally owned

firms. If the government insists on a joint venture as a condition of entry, perhaps with the

multinational taking a minority position, the

MNC’s choice can be a painful one: share its

proprietary technology with a local partner, and

risk losing control, or forgo the prospect of

present and future business in that country.

Needless to say, different companies make

different decisions in such circumstances, depending to some extent on the strengths of their

bargaining positions.

It is also true that many foreign joint ventures

simply reflect strategic needs, with little or no

influence from foreign government policies. As

pointed out earlier, joint ventures can reduce

risks in unfamiliar markets—limiting financial

exposure while drawing on the experience of

local firms familiar with marketing and distribution practices. Although direct investment

and joint venture decisions may reflect foreign

government policies, they may at the same time

reflect the firm’s desire to pursue an integrated

international strategy. Indeed, most American

managers view government efforts to manipulate markets as just another exogenous element

to be fitted into the strategic puzzle.

Other foreign government policies affect licensing more directly. Taxation of corporate

income but not of royalty flows encourages

licensing of affiliates, with royalties becoming

one method for transferring funds within the

MNC. For this reason, host governments may

tax international transfers involving royalty

payments, In addition, with foreign exchange

a scarce resource in most developing economies, governments often seek to control international payments directly. As with many
Ch. —

such regulations, governments tend to use rules

of thumb. These typically constrain allowable

royalties to a narrow range, Licensers might

find the permissible royalties adequate, even

generous, for some technologies, but quite inadequate for others (when set against the risks

of losing control of proprietary know-how). A

country that restricts royalties too tightly, thus

cutting itself off from some technologies, may

complain about the monopolistic practices of

multinationals, even though the royalties in dispute may the norm in other parts of the world.

The result? Lower levels of licensing revenue

for the U.S. company, coupled with less technology of potential use to the developing nation.

Finally, governments sometimes attach direct

conditions to licensing agreements—attempting, for instance, to accelerate technology transfers through unusually short licensing periods.

Both Mexico and Brazil limit trade secret pro6—Technology Trade: Licensing by U.S.-Based Firms ● 219

—

tection to 5 years. In the view of most corporate

managers, this is far too little time to permit

adequate earnings from proprietary knowledge.

Although renewals are possible, there are no

guarantees. Such conditions, always accompanied by trade barriers, have caused many firms

simply to stay away. At the same time, relatively

large countries like Mexico and Brazil, with attractive potential markets, have considerable

leverage. They have often been successful in

playing foreign companies off against one

another. In other cases, however, developing

countries have lost the benefits of technology

transfer by attaching conditions that foreign

firms have been unwilling to accept. Brazil, for

example, has established such stringent conditions relating to small computers that no company with up-to-date products has agreed to

transfer technology.

CONCLUDING REMARKS

Technical knowledge spreads internationally able close substitutes, at the risks of losing conthrough many channels other than licensing— trol over proprietary knowledge. An American

when foreigners study engineering and science firm may prefer to export but find dollar exin American universities, later to return home, change rates discouraging. Foreign government

they take technology with them. Competitors policies may close off investment. If it wishes

engage in reverse-engineering, pervasive in the to license, it may be pushed toward joint venearlier years of the semiconductor industry. tures with local companies.

Foreign subsidiaries are staffed largely by lo- Among the risks that a firm must evaluate, cal people; when they leave for other jobs, their

knowledge goes along. In R&D alone, the over- perhaps the greatest is that it will lose future

seas manufacturing affiliates of U.S. firms em- sales to its licensees. No matter how tightly the

licensing agreement is written, defining pre- ployed some 70,000 foreign nationals in 1982.26

cisely where and how the technology can be

With diffusion of technology inevitable, firms used, leakage and counterfeiting become more

try to capitalize on it rapidly, before its value probable once the technology is in use in somedeclines too much. In different circumstances, one else’s plant. Moreover, enforcement of the

this may imply exporting goods (or services], terms of the agreement can be difficult in a fordirect investment, or licensing, Decisions on eign country. All these factors make it difficult

which technologies to license, and where, de- to set fees for technology licenses.

penal on a firm’s strategic view. The company Given the risks and uncertainties, arms-length will look at the size of potential markets, at avail- agreements—though large in number—remain

Z6 u,.S ~Irec~ ~n ves~men~ AbrOa~: 1982 Benchmark sur~rey Dafa small in value compared to licensing between

[Washington, DC: Department of Commerce, December 1985), affiliates. But it is also true that intra-corporate

p. 243. Total employment in overseas manufacturing affiliates

of U.S. firms came to 3,4 million, Of 76,000 R&El employees, licensing remains largely hidden from the view

no more than 6,500 were U.S. citizens. of the U.S. Government, primarily because
220 ● International Competition in Services

charges between divisions of the same company

will seldom adequately reflect the value of the

licensed technology. For this and other reasons,

statistics on technology trade give little real

sense of the impacts on international competition (or on domestic employment).

For the United States, Europe remains the

major trading partner in technology. European

firms represent the largest source of licensing

receipts and the largest recipient of U.S. payments, although inward transfers from Japan

have been increasing more rapidly; technology

imports from Europe grew by 19 percent between 1983 and 1985, but imports from Japan

jumped by 29 percent.

Over the years, U.S.-based MNCs have begun transferring more advanced technologies;

with foreign firms catching up, only the latest

knowledge has value to them. As this and many

other observations suggest, American firms do

not have as strong a technological position, relative to the rest of the world, as they once enjoyed. By many indicators, U.S. priorities for

non-military technology development have

fallen below those of other countries, notably

Japan. Although a weakened balance of payments position in licensing is among the less

serious consequences of diminished comparative advantage in technology, it does have its

effects. Moreover, the LDCs and NICs are

demanding the most recent know-how, which

makes it more difficult to hold on to the advantages that remain.

In interviews, many managers of U.S.-based

firms stated that overseas exploitation of technological advantages has become more difficult in both developed and developing countries. While enterprising American firms have

found ways of dealing with foreign government

restrictions, more and more of the intracorporate avenues are being closed to them; the

consequences include increases in joint ventures and arms-length licensing agreements.

Given these circumstances, American firms increasingly employ licensing as one element in

quite complex strategies. At least for larger multinationals, these are likely to be global in scope.

Corporate managements spend a good deal of

time positioning their firms for ongoing international competition. For firms whose advantages lie in technical knowledge, licensing becomes an integral part of forward planning.

What of the claim that, by underpricing their

technology, American firms have helped foreign competitors catch up? In fact, matters are

seldom so simple, as the following example illustrates. Texas Instruments, as is well known,

used its patent position as a wedge to enter

Japan’s semiconductor market. 27 What is less

well known is that TI’s management believes

strongly in onsite manufacturing as a necessity for competing in high technology. TI felt

that, to sell in Japan, the company had to manufacture there. In 1968, it traded licenses—

covering technology TI had already made available to its U.S. rivals, but no trade secrets—for

permission to establish a 50:50 joint venture

with Sony. TI insisted on the right to buy out

its partner after 5 years, and thereafter operate a wholly owned subsidiary—a provision

which it expected to exercise from the beginning, and did. Today, TI claims that it is gradually coming to be treated as a Japanese business. The company maintains cross-licensing

agreements with all the major Japanese semiconductor manufacturers, and expects—like

IBM before it—to enter into a cross-licensing

agreement with MITI (important because many

patents resulting from joint government-industry R&D revert to the Ministry). Did TI underprice its technology? While Texas Instruments

evidently does not think so, the firm’s U.S.

competitors—which did not have strong enough

technological positions to force their way into

the Japanese market in earlier years—might

well differ.

In any case, if American companies licensed

technology to potential rivals in Japan under

terms that—with hindsight—seem too liberal,

most of these mistakes were made a decade or

more in the past, before Japan’s rising competiZT]nternatjona] Competitiveness in Electronics, OP. cit., PP. 140

and 193-194.
Ch. 6—Technology Trade: Licensing by U.S.-Based Firms ● 221

— —

tiveness was obvious to all. Few American

managers would any longer underestimate their

Japanese rivals. At this point, the pressing need

is for better developed mechanisms through

which U.S. firms, in many industries, can learn

from foreign technical developments. A more

rapid increase in inward licensing, implying

broader recognition by U.S. industry of the need

for two-way flows, would be a favorable sign

for future U.S. competitiveness, But most important of all, U.S. policymakers need to attend

to a pressing series of problems that affect the

technology base for all of American industry.

Many of the needs have been well-documented

and widely acknowledged—e. g., lack of laboratory equipment in the Nation’s universities. The

problems have been identified, but they have

not been solved.
Chapter 7

Jobs in the Services
CONTENTS

Page

Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ........................225

Employment and Structural Change in the U.S. Economy . ..............228

The Shift to Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ...............228

Job Creation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .................230

Mobility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .........................238

Temporary and Part-Time Workers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ....243

Temporary Employment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ............247

Part-Time Work, Voluntary and Involuntary . .........................248

Immigrants in the U.S. Labor Force . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .250

Distribution by Occupation and Industry ● ,,*..* ...*...* ● ....*.. .*** * 250

Illegal Immigration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .............251

Immigrants and Jobs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .............252

The Underground Economy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .........252

Concluding Remarks.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ..........253

Boxes

Box Page

X. Restructuring in a Department Chain: The Macy’s Case . .............242

Y. Deregulation, Expansion, and New Technology

at New York Telephone .,..,.. . . . . ● ,**.*. . . . . . . . . ..,**,** . . . . . . . . 244

Figures

Figure No. Page

44. Growth of the U.S. Labor Force . . . . . . . . . . .........................231

45. U.S. Employment by Industry and Sex . ............................231

46. Part-Time Employment in the United States . .......................246

47. Employment in the Temporary Help Services Industry . ..............247

Tables

Table No. Page

32. U.S. Employment bisector.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ......229

33. Sectoral Distribution by Occupation in the U.S. Economy, 1986 . ......230

34. U.S. Job Creation by Industry, 1972-84 . ............................232

35. High-Growth Service Industries, 1972-84 . ..........................234

36. Work Force Characteristics in Manufacturing and Selected

Nonmanufacturing Industries, 1980. . ..............................235

37. Union Representation by Industry . . . . . ............................236

38. Characteristics of Workers in Selected Occupations, 1980.............239

39. Industry Profile for Men and Women Employed Part-Time, 1984 .. ....249

40. Shifting Employment Patterns in the U.S. Economy . . . . . . . . ..........255
..—

Chapter 7

Jobs in the Services

SUMMARY

The number of people in the U.S. labor force

has been growing much more rapidly than the

total number of hours worked. The result? A

great deal of slack in the labor market. Unemployment remains at historically high levels,

although not so high as at the beginning of the

decade. Among the employed, part-time and

temporary work has been increasing. With

American companies facing competition from

a continually expanding number of techncdogically competent firms based in low-wage countries, U.S. wages and living standards, relative

to the rest of the world, are being driven downward. The United States, like other Western

economies, faces a future of chronic underemployment for many, and new labor market

opportunities for groups such as urban blacks

that seem quite limited.

This chapter examines U.S. employment patterns over the recent past—in terms of both service industries (regardless of occupation) and

service occupations (regardless of industry).

The growing percentage of the labor force

working in service industries, and in service

occupations in manufacturing industries, mirrors ongoing structural changes in the Nation’s

economy:

rising imports culminating in huge trade

deficits;

rapid technological change, including

automation in response to competitive

pressures;

shifts in demographics, social norms, and

patterns of demand (the entry of the baby

boom generation into the labor market,

many more women seeking jobs, consumer

preferences for small cars, many of them

imported).

The jobs being created in the United States

today differ on many dimensions from those

of 15 years ago. Many of the new jobs in services pay poorly compared with manufacturing

jobs, particularly those in the unionized smokestack industries. Unions themselves are in decline, part-time and temporary work on the rise.

Competitive pressures, largely from abroad,

have dampened wage growth, indeed forced

wages down, in many manufacturing companies. As one response to new competition,

American manufacturers have automated, cutting further into job opportunities. Hardpressed firms in industries like autos and steel

have slashed white-collar jobs as well as blue.

The consequences come through with striking

clarity in a comparison of manufacturing and

service employment in the Pittsburgh area,

where: 1) in 1982, pay in durable goods manufacturing remained nearly 50 percent higher

than the average for the area, although dropping; 2) pay in trade (wholesaling and retailing, including restaurants) was 40 percent below the average, and pay in personal services

47 percent below average; and 3) fringe benefits dropped rapidly with take-home pay.l Jobs

in the services, in sum, are poor substitutes for

jobs in manufacturing.

Measured by the number of jobs created over

the past decade, the U.S. economy has performed better than most other advanced industrial economies. But many more Americans

now have contingent or casual jobs than 20

“’Labor Mobility and Structural Change in Pittsburgh, 1977-

82, ” prepared for OTA by L. Jacobson, The WE. Upjohn Institute for Employment Research, under contract No, 533-6090,

The report analyzes a unique database assembled from Pennsylvania unemployment insurance records.

Pay in durable goods manufacturing fell from 63 percent above

the average in 1977 to 48 percent above in 1982.

In Pennsylvania as a whole over the period 1975-85, manufacturing employment dropped at an average rate of 1.63 percent

per year, while rising at 2.75 percent per year in the services-L.

Jacobson, “Job Creation and Destruction in Pennsylvania, 1975-

85, ” report to the Organization for Economic Cooperation and

Development, The Upjohn Institute for Employment Research,

NOV. 17, 1986, p. 12.

225
226 ● International Competition in Services

years ago, as shown by the steady rise in involuntary part-time employment. By many indicators (e.g., purchasing power per hour

worked), living standards in the United States

are headed downward—a direct consequence

of competition from low-wage economies in

other parts of the world. Given open U.S. markets, and steadily improving technological capabilities in large numbers of developing

countries—nearly all with substantial labor surpluses that promise to hold wages far below

U.S. levels—competitive pressures can only intensify. Many Americans who entered the labor force in the 1970s and 1980s will never earn

as much, in real terms, as their parents. At least

until the baby boom generation passes through

its prime earning years, competition among

Americans seeking jobs and advancement in

the U.S. labor market promises to be just as intense as competition among U.S. and foreign

firms in the world economy.

At the same time, a minority of skilled and

professional jobs in the services offer, as always,

lucrative opportunities for physicians, attorneys, stockbrokers. While many and diverse

patterns characterize work in the services, the

mobility patterns suggested by a listing of such

professions seem to be growing more common

(in the services and thus in the U.S. economy

as a whole). That is, upward mobility depends

on the right kind of entry-level skills and

credentials.

Two or three decades ago, Americans could

climb mobility ladders in many of the services

much like those in manufacturing, with greater

responsibilities and greater rewards in the form

of pay and perquisites for those who succeeded

or simply accumulated enough seniority, It was

possible to move from a sales job in a department store to a position as buyer (roughly

equivalent to a departmental supervisor), and

perhaps even store manager. Many of those opportunities are gone: new technologies and the

rise of higher education have knocked the rungs

out of mobility ladders in many companies.

These companies now tend to hire people with

the skills they need from outside, rather than

promoting (and training) current employees. As

the external labor market replaces internal markets, buyers and managers come from the ranks

of college graduates, often with specialized

degrees such as MBAs. Like the nurse—who

cannot become a physician through on-the-job

advancement—a sales person or clerk who

wants to move very far upward will need a new

set of credentials. If nothing else, employers

view a college degree as evidence of the ability

to learn—of retrainability.

In effect, more of the services are becoming

professionalized. One consequence is to sharpen

many of the differences in work setting between

jobs in the services and jobs in manufacturing—

differences that create substantial barriers to

mobility for displaced manufacturing employees. In addition to facing the prospect of substantially lower pay, an unemployed steelworker is unlikely to feel at home in a bank or

insurance office.

As many examples suggest, labor markets in

the services tend to fit a two-tier pattern, with

sharp divisions between professionals (and

others with specialized skills) and people with

lower skills and lower pay. To the extent that

these patterns broaden and persist, they will

aggravate the stratification already found in the

U.S. labor force: if it is too simple to speak of

a two-tier structure in the labor force as a whole,

with a small fraction of highly paid people at

the top, while the vast majority have low pay

and few prospects, it is certainly not too simple to speak of a segmented labor market, in

which moving upward will be possible only for

people with unusual abilities and ambition.

What does international trade and competition have to do with the picture sketched above?

Most of the impacts are indirect. Neither the

statistics nor the case examples in the body of

this chapter can be tightly linked to exports and

imports of services, which—as shown in chapter 2—remain relatively small. With exports of

services less than a fifth of goods exports, relatively few American jobs depend directly on

foreign sales of U.S.-produced services. Certainly trade helps create domestic jobs in many

service industries: the motion picture business

gets much of its revenue from overseas rentals;

Japanese and European banks in New York and
Ch. 7—Jobs in the Services ● 227

San Francisco hire many Americans, But, for

the U.S. economy as a whole, the indirect

effects—for instance, through service inputs

embodied in exports and imports of goods—

are much greater.

Service companies in many industries market their products primarily to manufacturing

firms, while many American jobs in the intermediate or knowledge-based services support

the activities of overseas affiliates of U.S.-based

firms. Beyond this, about 40 percent of Americans employed in manufacturing industries

perform service functions. Jobs in the services

may replace some jobs in manufacturing, but

they also depend on jobs in manufacturing—

and on the continuing competitiveness of the

manufacturing sector of the U.S. economy.

Other indirect impacts are more subtle. Pervasive competitive pressures on American service and manufacturing firms, stemming from

domestic deregulation as well as from imports,

have forced companies to reassess their business strategies, Many have sought to cut costs

and improve their flexibility by replacing some

of their full-time employees with part-time or

temporary workers. Not only does this help

meet fluctuations in demand (day-to-day or seasonal, as in banks and department stores, as

well as fluctuations tied to the business cycle),

but companies can hold down their hourly costs,

for fringe benefits as well as direct pay,

Since the middle 1970s, the number of contingent workers in the U.S. labor force—those

without formal or long-lasting ties to a company–has grown steadily. The majority hold

part-time jobs or are self-employed. When temporary and contract employees are added, together with illegal immigrants and those working at home or in the underground economy,

contingent workers total well over a quarter of

the Nation labor force. (Most of the work in

the underground economy is simply unreported, not otherwise illicit or illegal.)

In effect, companies have been able to push

much of the risk associated with business downturns onto their employees. During 1985, about

5.5 million Americans employed part-time

wanted full-time jobs but could not get them

(another 8.3 million were unemployed), The

trends outlined in this chapter suggest that

American service firms (and manufacturers)

are attempting to control costs and achieve flexibility in part by using workers who receive few

fringe benefits and little training, whose hours

can be varied to meet fluctuations in demand,

and who can be laid off more easily than regular employees.

Given a slack labor market that has seen involuntary part-time work rising for years,

greater reliance on contingent workers becomes an easy and obvious adjustment, at least

in the short run, for companies faced with

greater competitive pressures. Somewhat greater commonality of skills across industries—e.g.,

in computer-related occupations—makes it easier for firms to tap part-time or temporary workers as needed (while giving employees more

scope for horizontal mobility—although this

may be a poor second to vertical mobility). But

job ladders in the normal sense seldom exist

for contingent workers, and over the longer

term, companies that rely too heavily on parttime and temporary employees may well find

themselves with a work force lacking the skills

and experience base needed to meet new competition.

OTA makes no attempt in this report to project future employment in the service industries, A quantitative assessment would require

sector-by-sector analyses, including the indirect

impacts of new technologies and international

trade and investment. This chapter aims, instead, at a summary picture of U.S. employment

patterns, one that highlights service industries

and service occupations. The later sections,

touching briefly on the effects of immigration

and work in the underground economy, show

that the jobs taken by immigrants, legal and illegal, and the choices made by Americans who

work “off the books” fit consistently into the

larger picture. Immigrants divide sharply into

those with high skills and professional credentials (nurses and physicians from the Philippines, engineers from Taiwan) and those with

low skills who take jobs in personal services,

construction, or trade (e. g., restaurants) —most

of them from Latin America, Many of the
228 ● International Competition in Services

Americans who work in the underground econ- take opportunities that they happen upon. By

omy do so in response to disruptions and un- definition, they are part of the contingent lacertainties in the labor market, as well as under- bor force.

employment. People who fear future lay-offs

EMPLOYMENT AND STRUCTURAL CHANGE IN THE U.S. ECONOMY

Economic activities can be grouped in many

ways. The simple, most common division

breaks the economy into three broad sectors:

1) a primary sector, the largest components of

which are agriculture and mining; 2) secondary industries, manufacturing and construction; and 3) a tertiary or service sector. (This

is the conventional use of the term tertiary, not

the sense used in this report—see below.) The

outputs of the primary industries, extracted in

some way from the natural world (food, timber,

iron ore), provide inputs to secondary industries (food processing, housing construction,

steelmaking). The service sector, in essence,

takes in everything that is left—including, under most classification schemes, government.

This conventional threefold classification

reveals little concerning employment in the

services. Thus, as explained in chapter 1, this

report subdivides the services into knowledgebased and tertiary categories—reserving the

term tertiary for the subset of traditional service industries and occupations (table 6) such

as retailing and personal services. Throughout

the remainder of this chapter, tertiary will, as

elsewhere in the report, refer only to that subset of services.

The Shift to Services

As economies develop, employment in agriculture and mining shrinks, people find jobs

in manufacturing, and, somewhat later, in the

services. Post-industrial economies, those in

which the service sector has come to dominate,

emerged after World War 11, Table 32 provides

a summary picture of U.S. employment patterns

over the period 1975-85, based on a fivefold

classification that further subdivides both manufacturing and the services, identifying knowledge-based jobs and sectors in each.2 The breakdown is inevitably somewhat arbitrary. Many

of the jobs in traditional industries are highly

skilled and thus knowledge-intensive. On the

other hand, large numbers of people working

in knowledge-based services like health care

have routine, even menial, jobs. Nonetheless,

this classification helps delineate important

shifts in the structure of U.S. employment.

Since 1980, employment in the traditional industries (Sector II in table 32, manufacturing

and construction) has declined both relatively

and absolutely, Net new jobs have been created

in both the knowledge-based and tertiary services, along with knowledge-intensive manufacturing (Sector III). Services in total now employ more than 70 percent of the U.S. labor

force, with high continuing rates of growth.

Sector IV (knowledge-based services) grew by

one-third over the period 1975-85, as did tertiary service employment. Jobs in Sector III

(knowledge-intensive manufacturing) grew by

more than 40 percent.

Explanations for the relative growth of services employment would take the analysis well

beyond the bounds of this assessment. Cer-

‘The classification in table 32, along with much other material in chs. 7 and 8, is based on “International Competition in

the Service Industries: Impacts of Technological Change and

International Trade on U.S. Employ merit,” prepared for OTA

by E. Appelbaum, P.S. Albin, R. Koppel, and F. Hormozi under

contract No. 533-5560.

Because of the need to base table 32 on Bureau of Labor Statistics (BLS) categories, it does not correspond directly to the classifications in table 6. Moreover, at various points, ch. 7 uses data

from the Bureau of the Census in the Department of Commerce

as well as from BLS (part of the Department of Labor), Census

and BLS do not always use comparable categories and procedures. Largely because of this, it has not been practical to

rigorously maintain the distinction between knowledge-based

and tertiary services at all places in the chapter. Doing so would

have meant sacrificing much of the statistical detail available

in the databases of one or the other of the agencies.
Ch. 7—Jobs in the Services ● 229

—

Table 32.—U.S. Employment by Sector

Annual average (thousands)

1975 1980 1985

Sector 1, agriculture and mining . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Sector 11, traditional industries , . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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

Manufacturing excluding information machines (below) and

printing/publishing equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Sector Ill, knowledge-intensive manufacturing. . . . . . . . . . . . . . . . . . . . . . . . . . .

Electrical, electronic, and communication equipment excluding household

appliances and electric lighting. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Instruments and related equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Office and computing machines. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Printing/publishing equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Sector IV, knowledge-based services. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Education a 

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .,

Health . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Communications media . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Telecommunications (mainly telephone and postal service) . . . . . . . . . . . . . . .

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

Computerland data processing services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Other business services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Professional services (legal, engineering, accounting, etc.) . . . . . . . . . . . . . . .

Financial services (banking, insurance, real estate) . . . . . . . . . . . . . . . . . . . . . .

Government not included elsewhere . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Sector V, tertiary services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Transportation and public utilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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

Retail trade . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Lodging . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Personal services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Auto and other repair services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Tertiary business services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Other tertiary services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

4,319

18,500

3,457

15,043

2,225

1,426

489

284

26

28,582

7,448

5,393b

1,434

1,710

1,629

143

1,486

743

4,223

6,002

27,257

3,888

4,177

12,771

979

835

656

477

3,474

4,472

21,121

4,469

16,652

2,927

1,744

711

431

41

33,794

7,650

6,287

1,687

1,739

2,523

293

2,230

1,353

5,162

7,393

32,407

4,397

5,275

15,292

1,071

931

889

615

3,937

4,262

19,540

4,662

14,879

3,126

1,865

724

506

31

38,101

8,371

7,583

1,877

1,833

3,732

1,819

3,275

1,819

5,924

6,962

36,042

4,477

5,769

17,425

1,368

1,125

1,066

836

3.976

aFedera[ education employment included under government

bOTA estimate

estate transpoflatlon employment included under 90Wrnm0nt.

NOTE Totals may not add due to rounding.

SOURCES Supplement to Emp/oymenf and Eawings(W ashington, DC” Department ofLaboL Bureau of Labor Statistics, July 19&3 and June 1986L Ernp/oyrnentand

Earflinm 13u//etirr, 1979, m 1311-1312, except for farmina, forestry, and ftshina from ’’Proiectlons to 1995,” Bulletin No 2253 D.2, APrIl 1986, Department

of Lab&, Bureau of Labor Statistics

tainly, relative productivity trends would be

part of the story. Measures of productivity in

the services are poor—particularly on the output side, where the qualitative characteristics

of services like banking have changed dramatically over the past two decades. But, despite

the flaws in the data, it does appear that productivity in the services has increased less rapidly

than in manufacturing.3 Low productivity growth

coupled with expanding output means higher

rates of job creation,

3See,forexample, “TheServiceE conomy:O pportunity, Threat

or Myth?” Proceedings of a Workshop on Structural Change,

Department ofCommerce, Oct. 22, 1985, especia]lyH.K, Stokes,

Jr., “TheShiftt oServices: Does It Threaten Long-Run Productivity Growth,” pp. 105-116.

In many of the knowledge-based services,

automation has already proceeded through severa] generations of computer-based methods

and work organization (ch.8). Output has risen

in sectors like banking (in terms of such measures as transactions processed) without parallel increases in employment; indeed, it has been

said that providing today’s banking services

using 1950s technology would require half the

U.S. labor force. The continuing spread of automation through the services points to a major

question: Will new technologies deployed in

service industries eventually lead to productivity improvement so rapid that employment

growth slows relative to output? If so, rates of

job creation in the services could drop. Slower
230 • International Competition in Services

job creation would aggravate the unemployment and underemployment already endemic

in the United States.

Is this scenario likely? As in manufacturing,

domestic employment in the services will necessarily depend on trends in both productivity

and output. Output will depend in part on patterns of international trade and competition—

the effects of which are largely indirect. In part

because of these complexities, OTA cannot

definitively answer the questions posed above.

Some indicators do suggest that the services

are poised for rapid productivity growth, with

a marked slowdown in rates of job creation,

particularly for clerical workers. 4 One implication, consistent with much of OTA’s past

work, is plain. The United States will face continuing adjustment problems. Displacement

will be a fact of working life for many Americans. The policy implications are also plain.

The United States will need to maintain flexible

labor markets and continuing public and private sector commitments to training, retraining, and reemployment.5 Chapter 10 deals with

these issues of human resources policy.

Table 33 outlines the current distribution of

occupations in the U.S. economy. The table

shows that the vast majority of professionals,

managers, and technicians—as well as salespeople and clerical workers—work in the service

industries. (In terms of occupational rather than

industry classifications, most professionals fill

service jobs by definition.) Craft workers, ma4Automation of America Offices (Washington, DC: Office of

Technology Assessment, December 1985); also W. Leontief and

F, Duchin, ‘Z’he Future Impact of Automation on Workers (New

York: Oxford University Press, 1986). Leontief and Duchin suggest that clerical jobs could drop from about 17 to 18 percent

of U.S. employment to as low as 12 percent by 2000 (p. 14).

‘Technology and Structural Unemployment: Reemploying Displaced Adults (Washington, DC: Office of Technology Assessment, February 1986).

As one example of the magnitude of these displacement problems, note the situation of the production workers who lost their

jobs when International Harvester’s plant in Fort Wayne, IN,

closed in 1983, On the average, these men and women remained

unemployed for 39 weeks. When they found work, their new

jobs paid 20 percent less. Average family assets dropped by more

than $6,000. See “The New Job After the Plant Closed Meant

Considerably Less Pay,” Wa]]Street Journa], Oct. 22, 1985, p, 1.

Moreover, both clerical and managerial employees took pay cuts

greater than those of the displaced production workers.

Table 33.—Sectoral Distribution by Occupation

in the U.S. Economy, 1986a

Percentage of those in a

given occupation employed:

In service In nonservice

industries industries

Professionals . . . . . . . . . . . . 860/0 14 ”/0

Managers . . . . . . . . . . . . . . . 73 27

Technicians . . . . . . . . . . . . . 73 27

Salespeople . . . . . . . . . . . . . 94 6

Craft workers . . . . . . . . . . . . 36 64

Operatives, fabricators,

laborers . . . . . . . . . . . . . . . 40 60

Clerical workers and

administrative support . . 82 18

Service occupations . . . . . . 96 4

Other, primarily

agricultural . . . . . . . . . . . . 16 84

aBaSed on data for April.

SOURCE: Calculated from data in Ern@oyrner?t and Eam/ngs, table A-25, p. 32,

May 1986,

chine operators, and laborers, on the other

hand, find work primarily in manufacturing.

Because managerial and professional jobs pay

well, the occupational distribution outlined in

table 33 raises the average level of compensation in the services compared to manufacturing, At the same time, the disparity between

the wages earned by managers and professionals (as well as some salespeople) and the

wages of those in the “service occupations”

contributes to the two-tiered nature of compensation in the U.S. labor market (discussed below). Rapid growth in services enhances this

split between a small group of well-paid people at the top of the pyramid, and a very much

larger group with low wages at the bottom.

Differing mobility patterns also contribute;

those in occupations near the bottom of the

pyramid have limited prospects for moving up,

although making frequent lateral moves (turnover is high in unattractive jobs). Managers and

professionals, in contrast, normally move steadily upward in terms of pay over the course of

their careers,

Job Creation

Since the Second World War, the U.S. labor

force has grown steadily, nearly doubling between 1952 and 1985. As figure 44 shows, the

increase has been especially rapid since the
Ch. 7—Jobs in the Services . 231

Figure 44. —Growth of the U.S. Labor Force

1955 1960 1965 1970 1975 1980 1985

Year

SOURCE Bureau of Labor Statlstlcs, Employment and Eammgs,

October 1986, p 7

mid-1960s, as the postwar baby-boom generation entered the labor market. With the labor

force growing faster than the number of jobs,

unemployment has risen. Figure 45 breaks down

the increase in employment since 1960 by industry and sex. Large numbers of women have

joined the labor force. Manufacturing employment has changed little, but employment in

service industries—in 1960 already double that

in manufacturing—has continued to rise.

Competition and Structural Change

In U.S. manufacturing, structural shifts going back in many cases to the 1960s have had

far-reaching consequences for employment. Industries like steel, automobiles, and apparel

have been hit hard by import competition. Competitive pressures (along with the strength of

the dollar during the first half of the 1980s)

drove American firms to shift some employment overseas, move to low-cost locations

within the United States, and to automate.

In the services as well as in manufacturing,

changes in product design and in production

processes affect the overall number of jobs

available, as well as demand by occupations

and the characteristics of jobs within a given

industry or occupation, New products—money

market mutual funds, aircraft parts made from

Figure 45.— U.S. Employment by Industry and Sex

80,

10

t

1960 1965 1970 1975 1980 1985

Year

NOTE Services employment includes construction and government The

breakdowns by sex and by sector come from d! fferent series and may

not be strictly comparable

SOURCE Bureau of Labor Statistics, Employment and Eam/rrgs various

Issues

fiber-reinforced composites rather than sheet

metal—may mean more jobs or fewer jobs, as

well as quite different skill requirements. The

work done by medical technicians has changed

a great deal since the 1960s, largely because

of the introduction of computer-based laboratory equipment.

Competition forces firms to automate and reorganize their production processes; the next

chapter shows how American insurance companies have turned to computer-based automation, not only in back-office paper processing,

but for claims adjustments in the field. In insurance, domestic competition has been the

principal spur. In industries where international competition has been a factor, change

has often been more rapid and more fundamental: companies may not only redesign their

products and production processes, they may

move production offshore, seeking locations

with lower costs—notably for labor. While domestic competition can also lead to offshore

production—this was the case in the 1960s

when American semiconductor firms began
232 • International Competition in Services

moving abroad (mostly to Asia) —pressures

from imports hasten things along.

Domestic and international competition also

contribute to geographic shifts within the

United States. Manufacturing companies have

moved South and West in search of labor markets with lower wages and fewer labor unions.

Some service companies have followed: Citicorp tranferred its credit card operations from

Long Island to Sioux Falls, South Dakota in the

early 1980s; American Express now processes

travelers checks in Salt Lake City rather than

Manhattan. Jobs like data entry, provided exceptions to standard procedures are rare, can

be handled remotely with little or no productivity loss.

Some of this sort of work has also moved offshore, although the absolute numbers remain

small. 6 Technology that would facilitate the export of office jobs continues to emerge, Although the clarity of facsimile transmissions

remains a problem, and two-way satellite links

expensive, low transportation costs and low

wages make it cost-effective for some U.S. firms

to ship paper to the Caribbean and return magnetic disks or tape. Continuing technical advances promise to make offshore office work

‘See Automation of America Offices, op. cit., ch. 8, “Off-shore

Office Work;” also B. Stokes, “Beaming jobs Overseas,” IVational

Journal, ]uly 27, 1985, p. 1726. At present, a few thousand

workers—perhaps 10,000 at most—in several of the Caribbean

countries and Mexico, as well as Singapore, South Korea, and

India, perform coupon sorting, data entry, and routine data processing for as many as a hundred American businesses. Some

computer programming is done remotely, as well.

more practical. But before many of these jobs

actually move abroad, it seems likely that more

highly automated technologies (paperless transactions) will largely replace data entry and other

routine input-output jobs. While offshore office

work will, therefore, probably not cut severely

into U.S. job opportunities, continuing multinational expansion and decentralization by large

American corporations will see more of the

work now done at headquarters dispersed to

locations abroad.

The Dynamics of Job Creation

From 1972 to 1984, civilian employment in

the United States rose by 20.8 million (table

34)—a figure equal to jobs created minus jobs

destroyed, and thus at least hinting at the associated structural shifts and displacements.

About 8 percent of U.S. jobs disappear each

year, meaning that an equivalent number must

be created just to stay even. Net job creation

has depended almost entirely on expansion in

the services; since 1979, manufacturing employment has shrunk, so that the services, in

effect, have created more than 100 percent of

net new jobs. Although jobs have disappeared

in manufacturing slightly faster than they have

been created, rates of creation and destruction

vary widely across sectors in U.S. manufacturing. Knowledge-intensive or high-technology

manufacturing has continued, in general, to

create jobs (table 32). Other manufacturing sectors have declined, some very rapidly.

Some portion of job creation in services may

be a bit illusory, because manufacturing firms

Table 34.—U.S. Job Creation by Industry, 1972-84

Net new jobs Percentage of Employment share

Industrya

(thousands) net new jobs 1972 1984

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,785 100.00/0 100.0 ’%0 100.00/0

Mining . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 346 1.7 0.9 1.0

Construction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 456 2.2 5.3 4.6

Manufacturing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 261 1.3 26.0 20.6

Transportation/public utilities . . . . . . . . . . . . . . . . . . . . 657 3,2 6.2 5.5

Trade ... , . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,185 29.8 21,6 23.4

Finance, insurance, and real estate (FIRE) . . . . . . . . . 1,774 8.5 5.3 6.0

Other services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,485 40.8 16.7 22.0

Government . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,621 12.6 18.1 16.9

%ne-digit Standard Industrial Classification (SIC) basis.

SOURCE Emp/oymenf and Earn/ngs, May 1986, table B-1, p 45
Ch. 7—Jobs in the Services ● 233

have been hiring service firms to take on tasks

once performed by their own employees (maintenance, plant security, food service, engineering), It remains the case, however, that the

United States has in the net created jobs more

consistently than other major Western economies. Since the middle to late 1960s, unemployment rates have been gradually but steadily rising throughout the advanced industrial

nations, not excluding Japan. 7 While many of

the new service jobs in the United States have

been low in pay and status, as discussed be10W, at least the U.S. economy has been creating them. Most of the European economies

have not.

The dominance of the services in U.S. job

creation—in a context of declining manufacturing employment—raises troubling questions.

How do these jobs compare with work in manufacturing in terms of skill requirements and

pay? In terms of opportunities for advancement? The following sections address such

questions, utilizing a series of industry and occupational profiles-8 The industry profiles compare major service and non-service sectors in

terms of the kinds of jobs created and the workers and skills in greatest demand. The occupational profiles compare the demand for labor

as a function of skills and credentials across

industries,

Industrial Profile of Job Creation

U.S. manufacturing jobs reached a peak and

began to decline over the 1972-84 period. Although there were more manufacturing jobs in

1984 than in 1972, the relative share of manufacturing dropped by more than 5 percentage

points, as shown in table 34. Manufacturing

employment will undoubtedly continue to

shrink as a fraction of the total, In contrast,

almost all the service industries have experi71nternational Competitiveness in Electronics ~ashington, DC:

Office of Technology Assessment, November 1983), p. 345.

6These profiles are based on” I nternational Competition in Service Industries: Labor Market and Employment Issues, ” prepared

for OTA by J.A. Orr under contract No. 533-4845, Much of the

analysis is based on trends revealed in the 1980 census, which

provides far more information than is available between the 10-

year censuses,

enced substantial net job growth. Of nearly 21

million new jobs between 1972 and 1984, over

16 million (79 percent) were created in wholesale and retail trade, FIRE (finance, insurance,

and real estate), and “other services” (table

34)—with roughly one in three in a food- or

health-related enterprise.

Table 35 subdivides the industries listed in

the preceding table, showing large percentage

increases in employment in segments of wholesale trade (primarily durable goods), and in retail trade (mostly eating and drinking establishments—which, given a large initial base, created

21⁄2 million jobs). Almost all segments of the

FIRE industries saw rapid employment increases, as did “other services. ” In percentage

terms, expansion was most rapid in computerrelated services (a 325 percent rise, by far the

highest of any sector), followed by legal and

social services. But in total jobs created, again

because of the large initial base, health services exceeds even eating and drinking establishments, (Note that table 35, restricted to service industries showing 30 percent growth or

more over the period 1972-84, excludes some

relatively large sectors that created many new

jobs although expanding at lower rates.)

Table 36 lists demographic and occupational

characteristics as revealed by the 1980 census.

While the statistics themselves are now rather

dated, the 10-year census of population provides a wealth of information not otherwise

available. The table shows that manufacturing

employees, on average, earned substantially

more than those in many of the rapidly-growing

service industries; median annual (full-time)

earnings were 25 percent greater in manufacturing than in “other services, ” despite the high

annual earnings in the professional service categories.

Such differences have persisted; as of mid1986, average hourly pay in U.S. manufacturing was $9.70 (excluding benefits), compared

with $8,10 in the service sector (20 percent

lower). Service workers earn less in part because more of them are women, and also because they tend to be younger. According to

the table, more than two-thirds of the Ameri-
234 . International Competition in Services

Table 35.—High-Growth Service Industries, 1972-84a

Growth over

Net new jobs the period

Industry (thousands) 1972-84

Wholesale trade:

Machinery, equipment, and

supplies . . . . . . . . . . . . . . . . . . . .

Electrical goods . . . . . . . . . . . . . .

Groceries . . . . . . . . . . . . . . . . . . . . . .

Retail trade:

Eating and drinking

establishments . . . . . . . . . . . . . . .

Food stores . . . . . . . . . . . . . . . . . . .

Finance, insurance, and real estate

FIRE:

Commercial and savings banks .

Real estate . . . . . . . . . . . . ...

Insurance agents, brokers . . . . . . .

Savings and loans . . . . . . . . . . . . . .

Securities and commodities

brokers and dealers . . . . . . . . . . .

Medical and health insurance . . . .

Other services:

Business services:

Personnel supplyb . . . . . . . . . . . .

Computer and data

processing . . . . . . . . . . . . . . . . .

Services to buildings . . . . . . . . . .

Automotive repair, garages. . . . . . .

Amusement and recreation. . . . . .

Hotels and lodging. . . . . . . . . . . . . .

Professional services:

Health. . . . . . . . . . . . . . . . . . . . . .

Social . . . . . . . . . . . . . . . . . . . . . . .

Legal. . . . . . . . . . . . . . . . . . . . . . .

Engineering and

architectural . . . . . . . . . . . . . . .

Accounting, auditing, and

bookkeeping . . . . . . . . . . . . . . .

535

138

184

2,521

840

512

339

205

193

141

53

613

364

279

284

445

418

2,677

667

387

283

174

62%

42

35

7 0 %

30

500/ o

46

68

61

60

35

820/,

325

53

36

89

64

79

134

144

83

“ 85

aTwo. and three.diait Standard Industrial ClaSSifiCatiOflS.

blncfuding ternpor~ry help services and employment agencies

SOURCE: Bureau of Labor Statistics.

cans working in manufacturing industries were

men. In contrast, 45 percent in trade were

women, and more than 60 percent in “other

services. ” Everything else the same (and often

when it is not), men continue to earn more than

women. Furthermore, the average manufacturing worker can expect more pay simply on the

basis of age. The table shows those with jobs

in trade to have a median age of 32, compared

with 36 in manufacturing.

Service workers have more education, on the

average, than manufacturing employees; at

equivalent levels of education, they make less.

Especially among the younger workers in the

new service labor force, educational levels are

higher simply because more Americans now

finish high school; only in personal services is

the percentage of high school graduates lower

than in manufacturing—60 percent compared

with 70 percent. Of course, some of the new

jobs being created in the services demand more

education and better skills (or at least different

skills—ch. 8), while a few of the service sectors

listed in table 36 employ large numbers of professionals. Those with college degrees are most

heavily represented in business and professional services, and in the FIRE industries.

Within the FIRE industries, commercial and

savings banks added more than half a million

jobs between 1972 and 1984 (table 35), with savings and loans contributing another 193,000;

together, real estate and insurance accounted

for 700,000 (including several slowly growing

subsectors omitted from table 35). As in trade,

women fill many of these jobs, but the average

levels of education are considerably higher in

the FIRE industries—90 percent high school

graduates compared with 70 percent in trade,

and nearly a quarter with college degrees. At

the same time, FIRE employees are considerably older, on the average, than those in trade.

FIRE jobs tend to be full-time, but annual earnings are relatively low. Indeed, the coupling of

relatively high educational levels and relatively

low pay sets the FIRE industries apart from

other sectors in both the services and manufacturing. With exceptions such as managers,

underwriters, and brokers, many of the jobs in

these industries have been held by women who

are the second wage earners in the family (note

that the percentage of heads of households

found in banking is the lowest of all industries

listed in table 36). Chapter 8 discusses jobs in

banking and insurance from the perspective of

changes in work organization, illustrating some

of the other reasons for this combination of high

education and low pay.

Service employees are less likely to work full

time than those in manufacturing, This depresses annual earnings, and usually means

much lower fringe benefits. While more than

70 percent of manufacturing workers had fulltime jobs in 1980, half of all employees in the

trade sector worked part time. In “other services,” full-time employment predominates only

in the more skilled jobs (computer and data
Ch. 7—Jobs in the Services ● 235

L

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. . .

.

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. .

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.

n
236 ● International Competition in Services

processing, repair services, some subsectors of

professional services). Finally, relatively fewer

non-manufacturing employees belong to labor

unions. As table 37 shows, about a quarter of

American manufacturing workers continue to

be covered by collective bargaining agreements,

compared with less than 10 percent in many

of the service industries. (Differences in factors such as value-added also affect relative

wage levels across industries.)

Much more so than in blue-collar manufacturing jobs—where people can expect to advance with seniority, particularly in unionized

industries—career prospects for those who enter the services depend on educational background and credentials. Of the high proportion

of young and/or less educated employees in

entry-level positions, particularly in the trade

sector, some take jobs during interruptions in

schooling or on a part-time basis while students.

For these people, high rates of job creation in

the services mean easy entry into the labor market and widespread opportunities for initial

work experience. Many go on to better-paying

jobs in entirely different industries—jobs with

good prospects for upward mobility—when

they complete their schooling.

Those with less education and/or poor skills

face much dimmer career prospects. The jobs

they can get will be less likely to prove the first

rung on a career ladder, Although they may

learn and advance somewhat with on-the-job

experience, fewer career ladders seem to exist

in the services today than in the past; as discussed below, companies now tend to hire in

entry-level college graduates, rather than filling lower level administrative and supervisory

jobs with those moving upward in the ranks.

To get such jobs—and get a foot on the ladder

—may mean a 2-year degree, or in some cases

specialized training in fields like business.

The data in table 36, then, hold few surprises.

Higher incomes correlate with age, with union

membership, and, given some exceptions, with

levels of education. White males get the best

jobs in both manufacturing and the services.

Average wages in the services lag behind those

in manufacturing except in industries with high

proportions of professionals, The accounting,

auditing, and bookkeeping sector, for example,

shows relatively high median earnings—$16,600

for full-time employees in 1980 (table 36). This

is greater than the median for manufacturing

employees ($15,200) or in banking (only $10,500),

Table 37.—Union Representation by Industry

Percentage of wage and

salary workers covered by

collective bargaining agreements

Industry 1980a 1984b

All (including government). . . . . . . . . . . . . . . . . . . . . . . . . . . . 23,00/o 19.1 “/0

Government . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35,9 35.9

Private sector. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20.1 15.6

Service producing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13.5 10.6

Transportation, communications, and

public utilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48.4 39.6

Wholesale and retail trade. . . . . . . . . . . . . . . . . . . . . . . . 0.1 8.2

Finance, insurance, and real estate (FIRE) . . . . . . . . . . 3.2 2.7

Other services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8.9 7.2

Goods producing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30.5 24.5

Mining . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32.0 17.9

Construction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30.9 24.3

Manufacturing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32.3 26.5

Durable goods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34.8 28.0

Nondurable goods. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28.5 24.2

aPercentages for May

bAverage s for 12-month period ending September lg~

ClnCludes ~gricuiture,and forest~ and fisheries, in addition to those listed separately.

SOURCE L T Adams, “Changing Employment Patterns of Organized Workers, ” Monthly Labor RevJew, February 1985, p. 26.
Ch. 7—Jobs in the Services

even though women make up nearly half of all

accounting, auditing, and bookkeeping employees, But over half of those in this sector have

college degrees—indeed, the percentage is the

highest of all industries listed in the table,

Occupational Profile of Job Creation9

More than half of all new jobs created from

1970 to 1980 fall in one of two occupational

categories—both relatively low-skilled and

low-paid:

1. Sales/support, including sales clerks,

cashiers, and secretaries—which accounted

for 36 percent of new jobs over the 1970-

80 period;

2. “Service” occupations such as security

guards, custodians, food service workers,

and nurses aides—accounting for another

19 percent of all new jobs.

Rapid growth in food service and other retail

trade establishments, and in health care drove

job creation in both sets of occupations. But

job creation was also rapid at the high-skill,

high-pay end of the spectrum, with professional

and managerial/administrative occupations

comprising more than 26 percent of all newly

created jobs over this same period—about half

as many jobs in total as in sales/support and

“services.” Note that some of the people working in service occupations hold jobs in the manufacturing sector of the economy. Nurses aides,

for instance, may find jobs either in the services or in manufacturing (although many more

work in hospitals than factories).

While service occupations have grown, traditional manufacturing jobs like assembler and

machine operator have declined, and not only

in absolute numbers—on the manufacturing

side of the economy, the fraction of production

employees has dropped. Particularly in knowledge-intensive sectors like computers or microelectronics, companies are hiring increasing

numbers of skilled blue-collar and white-collar

employees. Nonetheless, manufacturing firms

otherwise unattributed data in this section comes from ‘‘International Competition in Service Industries: Labor Market and

Employment Issues, ” op. cit., table 11.3, and is based on the 1980

Census Public Use Sample.

● 2 3 7

in both durable and nondurable goods industries still employ large numbers of Americans

in occupational categories such as machine

operator and production craft worker; together,

these two groups accounted for over half of all

employment in U.S. manufacturing at the time

of the 1980 census,

In addition to the professionals, skilled whitecollar workers, and low-skilled clericals that

banks and insurance companies have always

depended on, these companies—like many

other service firms—increasingly seek employees with specialized technical skills such as

computer programming. According to the 1980

census, computer-related occupations made up

3.6 percent of employment in banking, and 4

percent in the insurance industry, compared

with 3.3 percent in durable goods manufacturing and only 1.0 percent in non-durables. 10 I n

total, more than 80 percent of insurance industry employees, and 68 percent of those in banking, filled jobs that can be classified as technical/professional (including such traditional

occupations as loan officer, underwriter, and

claims adjuster, but excluding managers) or

sales/support. Another 14 percent in insurance

and 26 percent in banking held managerial

jobs—compared with only 8.6 percent in manufacturing,

Within the technical/professional categories,

of course, the range in skills is vast: some but

not all of these people—e. g., data-entry clerks—

have semi-skilled jobs analogous to machine

operators and assemblers. Industries like legal

services employ, not surprisingly, 42 percent

professionals. Business and repair services

show the most varied occupational mix: roughly 20 percent mechanics and repairers, 23 percent production/craft workers, 30 percent technical and sales/support employees, and 15

1OBuSiness and repair services showed the highest fraction of

computer-related occupations—5.6 percent. Other service industries, notably the personal services, though large in absolute size,

create few such jobs (O. 1 percent). One percent of all jobs in trade

and the FIRE industries were computer-related, and 0.9 percent

in professional services. All these figures, which come from the

Public Use Sample of the 1980 Census of Population, have no

doubt increased over the intervening years. At the time of the

census, the overall figure for computer-related jobs, excluding

agriculture, was 1.5 percent,
238 ● International Competition in Services

percent managers. Mechanics and repairers,

as an occupation, show up in a broad range of

industries, as do occupations related to transportation and materials handling—important

in manufacturing (about 10 percent of all manufacturing jobs) and in trade (9 percent).

Labor force characteristics by occupation—

outlined in table 38, which parallels the profile by industries in table 36—illustrate the typical differences between manufacturing and

service jobs from a somewhat different perspective. Manufacturing occupations such as operator/assembler and production/craft worker

show above-average earnings and below-average educational levels. The high-growth sales/

support and service occupations, in contrast,

have the lowest average earnings of any major

occupational category. While 85 percent of

sales/support workers have a high school education, compared with 57 percent for operators/assemblers, the latter show median annual

earnings higher by $1,100.

In general, people in a given occupational

group make more money if they work in a manufacturing industry than in a service industry.

As table 33 indicated, many of those in service

occupations have jobs in industries classed in

the manufacturing sector, and vice versa. Eighteen percent of all clerical workers—a service

occupation —work for manufacturing firms.

Clerks employed in manufacturing have about

the same education, on average, as clericals in

other industries—but earn more. Likewise, a

typical 35-year-old in a sales/support occupation earned $18,000 in 1980 if he or she worked

in the manufacturing sector, but only $13,500

in trade or FIRE (and still less in other sectors—

median earnings came to only $11,000), again

despite similar educational levels. Managers in

manufacturing industries earn more than managers in the services, all other things the same,

Of course, other things are not always the same.

People in service occupations working for manufacturing companies tend to have other characteristics associated with higher incomes—

they are older, more likely to be men, and more

likely to work full time, Put another way, they

have different job histories, reflecting other

characteristic differences between manufacturing and the services.

Although the faster relative growth of the

service industries has been the primary reason

for the shift toward service occupations in the

U.S. labor force, growth of service functions

and service jobs within manufacturing has also

been important. The proportion of nonproduction workers in many manufacturing companies has been rising. At the same time, American manufacturers are also making greater use

of outside contractors and people who work

for temporary help service firms—sometimes

in production, but more commonly to fill jobs

ranging from engineering and drafting to plant

security and cafeteria work—as discussed in

a later section.

MOBILITY

The kinds of jobs being created and their dis- Manufacturing work, particularly in uniontribution within the economy help determine ized industries, offered attractive opportunities

worker mobility, both vertically (upward within for many Americans in the years following the

a firm or industry) and laterally (e.g., from man- Second World War. Collective bargaining agreeufacturing to the services). Overall, employment ments meant, not only substantially more pay

in service industries seems to offer fewer op- than in non-union companies, but a framework

portunities for upward mobility, though hori- within which on-the-job training and experizontal mobility may be greater than in manu- ence combined with job tenure and seniority

facturing. rules to provide upward ladders by which em-
. .

.

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.

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Ch. 7—Jobs in the Services ● 2 3 9

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240 • International Competition in Services

ployees could expect to advance in terms of

skills, responsibility, and income. Abroad spectrum of skilled occupations separated unskilled

or semi-skilled laborers and assembly workers

from college-trained managers and supervisors—a spectrum including craft workers (millwrights, pipefitters, tool setters, machine repairers), technicians and draftsmen, and, in

many cases, foremen risen from the ranks. After the war, those who entered rapidly expanding capital and consumer goods industries

could expect job security, steadily rising income, and relative affluence-prospects that

have vanished over the last 10 years, notably

in industries like steel and automobiles, as a

result of international competition and structural change in the U.S. economy.

It is no surprise that few manufacturing workers have moved laterally into the services (less

than 500,000 over the period 1979-84).11 Because

manufacturing workers can earn considerably

more than those in service occupations with

the same level of education, people with wellpaying manufacturing jobs hold on to them

whenever possible. And, because a good deal

of the decline in U.S. manufacturing employment has come through attrition (retirement

and voluntary quits), the number of manufacturing workers looking for jobs in the services

tends to be smaller than might be expected

based on the publicity given mass layoffs and

plant closings in depressed industries.

But what about the career prospects of the

younger, more educated service workers profiled in the 1980 census (tables 36 and 38)? As

the service-based U.S. economy continues to

mature, will levels of pay rise so that these people will experience job histories in terms of income and upward mobility comparable to their

forerunners in manufacturing? Probably not.

New entrants into the labor force with a high

school education (or less) seem unlikely to have

the opportunities that those with similar backgrounds could expect a generation ago. The

manufacturing jobs these people could enter

are vanishing. The service jobs for which today’s high school graduates can qualify will not

‘l’’ Labor Mobility and Structural Change in Pittsburgh, 1977-

82, ” op. cit.

offer the career prospects of the manufacturing jobs available 30 years ago.

Of course, job ladders do exist in the services. But many examples, including several

summarized later in this section, and in chapter 8, suggest that prospects for younger Americans currently entering the service industries

will not be as good as for their parents who went

to work in factories.12 Vertical mobility may be

less, in part because service companies tend

to hire people with specialized skills (selling)

or educational backgrounds (computer programming) for many of their openings; where

on-the-job learning can still lead to advancement, many career ladders are nonetheless

capped at relatively low levels. Horizontal

movement will be easier, particularly for nonunion workers with no seniority to give up—

but moving, say, from a clerical job in retailing

to a similar job in the insurance industry may

not lead to much of an increment in pay, or

to new opportunities.

People in some service jobs do develop specialized occupational skills that are easily transportable across industry boundaries. These

skills may begin with relatively formal education and training (accounting). In other cases,

they may be developed on the job (computer

graphics)—although on-the-job skill development has generally been more important in

manufacturing than the services, if only because manufacturing workers have not been

as well-educated to begin with. To the extent

that commonality of skill requirements across

the services (including social skills) grows,

lateral mobility will increase; it has probably

always been easier to go from selling shoes to

selling insurance than from making shoes to

making steel—certainly easier to do so without

moving to another city or State. Of course,

many skilled and craft workers in manufactur12See, for example, “Labor Mobility and Structural Change in

Pittsburgh, 1977 -82,” op. cit.; “Testimony of Dr. Eileen Appelbaum, Temple University, Philadelphia, PA 19122, The Shrinking Middle: Evidence from the Insurance Industry, ” Service lrldustries: The Future Shape of the American Economy, hearings,

Subcommittee on Economic Stabilization, Committee on Banking, Finance and Urban Affairs, House of Representatives, June

8, 12, 14, and 28, 1984 (Washington, DC: U.S. Government Printing Office, 1984), p, 627,
Ch. 7—Jobs in the Services ● 241

ing—toolmakers, electricians—have always had

know-how that could be readily transferred

across industry boundaries.

While lateral mobility may be on the rise, giving service workers greater flexibility than some

of their counterparts in manufacturing, upward

channels in many service firms have been cut

off. Partly because companies now hire collegetrained people for jobs once filled through promotion, and partly because changes in work

organization (largely computer applications)

have stripped away some of the rungs on career ladders, many service workers have little

opportunity for advancement. Both factors—

structural/organization change, and technological change—have contributed to the development of two-tiered employment patterns in the

United States. Boxes X and Y illustrate,

In industries as different as retailing and

telecommunications (boxes X and Y), new patterns of hiring fence off supervisory and

managerial jobs from most of the work force.

In both cases—as in others described in the next

chapter (banking, insurance) —deregulation,

new competition, and sweeping technological

change have led to restructuring, reorganization, and shifts in personnel structure. A telling example comes from a major insurance

company with offices in New York City. *3 This

firm once hired large numbers of clerks and

messengers straight from high school. To maintain a pool of desirable entry-level candidates,

and help in the selection process, the company

took on as many as 2,000 high school students

each summer; over the past dozen years, the

number of summer jobs has been cut to 100.

Rather than hiring high school graduates, the

firm now seeks entry-level employees with at

least an associate degree from a community college. As other studies demonstrate, this is

hardly an isolated instance; some 20,000 unskilled entry-level jobs reportedly disappeared

in New York City during the 1970s, as banks,

insurance companies, and utilities replaced

their clerks and runners with computers and

13E. Cinzberg, T. J, Noyel]e, and T. M. Stanback, Jr., ‘ ‘Technology and Employment: Concepts and Clarification s,” Conser\’ation of Human Resources, Columbia Uni\rersity, October 1985,

p. 4-13.

information networks.14 Currently, banks are

hiring perhaps 20 percent of their new employees at the high-school level; 10 years ago, the

proportions would have been reversed, with as

many as 80 percent of newly hired workers having no more than a high school education. 15

Given the explosion in higher education over

the postwar period, it is hardly surprising that

service companies in many industries now

place a premium on hiring people with specialized expertise directly from colleges and universities. Why pay to train existing employees in

the latest techniques of finance, marketing, or

data processing when a generally slack labor

market makes it is easy to hire someone new?

Thus selection processes have shifted to emphasize credentials and schooling, to move the

costs of training and skill development outside

the firm, and to encourage lateral moves between companies rather than upward moves

in an established internal labor market, As a

result, many more people now split their time

between work and school, studying part-time

or at night to qualify for positions with prospects for advancement. Instead of on-the-job

training and experience leading to a better position, Americans today are much more likely

to hold one job while studying on their own

for another, perhaps in a quite different field.

Stratification in the services, then, contrasts

markedly with traditional patterns in manufacturing, There, labor unions sought to minimize

differences in wages and working conditions

among their members—differences that have

become commonplace in the services, The comparisons across industries and occupations in

tables 36 and 38 demonstrate the sharpness of

14T. Bailey and R. Waldinger, “Employment Problems in the

Shifting New York Labor Market, ” ~el%, York Affairs, Sunl Iner

1984. Cited in T.J. Noyelle, Be~rond industrial Dualism: Afarket

and]ob Segmentation in the New Econom~~ (Boulder, Co: [l’estview, 1987).

IsMost of these new hires fill positions like tellers, where turnover has always been high. E\’en so, banks are now seeking out

people with several years of college for such jobs. See O. flertrand and T. Noyelle, “Changing Technology, Skills and Skill

Formation in French, German, Japanese, Swedish and U.S. Financial Service Firms: Preliminary Fin dings,’ report to the Center for Educational Research and Innovation of the Organization for Economic Cooperation and Development, August 1986,

table 1 (following p. 52).
242 ● International Competition in Services

Box X.-Restructuring in a Department Chain: The Macy’s Case1

Career paths in retailing have changed radically in the United States, a process still underway.

Rising consumer spending after World War II, and the growth of the suburban middle class, led to

intense competition. Established downtown department stores like Macy’s began moving to the suburbs

and to shopping centers in order to meet competition from newer discount retailers (e.g., K-Mart)

as well as mass merchandisers (Sears, J.C. Penney). Most of the expansion took place outside the

major urban centers that had been strongholds for chains like Macy’s. Many small independent stores

in the cities vanished; survival for both large and small meant restructuring to serve the growing

suburban market.

In 1948, R.H. Macy & Co., established 90 years earlier, operated six large stores and a few smaller

branches. Over the next 30 years, the company opened more than 80 new outlets. In battling the discounters, Macy’s first tried to imitate them, but with little success. Seeking a new strategy that would

prove more effective, the company went through a series of rapid changes as it opened new stores,

revised its managerial and administrative procedures, and installed computer systems for accounting, billing, and inventory control. Major shifts in the structure of employment followed.

The most fundamental change entailed separating store management from merchandising. Originally, each department in a store was the responsibility of a “buyer,” who personally selected the

merchandise to be stocked in his or her department. Buyers not only handled marketing, but they

hired the sales staffs for their departments. Management and merchandising were integrated in the

person of the buyer. Rapid expansion doomed this system, in which each buyer operated as a nearly

independent agent. There were far too many stores, too many departments; coordination was impossible, costs could not be controlled. In Macy’s new structure, divisional administrators supervised

purchasing and merchandising for an entire (geographic) division. Store management had its own

hierarchy; managers ran their stores, but no longer supervised the selection of merchandise.

With two parallel chains of responsibility—one for merchandising, one for store management—

good communications between the two sets of line administrators and managers were vital. To aid

in this, and to help develop the large numbers of new managers needed to staff their growing company, Macy’s executives required line managers to move back and forth between store operations

and merchandising as they advanced. (The restructuring also involved extensive changes in other

parts of the organization-e.g., financial management.)

Below these managerial and administrative levels, the break with the past has been just as sharp,

although for different reasons. With stores remaining open in the evenings and on weekends, a work

force that had been two-thirds full-time in the mid-1960s became two-thirds part-time by end of the

1970s. Macy’s turned to part-time employees not only to cover longer store hours, but also to reduce

labor costs. Fringe benefits as well as pay scales could be trimmed for part-time employees, few of

whom advance much beyond the minimum wage. In recent years, three out of four of those on the

sales floor (who comprise four-fifths of the nonmanagerial staff) have been part-time workers. In the

back-store jobs (shipping and receiving stockrooms and distribution centers) that comprise the remaining fifth of the company’s nonmanagerial labor force, only one in four employees works part time.

The demographics of the sales staff have changed as well. Once mostly white females over age

30, today the typical sales clerk is younger and more likely to be a minority (although women have

actually risen from about 70 percent of the company’s total work force in 1966 to 74 percent in 1982—

largely because computers have taken over much of the back-store work once performed by a largely

male clerical staff). While Macy’s has placed more women in managerial positions in recent years,

most of the firm’s female employees still work in low-level sales jobs; the company has made less

progress in placing minorities than women in managerial and professional positions.

IBaaed on T.J, NoyeUe, Beyond Industrial DwWm: Market and Job Sesment@tion in the NOW Economy (~ulder, CO: wes~iewt 1987)9

Chapter 111 (Retailing: The Caaa of R.H, Macy & Co.).
Ch. 7—Jobs in the Services • 243

When buyers ran their own departments, Macy’s employees could move into junior management

positions from the sales floor. Starting in an entry-level job such as greeting card sales or as a stock

clerk, they might work their way into a lead or commissioned sales job (handling, say, furniture or

major appliances), eventually into supervision (e.g., as an assistant buyer). People could and did enter

at the bottom, become buyers, and rise to be store managers. The new managerial structure has effectively blocked these channels, with the shift toward a part-time sales force also contributing. Today,

sales-floor employees, for practical purposes, are stuck where they are. Management trainees are hired

in from college (or sometimes from other firms), normally beginning in supervisory positions on the

floor. The next step-over to the merchandising side-is an assistant buyer’s job. Steady advance through

the management hierarchy is the reward for those who perform best—although turnover is high, with

many people leaving, voluntarily or involuntarily, to be replaced by a new crop. (Turnover is also

high among the sales staff.)

In the back of the store, computer-based systems have taken over account processing and billing,

financial and inventory control. Most of the routine jobs have disappeared; in some stores, two or

three people do work once handled by 25 or more stock clerks. As a consequence, the back-office

staff has shifted toward skilled and professional employees who can maintain and use the new equipment. Macy’s hires in many of these people because of their skills; opportunities for low-skilled employees to learn on the job are limited.

Macy’s has achieved its objectives. During the 1970s, costs were cut and productivity grew rapidly.

The proportion of sales people in the labor force has not changed much, but employment has otherwise shifted away from clerks and laborers toward managers and professionals.

With a college education the prerequisite for entering on the managerial track, and the back-store

shift toward higher skill levels, earnings patterns for Macy’s employees have become bimodal. At

the upper end are the executives, managers, and professionals–at the lower end, the sales staff, largely

part-time, together with the smaller number of clerks and laborers still needed in the back of the store,

on the loading docks, for mopping the floors.

Macy’s restructured under intense pressures from discount retailers. Forced to cut costs while

expanding rapidly, senior managers felt the company could no longer rely on an internal labor market; they brought in trainees directly from college, invested heavily in data processing equipment,

and sought to impose discipline on their buyers’ fiefdoms. The new requirement of a 4-year college

degree for entry on a management track, plus computer automation, effectively closed off career ladders that earlier gave employees with high-school backgrounds the opportunity to advance.

the distinctions in pay, frequency of part-time strains could develop if younger entrants, perwork, age, and educational background among haps including those with college degrees, face

workers in differing sectors. With stratification career prospects and living standards inferior

on the rise in the U.S. labor market, severe to those of their parents.

TEMPORARY AND PART-TIME WORKERS”

With domestic and international competition temporary or, more commonly, part-time jobs

forcing American firms to cut costs, many have —in search of flexibility. Using short-term, projturned to contingent workers—e.g., people with ect-related, or part-time employees rather than

1.9Much of this section is based on “International] Competition pared with that in tables 36 and 38. The two earlier tables use

in the Service Industries: Impacts of Technological Change and the Census definition for full-time employment—35 hours or more

International Trade on U.S. Employ merit,” op. cit., ch. 4, includ- per week plus at least 50 employed weeks per year—rather than

ing specifics not otherwise cited. The data on part-time employ- the Bureau of Labor Statistics definition of 35 hours or more

ment in figure 46 and elsewhere below cannot be directly com- per week at the time of the surve.v.
244 ● /international Competition in Services

Box Y.-Deregulation, Expansion, and New Technology at New York Telephone

During the 1970s, new competition stemming from deregulation, along with exploding residential and commercial demand in the New York metropolitan area, led to massive organizational change

at New York Telephone (NYT)—organizational change that was possible only because of the replacement of electromechanical switchgear by computerized systems. Reorganization stemming from deregulation culminated, at least for the time, in the AT&T breakup—which left NYT a division of NYNEX, one of the Bell operating companies. Other forces for change-notably, the ever-expanding .

telecommunications needs of businesses in the New York area—will continue and perhaps grow

stronger.

Also contributing were circumstances in earlier years that had left NYT’s equipment in a state

of disrepair; because so much of its switchgear was obsolete, and because demand was growing so

fast, when NYT began installing computerized switching equipment, it did so at higher rates than

many other telephone companies. An entirely independent set of forces were also at work. Shifts

in NYT’S personnel structure came faster and cut more deeply because of a lengthy strike during

the early 1970s. In addition, a poor affirmative action record led NYT to accept a new set of personnel

practices as part of a consent decree negotiated with the Federal Government. As a result of this

consent decree, the company nearly stopped its hiring on the outside, moving women and minorities

into more desirable jobs at a time of shrinking overall employment. When NYT resumed hiring in

substantial numbers, it sought college-trained engineers, professionals, and management trainees to

help it deal with new technical and marketing needs.

As the end of the 1960s approached, NYT had been deferring investment and postponing maintenance because of low profits. Meanwhile, demand skyrocketed. The company was ill-prepared to

meet a market growing by hundreds of thousands of new lines per year. Service was poor, equipment

broke down, customers complained.

Infusions of capital from AT&T—more than $10 billion during the 1970s—rescued NYT from crisis. Meanwhile, a largely fortuitous series of events contributed to major changes in work rules and

job descriptions, and thus to the structure of employment. In 1971, NYT’s union called a strike-one

that was not to be settled for 8 months. To maintain service, engineers, managers, and supervisors

took over many of the tasks of the striking union members. Other AT&T divisions flew in planeload

of professional and managerial personnel on weekends. As the strike lingered, these non-union personnel installed some 700,000 new telephones, carried out the necessary maintenance on central switching systems, learned to climb telephone poles. This unplanned training convinced NYT’s management of the need for sharp cuts in some parts of the company’s labor force, and of a parallel need

for changes in the content of many jobs.

Three primary forces shaped the restructuring that followed the strike: 1) new technology, primarily in the form of electronic central office (CO] switching equipment; 2) affirmative action requirements; and 3) the changing market for telecommunications services. Much of NYT’s new investment

went toward electronic CO switches. In essence large computers (ch. 5), they needed little routine

maintenance compared to the older electromechanical switchgear. What maintenance they did require called for new skills-e. g., editing computer programs. Engineers and computer specialists took

over most of this, including trouble-shooting. Switchmen—the craft workers who had maintained

the old electromechanical equipment-were relegated to the simpler and more mundane tasks that

still needed to be performed; in effect, their jobs, when not eliminated, were deskilled. A CO switching system once manned by a crew of 30 to 40 switchmen could now get by with 2 or 3.

Furthermore, with the new electronic exchanges, a much smaller complement of operators could

handle a given volume of traffic. Computers took care of the bulk of the routine calls. NYT’s operators

were needed mostly for, directory assistance and international dialing.

sBaaed on T.J. Noyell% Bqvtand hnfustrikf Duafkm: Market and J& Segmentation in the New Economy @odder, Ml: WeSWiew, 19S7)>

Chapter IV (Utilitiaa: The Case of New York Telephone).
Ch. 7—Jobs in the Services ● 245

Change was just as rapid in the field. Computer-based customer equipment—e.g., PBX’S (private

branch exchanges)—was easier to install, easier to maintain. Cuts in jobs for equipment installers

followed, especially after new regulatory decisions permitting customers to hookup their own telephones. At the same time, deregulation and new competition led the company to beef up its marketing

staff.

Between 1972 and 1977, NYT’s work force dropped from 106,000 people to 75,000. At the end

of this period, the company employed about the same number of skilled and craft workers (for a much

larger equipment base), but a smaller number of operators. The percentages of sales representatives,

managers, and professionals in NYT’s work force were up substantially. (Like other large businesses,

NYT moved rapidly to computerize its billings and accounts over these years, which also had major

impacts on staffing patterns.)

Federal legislation in the form of affirmative action standards came into play during the middle

1970s. In earlier years, as the company had grown, most of the craft jobs (e.g., switchmen and linemen) went to white males. Women filled almost all the openings for operators and in customer service

departments. Blacks were found mainly in janitorial and other support roles. Operating under guidelines for hiring minorities and women set out in a 1973 consent decree negotiated with the Justice

Department, NYT began moving women, blacks, and other minorities into more desirable jobs. Simultaneously, the company’s overall employment was shrinking; for a time, NYT all but stopped hiring

on the outside, filling openings by offering them to existing employees. (In 1970, the company had

hired some 35,000 people, while 30,000 others left.)

Affirmative action—combined with new technology that cut back on the need for craft workers,

plus competition that forced NYT to begin actively marketing its services-meant very high rates

of lateral job transfers. Operators could become sales representatives; switchmen became equipment

installers. Mobility increased within the firm; new internal job ladders appeared; formerly closed

opportunities opened. But this period proved short-lived.

As it responded to growth in the New York market for telecommunication services, and particularly to increasing competition, NYT began searching out managers and other employees with specialized expertise in fields ranging from engineering and marketing to finance and law. Trying to

stay ahead of rivals who seemingly offered new rate structures and new services almost daily, NYT

was becoming professionalized. With the shift from line to staff personnel, typified by the new emphasis on marketing, the frequency of internal promotions dropped during the 1970s (except for shifts

mandated by affirmative action, many of which were lateral as much as vertical). Cost pressures,

together with the pace of change, discouraged internal training; it was quicker and cheaper to hire

people with needed skills, rather than retrain existing employees as computer programmers or marketing specialists. In many cases, new entrants took positions that in earlier years would have been

filled through promotions from within.

Today, NYT hires almost exclusively on the outside to fill professional and managerial openings,

with a college or vocational-technical degree the minimum job qualification. No longer is NYT a craftoriented company, in which employees could progress via seniority and on-the-job training up a skill

ladder and perhaps into a supervisory position. While many older men without college degrees can

still be found in NYT’s middle management ranks, they are the last of their kind.

full-time staff is a simple way to adjust for var- A recent survey of some 5,000 American firms

iations in demand. Work that once took place found many more in the services than in manwithin a large firm (or public organization) may ufacturing relying on part-time and temporary

be subcontracted to small companies, or to in- employees; fewer than 6 percent of the comdividuals. Subcontractors, in turn, may have panics questioned reported that they planned

people on-call so that they can respond quickly. to replace any of their part-time or temporary
246 ● International Competition in Services

workers with full-time staff during 1987.

17 I n

a typical case, a U.S. bank that had formerly

staffed its branches exclusively with full-time

employees began, in 1984, to fill all new vacancies with part-time workers. The bank’s managers sought to restructure their work force so

that they could cover peak hours without having extra people on hand at other times.

On the supply side of the labor market, selfemployment has been growing—to some extent

in response to new opportunities. For instance,

skilled workers and professionals, whether

engineers or truck drivers, may choose to work

as independent contractors. But some selfemployment, like much other contingent work,

is involuntary-as when an accountant who has

been laid off or pushed into early retirement

starts an income tax service. As figure 46 shows,

17J.W, Duncan, “Survey Shows Continued Use of Temporary

and Part-Time Workers,” Dun & Z3raistreet Looks at Business,

November/December 1986, p. 1.

On the bank example, below, see “Changing Technology, Skills

and Skill Formation in French, German, Japanese, Swedish and

U.S. Financial Service Firms: Preliminary Findings,” op. cit.,

pp. 40-41. At the same time, this bank raised the minimum requirements for entry-level employees. Formerly, it had hired

mostly high-school graduates; now the bank sought women with

at least some college.

Figure 46.—Part.Time Employment in the

United States

involuntary part-time work now accounts for

5 to 6 percent of total U.S. employment—small

as a percentage but large in absolute terms (5.5

million at the beginning of 1987); growing numbers of Americans take part-time jobs, not because they want to, but because they cannot

find desirable full-time positions.

When all contingent workers are added together—the self-employed, together with parttime, temporary (voluntary and involuntary),

and contract workers, plus illegal immigrants

and people who work at home or in the underground economy—the total reaches 25 to 30 percent of U.S. employ ment.18 Some of these people become eligible for fringe benefits such as

retirement plans, health insurance, and paid

vacations. Most do not. For only a few does

a contingent job represent one step on a career

ladder; indeed, almost by definition, contingent

workers—those without a lasting association

with some company—have no access to internal labor markets. This ongoing change in the

U.S. labor market transfers much of the risk

associated with business downturns, illness,

and other interruptions in people’s ability to

work from companies to individuals. American

corporations have begun looking to temporary

employees, in particular, as buffers—much as

in more primitive economies, where casual

work is common.

Because typical service products cannot be

I held in inventory, but must be supplied on de- r

I

mand, it is no surprise that service companies

employ many more people on a temporary or

part-time basis than goods-producing firms. Table 36 showed that half or more of the labor

force in some service sectors works part time.

@’Trends Toward Labor Flexibility in the Reported and UnInvoluntary

A

reported Economy, ” prepared for OTA by S. Christopherson un1 der contract No. 533-5745.

Year

SOURCE: “International Competltlon In the Service Industries: Impacts of

Technological Change and International Trade on U.S. Employ.

merit, ” prepared for OTA by E Appelbaum, P S Albln, R Koppel, and

F. Hormozi under contract No 533.5560, table 4-5

A number of large American corporations—including New

York Telephone and Blue Cross/Blue Shield—have begun homework programs, through which “independent clerical contractors” can do jobs such as data entry from their homes (p. 14).

While it seems likely that no more than 10,000 Americans now

do this kind of work, about 90 percent on a part-time basis, some

250 firms now have homework programs. The companies tend

to view them as experiments; homework could expand substantially in the future.
Ch. 7—Jobs in the Services ● 247

Many service firms employ large numbers of

people on a part-time basis simply because they

need staff to cover long and odd hours, as the

Macy’s case or the bank example above illustrate, Nursing homes, day care centers, and

restaurants provide other illustrations, along

with retailers who hire extra workers in peak

business periods before Christmas.

In manufacturing, a far greater percentage

of employees work a regular full-time week, although some manufacturing firms do bring in

temporary workers to cover periods of high demand, Many have also begun hiring temporary

employees with specialized skills for short

periods, and contracting for services including factory maintenance, drafting, technical

writing, and plant renovations—in many respects a widening of business services categories beyond such traditional functions as auditing and accounting, advertising and market

research, and legal services. Contract engineering by job shops, for example —prominent in

defense and aerospace since the 1960s–has begun to penetrate other manufacturing sectors

much more deeply.

Temporary Employment

Traditional routes to staffing flexibility include seasonal hiring, periodic layoffs, and

keeping a tight labor force while paying for

overtime when necessary; companies in seasonal businesses like toys may double their employment while producing for the Christmas

rush. For decades, also, temporary help agencies have been supplying office workers. More

recently, temporary help has become one of the

faster growing service industries and service

occupations in the U.S. economy, expanding

at more than 10 percent per year. 19 As figure

lg~mp]oy,ment growth in the temporary help services industry has averaged 1 I percent a year over the last 13 years, compared with a 2.1 percent growth rate for nonagricultural jobs

in general—H. Collins, “Unions Decry Trend to Short-Term F’ederal Jobs, ” Philadelphia Inquirer, Feb. 5, 1986, p. B1.

The Federal Government itself filled nearly 250,000 jobs with

temporar} employees during 1984 (as reported by the Office of

Personnel Management), a number expected to continue increasing as a result of new regulations governing the employment

of temporary workers that took effect at the beginning of 1985.

Federal officials publicly welcomed the new rules. Hiring temFigure 47.— Employment in the Temporary Help

Services Industrya

703,200

400,900

255,700

471,800

302,900

W(

1982 1983

630,800

398,900

1984

438,200

1985

Year

aAnnual averages based on monthly reporting

SOURCES Employment and ~afrmgs, Supplement, Revised Establishment

Data, 1984, p 309; 1985, p 156, 1986, p 178 Employment and Earn

/rigs, 1984, 1985, and 1986, various msues, tables B 2 and B 3

47 indicates, in 1985 the industry placed an

average of over 700,000 workers each day, more

than 60 percent women. In 1982, 0.65 percent

of women holding nonagricultural jobs worked

for a temporary help services agency, a figure

that reached 1 percent in 1985. Note that figure 47 does not include the growing number

of temporary workers hired directly by companies, rather than through an agency,

With clients demanding a broader range of

skills, the temporary help services industry has

diversified well beyond the typists and clerical workers who were its mainstay 15 years ago.

poraries, who have no civil service protection, makes it easier

for Federal agencies to adjust the size of their work forces while

cushioning permanent employees against lay offs. Moreover, the

temporary jobs carry no medical or retirement benefits other

than social security.
248 ● International Competition in Services

Silicon Valley electronics firms, for example,

can now call a temporary agency for extra assembly workers. Half the temporaries placed

by agencies currently fall outside the category

of office workers. For 1984, estimates of the industry’s placements in terms of revenues break

down as follows: office workers, 49,4 percent;

professional and technical, 34.4 percent; health

service workers, 8.8 percent; and, industrial

workers, 7.4 percent. 20 Although still relatively

small in absolute terms, health service temporaries—most of them supplied to hospitals and

nursing homes—comprise the fastest growing

category. Hospitals rely on temporary help

agencies for growing numbers of nurses, laboratory and other technicians, therapists, and

housekeepers. Many also use nurse’s registries

and call-ins,

The temporaries in greatest demand by manufacturing companies tend to be people in service occupations, not production, with generic

rather than industry-specific skills. One survey

of chemical and electronic components manufacturers found that most of the electronics

firms used temporaries to fill technical jobs

(drafting, computer programming, technical

writing and illustrating, electrical engineering),

while chemical firms continued to call mostly

for office workers (secretaries, receptionists,

word processing operators, file clerks, messengers). Chemical firms did use technicians

and engineers on a temporary basis, but less

heavily than in electronics,

Banks also use temporaries in positions calling for relatively standardized skills—file clerks,

bookkeepers, data-entry technicians, messengers, security guards—the sorts of occupations

in which temporary help agencies specialize,

But banks have also begun filling transient

needs with people who have more specialized

skills—e.g., experience in banking practices and

procedures, even firm-specific knowledge of financial products. How do they accomplish this?

Primarily by creating internal labor pools of

full-time employees who move as required from

ZO’’International Competition in the Service Industries: Impacts

of Technological Change and International Trade on U.S. Employment, ” op. cit., ch. 4, pp. 9-10.

one branch or office to another. From the employee’s perspective, of course, though specific

assignments are temporary, employment with

the bank (or other service firm) need not be.

Some banks now maintain floating pools of

branch managers and operations managers, as

well as tellers and new account clerks.

Self-employment and independent contracting, two other forms of contingent employment,

have also been expanding in the United States.

Men who are self-employed tend to work in

construction and in transportation, communications, and utilities, The available data suggest that most self-employed women and minorities work in retail trade and other tertiary

services; in 1980, for example, approximately

800,000 self-employed women worked in trade,

while another 1.2 million found employment

in “other services. ” These sectors, particularly

trade, also attract many self-employed white

males, Independent contractors have, in addition, become a major source of skilled and

professional workers for industries needing

short-term specialized services ranging from

graphic design to systems analysis.

Part-Time Work, Voluntary and Involuntary

As figure 46 indicated, the fraction of parttime employees in the U.S. labor force has been

in the vicinity of 20 percent since the latter part

of the 1970s—compared with about 15 percent

during the 1950s. Involuntary part-time work

has been expanding slowly but steadily—from

2 percent of the total labor force in 1967 to more

than 5 percent during the slack employment

periods of the 1980s. Part-time employees who

would prefer full-time jobs have recently made

up 25 to 30 percent of the 20 million Americans working less than 35 hours per week. Figure 46 also shows that, since the latter part of

the 1970s, the entire increase in part-time employment in the United States can be accounted

for by growth in involuntary part-time work,

Historically, women have been far more likely

than men to take part-time positions (table 39);

a third of all women work part-time, compared

with 15 or 16 percent of men. Furthermore, the

proportion of women taking part-time jobs in-
Ch. 7—Jobs in the Services . 249

Table 39. —Industry Profile for Men and Women

Employed Part-Time, 1984

Percentage of those

employed working less

than 35 hours per weeka

Men Women

Total ... . . . . . . . . . . . . . . . . . . . . 15.9”/0 32.60/o

Manufacturing. . . . . . . . . . . . . . . 9.2 17,3

Trade . . . . . . . . . . . . . . . . . . . . . 23,5 47.7

Retail ., . . . . . . . . . . . . . . . . . . 28.8 50.9

Finance, insurance, and

real estate (FIRE) . . . . . . 12.4 20.1

Service . . . . . . . . . . . . . . . . . . . . . 19.9 35.7

Business and repair. . . . . . . 17.9 35.2

Personal ., ... ... . . . . . . . 20.9 41.8

Other professional . . . . . . . . 12.4 27.0

aAnnUal averages, excluding agrlcutture

SOURCE ‘International Competition In the Serwce Industries Impacts of Tech

nologlcal Change and I nternatlonal Trade on U S Employment, pre

pared for OTA by E Appelbaum, P S Albln, R Koppel, and F Hormozl

u rider contract No 533.5560, from unpubll shed Bureau of Labor Statistics data

voluntarily has nearly doubled, from 12.1 percent of those employed part-time in 1970, to

22 percent in 1985. Note that table 39, based

on monthly averages, tells only part of the story,

The number of Americans who experience involuntary part-time employment at some point

during the year—because their employer puts

them on short hours, or because a part-time job

is all they can find—is much higher than the

monthly figures suggest. During 1983, 14,9 million Americans experienced some period of involuntary part-time employment,

Part-time jobs cluster by industry more than

temporary employment, with over 70 percent

of all part-time workers found in trade and

“other services. ” While companies often use

temporaries—many of whom work variable

hours–as buffers, part-time workers tend to fill

more predictable needs, For instance, restaurants and other retail establishments typically

prefer to have their own people available, with

firm-specific training and experience, rather

than call on temporaries. Not only is customer

service an important part of such jobs, but supervision is more difficult than in an office environment. As noted earlier, part-time work in

many service industries—not only wholesale

and retail trade, but entertainment, recreation,

and “other services’’—is in a part a function

of lengthening business hours. More women

than men work part-time in such industries because they are more likely to have sales jobs.

(In Macy’s stores–box X–women work on the

floor, men on the loading docks.)

Perhaps 20 to 25 percent of those who work

part-time hold two or more jobs—by choice or

by necessity. Roughly 5 million Americans report that they hold multiple jobs; the number

has been growing at about the same rate as the

overall size of the labor force. Larger than average numbers of moonlighters work one of their

jobs in public administration (7.6 percent, clustered particularly in teaching and in State and

local government), agriculture (6.1 percent), and

“other services” (also 6.1 percent).

Multiple job-holding by women rose steeply

during the 1970s. Men tend to hold one job on

a full-time basis, working part time elsewhere;

40 percent of male moonlighters are selfemployed in their second job. In contrast,

nearly half of all women working two jobs hold

both on a part-time basis. Much part-time selfemployment takes the form of unreported work

in the underground economy (discussed below);

men are much more likely to freelance on a cash

or barter basis, while women tend to hold second jobs in the above-ground economy. Multiple job-holding by men also appears to be more

cyclical, increasing when opportunities rise

during periods of economic expansion, dropping back during recessions. Multiple jobholding by women, in contrast, has shown

steady growth since the 1960s. More men than

women claim they hold a second job because

they enjoy it, or because they are saving for the

future; women, especially minority women,

work multiple jobs to meet their day-to-day expenses.

63- 5? 7 () - 87 - 9
250 ● International Competition in Services

IMMIGRANTS IN THE U.S. LABOR FORCE21

In 1965, Congress amended the Immigration

and Nationality Act, increasing the number of

immigrants who could be admitted each year

as workers with needed skills (to 290,000), while

tightening the certification requirements. In

addition, the 1965 amendments eliminated

quotas based on national origin, and made it

easier for family members of U.S. citizens to

enter. Immigrants can also be admitted as political refugees; in some years, nearly as many

people have entered outside the occupational

preference system—i.e., as refugees or under

the family reunification provisions—as through

it. The Immigration Reform and Control Act

of 1986 left the system for legal entry largely

unchanged.

The amendments have changed the mix of

skills, educational backgrounds, and occupations that immigrants bring to the U.S. economy. Under the earlier national origin quotas,

more than half of all immigrants came from

Europe. Since 1965, the immigrant stream has

become much more diverse, and shifted toward

entrants from Asia and Latin America, with

Europeans dropping below 20 percent of the

total. Relatively large fractions of professionals

(e.g., nurses, physicians, engineers) have entered under the occupational preference system. At the same time, many women with low

skills have been admitted under the family reunification provisions; they have increased the

supply of workers in tertiary service industries.

(Women constitute slightly more than half of

all immigrants.)

During the first half of the 1980s, 2.8 million

immigrants entered legally. Illegal aliens—of

whom there may be 2 million to 5 million—

differ from legal entrants in demographics,

skills, and countries of origin (many more come

from Mexico). As a whole, immigrants cluster

into two groups at the high and low ends of

the skill/pay spectrum: in this sense, U.S. immigration policy reinforces the two-tiered pattern

that characterizes employment in the Nation’s

service industries.

zlThiS Section is based on “Immigrants in the Service Sector, ”

prepared for OTA by S. Christopherson under contract No.

533-5745.

Immigration adds to the size of the U.S. labor force, and immigrants compete for jobs

with native-born Americans. Given the unemployment and underemployment that have typified U.S. economic performance in recent

years, it is probably fair to say they have taken

some jobs from native-born workers. At the

same time, as pointed out in chapter 6, American industry has come to depend quite heavily on foreign-born engineers and scientists,

many of whom first come to this country to further their education. A balanced view of the

impacts of immigration must take account of

such factors, as well as the overall thrust of immigration policy in a country that historically

has welcomed people from abroad.

Distribution by Occupation and Industry

More than half of all immigrants, legal and

illegal, live in California, New York, Florida,

and Texas—mostly in large metropolitan areas.

New entrants with professional and technical

skills tend to settle in the same areas as the rest

of the immigrant population, with some exceptions such as physicians. Many of the latter start

practices in small towns and rural areas that

offer them better opportunities.

Women and children who report no occupation make up 60 percent of legal immigrants,

generally entering under the family reunification provisions. With the advent of more stringent labor certification requirements in 1965,

the number of entrants listing professional/technical occupations more than doubled; about one

in four of the current immigrant labor pool

claims such an occupation, compared with 17

percent for the U.S. labor force as a whole. Of

209,000 immigrants in 1983 who designated an

occupation on admission, 39,000 fell into professional or technical categories—19 percent

of those listing occupations, and 7 percent of

all immigrants. Nearly half of those declaring

a professional/technical occupation fall into one

of four categories—engineers, nurses, physicians (and dentists), and teachers. Engineers

comprise the largest group, accounting for

about 17 percent of professional/technical en-
Ch. 7—Jobs in the Services . 251

trants in 1983, with the other three occupations

each representing about 10 percent.

In general, immigrants from Latin America

are less likely to report a white-collar background than those from Europe or Asia, more

likely to be unskilled and female. By the late

1960s, Asian countries—India, the Philippines,

Taiwan—had replaced Europe as the source of

most professional and technical immigrants;

less than 2 percent of entrants from Mexico

claim a professional or technical occupation,

compared with 14 for the Philippines and 19

percent for India. However, occupations reported at entry do not necessarily correlate with

the jobs that immigrants find in the United

States. Many are downwardly mobile, at least

at first.

Most immigrant professional and technical

workers take routine jobs in their fields, or move

laterally and downward. Physicians may have

trouble gaining a medical license; accountants

may have to accept jobs as bookkeepers or clerical workers. Not only may immigrants have

inferior skills, but some employers no doubt discriminate against them. The effects of immigration on U.S. labor market conditions, therefore,

cannot be directly inferred from occupations

listed on entry. The “fourth wave” of immigrants—those entering since 1965—will probably have trouble catching up in terms of skills

and income with native-born Americans. This

conclusion holds at both the high and low ends

of the skill/pay spectrum, although low-skilled

immigrants can expect to be upwardly mobile

in the United States, as compared to their countries of origin.

If immigrants are more likely than the average U.S. worker to claim professional/technical skills, they are also twice as likely to be unskilled laborers and four times as likely to be

domestic workers. The split between high and

low skills is sharper for women than for men.

While many immigrant women do fall at the

professional end (the largest single group consists of nurses), much larger numbers cluster

at the bottom. Almost all the women admitted

under the occupational preference system in

recent years have been either professionals or

low-skilled service workers (including housekeepers, dressmakers, and household servants);

the proportion of immigrant women with clerical occupations is only half that for women

in the U.S. labor force as a whole. Occupational

profiles for male immigrants resemble those for

the rest of the male labor force more closely.

Illegal Immigration

Largely because the vast majority of illegal

aliens come from Mexico, this group differs

greatly in terms of skills and occupations from

those who enter legally. Many more illegal immigrants cluster at the low-skill end of the spectrum. Although skilled workers and white-collar professionals have entered illegally in some

numbers—e.g., from the Philippines—little is

known about these people; almost certainly,

however, the professional/technical group is

relatively much smaller than for legal immigrants.

Taken together, the many studies on illegal

aliens suggest numbers in the range of 2 million to 5 million, with estimates for the Select

Commission on Immigration and Refugee Policy indicating 31⁄2 million to 5 million (something under 3 million from Mexico). Many undocumented workers, especially those from

Mexico, stay in the United States for only a few

months, making estimates more difficult. Most

illegal aliens live in major U.S. cities, with a

distribution by State similar to that for legal entrants,

Although many undocumented workers take

jobs in agriculture, they have also moved in relatively large numbers into blue-collar manufacturing. Surveys show that more than half the

Hispanic women entering illegally find work

in manufacturing (versus about 10 percent for

women in the U.S. labor force as a whole)—

e.g., in the southern California garment industry. Large and increasing numbers of illegal entrants from Mexico and the rest of Latin America do construction work, or take jobs in

restaurants and other service firms.

Like legal entrants, illegal aliens—except for

those from Mexico—tend to be downwardly

mobile in the United States. Many who enter
252 ● International Competition in Services

from Mexico move from agriculture into construction and manufacturing, or upward in

terms of service occupation. In some contrast,

people with white-collar backgrounds entering

illegally from countries like El Salvador or the

Philippines often find themselves in lower

status white-collar jobs than they formerly held.

Immigrants and Jobs

Do immigrants take jobs and job opportunities from native-born citizens? Assuming that

immigrants gradually become assimilated into

the U.S. economy, seeking to move up job ladders and otherwise compete with native-born

workers having similar educational backgrounds and skills, the answer must be yes. On

the other hand, to the extent that immigrants

find work in labor market segments where few

native-born Americans seek jobs—because, for

example, of the nature of the work (domestics

and custodians) —then it is equally fair to say

that immigrants contribute their labor to the

economy without taking jobs from those born

here.

Legal immigrants with professional and technical backgrounds compete with native-born

workers in nursing, medicine, engineering, and

other white-collar occupations. These professions have traditionally provided relatively

open channels of advancement for anyone who

enters—including native-born women and minorities—because skills can be obtained through

schooling rather than apprenticeship or on-thejob training. While there has sometimes been

evidence of oversupply in such fields, serious

unemployment seems unlikely; health care, for

example, is still growing rapidly. Frequently,

as with the small-town physician, immigrants

fill slots at the bottom of the pay and status ladders for their occupational group. In the professions, crowding out by immigrants would seem

unlikely. The most severe impacts of immigration have been felt, not in the United States,

but in the countries these people have left, some

of which have suffered severe drains of talent.

At the same time, with unemployment remaining high, and underemployment on the rise, immigration can only make things more difficult

for native-born Americans with poor education

and low skills.

THE UNDERGROUND ECONOMY22

The major categories of underground economic activity—those that escape the national

accounts—have little in common except their

unreported nature. Underground economic

activities include: 1) explicitly illegal activities

such as prostitution and drug dealing; 2) unreported wages and salaries, along with other

legal transactions that shield earnings (including capital gains and dividends) from taxation;

and 3) goods or services obtained through barter. By all estimates, unreported earnings from

otherwise legal activities makes up the largest

of these categories.

The limited information available on the composition and growth of work in the underground economy points to close relationships

ZZThis section is based on “Trends Toward Labor Flexibility

in the Reported and Unreported Economy, ” prepared for OTA

by S. Christopherson under contract No. 533-5745.

with broad changes visible elsewhere in the labor market. For example, unreported wages

and salaries appear to correlate with the increase in part-time and temporary work in the

United States, particularly among those who

hold multiple jobs; in general, underground employment appears to have grown at about the

same pace as overall U.S. employment, with

more people working off-the-books when the

economy picks up, presumably because they

have more opportunities.

Attempts to estimate the size of the underground economy depend on relatively arbitrary

assumptions. As for illegal immigrants, the estimates cover a considerable range. Moreover,

most of the surveys and other estimating procedures have focused on individuals and households, rather than businesses, although unreported transactions between companies more
Ch. 7—Jobs in the Services ● 253

than likely exceed those involv

and households (perhaps by a

ing individuals

large margin).

Thus more data have been collected on, say,

unreported cash income for people working as

cab drivers, house painters, and waitresses than

for transfers of funds overseas by businesses

seeking to avoid taxation.

Because most people who work off-the-books

also hold above-ground jobs, estimates of unreported wages or revenues, such as those made

by the Internal Revenue Service, cannot be

directly related to employment levels. Estimates

based on conservative assumptions have placed

full-time underground employment at about 4

percent over and above reported U.S. employment levels—perhaps 5 million people currently, 23 The number of people working on a

part-time basis in the underground economy

is no doubt several times greater.

z3[) ()’ Nf~il], [;roltth of tht; [ ~ndcrground Econom~’ 1950 -81.’

Some [<ticlence fi’rom the (,’urrf:nt I)c)pulation Surt’e~, report to

the J{) i nt E[(lnr) m i[; ( ;orn m [t tee (lt’ash i ngton, DC: U.S. Government Print in~ of fi[:e, I)fx,. 9, 1 983). An estimated 800,000 of these

pfxjIJle arf; Self-(!nll)lo}f;(i.

Most of the studies of the underground economy suggest that the trends explored earlier in

the chapter—particularly the use of contingent

workers by businesses seeking greater flexibility—have contributed to its growth, Companies

that hire people off-the-books (which may include illegal aliens) not only avoid paying fringe

benefits, but also payroll taxes. If they can hide

some of their revenues, they may also be able

to escape income taxes. These processes feed

on one another. Contingent employment increases risks for the worker; with less assurance of future wages, more people will supplement their income as opportunities come along.

Some of these opportunities may go unreported

—working extra hours in a regular job for cash,

doing auto or home repairs for a neighbor. Deregulation and a free-market approach to economic activity mean increased uncertainties.

Work in the underground economy becomes

more tempting for Americans seeking a hedge

against an unknown future.

CONCLUDING REMARKS

From 1972 to 1984, American companies created nearly 21 million new jobs. Given the size

of the Nation’s economy, the patterns revealed

by the 1980 census have been changing relatively slowly; nonetheless, the trends are unmistakable, Manufacturing jobs will continue

to decline relative to the services, and almost

certainly in absolute terms as well. The trade,

FIRE and “other service” industries will expand, creating jobs that, on many dimensions,

make poor substitutes for the manufacturing

positions that the U.S. economy created in large

numbers during the earlier postwar period:

Everything else the same, jobs in the services pay less than jobs in manufacturing.

This is true for both skilled and unskilled

work, and for most managerial positions.

Prospects for upward mobility in the services tend to be limited. Entry into jobs with

such prospects commonly requires specialized educational credentials (or other evidence of retrainability).

While women fill a higher fraction of

managerial jobs in the services than in

manufacturing, many of the women who

have entered the service industries earn

relatively little and face very restricted career opportunities. As women moved into

the labor force in greater numbers, companies restructured work to employ them

on a part-time basis. Many well-educated

women in industries like banking and insurance fill dead-end jobs that consist basically of skilled clerical work.

Formal education and training as a route to

upward mobility has become more important

as workplace technology has grown more complex. While new technology deskills some jobs,

it upskills others—processes explored in the

next chapter. With companies, in effect, seek-
254 • International Competition in Services

ing people with education/training credentials

that indicate an aptitude for ongoing retraining, only those who are prepared can take advantage of the opportunities opened by upskilling. One of the functions of higher education,

at least in theory, has been to equip people for

continuing learning. Both colleges and vocational/technical schools will have to do this in

fact as well as in theory if the U.S. economy

is to prosper in the years ahead.

New entrants and displaced manufacturing

workers whose backgrounds make them illsuited for retraining will have a difficult time—

in contrast to many of those who entered the

manufacturing sector in earlier years with little education, but went onto achieve relatively

high career earnings. Many such people will

find themselves confined to occupations like

sales or clerical work. Their earnings potentials will suffer, particularly in comparison with

unionized manufacturing workers; for many

years, wage levels in manufacturing have remained above those for most non-manufacturing workers by a relatively constant margin.

Moreover, differences between the social environments of work in manufacturing and in the

services will continue to limit opportunities for

displaced manufacturing workers.

The knowledge-based service industries show

sharp divisions between people with jobs high

in pay and in skill requirements (loan officers,

stockbrokers) and occupations low in pay and

skills (bank tellers, data-entry clerks). As employment in the services has increased, a twotiered wage pattern has emerged. At the high

end of the scale, a minority of technical and

professional workers, many of them in computer-related occupations, can expect high

earnings and ample opportunity to move upward. A much larger group appears stuck at

the bottom. A slack labor market, the largely

non-union environment of the services, and

competitive pressures in industries like retailing—populated by very large numbers of firms

—mean constant downward pressure on wages,

Crumbling internal job ladders in many service firms reinforce the tendencies toward

stratification, making it more difficult to move

upward via seniority and on-the-job experience.

Broader access to schooling can make up for

the decline of internal labor markets in part,

but not entirely. Upward mobility for some people will be cut off.

The growth of the service industries does

mean new jobs for Americans who can qualify

for high-wage, high-skill positions in knowledge-based sectors like telecommunications,

banking, and the professions–jobs that will

coexist with the many low-skilled, low-paying

openings that the economy has also been creating. The latter can be found, not only in the

tertiary services, but in the knowledge-based

sectors as well. The growth of the health services industry has meant many new jobs for food

preparation, custodial, and laundry workers,

as well as physicians, nurses, and laboratory

technicians.

Because so many service jobs depend on demand based in other sectors of the economy—

and ultimately on U.S. living standards—

competitiveness and economic growth will remain essential for job creation at both ends of

the pay/skills spectrum. To the extent that

American firms move successfully into higher

value-added services and goods, making possible higher living standards overall, Americans

with jobs in the tertiary services will also be

better off–at the least through broader opportunities, To continue moving into high-valueadded services and goods, continuing investments in human capital will be essential; beyond this, American companies will have t o

utilize the skills and abilities of their employees effectively—a subject to which the next

chapter turns.

Because direct exports (and imports) of services remain relatively small, the first-order impacts of trade and competition in the services

on domestic employment are small. But trade

pressures in manufacturing—and in many services that depend on manufacturing—have driven

American firms to seek lower labor costs and

greater flexibility in their labor forces. Companies in industries hurt by import competition—autos, steel—have slashed white-collar as

well as blue-collar payrolls, laying off many people in service occupations. Domestic competi-
tion—driven in many cases by deregulation

(most obviously in the airline industry)–has

created similar pressures in service sectors.

For such reasons, companies in many parts

of the U.S. economy have restructured to replace permanent employees with temporary

and/or part-time workers. This is as true in the

health care industry as in banking. With the

spread of profit-seeking hospitals, health maintenance organizations, and specialized clinics

(and because of changes in Medicare payments), hospitals have sought to tie staffing

levels more closely to patient demand—by using

temporary employees during peak periods, as

well as contracting out food service and housekeeping. It is no longer true, if it ever was, that

the typical part-time employee is the teenager

with a job at MacDonald’s, or the housewife

who works a few weeks at Macy’s to earn a

little extra for her own Christmas spending,

As the examples above suggest, both domestic and international competition contribute to

the rise in contingent employment. Table 40

compares typical labor force patterns in older,

smoke-stack manufacturing companies—characteristic of the 1950s and 1960s—with those

found in many service industries (as well as

some kinds of light manufacturing). Companies

seeking flexibility or pursuing new strategies

through restructuring and automation (Macy’s,

New York Telephone, examples following in

chapter 8) may redesign jobs so they can be perCh. 7—Jobs in the Services ● 255

—

formed by people with less skill and lower pay

(cashiers replace retail clerks who once also

helped customers choose merchandise). Selfservice replaces semi-skilled jobs. Banks use

part-time workers on Mondays and Fridays,

their peak days. In other cases, two part-time

jobs may take the place of a full-time position.

As the next chapter illustrates, trade pressures

and other competitive forces mean that many

more American companies will seek to move

toward a work force structured more like that

on the right hand side of table 40.

Contingent employment transfers risk downward to the worker, who may not be covered

by health and accident insurance, a pension

plan, the other benefits that regular full-time

employees have come to expect. By definition,

contingent workers have little or no access to

internal job ladders (and thus little opportunity

for on-the-job training). Employers face fewer

constraints regarding layoffs, hiring and promotion policies, job assignments and work

rules, They can dispense to some extent with

both the implicit and explicit contracts (i.e.,

agreements with labor unions, laws and regulations) that govern relationships with their fulltime employees. This drive for freedom and

flexibility, tied to the broad trends toward deregulation in the U.S. economy—and perhaps

also to shifts in individual preferences—lies behind the growth in part-time and temporary employment in the United States.

Table 40.—Shifting Employment Patterns in the U.S. Economy

1950s-1970s 1980s

Large core work force of full-time,

permanent employees, particularly in

unionized manufacturing industries.

Firm-specific knowledge acquired through

on-the-job training, plus seniority, meant

steady advancement in earnings via the

firm’s internal labor market.

Flexibility for the firm through overtime

and/or a buffer of full-time employees to

meet variations in demand.

Examples: chemicals, steel, automobiles,

Growing contingent work force of parttime, temporary, and casual employees.

Portable skills—often acquired through

formal education and training—replace

firm-specific knowledge, as the external

labor market replaces internal job

ladders.

Flexibility for the firm comes through a

smaller core of more highly skilled

employees, coupled with contingent

workers.

Examples: banking, retailing, health care,

some manufacturing,

SOURCE Off Ice of Technology Assessment, 1987
256 • International Competition in Services

Relying on a buffer of contingent workers

brings short-term savings. Just as some American companies have negotiated give-backs

with labor unions—or established dual wage

structures, with new entrants starting at lower

levels than their predecessors—part-time and

temporary workers can help hold down the bill

for wages, benefits, and training expenses. On

the other hand, the very lack of training, and

of prospects for advancement, diminishes a

firm’s ability to make use of the human capital

its employees bring to the workplace. When

companies design standardized jobs that can

be performed by temporaries in for two days

or two weeks, they maybe sacrificing efficiency

both immediately and over the longer term.

(The next chapter explores some of the less obvious reasons.) Over the medium term and

longer—periods of years rather than months—

companies that substitute flexibility in numbers

for the flexibility created by a work force rich

in experience-based skills and know-how risk

losing their ability to compete.

Photo credit: Smithsonian Institution
Chapter 8

Moving Toward a High-Skill Economy:

Computer Applications and Work

Organization in the Services
CONTENTS

Page

Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ........................259

Service Jobs and Manufacturing Jobs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .262

Using Computer and Communications Systems . . . . . . . . . . . . . ............263

Business Applications of Computer Systems.. . . . . . . . . . . . . . . . . . . . . ....265

Motivations: Cost Control and Strategy . .............................267

Integration: Technical and Organizational Dimensions . . . . . . ...........269

Systems Design and People’s Skills . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .272

Integrated Production Systems: The New Model. . ......................278

Impacts on Competitive Ability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. ....282

Concluding Remarks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ............285

Appendix 8A: Restructuring and Work Reorganization at MetroBank .. ...288

Boxes

Box

Z. Claims Processing in the Insurance Industry . . .

AA. Technological Advances in Computing Systems

BB. Tasks, Jobs, and Skills . . . . . . . . . . . . . . . . . . . . . .

Figures

Figure No.

48. Intra-Corporate Information Flows . . . . . . . . . . . .

49. Characteristics of Firms and Industries . . . . . . . .

Tables

Table No.

Page

● . . . . . . ... 264

● .... .... . 267

. . . . . . . . . 2 7 6

Page

. ..... . . . 270

...... . 277

Page

41. Examples of Strategic Applications of Data Processing and

Communications Systems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ....0.269

42. IBM’s Intra-Corporate Computer Networks . ........................270

43. Patterns of Computer Use by Occupation. . . . . ......................276

44. Typical Changes in Cost Structure for New-Model Organizations .. ....284
Chapter 8

Moving Toward a High Skill Economy:

Computer Applications and Work

Organization in the Services

The preceding chapter outlined the patterns

emerging in the U.S. labor force over the past

15 years—a period during which manufacturing employment stagnated and began to decline

while job opportunities in the services continued to expand. Some of the jobs created have

been low-skill, low-wage positions in the tertiary services; others have been knowledgebased, with far better prospects for upward mobility and job security. Where possible, chapter 7 examined these trends quantitatively, in

terms of numbers of people employed, their

ages, educational backgrounds, earnings,

This chapter is descriptive rather than quantitative. In places it is speculative. The chapter

explores work organization and computer applications in the services, asking: How does international competitiveness depend on skills

and knowledge? How do companies make use

of computer-based systems to enhance or to replace the capabilities of their employees? With

74 million people in the Nation’s service work

force, and some 38 million in the knowledgebased sectors, generalizations remain open to

question, But conclusions do follow. To get and

hold good jobs in the services, Americans will

have to bring better knowledge and skills to the

workplace. Public education will have to respond to new demands. Companies will have

to provide better training, and do so on a continuing basis. In the knowledge-based services,

employees at all levels will find themselves taking on more responsibility. And, while large

numbers of relatively unskilled (and low-paying) service jobs will remain in the U.S. economy, many of these jobs will depend on prosperity created in part by knowledge-based

services.

More often than not, technology in the services means applications of computer and communications systems, The knowledge-based

services are in the midst of a transition from

large and expensive mainframe computers,

tended by experts, to distributed computing,

used by everyone. The personal computer is

only the most obvious sign of this transition,

Yet before companies and their employees can

come to grips with today’s technology, new

waves of hardware and software will arrive—

making it much easier, for example, to link PCs

with powerful mainframes, helping create farflung integrated networks. People and organizations will have a hard time keeping up, much

less planning for the future.

In many U.S. service firms, proprietary technologies—including computer applications—

have become integral elements in competitive

strategy. Isolating the contributions of proprietary know-how tends to be a good deal more

difficult for service products than for tangible

goods. Manufactured products can be inspected

and tested, performance evaluated by objective

measures, making it easier to judge relative contributions of proprietary technology, and—

much the same thing—human capital. Chapter 3 illustrated some of these complexities for

banking, chapter 5 for computer software; software is much the easier case because computer

programs can be compared on a price/performance basis far more readily than banking services. But when the question becomes: Precisely

why is one program better than another? answers can be hard to find. In the end, proprietary technology is a matter of judgment and experience more than well-codified knowledge.

Individual expertise makes a difference; so do

259
260 . International Competition in Services

group and social skills. Both the people in a

company and their tools matter. When a company decides to buy a million-dollar software

package from a vendor, its employees must select the right package; typically they will also

contribute to design modifications that tailor

it to the company’s needs.

No one can specify with any precision how

human capital affects competitiveness, although no one denies its importance. Much of

this chapter focuses on applications of computers, because, for many years to come, this

set of technologies will have enormous impacts

on competitiveness in the services, and on the

jobs and skills of people who work in service

industries. At the micro level, work organization—how companies design tasks for individuals (e. g., data entry), and combine these tasks

into groups (e.g., for processing financial transactions) —strongly influences the cost and quality of service. Some companies have sought to

develop flexible systems for the delivery of services (and goods) —systems highly responsive to

market demands (e.g., portfolios of mutual

funds, among which customers can switch), as

well as strategic applications of computing

power such as on-line customer ordering, or

corporate cash management systems. But cheap

computing power also creates opportunities for

rigid, mechanistic forms of automation (check

processing in many banks, directory assistance

from the telephone company). Sometimes improved competitiveness calls for flexibility,

sometimes for cutting costs through rigid and

tightly controlled forms of work organization.

Obviously, a vast middle ground separates these

two poles.

Over the longer term, strategic applications

leading to new products, different services, and

expanding markets will have greater impacts

on international competitive standing than costcutting applications of computers. Some of

these strategic applications will emerge at the

micro level of individuals, work groups, and

departments; they can be viewed in a work

organization framework. Examples include

Citibank’s replacement of centralized transaction processing by a decentralized, productoriented system—described later in the chapter. Other strategic applications must be viewed

in organization-wide terms—often at the macro

level of multinational integration.

Despite a shortage of concrete information

on how computer applications and computer

integration affect the competitive ability of particular companies, at either micro or macro

levels, OTA’s analysis suggests differences in

approach internationally, which appear to

translate into differences in competitive

strength. At the micro level of work organization—integration of people and machines,

rather than integration of dispersed corporate

operations—many foreign firms do as well or

better than their American counterparts. At the

macro level of international integration, U. S.-

based firms seem to be well ahead of their foreign competitors in the ability to link and coordinate the activities of divisions and affiliates thousands of miles apart.

American companies may spend more money

on computers, but some foreign firms—particularly in Japan—use the money they spend more

effectively. They scrutinize investment decisions for hardware and software more closely,

and at more levels in the organization, invest

more heavily in the training of their people, and

operate highly developed systems for maximizing individual contributions to corporate goals.

(These differences seem more evident in manufacturing than the services; Japanese service

industries, with exceptions such as telecommunications and banking, appear relatively undeveloped compared to American industries—

although this may simply be because analysts

in the West have not focused as much attention on them.) Large Japanese corporations lag

behind their American counterparts in the raw

capability of their installed computer and communications systems, but use what they have

at least as effectively. Moreover, concerted efforts in Japan to move towardan‘‘information

economy” (chs. 5 and 9) suggest that Japanese

companies may begin to catch up in computer

utilization during the 1990s,

At both micro and macro levels, current positions matter less than decisions being made

today. These decisions—how to use computer
Ch. 8—Moving Toward a High-Ski/l Economy: Computer Applications and Work Organization in the Services ● 261 —

and telecommunication technologies (which

will depend in part on the capabilities of the

people a company can hire, and on the training it chooses to provide) —will influence competitiveness 5, 10, 25 years from now. Managers

face difficult decisions, A great deal of technology exists; many of the possible applications

remain largely unexplored. As noted below, nobody knows the capabilities that artificial intelligence (AI) may bring to the workplace in

the 1990s. The specialists who develop the systems tend to be interested in technology for the

sake of technology, rather than in appropriate

applications. Some companies plunge ahead,

making investments and reorganizing work in

the hope of establishing a competitive advantage, even though they may have no more than

a hazy idea of the outcomes to be expected.

Others move more slowly, sticking to what they

know and understand. Sometimes one approach will prove right, sometimes the other,

Two examples—one at the micro level, one

at the macro—illustrate the uncertainties.

Today, many companies must ask whether AI,

touted for 25 years, is finally ready to enter the

workplace on a large scale. Expert systems intended to supplement people’s skills have become one of the favored near-term applications,

What should the prospective user—bank, insurance company, medical clinic—do? Invest its

money, time, and effort now? Or continue to

wait, at the risk of losing out to competitors who

get a head start? At the macro level, the wellpublicized strains between General Motors and

its EDS subsidiary illustrate another set of problems, GM purchased EDS in large measure to

get help in implementing its strategy of multinational integration (ch. 5). Since the acquisition, GM’s management has come in for

ample criticism, Some of it is no doubt justified, but the fact is that the task of putting

together and learning to use a worldwide computer and communications network is enormously complex, the territory largely uncharted,

mistakes inevitable.

Despite the confusion and uncertainty such

examples hint at, the outlines of a new model

of computer-integrated production have begun

to emerge. The model fits some companies in

both the services and manufacturing, but so far

probably only a few thousand American firms

in total. The common characteristic of these

new-model firms is their combination of efficiency and flexibility. In the past, flexibility—

the ability to respond to changing market conditions, to alter the firm’s output or way of doing business (because of shifting consumer

tastes, ups and downs in the business cycle,

competitive pressures, new technological opportunities)—generally came at the price of efficiency. Flexibility meant labor-intensive operations. People are flexible, they can adapt.

Machines, in the past, could not, The trade-off

was a simple one: either a flexible organization,

labor-intensive and relatively low in productivity, or an inflexible, mechanized production

system, Mechanization brought higher productivity but also higher costs for adapting to

change. What the computer brings is the potential (not always realized) for both productivity and flexibility,

Achieving both flexibility and efficiency

places new demands on the labor force. Employees at all levels in new-model organizations

must take on greater responsibilities. Integrated

systems will put them in touch with more people, both inside the firm (colleagues in work

groups, people in other departments) and outside (customers with problems or inquiries).

Some kinds of work, in some companies, will

be more fluid, less predictable. Some jobs will

be upskilled; the people that fill them will need

both broader and deeper skills—problem-solving and reasoning, social skills. Companies will

rely on employees with these skills to compete.

People will need these skills to get good jobs

and keep them, to advance. New applications

of computer and communication technologies

mean new demands on the public education

system; they will also mean new kinds of corporate training programs. At the same time,

other jobs will be deskilled: the computer will

make them simpler, more routine, less demanding, less interesting. Stratification in skills goes

hand in hand with the stratification in wage

levels and mobility prospects discussed in chapter 7. To keep job ladders and mobility channels open, the U.S. economy will need to con-
262 ● International Competition in Services

tinue creating large numbers of jobs at the

high-skill end of the spectrum; policy makers

will need to make sure the United States creates education and training systems that can

prepare people for these jobs.

This chapter, then, suggests that a labor force

rich in the skills needed for integrated production systems—in which applications of computer technologies enhance people’s skills and

contribute to organizational flexibility-will aid

American firms in international competition,

contributing to job creation and the Nation’s

standard of living. Indeed, to compete effectively with economies having lower wages and

living standards, the United States has literally

no option but to create greater numbers of jobs

in which computer and telecommunications

systems enhance people’s skills, helping them

produce higher value-added services and goods.

This implies better education and training,

especially for new entrants to the labor market

and younger employees; a high-wage economy

can only remain competitive through continuing investment in human capital. The alternative? Continued loss of ground to low-wage

economies, followed by declining wages and

lower living standards in the United States.

SERVICE JOBS AND MANUFACTURING JOBS

Preparing hamburgers in a fast-food restaurant has a good deal in common with assembly work in an automobile factory; the job of

a white-collar clerk feeding forms into an optical character reader resembles that of a blue-

-collar employee tending a punch press in a

metal stamping plant, or a kitchen worker loading food onto trays in a hospital, As such examples imply, the nature of a job may depend

as much on work organization as on whether

the job falls nominally on the service side or

the manufacturing side of the economy. Indeed,

viewed as encompassing skills, expertise, knowhow, and work organization, technology becomes a major competitive weapon even in

many of the tertiary services. The most casual

observer sees the differences among fast-food

restaurants, Each faces the same fundamental

problem: defining a menu; managing a highturnover labor force with limited skills and little job experience; dealing with a work load that

fluctuates greatly during the day. How to organize production to give customers what they

want, when they want it, while minimizing

operating costs? Each chain has reached its

own solution—a matter of proprietary technology in the sense of firm-specific knowledge and

expertise, standardized procedures, training

manuals. Some look more like production lines;

others emphasize customer choice,

Differences between the services and manufacturing run deeper when it comes to jobs for

professionals, In manufacturing firms, most of

these people fill managerial and staff positions.

They may supervise production in manufacturing, but in the services many professionals

will be an integral part of the process; lawyers,

surgeons, and teachers produce service outputs

with their own minds and hands. In an accounting firm, professionals carry much of the responsibility for direct production; the accountants employed by a stamping company are no

more part of the production process than the

supervisors.

Despite such contrasts, numerous similarities emerge when comparing knowledge-based

service jobs with high-technology manufacturing—the most obvious being applications of digital electronics to rationalize production, support managerial decisionmaking, and aid in

design, development, and marketing, If some

tertiary service firms depend heavily on proprietary technology, almost all those in the intermediate or knowledge-based services do. All

financial service firms of any size, for instance,

have had to develop the internal expertise

needed to implement complex computer applications. Hartford Insurance Group employs

well over a thousand programmers. Airlines
Ch. 8—Moving Toward a High-Ski// Economy: Computer Applications and Work Organization in the Services . 263

that have developed their own reservation systems have reaped competitive advantages; with

price competition holding down differences in

fares, quick and easy bookings for customers

who telephone directly, a well-established network of relationships with travel agents, and

responsive service for major corporate customers count for a good deal. Note that an effective reservation system depends not only on

computer hardware and software, but also on

the airline’s employees—their training, responsiveness, and commitment to their employer’s

goals. Everything else the same, the airline that

makes customer service a genuine objective,

and conveys that successfully to its employees,

should be able to fill more seats than its competitors,

In many industries, knowledge and skills ultimately determine international competitive position; there is plenty of truth in the saying that

investment bankers live off their wits. Regardless of industry, the capabilities that people

bring to the workplace affect productivity and

competitiveness: through technical skills, those

of the software engineer or the computer repairman, loan officer or insurance underwriter;

through managerial and administrative skills,

those of the buyer in a department store, the

branch manager in a bank, the foreman in a

copper mine. The work may range from finding investment capital at the lowest costs, to

planning new products, to lobbying government agencies, Sometimes the knowledge that

matters is well-codified (as in the computeraided engineering methods used to design a

hydroelectric power station), sometimes tacit

(as in the experience-based judgment that bank

employees bring to the arrangement of financing for that power station). In all cases, the technology is developed by people, embodied in

people’s skills, transferred and diffused by

people,

USING COMPUTER AND COMMUNICATIONS SYSTEMS

In industries like financial services, some

computer applications simply automate portions of an existing production process. Other

applications enable firms to create new service products, or provide existing services in

new ways. Prentice-Hall now supplies its tax

service, formerly delivered in loose-leaf form,

on-line to law and accounting firms, as well as

to corporate tax and legal departments.

New products can lead to new jobs, Whether

they door don’t, they typically mean new skills

and new learning for the existing work force.

Appendix 8A, at the end of the chapter—a case

study of restructuring at MetroBank (a fictionalized name) —illustrates. MetroBank’s strategy

required that customer service representatives

(CSRs) actively sell a new line of products (e.g.,

credit cards, individual retirement accounts),

In the process, the CSRs had to learn to use

a redesigned and expanded computer system

giving on-line access to customer accounts.

Managers whose roles had been largely administrative had to learn to coach the CSRs, as well

as to market the bank’s services, including

loans, to business customers. Moving into these

new roles proved difficult, and sometimes painful, for both sets of employees. MetroBank’s systems division, meanwhile, carried out its redesign of the computer network with little

attempt to understand the CSR’s working situation and needs, aggravating the difficulties.

This bank’s experience is not unusual; similar

stories can be heard in other financial services

firms and in other industries.

In some applications, the computer follows

the same rules and procedures as the people

it supplements or replaces: knowledge—once

the monopoly of people with skills and experience—becomes embedded in the system, Box

Z, which traces the evolution of automated

claims processing in the insurance industry,

describes how companies have put computers

to work doing what people once did, faster and

cheaper.

As box Z shows, work has changed radically

for both clerical employees and claims adjus-
264 ● /international Competition in Services

Box Z.—Claims Processing in the Insurance Industry1

Insurance companies began automating in the

1960s, installing computer systems for batch

processing of high-volume but relatively routine

claims—group health plans, automobile coverage. Labor intensity remained high through the

middle 1970s, with clerks continuing to check

and double-check the process at many points.

These partially automated systems functioned as

outlined below, using workers’ compensation as

an example:

1.

2.

3.

4*

Claims went first to an adjustor, who would

verify the loss and the identity of the insured.

The adjustor then filled out an instruction

sheet, by hand, got it approved by a supervisor, and sent the sheet to a typist who prepared a data entry coding form.

Each day, a batch of these forms went to the

company’s data processing center, where a

clerk would pull a copy of the policy to check

the coverage levels, then complete a different form and send it on to the keypunch

department. If the policy were missing from

the file—often the case—the clerk had to

write to another office for a duplicate of the

original rating sheets. A claims coder would

then recode the policy before the claim could

be processed and sent for keypunching.

After keypunching, the computer took over,

printing checks to be mailed to claimants

and recording payments. Processing took

place in batches at night. Clerks continued

to log each payment by hand. These logs

were reconciled with the computer records

once a year.

This process may seem complex, but others were

more so; before paying a fire insurance or automobile claim, for example, an examiner would

have to inspect the damage. Often, negotiations

with other insurance carriers or with repair companies would follow.

Work reorganization in this industry has been

driven by domestic competitive pressures (there

is little international competition), with companies striving to cut costs and increase productivity in order to improve profitability and market share. Around the middle of the 1970s,

IAdapted from “Draft Report: Insurance,” prepared by B. Baran

under contract for the OTA assessment, Technology and the American Economic Transition, pp. 49-54.

insurance companies began to invest in on-line

systems. Here, two alternative patterns of work

organization have emerged, one with claims adjustors as end users, the other with most tasks

performed by clerical employees.

●

●

Where adjustors use the system themselves,

clerks first screen and sort incoming claims.

The adjustors investigate, authorize, and

print settlement checks at their terminals,

avoiding most of the intermediate steps of

the older batch processing procedures.

With clerical workers as end users, the software must contain decision rules that can

dispose of the majority of claims. When a

clerk at a terminal runs into a case that the

system can’t handle, she or he calls on an

adjustor for help.

Productivity has grown enormously with both

approaches, which differ in the ratio of more

highly skilled adjustors to clerical workers, and

in the intelligence built into the system.

Today, vendors market dedicated systems for

health care claims that function as follows:

1.

2.

3.

4,

Incoming claims go directly to a clerk or assessor, who checks the form for completeness and assesses the claim (for coverage,

contractual limits, reasonable and customary limits).

The operator calls up files with personal information on the insured [and may amend

them), while the system creates windows

that display allowable payments and explanatory codes (e.g., for physician charges,

laboratory tests, drugs).

Using other windows, the clerk or adjuster

can take account of co-insurance, catastrophic clauses, deductibles, and yearly or

lifetime maximums,

A final window displays a draft payment

form for the operator to verify or modify, and

approve.

These systems not only issue checks automatically; some can prepare form letters with

upwards of 2,000 variations. The system will

automatically generate accounting and management reports that help the company predict claim

frequencies and estimate its loss ratios. It can also

track employee productivity. With insurance

companies continuing to extend the capabilities

of these systems, clerical workers (where they are
Ch. 8—Moving Toward a High-Skill Economy: Computer Applications and Work organization in the Services ● 265

the operators) can handle two-thirds or more of

all claims with no need to call for help from an

adjustor.

The new systems eliminate coding, keypunching, and manual verification. With most of the

repetitive and redundant tasks gone, opportunities for mistakes are fewer. So are opportunities

to catch them. While some checks on accuracy

can be built into the software, employees—

whether clerks or adjustors—must take most of

tors in the insurance industry. Clerical jobs have

grown more demanding, with people previously viewed as unskilled asked to take on many

of the responsibilities of adjustors and assessors, While clerical jobs have been upskilled,

pay has not changed much. The work of the

remaining adjustors has also been upskilled,

They get fewer routine cases; more of their

workload consists of claims that the computer’s

built-in decision rules cannot handle,

In other commonly found patterns, it is the

middle levels of knowledge and skill that become part of the system—leaving people with,

say, data entry jobs at one extreme, and highly

skilled tasks beyond the computer’s capabilities

at the other. In effect, work reorganization

deskills some jobs while upskilling others. Eventually, many of the jobs like data entry will also

disappear (because operators working at on-line

terminals normally do this themselves).

As digital systems become still more pervasive (in many industries, their power has barely

been felt), their influence on the organization

of work still greater, both people and organizations will have to learn and adapt. This means

designing applications that are well-suited to

the skills, aptitudes, and motivations of the

firm’s employees, integrating their skills and

abilities with those of the system—no easy task.

Suppose, for example, that a multinational bank

decides to invest in a computer network for

linking its branches and subsidiaries. Viewed

as a straightforward application of available

technology, the critical skills lie in the design

of the system: choice of equipment; when to

use leased lines and when to rely on the public

the responsibility for the correctness and completeness of their own work.

The next steps? A number of large automobile

insurers have begun to give adjustors in the field

portable PCs. By dialing into computers at a

branch or main office, adjustors get the names

and addresses of claimants to be contacted. They

can print checks with their PCs. With almost all

the work done remotely, there are no backups

except those that can be built into the computer

system.

infrastructure; software for running the network, But viewed as a means for the bank to

minimize financial risks and maximize profits, the problem is to develop a system with installed performance (as opposed to design

specifications) that will meet the needs and

complement the abilities of the bank’s worldwide staff. Such a view helps clarify the difficulties involved: few if any of the bank’s operating

employees will understand computer networks;

the system designers will not understand banking. Still, if the bank manages this task well,

it may be able to capitalize on fleeting differences internationally of l/32nd of a percentage point in interest rates. If it manages the task

poorly, the network might be close to useless,

and require extensive redesign.

Business Applications of Computer Systems

Over much of the 30-year history of computer

use within business organizations, companies

have simply automated existing tasks. Insurance companies began with batch processing

of claims, as described in box Z. Banks learned

to process checks more cheaply, helping them

keep up with rapidly expanding transaction

volumes. Businesses of all kinds automated routine functions such as payrolls to cut costs. Analytical applications such as computer-aided decision support for financial risk analysis came

later,

Today, computing power is so cheap that its

applications have become part of everyday

working life for millions of Americans, New

applications can be tailored to the requirements
266 • IInternational Competition in Services

of upper managers and executives (work stations for the corporate treasurer). Companies

can use computers to regulate and monitor routine production (as in the well-publicized cases

where telephone operators find their work overseen by call-monitoring systems).1 Some people find themselves with jobs that are more challenging and perhaps more rewarding; others

find themselves part of a mechanized system

little different from a 1930s-era assembly line

except for the computer at its heart.

In the early years, as computers began to

proliferate, corporate data processing (DP) departments with professional staffs took most

of the responsibility for selecting hardware and

software, particularly in the larger firms that

pioneered back-office applications in banking

and insurance. Smaller businesses began purchasing systems during the latter part of the

1960s, as prices dropped.2 Applications broadened well beyond the accounting and recordskeeping packages that had been on the shopping

lists of most first-time business customers, Digital equipment also began turning up on the factory floor for industrial process control.

The centralization of the early years started

to wane during the late 1970s—a result of distributed processing, friendlier systems, and, a

few years later, the spread of personal computers. With perhaps 8 million PCs in use in

American businesses—half as many as have

been bought for home use, and a penetration

that remains below 15 percent—massive new

waves of expansion and technological change

lie ahead (box AA).

Business purchases of PCs, along with continued progress in networks and distributed

computing, have helped destroy the monopolies that centralized DP departments once enjoyed in American corporations. With large

firms moving toward decentralized informaISee, for example, M.W. Miller, ‘‘Computers Keep Eye On

Workers and See If They Perform Well,” Wall Street journal,

June 3, 1985, p. 1; W. Serrin, “More Workers’ Terminals Are

Staring Back, ” New York Times, May 14, 1986, p. B8,

‘See, for example, Appendix C, “Computers: A Machine for

Smaller Businesses,” International Competitiveness in Electronics [Washington, DC: Office of Technology Assessment, November 1983), pp. 531-535.

tion utilities, a few have even converted their

DP centers to employee training facilities. Although some companies continue to write their

own software, standardized applications packages have taken over much of the corporate

market in the United States (ch. 5). When vendors like McCormack & Dodge and MSA sell

integrated software for accounting (general

ledger, accounts payable and receivable, fixed

assets, personnel and payroll, purchasing, inventory management), there is no longer much

point in a firm putting its own programs together.

The need today? Software and systems applications for strategic purposes. Most firms that

operate on an international scale have already

achieved many of the savings possible through

automation of existing functions. The next

wave of applications will help them deliver

goods and services to customers more effectively. American Hospital Supply, to take one

example, has linked its computers with those

of hospitals and clinics, which can now place

their orders electronically. In such cases—i.e.,

if a firm can establish a competitive edge with

a unique software package—internal development may still make senses

%ome companies have also chosen to market software originally developed for their own use, as a new line of business or

to recoup some of their development costs. Accounting firms

like Arthur Anderson and Peat, Marwick, Mitchell have been

marketing software packages to their customers for years, as have

a number of investment banks—E. D. Myers, “Big Eight V.

ADAPSO?” Datamation, Jan. 1, 1986, p. 32; P Hodges, “Do the

Big Eight Add Up?” Datamation, Feb. 15, 1987, p. 63.

Salomon Brothers, for another example, offers software for

economic forecasting and equity screening; originally developed

to support their in-house investment management operations,

outside sales have been directed at institutional investment

managers. Manufacturing firms including Westinghouse, Standard Oil, Republic Steel, and Boeing have established subsidiaries

for marketing soft ware (or computing services) to other companies. Boeing Computer Services sells time on its Cray X-MP supercomputer, A telecommunications link between Boeing’s offices

in England and the United States gives engineers at Britain’s

National Nuclear Corp. access to a simulation program originally developed by Lawrence Livermore Laboratory for the U.S.

Department of Energy. The program predicts the consequences

of failures in the cooling system of a nuclear powerplant. See

“Boeing Draws on Its Years of Experience, ” Financial Times,

Oct. 14, 1985, p. 12.
Ch. 8—Moving Toward a High-Ski// Economy: Computer Applications and Work Organization in the Services ● 267

Box AA.-Technological Advances in Computing Systems

In the services, computer and telecommunications systems do two fundamental kinds of

things:

1.

2.

provide error-free management, manipulation, and transmittal of almost unimaginably

large volumes of data and information (the

primary sources of error will normally be at

the input end, except for software bugs and

system design flaws); and

solve mathematical (and logical) problems

previously intractable, leading to new analytical tools (expert systems for decision support) and real-time control models for production processes (optimization of message

traffic in a telecommunications network).

Over the medium term of 5 to 10 years:

• Businesses will continue to invest heavily in

distributed systems and dispersed computing power, with cheap machine intelligence

and inexpensive mass storage available in

many locations (through local and wide area

networks, LANs and WANs—ch. 5). * Half or

 * Of 40 multinationals surveyed for OTA, more than 80 percent had

introduced or were planning to install LANs, with office automation

the most common initial application—’’Data Processing in Multinational Corporations,*’ draft prepared for OTA under contract No.

533-6410 by Mackintosh International Ltd. This survey, which forms

the basis for portions of the analysis elsewhere in the chapter, covered multinational corporations (MNCs) with headquarters in the

United States, Europe, and Japan (16 American, 16 European, and

8 Japanese). Seventeen companies were primarily service suppliers;

the rest did most of their business in manufacturing.

The survey found that many managers, somewhat at sea with the

possibilities of computer-based systems, feel there is too much new

technology to successfully understand and utilize. Not only do

managers and lower level emp[oyees who feel intimidated or threatened by the new technologies resist learning about them, but many

executives seem confused over the economic benefits. The MNCs

most comfortable in this environment tended to be those already quite

familiar with the new technologies, either because they produce them

or because they have lengthy experience as users (computer manufacturers, aerospace companies, large financial services firms).

On expert systems in financial services, below, see ch. 3; on ISDN

(Integrated Services Digital Networks), see chs. 5 and 9.

Motivations: Cost Control and Strategy

Multinationals expand and improve their

computer and communications networks to cut

costs and/or pursue new business strategies.

Their expectations may or may not be met; in

many cases, system performance fails to live

up to expectations—or, putting it another way,

more of major U.S. financial services firms

expect to have expert systems installed on

at least an experimental basis by 1990. (One

result will be to begin a new wave of deskilling in banking.)

Companies will use these distributed computing systems for manipulation and communication of text and graphics, as well as

quantitative data, the system becoming a

telecommunications network and information storage device as much as a calculating

machine. This evolutionary change will culminate in the widespread availability of

ISDN services.

The growing range of inexpensive, off-theshelf software for small machines will enable

people without specialized training to use

computers for routine applications that go

well beyond the word processing and bookkeeping common today. Examples include

desktop publishing and much more powerful

graphics packages. While falling prices for

hardware lie behind the explosive growth in

computer applications in business and industry, it is software that determines what

computers can ultimately do.

The early expert systems for banking will be expensive. Standardized software packages for PCs

are cheap. ISDN will be a massive and costly undertaking. The point is simply to suggest something of the directions and scope of technical

change. Within the next few years, still less costly

mass storage on optical discs will provide a major boost for business applications. Somewhat

further ahead, corporate users should be able to

begin making extensive use of AI, and, perhaps,

natural language processing. Where very large

data bases and fourth-generation languages combine to overload the largest current businessoriented systems, some companies may turn to

supercomputers.

the impacts on cost structure and competitive

ability differ from those anticipated. Often, no

more than a hazy idea of future benefits will

be possible in advance, This was probably the

case with IBM’s venture into a unified worldwide engineering and manufacturing database

during the early 1970s—an undertaking that evidently proved far more time-consuming, costly,
268 • International Competition in Services

and painful than the company anticipated. With

the focus shifting toward providing new services and entering new markets, risks will go

up because failure may endanger a company’s

strategy as well as its cost structure, But to the

extent that strategic applications work out as

planned, the company may benefit in indirect

ways, hard to capture with conventional accounting measures. For instance, a firm may

be able to create new forms of customer loyalty.

In the United States, particularly in contexts

such as computer-aided manufacturing, investment decisions have frequently been criticized

as short-sighted, most commonly on grounds

that managers fail to anticipate and account

for some of the potential benefits,’ The crucial

decisions generally concern pace and priorities. How fast should the company move into

expert systems? Which links in a planned global

computer network should be installed first? If

nothing else, such questions point to the broad

gray area separating investments made to control costs (where paybacks can be estimated in

straightforward fashion) from those undertaken

for strategic reasons (where uncertainty will

be much greater).

Current priorities for strategic applications

in the services include on-line access to customer records for tracking shipments and handling inquiries, and database applications for

marketing, along with electronic customer ordering. 5 Banks and financing companies have

4

See, for example, G.J. Michael and R.A. Millen, “Economic

Justification of Modern Computer-Based Factory Automation

Equipment: A Status Report, ” Annals of Operations Research,

vol. 3, 1985, p. 25. Of course, accounting calculations sometimes

serve simply to validate decisions made for other reasons.

sFor example, a French chemical manufacturer permits customer access to the chemical firm’s own database for placing

orders and tracking shipments, A chemical company based in

the United States has installed PCs at the water treatment plants

it supplies; the PCs are linked to a host computer for automatic

ordering and billing. In the future, the host machine will be

direct]}’ linked to process control computers in the water treatment plants, These examples come from “Data Processing in

Multi-national Corporations,” draft prepared for OTA under contract No. 533-6410 by Mackintosh International I.td. Imperial

Chemical Industries, a British company, likewise plans links with

100 of its customers by the middle of 1988 using a commercial

\’alue-added network—” ICI Set To Forge Data Exchange Links

With Its Customers, ” Financial Times, Apr. 23, 1986, p. 10. Not

only purchase orders and invoices, but shipping forms and requests for quotes can now be handled over the electronic grid.

Electronic pa~ments may follow. The American National Standbegun using interactive systems to prepare

home mortgage agreements. Hotels provide

automated check-in/check-out services. Securities dealers supply major customers (e.g., pension funds) with terminals that not only display

quotations but enable the customer’s traders

to execute buy and sell orders.

Table 41 lists other examples of strategic applications. These have been divided into two

categories, corresponding to the distinction between micro and macro levels of integration

treated in more detail in the next section,

Briefly, computer integration at the micro level

has its primary impacts on individual and group

tasks; a work organization perspective becomes

appropriate. The macro level of integration

refers to linkages among departments, divisions, and affiliates, as well as to linkages

among firms; an organizational perspective will

generally be most useful.

Computer links between firms are not new.

Airbus Industrie, the international joint venture, relies on computer networks to coordinate engineering design and development, as

well as production, Earlier chapters described

the SWIFT banking network, along with air

travel reservation systems that interconnect airlines and travel agents, But in recent years interfirm computer links have been expanding more

rapidly, with ramifications that have yet to be

explored. Certainly these implications seem to

differ from those of telephone or postal communications. Netting arrangements among gasoline suppliers, for example, suggest that the

computer systems of major oil firms may be

more closely coupled with one another than

with those of their own wholesalers and dealers,

or pipelines and refineries.

Some analysts have argued that, at the most

fundamental level, corporations evolve to minimize transaction costs—basically, the costs,

most of them indirect and less than visible, associated with moving, manipulating, and otherwise making use of information.6 Continuing

ards Institute has been working on a generic electronic order

form that firms could use regardless of industry–A. Pollack, “Doing Business by Computer, ” IVew York Times, July 10, 1986, p. D2.

‘%ee. for example, 0, E. Williamson, ‘‘Transaction Cost Economics: The Governance of Contractual Relation s,’ ]ournal of
Ch. 8—Moving Toward a High-Sk//l Economy: Computer Applications and Work Organization in the Services • 269

Table 41 .—Examples of Strategic Applications of

Data Processing and Communications Systems

Computer integration at the micro level:

● An American manufacturing firm coordinates customer

service calls based on a set of software rules that assign

priorities dynamically to the queue of requests.

● A West German bank, which introduced a home banking

system in 1983, makes customer account records available on-line to its sales and marketing representatives

through 4,800 terminals, (The advantages are greater than

for an American bank because German banks can hold and

trade in securities for their clients.)

Computer integration at the macro /eve/:

●

●

●

Customers can call a fast-food chain’s 800 number for

home delivery. A network of regional centers distributes

the orders among local outlets on the basis of work load

as well as proximity to customers, The chain has equipped

10,000 delivery trucks with hand-held computers to help

reduce paperwork, and uses a nationwide database of

demographic information when planning and promoting

new products,

A diversified Japanese MNC provides all of its upper

managers with on-line access to the corporate database

on production, pricing, and sales. Experience so far has

shown that some of the managers access the database

hundreds of times per month, others hardly at all,

An American-owned book wholesaler uses point-of-sale terminals to automate ordering, provide stock control, and

speed response to customer orders.

SOURCE ‘Data Processing (n Multl national Corporations draft prepared for

OTA under contract No 5336410 by Mackintosh International Ltd

technological developments reduce transaction

costs both within firms and among firms. If the

new systems alter or shift transaction costs

sufficiently, quite dramatic changes in organizational form and business practice could result, with major impacts on international competitiveness. Note that such outcomes need not

depend on large direct savings in easily measured cost categories. Realignments among

firms and industries could result from indirect

or less visible effects of computer-based technologies. For example, shared computer networks will make communications between

firms both easier and more easily hidden. Will

information sharing lead to collusion and other

forms of anti-competitive behavior?

Already, Chrysler Corp. ’s suppliers can tie

their computers into the automaker’s engineering/manufacturing network, or use terminals

.

1,,~ It ,i~](l lj(’ollofnf(’,$,” \’(l], 22, 1 ‘179, p~), 2 33-261; Nl, [{, [Uas\{Jn,

"Transaction Costs and the th[: Thcor} of Nfu]t inat i[)nal [jnter~)ris(>,”

,\’f~tt ‘~’1]~’f)ri{’~ ~)/ ,$/[]//{r),]ti~)~]:/i E~)t(>rprise, A, \l. Rugrna II ( P(1, )

II,(jn(l(~n: (;roorn” l{ f~lrn, 1082), ~)[~ 24-4:1,

supplied by Chrysler. T GM’s planned worldwide data processing and communications network will also link thousands of suppliers, as

well as GM offices and plants. Chrysler and GM

share many of the same suppliers. These suppliers may also sell to Ford and Toyota. Indeed,

Ford and Toyota may sell components or subassemblies to Chrysler and GM. How far will

integration of the various systems go? From a

technical standpoint, the growing consensus

around GM’s Manufacturing Automat ion Protocol suggests that mutual compatibility will

be the eventual outcome. If so, what will the

consequences be, if any, for competition, nationally and internationally? At the least, such

possibilities pose new questions for antitrust

policy.

Integration: Technical and

Organizational Dimensions

By now, many companies in advanced industrial economies have enough experience with

computers, peripherals, communications links,

and software to regard them as standard tools

of business practice, But if familiar, hardware,

software, and their applications have grown up

independently of one another, and often remain

incompatible. Equipment from different manufacturers may not be able to communicate.

Users in different parts of a company often

make differing technical and organizational

choices.

Integration at the Macro Level

Worldwide integration requires effective

communications among people who may be

thousands of miles apart. Firms with managerial responsibilities dispersed to many locations

need systems that can provide effective communications both horizontally and vertically

(figure 48). Typical applications include:

● finance (reporting by divisions and subsidiaries; consolidation of accounts; manage-

— --- “ ~ l~r{~~]u~t,~.it~., ~l]a] it~ ~n[~ I]rofitahi]itj Through I{nlerglng

‘1’[)(:hrlologi(;s,”” .~utom~)tjtc EnginccrIrIg, Nlarch 198(;, p, 52, ‘1’he

[;h r}~ler ~}stcnl, {:cntert;(] on 28 Iarg[) [)ro(:ess[)rs, in(, III(ics n)[)r”~:

than 1, 100 t(:rrninals, ahout }liIlf’ for (.olIli)llter-iii (l(;(l (l{}si~n ,111(1

ma nt] fa(, t (1 r i rig.
270 ● International Competition in Services

Figure 48.— lntra-Corporate Information Flows

SOURCE: Mackintosh International Ltd , under contract No 533-6410 to OTA

●

●

ment of both short and long term financing, including international diversification

of risk and cash management);

marketing and distribution (coordination

of advertising/marketing strategies; processing of orders; inventory management;

pricing; shipping);

R&D, product design, and production control (international coordination of R&D

●

projects; computer-aided design and manufacturing or CAD/CAM databases, including

customization of products for particular

markets; production planning and scheduling, including change notices, quality control records, and inventory control for purchased inputs as well as final outputs);

administrative and clerical (electronic filing; messages and mail; employee travel

arrangements).

Many companies began with financial reporting, but as multinational manufacturers gained

experience with international data networks,

more of their internal traffic has dealt with planning, production control, purchasing, and sales.

During the 1970s and early 1980s, large corporations often put together separate networks

for marketing, engineering (perhaps including

production), and administration. In many

cases, these networks, with beginnings in different places at different times, remain incompatible; IBM currently operates five or more (table

42). American Express maintains separate databases for its regular and gold cards.

Integration in a technical sense suffers when

one piece of hardware cannot talk to another,

and when software developed for one computer

will not run on others. Integration in an organizational sense suffers when people in different parts of the corporation with related jobs

continue to work with different systems. In the

past few years, managers in Japan and Europe,

as well as the United States, have begun seekTable 42.—IBM’s lntra-Corporate Computer Networks

Network Function

Professional Office Support System Worldwide electronic mail linking 290,000 of IBM’s

400,000 employees.

Digital Communications System Radio-based system for 20,000 field service repair

engineers in the United States, each of whom

has a hand-held computer for communicating

with a dispatch center, getting technical

guidance, checking on the availability of parts,

and billing customers.

Remote Technical Assistance Links 40,000 engineers in 62 countries, primarily

Information Network for troubleshooting.

Hands-On Network Environment Sales and marketing system for 25,000 employees.

Administrative Access System Ordering and payroll for 35,000 employees.

SOURCE D. Kneale, “Sharpening An Edge, ” Wa// Street Journal, Nov 10, 1966, p. 38D
Ch. 8—Moving Toward a High-Skill Economy: Computer Applications and Work organization in the Services • 271

—

Photo credit Chase Manhattan Bank

Large American banks maintain offices

in dozens of countries.

ing to reduce these incompatibilities and to

more effectively integrate computer applications into ongoing operations. While capital

costs will be high, many MNCs have decided

the time has come when the benefits of greater

system integration (including lower operating

costs) will outweigh the investment costs.

While desirable in principle, technical integration—so that equipment can communicate

easily, software run on different machines—

promises to come slowly at best. Suppliers

differentiate their equipment for marketing as

well as technical reasons. So long as centralized batch processing was the rule, few users

made compatibility a high priority; they simply picked equipment for a given, specific purpose, As a result, most users now have substantial investments in incompatible hardware and

software, inventories that have grown piecemeal over the years. The fast-food chain MacDonald’s, for example, operates computers

from half-a-dozen manufacturers at its headquarters alone, none of which can communicate with the others. e

fI1] [)s Ides ~pf}{ 1 a 1 i ~,[~(1 i~[ I rk \t at it) ns from +[?\e I a I \en (1 () rs, t h[I

c:om [la n ~’ ha\ ~eneral [){] rl)()\(! rna(: h i nc\ bu llt IIJ’ I 13 hl, ‘[’a n(icnl,

The choices of hardware and software a firm

makes as it seeks to integrate its computer systems will depend on the company’s existing

lines of business and strategy, but will also help

shape the firm’s future structure. Horizontal/vertical integration may be encouraged or

discouraged. Product lines and manufacturing

technologies of certain kinds may be favored.

Employees with certain skills will become more

or less valuable.

If many of the corporate networks operated

by U.S.-based multinationals remain independent and incompatible, American firms nonetheless seem to be ahead of their foreign competitors at macro level integration. 9 They have

invested more heavily in wide area networks,

and use them more extensively and effectively.

This lead holds both in high-technology manufacturing (commercial aircraft, computer hardware) and in services (banking, insurance).

U.S.-based service firms have generally moved

further toward integration in a technical sense

(e.g., standardizing on network protocols and

software packages) than either European or Japanese MNCs. Nonetheless, the decentralized

management typical of American companies,

while creating an environment in which innovation can flourish, often leads to differing technology choices across departments and divisions, as well as across countries. In contrast

to American firms, operating divisions in Japand AT&T, plus Wang word processing equipment-j. Rippeteau,

“Enter the Intelligent Telephone Line, ” Financial 7’imc. s, Apr. 4,

1986, p. 12. Note that many computers cannot commun i(:ate e~erl

if built by the same manufacturer.

Ch. 5 included other examples of incompatibilities among s\stems, and the growing impetus for integration and commonality}’. Many M NCS view their co mpatihil it~’ p rob] erns as serious

al read~’, and bound to get worse before the~’ get bett~’r. I n general, a company that imposes compat ibilit~’ standards will face

greater expenses in the short term because d if fereut departments

may not be able to choose the low-cost system for their particular needs. Multinationals that hate gro~lrl b}’ a(:quisition face

particular problems in terms of compatibility}’, but lack of interuatio nal standards for hardware and e\en more for software

makes integration a long-term goal for everyone. Ch.s. !) ;+n{l I ()

illustrate some of the problems from the standpoint of inter na -

t iona] agreements on technical standards.

~“Data Prm,cssin,q in hlulti-nationa] Corporations, ” op. cit. Llcccntral ized American (:ornpanies experiment more with ne\\ data

processing and communicant ions technologies. European multinat Ionals tend to bc hehind [1 .S .-based hl NCS in technology a n(i

behind )apanesc hlN(’s at nli(ro-leiel integration of people into

the s}sl[”nl.
272 • International Competition in Services

anese corporations have less autonomy in

deciding on computer applications. Companywide standards are more common; greater effort goes toward searching for consensus on

how to implement computer-based automation.

Japanese companies are slow to adopt computer and telecommunications technology, and

have lagged in putting together integrated multinational organizations (as noted elsewhere,

their strategy in manufacturing has generally

been to export from Japan unless or until forced

to invest abroad), But at the micro level of work

organization, their careful and cautious approach has served the Japanese well, at least

in manufacturing industries.

Integration at the Micro Level

U.S.-based MNCs tend to be ahead of their

Japanese counterparts in the use of the most

advanced hardware and software. But it seems

clear that the Japanese are well in the lead when

it comes to manufacturing systems that effectively integrate people and machines—matters

of task design and work organization more than

choice of equipment.10 This has been a major

source of competitive success in industries including automobiles and microelectronics, One

indicator: the ability of Japanese firms to

achieve higher yields and higher quality in the

production of large-scale integrated circuits

while using the same equipment as American

firms.

The consensus-building mechanisms that

have left some Japanese corporations behind

in multinational integration here give them advantages: their ringi decisionmaking processes

‘“See, e.g., International ~’[)xl]~)t:titi~’(?x](?ss in Ele~:tronics, op.

c it,, chs. 6 and 8,

lend themselves to conflict resolution and the

development of shared values, necessary attributes of integrated systems at the micro level (for

reasons discussed in the next section). In general, large Japanese companies also invest more

in human capital than their American counterparts—e.g., in corporate training and retraining programs. Thus far, however, there is little

evidence that Japanese service firms gain competitive advantages through better integration

of available technologies into ongoing operations.

The question then becomes: If large Japanese

manufacturing companies get a competitive

edge through their ability to design and manage integrated production systems, will Japanese service firms eventually do the same?

OTA’s analysis suggests that they will, although

the relative immaturity of many Japanese service industries means that it may take 10 or 15

years.

Over the medium to long term, Japanese companies should be able to successfully adapt their

consensus-based organizational traditions to

production processes characteristic of the

knowledge-based services. Japan’s push into

software and fifth-generation computer systems, discussed elsewhere, indicates high levels

of resolve in both government and industry. As

they have done in the past in manufacturing,

Japanese companies will probably be able to

avoid some of the mistakes made by pioneering U.S. firms. If today their hardware and especially their software remains well behind that

found in American service firms, there seems

little doubt that Japanese companies will eventually make good technical choices, and arrive

at production systems well-suited to the characteristics of their labor force.

SYSTEMS DESIGN AND PEOPLE’S SKILLS

Data processing and communications sys- view, But the ideal is seldom approached, given

terns in all their variety place new demands on the pace of technological change, the foibles

the people who use them. Ideally, of course, of designers and their fascination with techboth hardware and software would be devel- nology for its own sake, the universe of alteroped with the needs and abilities of users in native system architectures permitted by the
Ch. 8—Moving Toward a High-Skill Economy Computer Applications and Work Organization in the Services . 273

many component and subsystem choices, (See,

for example, the section entitled “Technology”

in the MetroBank case study, app. 8A, )

Technical capabilities impose one set of constraints. Some things are possible, some are not;

some expensive, some cheap. Managers at a

distance from the workplace may impose their

own constraints. Who, then, actually designs

computer-automated jobs? In most cases, technical experts have more control than any other

group, simply because they are the only ones

who fully grasp what can be done. Given their

monopoly on technical knowledge, the experts

—including those who work for vendors and

suppliers—have a great deal of influence over

the perceptions and expectations of everyone

else. Sometimes the experts or the managers

consult the people who will have to use the system, sometimes they don’t. In many cases it

seems safe to say that, when it comes to the

design of work, as opposed to the design of the

system in a strictly technical sense, no one is

in charge.

In such a setting, job requirements evolve,

often with a great deal of trial and error. Despite confusion, uncertainty, and mistakes,

large and small, new patterns in the use of

computer-based systems have begun to emerge

in American industry—albeit patterns that are

not yet sharply defined. Flexible product development and production systems, in the extreme verging on customized production, have

become primary objectives for businesses operating in shifting and unstable environments,

domestic and international, in service industries and manufacturing.

Flexibility means different things in different contexts, but first and foremost implies

rapid response to shifting competitive circumstance: 11

● tailoring product attributes in response to

I Istudents and practitioners of management, along with critics,

periodical}’ rediscot’er the ~’irtues of flexibility, Simon, \vritin~

more than 20 years ago, covers much the same ground as those

in the 1980s who call for flexible organizations and customized

production as remedies for the competitive dilemmas of American industry. See, for example, H.A. Simon, 7’he Shape of A utornation (New York: Harper & ROLV, 1965).

On flexibility in manufacturing, including applications of robotics, see International Competitiveness in Electronics, op. cit,,

pp. 233-246.

changing patterns of demand, or to create

changes in demand (the sport shoe example in ch. 5);

thrusts into new geographic or product

markets (interstate and offshore banking,

the home equity lines of credit spurred by

changes in U.S. tax law);

new products made possible by new technological opportunities (on-line information services);

shifts in operating level or product mix, as

a consequence of business downturns or

new competition (American automakers,

hit hard by Japanese competition in the

early 1980s, sought to drive down their

break-even points, enabling profitable operations at lower production volumes);

changes in government policy (leading,

for instance, to new opportunities for service firms that provide hazardous waste

disposal).

Plainly, technology itself is part of the problem;

technical change comes more rapidly than ever

before, and firms in many industries find it hard

to keep up. But technology is also part of the

solution. The ability of an organization to respond to change depends on its store of technical knowledge, on how well its employees can

use the tools available—whether these are developed internally or purchased in the marketplace.

Sometimes competitive circumstances call

for computer systems that replace peoples’

skills, sometimes for applications that enhance

peoples’ skills. In the first case, typified by transactional applications emphasizing cost control

and illustrated by (most of) the insurance claims

processing examples in box Z, the automated

process is a relatively mechanical one; the system does more or less what people once did.

(Box C inch. 1 distinguishes between transactional and analytical applications of computer

systems.) Back-office paper processing in banks

provides another set of examples. In the services, semi-skilled clerical employees are generally the first to find their jobs deskilled or

given over to the system.

The second case, enhancement of people’s

skills—illustrated by the ways in which MetroBank’s CSRs can use their terminals—includes
274 ● International Competition in Services

both analytical and strategic applications. Here

the computer helps people do things they could

not do before—e.g., interpret signals from a

CAT scanner—or helps them do things faster

or more easily. Giving employees in the front

office of a bank on-line access to customer

records creates a new menu of organizational

opportunities. Their work now an intrinsic part

of the firm’s marketing strategy, MetroBank’s

CSRs had to acquire a new set of skills. This

entailed much more than learning to use an “information utility. ” The greatest changes were

attitudinal—learning to actively sell the bank’s

products. The new demands on the CSRs were

part of a much broader set of shifts, as MetroBank tried to alter its culture—in part to cope

with uncertainties posed by deregulation. With

new job requirements and new learning come

better career prospects, should the CSRs wish

to take advantage of them (some do not).

Other examples from banking include decision support systems incorporating economic

models for use in judging lending risks. (How

will falling oil prices affect a small, independent gasoline distributor’s business?) Again, the

computer system enhances people’s skills—

here people who will probably have professional skills to begin with. To take a different

example, when computer-aided drafting replaces manual drawing in architecture, engineering, and construction firms, productivity

goes up, sometimes by factors of 10 or more.

Beyond the direct impacts, designs can be

changed more easily and more quickly; the

computer can estimate construction costs for

alternative designs, prepare bills of materials,

estimate heating and cooling loads, prepare perspective drawings in sun and shadow. Designers can explore more options. Clients can pursue them in greater depth. The design firm has

greater flexibility: it can respond more readily

to customer needs and desires, pursue new

kinds of business. (Somewhat paradoxically,

another result of computer-aided drafting is

likely to be greater standardization; the computer can store and recall design features from

a library, for the operator to put together more

or less mechanically.) But while the automated

system opens up new avenues for the designer,

it takes over many of the manual skills of the

draftsperson. Jobs for drafters are deskilled.

Companies with these systems commonly hire

people with vocational-technical schooling but

no more than, say, a year’s manual drafting experience. They feel that those with longer experience will be overqualified (and perhaps

overpaid), and unable to adapt as well.

As the drafting example suggests, computer

applications in the services lead to the deskilling of some jobs and the upskilling of others.

The patterns can be complex and confusing,

with many exceptions, but the empirical evidence indicates that upskilling will be more

common where people already have good skills

and good educational credentials. Other jobs

tend to be deskilled.12 Computers spread knowhow through an organization, making it available to many more people, raising the average

skill level at which employees can operate, and

helping to preserve and maintain knowledge;

1zFor a summary, see p. Flynn, “The Impact of Technological

Change on Jobs and Workers, ” final report to Department of Labor, Office of Employment and Training, 1985. Also Technology and Structural Unemployment: Reemploying Displaced

Adults (Washington, I)C: Office of Technology Assessment, February 1986), pp. 335-354.
Ch. 8—Moving Toward a High-Skill Economy: Computer Applications and Work Organization in the Services ● 275

in the process, they make some people, and the

skills these people have, redundant.

The implication is straightforward but daunting: American companies and American education and training institutions will have to do

a better job of preparing people for high-skill

jobs, Plainly, many Americans will continue

to fill low-skilled, dead-end jobs. But jobs in tertiary services like retailing, hotels and restaurants, and recreation depend on the size of the

Nation’s economy, on living standards, and in

some sense on international competitiveness.

Expenditures on health care, entertainment,

and vacation travel go up with levels of affluence; most people would prefer jobs at Bloomingdales to jobs at K-Mart. The more high-skill jobs

the U.S. economy can create, the more work

of other kinds there will be. This section, then,

touches on the nature of skills themselves, before going on to the ways in which companies

use the skills of their employees. (Ch. 10 treats

the implications for human resources policies.)

Well-defined skills characterize some professions, vocations, and occupations, but the notion of skill remains fuzzy and ambiguous beyond rudimentary levels. Box BB touches on

some of the reasons. Reading, writing, and

arithmetic as taught in schools are skills. So are

reading critically, writing incisively, and thinking quantitatively (along with learning itself)—

but these are much harder to pin down or to

teach. And at higher levels, as Polanyi points

out so aptly, skilled people “know many more

things than they can tell.” 13 Schooling, of

course, also conveys the rudiments of workplace discipline—showing up on time, tolerating if not respecting authority. Along with their

other objectives, schooling, apprenticeships,

and training programs help people learn to deal

with co-workers, customers, and clients.

The better a firm uses the skills and knowledge of its employees, the more competitive it

can expect to be. There is more to this than

grouping tasks as if they were building blocks,

just as there is more to computer applications

than distinguishing between replacement and

enhancement of people’s skills. But from the

perspective of the system and how it functions,

two extremes in the design of work can usefully be distinguished. At one extreme—when

the computer is used in more-or-less direct fashion to automate what people once did—the system will be rule-based and mechanistic. The

“program” is a rigid one, procedures formalized, mass production—of insurance claims or

Model Ts—the objective. At the other extreme,

where product and process characteristics vary

and flexibility becomes a buzzword, the organizational program must vary too. This, of

course, is one of the things computers are good

for: flexible rather than fixed automation. Software can be written to accommodate variation,

new programs loaded as needed. On the left

axis in figure 49 (which is identical to figure

6 in chapter 1), the two extremes have been

labeled adaptive and rigid, suggesting the difference between a system that can adjust dynamically to its environment—even if that environment is shifting and unstable—and one that can

change only slowly.

Figure 49 suggests how various industries

and enterprises might be characterized in terms

of work organization and computer utilization.

Where a firm belongs will depend on patterns

of computer use among the occupational groups

in its work force. Table 43 provides a general

framework. The table breaks occupations down

into two major categories: those in which computer systems have not (yet) had substantial impact on work and skills (the first 3 of the 1 1

occupational groups); and those where utilization of computer systems in the production process is common and helps define the nature of

the work (the remaining 8 occupational classes).

Organizations with limited and/or routine use

of computers tend to cluster at the left in figure 49, some characterized by rigid forms of

work organization (fast foods), others by more

adaptive forms (real estate). Most of the jobs

in such organizations would fall in occupational categories 1-3 in table 43, with some perhaps in 4-7 (extensive but routine computer use].

A second major cluster of enterprises, at the

top right, consists of those in which computer
276 ● International Competition in Services

Box BB.—Tasks, Jobs,

Even “unskilled” workers must possess a wide

range of very real abilities, including some degree of problem-solving skill. They must get along

with co-workers, conform to the discipline of the

workplace. Literacy may or may not be necessary, but communication certainly is. Skilled

workers rely on broader and deeper stores of tacit

know-how (anticipating problems, troubleshooting, generalizing from a limited number of cases),

along with well-codified knowledge (how to use

DO statements in Fortran programs). Most professionals depend heavily on book learning, but

need tacit knowledge and good judgment as well

—skills that go far beyond knowledge acquisition

and reasoning.

Some tasks are simple and fixed, repeated in

the same sequence every few minutes or few seconds. This is the case for much unskilled and

semi-skilled work: data entry, collecting bridge

tolls from motorists. Skill levels go up as judgment and experience come into play; supermarket checkers must be better at making change

than toll collectors. Sales clerks in department

stores need to assist customers as well as take

their money. Social skills come into play in

almost all jobs. Retail chains train their sales

clerks in how to behave toward customers, Police officers need good sense when it comes to

people and their behavior. In the professions,

education and training shape social skills and

attitudes (so that physicians, for example, behave

quite differently among themselves than they do

in front of nurses or patients).

For skilled work, the universe of possible tasks

and procedures (hence the tool kit of skills, the

base of knowledge and experience) will be large.

The surgeon or cabinetmaker selects from these

as needed to do his or her job. Some of the skills

are manual, some mental. Lawyers may need

good instincts, the ability to think on their feet

(like the police officer), coupled with the conceptual skills and fortitude to deal with complex

cases that may last for years. A software engineer designing a large program may face thousands of choices in arranging instructions,

branches, and subroutines; arriving at the overall shape of the program takes a different set of

skills than writing reasonably error-free code on

a line-by-line basis.

As such examples suggest, only relatively routine work can be viewed in terms of procedures

and Skills

put together from sequences of well-defined

tasks. The greater the need for conceptual and

judgmental skills, the less precision the notion

of work organization conveys.

By the same token, outputs are harder to evaluate when work depends on higher-order skills

such as planning. Standards of quality become

subject to debate and disagreement; as discussed

in chapter 2, consumers may have little basis for

evaluating the services of physicians or lawyers,

even after delivery of the service. Evaluation may

itself demand judgment and skill (thus creating

jobs for people such as music critics). Distinctions between minor league and major league

baseball pitchers, chess masters and grand

masters, artists (including computer programmers and architects) whose work will last or disappear, may escape observers who are not themselves highly skilled. Instinct, feel, judgment,

intuition, inspiration—this is the vocabulary of

such distinctions. Measures of productivity may

be equally uncertain. Baumol has often noted that

string quartets performing for alive audience are

no more productive today than a hundred years

ago; one might add that people’s ability to evaluate and appreciate such performances has probably not improved either.1

Measures of skill, then, can rarely be very precise beyond some point of relatively ordinary

competence. For such reasons, it is too much to

expect expert systems to be able to replicate the

procedures of people who truly are experts,

though it is not too much to expect computer programs to be ordinarily competent.2 When learning, people follow rules and instructions for playing a violin or writing software. Those who have

become acknowledged experts may sometimes

follow clearly visible rules and procedures, sometimes not. Sometimes they break the rules.

Higher-order skills involving problem-solving

%M, for example, W.J, Baumol, “Productivity Policy and the Service Sector,” Managing the Service Economy: Prospects andl%oblems,

R,P. Inman (cd.) (New York: Cambridge University Press, 1985), p,

301. Beyond the live audience case, broadcasting and recording technologies have of course led to huge productivity advances,

% H. Dreyfua and S. Dreyfus, “Why Computers May Never Think

Like People,” Technology Review, January 1986, p. 43; alao H.M. Collins, R.H. Green, and R.C, Draper, “Where’s The Expertise?: Expert

Systems As a Medium of Knowledge Transfer,” Expert Systems 85,

M. Merry (cd.) (Cambridge, UK: Cambridge University Press, 1985),

p. 323.
Ch. 8—Moving Toward a High-Ski/l Economy: Computer Applications and Work organization in the Services . 277

normally come only with time. Extended training, with a good deal of supervised practice, go

into making a competent physician or air traffic

controller; expertise follows with accumulated

experience.

Finally, it is seldom that isolated tasks set the

bounds for work. Many jobs require a good deal

of contextual knowledge—an understanding of

how the organization and its processes function

(table 43), An employee with good contextual

knowledge should be able to diagnose problems,

Figure 49.— Characteristics

Adaptive,

Flexible

Organization

of

work

Rigid,

Pre-programmed

dyna

compar

advant

help customers, and otherwise get things done

because he or she knows where to go and who

to talk to; relationships with other people may

in fact be the primary defining features of computer-assisted jobs. The associated skills may also

be the most difficult to learn: the changing interactions between bank employees and their customers discussed in appendix 8A—and the changing

relationships between supervisors and subordinates—illustrate some of the complexities of developing new social and managerial skills.

of Firms and Industries

Enhancement

of human

skills

Tertiary I Old New / KnowledgeComputer

utilization

replacement

of human

skills

(traditional)

/

manufacturing manufacturing

/

based

services services

SOURCE Office of Technology Assessment 1987
278 • International Competition in Services

Table 43.—Patterns of Computer Use by Occupation

Occupations with limited and routine use of computer

systems

1. Shopfloor work in manufacturing where computerbased automation is uncommon.

2. Service industry jobs with little or no use of computers

(hair stylists, entertainment).

3. Managerial and professional work where people use the

system at their own discretion, or for routine functions

only (e. g., word processing).

Occupations with extensive computer utilization

Routine:

4. Input-output (data entry, materials handling, loading and

unloading of automated production equipment). In general, input-output jobs require little or no interaction

with customers, in contrast with data gatekeeper jobs,

below.

5. Data gatekeeper—jobs at the boundary between the

firm and its customers or suppliers, but requiring little contextual knowledge of the product or production

process (e.g., directory assistance operator, order taker

for classified advertising).

6. Machine tender (routine monitoring of computer-automated equipment).

7, Troubleshooter (component or equipment level, including routine maintenance and repair, as well as quality

control).

Non-routine:

A. Technical and paraprofessional

8. Customer/client/intrafirm service representative—provision of services, outside or inside the firm, requiring

greater contextual knowledge than data gatekeeper

jobs (e.g., loan officer, travel agent, insurance adjustor, administrative assistant). In jobs with high contextual knowledge requirements, people must understand

how the organization works and be able to use that

knowledge to get things done.

9. Diagnosis, evaluation, repair, operation, system maintenance (database librarian, paralegal, medical laboratory technician, currency trader).

B. Design, system control, professional

10. Process control, system troubleshooting, crisis intervention (air traffic controller, powerplant operator,

financial manager, numerical control machine tool

programmer).

11. Product, process, and system design (urban planner,

architect, chemical engineer, research scientist).

SOURCE Adapted from ‘International Competition in the Service Industnes Im

pacts of Technological Change and International Trade on U S Em

ployment, ” prepared for OTA by E Appelbaum, P S Albln, R Koppel,

and F Hormozl under contract No 533-5560

systems enhance the skills of employees in

adaptive settings. The greater the fraction of

a firm’s jobs that fall in categories 4-11 of table

43, the farther to the right the firm would be

placed in figure 49. A preponderance of jobs

in categories 4-7 implies using the computer

as a replacement for human skills, hence a position in the lower right portion of the chart.

More jobs in categories 8-11 would move the

firm upward, closer to the pole marked enhancement of human skills.

Firms with rigid forms of work organization

typically employ many people in routine occupations, complemented by a small superstructure of technicians and professionals. Adaptive organizations, on the other hand, generally

need people with both broader and deeper

skills, and employ relatively large proportions

of workers in technical and paraprofessional

categories. Rigid work organization correlates

with deskilling (except for the technicians and

professionals who design the system and keep

it running), adaptive with upskilling.

As figure 49 and table 43 suggest, among the

occupations most susceptible to technological

displacement are routine input-output and data

gatekeeper jobs with low contextual knowledge

requirements. For instance, self-service, aided

by computer systems, has meant declining job

opportunities for gasoline station attendants

and bank tellers. Other service jobs requiring

little contextual knowledge can be exported to

low-wage offshore locations (ch. 7). In contrast,

high contextual knowledge implies judgmental

skills; such jobs are harder to automate, although offering many opportunities for computer enhancement and assistance. Also note

that tenure in jobs with low contextual knowledge requirements does little to prepare workers for upward moves within the firm.

INTEGRATED PRODUCTION SYSTEMS: THE NEW MODEL

Figure 49 suggests the outlines of a new services and goods, emphasizing strategic apmodel for computer-assisted production, one placations of computers and patterns of use that

typified by U.S.-based firms in the upper right enhance the skills and abilities of at least some

of the picture. These new-model firms design, of their employees. Many have organized themdevelop, produce, and market knowledge-based selves as integrated production systems, with
Ch. 8—Moving Toward a High-Skill Economy: Computer Applications and Work Organization in the Services ● 279

integration implying substantial use of computers and telecommunications to more closely

couple product design, production, and marketing and to tie together dispersed geographic

locations. In search of flexibility and entrepreneurial behavior, these companies tend to stress

employee training and skill development, along

with controlled risk taking, delegation of authority, and decentralization. They often approach their markets on a global basis, even

when small (e. g., PC software firms).

Some manufacturing firms, as well as knowledge-based service suppliers, fit the new model,

In both the services and manufacturing, the

new model differs from the old in the social

system as well as the technical system, with

managers recognizing that it is the interrelationships of computers and people, more than

the technical system in isolation, or people’s

skills and abilities in isolation, that determines

the firm’s ability to respond to changing circumstance, and, over the longer term, to meet

international competition.14 New social systems

generally attempt to increase employee identification with the organization, and commitment to its goals. Sometimes this means real

if localized power for employees at lower levels

—e. g., a voice in hiring new members of work

groups (and perhaps in firing), peer approval

for pay raises, Sometimes it means no more

than consultation on changes in work organization. In other cases, it has become little more

than a sophisticated form of paternalism.

A greater fraction of the employees in newmodel firms will need specialized knowledge

and training, sometimes job- or occupationspecific, sometimes firm- or industry-specific.

Computer graphics, for example, has narrowed

1 qrrh is ~or~espon~s to the classical statement of objectives of

the soc iotechnical systems approach to job and organizational

design-the search for a joint optimum between the technical

s}’~tem (including both process and product technologies) and

the social system (that is, the people in the organization, with

their skill endowments and foibles, preferences for cooperation

or (,[)nfli( t. informal groupings). See, for example, E. I,. Tri\t,

et a]., Organizational Choice: Capabilities of L’rou[).s at the Coal

Face 1‘rider L’hanging Technologies (London: Talistock, 1963];

E. I.. ‘[’rlst, ‘ ‘The Evolution of Soc iotechnical Systems as a Con-

(,e~)t ua 1 F’ra mewo rk and as a n Action Research Program, Pcrspecti~es on organization lle.~ign and Beha ~ior, A. H. L’a n d e

t’en an(l tl’, F, Jo}(.[’ (e(ls. ) [NeY\ }’ork: 1}’ile}, 1981), p. 19.

some of the differences in skills among people

who do cartoon animation, design theater and

movie sets, draw maps, or prepare graphic layouts for magazines and books, financial displays, scientific illustrations. Such jobs are

found in different industries, and traditionally

have been viewed as requiring different skills.

With computer automation, they are converging. Likewise, data gatekeeper jobs call on similar kinds of skills across industries—communicating over the telephone, customer service,

using data processing systems to access, store,

and retrieve information. Note that overlap in

job skills among seemingly different occupations and industries eases lateral mobility, one

reason for growth in temporary employment

(ch. 7). In general, employees of new-model

firms will be expected to bring broader (and

perhaps deeper) skills to the workplace; the

company may use job rotation, work sharing,

and small-group production to help develop a

multi-skilled labor force. Contextual knowledge

will be more important for more people, who

will need to know how their work fits into the

chain of production, so that they can troubleshoot problems, help customers, make good decisions.

Somewhat more concretely, most companies

with organizational structures evolving toward

the upper right portion of figure 49 share characteristics from the following list:15

● Firms define jobs somewhat more broadly

than in traditional organizations. Sometimes broader skills and responsibilities follow more or less directly because computer

automation permits each person to do more.

Sometimes groups take over responsibility for a number of tasks, with individuals

learning several jobs and rotating among

them. By working in groups, people learn

from one another, more easily share skills

and information. When people know each

others’ jobs, or can simply do more, the

organization becomes more flexible.

15A n earlier \,ersion, adapted for manufacture ing, appeared i n

Technolog~’ and Structural Unemplo~’ment: Reemploj’ing Displaced Adults, op. cit., pp. 356-357,
280 ● International Competition in Services

●

●

●

New-model firms, where an employee’s

actions may have impacts that reach

deeper and spread more broadly than in

a traditional organization, call for greater

contextual knowledge. With many centers

of responsibility, and people at relatively

low levels making decisions and taking action, employees need to understand h o w

their work affects the rest of the organization. When the same person sells insurance

and prepares the policy documents at an

on-line terminal, that person must know

more and take more responsibility.

When people gain more responsibility

and control over their work, they may get

more satisfaction from their jobs (some do,

some don’t).

As a result of broader job definitions and

the need for contextual knowledge, corporations may find they need to give their employees more and better training, and may

seek deeper as well as broader skills (even

among employees normally classed as unskilled or semi-skilled).

Firms that have moved to product-centered rather than functional organizations

(a distinction discussed at greater length

below) usually provide training covering

the product line; a few companies have

gone beyond, say, marketing information,

beginning to discuss profitability or longrange planning with their employees—

topics ordinarily reserved for managers.

Many training programs are intended to

expose employees to corporate goals and

enhance motivation, sense of belonging,

and commitment to those goals. Such objectives often merge into the development

of contextual knowledge; for instance, a

company may devote considerable effort

to showing employees how their jobs contribute to the firm’s end products. People

may be encouraged to view themselves as

immediate participants in the production

of final services, rather than simply doing

a job somewhere along the chain of production, (“I work for MetroBank” rather

than “I’m a bank teller.”)

Employees at lower levels maybe granted

a say in decisions on equipment and procedures (e. g., word processing or spreadsheet software), as well as day-to-day operations.

Typically, participation takes the form

of meetings between employee representatives and the company’s technical and

managerial staff. Planners may seek to

draw on the experience of the current work

force.

Consultative mechanisms, regardless of

form, seldom give low-level employees any

real control over major decisions—those

that shape the system. Only in cases of massive opposition to proposed changes, o r

where employees are represented by strong

labor unions with independent sources o f

technical expertise, are they likely to b e

able to influence the fundamental choices

that shape the organization of work and

the application of technology.

Managers may give groups of workers

some or all of the authority formerly vested

in first-line supervisors, perhaps including

limited control over pace, task design, and

work methods, along with responsibility

for quality and for coordination with other

departments.

When groups take over responsibility for

monitoring absenteeism, for allocating

work, and for quality control, the supervisor’s role may become primarily that of

facilitator and communications channel

with higher management, As illustrated in

appendix 8A, supervisors commonly find

themselves spending more time on management, less on administration. Often, the

ratio of supervisors to production employees declines; some companies have eliminated first-line supervisors entirely.

Giving supervisory control to work

groups can heighten job stress. Among the

causes are intra- and inter-group competition—forces that managers look to for

greater productivity. Moreover, work groups

often have some control over membership

—perhaps the power to veto prospective

new employees. People who do not fit in

may find themselves not only uncomfortable, but out of a job, Work groups carry

potential for inequities and abuse that few
Ch. 8—Moving Toward a High-Skill Economy: Computer Applications and Work Organization in the Services ● 281

●

●

●

American companies have as yet acknowledged.

In selecting new employees for some kinds

of jobs, companies may weigh motivational

and attitudinal factors more heavily than

past experience (or, in some cases, education). Social skills may get new emphasis.

Some American firms have adopted multiple levels of screening, with aptitude and

perhaps psychological tests followed by interviewing. The interviews might involve

prospective peers as well as the personnel

department and supervisors.

Pay scales may reflect the skills an employee has acquired (e.g., the jobs he or she

has mastered—pay for skills) and/or performance (payment for results). In addition

to meeting objective standards such as

written tests, an employee seeking a payfor-skills increment may have to be passed

by other members of the group, as well as

by supervisors.

In decentralizing, some companies have

replaced functional with product-centered

organizations. The common objective is to

channel work smoothly and directly from

input to output of the system—creating a

faster, more flexible (if not necessarily

more efficient) production process.

The benefits of “channelization” can be

quite real, even if hard to quantify. As discussed below, banks have replaced centralized data processing divisions with smaller

departments specialized by type of customer (retail stores) or transaction (currency exchange). When a single department provides most or all of the services

a given client needs, the bank’s employees

can respond more quickly, the system becomes more nearly transparent to the client (and to the bank’s own employees).

Product organizations can also contribute to employee motivation and commitment; people may identify more readily

with a department that supplies a complete

product rather than a piece of one.

people. This may be a matter of circumventing

a lack of literacy or numeracy in the labor pool,

designing equipment so that it can be used more

easily and more productively (user-friendly

computer systems), or finding better ways to

call on the capabilities of those who are overeducated for the jobs they find themselves in,

Although no census exists, several thousand

U.S. companies appear to share a substantial

number of attributes from the list above, with

the number in manufacturing probably exceeding that in services.16 A much larger number

of American firms have taken smaller steps,

such as the introduction of quality circles. In

the services, new model organizations are far

more likely to be found in, say, banking, than

in construction,

As more organizations consider alternatives

such as those outlined above, the questions for

U.S. companies and their employees include:

Compared with foreign competitors, will American service firms react slowly and uncertainly?

Or will they take the initiative? How will decisions taken by corporations, collectively, affect

competitiveness? How will skills be affected?

Will people be integrated into the system or out

of it? Will job ladders and prospects for upward

mobility be truncated?

The answers depend mostly on whether

American managers in large numbers search

out new ways of maximizing the contributions

of individual employees to competitive performance—a search that some U.S. firms have

embarked on, along with a few European companies and many Japanese organizations (the

latter particularly in manufacturing). It seems

clear that widespread adoption of at least some

features of the new model can help improve

the competitiveness of American industries,

and thus aid in preserving job opportunities

over the longer term. Nonetheless, in the short

run, work reorganization in conjunction with

computer automation typically causes some

While the primary thrust in most new-model

firms has been to select and fit people to existing or redesigned jobs, jobs can also be fit to

l~see R, E. Wa]ton, “From Control to Commitment in the \Vorkplace, ” Harvard Business Re}riek$’, hlarch-April 1985, p. 76. Also,

Product j~’jty Through Work Inno\’ation.~: A tl’ork in America

Institute Polic~ Stud~’ (New York: Pergamon, 1982], p. 3.5.

63-527 0 - 87 _ 10
282 • International Competition in Services

kinds of job opportunities to disappear, people to be displaced.

While a number of the steps outlined above

may contribute to making some kinds of work

more satisfying, new forms of production systems also bring new dangers, born of the inherent conflicts of interest between firms and

their employees. Training programs can end

up resembling indoctrination. And what, for

example, of people who find themselves at odds

with a work group? The more authority managers cede to such groups, the greater the potential for abuse by the group. (Which is not

to imply that managers never abuse their

power.) Questions of equity would seem to exist already, first and foremost where groups can

veto new employees. The modern, bureaucratic

corporation, after all, emerged in part from efforts to counter the favoritism, nepotism, and

corruption that afflicted earlier forms of organization. In 19th century U.S. factories, Irish

gang bosses hired other Irishmen. Groups of

Cornish miners working on contract in the Midwest, if not members of the same family, often

came from the same village. Work groups today

are hardly likely to take such forms, but possibilities for coercion and abuse can plainly arise.

Furthermore, practices such as screening

hundreds of applicants before picking a few

dozen will strike many Americans as less than

fair; a corporation, after all, is not an athletic

team. Labor unions, where they exist—and they

are relatively rare in U.S. service industries (ch.

7)—can help safeguard the rights of individuals

and protect against discrimination in hiring and

firing, But some American managers see organizational change as a way to keep out labor

unions, and not a few companies view unions

as incompatible with new forms of work organization.

IMPACTS ON COMPETITIVE ABILITY

As noted earlier, American managers have

often been criticized for placing higher priorities on immediate cost savings and short-term

profits than on investments leading to indirect

and/or strategic payoffs visible only over the

longer run, As this section will show, many of

the most significant impacts of new-model production systems come about indirectly. For instance, greater job satisfaction can help reduce

employee turnover, hence costs for training

new employees (including lost production during on-the-job learning). Thus the speed with

which American companies move toward newmodel organizational forms may provide one

test of the proposition that incentives in the U.S.

economy skew managerial decisions toward the

short term.

Citibank’s shift in its back offices from a functional to a channelized or product organization

illustrates some of the indirect impacts, here

through improved customer service. 17 During

17R. W, Wa]ter5, “The Citibank Project: Improving Productivity

Through Work Redesign,” The Innovative Organization: Productivity Programs in Action, R. Zager and M,P. Resow (eds.) (New

York: Pergamon, 1982), p. 109.

the 1960s and into the 1970s, Citibank, like most

financial services firms, fed all its transactions

through a large centralized data processing division—the functional approach common in an

era of batch processing on expensive mainframe

computers. In Citi’s DP division, all transactions (e.g., checks) passed in sequence through

half a dozen departments organized by function (e.g., coding and keypunching—the system

roughly paralleled that described in box Z for

batch processing of insurance claims). Different transactions—checks, letters of credit, foreign exchange—took different routes through

the DP division, but all were handled in basically the same way, There were no distinctions

between, say, corporate and individual accounts. Each time the paperwork for a transaction crossed the boundaries between departments, it moved from the province of one

manager to another, With responsibility fragmented, errors were easy to make and hard to

trace.

The company redesigned and decentralized

its transaction processing system so that a single manager would have end-to-end responsi-
Ch. 8—Moving Toward a High-Skill Economy: Computer Applications and Work Organization in the Services ● 283

Photo credit Burroughs Corp

Automated reader/sorter for processing checks.

bility for a single type of transaction (product).

Different departments now handle letters of

credit, depending on the customer (government, correspondent banks, Citicorp branches)

as well as the geographic market. Each transaction follows a well-defined path or channel

from the time it enters the Citibank system until it leaves, with management responsibility

clearly defined at each point.

Just as in the insurance industry, cheap com -

puting power, specialized work stations, an d

friendlier software make product forms of orga -

nization practical in banking. Of course, assign -

ing different departments full responsibility fo r

the needs of different groups of customers in -

evitably means duplication of equipment. Cap -

ital costs may rise. But today, in many banks,

checks stay within one department, lines of

responsibility are shorter, and, in principle,

service is faster and more responsive. A customer with a question should get a quick answer. Even if the company’s cost structure does

not show improvement, better service should

be good for business and for competitiveness.

Given such examples, it should be no surprise

that little concrete data exists for evaluating

work reorganization and computer integration

in new-model organizations. Certainly, most

companies, when they introduce new forms of

production systems, do so to improve efficiency, defined broadly. But they seldom reveal quantitative information on the success of

these efforts. Indeed, it can be hard for the company itself to tell whether new forms of work

organization have been successful, if only because conventional accounting measures may

fail to capture the full range of benefits. After

all, what is the dollar value of better customer

service or greater flexibility? How can projections into the future capture strategic advantages?

Some generalizations, nonetheless, hold quite

broadly. New-model organizations normally

have somewhat higher fixed costs compared

with old-model systems. Even in the absence

of heavy investments in computers, peripherals,

and software, capital costs typically go up for

the simple reason that many job redesigns entail redundant equipment for parallel product

departments or work groups. New buildings

will cost more to the extent that they provide

more space or need coaxial cabling and light

guides for computer networks and telecommunications links. As table 44 indicates, direct labor costs may go up or down, with substantial

indirect cost savings possible. Training costs

per employee increase when jobs become broader

or more complex, although net expenditures

on training may drop if turnover declines. Reducing or eliminating first-line supervisors cuts

labor costs directly. Shorter, more direct interpersonal communication channels can also

save money.

But costs give only part of the picture. When

MetroBank (app. 8A) reorganized, it accepted

relatively high costs as part of its new strategy.

purchasers who get more responsive service

may order more; new customers may be attracted by word of mouth. The point is a general one: work reorganization can help companies initiate and pursue new business strategies.

There is every reason to believe that, over the

longer term, new-model firms in U.S. service

industries (and in manufacturing) will be able

to gain advantages in both domestic and international competition.
284 ● International Competition in Services

Table 44.—Typical Changes in Cost Structure for New-Model Organizations

Direction of cost shift

Capital costs:

Buildings and equipment Up (smart buildings, more computers)

Transient costs associated with work reorganization:

Start up

Lost time for meetings and

consultations with employees during

the design phase

Consulting and contract services

Direct operating costs:

Direct labor content per unit of output

Pay scales

Quality control, inspection and errorcorrection costs

Indirect operating costs:

Downtime (unplanned idle time)

Lost production during meetings

Training costs per worker

Heating, lighting, other utilities and

services

Maintenance costs

Indirect labor and supervisory costs per

unit of output

May go up or down. Broadening of jobs

and skills tends to increase startup

costs

up

Up, if used

May go up or down

Up or down. Pay-for-skills, bonus, and

gain-sharing tend to raise wage levels,

but many of the companies in the

United States adopting such plans will

probably remain non-union.

Down

Down, especially where more flexible

systems replace old-model organizational

forms such as assembly lines, with their

potential for shutdowns caused by

minor problems.

up

up

Up or down. Employee suggestions may

lead to savings.

Generally up. (More equipment means

more maintenance, although computer

and telecommunications equipment is

growing steadily more reliable.)

Down

Cost categories with both direct and indirect components; intangible costs:

Cost penalties and avoidable mistakes Down

resulting from insufficient employee

involvement in the initial design of

the production system

Costs associated with employee Down

absenteeism and turnover (including

recruitment expenses, training,

overtime, wages for relief and utility

workers)

Added costs associated with operating at Down

part-capacity

Communication costs within the Up or down

organization

Wastage, including theft Down

Grievances Down

Costs associated with minor changes in Down, unless new equipment needed

product design

Customer dissatisfaction Down

Other costs attributable to employee Down

dissatisfaction or low morale

SOURCE Office of Technology Assessment, 1987
Ch. 8—Moving Toward a High-Skill Economy Computer

CONCLUDING

Applications of technology matter for competitiveness in services: they exert direct and

indirect impacts on costs; lead to new strategic opportunities; help ensure consistent and

high-quality output; keep customers satisfied;

enhance the firm’s reputation. Most of the early

uses of computer and communications systems

focused on cost cutting. Today, strategic considerations—seeking to establish new products,

push into new markets, provide better service

to customers—have overtaken cost control as

a managerial priority. Reorganized and more

flexible production systems have become intrinsic elements in the strategies of a growing

number of American service firms. Japanese

companies have turned effective work organization into a potent source of competitive

advantage in manufacturing; they could eventually do so in the services, American service

firms cannot afford to fall behind.

Given the unstable operating environments

that now characterize so many international

industries, greater flexibility-in part through

a labor force with broader and deeper skills (and

in part from greater use of temporary and parttime employees)—can enhance competitiveness. So can technology that helps people use

their skills effectively, New possibilities for the

applications of technology often appear faster

than people can apply them. Managers have

been confused, unsure of how to invest their

firm’s resources, Lower level employees have

been confused, unsure whether or not to welcome the terminal that appears on their desk

one morning. Economists have looked at the

statistics and concluded that much of the

money has been wasted, that new technologies

have been deployed unwisely because productivity growth in the services remains low; they

are confused because their measures fail to capture changes in output characteristics.

This avalanche of technology opens new

avenues for designing production systems that

match the needs of the people using them—

and the needs of customers, By adopting system design criteria that judge technology in

terms of its contributions to the system as a

Applications and Work Organization in the Services • 285

REMARKS

whole, companies can—in principle—achieve

combinations of flexibility and efficiency unheard of when computers were expensive,

Good solutions to the problems of computer utilization in new-model production systems can

cut costs and improve productivity while also

yielding strategic advantages.

New-model production systems will be simultaneousl y more integrated and more flexible,

What does this imply? On a macro level, greater

use of computer networks to link dispersed

operating units, and greater commonalit y 

i n

equipment and in databases—the goal being to

tie product development and marketing more

closely to the production process, On a micro

level, it implies decentralized and semi-autonomous forms of work organization—product departments, end-to-end production channels,

employees with broader and deeper skills, job

rotation.

In theory—practical implementation is another

matter, as the appendix to this chapter shows—

a more integrated system should (perhaps somewhat paradoxically) be able to adapt more readily to new product designs, to shifts in mix or

volume, even to changes in government policies, To do so, the system must effectively integrate people and machines, which, in turn,

means that employees at all levels will need new

skills—reasoning, problem-solving, acting autonomously.

Micro level integration becomes easier with

smaller, cheaper, more friendly computer systems. For instance, fourth-generation languages

mean that end-users with relatively little training can create their own applications programs,

Indeed, fourth-generation software, making

possible fluid and evolving system designs, may

permit firms to move toward organizational

structures, as well as particular applications,

that can evolve over time to meet the needs and

desires of individual employees,

In general, effective integration implies giv -

ing employees at all levels greater responsibility, This may mean giving them a stake in th e

success of the enterprise—and in the securit y
286 ● International Competition in Services

of their own jobs—through gain-sharing, bonus,

or profit-sharing plans. Even among the most

tradition-bound American managers, many

have begun to acknowledge the need for greater

employee involvement as companies move into

high technology and face new competitive

pressures,

Given better computer and communications

systems, and a better educated, better trained,

and more responsible work force, companies

should be able to maintain effective internal

coordination and control, even as management

styles loosen, Why? Because managers seek

tight control in part as a hedge against partial

or faulty information. With an integrated production system, enlightened corporations may

loosen the reins, upper managers lose some of

their fear that the system will go out of control.

Meanwhile, less enlightened companies may

move in the opposite direction, towards more

rigid forms of work organization, Some will

seek to use more and better information to

tighten supervision, losing the benefits of flexibility. Of course, productivity in some industries will continue to depend on close control

over task assignments, and on rigid forms of

work organization: there is little need for flexibility (outside well-defined bounds) in most fastfood outlets, or in a telephone company, And,

although managers may seek to reduce costs

associated with employee absenteeism, turnover, even sabotage, they do not develop new

production systems just to keep people happy,

Particularly in the tertiary services, tensions

between productivity and quality of working

life may change little if at all; managers will

push for efficiency, employees for less stress,

a more tolerable environment. Productivity will

continue to come at the expense of job satisfaction and quality of working life, if only because some kinds of production—in the services and in manufacturing—will continue to

demand routine and repetitive work; flexibility is not always needed,

More broadly, however, continued development of new-model organizations seems likely

to slowly extend the bounds of employee control. The reasons are largely technological, inherent in the design and operation of complex

systems. Distributed computing will be a primary tool for automation and integration.

Highly automated systems may need fewer employees, but these employees will bear heavier

responsibilities. Automated systems cannot be

idiot-proofed; indeed they tend to be more sensitive, less robust than labor-intensive systems.18

One person’s mistake can shut down a highly

integrated system, where in a more labor-intensive organization the consequences would remain localized. If integrated systems are to

function effectively, employees must have considerable freedom of action, and the knowledge

and skills to intervene swiftly and appropriately. In consequence, some of the distinctions

between managers and other employees will

narrow. As ordinary employees take on greater

responsibilities, companies will find it in their

interests to treat and train them more like supervisors and professionals. A high-skill economy will depend on a labor force that can accept authority, use good judgment.

The technology of integrated production systems, then, will break down some of the barriers in hierarchical organizations. In many

cases, the barriers will come down fastest and

farthest within management. Natural enemies

—marketing departments and back offices,

managers on the same level in the hierarchy—

will have to work together, much as production and quality control must be integrated in

new-model manufacturing plants. Particularly

at middle levels, managers will lose power (and

some will lose their jobs). None of this will happen without a struggle. American industry carries a heavy burden: hundreds of thousands of

managers who learned the ways of the 1950s

and 1960s, many if not most of whom will never

feel at home in a new-model system.

la’I’he reasons begin but hard]y end with the elusiveness of software errors, In general, control models themselves can onl~ represent a portion of the system, so that people must bridge the

resulting islands of automation. Furthermore, control models

tend to break down because of contingencies that were o\rerlooked or simply cannot be incorporated into the model. By definition, when the model breaks down the system is out of control and people must take over, Technical constraints inherent

in control models mean that development of large-scale computerintegrated systems will continue to be slow and painful, with

progress depending on trial-and-error arid incremental improvement.
Ch. 8—Moving Toward a High-Skill Economy: Computer Applications and Work Organization in the Services ● 287

In the end, it will be more difficult to trace

power and authority to particular people except at the upper executive levels. The implication: evolving organizations will need new

mechanisms for resolving conflicts among

managers with different goals and priorities

(one of the things Japanese companies are good

at), as well as for resolving conflicts between

labor and management. Where these mechanisms do not develop, competitiveness will suffer. Likewise, where companies rely too heavily on computers, particularly in routine

applications, they may find their work force

slowly losing the core of experience-based

learning that will always be needed, A further

implication: group responsibility will have to

replace individual responsibility, managers will

have to begin thinking of themselves as members of multi-skilled work teams.

What does this mean for Americans in the

labor force, or ready to enter it? In some cases,

it will mean greater stratification within serviceoriented companies. Some highly skilled (and

highly motivated) employees will have relatively

secure jobs, with good pay and prospects for

rapid advancement, Others will have full-time

jobs but limited upward mobility, A third group

may find themselves limited to part-time and

temporary work, serving as buffers against uncertainty and market fluctuations. Credentials

will become more important for securing the

kinds of entry-level positions that lead to onthe-job learning and skill development, More

career ladders will begin with post-high school

education—2-year and community colleges, vocation-technical schools, bachelor’s level programs. High-school graduates—and those who

have not graduated–will have a more difficult

time proving to employers that they deserve a

chance to learn and move upward. On-the-job

learning in the new services maybe just as important as in the older manufacturing industries, but the preponderance of mental and social skills over manual skills will lead employers

to place more emphasis on educational credentials for entry.

Greater flexibility and improved competitiveness will prove a two-edged sword in another

way: some service industries may be able to increase their competitiveness only at the expense

of jobs and job opportunities. In others, output

may grow sufficiently to keep everyone at work,

or to create new jobs. But companies that can

respond quickly and effectively to shifts in exchange rates and world market conditions, the

uncertainties of consumer demand, and changes

in technology itself, will always be well-placed

to prosper in international competition, To

strengthen its long-term competitive capacity,

the United States will have to strengthen its institutional mechanisms for continuing education and training (ch. 10).

Most of this chapter has focused on industries that have invested heavily in computers

and communications, doing so in rather speculative fashion, But jobs in the traditional, tertiary services—including those least likely to

be automated—will continue to depend in various ways on the knowledge-based sectors; a nation that grows more competitive in high-valueadded industries will, all else equal, have higher

living standards and more jobs for everyone,

Because of this, one of the most effective, if indirect, roles for government comes through the

complex of policies that support and encourage

the development of human capital. This implies

not only education and training—traditional

responsibilities of Federal, State, and local

governments—but aid for the adjustments and

transitions involved when people and companies find themselves moving into new and different forms of work organization. The rationale is straightforward: by helping ease and guide

the transition to a knowledge-based economy,

public policies can contribute to maintaining

U.S. employment, to the international competitiveness of U.S. firms, and to the Nation’s standard of living.
288 ● International Competition in Services

APPENDIX 8A: RESTRUCTURING AND WORK

In the late 1970s, MetroBank—a medium-sized

competitor in a large urban/suburban market—

entered a crisis from which it is still recovering.

Burdened with bad international loans, and locked

into long-term deposit certificates at a time of rising interest rates, the company faced a cash flow

squeeze; it was saved only when a consortium of

other banks lent it capital. When the consortium

partners insisted that MetroBank restructure its

operations, the president and executive team were

replaced, many middle managers were fired,

branches, subsidiaries and real estate holdings were

sold, and liabilities (including the deposit base) were

cut in half, A new strategy and new structure meant

new job responsibilities for nearly all the bank’s employees.

New Products, Changing Jobs

Two years into its reorganization, MetroBank

faced the question of formulating a strategy suited

to its altered circumstances. Recent history showed

it could no longer be a national player, while suggesting a focus on the regional market. Although

many commercial clients had withdrawn their accounts when the bank was threatened, the retail

base remained loyal. Household customers identified with Metro Bank, a local mainstay for decades.

To build on this base in a period of deregulation—

with ongoing competitive threats from other financial service firms, including entrants from outside the banking industry —MetroBank sought to

broaden its range of products and to stress personalized service. This high-value-added niche strategy

encompassed three main elements:

1. development of 14 new banking products (e.g.,

credit cards, Keogh and individual retirement

accounts, money market accounts, moneysaver checking accounts, car leasing), thus

offering consumers a portfolio of services;

2. an active selling program at the branch level

intended to increase the number of accounts

and products per household; and

3. decentralization of responsibility for commercial lending to smaller businesses from the

main office to the branches.

Together, these three steps were meant to stabilize

the deposit base by increasing customer reliance

19This appendix is based on a case study prepared for OTA

by L. Hirschhorn, Wharton Center for Applied Research, under

contract No. 533-597o. The name of the bank and some details

have been changed.

on

REORGANIZATION AT METROBANK19

the bank, and to focus lending within MetroBank’s market. Senior managers hoped to develop

“relationship” banking at the branch level by

strengthening ties with neighborhood businesses.

At this time, MetroBank operated about a hundred

branches, and employed 2,000 people.

With the new strategy in place, MetroBank’s employees describe their jobs differently. Branch personnel, including managers, refer to a shift from

operations to sales, from administration to planning, from order taking to selling. As one branch

manager put it, “Before . . . all you had to do was

to see if there were enough supplies, if procedures

were followed, and get the paperwork done. You

wanted to get people in and out the door. Now . , ,

we’re in the retail business. ”

Employee roles changed, particularly for customer service representatives, branch managers,

and area managers:

Customer Service Representatives. Prior to the

crisis, the CSRs (or platform workers, as many

employees call them) helped customers balance

their check books and open new accounts, They

were a cut above secretaries. But MetroBank’s

senior managers believed that the CSRs had to

become the backbone of the selling effort in

each branch, They were to “cross-sell” products—to convince customers coming in for help

to buy other products and services. MetroBank’s management created a budget for retraining the platform workers, and instituted

a measurement system to assess their sales performance.

Branch Managers, In the past, branch managers were primarily administrators, evaluated

largely on their ability to control costs. Since

the restructuring, they have been asked to generate loans, particularly among businesses with

revenues of less than $10 million. Many of the

branch managers, lacking prior lending experience, have enrolled in the bank’s ongoing credit

and lending courses. In addition, branch managers must coach and supervise sales efforts

by the platform workers.

Area Managers. This is a new position, the least

defined of the three. Each area manager oversees a group of branches, helping with planning, marketing, and budgeting.

As this summary suggests, MetroBank’s restructuring will, if successful, upgrade the jobs and skills

of many employees in its 100-some branches, CSRs

will sell rather than simply respond to inquiries,

branch managers develop loans on the outside as
Ch. 8—Moving Toward a High-Skill Economy: Computer Applications and Work Organization in the Services ● 289

well as administer operations on the inside, Employees will have to cope with greater levels of uncertainty as the bank tries to actively shape its markets, rather than taking them as givens.

The Transition

Developing new skills and managing the shifting

relationships between main office and branches has

meant a series of adjustments, many of them less

than smooth.

New Skills

The transition has been a difficult one for the hundreds of platform workers expected to do the bulk

of the selling and cross-selling of new products that

range from credit cards to second mortgages for

financing a child’s education. MetroBank purchased two off-the-shelf training courses from a vendor; all CSRs took the course dealing with selling

skills, plus a shortened version of a course on financial counseling. The courses proved no more

than marginally effective.

The platform workers face three sets of difficulties: taking authority; managing uncertainty; and

planning their time. Two studies by consulting firms

indicated that CSRs feel out of place selling the

bank’s products and services. A shopper’s study (in

which pseudo-customers came in with unstructured

requests) found that platform workers could explain

bank products effectively, but frequently failed to

close the sale. Interviews with the platform workers showed that most still see their work as customer

service-e.g., explaining bank statements—not sales.

Almost all complained that they did not have time

to cross-sell; moreover, they tended to see management pressure for greater selling effort as simply

asking for more work. Striking disparities characterize the language of senior managers, who speak

of culture change, and the words of CSRs, describing what to them seems a “speed-up. ” Earlier, most

of the platform workers (and other line employees]

functioned primarily like clerks and secretaries.

While their resistance reflects some of the classic

tensions between managers and workers, it also reflects the difficulty of instituting major changes in

the everyday responsibility of a relatively large

group of employees.

Eventually, the question of career prospects and

ambitions may prove central. Metro Bank has cut

its costs in part by using more part-time tellers and

a ‘‘tight platform in many branches. The company

has continued to view its line workers as expenses

rather than assets, while at the same time wanting

them to take on more responsibility. Interviews

show that few CSRs identify with the bank as a

whole. Many like to work close to home. They are

not only reluctant to take on authority and to sell,

they don’t want a career that would take them to

other branches, One said, “If I wanted to go up, I

would have been out of this branch a long time

ago. . . . All I want is my 10 years and to vest my

pension. ” Interviews also indicate that many CSRs

still think of themselves in secretarial terms, raising the question of whether MetroBank is recruiting the right kinds of people. The desire to control

costs leads to hiring of platform workers in the labor market for secretaries and clericals. Yet the image held by managers suggests someone who wants

authority and opportunities to rise in the bank.

Technology

Some staff and managers at MetroBank believe

that improvements to the computer network used

by the platform workers will help. The redesign of

the system will proceed in three stages. At first,

CSRs will be able to call up information but not enter data. In the second stage, they will be able to

change files on-line. Eventually, they will be able

to produce final documents ready for customer signature. Experience at other banks suggests that this

will help give employees a new perspective on their

jobs. Platform workers will have full and complete

data on the customer and on all the bank’s products. They will no longer need to call the main office for information. In addition, they will be able

to walk customers through various “what-if” demonstrations (e. g., the pay-out on an IRA] as a selling

aid. Eventually, their terminals will be able to display taped presentations on the bank’s products. As

the terminal becomes an information utility, the

platform workers may come to accept that they are

in positions of real responsibility and authority.

Thus far, redesign of the computer network has

not gone smoothly. Branch and division managers

have had trouble working with the systems division.

Systems engineers have shown little knowledge of,

and little interest in, the development of user-

-friendly software—nor have they made any effort

to learn from the platform workers, or get feedback

from them, Most strikingly, the systems division has

failed to provide training, despite repeated requests

and protests from MetroBank’s line managers.

Managing Uncertainty and Planning Time

Previously, the CSRs simply helped customers as

they entered the branch, Platform workers did not
290 ● International Competition in Services

have to plan who they would see, when and why,

for how long. Now, they have been asked to develop

a sense of priorities — to gage the value of time spent

with each customer, and the value of time spent on

service as opposed to sales. As one branch manager

put it, “In an 8-hour day, you can’t wait on one customer for an hour. I tell my people to develop each

customer to the maximum. They should also try to

get their operations work done outside of contact

hours, ” Some platform workers complain that they

have too much paperwork, and cannot do the telephone selling expected of them after the branch

closes in the afternoon.

The CSRs must also learn to live with uncertainty.

The outcome of a sales encounter may not be apparent for weeks; success can only be measured by

averages. Psychologically, this means that the platform workers must learn to live with failures by betting on future successes. Earlier, the platform workers could get a sense of accomplishment simply

through helping customers as they entered the

branch.

Relationships Between Branches and the Main Office

This aspect of the transition has two dimensions:

working relationships between superiors and subordinates (which changed with the decentralization

of lending responsibility); and relationships between line and staff. Before restructuring, branches

were viewed as little more than mail drops for the

main office’s lending business. MetroBank’s new

strategy calls for branch managers to spend half

their time calling on potential loan customers. To

help them develop lending and selling skills, the

branch managers were given credit and salesmanship courses. Senior executives also wanted to shift

their managers’ attention from expenses to profits,

from absolute deposit levels to market share. As one

area manager said “I tell my branch managers, ‘You

are a profit center. ’ We are not telling them, ‘You

must ring zoo door bells . . ,’ we are saying, ‘tell us

what you did, what you achieved. ’ “

Thus the rules have changed just as much for

lower level managers as for the platform workers

they supervise. One branch manager said, “. , . in

commercial lending, you walk out the door not

knowing if you have accomplished anything.” At

the same time, branch managers must now coach

their own subordinates, rather than simply monitoring their performance. Formerly, the CSRs and

other branch employees had little discretion; they

simply followed standard procedures. Now, the supervisors face a more difficult job: helping CSRs

learn to sell, and to use the new computer system.

Interviews indicate that few branch managers, as

yet, have mastered the coaching process. Indeed,

one noted that he needed supervision from his area

manager: “We need someone to take a look at individual management styles, how you’re doing compared to the norms. Not necessarily someone to look

over your shoulder, but someone to go out on a sales

call, and sit in on a staff meeting. ”

Planning is also new for the branch managers.

MetroBank’s marketing department regularly asks

each manager to assess his branch’s performance,

evaluate its strengths and weaknesses, and prepare

a business plan. The head of the market planning

unit has expressed considerable disappointment

with this exercise, reporting that the branch

managers were not very self-critical, argued that

they had no real control, and were insensitive to

market share as a measure of success. The marketing department has since taken over preparation

of business plans for the branches.

The Area Managers

The most striking characteristic of an area

manager’s job is its poor definition, In principle,

area managers are in charge of marketing for a

group of 5 to 10 branches. Yet they have no marketing budgets, One said, “I need permission to spend

$2,000 for a party at a senior citizens home. ” Nor

do area managers systematically review the performance of branches.

The poorly defined role of area managers may

suggest that MetroBank has focused too heavily on

the lower levels, placing most of the burden of

change on those in the branches. Upper management may be “leading from behind, ” reluctant to

cede real power to those lower in the hierarchy even

though this is necessary for decentralization to

work. whenever top managers delegate authority,

they face loss of control, MetroBank’s senior executives may have felt more comfortable delegating to

those at the bottom—whose authority will in any

case be limited to a single branch—rather than to

the area managers.

Such possibilities highlight what MetroBank executives call the problem of “creating a new culture. ” Those at all levels speak of the old culture

as a bureaucratic one. They know that success in

the future depends on becoming less bureaucratic,

which means authorizing people to act with more

independence. But the older culture, and its norms,

persists. while wanting the platform workers to take

more initiative, some managers think they’re lazy,

Meanwhile, ample evidence exists that platform

workers lack the support (e. g., coaching, computer

training) needed to be effective in their new roles.
Ch. 8—Moving Toward a High-Ski/l Economy: Computer Applications and Work Organization in the Services ● 291

Customers

In many high-value-added industries, products

are tailored to fit the client’s needs; the customer

has an intrinsic role in the production process, in

effect co-producing the service. This leads MetroBank’s senior managers to speak of relationship

banking, while for the platform workers it means

educating the customer. In interviews, many CSRs

reflected on customer confusion over the features

and benefits of IRAs and other new products: “. . . a

lot of people don’t know anything about money market accounts ., . people are afraid to use overdraft

protection , , . customers can’t see that if they pay

off on their credit cards in time there is no finance

charge .

In fact, marketing experiments suggest that many

of Metro Bank’s customers are quite conservative.

Few have responded to offers such as free checking and free travelers checks as part of packages

including other products. Some of MetroBank’s

product development efforts have failed for reasons

that executives attribute to customer confusion.

Regardless of the reasons for such failures, they

highlight the need for firms in high-value-added industries to develop a good grasp of customer desires

and motivations. In pursuing its high-value-added

strategy, MetroBank has become dependent on how

its consumers see the world, on what they want.

Summary

For MetroBank’s strategy to succeed, its employees, including managers, will need new skills and

attitudes. At the most general level, this means

learning to live with uncertainty. For the bank as

a whole, the marketplace is less predictable because

of deregulation. For individual employees, uncertainty (and anxiety] comes with the need to sell new

retail products and bring in loan business. By giving the platform workers more immediate access

to information, and by increasing their apparent

competence in the eyes of customers, the redesigned

computer system may help resolve some of the tensions. But several years after restructuring, MetroBank cannot yet feel confident in its new strategy.
Chapter 9

Foreign Government Policies
. 

Page

Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 . . . . . . . . . . ................295

Government Policies Toward the Services . ............................296

Trade Policies and Domestic Policies . . . . . . . . . . . .....................296

Barriers to Trade and Investment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ....296

GATT and the U.S. Services Initiative . ...............................298

How Nations Think About the Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .301

Development Strategies ... . . . . . . . . . . . . . . *.** 302

High Technology and the Promotion of Innovation . . . . . . ..............303

R&D Supports and Subsidies ....... 306

Other Policies Relevant to the Services.. . .............................311

Public Procurement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .............311

Regulatory Policies ....... .. 312

Standards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ......................315

Intellectual Property Protection . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .318

International Negotiations . . . . . . . . . . . . . . . . . . . . ........ 321

GATT and the Uruguay Round; Other Forums . ..... 322

Toward a Better Linkage of Foreign and Domestic Policy . .............322

Concluding Remarks. . . . . . . . . . . . . . . . . . .... .. .. ... ...323

Boxes

Box Page

CC. Where Do Agreements on Foreign Investment Fit?. . ................299

DD. Transborder Data Flows and Related International

Telecommunications Issues . . . . . . . . . . ............................304

EE. ESPRIT and Alvey: Two European Technology Development

Programs ... .. . 307

FF. How Much Does the United States Spend on Services R&D? . ........308

GG. Protecting Intellectual Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ..319

Tables

Table No. Page

45. Policies Affecting the Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. ....296

46. Technology Policy in Five Industrial Countries . . . . . . . ...............305

47. U.S. Government Figures on Industrial R&D Spending .. .. ... ... ... ..309

48. Estimated 1987 R&D Spending by U.S. Service and

Goods-Producing Sectors . . . . . . . . . . ...............................309

49. Projects Related to Information Technology Supported by Japan’s

Ministry of International Trade and Industry . ......................310

50. Examples of Regulatory Barriers Affecting Services

Trade and Investment ...... ● . 312

51. National Treatment in Financial Services. . .........................314

52. Telecommunications Regulations Compared . .......................314

53. Standards and Licensing Requirements That Conserve

as Nontariff Barriers. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ....315

54. Examples of Issues and Forums Relevant to the Services . ............323
Chapter 9

Foreign Government Policies

SUMMARY

Since the November 1982 Ministerial Meeting of the General Agreement on Tariffs and

Trade (GATT), the United States has pressed

for multilateral negotiations aimed at liberalizing services trade. As discussions continued,

the prospective agenda broadened: services became the centerpiece of a group of “new issues”

including foreign investment, trade in hightechnology goods, intellectual property protection and anti-counterfeiting measures, and restrictions on transborder data flows. For a time,

the U.S. proposals led some people to refer to

the planned talks as a services round. Eventually the scope expanded still further, as the

United States and other countries sought discussions on issues well-removed from services

—e.g., agricultural trade, The preparatory process initiated at the 1982 Ministerial culminated

4 years later in agreement to begin the Uruguay

Round, during which GATT members will discuss services for the first time. The 4-year schedule for the new round is an ambitious one; given

the pace in such organizations, and the difficulties to be expected, inclusion of services within

GATT codes before the middle to late 1990s

would be surprising.1

This chapter outlines government policies in

major trading nations and developing countries

in the context of the Uruguay Round. The focus is on policies toward the services as a group,

to the extent that such policies exist. In fact,

few governments have had active policies toward the services sides of their economies,

IOn the C, ATT, see U.S. Industrial Competitiveness: A Comparison of Steei, Electronics, and Automobiles (Washington, DC:

Office of Technology .%ssessment, July 1981), pp. 185-186. On

the preceding Tokyo Round, U.S. trade law as it relates to merchandise, and U.S. trade policy in general, see International Competitiveness in Hectronics (Washington, DC: Office of Technology Assessment, November 1983), ch. 11, especially pp. 430-438.

For a discussion of national and international regulations covering trade in services, see R.K. Shelp, l?e~~ond industrialization:

Ascendancy of the G)obal Ser~rice l?conom~ (New York: Praeger, 1981), chs. 5-7.

preparations for the new round were dogged

by controversy in part because few governments grasped what was at stake, and what they

might have to gain. Resistance came at first

from other industrialized countries, as well as

the more industrialized developing countries—

notably Brazil and India.

By the middle of 1986, the rest of the industrialized world had lined up behind the U.S.

position—which itself had shifted to de-emphasize services somewhat. But opposition by a

group of about 10 developing countries remained firm, and has become, in effect, the

beginning of their negotiating strategy. Opposition—which extends not only to services, but

to the new issues generally—has been rooted

in part in the economic development strategies

pursued by these countries. Baldly stated, parts

of the developing world also believe that anything the United States wants is likely to be bad

for them. This chapter seeks to explain the opposition, while also reviewing policies in other

countries that affect trade and competition in

the services; among other purposes, such a review may suggest lessons for the United States

—both policy approaches the Federal Government might emulate, and those it should avoid.

Several of the other new issues straddle the

boundary between goods and services; the

chapter treats them mostly as they relate to services trade, Investment restrictions, for example, have particular relevance because a foreign presence is needed for producing so many

service products; the Uruguay Round participants will take up trade-related investment—

meaning, most directly, performance requirements that set conditions (such as exporting

some production) for direct investment. When

it comes to trade in high technology, most of

the questions revolve around subsidies and

other aspects of national industrial policies.

These touch particularly on the complex of

295
296 ● International Competition in Services

services associated with information processing, as do transborder data flow (TBDF) restrictions—which could also affect services like

banking that depend heavily on international

telecommunications. Intellectual property protection is particularly important for software

and information services.

The Uruguay Round promises to be the most

complex since the founding of GATT in 1947.

The reasons begin with the loss of U.S. economic hegemony, which makes these talks

more nearly a negotiation among equals than

at any time in the past. Reaching agreements

on services will be especially difficult because

many service industries have traditionally been

regulated by governments for domestic reasons

(protection of consumers and investors in the

case of banking and insurance) or operated as

public monopolies (telecommunications). For

governments wishing to protect their service

industries, regulatory policies have provided

convenient barriers to trade and investment.

And lacking clean distinctions between trade

policies and domestic policies, governments

will, quite naturally, resist what they regard as

interference in their domestic affairs.

GOVERNMENT POLICIES TOWARD THE SERVICES

Trade Policies and Domestic Policies

Table 45 distinguishes broadly between trade

policies and policies that are primarily domestic but have implications for trade. The middle

ground includes government organization, collection and analysis of statistical data, and taxation. (App. 10A, at the end of the next chapter, gives examples of the ways U.S. tax policy

can affect competitiveness.) Many policies,

regardless of category, affect competitiveness

indirectly —i. e., by conditioning corporate decisions. The range of these indirect impacts extends to expectations of future policies; if

managers think Congress may pass a tax bill

this year, that expectation will influence their

capital investment choices. Some of the policies

listed in table 45—e.g., foreign investment controls—have been unimportant in the United

States, though familiar tools elsewhere.

Of course domestic policies affect trade,

while trade policies serve domestic purposes.

The United States deregulated its telecommunications industry for domestic reasons, but this

shift in policy has had widespread international

ramifications. At the same time, governments

may design regulatory policies to act as nontariff barriers (NTBs), particularly in industries

like banking and insurance where it is easy to

tilt the rules to give domestic firms an advantage. Table 45 simply imposes a nominal ordering on policies with possible impacts on

trade and competition in the services.

Barriers to Trade and Investment

Any policy that discriminates against foreign

suppliers except a simple tax on incoming goods

or services constitutes a non-tariff barrier.

When the French required all imported videoTable 45.—Policies Affecting the Services

Nominally domestic but with

Primarily trade-related Both trade and domestic imports impacts on trade

Nontariff trade barriers (NTBs) Taxation (differential rates across Technology policy (including R&D

Foreign investment controls sectors, R&D tax credits, etc.) supports and subsidies, and

Export credits and subsidies (e.g., Data collection and analysis technical standards)

tied development aid) Government organization Investment grants and subsidies

Export promotion Procurement

Export restrictions Labor market and human resources

policies

Domestic regulation (including

antitrust and competition policy)

Intellectual property protection

SOURCE Off Ice of Technology Assessment. 1987

--
Ch. 9—Foreign Government Policies ● 297

cassette recorders to enter through Poitiers,

where they overwhelmed the small port-ofentry staff and backed up by the truck-load,

France was imposing an NTB. An equally wellpublicized example: Japan’s use of product

standards to keep out American-made baseball

bats. Foreigners have said that U.S. product

liability laws amount to NTBs. Some Americans make the same claim for Japan’s vast and

fragmented retail distribution system; the country has many more—but smaller—retail outlets

per capita than Europe or the United States,

with more layers of distribution to supply

them. z Other NTBs include formal and informal quotas, implicit and explicit subsidies for

domestic producers, and discriminatory government procurement practices (buy national

requirements).

Given the nature of production in the services, most trade barriers will be non-tariff in

nature (ch. 2). (The exceptions consist of service products with at least some of the characteristics of goods—e.g., computer software—

so that shipments can be monitored at borders

and duties assessed.) NTBs pose knotty problems for negotiators. Quotas and direct subsidies are visible, but other policies may be NTBs

only in the eye of the beholder. Moreover, when

it comes to implicit subsidies, or regulatory policies that treat, say, foreign banks differently

from domestic banks, the impacts on trade may

be uncertain. This makes it more difficult for

governments to negotiate matching concessions.

Trading tariff cuts on wheat for those on computer chips may be straightforward compared

with reaching agreements on banking regulations that treat domestic and foreign firms in

ways agreed to be fair.

No matter how an NTB functions, the usual

result is the same as for a tariff—restricted supply, higher prices. Of course, that is the purpose: governments impose import quotas to

raise price levels, increasing the revenues of

z“I’he typlca 1 7-E 1 e~en store III j apa n is half the size of one i n

the [Jn iterf States—S. Chira, “(convenience Stores Are Thriving

in Japan, NeLt’ }’ork Times, Dec. 24, 1984, p. 33, L\rhile 7- Ele\’en,

like many tVestern companies, has learned t{) accommodate itself to t hc Jiipa new m;i rket, others ha~’e heen unahlr to find thel r

Ltajr th r{)u~h th[! maze of distribution [,ha nnel~.

domestic producers. The U.S. Government has,

at various times, restricted imports of steel so

that American steelmaker could raise their

prices, supposedly generating profits to be put

toward modernization and renewed competitiveness. Subsidies or procurement preferences

for domestic suppliers have the same objective:

financial support through greater cash flow or

higher profits.

Keeping in mind that many NTBs in the services have possible rationales in terms of domestic regulations, they can be classified into three

types: 3

1. purely protectionist NTBs, more or less

openly designed to shelter domestic companies from foreign competition;

2. quasi-NTBs, most commonly regulations

with some justification in terms of domestic policies but which may also have been

tailored to protect a domestic industry;

3. accidental NTBs, instituted for bona fide

domestic purposes but restricting, perhaps

inadvertently, trade or investment.

If pure NTBs are transparent and clearly protectionist, quasi-NTBs come with a built-in

excuse—while accidental NTBs, in effect, are

honest quasi-NTBs with protective side-effects.

The maze of banking regulations in the United

States, for example—many under the control

of the States—includes some provisions that

give U.S. banks advantages over foreign-owned

institutions and other provisions that place U.S.

banks at a disadvantage. And if a domestic industry is regulated for bona fide reasons, while

foreign firms might be able to evade these regulations, then pre-conditions on entry may be

quite legitimate, serving to equalize competition and avoid disruption of the industry. Insurance provides a typical case. Governments

normally require insurance companies to maintain reserves of capital sufficient to cover possible claims. If the host country insists that capital reserves be held inside its borders, and if

the reserve requirements are high, foreign car-
298 ● International Competition in Services

riers may decline to enter the market. Such a

policy effectively insulates domestic firms. In

some countries, capital requirements imposed

on insurance firms fall into the quasi-NTB category, while in others they are closer to accidental NTBs.4 A later section of the chapter

4

See B. Hindley, “Economic Analysis and Insurance Policy

in the Third World, ” Thames Essays No. 32, Trade Policy Research Centre, London, 1982. In assessing the benefits of greater

international competition in insurance, Hindley acknowledges

the need for regulations to protect policyholders. He argues that

discusses regulatory NTBs in banking and telecommunications in more detail.

foreign firms should be allowed into local markets, perhaps with

special safeguards: as they import their own knowledge and expertise (i.e., technology), thereby exerting competitive pressures

on local firms, the latter will be forced to become more efficient.

In essence, Hindley advocates conditional admittance to developing economies for multinational firms, coupled with national

treatment once they have been admitted, (National treatment

implies the same rules for all firms doing business within the

country, irrespective of ownership.) Any discrimination would

then attach to the conditions of entry.

GATT AND THE U.S. SERVICES INITIATIVE

The 1982 GATT Ministerial produced only

an agreement that member countries would

voluntarily prepare national studies of their

service industries; although the United States

had hoped for a decision that services would

be part of the next trade round, none was

reached. Nevertheless, the process of carrying

out the national studies helped move the process along, in part because most of the industrialized countries found that they had greater

strengths in the services than they had realized.

The U.S. study, the first to appear (at the end

of 1983), laid out this country’s position:5

●

●

●

●

the principle of national treatment should

govern services trade;

negotiators should seek greater transparency

in regulations and trade barriers;

GATT members should offer opportunities

for comment on proposed laws or rules

affecting services trade; and

the talks should include mechanisms for

settling disputes.

National treatment implies the right of foreign

firms to market access sufficient for them to

do business. If they are legally required to establish offices or local production facilities—e.g.,

6“U. S. National Study on Trade in Services, ” A Submission

by the United States Government to the General Agreement on

Tariffs and Trade, Prepared Under the Direction of The Office

of the United States Trade Representative, Washington, DC, December 1983.

to sell insurance—then national treatment is

equivalent to right of establishment. More

broadly, national treatment means treating foreign and domestic firms alike. The principal

of transparency means that rules should be explicit. As a first step, parties to the multilateral

trade negotiations (MTN) might make known

policies and practices that regulate or limit access to their markets, creating a basis for negotiations aimed at reducing barriers and otherwise liberalizing trade and investment. Finally,

the United States argued that, to function effectively, GATT codes covering services would

have to be accompanied by agreement on procedures for resolving disputes. These principals

have remained central to the umbrella agreement that the United States seeks. Box CC discusses the special problems of barriers to foreign investment—unavoidable given that it

takes a local presence to supply many services.

By the end of 1983, both Japan and the European Community (EC) had become more receptive to discussion of services in GATT. The remaining opposition centered in a group of

industrializing countries. In the fall of 1985, a

year later than originally scheduled, another

GATT Ministerial Meeting reconsidered the

services issue in light of the national studies.

At this meeting, Brazil, Yugoslavia, Argentina,

and India led a coalition of developing countries opposed to including services—and especially banking, insurance, and the high-tech-
Ch. 9—Foreign Government Policies ● 299

Box CC.—Where Do Agreements on Foreign Investment Fit?

No set of international agreements covers direct investment, although a start was made during

the Tokyo MTN Round, completed in 1979. Since its inception in 1947, negotiations and agreements

within GATT have centered on trade in tangible goods. At first, the goal was reduced tariff levels.

During the Tokyo Round—the seventh held under GATT auspices—attention shifted to NTBs, primarily as they affect merchandise trade. In general, the codes negotiated in the Tokyo Round were

weakly worded; none have been signed by a majority of the 92 GATT members. * Only the subsidies

code touched on investment issues, in a context of state aid for capital investment.

Agreements within the Organization for Economic Cooperation and Development (OECD) do cover

direct investment. The 24 OECD members include the primary exporters of services-the United States,

Japan, the major Western European economies (ch. 2)–but not the less developed countries (LDCs),

which tend to be net importers of services. Many of the LDCs have strongly held reasons for seeking

to regulate or restrict foreign direct investment (FDI).

Depending on their objectives, governments may limit FDI to protect domestic industries, permit

inward investment (while perhaps setting minimum employment levels, or requiring that some of

the resulting output be exported), or offer incentives to attract foreign firms. The possibilities are

not mutually exclusive; over the past two decades, LDC governments have become more sophisticated and more aggressive in bargaining with multinationals on such questions (ch. 6). Sometimes

they offer investment incentives to steer resources to favored sectors—low interest loans or tax holidays, below-market leases on buildings or land, manpower training grants that reduce operating costs

for the foreign firm. Government agencies may provide assistance in site preparation, build roads

and ports, offer preferential access to foreign exchange, or protect the market to be served through

tariffs or NTBs. Such policies are common throughout the world, not excluding developed countries

and many States within the United States.

Sometimes a country may wish to encourage firms that will compete with importers; sometimes,

export-oriented industries will be preferred. Many governments combine selective investment incentives with performance requirements that constrain the actions of foreign investors in a manner consistent with the country’s desires. For example, a multinational corporation (MNC) might be forced

to accept a joint venture with a local firm, perhaps in a minority position, as a condition for entry.

Or the foreign investor might be directed to purchase from domestic suppliers—e.g., through local

content rules. Numerous variations on such schemes are possible, limited mostly by the imaginations

of government officials.

Because delivery of many services requires a foreign presence, negotiations on investment become a natural complement if not a necessary part of negotiations on services trade. But with governments in both LDCs and newly industrializing countries (NICs) viewing investment controls as an

integral part of development strategy, negotiations will be contentious. Planning for the Uruguay

Round has focused on investment controls as they affect trade flows-i. e., requirements for exporting

some of the production resulting from the investment. Given this, the United States may well choose

to pursue broader investment agreements in parallel forums (e.g., the OECD) and bilaterally.

*More GATT members, 35, subscribed to the standards code than to any other. The subsidies codes attracted 34 signatories, while 21 have

signed the procurement code. Some counties have accepted codes but not yet formally signed. See R.M. Stern, J.H. Jackson, and B.M. Hoekman,

“An Assessment of the Implementation and Operation of the Tokyo Round Codes,” University of Michigan, 1988, p. 123. The subsidies and

government procurement codes were drafted to cover services as well as goods.

On the effectualness of GATT, see G. Putka, “GATT Knows Who The Trade Sinners Are, But It Doesn't Matter,” Wall Street Journal, Jan.

2, 1985, p. 1; also J. Hein, “What Will the GATT Beget?” Across The Board, September 1985, p. 29.
300 • International Competition in Services

nology information-intensive services—in the

new round.6

Developing countries were particularly concerned that they would be asked to make concessions on imports of services, even though

the United States, the EC, and other advanced

countries had erected new barriers against their

goods, sometimes in violation of earlier agreements. Among these barriers, the opponents

cited the increasingly restrictive Multi-Fiber Arrangement, voluntary restraints on shipments

of steel, and more vigorous enforcement of

anti-dumping and countervailing duty laws.

The LDCs and NICs argued that these new barriers should be rolled back before another MTN

round began. They also wanted assurances that

services liberalization would not disrupt domestic banking sectors and fledgling high-technology markets, Pointing to the absence of existing

GATT jurisdiction over services, the opponents

tried to switch discussion to forums they regarded as more favorable to their interests—

e.g., the United Nations Council on Trade and

Development (UNCTAD) or the United Nations

Industrial Development Organization (UNIDO).

As a group, the industrial countries responded

that they needed to expand their exports of

services if they were to accept a continuing flow

of goods from the developing world. But not

all the industrial countries were unhappy with

the opposition. A number had managed to

establish and maintain a strong foreign presence in services such as banking and construction despite NTBs intended to keep them out.

Those that had jumped the barriers—the French

in Francophone Africa, the British in their

former colonies in Africa, the Japanese in

8A group of lo—also including Cuba, Egypt, Nicaragua, Nigeria, Peru, and Tanzania—consistently opposed GATT negotiations on services. See W. Dullforce, “Compromise Boosts Chances

for New Gatt Round,” Financial Times, July 21, 1986, p. 2. The

EC did not formally endorse services trade negotiations until

March 1985. Japan was quicker to support the new round, no

doubt hoping to deflect attention from its continuing bilateral

trade surpluses.

Southeast Asia—now had a stake in preserving these barriers to exclude other competitors.

Still, the primary resistance came from the

developing countries. These, in the end, had

little option but to come to the table.7 By late

1985, the members of GATT had agreed to start

a new MTN round in September 1986. At the

September meeting in Punta del Este, Uruguay,

GATT members hammered out a declaration

on the new round. Although the United States

got much of what it wanted in the September

1986 declaration, negotiations on services will

proceed on a separate track from those on

goods—a concession to the countries that remain opposed to discussing services.8 The negotiating group on services will report to the

same overall committee as that on goods. When

the two sets of deliberations have been completed, a special session of the parties to GATT

will be held “regarding implementation of the

respective results. ” The talks on services may

also move on to sector-specific matters.

Why did it take 4 years of sometimes acrimonious debate to reach this point? Largely

because the various countries defined their interests differently, with prior choice of development strategy perhaps the single most important factor.

7As continuing opposition—spearheaded by Brazil and India—

led to a more confrontation} tone on the American side, U.S.

Trade Representative Clayton Yeutter was quoted as saying, “We

simply can’t afford to have a handful of countries, responsible

for 5 percent of world trade, dictate the destiny of a large number of countries who deal with 95 percent of that trade.” See

S. Auerbach, “Yeutter Hits Blockers of Trade Talks, ” Washington Post, Nov. 15, 1985, p. El, Ten months later, the United States

was still threatening to walk out of the trade talks if other countries did not agree to its proposals—S.J. Paltrow, “Trade Aides

Fail To Narrow Differences Prior to the New Round of GATT

Talks, ” Wall Street Journal, Sept. 8, 1986, p. 30. As part of their

counterattack, U.S. officials began to suggest that it might prove

difficult to renew the Generalized System of Preferences if the

LDCS and NICS continued to block the new round.

oFor the text of the declaration, see “Ministerial Declaration

on the Uruguay Round, ” attachment to “Testimony on the Results of the GATT Ministerial, ” Ambassador Clayton Yeutter,

United States Trade Representative, before the Subcommittee

on Trade, Committee on Ways and Means, U.S. House of Representatives, Sept. 25, 1986.
HOW NATIONS THINK

At some risk of caricature, the ongoing debate concerning the role and importance of

services can be summarized in terms of two

extreme views. The first—call it the post-industrial view—holds that services are displacing

the primary (agriculture/mining) and secondary (manufacturing) sectors in all the Western

economies. Not only are service firms creating most of the new jobs and wealth, but this

must be counted a good thing because jobs in

the primary and secondary sectors are hard,

dirty, and dangerous, while service work tends

to be pleasant and to pay well (at least in the

professions). People of this persuasion see no

cause for concern in relative or absolute expansion of the services. In fact, they see this expansion as a welcome development, part of the

transition from old industrial societies to a new

and better post-industrial future.9

Those holding the opposing view—deindustrialization—believe that the developed economies rest on a foundation of manufacturing.

Expanding textile, steel, and automobile production created wealth and employment in the

past, and high-technology goods will be the basis of new wealth and employment in years to

come. Adam Smith, who held the services to

be parasitical, was right: the growth of the services signifies weakness, an eroding industrial

base. Evidence for this proposition includes the

continuing high proportion of manufacturing

in Japan’s rapidly expanding economy. Proponents of the deindustrialization thesis point

to the long-lasting distress created by layoffs

and plant closings in societies that failed to protect their manufacturing base—Britain being

the preeminent example. There, many firms in

declining, traditional sectors have closed or

contracted, unemployment remains high, foreign manufacturers continue to win larger

shares of the market, while most of the new jobs

lie in low-wage, tertiary services.

‘Perhaps need less t{) say, Dan iel Bell pioneered this first pcr-

~pe(:tive in 7’he Corning of Post-lndustrjai Societ.I’ (New York:

f3asic Books, 1973). The best-known statement of the second ~riew,

below, IS [J, Bll]e5tone and B. Harrison, ‘I’he [)e-lr]fir~.striafizatic)n

c)f .~merj[::i (New }rork: Basic 1300ks, 198’2].

Ch. 9—Foreign Government Policies ● 301

ABOUT THE SERVICES

The post-industrial and deindustrializati on

theses cannot both be true. But both could prove

false, at least in their oversimplified forms.

OTA’s analysis, which stresses the ties between

services and manufacturing—particularly in the

cluster of industries that share a strong dependence on information technologies—suggests

alternative paths. Computer and communications technologies help firms cut costs and pursue new competitive strategies, as discussed

in chapter 8. In so doing, they accelerate processes of economic growth and structural change,

They also accelerate the need for adjustment.

For the United States, then, the question is not

so much a matter of post-industrialization or

deindustrialization; the questions become:

What set of internationally competitive industries will emerge once the U.S. economy has

passed what Piore and Sabel call an industrial

divide? 10 What rates of growth in national income, living standards, and employment will

accompany the transition from one dominant

mode of doing business to another?

No one knows what the new industrial structure will look like, in the United States or elsewhere, but economic actors must make assumptions and place their bets. Certainly in Japan,

the officials who staff agencies like the Ministry of International Trade and Industry (MITI)

share a vision of the future in which information-based technologies will have great strategic significance, and knowledge-intensive services will account for a large share of Japan’s

gross national product. Most of the members

of the EC have likewise begun to act on the belief that computers and communications systems will be critical in preventing further

widening of the technological and competitive

gaps separating them from the United States

and Japan. Nonetheless, for the European countries, as for the United States, worry over job10 M, IJiore and (;. Sabel, The Sel:ond Industrial 1]1 lrr’de ( Ne\\.

}“ork: Basic Books, 1984).

The new profile is hard to make out, if for no otber reason

than that nations ranging from Britain to the L’nited States to

Japan are somewhere in the midst of a process that ma] end

i n a period of slo~~,er paced chan~e, but probabl}. \\ill not,
302 ● International Competition in Services

less growth and other pieces of the deindustrialization picture cloud visions of the future.

Development Strategies

To policy makers in the developing world, the

services have rarely seemed cause for either

optimism or concern. While governments everywhere pay attention to industries like banking,

relative to other economic problems in the

LDCs, the service sector as a whole has simply

not been important. Still, a number of countries further along the development path—NICs

like Brazil, Mexico, South Korea, Taiwan, and

India—have begun to promote domestically

based high-technology industries, with products that depend on service inputs (e.g., knowledge and information). Some of the favored

business ventures have been nominally goodsproducing (computer peripherals), others services-producing (data entry, software). The NICs,

then, tend to see growth in the services—and

especially in the high-technology services—as

a necessary part of overall development strategy. Wary of concessions that might expose

their emerging industries to external competition, they perceive liberalization in the services as threatening their interests.

Development strategies, despite many variations, tend to align themselves with one of two

fundamental approaches: 1) import substitution; and 2) export-led growth.11 Import substitution begins with high trade barriers to create a sheltered domestic market; the goal is to

help otherwise uncompetitive enterprises gain

a foothold and begin to grow. In contrast, economies pursuing export-led development tend

to have lower protective barriers—or at least

less obvious barriers—relying instead on subsidies and other supports to nurture exportoriented firms. With export-led development,

the faster growing businesses will typically be

llThe discussion following owes much to S. Haggard and C.-I.

Moon, “The Korean State in the International Economy: Liberal,

Dependent or Mercantile,” The Antinomies of Interdependence,

J. Ruggie (cd.] (New York: Columbia University Press, 1983]. Also

see National Policies for Developing High Technology industries, F.W, Rushing and C.G. Brown (eds.) (Boulder, CO: Westview, 1986]; and International Competitiveness in Electronics,

op. cit., pp. 383-389.

found in industries where the country has a

comparative advantage. If it is rich in low-wage

labor with adequate basic skills, many of the

new businesses will be in manufacturing; arable land and a suitable climate favor agriculture.

Very generally, the Latin American NICs tend

to be import substituters, while those in Southeast Asia have pursued export-led growth.

Among the Asian nations, India looks more like

Brazil in terms of its development strategy than

Singapore or Malaysia. Needless to say, many

combinations of import barriers and subsidies

can be found in particular countries.

Nations following import substitution policies will normally oppose liberalization of services trade because this means lowering barriers

viewed as necessary for development, This is

plainly the case with Brazil. Of course, some

domestic interest groups may favor reductions

in trade barriers. In Brazil, firms that use telecommunications services in their own businesses would like to see fewer restrictions, as

would many purchasers of computers (box N

in ch. 5); nevertheless, those favoring a more

open market have had little success against the

combined forces of nationalist political groups

and Brazilian companies dependent on protection.

Export-led developers should be more favorably disposed; liberalization, bringing better access to business services, could help the competitiveness of their manufacturing industries.

Some of the service providers in these countries would no doubt prove able to compete internationally. But NICs that have been following an export-led strategy may wish to continue

protecting domestic banks (which help provide

financing for export-oriented manufacturers),

as well as infant high-technology service industries (e.g., software in Singapore and Hong

Kong). Although export-led strategies have generally proven more successful than import substitution, the Asian NICs face real difficulties

in deepening their economies, Many of these

countries will probably continue to go along

quietly with those seeking to delay meaningful

liberalization of trade and investment in the

services,
Ch. 9—Foreign Government Policies ● 303

High Technology and the Promotion

of Innovation

The contrasting views of the future of industrial society outlined above explain some of the

squabbling leading up to Punta del Este. Beyond the more abstract debates over development strategy, post-industrialism, and deindustrialization, many governments are beginning

to pay more attention, in a practical sense, to

the linkages between services and the rest of

their economies. For instance, telecommunications issues such as pricing and TBDFs have

excited interest in both industrial countries and

the NICs (box DD). To policy makers, the infrastructural role of telecommunications has come

to seem a pre-condition for development paralleling in significance the networks of railroads

and highways of earlier years. Many governments have provided support for informationrelated technologies believing that this would

contribute to development and competitiveness

throughout their economies.

Policy makers seeking to promote innovation

can choose from a long list of tools. But effective choices depend on a policymaking system

that enables government to formulate and implement policies with some consistency. In

most of the countries that have developed such

systems—typically through often-painful learning and experience (e.g., in Japan)—the industrial policy apparatus is relatively centralized.

With only a few agencies involved, and with

political traditions that grant powerful tools to

government—subsidized loans, control over access to import licenses, funding for development of proprietary technologies—industrial

and technology policies can be coherent and

targeted. (Of course, consistency is not always

a virtue; many governments have stuck too long

with bad ideas.) Table 46 summarizes some of

the similarities and differences in approach to

technology policy in five major industrial

countries.

Japan

If centralized institutional arrangements for

industrial policies carry substantial risks—i.e.,

failure to recognize mistakes and abandon unPhoto credit: British Airways

Governments have often played major roles in aircraft manufacturing (e.g., for the Concorde, pictured here)

as well as in air transportation.
304 • International Competition in Services

Box DD.—Transborder Data F1OWS and Related International Telecommunications Issues*

Frequently cited examples of government restrictions on transborder data flows include Brazil’s

limits on access to foreign databases and West Germany’s local processing requirements (ch. 5). The

latter force companies that supply remote data processing and information services to carry out a

portion of the associated computing within the Federal Republic. Some observers also cite U.S. restrictions on data communications between Dresser Industries and its French subsidiary during the

Siberian pipeline dispute of 1982.

Since the middle 1970s, the Organization for Economic Cooperation and Development has been

the primary forum for discussing TBDF restrictions. Governments have tended to rationalize their

TBDF policies and proposals in terms of concern for personal privacy, in contexts ranging from credit

ratings to medical records. Much of the early work by the OECD staff explored the issue in this context. But it soon became clear that TBDFs should be viewed more broadly, as a new form of protectionism and a possible revenue source for governments.

Customs duties on data or information-one form of TBDF restriction—raise the question of determining value. While potentially controversial, valuation of data flows may in the end be more important for measuring trade volumes than in relation to possible trade barriers. The problems of establishing the value of information are compounded when the information moves between divisions

of a multinational enterprise. Just as for royalties on licensing agreements, an MNC may charge subsidiaries either more or less than the prices that would be set in a market transaction. To the multinational, such charges can become a useful means for transferring funds internationally.

Beyond the question of customs valuation lies a narrower issue, one of far greater near-term significance: tariffs (pricing) for international telecommunications. In the past, tariff structures have

commonly been based on connect-time—the elapsed time for transmitting a message, regardless of

the volume of data transmitted. More recently, some countries have proposed or implemented tariffs

based on the volume of information (as measured, for example, by the number of bits of digital data).

This is partly a consequence of the transition to packet switching. A packet-switched telecommunications system breaks down messages-voice as well as digital data—into short bursts, or packets. The

packets can be sent independently of one another (i.e., over different circuit paths); they are reassembled at the receiving end. With independent routing of the packets, circuit paths can be utilized to

their full capacity (avoiding, for example, dead time because of pauses in any one message). Because

each packet must be tracked during transmission, it is an easy matter to base charges on the number

of packets sent, rather than the time required to transmit the message.

Volume-based pricing has been an attractive prospect for some PTTs (post, telegraph, and telephone authorities), particularly those that view faster speeds for data transmission as taking money

from their pockets. Many PTTs see the added revenues from volume-based tariffs as a help in subsidizing postal services, in paying for investments in infrastructural improvements like ISDN (Integrated Services Digital Networks, ch. 5], or for diversifying into value-added services. Any largescale movement toward volume-based tariffs, however, would mean substantial disruptions in an international system which has grown and prospered under time-based pricing, closely related to actual

costs. Time-based pricing has created strong incentives for innovations that increase transmission

speed. A shift to volume-related pricing would move the system away from cost-based prices. It would

also radically alter the incentives for innovation, slowing the pace of technological advance in

telecommunications-related services and equipment, while making a good deal of existing technology, particularly customer premises equipment, obsolete. Beyond this, movement toward volumebased pricing could greatly increase costs for some users of the international telecommunications

*The best single summary of TBDF issues remains L de Sola Pool and R.J. Solomon, “Transborder Data Flows: Requirements for International Co-Operation,” Policy Implications of Data Network Devdopznenfs in the OECD Area (Paris: Organization for Economic Cooperation

and Development, 1980), pp. 79-139. Also see J. Bortnick, “International Data Flow Issues,” Congressional Research Service Issue Brief IB8104O,

Apr. 19, 1985. For a summary of the activities of a dozen international bodies, see K.P. Sauvant, Trade and Foreign Direct Investment in Data

Services (Boulder, CO: Westview, 1986), app, C.
Ch. 9—Foreign Government Policies ● 305

infrastructure. MNCs and other major customers have understandably been concerned that PTTs

might use their monopoly positions to raise tariffs arbitrarily, upsetting corporate investment plans.

Given that regulators in the United States have avoided volume-related pricing, and that American

firms have come to depend on pricing is a function of connect-time only, the U.S. Government may

find itself needing to defend the interests of American companies in both bilateral and multilateral

negotiating forums in the years ahead.

Table 46.—Technology Policy in Five Industrial Countries

Reliance on industry- Centralization within Reliance on defense

specific measures government spending

United States . . . . . . . . . . . . . . . . . . . . . . . low

Japan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . high

Federal Republic of Germany . . . . . . . . . low-medium

France. . . . . . . . . . . . . . . . . . . . . . . . . . . . . high

United Kingdom . . . . . . . . . . . . . . . . . . . . med i urn

SOURCE Office of Technology Assessment, 1987

promising avenues—Japan, preeminently, has

evolved a policymaking system that seems both

centralized and effective.12 In recent years,

MITI has had to share some of its power with

other agencies—e.g., the Ministry of Posts and

Telecommunications–but policymaking authority remains concentrated in comparison with

most other advanced industrial economies. The

Japanese Government no longer uses direct subsidies or control over import licenses to persuade firms to move in particular directions.

Nevertheless, through measures such as incentives for joint development of new technical

know-how, the government has helped Japanese firms reach the technological frontiers

(perhaps the best-known example being the

VLSI project of the late 1970s). At the same time,

Japan’s Government has taken advantage of

fierce rivalries among the nation’s industrial

groups, or keiretsu, to assure that domestic

competition remains a spur to competitiveness

even as firms share some of the work of technology development.

United States

The United States also promotes technology

development, but–preferring the hurly-burly

IZFor a review of both process and substance in Japan’s approach to high technology, see International Competitiveness

in Electronics, op. cit., pp. 413-422.

low high

high low

medium low

high high

low-medium medium

of political competition to the competition of

ideas—does so using different methods. As discussed in chapter 6, military funding provides

most of the government push for technology

development. Health-related spending is a distant second. In comparison with Japan and the

EC, Federal agencies support little commercially oriented R&D.

Widespread support for university research,

coupled with R&D funded by the Department

of Defense (DoD) in the larger aerospace and

electronics firms, and in Federal laboratories,

have created an unmatched scientific establishment and an equally unmatched array of hightechnology military systems. With some exceptions, neither the science base nor the military

technologies have been very closely linked to

the needs of commercial firms; today, the increasing specialization of mission-oriented military R&D throws even the theoretical possibilities for strengthening such linkages into

doubt.

Defense spending has biased U.S. strengths

in the direction of technologies with at least

a dual-use nature: commercially, the United

States generally does best where technical

knowledge can be adapted to civilian as well

as military applications. Noting again the exception of medical research (which has laid

many of the foundations for biotechnology),
306 ● International Competition in Services

U.S. excellence in aircraft, computers, space

technology, and telecommunications has depended in part on complementarities between

military and civilian technologies. These complementarities will diminish as defense systems

become more exotic and competition in civilian technologies from countries like Japan

grows more intense. The trends are plain in

both the aircraft and electronics industries,

where military and civilian technologies have

been diverging for 25 years and more. In the

future, spillovers from military R&D will have

still weaker effects in stimulating internationally competitive civilian industries.

Europe

Despite earlier scares over technology gaps,

only since the beginning of the 1980s have the

EC nations grasped how far they were falling

behind the United States and Japan. While

many European governments have traditionally supported technology development, the EC

Commission has also begun to channel substantial funding in this direction. Planning began

in 1982 for the ESPRIT program (European

Strategic Program for Research in Information

Technology, box EE), which supports work in

computers and information technology. ESPRIT has been followed by RACE (R&Din Advanced Communication-technology for Europe), BRITE (Basic Research on Industrial

Technologies for Europe), and Eureka—this last

intended to be closer to commercial technology development than ESPRIT.

Current plans call for all the Eureka money

to come from national governments and the

companies involved, rather than the EC budget.

The Europeans have held that U.S. military

spending amounts to a subsidy for American

high-technology industries. With the French,

in particular, claiming that the Strategic Defense Initiative (SDI) would become a technological cornucopia for American firms, Eureka

emerged in part as a counter to SDI spending.

Recent signs suggest that the Europeans are beginning to appraise the benefits of military R&D

more realistically .13

Most of the Community’s members have wellestablished industrial policies of their own, with

responses to the technological challenges, especially of Japan, that span a considerable range.

(While Europe has in many respects learned

to live with U.S. investments and exports,

Japan’s successes, many of which have come

at the expense of European more than American manufacturers, have provoked new anxiety.) West Germany, for instance, pursues its

technology policies mainly through the Ministry of Research and Technology (the German

acronym is BMFT), which relies heavily on direct R&D subsidies. Over the years, BMFT programs designed to promote information technologies—focusing primarily on mainframe

computers and microelectronics—have met

with limited success at best.14 While the BMFT

has recently given more attention to telecommunications and software development, a hardware bias still seems to characterize the programs of both the government and of major (and

favored) firms like Siemens.

French policies have been more imaginative,

as illustrated by the Teletel/Minitel system described in chapter 5. In its policymaking system, France resembles Japan more than Germany or the United States. But while Japan

spends little on defense-related R&D, France

relies heavily on military spending to stimulate

technology development; although the French

Ministry of Research and Industry is the center

for industrial and technological policymaking,

defense planners have a strong voice (and not

just because of the funds they command).

While direct subsidies like the Alvey program

(box EE) have been common in the United Kingdom, the British Government exerts less control over the fate of firms and industries than

is the case in France. As in France and the

United States, relationships between the government and defense contractors have been

central to Britain’s technology policy. In both

the United Kingdom and France, large firms—

many with commercial interests in computers

and telecommunications—get substantial pro13P. Lewis, “Military Spending Questioned,” New York Times,

NOV. 11, 1986, p. D1.

IA]nternatjona) Competitiveness in Electronics, op. cit., P P.

405-412.
Ch. 9—Foreign Government Policies ● 307

Box EE.—ESPRIT and Alvey: Two European Technology Development Programs

ESPRIT’s 200 current projects are pointed at pre-competitive R&D—well before the stage of commercial development. By drawing a line upstream from commercialization, the program seeks to avoid

overlap or conflict with ongoing R&D funded by national governments or by participating companies.

The ESPRIT schedule calls for $1.3 billion in funding over the period 1984-89. A dozen large companies carry out much of the research in five principal areas: microelectronics, software, advanced

information processing, office automation, and computer-integrated manufacturing. At the same time,

program requirements call for each project to involve participants from at least two EC countries,

so that several hundred smaller firms also take part. So do more than a hundred universities and

nearly as many research institutes. The program aims not only at developing technology, but, by encouraging cooperation, at changing the relationships among firms in Europe as one step toward a

more truly common market. Whether it will succeed in this latter objective remains to be seen.

Britain’s Alvey program—named for the chairman of the committee that recommended it—represents an explicit response to Japan’s fifth-generation computer effort (ch. 5). Beginning in 1984 and

planned for 5 years and a total budget of $525 million, Alvey supports individual projects chosen

on a competitive basis. The Department of Trade and Industry, which is responsible for program

management and overall coordination, contributes the major share of government financing, along

with the Department of Education and Science and the Ministry of Defense. Alvey funds go toward

five principal types of research:

• computer architectures;

. very large-scale integrated circuits (VLSI);

. expert or knowledge-based systems, a form of artificial intelligence (AI);

. man/machine interfaces (which includes other AI work); and

● software engineering.

Alvey’s software engineering R&D is aimed quite directly at increasing the international competitiveness of British industry; a stated objective is “to establish tools and methods necessary for the production of high quality, cost effective software of world leading standard.”* To aid in this, a portion

of the budget has been set aside for diffusing technology to industry.

With 300 projects involving more than a hundred companies and almost all of Britain’s universities, often in partnership with industry, the program’s directorate has struggled with problems of

coordination—as well as with evaluation of project proposals—in an effort to make Alvey add up to

something more than the sum of its parts. Good proposals have been scarce in some technical fields,

leading the directorate to take an active role in encouraging formation of project teams. Elsewhere,

notably for work related to VLSI microcircuitry, large numbers of proposals have been received and

funded; nearly half the money committed through mid-1985 went toward VLSI R&D.**

Evaluating such a program shortly after its halfway point can be unfair as well as misleading,

but Alvey does seem to be overemphasizing hardware, and particularly integrated circuits, at the

expense of soft-ware and applications. In part, this reflects the predilections of British research scientists and engineers, far more of whom have worked on hardware problems than software in the past.

Even more, as a research program—and again despite the efforts of its managers and the objectives

set down so frequently in program documents—Alvey seems in danger of following the path of its

many predecessors: giving research a boost without finding ways to translate the results into meaningful

help for industry.

*D.E. Talbot, ‘{Alvey Software Engineering-A Strategy Overview,” Alvey Directorate, London, Department of Trade and Industry, no date,

p. 1.

● ● “Chips Take Lion’s Share of Alvey Cash,*’ Financial Times, June 18,1985, p. 6, Also, D. Fishbck, ‘“ ‘Tripe’ TO Describe Alvey Programme

As Just Academic,” Financial Times, Nov. 4, 1986, p. 10.

The EC’s ESPRIT program has also budgeted more money for microelectronics than any of its other four areas, but ESPRIT looks considerably better balanced than Alvey. The ESPRIT allocations: microelectronics, 23.5 percent; advanced information processing, 22.8 percent; office

automation, 21.9 percent; software, 18.9 percent; and computer-integrated manufacturing, 12.9 percent—H. Hunke, “Updating the European

Strategic Program in Information Technology [ESPRIT),” presented at the Artificial Intelligence Conference, London, Apr. 14-15, 1986.
308 • International Competition in Services

portions of their revenues from military contracts and have become primary agents of technology promotion.

R&D Supports and Subsidies

As pointed out in box B (ch. 1), service industries depend on much the same technology/

science base as manufacturing. Interdependencies are many: for example, the design of telecommunications equipment will be a function

of the services to be provided. But with the exception of the information-related industries,

services remain close to invisible in the industry/technology policies of most countries (as opposed to their regulatory policies), Indeed, governments seldom collect meaningful statistics

on R&D in the services (see box FF); many—

including the U.S. Government—barely seem

to recognize that service companies conduct

product and process development projects

much like those found in manufacturing firms.

When it comes to telecommunications and

related industries, governments have paid far

more attention to the development of new

equipment than new services; often when they

have promoted services, governments have

done so to support related manufacturing sectors. Thus in the 1950s, Japan rapidly expanded

its television broadcasting to help build domestic sales from which the country’s consumer

electronics industry could gain strength before

moving into export markets.15 Nor are programs

like ESPRIT and Alvey (box EE) new; indeed,

they can be viewed as responses to government

projects elsewhere.

In the 1960s and 1970s, governments in Europe and Japan sought to help their computer

industries catch up with American firms. In

the latter part of the 1970s, microelectronics

technologies rose to the top of priority lists. In

large measure, the microelectronics thrust in

ESPRIT represents a European response to

Japan’s earlier VLSI project. The same is true

of France’s Plan des Composants, and the

Philips/Siemens Megabit project, while Japan’s

151 bid., ~lp. I I 9-12 I and 180-182. Many countries have also used

broadcasting standards as NTBs to shelter their domestic industries from foreign TV manufacturers.

fifth-generation computer project (ch. 5) has

been met by the software and AI portions of

ESPRIT and Alvey. In the industrial policy

equivalent of an arms race, escalating expenditures for high technology have culminated in

very large efforts like Eureka and France’s

multi-billion dollar Filiere Electronique. Those

in Europe who see military spending as central to U.S. technology policy might wish to add

SDI to the list. But it is Japanese rather than

American efforts that have stimulated most of

these reactions.

Nonetheless, in Japan—with the uncertain

exception of the ISDN Information Network

System project—MITI and other government

agencies have generally funded technology development at relatively low levels. Programs

like ESPRIT and Alvey support many individual projects, chosen competitively. Japanese

industrial policy provides money for a wider

variety of projects, with extensive efforts to

maintain coordination (although many in the

West have overstated the degree of cooperation

among Japanese firms).

Table 49 illustrates in terms of MITI’s projects

(only) for information-related technologies (only)

during 1985 and 1986. Tax incentives, some of

which are substantial, have not been included.

Omitting the loan funds that are listed, the 1986

total does not reach $400 million. MITI’s support, then, is noteworthy more for the diversity of projects than for the money provided.

The Japanese approach has evolved over many

years of experience in supporting technology

development. No list even remotely similar in

range could be compiled for any U.S. Government agency; indeed, even if all U.S. Government agencies were surveyed, the results in

terms of comprehensiveness and attentiveness

to industrial development needs would pale

alongside table 49. Recent history also suggests

that Japan’s approach works better than the

European efforts described earlier.

The military thrust of U.S. R&D programs

compared to those of other countries, and especially Japan, raises real questions for the Nation’s technology policy. The Japanese need not

devote resources to the design and production

of integrated circuits that can withstand the
Ch. 9—Foreign Government Policies . 309

—

Box FF.—How Much Does the United States Spend on Services R&D?

To the casual observer, R&D in U.S. service industries must seem nearly invisible. The National

Science Foundation’s (NSF) biennial Science Indicators series–the primary U.S. Government compilation of R&D statistics—hardly mentions the services. A few summary tables suggest that non-manufacturing

industries account for 3 to 4 percent of U.S. spending on industrial R&D—a little over $2 billion currently. * Table 47 summarizes the NSF figures, which are much too low to be realistic.

Many activities of service firms fall outside NSF’s definitions of R&D, which have been oriented

toward manufacturing companies. At the same time, many service firms—even those that for years have

budgeted substantial sums for the development of proprietary technology–do not think of what they

do as R&D, at least in self-conscious or systematic fashion. For example, product development departments in banks are new, as pointed out earlier in this report, even though they may simply represent

a reorganization of existing functions. The extraordinarily low figures in table 47, then, reflect underreporting of R&D expenditures for largely historical reasons—much like the underreporting of exports

and imports of services in the U.S. current account (i.e., collection and reporting of data under obsolete

or unexamined rules). NSF does plan somewhat broader coverage of services in its next survey, to be

conducted in 1988,

What would a more realistic estimate look like? The very large size of the service sector of the U.S.

economy suggests that, even if few service firms spend more than a fraction of a percent of sales on

R&D, the total must be substantial. And in fact, some service companies allocate several percent of sales

to such activities (although others spend little or nothing).** Data on R&D spending as a percentage

of sales provides the basis for sectoral estimates carried out at Battelle Memorial Institute and included

in Battelle’s recent R&D forecasts.*** Using an input-output model, Battelle’s procedure yields estimates

of R&D by line of business—regardless of the nominal sectoral classification of the firm conducting the

R&D. The result is a series of estimates for services-related R&D, some of it conducted by firms otherwise

classed in manufacturing industries. (Some of these firms produce services as well as goods; others sell

to service firms and carry out services-related R&D to support this portion of their business.) Table 48

gives Battelle’s estimates for the 10 largest industry sectors in terms of sales, as well as summary figures

for all of U.S. industry. While the figures for individual sectors should be seen as only rough approximations, the table as a whole gives the best picture of services-related R&D spending that OTA knows of.

As table 48 indicates, the services, as a whole, spend only 0.7 percent of sales on R&D—compared

with more than 2 percent for the goods-producing portion of the economy. But the services total reaches

$26 billion, more than 10 times greater than the NSF figures for non-manufacturing industries in table

47. (Battelle’s services total comes to about one-quarter of industrial R&D, and one-fifth of the $127 billion forecast for all U.S. R&D in 1987, including that performed by government, universities, and nonprofit laboratories.) This $26 billion figure seems a reasonable estimate for total services-related R&D

spending in the United States—a sum suggesting that R&D in the services is far more important than

has been commonly appreciated. (To OTA’s knowledge, no estimates comparable to those in table 48

exist for other countries.)

*According to the most recent edition of Science Indicators, more than half of this R&D takes place in the following R&D-performing nonmanufacturing industries: electric, gas, and sanitary services; computer and data processing services; miscellaneous business services (including R&D laboratories and computer software firms); and engineering, architecture, and surveying. Sea Science Indicators: The 1985 Report

(Washington, DC: National Science Board, 1985), p. 78. Health services go unmentioned, although the 1986 Federal budget figure for healthrelated R&D of $5.1 billion can be found on p. 227. Much of the health services industry consists of not-for-profit institutions, presumably excluded from summary figures for “R&D-performing non-manufacturing industries.” But the primary point is that spending on health-related

R&D is nowhere associated with a major identifiable service sector. The same is true for education.

NSF’s definition of development, referred to below, reads as follows: “systematic use of the knowledge or understanding gained from research, directed toward the production of useful materials, devices, systems or methods, including design and development of prototypes and

processes” (p. 221). Given this wording, a good deal of R&D directed at new service products and processes should qualify.

**See K.J. Freeze and R.S. Rosenbloom, “Bane One Corporation and the Home Information Revolution,” Harvard Business School Case

Study 9-882-091, 1982, for discussion of R&Din a bank that allocates 3 to 5 percent of earnings to R&D–several million dollars annually. Should

the 3 percent be representative for the banking industry as a whole, annual R&D spending by U.S. banks alone would approach $500 million.

Manufacturing firms typically spend in the range of 1 to 10 percent of sales on R&D, with industries like primary metals (e.g., steel) near the

bottom, and high-technology sectors like computers near to the top.

***Probable Levels of R&D Expenditures in 1987.’ Forecast and Analysis (Columbus, OH: Battelle Columbus Division, December 1986), pp. 19-22.
310 ● International Competition in Services

Table 47.—U.S. Government Figures on Industrial R&D Spendinga

Expenditures

(billions of current dollars and percentage of total)

1970 1980 1983 1986b

Manufacturing industries (all) . . . . . . . . . . . . . . . . . $17.4 (96.1%) $42.7 (95.9°/0) $60.8 (96.7°/0) $83.0 (97.4°/0)

Non-manufacturing industries . . . . . . . . . . ... , . . 0.705 (3.9%) 1.82 (4.1 0

/0) 2.07 (3.3°/0) 2.26 (2.60/o)

aR&D performed by ~rjvate ~ompanje~, jn~l”djng that paid for by the Federal Government. NSF repofis Federal funding for R&D carried out by nOn-tTIanUfaCtUring

industries at $0779 billion in 1980, and $1.048 billion in 1983 The estimated 1986 figure is $1.092 billion.

bEstimated,

SOURCES. 1970, 1980, 1983–Sc/ence Indicators: The 1985 Report (Washington, DC National Science Board, 1985), pp. 253.254, 265. 1986–Probab/eLevels of f7&D

Expenditures IrI 1986: Forecast and Analysis (Columbus, OH: Battelle Columbus Division, December 1985), p. 12.

Table 48.—Estimated 1987 R&D Spending by U.S. Service

and Goods-Producing Sectorsa

R&D as a Estimated 1987

percentage R&D spending

of sales (billions of dollars)

Service sectors:

Trade . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.44°/0 $3.39

Real estate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.04 0.22

Residential construction . . . . . . . . . . . . . . . . . . . . . . . . . 0.60 1.59

Finance and insurance. . . . . . . . . . . . . . . . . . . . . . . . . . . 0.50 1.21

Nonresidential construction . . . . . . . . . . . . . . . . . . . . . . 0.60 1.41

Educational services. , . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.60 1.38

Other business/professional services . . . . . . . . . . . . . . 2.50 4.15

Top seven services . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.54°/0 $13.3

All services. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.73°/0 $26.0

Goods-producing sectors:

Food production . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.0 0

/0 $3.88

Motor vehicles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.41 6.01

Petroleum refining . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.60 1.45

Top three goods-producing . . . . . . . . . . . . . . . . . . . . . 1.29°/0 $11.3

All goods-producing . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.15°/0 $69.9

All U.S. industryb. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.36°/0 $98.5

aonlY the ICI largest sectors, as ranked by sales, have been listed separately—7 service sectors, and 3 goods sectors. R&D

expenditures include government-funded projects conducted by industry, Sector definitions do not necessarily correspond

to those of the Standard Industrial Classification system. The all-services subtotal excludes public utilfties The all.goodsproducing subtotal includes agriculture and mining

bAll Semices pIUS all goods-producing Pius Public utllltles

NOTE. Subtotals may not add because of rounding

SOURCE Probable Leve/s of R&D Expenditures In 1987 Forecast and Ana/ysis (Columbus, OH Battelle Columbus Division,

December 1986), pp 21-22

electromagnetic pulse from a nuclear explosion, or to software for controlling a ballistic

missile defense system. Will technologies from

DoD’s VHSIC (Very High-Speed Integrated Circuit) program, SDI, and the DoD Strategic Computing effort yield fruitful commercial spinoffs,

such as benefited American computer and electronics firms in earlier years? The increasingly

specialized nature of military technologies suggests skepticism. Rather than assuming that military spending will in some sense pa y off in the

civilian economy, U.S. policy makers might pay

closer attention to programs like Japan’s SIGMA

or France’s Teletel/Minitel—perhaps even to

the extent of seeking to emulate some of their

objectives.
Ch. 9—Foreign Government Policies ● 311

Table 49.— Projects Related to Information Technology Supported by

Japan’s Ministry of International Trade and Industry

Budget (millions of yen)a

Description 1985 1986b

Robots for dangerous conditions (JUPITER) . . . . . . . . . . . . . . . 1,900 2,450

Fifth-generation computing . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,780 4,500

High-speed computer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,020 2,930

New-function integrated circuits . . . . . . . . . . . . . . . . . . . . . . . . . 1,590 1,540

Reliability improvement for information equipment . . . . . . . . . —c11,000d

Industrialization of software production (SIGMA) . . . . . . . . . . . —c

6,000d

Interoperative database technology . . . . . . . . . . . . . . . . . . . . . . 20 840

Survey on information processing in education . . . . . . . . . . . . —c220

Teacher education and training related to information

technologies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . —c 1,000d

Promotion of database and information services . . . . . . . . . . . 10 110

Development of databases and information processing and

communications systems . . . . . . . . . . . . . . . . . . . . . —c 7,500d

Support for smaller businesses:

Information networks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 370

Software . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . —c200

Consulting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . —c440

Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . —c 4,300e

Equipment leasing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . —c41,000

Planning and development of information systems for

model communities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70 70

Survey on regional information systems . . . . . . . . . . . . . . . . . . —c

10

Promotion and improvement of regional information

systems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . —c 4,000e

Development of standards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70 880

aBeCa”SeOf recent exchange rate sh!fts, fiscal year budget levels have been given In yen For 1985. the average rate ‘W’S 237

yen to the dollar The rate dropped to an average of 167 yen to the dollar In 1966

bRequest

C1986 first year

dAllocatlon for Japan Development Bank loans

‘Includ!ng loan funds

SOURCE “MITI’s F!scal 1986 POIICY Measures Outllne,” Japan RePod–Science and Technology. Joint Publlcat!ons Research

Service JPRS-JST+36060-L, Aug 29, 1986, PP 84-99 Translated from Nrkkei Elecfronlcs, October 1985

OTHER POLICIES RELEVANT TO THE SERVICES

The remainder of this chapter adds more detail to the picture of development strategies begun earlier, covering several other policy tools

listed in table 45. Chapter 10 turns specifically

to U.S. policies and options.

Public Procurement

Government funds pay for heavy construction projects (ports, the Interstate Highway System). Telecommunications and data processing firms find some of their best customers in

government agencies, as do computer software

suppliers. In France, the government has begun to subsidize outside consulting services for

small and medium-sized firms; the aim is to

build demand for business services, while at

the same time helping smaller French manufacturing companies adjust to changes in their

markets.

As noted in chapter 5, preferential purchasing policies by Nippon Telegraph & Telephone

(NTT)–until recently a public corporation–

helped the company’s suppliers improve their

technology. Favored firms built large and capable organizations on the base of sheltered domestic markets created for them by NTT and

the Japanese Government. Although manufactured products were the focus, the impacts

spilled over into services, just as U.S. Government purchases of semiconductors and computers provided indirect aid for the software

and telecommunications services industries

here.
312 ● International Competition in Services

Attempts by European governments to build

national champion firms have been less successful than in Japan. The European examples

show the possible costs of sheltering domestic

industries through procurement preferences.

Favored firms may be less inclined to compete

for international markets, and, as time passes,

less able to do so—a problem that Japan has

avoided in part through continued strong domestic competition, which has pushed Japanese

firms to innovate rapidly and effectively.

Despite the partial exceptions of the information industries and construction, public procurement has seldom been turned to the direct

promotion of service industries the way it has

for, say, computer hardware. Thus an extension of the existing GATT Agreement on Government Procurement to cover services seems

a reasonable prospect. This code, relatively

weakly worded, currently exempts all services

except those directly linked with purchases of

goods. It also exempts preferential procurement

policies that can be tied in some way to national

security—a big loophole. Extending the Agreement to services irrespective of association with

goods, and strengthening it generally, should

help open service markets for many American

firms. Of course, this would also open previously sheltered U.S. markets; thus the engineering and construction industry opposes such a

step.

Regulatory Policies

Regulations as NTBs

When regulations function as quasi-NTBs, the

difficulty for negotiators, legislators, and those

charged with enforcing the rules is to separate

legitimate uses from illegitimate. Some cases

are obvious—rules that bar foreign-owned bank

offices or subsidiaries (the practice until recently in Canada, Japan, and Australia). More

subtly, governments may require foreign banks

to maintain higher capital/loan ratios, or restrict

access to clearinghouses or giro payments networks. The Tokyo Stock Exchange remained

closed to foreign firms until 1985, when—after

continuing pressure from the U.S. Government

—four American companies were given seats.

In professional services, licensing restrictions

have often become quasi-NTBs, Table 50 gives

further examples. Many of the NTBs listed have

been in place for years–e.g., in ocean shipping.

They can have major consequences for competitiveness, the more so if some countries

maintain much tighter restrictions than others,

When regulatory regimes in industries like

shipping remain stable over time, firms in various parts of the world eventually adjust to the

competitive landscape. But shifts in regulations

can have sudden and sharp consequences for

international competition. In recent years, two

events in the United States have upset the status quo: passage in 1978 of the International

Banking Act, and the AT&T breakup 6 years

later. The International Banking Act gives foreign banks relatively unrestricted access to the

U.S. market (while placing their operations here

under the U.S. regulatory system), The AT&T

breakup likewise opened American markets

to foreign suppliers of telecommunications

equipment,

With domestic markets open, the U.S. Government has strong incentives to seek equal access abroad on behalf of American companies.

Of course, the unilateral nature of U.S. actions

has meant that foreign governments have little reason to go along unless the United States

threatens to reverse course and close its markets once more—a threat embodied in some of

the reciprocity legislation introduced in Congress over the past few years. Other countries

have objected strenuously to the protectionist

flavor of such measures, despite the fact that

a number of regulatory bodies in the United

States—including the Federal Communications

Commission (FCC) —already apply reciprocity

principles in decisions affecting international

business.

Examples From Banking and Telecommunications

Regulatory regimes in financial services vary

greatly among the industrial countries. Both

France and Germany permit universal banking

—i. e., they make no distinction between investment banking and commercial or retail banking. In the United States, Britain, and Japan,
Ch. 9—Foreign Government Policies ● 313

Table 50.— Examples of Regulatory Barriers Affecting Services Trade and Investment

Banking:

Canada . . . . . . . . . . . . . . . . . . .

Mexico . . . . . . . ... . . . . . . . .

India . . . . . . . . ... . . . . .

France. . . . . . . . . . . . . . . . . . .

Insurance:

Bolivia . . . . . . . . . . . . . . . . . . . . . . .

Australia. . . . . . . . . . . . . . .

Turkey . . . . . . . . . . . . . . . . . . . . . . .

Telecommunications:

United States . . . . . . . . . . . . . . . . .

Japan . . . . . . . . . . . . . . . . . .

Federal Republic of Germany. . .

France. . . . . . . . . . . . . . . . . . . . . .

Engineering and construction:

United Kingdom . . . . . . . . . . . . . .

Venezuela. . . . . . . . . . . . . . .

United States. ., ., . . .

Shipping:

United States . . . . . . . . . . . . . . .

Airlines:

Portugal . . . . . . ..., . . . . . . . .

United States . . . . . . . . . . . . . . . . .

Foreign banks limited to no more than 16 percent of

total banking system assets (8 percent until 1984)

Market closed to foreign banks except through

offshore banking facilities

Higher taxes on foreign banks

Domestic banks have access to subsidized loan funds

Foreign insurance companies required to maintain

much higher capital reserves

No new foreign entrants permitted (many other

countries have similar restrictions)

Some reinsurance must be placed with publicly

owned company

No foreign ownership of basic telecommunications

service providers

Foreign participation limited to joint ventures

Public monopoly for all services

Public monopoly for all except information services

Only British firms eligible for design contracts on

North Sea oil projects

Foreign consultants must work through local firms

Embassy construction abroad may be limited to U.S.

firms

Jones Act restricts coastal shipping to U.S. carriers

(many other countries have similar restrictions)

Government loan guarantees and other financial

assistance (many other countries subsidize

domestic air carriers)

Government travel restricted to domestic carriers

SOURCES Off Ice of Technology Assessment, “Selected Problems Encountered by U S Service industries in Trade in services,’

Off Ice of the United States Trade Representative, printout, Sept 6, 1985.

more or less strict rules prohibit commercial

banks from engaging in some forms of investment banking and brokerage activities. U.S.

banks cannot participate directly in the financing of corporate stock or bond offerings; Japanese banks can hold ownership shares in corporations as part of their overall portfolios, but

cannot act as brokers or trade in stocks.

As markets for financial services have become more internationalized, American banks

and investment firms have pressed for relaxation of regulatory restrictions, particularly those

that have not applied to their competitors overseas. Other countries, noting the deregulatory

momentum in the United States, react with similar steps of their own—steps that in some cases

will have major consequences for international

competition. Certainly this is the case with liberalization of financial markets in Japan and elsewhere, as discussed in chapter 3. (See table 51

for recent changes in financial services regulations.)

Japanese corporations increasingly seek funds

in international capital markets, Foreign companies have begun to seek capital in Japan or

the Euroyen market. Greater competition inside Japan will result in aggressive moves by

Japanese financial institutions abroad, with the

yen becoming a more common international

medium of exchange. Trading volume on the

Tokyo Stock Exchange will continue to increase; indeed the Japanese stock market passed

that of the United States in total capitalization

in the spring of 1987. Meanwhile in London,

the deregulatory “Big Bang” of October 1986

means new opportunities for British financial

services firms at home, reducing their need to

move overseas, but also creating new opportu63-527 (] - 87 - 11
314 ● International Competition in Services

Table 51 .—National Treatment in Financial Services

Banking:

United States . . . . . . . . . . . . . . . . National treatment; some State laws may restrict entry

Japan . . . . . . . . . . . . . . . . . . . . . . . . Substantial progress toward national treatment since

1979

Canada. ., ... , . . . . . . . . . . . . . . . . Incremental shifts toward national treatment in 1980 and

1984; further changes proposed for 1987

Securities firms:

United States . . . . . . . . . . . . . . . . . Federal law generally calls for national treatment and

equality of competitive opportunity

Japan . . . . . . . . . . . . . . . . . . . . . . . . National treatment generally followed; some movement

toward full equality of competitive opportunity

Canada. . . . . . . . . . . . . . . . . . . . . . Varies by province (Ontario prohibits entry into full service securities businesses, while Quebec, for instance,

allows foreign firms to enter and operate on same

terms as Canadian firms)

France . . . . . . . . . . . . . . . . . . . . . . . Entry and national treatment accorded with some exceptions (e. g., membership on the Paris Stock Exchange

limited to firms with headquarters in the European

Community)

United Kingdom . . . . . . . . . . . . . . . Major reforms in progress, with relatively open entry and

national treatment expected under most circumstances

SOURCES “National Treatment Study. Report to Congress on Foreign Government Treatment of US Commercial Banking

and Secuntles Organizations, 1966 Update,” Department of the Treasury, Washington, DC, December 1966, “Report

to Congress on ForeIan Government Treatment of U.S Commercial Banklna Organizations 1984 UDdate, ” Department o~ the Treasury: Washington, DC, 1984

nities for foreign firms to enter the U.K. market; when the deregulatory schedule was announced, American financial services firms

quickly began seeking mergers and acquisitions

in Britain.

Despite greater integration in world financial markets, asymmetries in regulatory regimes

will persist. Should the United States move

toward universal banking, for instance, this

would come about only after prolonged debate,

or, more likely, continued piecemeal erosion

of existing restrictions. Policy makers will have

to weigh not only domestic concerns, but the

impacts of regulatory change on the international competitive position of U.S.-based banks

—a question seldom considered in the past, but

now of considerable import. But the policymaking apparatus in the United States does not

yet reflect the new importance of international

competition in financial services.

Table 52 contrasts regulatory regimes for

telecommunications in the five large industrial

countries. In the United States, competition in

long-distance services has been largely deregulated, although AT&T’s rates remain under

some controls as a result of the settlement agreement. With a shaky distinction between basic

--

and enhanced services, and the seven regional

holding companies (RHCs) formed after the

breakup still precluded from offering the latter, the stage seems set for continued controversy. Policy guidance, after a fashion, continues to come through the offices of the FCC,

the Department of Justice, and U.S. District

Court Judge Harold Greene.

The German system provides the greatest

contrast with deregulation here (see box N, ch.

5). In the Federal Republic, a single agency, the

Bundespost, remains the monopoly provider

of communications services, including mail

and television. The other three countries offer

closer parallels with the United States—as well

as possible lessons. Japan’s system, for example, shows the advantages of a clear separation

between basic and enhanced services. Careful

distinctions between Class 1 (basic) and Class

2 (enhanced services) carriers, and among types

of value-added networks, have created a predictable environment: firms can calculate their

interests and seek the appropriate licenses.

Meanwhile, given uncertainties as to what the

new rules in the United States will be, the RHCs

have been scrambling for new markets and testing the bounds of the permissible. In France,

even though most telephone and data services
Ch. 9—Foreign Government Policies . 315

—

Table 52.—Telecommunications Regulations Compared

United

States

Public monopoly . . . . . . . . . . No

Geographic basis for regulation . . . . . . . . . . . . . Regional

Regulatory separation between basic and

enhanced services? . . . . . . . . . . . . Currently, yes

Competition in long-distance service? ... . Yes

Competition in value-added services?. . . . . . . . Yes

SOURCE Off Ice of Technology Assessment, 1987

remain under state control, competition in information services has been only lightly regulated. Judicious use of public funds to subsidize installation of Teletel/Minitel terminals

spurred growth in the French market for enhanced services. Again, the lesson seems straightforward: regulations need not stifle innovation

and market forces; competition flourishes when

the rules are clear.

Standards

Government participation in determining

product, technical, and professional standards

has a dark side and a light side, Sometimes governments manipulate standards or professional

licensing requirements to create NTBs; Japan’s

product standards have been a sore point with

other governments for years .16 In other cases,

international agreements on technical standards can help create regional or world markets

in place of fragmented national markets, Table

53 lists common NTBs in the services fostered

by national standards and licensing requirements; many more examples could be cited.

Technical Standards

If national standards can act as NTBs, international standards can help to open markets—

which does not mean that countries will be able

to agree. Electrical outlets illustrate the problems. Hundreds of different designs for plugs

and sockets exist around the world. Different

l~st}~, f. r CXa m p]e, D, Ch ri stel O\\”. “Japan’s intangible Barriers

to ‘1’rad(’ in ~lanufa[:tllres, ” Federal Resert’e Bank of ibre~t J’orA

Quartf)rlf Rt?L iet~ . ~tinter 1 !385-86, p. 11.

I;or’ tlI[> IInite(] States alone, the Nation [i] 13ur[;au of Stan(],ir(]’\

(] a t a ha s[: n [jii’ I n (. ] u (ies more than 30,000 ire] u n ta r}’ t c(: h n i(. ,i ]

st a JI (] a r(]s. ‘]>h e B u reau a] so ser~res’ as a foca] lmi n t for i n formati{)n an(l (,(jml)lalnt~, on f(]reign 5tandarcls,

United Federal Republic

Japan France Kingdom of Germany

No Yes No Yes ‘-

National National National National

Yes Yes Limited No

Yes No Yes No

Yes Yes Yes Some

Table 53.—Standards and Licensing Requirements

That Can Serve as Nontariff Barriers

Sector Possible barriers ‘

-

Construction . . . . . . . . . . . . Building and material

standards

Telecommunications. . . . . . Potentially differing ISDN

systems, modem signal

speeds, network protocols,

incompatible system

architectures

Financial services . . . . . . . .Access to clearing systems

(CHIPS and CHAPS, ch. 3)

or giro payment systems

Law . . . . . . . . . . . . . . . . . . . . Bar admissions; limitations on

type of practice

Architecture, engineering . .Licensing of foreign

professionals

SOURCE Of flc-e of Techno~gy Assessment, 1987

countries use different voltages. National bodies for setting standards often exclude foreign

firms. The result? Domestic appliance manufacturers typically have a slight cost advantage.

After more than a dozen years, international

discussions have ended with no progress toward agreement on a universal standard.17

Sometimes, of course, international standards

do emerge: 1) in the absence of, or in spite of,

the policies of governments; 2) because one or

more governments adopt standards that become a clear choice for technical reasons; or

3) as a result of cooperation among governments and firms in international standardsetting bodies, Examples of the first case include the IBM PC as a de facto standard. While

many companies independently bought large

numbers of IBM PCs, the MAP (Manufacturing

Automation Protocol) standard for linking factory automation equipment stems from the initiatives of a single major purchaser on the world

1~]. (;allcot(, ‘IA \l’orld-L\’ide l)lu~ Fa[:es I)ls(:onnection After

74-}’[’(1 r E f fort,‘‘ tl’ai] .Street )oIJrIJal, :!pr, 1, 1982, I), 1,
316 ● International Competition in Services

market—General Motors (GM). MAP has now

been accepted by several hundred other firms.

Suppliers of both equipment and parts must go

along if they expect to sell to GM. Prospective

purchasers have adopted the standard because

they know a great deal of MAP-compatible

equipment will be available, None of this would

have happened, of course, if MAP had not received wide acceptance as a reasonable choice

on technical grounds. With the International

Organization for Standarization (ISO) now involved, the eventual outcome may be a global

standard.

National governments have sometimes acted

unilaterally to establish standards for computer

languages. Several international standards have

come about largely because the U.S. Department of Defense first imposed them on military contractors—an example of the second

case listed above. DoD now hopes that Ada will

replace most of the 400 or so languages currently in use for defense systems.18 In some contrast, the Japanese Government sought to make

MSX a standard for operating systems in small

home computers. While MSX had considerable

success in Japan, it has not been accepted elsewhere. Currently, the West German Government is trying to establish a global standard for

ISDN that will benefit the leading German

equipment manufacturer, Siemens. To have

much chance of success, the Federal Republic

will have to convince other EC countries to go

along. This may happen: the Society for Worldwide Interbank Financial Telecommunications

(SWIFT) was able to set formatting standards

and protocols for communications among member banks in part because a number of governments backed SWIFT rather than competing

U.S. proposals. In doing so, they relaxed their

own rules governing interfirm telecommunications services.

Individual companies and national industries

can reap substantial benefits if they get their

standards adopted internationally, but this usulaprobably a vain hope—see J. Jacky, “Ada’s Troubled Debut, ”

The Sciences, January 1987, p. 20. DoD spent something over

$10 billion in 1985 for mission-related software, more than five

times its hardware costs—E.J. Joyce, “SE]: The Software Battleground,” Datamation, Sept. 15, 1986, p. 109,

ally takes a strong market position to begin with,

As the MAP example illustrates, for others to

accept a standard, they must perceive benefits

for themselves. But given enough market power, big firms or the governments of powerful

countries can sometimes establish standards

that would not survive marketplace tests, or that

are not at the technological frontier. Such an

outcome can—like premature establishment of

standards, or unduly restrictive technical specifications–foreclose desirable technological

paths. These are real dangers, although often

exaggerated by those opposed to standards for

other (e. g., commercial) reasons.

Many international bodies provide forums for

discussing standards. One of the oldest, the

World Postal Union, originated in efforts to reduce incompatibilities in national mail systems.

The International Telecommunication Union

(ITU) grew out of the International Telegraph

Union, founded in 1865. In addition to these

more specialized bodies, committees within

organizations like the OECD also provide forums for standards setting. The Tokyo Round

GATT negotiations led to a new code (the

Agreement on Technical Barriers to Trade) that

counts as a small step toward making it more

difficult for governments to use standards as

NTBs. 19

Perhaps the most important recent attempt

to create an international standard began with

a group of companies seeking an alternative

to IBM’s Systems Network Architecture (SNA)

for linking computers. Their Open Systems Interconnection (OSI) alternative is important for

two reasons: 1) network architecture and interconnection standards will be central to the

design of the next generation of mainframe

computers, and also to the telecommunications

infrastructure (especially ISDN); and 2) many

of the European participants have sought to define an OSI standard that would eliminate some

of the advantages IBM now gets from its dominant position in the world market for large computer systems. General Motors’ MAP standard

is itself an OSI variant.

IQ]nternationa] COMpetltiVeness in Electronics, op. cit., Pp.

436-437.
Ch. 9—Foreign Government Policies ● 317

After some 10 years of deliberation in forums

including the ISO and the ITU’s Consultative

Committee for International Telephone and

Telegraph (CC ITT), the OSI standard gathered

enough adherents that even IBM has begun to

offer OS I-compatible equipment. The complex

seven-layer specifications would arouse little

controversy in the abstract, but on specifics the

participating computer and telecommunications firms disagree; resolution of details inevitably works to the advantage of some, the

disadvantages of others. Furthermore, some

computer manufacturers—notably IBM—felt

that they were being asked to supply proprietary information. IBM’s reluctance to be too

specific about its own systems encouraged the

(perhaps not unrealistic) paranoia of other companies, In fact, the slowness with which IBM

released technical details on SNA became a major factor in the ongoing dispute between IBM

and the European Community, figuring in the

settlement of the EC’s antitrust suit against

IBM.

20

The stakes will be still higher for ISDN standards, with strong temptations for public telecommications authorities to implement ISDN

in ways favoring domestic suppliers. The German Bundespost’s efforts to help Siemens may

simply be the first of many such attempts. As

for OSI, the motives lie mostly in competition

for hardware markets, not services. With competition in international markets for telecommunications equipment fierce, more companies

Zoon osI and it5 re]ation5h ip to proprietary}, network architectures, see A. Meijer and P. Peeters, Computer Network Architectures (Rockvil]e, MD: Computer Science Press, 1982) and Future

Information Technology—1984: Telecommunications (Washington, DC: Nationa] Bureau of Standards, 1984), ch. 1. The seven

layers range from connector designs at the physical interface

[layer 1) to an application-specific layer (number 7).

The recently organized Corporation for Open Systems (COS),

a nonprofit group of American and some foreign computer and

telecommunications firms, represents the latest step in attempts

to agree on networking standards. Although originally viewed

as something of an anti-IBM coalition, I B M has now joined; with

so many IBM computers in use, even that firm’s biggest competitors felt they could not afford to leave IBM out of efforts to

establish industry standards. See A, Pollack, “Computer hlakers

Seeking Standards, ” New York Times, Jan. 6, 1986, p. D4; “IBN1

Joins Group for Standards on Interconnection,” Electronic NeL~rs,

F’eb, 10, 1986, p. 16. The COS will support the 0S1 standard.

are chasing business than can expect to survive. This strengthens the resolve of governments to help “their” firms, some of whom may

not get a second chance if they lose out in early

rounds of competition for ISDN sales,

Professional Licensing

While licensing standards for lawyers, engineers, architects, and other professionals may

at first seem quite different from technical or

product standards, they function in rather analogous fashion, On the one hand, they provide

information for customers; on the other, they

limit market entry and raise costs for those who

wish to compete,
378 ● International Competition in Services

Professional licensing places a floor under

expertise. Indeed, given the problems consumers face in evaluating the expected quality

of service products such as medical care or legal advice, professional licensing has a vital role

in the marketplace. But licensing can easily be

turned to the creation of unfair entry barriers.

It took 4 years of negotiations between the U.S.

and Japanese Governments before Japan agreed

to loosen its restrictions on foreign lawyers; because foreign-owned firms will not be allowed

to hire Japanese attorneys or to give advice on

Japanese laws, ample grounds for complaint

remain. 21 Other professional services—e. g.,

accounting—provide similar examples of credentials and certification requirements serving

as NTBs; many countries, for instance, routinely deny visas to professionals who do not

hold locally valid credentials.

Intellectual Property Protection

Counterfeiting—of clothing, auto parts, pharmaceuticals, personal computers with false or

misleading brand names and trade marks—has

become a big business.22 So has illegal copying

of books, audio recordings, movies, videotapes,

and computer soft ware. In many countries,

weak laws and lax enforcement mean that none

Z1’rhe new regulations will be enforced by Japan ‘S Department

of Justice, See “Foreign Attorneys’ Practice in Japan, Other Services 1 ssues Focus of Chicago Conference, International Trade

Reporter, Feb. 12, 1986. Also, T. Lewin, “Lawyers Await Japanese Rules,” Nenr }’ork Times, July 29, 1986, p. D2.

ZzWhi]e estimates for LJ ,S. sales of counterfeit goods, almost

all imported, run well into the tens of billions of dollars, there

is little agreement on the actual size of the counterfeit goods

market. See A.M. De Stefano, “Customs Agents Fight OftenI,osing Battle Against Illegal Imports: Up to $40 Billion of Fakes,

Contraband Enter Yearly, Some Experts Estimate, ” Wall Street

journal, Jan. 28, 1986, p. 1; and B. Stokes, “Intellectual Piracy

Captures the Attention of the President and Congress, ” National

)ournal, Feb. 22, 1986, p. 443. On efforts to control illegal imports, see U.S. Firms View’s on Customs Protection of Intellectual Property Rights, GAO/NSIAD-86-96 (Washington, DC: U.S.

General Accounting Office, May 1986); and D. Hebditch, “Pirate’s

Paradise, ” Datarnation, Sept. 1, 1986, p. 71. On the general problem, see Intellectual Prvpertj Rights in an Age of Electronics

and lnforrnation (tVashington, DC: Office of ‘1’echnology Assessment, April 1986).

The major offenders, according to most accounts, include Singapore, Taiwan, Indonesia, South Korea, the Philippines, Malaysia, Tbailancl, Brazil, Egypt, and Nigeria—C. H. Farnsworth, “U.S. IJlanS I.. Defend !ts patents,” ,\’e\% l“ork Times, Apr. 7, 1986,

p. 1)1.

of the usual instruments—patents, copyrights,

trademarks—provide much protection for intellectual property rights. With most of the

counterfeiting and copying taking place in

LDCs and NICs, the industrialized countries

have a common interest in seeking stronger protection. Most of the problems in services arise

in information-related products—audio and

videotapes, databases, computer software.

Pirating of books has been a major industry

in countries like Singapore for years; it is no

surprise to see the pirates moving on to software, But why has intellectual property protection become a new issue in the Uruguay

Round? In part because of new technology, as

explained in box GG. As long as most computer

programs ran on expensive machines, illegal

copying remained a minor problem. With lowcost PCs opening a mass market, counterfeiters

not only sell fakes that resemble IBM and Apple hardware, they also copy and sell software

for these machines. Illegal copying by individual users has also been widespread. With no

technical means for reliably preventing copying likely to emerge, the problem remains one

for the legal system (or the market).

Services supplied over the telecommunications infrastructure raise similar issues. An online database—consisting, say, of news stories

—might not at first sight appear too different

from the print media on which it draws. But

it is, largely because the database, like fourthgeneration software, has a form that is fluid

rather than fixed. Copyrights were intended for

works like books, musical compositions, and

motion pictures; how can information be registered and protected when the database changes

every day?

Meanwhile, as pointed out in box GG, some

developing countries, and a few in the industrialized world, have considered or taken steps

to relax, rather than strengthen, intellectual

property rights. Weak forms of copyright/patent protection have been proposed in Mexico,

Brazil, and Japan. The motives are straightforward: to make it easier for domestic firms to

take advantage of foreign technology. While the

Japanese copyright proposal for software was
Ch. 9—Foreign Government Policies ● 319

Box GG.—Protecting Intellectual Property

In general, intellectual property can be protected as: 1) a work of art (motion pictures); 2) a work

of fact (encyclopedias, computerized databases); or 3) a work of function (inventions, technological

know-how). l Patents, not copyrights, have traditionally protected works of function.

Systems of Intellectual Property Protection

As pointed out in chapter 6, there is no such thing as an internationally valid patent, trademark,

or copyright: each nation administers its own system. In many countries, copyright and patent laws

have evolved side by side with international agreements like the Berne Convention for the Protection

of Literary and Artistic Works, the Universal Copyright Convention, and the Paris Convention. While

the United States has never joined the Berne Convention, it is one of 96 members of the Paris Convention, the oldest international treaty on patents, trademarks, and unfair competition.

Legal protections for intellectual property tend to be similar among the industrialized nations;

American businesses have become familiar with them, feel able to work with or around them, and

generally believe them adequate. It is in the LDCs and NICs that lack of effective intellectual property

protection has led to competitive difficulties for U.S.-based firms. Some countries rationalize weak

protection for intellectual property in the name of low costs for consumers. It seems clear, however,

that policies in many of the LDCs have been structured to help local firms acquire foreign technologies as quickly and cheaply as possible. Indeed, developing countries—primarily the Group of 77—

have been seeking reduced levels of intellectual property protection in several multilateral forums,

claiming that this is justified to redress the imbalances they perceive between technology haves and

have-nets.z Many LDCs question the view that private ownership of technical knowledge leads to

efficiency in economic development processes; they feel that protection for intellectual property hurts

them while benefiting foreign-based MNCs.

Intellectual Property as a Trade Issue

In the past, intellectual property rights have seldom been viewed as trade-related matters like

tariffs or subsidies. This has changed over the last few years, as complaints over counterfeiting and

piracy have escalated. In the United States, the issue has caught the attention of the Economic Policy

Council in the Cabinet, as well as Congress. The Trade and Tariff Act of 1984 makes protection for

U.S. intellectual property rights a factor in decisions on renewal of agreements under the Generalized

System of Preferences. Among bills in the 100th Congress, both H.R. 3 and S. 490 address the international dimensions of intellectual property rights. Moreover, the Semiconductor Chip Protection Act

passed in 1984 extends protection to foreign parties only if their home country makes good-faith efforts to reciprocate.

National treatment has been common in intellectual property protection—meaning that foreign

parties are to be on the same footing as residents. In fact, overt discrimination has never been common; one result of national treatment is to help perpetuate the uneven levels of protection that have

existed. At the moment, then, perhaps the greatest need is for harmonization in intellectual property

protection—not an easy task given the unwillingness of some countries to control copying and counterfeiting. Some do not subscribe to international regimes; others ignore them. In part because of

disillusionment with WIPO and UNCTAD, the United States and other developed nations have turned

to GATT in search of relief—a step that developing countries have resisted, arguing that intellectual

property issues belong exclusively in WIPO.

ISee Zntellectuai Property Rights in an Age ofl?iectronics and Znibrxnation (Washington, DC: (lffice of Technology Assessment, April 1986),

PP. 65-88. The rising number of cases brought before the U.S. International Trade Commission, rather than patent courts and other specialized

tribunals, illustrates the increasingly political nature of trade-related conflicts over intellectual property rights.

ZWithin the World Intellectual Property organization (WIPO), a United Nations body that now administers the Paris Convention, the LDCS

have proposed compulsory licensing and patent forfeiture requirements, The Code of Conduct on the Transfer of Technology prepared by the

United Nations Conference on Trade and Development (UNCTAD) would forbid business practices such as restrictions on exporting by licensees. See Preserving America’s Industrial Competitiveness: A Special Report on The Protection of Intellectual Property Rights (Washington,

DC: President’s Commission on Industrial Competitiveness, 1984), pp. 35-37.
320 ● International Competition in Services

While multilateral forums like WIPO do provide a venue for discussion, such bodies are unlikely

to take meaningful action. Given problems of some urgency in fast-moving industries like software

and information services, U.S. negotiators will need to involve WIPO but cannot depend on it for

progress. Bilateral negotiations will probably prove more fruitful, at least in the short run. Indeed,

in the case of South Korea, they already have. After extended negotiations, Korean officials agreed

to implement stronger patent and copyright protections.3 Progress bilaterally can help lay groundwork for more comprehensive multilateral agreements, in GATT or elsewhere. But protection for

software poses still knottier problems, because traditional mechanisms have proven inadequate for

technical reasons.

Computer Software

None of the familiar categories of intellectual property protection fit software comfortably; because computer programs have high development costs but low production costs, and can be easily

duplicated, unauthorized copying is common–particularly for the standardized programs that run

on small machines. Piracy and counterfeiting have become a major concern for U.S. software producers, both at home and abroad; ADAPSO, the trade association of computer software and services

firms, claims that unauthorized copying cost the American industry $800 million in lost revenues

in 1985. At present, American software companies lead the world; without better control over illegal

copying, their future competitiveness could be harmed. The special problems of protecting softwareand its significance-make this something of a test case for the evolution of the intellectual property

protection system.

Of the two routes to protection, technical means—supplying programs in such a form as to make

copying impractical or impossible-have consistently proved ineffective. Software pirates quickly

find ways around new protective schemes, no matter how ingenious, just as car thieves manage to

keep stealing automobiles; indeed, a copy-protection defeating industry exists.4 Moreover, corporate

customers have tended to oppose the technical schemes because of their inconvenience. Legal means,

the second route to protection, seem to offer the only hope of a practical solution. The problem is

that neither the laws governing patents and copyrights, nor the administrative procedures for enforcement, were designed with products like software in mind.

In effect, software falls between the stools of patent and copyright law. Of the three types of intellectual property--works of art, fact, or function-computer programs would be classed most naturally

as works of function. However, they do not fit this class in a legal sense, generally failing tests based

on prior art and tangible physical form. U.S. courts have held that patents can only be granted for

programs that implement physical operations-e.g., running a typesetting machine or a numerically

controlled machine tool. Although many such applications exist, and patenting of programs has been

rising, such applications account for only a tiny fraction of all software.

Patents, where granted, protect the functional aspects of the program—what it does, rather than

the code that implements the program’s functions. Under U.S. law, software can be protected through

copyright as a form of writing or work of art; but in this case the copyright protects the written or

coded program, not its function or its logical structure. Because the same functions can be coded

in many ways—indeed, there maybe an almost infinite set of program codings (and logical structures)

that will yield a functionally equivalent software package-protecting only the code accomplishes

little. With effort, others can duplicate what the program does without duplicating the coding.

%.B. Butler, “US and S. Korea Reaolve Trade Disputes,” EYnunclaf Tfmes, July 22, 1S86, p. 6. Under previous Korean laws, for example,

chemical and pharmaceutical products could not be patented. Alaoaee “U.S. Plans To Defend Ita Patenta,” New York Times, April 7,1986, p. D1.

-, for example, J. Taylor, “The Copy Protection Wara,” PC A4agaxine, Ian. 14, 1966, p. 165; also P.B. Gray, “A Software40ck Breaker

Becomee A Hero to Some, a Villain to Others,” WaU Street burnaf, Feb. 27,1986, p. 23. On uaer opposition, eee V. McClellan, “Padlock Copy

Protection: End of an Era,” Digital Review, Sept. 1, 19S6, p. 64.
Ch. 9—Foreign Government Policies ● 321

Gradually, then, legal decisions have been accumulating that extend copyright protection to the

functions available to users. Currently, an infringement suit can be brought if someone else’s software

closely resembles, from the user’s viewpoint, the copyrighted products This is a limited step, in part

because software is evolving in the direction of programs that users can modify to suit individual

requirements (fourth-generation language s, ch. 5). If customers can define or change the function

of purchased software, will it be possible to protect the functional features? At present, there seems

no easy way out of such dilemmas; in any event, copyright law in much of the rest of the world has

hardly begun to confront them.

‘E. Lach, “Court Backs ‘Look & Feel’ Copyright, ” Infoworld, Oct. 20, 1986, p. 1; W.M. Bulkeley, “Courts Expand the Copyright Protection

of Software, but Many Questions Remain,” Wall Str@)ournal, Nov. 18, 1986, p, 35; D. Stipp, “Lotus Suit Charges Two Software Firms Infringe

on 1-2-3 Program Copyrights,” Wall Street Journal, Jan. 13, 1987, p. 8.

ultimately defeated because of protests from consuming, A dozen other countries have been

domestic as well as foreign software suppliers, equally blatant offenders. Dealing with them

the Mexican and Brazilian laws still stand. on a case-by-case basis, rather than in mulOn the other hand, recent concessions by tilateral forums, puts considerable strain on the

South Korea—a notorious offender—show that responsible U.S. agencies. And, in countries

progress is possible (see box GG). The agree- where governments have tolerated piracy and

ment, which took several years to negotiate, also illegal copying for years, enforcement may be

suggests the dimensions of the problem. Bi- more important than the letter of the law,

lateral negot ations are expensive and timeINTERNATIONAL NEGOTIATIONS

The United States has many competitive

strengths in the services, starting with an unmatched base in information technologies. The

first step in maintaining the Nation’s competitive position is simply to continue the policies

that have helped foster past growth—policies

that range from promotion of competition

through vigorous antitrust enforcement to support for research in technology and science,

In an increasingly interdependent world economy, however, domestic measures will not by

themselves suffice. Nor will trade negotiations

within GATT, no matter how successful. Negotiations in other forums will also be needed,

Reasons for pursuing issues related to the

services in forums outside GATT begin with

the need to improve GATT discipline over trade

in goods. Pushing too hard for a services agreement might endanger progress on the goods

track. Despite attempts to separate them, and

despite the two-track agenda for the Uruguay

Round, goods and services will remain linked

in the eyes of many countries. When it comes

to the services, it is possible that negotiations

will move beyond general questions to sectorspecific issues, If they do, some nations will

seek concessions on goods trade in exchange

for concessions on services.

In any case, a GATT umbrella agreement on

services should make progress easier in other

multilateral forums and in bilateral talks (where

the U.S.-Israel Declaration on Trade in Services may also provide a model for future agreements). Although the choice of forums for supplementary discussions will itself become a

matter for negotiation among governments—

and among agencies within the U.S. Government—there are a priori reasons for suggesting that GATT and the OECD will remain the

appropriate places for issues of trade and investment flows, that specialized bodies like the

CC ITT offer the best prospects for agreements
322 ● International Competition in Services

on technical standards, that export subsidies

and mixed credits are a matter for the OECD,

and so on.

GATT and the Uruguay Round; Other Forums

While the United States has laid solid groundwork for discussions on the entire range of new

issues within GATT, resistance on the part of

developing countries will continue as the Uruguay Round unfolds. Few of these countries

have developed more than a vague sense of their

interests; the strong stand of the United States,

and now Japan and the EC, heightens suspicion that concessions on services and other new

issues will be to the disadvantage of the Third

World, As developing countries focus on the

substance of the negotiations, analyzing the potential benefits of liberalization, some of their

suspicions will be dispelled. But if pragmatism

will overcome some objections, it will not be

enough when these objections have roots in ongoing strategies for economic development.

LDCs and NICs will continue looking to import substitution and export-led growth as paths

to industrialization and an improved position

in the world economy; they will continue to resist efforts to lower barriers that shelter firms

and industries they regard as vital for development.

Given continuing Third World opposition—

some of it stemming from desire to slow the

inroads of Western cultures, some from traditional reliance on regulatory practices that create quasi-NTBs, some from long-held development objectives—the United States and the

other industrial countries may have to turn to

forums that do not require the consent of developing countries. When it comes to narrower

questions, bodies outside GATT not only have

a well-established place but may offer better

prospects for reaching agreement. Table 54

gives a possible schema for matching issues and

forums. The OECD, for example, could provide

something of a parallel to GATT for the more

general issues; indeed, several OECD codes are

being revised to integrate services more fully.

Moving ahead in the OECD (or bilaterally) while

the Uruguay Round is in progress risks resentment in developing countries if they feel unable to influence the new regimes being negotiated; even so, this could be a prod to substantive

negotiations within GATT.

Moreover, bilateral negotiations on servicesrelated issues between the United States and

such major trading partners as Japan, Canada,

and the members of the EC will be needed no

matter the progress in GATT. There can be no

simple formulas for such talks. Rubrics like national treatment and reciprocity put forth in

the past have not proved very useful in finding

common ground for resolving long-lasting conflicts; nor have these general principles proven

of much value in defending U.S. interests in

specific cases. Nonetheless, greater harmonization of policies affecting services will clearly

remain a primary aim of U.S. negotiators.

Toward a Better Linkage of Foreign

and Domestic Policy

When it comes to negotiating with other governments, the United States must live with a

real disadvantage: the lack of a coherent institutional structure for arriving at bargaining positions and determining who will do the negotiating—a longstanding and much-noted aspect

of U.S. trade policy, Talks on services will bring

new complications where they touch on matters under the jurisdictions of regulatory agencies that have usually been well-removed from

international deliberations and international

responsibilities,

The Office of the United States Trade Representative (USTR) shares the responsibility of

preparing for trade talks with the Department

of Commerce, as well as the Departments of

State and Treasury. A panoply of agencies—

the Federal Reserve Board, FCC, Department

of Justice, Federal Trade Commission, among

many others—play a role in domestic decisions

that have direct or indirect impacts on the international competitiveness of U.S. industries,

and, potentially, on U.S. negotiating positions.

Some of these agencies have responsibilities

that extend to international matters; others have

largely domestic horizons. In the absence of

careful White House scrutiny, and continuing

supervision, U.S. policies can easily become incoherent and stay that way.
Ch. 9—Foreign Government Policies ● 323

Table 54.—Examples of Issues and Forums Relevant to the Services

GATT OECD Other

Trade barriers . . . . . . . . . . . . . . / United Nations Council on

Trade and Development

(UNCTAD)

Investment barriers . . . . . . . . Trade-related / Economic summits; United

Nations Commission on

Transnational Corporations

(UNCTC)

Transborder data flow

restrictions . . . . . . . . . . . # / UNCTC

Government procurement

regulations . . . . . . . . . . . . . . . @ #

Export credits . . . . . . . . . . . . . . / # UNCTAD

Intellectual property . . . . . . . . . / # WIPOa

Technical standards . . . . . . . . . @ # International Organization for

Standardization (ISO); ITU

(including CCITT and b

WATTC)a

KEY GATT = General Agreement on Tariffs and Trade,

OECD = Organization for Economic Cooperation and Development;

WIPO = World Intellectual Property Organization,

ITU = International Telecommunication Union

aNow affiliated with the United Nations

bThe ccI~ (consultative committee for International Telephone and Telegraph), a permanent IW body, makes recommendations

on technical standards The WA1’TC (World Admi nmtrative Telephone and Telegraph Conference) meets on occasion to consider

changes in ITU regulations

SOURCE Office of Technology Assessment, 1987

The need to develop and present a consistent U.S. position will become, if anything, more

pressing if the Uruguay Round moves on to

sector-specific deliberations—e. g., for services

like telecommunications, where other forums

have established and ongoing roles. Thus the

U.S. position at upcoming ITU meetings (table

54) will need to be closely coordinated with any

sector-specific discussions on telecommunications that might be underway in GATT. The

ITU has scheduled a plenary session of the

CC ITT during 1988, along with a World Administrative Telephone and Telegraph Conference

(WATTC) meeting–the first since the early

1970s. These will be followed by a plenipotentiary meeting of the ITU in 1989. When it comes

to the ITU, the State Department has the job

of developing and presenting the U.S. position

—with substantive policy input from other

agencies, and extensive consultation with the

private sector, This task has become much more

CONCLUDING

The United States comes to the new GATT

round in an impressive position. The international competitiveness of American service

difficult with the breakup of AT&T. Not only

do several Federal agencies need to be involved

—State, the FCC, USTR, Commerce’s National

Telecommunications and Information Administration—but literally hundreds of U.S. firms

now have a stake in ITU decisions.

It has become trite for reports like this to suggest remedies such as more effective coordination by the Executive Office of the President

or consolidations of existing agencies (e. g., a

department of international trade and industry). Nevertheless, even those who regard such

proposals as unrealistic must admit that the

problems are real ones, and sometimes have

serious consequences for U.S. foreign economic policy. Services, as a new issue on the

national agenda, may offer an opportunity for

Congress and the executive branch to consider

a somewhat less chaotic set of arrangements—a

question to which the next chapter returns,

REMARKS

firms remains generally high; the size of the

U.S. market makes the threat of restrictions on

foreign access a powerful negotiating weapon.
324 ● International Competition in Services

But the Uruguay Round also poses a major challenge for U.S. leadership. As the United States

continues to impose ad hoc restrictions on imports of goods, gaps between action and rhetoric become harder to paper over. Developing

countries will not be likely to accept liberalization of services trade accompanied by continued closing of markets for the labor-intensive

goods they must export in order to grow and

to service their debt. Nor does the United States,

today, necessarily have the economic muscle

to get its way.

The background prospect of a surge of protectionist sentiment in the United States, or

reciprocity legislation, may deter some of the

more objectionable forms of protectionism in

other countries, and help bring them to the bargaining table. But given the nature of the problems afflicting the international trading system,

more may be needed than bargaining as usual.

When it comes to intellectual property rights,

for example, the United States has been successful with South Korea, as well as in getting

the issue onto the Uruguay Round agenda.

Meanwhile, various bills have been proposed

to penalize countries that fail to recognize the

rights of U.S.-based firms. Some bills would set

time limits for negotiations with offending

countries; if an acceptable agreement could not

be worked out, the President would be expected

to apply countermeasures of one sort or another.

Others would prescribe specific negotiating objectives. But the greater need seems to be for

a U.S. strategy aimed at establishing a new regime for intellectual property protection—one

better suited to current and emerging technologies. Developing such a strategy might take

a good deal of analysis and planning before negotiations began.

International technical standards provide

another sort of illustration of the shortcomings

in the U.S. approach to foreign economic policy. This country does not always have a good

grasp of what is at stake when it comes to such

questions. To many people, the standard-setting process seems opaque, the technical questions a mystery. Many of the firm-specific or

country-specific interests remain hidden. International negotiating forums are slow-moving

and perplexing, if not byzantine.

It is certainly true that those who set broad

policy goals will seldom need to concern themselves with the details of standards; still, in the

United States, the policymaking community has

perhaps underestimated their significance for

international competition, particularly with tariff barriers largely down and NTBs taking their

place. Although the subject is esoteric compared to quotas for steel or subsidies for agricultural products, conflicts over OSI standards

have already done real if minor damage to

U.S.-European relations.

The point is a more general one: leaving aside

national defense, the U.S. policymaking community seldom shows much interest in or understanding of technical matters. Finding new

ways of protecting intellectual property rights

inevitably raises questions that demand some

appreciation of the technologies involved in,

say, fourth-generation computer languages. So

does grasping the stakes involved in negotiations over ISDN standards,

The possibilities for U.S.-European and U. S.-

Japanese cooperation on R&D related to communications and information technologies (or

further cooperation in space) provide a further

example of the increasingly technical character of matters that, most fundamentally, remain

in the realm of foreign policy or international

economic policy. Cooperation might help reduce tensions among the major industrial countries, as well as unnecessary duplication in

research. Cooperation on, say, R&D or demonstration projects for ISDN would be easier to

arrange (and probably more productive) if

limited to industrialized nations. But participation by Third World countries could help reduce the suspicion that initiatives aimed at

liberalizing services and high-technology trade

would necessarily work to their detriment, Including developing countries in multinational

development projects could become an incentive for cooperation on other fronts. The Third

World has strong interests in not being relegated to the margins of technology trade; these

interests create opportunities for liberalizing
Ch. 9—Foreign Government Policies ● 325 —

the world trade regime (as well as impediments). The United States, however, has had

little experience in developing such programs,

or in managing them so they function effectively.

Fundamental conflicts of interest, as well as

lagging understanding by some countries of

what they might gain, slowed the process of

laying groundwork for the new MTN round.

The talks themselves promise to be the most

difficult in GATT’s 40-year history, USTR has

been at the center of U.S. efforts to pursue services liberalization since the beginning. The

agency will be stretched for resources as the

Uruguay Round proceeds, and as services issues proliferate in other forums and bilaterally.

With international negotiations dealing with

specific sectors arising alongside those on

broader principles, USTR will have to rely on

staff work by other agencies. These agencies,

in order to provide effective support, will have

to quickly come up to speed as specialized problems surface. U.S. representatives will have to

be flexible in their choice of forums—and in

coordination of negotiations—and careful to appreciate the underlying development strategies

of other countries. Advisory processes will

probably need restructuring. At present, USTR

works with 14 Industry Sector Advisory Committees (I SACS) representing manufacturing industries, but only two groups drawn from the

services. The farther negotiations move beyond

general principles to sector-specific issues, the

greater will be the need for new ISACs to speak

for service industries and their employees. The

next chapter discusses both resources for USTR,

and advisory mechanisms, in more detail.

Among U.S. handicaps as the new round begins, two deeply rooted attributes of the Nation’s policymaking system stand out: 1) reliance by the Federal Government on military

spending, almost exclusively, to stimulate technological development; and 2) dispersed decisionmaking authority when it comes to regulatory

and trade policies, GATT has been successful

in reducing tariff levels, somewhat less so in

controlling other direct barriers to trade (e. g.,

quotas). Meanwhile, countries around the world

have been turning to indirect and less visible

policy instruments: subsidies, discriminatory

regulations, the entire array of tools associated

with national industrial policies. Certainly, U.S.

negotiators have had success in dealing with

some of the indirect barriers—e. g., convincing

the Japanese to let in foreign lawyers. But in

a more general sense, the United States finds

itself increasingly unable to respond. We have

no tradition of explicit industrial policy, thus

cannot credibly threaten to provide concerted

support for U.S. firms internationally; other

countries know that any policy extending such

support would be subject to reversal on short

notice. At a minimum, achieving U.S. goals on

services and other new issues in the Uruguay

Round will demand careful attention to the

management of jurisdictional overlaps within

the Federal Government, particularly where domestic regulatory policies and foreign economic policy come together, Beyond this, the

many Federal agencies whose policies affect

the competitive ability of U.S.-based service

firms—either directly or as side-effects of domestic regulatory policies—will need to take

greater account of these impacts in the future,

a point stressed in the next chapter,
Chapter 10

U.S. Government Policies:

Issues and Options
CONTENTS

Page

Summary . . . . . . . ........ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ........329

Overview of Policy Options .. . .. ... ........ . .......33 0

The Services in U.S. Trade Policy . . . . . . . . . . . . . . . . ........... ....333

U.S. Trade Policy: Overtaken by Events?. . . . . . . . . . . . . . . . . ...........333

The Service Industries: New on the American political Agenda .........334

Negotiating Strategies in the Uruguay Round . ............. . .......335

Trade Analysis and Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. ....339

Support for the Negotiations Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ..342

Other Trade-Related Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ..345

Domestic Policy and International Competitiveness . ....................348

The Example of Banking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ........348

The Case of Telecommunications . . . . . . ........ . ...................352

Human Resources Policies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ........ ..354

Reevaluation of Human Resources Policies . . . . . . . . . ..................355

Adult Education and Training. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ..356

Vocational and Paraprofessional Education and Training . .............359

Instructional Technology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .........359

Industrial and Technology Policies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. ...361

R&D in the Services. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. .. .. .. .......361

Research, Development, and Diffusion of Commercial Technologies . . . ..361

Access to Foreign Technology . . . . . . . ...............................365

Military R&D; Federal Government Procurement. . ....................366

Technical Standards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .............367

Organization and Effectiveness of Federal Policymaking.. . . . ............369

Concluding Remarks. . . . . . - . ....... . .............................,372

Appendix 10A: Effects of Tax Policy on International Competitiveness

in the Services . . . . . . ● . . . . . . . . . . . . . . . . . . . . . . ● . . ● ● ● ● . . ● . . . ● 374

Boxes

Box Page

HH. The R&D Tax Credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .364

II. Federal Procurement of Engineering and Construction Services .. ....367

Figure

Figure No. Page

50. USTR Advisory Committees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .......344

Tables

Table No. Page

55.

56.

57.

58.

59.

60,

61.

Summary Guide to Policy Options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .331

Issue Area I: The Services and U.S. Trade Policy . . . . . .............0336

Other Trade-Related Issues . . . . . . . . . . . . . . . . . ......................345

Overseas Commercial Services Compared . . . . . . . . . . . . . . . . ......347

Issue Area II: Linkages Between Domestic Policies and International

Competitiveness. .. .. .. . . . . . . . . . . . . . . . . . . . . . . . ........349

Issue Area III: Human Resources. .. ... ... ... . ..............,.357

Issue Area IV: Technology Development . ........................362
Chapter 10

U.S. Government Policies: Issues and Options

SUMMARY

International competitiveness has domestic

roots: the ability of an American firm in any

industry to compete with foreign rivals depends

on its costs of production, on the design of its

products, on its marketing skills—in short, on

its ability to provide customers with what they

want, at a price they’re willing to pay. No U.S.

trade or foreign economic policy can in itself

reverse the fortunes of an industrial sector that

has lost, in a fundamental sense, the ability to

compete internationally. Domestic policies of

the U.S. Government might (or might not) be

able to help such an industry rebuild its competitiveness. Trade policy might be able to

equalize the terms of competition between U.S.

and foreign firms. The same logic holds for an

American industry at the top of the international competitive ranking: Federal policies

cannot ensure that the sector will remain on

top, although they can support the industry’s

own efforts. The implication: when it comes

to international competitiveness, the first condition for effective policymaking is an appreciation of what government can expect to accomplish and what it cannot. The second condition

is an appreciation for the ways (often subtle and

indirect), and the time scales (often long), in

which domestically directed policies—whether

dealing with regulation of banking, with support for technology development, with education and training—affect the international competitive ability of American firms.

Such is the context for the discussion in this

chapter of government policies that affect the

competitiveness of the Nation’s service industries. The chapter covers 33 policy alternatives.

Much of the discussion reflects the “new issues” character of trade and competition in the

services. Governments are just beginning to

grapple with the implications for international

trade and competition of economies heavily

tilted toward the services. While the United

States is further along than most, here too the

process of articulating goals and implementing policies remains in its early stages. Efforts

by business interests to get services trade onto

the Nation’s policy agenda began in earnest in

the 1970s. By 1982, the U.S. Trade Representative (USTR) was seeking a place for services in

a proposed new MTN round (multilateral trade

negotiations, ch. 9). Congress, in its 1984 trade

bill, gave USTR responsibility for coordinating the development of trade policy for the services, and charged the Department of Commerce

with devising a service industries development

program. Meeting in Uruguay in September

1986, members of the General Agreement on

Tariffs and Trade (GATT) agreed to begin a new

trade round including discussion of services.

The Uruguay Round negotiations promise to

be lengthy and difficult. The concessions the

United States can realistically ask of other nations, and those it can offer in return, will depend to considerable extent on domestic regulatory structures. But while trade negotiators

must remain keenly aware of the constraints

and opportunities presented by domestic policies, the linkage has been mostly one-way: considerations of international trade and competition have seldom had much influence on

domestic policymaking. The policymaking

apparatus stems from an era when trade and

domestic policies could be kept separate and

distinct. Even in the 1950s and 1960s, the impacts of Federal policies rarely extended beyond the domestic economy. This is no longer

true, but policymaking processes seldom reflect

the new realities—and far less for service industries than for manufacturing (because services trade is not only smaller but less visible).

The central message of this chapter can then

be summarized as follows:

● American service industries must compete

in a world of increasingly potent rivals.

● Federal Government policies traditionally

329
330

●

●

● International Competition in Services

viewed as domestic affect the ability of

American firms to compete internationally.

Policy makers—including those in regulatory agencies—need to consider, as a matter of course, the impacts of their decisions

on international trade and competition.

This new and broader view will be more

vital for the services than for manufacturing because government policies have

greater influence over competitiveness in

the service industries, many of which are

regulated,

If the needed changes come too late, U.S. international competitiveness in the services will

probably slip. If competitiveness in the services slips as much as it has in manufacturing,

the Nation’s living standards will be further endangered,

Although the new competitive realities for

American industry have been apparent since

the 1970s, Federal agencies by and large continue to slight the international impacts of domestic policies. Today, policy issues—be they

matters of R&D support for industries like engineering and construction (E&C), the role of the

Federal Communications Commission (FCC)

as the telecommunications industry continues

to restructure, or restrictions on interstate

banking—must be seen in a new context. This

context—one in which U.S. industries are immersed in a global economy, sometimes competing with foreign firms, sometimes cooperating with them—means that domestic and

foreign economic policies can no longer be

viewed independently, Because the changes are

so fundamental, it may be time for Congress

to seriously consider equally fundamental shifts

in the structure of the Nation policymaking

apparatus. While changes in structure (for instance, the establishment of a cabinet-level department of trade) are no substitute for good

policy, they could give policy makers the tools

needed to implement well-conceived policies—

tools that, judging by results, they do not currently seem to have.

OVERVIEW OF POLICY OPTIONS

Beginning with trade issues, the discussion

in this chapter turns to linkages between domestic policies and international competitiveness, to human resources, and to technology

development, before returning to the policymaking process itself, This section outlines the

main themes, with selective references to the

policy options listed in table 55. This first table

identifies the issues and options covered in the

chapter, listing each by number. Tables 56, 57,

and 59-61, which follow later, summarize the

options. Appendix 10A, at the end of the chapter, outlines a few of the many ways in which

tax policy can affect competitiveness in the

services.

With major trade bills (H.R. 3 and S. 490)

quickly introduced in both House and Senate,

a new record current account deficit in 1986

(some $141 billion), and a new GATT round

beginning, there is every reason to expect that

trade will remain in the spotlight during the

100th Congress, The Administration, as well,

may be ready to assign competitiveness a higher

priority. 1 Two overriding concerns will continue to shape the debate: 1) how to manage

the strains that rapid competitive shifts have

forced on the U.S. economy; and 2) how to continue working toward a more open international economic system. These two broad objectives inevitably come into conflict.

A trade policy that the public understands

and accepts must be based on a shared view

of U.S. interests. The question policy makers

constantly face from domestic constituents and

interest groups is this: How, specifically, does

the United States benefit from continued liberalization of the world trading system? Good answers depend on an understanding of the

I President Reagan’s competitiveness package is the proposed

Trade, Employment, and Productivity Act of 1987, H.R. 1154

and S. 539.
Ch. 10—U.S. Government Policies: Issues and Options ● 331

Table 55.—Summary Guide to Policy Optionsa

Issue Area Option Relevant service sector

/. The Services and U.S. Trade Policy (see table 56, p. 336; for details)

A. NEGOTIATING OBJECTIVES

—Congressional guidance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

B. COORDINATION OF SERVICES POLICY

c.

D.

E.

Il.

A.

B.

Ill.

—Oversight on coordination of trade negotiations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

TRADE ANALYSIS AND DATA

—Long-term analysis for trade policy and planning . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

—Oversight on collection of services trade data (also see Option 12) . . . . . . . . . . . . . . 4

—Improving the data on trade in services and on technical licensing . . . . . . . . . . . . . . 5

SUPPORT FOR THE NEGOTIATIONS PROCESS

—Staff and budget for USTR and other agencies. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

–Service sector advisory committees (also see Option 16) . . . . . . . . . . . . . . . . . . . . . . . 7

—Continuing evaluation of U.S. and foreign regulations that act as non-tariff

barriers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

OTHER TRADE-RELATED ISSUES (see table 57, p. 345)

—Overseas promotion of exports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

—Tied aid and mixed credits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

—Trade and Development Program (TDP) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

Linkages between Domestic Policies and International Competitiveness (table 59, p. 349)

EXAMPLES FROM BANKING AND FINANCIAL SERVICES

—Data on international trade in banking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

—Office on international impacts of banking policies . . . . . . . . . . . . . . . . . . . . . . . . . . .

—International coordination of regulations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

EXAMPLES FROM TELECOMMUNICATIONS

—Negotiating objectives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

—Advisory committee on telecommunications negotiations . . . . . . . . . . . . . . . . . . . . . .

—Institutional mechanisms for addressing impacts of domestic policies on

competitiveness. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Human Resources (table 60, p. 357)

A. EVALUATION

—Fundamental reexamination of human resources policies as they affect

competitiveness. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

B. ADULT EDUCATION AND TRAINING

—Demonstration projects for training/retraining of the active work force . . . . . . . . . . .

—Increasing the national commitment to education and training of active workers . .

—Postsecondary vocational/technical curricula . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

C. INSTRUCTIONAL TECHNOLOGY

—Inventory of federally developed training materials . . . . . . . . . . . . . . . . . . . . . . . . . . . .

—Transfer of federally developed training methods, procedures, and course

materials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

—Funding for research, development, evaluation, and dissemination of instructional

technologies. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

IV. Technology Development (table 61, p. 362)

A. R&D IN THE SERVICES

—Improving Federal Government data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

B. THE U.S. TECHNOLOGY BASE

—Federal support for commercial R&D . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

—Technology diffusion to industry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

—Implementation of Japanese Technical Literature Act. . . . . . . . . . . . . . . . . . . . . . . . . .

—International exchanges of technical personnel . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

—Equitable access to foreign technology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

—Analysis of impacts of defense-related R&D on U.S. competitiveness . . . . . . . . . . . .

C. TECHNICAL STANDARDS

—Federal testing and demonstration facility for ISDN . . . . . . . . . . . . . . . . . . . . . . . . . . .

—Preparation for upcoming meetings of the

International Telecommunication Union . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

29

30

31

32

33

all

all

all

all

all; licensing

all

all

al I

primarily E&C

primarily E&C

primarily E&C

banking

banking

banking

telecommunications;

telecommunications

telecommunicate ions

all

all

all

al I

potentially all

potentially all

all

all

all, E&C

all

all

all

all

all

information and

telecommunicate ions;

indirectly all

information and

telecommunications;

indirectly all

aThf~ table appeared In ch 1 as table 2

SOURCE Off Ice of Technology Assessment, 1987
332 ● International Competition in Services

sector-specific strengths and weaknesses of the

Nation’s economy. This will be as true when

it comes to liberalization of trade and investment in the services as it has been for goods

trade. OTA’s analysis in earlier chapters shows

many U.S. service industries to be highly competitive internationally. It is the case that the

E&C industry has been losing ground since the

1970s, while sectors like banking face strong

competition. But considering the services as

a whole, liberalization of trade and investment

should help maintain U.S. advantages.

To get agreements in the services, however,

the United States will probably have to make

concessions elsewhere: discussion of services

in the new round will not take place in a

vacuum. With GATT discipline over trade in

goods breaking down, crafting the U.S. position may prove tricky. Along with other industrialized nations, the United States has restricted imports of goods ranging from steel to

textiles, automobiles to television sets. Some

of these restrictions plainly meet GATT tests;

others have evaded the spirit if not the letter

of the rules. As pointed out in the preceding

chapter, much of the opposition to services negotiations in the new round has arisen among

developing nations that have found access for

their exports of merchandise closing down. Despite the two-track nature of the Uruguay

Round, the Third World will certainly ask that

the industrial countries take more of their goods

in return for liberalization in services.

On such questions concerning the place of

the services in U.S. trade policy, OTA discusses

eight policy options (table 55), beginning with

negotiating strategy in the Uruguay Round.

While Congress traditionally gives the executive branch considerable flexibility in conducting such negotiations, congressional guidance,

formal or informal, will be needed if the Administration is to bring back a politically acceptable agreement (Option 1). Congress may also

wish to assure, through oversight and legislative action where needed, that executive branch

coordinating procedures are adequate to develop and maintain consistent U.S. positions

in GATT and the other international forums

where services will be discussed (Option 2).

With a growing number of countries active

in world trade, and with trade negotiations on

more fronts, better analytical support has become a critical need for U.S. trade policy (Options 3-5). As OTA has noted elsewhere, Federal agencies could with little difficulty

substantially improve their data on trade in

services. 2 Better data will not be of much value

to decisionmakers, however, without the analytical expertise to place it in long-term policy

perspective. The desire to strengthen processes

for formulating and implementing policy lies

behind many of the proposals to create a new

department of trade, or otherwise reorganize

executive branch trade functions. By itself,

trade reorganization would not necessarily accomplish this; but Congress could create better support systems—available should policymakers choose to call on them.

Regulatory decisions influence U.S. competitiveness in many ways—some direct, some

indirect—particularly in sectors like banking

and telecommunications, overseen by numerous agencies having overlapping or complementary responsibilities. Yet potential impacts on U.S. competitiveness rarely have much

of a role in agency decisions; when they do,

the matter is usually viewed as exceptional.

Sooner or later, this will have to change, with

decisionmaking, regulatory and otherwise, routinely encompassing competitive impacts:

OTA’s analysis points to the need for a betterdeveloped institutional framework for dealing

with the linkages between domestic policies

and international competitiveness. Here, examples from banking and telecommunications provide the primary context for examining alternatives (Options 12-17).

Previous OTA assessments have consistently

pointed to human capital as the foundation for

internationally competitive industries. Americans will need new skills as their employers

restructure and adopt new technologies. People with poor skills are most likely to lose their

jobs as a consequence of restructuring. But

compared with other industrial nations, the

2Trade in Sertrices: Exports and Foreign Revenues [Washington, DC: Office of Technology Assessment, September 1986].
Ch. 10—U.S. Government Policies: Issues and Options ● 333

U.S. Government provides little public support

for adult education and training (Options 19-

21). More emphasis on the development of instructional technologies also seems called for;

computer systems pose fundamentally new opportunities at all levels of the educational system. Using them effectively will demand research and pilot projects (Options 22-24). Most

generally, adapting an education and training

system rooted in the 19th century to the needs

of the 21st may well require a comprehensive

overhaul of public policies. The first step is to

reevaluate these needs and policies at the most

fundamental level; the effort to reformulate human resources policies has hardly begun, despite the many studies of the U.S. educational

system to appear over the past several years.

Throughout this report, OTA has stressed the

interdependence of manufacturing and the

services—with the competitive ability of U.S.

firms in data processing and information services, for instance, depending on the competitiveness of U.S. computer and telecommunications equipment manufacturers, as well as

software firms. Likewise, U.S. competitiveness

in financial services stems in part from the excellence of the Nation’s telecommunications

infrastructure—and, more generally, from the

ability of American companies to effectively

utilize computer-based technologies of all kinds.

As such examples suggest, the services depend

on much the same technology/science base as

manufacturing. Because the very idea of R&D

in the services has been ill-defined and often

unrecognized, the first step here is simply for

Federal agencies to acknowledge the role of

THE SERVICES IN

U.S. Trade Policy: Overtaken by Events?

Although the United States has worked actively to promote a liberal international economic order since the 1940s, our leadership has

been called into question in recent years. And,

with other nations catching up economically,

a series of Administrations has been criticized

for lacking policies suited to the new problems

technology in service industries (for instance,

by revising procedures for collecting data on

R&D related to the services–Option 25).

But as the analysis in chapter 6 suggests,

along with previous OTA reports, the Nation’s

technological problems go much deeper. In recent years, the political climate has been less

than hospitable for Federal spending on applied

research (except for defense) or commercial

technology development; the Reagan Administration has been content to fund basic science,

holding that this will suffice to rebuild the international competitiveness of American industries. Congress, in several pieces of legislation,

has enacted a framework for a more comprehensive technology policy. As yet, the Administration has implemented only a few of the specifics in these laws. If Congress wishes to

strengthen the Federal role in development and

diffusion of commercial technologies, additional directives to the Administration maybe

required (Options 26, 27, and 31).

Finally, the Nation’s overall policymaking

system may itself need redefinition. Structural

change in the U.S. and world economies has

helped bring the problems into focus, but real

change—in the sense of better coordination and

integration of trade and domestic policies (as

these affect both the services and manufacturing)—has yet to follow, Redefinition need not

imply self-conscious attempts at reorganizing

or reapportioning responsibilities for either

trade or domestic policies, although there is no

reason to rule these out a priori,

U.S. TRADE POLICY

of maintaining U.S. competitiveness in a world

of increasingly able competitors.

OTA’s previous assessments of international

competitiveness have stressed two points concerning trade policies and trade negotiations:3

‘See, in particular, lnternatjona) Cornpetiti\’eness in EIef:tror]jcs

(Washing tori, DC: office of Technology Assessment, November

1983), ch. 11.
334 ● International Competition in Services

●

●

Structural change in the world economy

has outstripped the response capability, not

only of GATT, but of U.S. trade law. Driven

in part by technological change and in part

by international business practices, patterns of production and trade now take

forms that were not anticipated when the

GATT framework was devised. In effect,

governments have greater difficulty in

defining national interests in a highly integrated global economy—one in which a

fifth of U.S. imports (and much more for

some products) represent shipments from

American-owned affiliates abroad.

National industrial policies, adopted by

governments around-the world, have also

changed the rules of the game. Providing

multiple forms of indirect support for domestic firms, industrial policies aggravate

the problems posed by non-tariff barriers

(NTBs) because many of the routine tools

now used by governments can be viewed—

i.e., by other nations—as trade restrictions

or unfair forms of competition. The record remains mixed when it comes to the

effectiveness of industrial policies, but it

seems clear that many countries are learning to make steadily better use of them. Certainly, experience over the past two decades has taught foreign governments how

to bargain more effectively with multinational corporations (MNCs), using the tools

of industrial policy to shape economic development in accord with national goals

(chs. 6 and 9).

Structural shifts and evolving practices in international business have affected trade and investment in the services fully as much as in

goods-producing industries. So have national

industrial policies, particularly in sectors like

telecommunications.

Policymaking processes within the U.S. Government, as well as in bodies like GATT, have

shown no more than modest capacity to adjust

to the new realities. Whether in the steel industry or microelectronics, events now seem to

move too quickly for the policy apparatus to

respond. By the time trade complaints have

moved through the system, and some resolution seems at hand—often a matter of years—

the competitive landscape may have changed

almost beyond recognition. Voluntary restraint

agreements (VRAs) covering imports of machine tools, for example, came (at the end of

1986) a decade after the Nation’s trade balance

in these products turned negative, and more

than 3 years after a request for relief by the National Machine Tool Builders’ Association.

More fundamentally, history offers little hope

that, in an industry like this, VRAs will make

much difference for competitive prospects.

The mounting U.S. trade deficit has resulted,

on the one hand, in sector-specific trade restrictions like the machine tool VRAs. On the other

hand, the United States has continued to advocate further liberalization of world trade—both

rhetorically, and through concrete proposals

in GATT and other international bodies. As

events continue to unfold, it becomes more difficult for the government to reconcile the discrepancies between these two sets of actions.

The enormous number of trade bills proposed

in recent years—more than 700 introduced in

the 99th Congress, 400 in the first five months

of the 100th—shows the extent of concern. Congress enacted major trade laws in 1974, 1979,

and again in 1984. Trade remained a prominent legislative concern during the 99th Congress—a concern that carried over into the

100th Congress.4 In April of 1987, the House

passed an omnibus trade bill (H.R. 3); in May,

the Senate Finance Committee reported out its

trade package (S. 490). (Other Senate committees were still at work on their contributions

to comprehensive trade legislation.)

The Service Industries: New on the American

Political Agenda

Trade in services has more visibility in policy circles than ever before, as reflected in actions taken by both Congress and the executive branch over the past dozen years. Since

dThe House passed an omnibus trade bill in 1986 (H. R. 4800).

While several major trade bills were proposed in the Senate during the 99th Congress, none was reported out of committee. See

R.J, Ahearn, et al., “Trade Legislation: Comparative Analyses

of H.R. 4800 and Selected Senate Trade Bills, ” Congressional

Research Service report 86-740, June 10, 1986.
the early 1970s, business interests have sought

to focus attention on barriers to services trade,

with prominent corporations arguing that they

have been underrepresented in previous MTN

rounds. Banking and finance, insurance, tourism, motion pictures, telecommunications, and

transportation got much of the early attention.

In 1982, the first business organization concerned with the services as a whole emerged—

the Coalition of Service Industries (CSI), with

members ranging from banks to firms providing temporary help services. While the U.S.

Chamber of Commerce includes a services

group, and sectors like banking, insurance, and

construction have had their own trade associations for years, CSI was the first organization

formed to promote the interests of all services.

On the labor side, unions representing service industry employees—including the United

Food and Commercial Workers, the Service

Employees International Union, Communications Workers of America, and the American

Federation of State, County and Municipal

Employees—have been active much longer than

CSI. In recent years, organized labor has placed

a high priority on gaining members on the service side of the economy, where, in contrast to

manufacturing, U.S. employment has been rising. Labor unions, however, have expressed

deep reservations over bringing services into

GATT; in part, this reflects a concern that the

United States might need to give ground in

manufacturing as the price of lower barriers

to services trade,

In Congress, the most important initiative to

this point has been passage of the International

Trade and Investment Act, part of the Trade

and Tariff Act of 1984 (Title III of Public Law

98-573). The Act gives primary responsibility

for developing services trade policy to USTR;

specific duties for the Department of Commerce

include developing policies to increase the competitiveness of U.S. service industries (in consultation with other agencies), collecting and

analyzing data on the services, preparing a biennial report for Congress and the President, and

providing staff support to USTR on servicesrelated trade issues. On a day-to-day basis, the

Office of Service Industries (part of the InterCh. 10—U.S. Government Policies: Issues and Options ● 335

national Trade Administration, ITA) has

responsibility for Commerce’s service industries development program, While the 1984 law

provides a legislative mandate for coordination

among the dozens of Federal agencies involved

in services policy, it is far from clear that the

executive branch has managed to implement

it effectively. Nor had the initial report on Commerce’s services program been submitted when

the 99th Congress adjourned.

Negotiating Strategies in the Uruguay Round

During the new GATT round, negotiators will

deal with services and goods on separate tracks,

Other new issues will share the stage with services, as discussed in the preceding chapter, with

intellectual property rights and counterfeiting,

as well as trade-related investment, on the goods

side of the agenda. In addition, the Uruguay

Round will take up agricultural trade—a subject GATT has been unable to come to grips

with in the past. With the new round scheduled to last until the fall of 1990, Congress will

have ample opportunity to review progress and

provide guidance to U.S. negotiators. An opportunity seems likely in 1987, as Congress

looks at alternatives to renew fast-track approval processes for trade agreements. This or

some other early occasion would give Congress

the opportunity to take stock of U.S. negotiating strategies (Option 1, table 56),

The Tokyo Round showed ongoing congressional involvement to be desirable and most

likely essential if U.S. negotiators are to bring

back a politically acceptable agreement.’ Many

channels, formal and informal, can serve this

purpose. Members of Congress—five from each

house–serve as official advisors to U.S. MTN

delegations. In this capacity, they can attend

negotiating sessions, and are to be kept informed of all developments. Congressional

committees with jurisdiction over trade can

seek the views of, and provide guidance to, U.S.

negotiators in executive session. Congress also

‘See R, R, Ri\rers, “The S\stem CAN Work: The Trade Act of

1979, ” and R.S. Strauss, “Colmnlentary: On Trade, ” &faking Go Irernmen t 11’ork: From JI’hite Hou,se 10 Congress, R.E, Hunter,

\\’. I.. Berman, and J, F’, Kenned\’, eds. ( Boulder, CO: West\ ’iew,

1986), pp. 8-30.
336 ● International Competition in Services

Table 56.—issue Area 1: The Services and U.S. Trade Policy

—

Issue Options for Congress Comments

A. NEGOTIATING OBJECTIVES

While negotiators need flexibility, close continuing contact with Congress is essential

if the Administration is to secure a trade

agreement acceptable to the legislative

branch

B. COORDINATION OF SERVICES POLICY

Developing trade policies for services will

require effective coordination among more

than 30 Federal agencies (including numerous regulatory bodies) with responsibilities for services. U.S. negotiators will

need to develop and present coherent positions at GATT and other multilateral forums, as well as in bilateral discussions.

C. TRADE ANALYSIS AND DATA

Better analytical support would make for

better U.S. trade policy. Long-term policy

planning is a particular need, given the protracted nature of negotiations in forums

such as GATT, which often span two or

more administrations and several Congresses, (Indeed, because the U.S.

negotiating position may shift over time,

other countries sometimes take a waitand-see attitude before negotiating

seriously.)

The current database on trade in services is

seriously deficient. Without better information, policy makers will have continuing

difficulty devising negotiating strategies

and weighing trade-offs among competing

objectives.

OPTION 1: While the Uruguay Round is in

its early stages, Congress could provide

specific guidance to the Administration

on the outcomes it views as most critical

to U.S. interests. This could take forms including:

● informal congressional consultations

with USTR;

● requiring formal consuItation and

reporting at several junctures before the

Administration seeks congressional approval of new GATT agreements;

● legislative statements of U.S. negotiating objectives, possibly including objectives for specific service sectors, This

could involve amending the relevant

portions of the Trade Act of 1974 (e.g.,

Sec. 104A, added in 1984 to define

broad goals dealing with services trade,

foreign direct investment, and trade in

high-technology goods).

OPTION 2: Also at an early point during the

Uruguay Round, Congress could conduct

oversight (and provide guidance and direction where needed) on executive branch

coordination of services trade policy, under Title Ill of Public Law 98-573. In particular, Congress might use the oversight

process to determine whether coordination is adequate for ensuring consistent

U.S. positions in GATT and the other international forums where sector-specific

and specialized issues (e. g., intellectual

property protection) will be discussed.

OPTION 3: Establish a new office for trade

policy analysis, to provide continuing analytical support and institutional memory

for executive branch decisionmaking. The

office could focus on support for day-today decisions, on longer term policy development, or both,

OPTION 4: Conduct oversight on implementation of the International Investment and

Trade in Services Survey Act (as amended

in 1984) to determine whether some of the

discretionary provisions for data collection should be made mandatory.

The new GATT round raises fundamental

questions concerning the U.S. role in the

world trading system—matters going far

beyond possible GATT coverage of the

services:

● In what ways would a stronger GATT

serve U.S. interests?

● WilI U.S. initiatives in services trade

and other new issues—and in agricultural trade—serve to strengthen GATT

as an institution? Will some of them

and not others?

. Other nations will inevitably seek concessions in exchange for agreements

that U.S. policy makers view as important. What sorts of trade-offs is the

United States likely to face as we move

into the Uruguay Round?

● How will U.S. negotiators assign relative priorities to goods and to services

when conflicts between the two arise

during the discussions?

Title Ill of Public Law 98-573 gave USTR

responsibility for developing and coordinating services trade policy, using the

interagency Trade Policy Committee (or

its subcommittees). The law assigns Commerce the task of developing, in consultation with other agencies, policies to

increase the competitiveness of U.S. service industries.

Negotiations affecting trade in services may

take place in other forums as supplements to or in parallel with GATT, Examples include OECD, the World Intellectual

Property Organization, and the international Telecommunication Union. (See table

54 in ch. 9 for further examples.)

The primary reason for creating a new trade

policy analysis unit, rather than simply

providing more resources to an existing

office, would be to place the new group

close to policy makers—and to staff and

structure it accordingly.

In Section 306 of Public Law 98-573, Congress amended prior law to give clear

authorization to the President to collect

data on trade in services, as well as to

continue surveys on foreign investment.

However, Congress left collection of services data discretionary; implementation of

some surveys has been substantially

delayed within the Administration (see

Option 5).
Ch. 10—U.S. Government Policies: Issues and Options ● 337

Table 56.—issue Area 1: The Services and U.S. Trade Policy—Continued

Many of the needed Improvements in serv- OPTION 5: Direct the Commerce Department

ices data would entail changes I n proce- to take specific action to improve data on

dures of the Bureau of Economic Analysis trade in services. Possible steps Include:

(BEA), the Commerce Department unit ●

that compiles trade statistics The Administration has failed to approve some

BEA proposals. Without a congressional “

directive, delays may continue

●

surveying service transactions between

unaffiliated firms (by proceeding with

the BE-20 survey or a modified version),

expanding the Census of Service industries;

altering BEA procedures for presenting

royalties and license fee data to distinguish technology from other categories

of intangible property, and to provide

data on numbers of Iicense agreements

by year, and on receipts and payments

on new Iicense agreements in a given

year

D. SUPPORT FOR THE NEGOTIATIONS PROCESS

Despite the growing number of issues on

If

the Nation’s trade agenda, budget and

staff resources for negotiations remain

modest To be effective in GATT and

other forums, USTR and other agencies

will need Increased support

discussions on services trade move beyond the umbrella stage to sector-specific

topics —and for such talks elsewhere—

U S negotiators will need more input

from service industries and their employees, and from users of services

Regulatory policies lie behind many of the

barriers to services trade and Investment,

includlng regulations that serve Important

public purposes Progress in reducing barriers will depend on willingness by countries to acknowledge and identify

regulations that unnecessarily discriminate against foreign firms

SOURCE Off Ice of Technology Assessment, 1987

OPTION 6: Expand USTR’s budget and staff

to meet not” only the heavy continuing

workload expected over the course of the

Uruguay Round. but also to carry on planning and preparations for subsequent

negotiations, including those in other international forums.

OPTION 7: Direct the Administration to establish several more Industry Sector Advisory Committees (ISACs) to speak for

particular service industries, and several

additional labor subcommittees to speak

for their employees To prepare for sector

specific talks—indeed, to help determine

whether these would be desirable from

the U.S. point of view—Congress could

direct the Administration to establish and

consult with the new advisory groups at

an early date

OPTION 8: Direct USTR (in cooperation with

other agencies) to give high priority to

evaluating both U S and foreign regulations that act, Intentionally or Incidentally,

as non-tariff barriers to trade and investment in the services By taking the initiative, the United States could encourage

other major trading nations to examine

their own regulatory barriers.

has the option of prescribing specific negotiating goals (e. g., as amendments to existing objectives in Sec. 104A of the Trade Act of 1974,

as amended).

OTA’s analysis suggests a number of specific

issues that Congress could examine as it reviews prospects for the Uruguay Round:

● How difficult will it be to take meaningful

steps toward liberalization of trade and investment in services? The obstacles seem

real enough: 1) continuing resistance from

Comments

OTA discusses further steps for Improving

the database on services trade in its special report, Trade in Services: Exports and

Foreign Revenues. Also see Opt Ion 12 in

table 59 on financial services

As part of this process, Congress could

direct the Administration to compile and

annually update a statement Iisting the

contributions of all Federal agencies to

U.S. trade negotiations, and specifying

measures taken by these agencies to

maintain support at adequate levels

The trade advisory committee system authorized by Sec. 135 of the Trade Act of 1974

provides a mechanism for private sector

i n put into trade negotiations. WhiIe an

overall Services Policy Advisory Committee exists, only one ISAC (or two, counting that for wholesaling and retailing)

represents the services at the sectoral

level, compared with 14 for goods (See

Option 16 for discussion of telecommunication s.)

USTR reports annually to Congress on foreign trade barriers. The agency made a

start on identifying U.S. regulations affecting trade in services when it prepared

the U S. national study on services. submitted to GATT in 1983 To reach agreements on reducing barriers to services

trade, nations will first have to decide

what topics are appropriate for discussion. —

developing countries and some industrialized nations, the latter mostly centering on

sector-specific issues; 2) probable conflict

within the U.S. Government over relative

priorities for services and other concerns

(i.e., agriculture, trade in manufactured

goods); 3) resistance to liberalization of

services trade on the part of some domestic interests.

The International Engineering and Construction Industries Council, for example,

has cautioned that bringing services into
338 • International Competition in Services

GATT could mean costs as well as benefits to the U.S. E&C sector.6 As for labor,

the AFL-CIO continues to express its concern that the price of liberalization in the

services might be further concessions on

goods, leading to more imports, further erosion of the U.S. manufacturing base, and

job losses.

Under these circumstances, U.S. officials

have been forced to advocate selective liberalization of services trade. Easing entry

for foreign workers is a politically sensitive issue; so are some kinds of NTBs.

While many U.S. service firms would like

to see GATT guidelines that would let them

move professional employees freely from

country to country, such an agreement

would be hard to achieve without opening

the way for, say, foreigners to work on construction projects here. Among the more

notable NTBs affecting services, restrictions on shipping, such as the Jones Act

in the United States—which limits domestic shipping to vessels built here, crewed

by Americans, and flying the U.S. flag–

would be difficult to change. (Many other

countries have similar laws.)

How useful would an umbrella agreement

on services actually be? USTR seeks a

broad and general set of principles that

would create a framework for continued

discussions in later years (see ch. 9, p. 298).

Later in the Uruguay Round, negotiations

under that umbrella, dealing with narrower

topics and with specific service sectors,

might or might not take place. One of the

primary umbrella objectives, for example,

is for all GATT members to concur in

honoring the principle of national treatment for foreign-based service firms—

meaning that domestic and foreign companies would operate under the same rules.

Such goals seem sensible if abstract, and

not very ambitious. While an umbrella

agreement would set the stage for sectorspecific talks, there are real questions about

the ability of GATT to resolve the sticky

political problems that would follow.

“’IECIC Paper on GATT-March 20, 1986, ” International Engineering and Construction Industries Council, Washington, DC.

●

For the United States, moving onto sector-specific subjects (bilaterally or multilaterally) would mean soliciting a good deal

more input from individual service sectors

and their employees. Lacking this, it is hard

to see how U.S. negotiators could conduct

an intricate series of bargaining sessions

dealing with the particular problems of particular sectors.

Regardless of whether sector-specific discussions take place during the Uruguay

Round, a U.S. policy of conducting bilateral negotiations while the GATT deliberations continue seems unavoidable—

indeed desirable (ch. 9). Moreover, multilateral discussions will also be proceeding in other, more specialized, forums. The

International Telecommunication Union

(ITU) has an important series of talks

scheduled for 1988 and 1989, while the

GATT ministerial declaration states specifically that the Uruguay Round discussions on intellectual property rights are not

to prejudice initiatives in the World Intellectual Property Organization (WIPO) or

elsewhere.

Is it realistic to expect GATT to deal with

questions of investment? Continued opening of the international economic system

implies greater integration of trade and investment regimes; it has become increasingly difficult to retain the rather artificial

separation between the two. Because international business activity in many of the

services requires foreign direct investment

(FDI), any substantial reduction in barriers

to services trade implies a loosening of restrictions on FDI. But many developing

countries view control over inward investment as a vital tool for steering economic

development; they will resist any move to

reduce their leverage. Indeed, some less

developed countries (LDCs) may fear that

talks on services are little more than a stalking horse for an agreement on direct investment.

GATT itself has traditionally focused on

trade, with investment issues a matter for

bodies like the Organization for Economic

Cooperation and Development (OECD) and
.

the International Monetary Fund. In the

Uruguay Round, trade-related investment

—basically, the question of performance

requirements (such as rules permitting FDI

only on condition that some fraction of production be exported) –will be on the goods

side of the agenda.

• With so many highly contentious issues up

for discussion, does the Uruguay Round

promise to strengthen GATT, and thus help

move the world economy toward greater

openness? Dependent on consensus among

its members, and lacking in enforcement

procedures, GATT appears weaker today

than ever. With its ability, as now structured, to maintain a minimal level of discipline over goods trade in some doubt,

would an agreement on services help to

strengthen GATT? Put another way, if the

objective is a stronger GATT, would it

make more sense to concentrate on existing and widely acknowledged problems before taking up new issues?

Without teeth in GATT enforcement procedures, and without, for example, modifying the safeguards provisions—Article

XIX, which permits governments wide lattitude in negotiating “voluntary” restraint

agreements or other import restrictions—

there seems little prospect of reversing the

incremental movement over the past decade toward a system of managed trade. If

this movement continues, bilateral agreements and exceptions to GATT principles

such as the Multi-Fiber Arrangement will

eventually become the dominant reality.

If the United States really seeks a

stronger GATT, fundamental problems

such as these deserve high priority. If, on

the other hand, the United States would

prefer to continue withdrawing as champion of an open international economy,

then a strategy of pursuing incremental

changes that serve U.S. interests, rather

than seeking more basic reforms of GATT

procedures, becomes appropriate. Congress may wish to delve into such matters

before the Uruguay Round moves too far

into matters of substance.

Ch. 10– U.S. Government Policies: issues and Options ● 339

In any case, given a range of services-related

issues to be addressed in a range of international forums, effective coordination among the

various U.S. delegations will be necessary (Option 2, table 56). As noted above, the Trade and

Tariff Act of 1984 assigns both USTR and Commerce statutory responsibilities for coordination and consultation with other agencies on

policies related to the service industries. At this

point, it is not clear how well the procedures

are working, Congressional oversight could

reinforce the importance of coordination; Congress could also explore the possible need for

additional legislation.

Trade Analysis and Information

This and other OTA studies have stressed the

need for good information and analysis in support of trade policy (and domestic policies as

they affect trade)—an especially critical need

today, with international trade relations far

more complicated than when GATT was established. Not only have many more nations become active exporters and importers, but the

multinational corporations that now play such

a prominent role in trade and investment hardly

existed 40 years ago. Congressional action to

strengthen the analytical support system for

trade decisions could lead to better policy. So

could improvements in the data on trade in

services.

U.S. trade policy has become increasingly

reactive over the past 10 or 15 years, responding primarily to immediate pressures—surging

imports of machine tools or semiconductors,

the fluctuating strength of the dollar, Lobbying by business, labor, and other interest groups

focuses on matters of short-term advantage or

disadvantage, For their part, politicians often

tend to view interest groups as tactical allies

in the short run, rather than partners in an ongoing effort to develop a coherent policy. Under these circumstances, trade policy can easily devolve into a string of contests over the

topical issues of the day. In the absence of

longer term perspectives, changes in the world

economy and shifts in international competi-
340 ● International Competition in Services —

tiveness catch the United States unawares.

Then the consequences—plant closings and

layoffs, an enormous trade deficit, the Nation’s

new status as an international debtor—become

the pressing realities, to be dealt with in a crisis atmosphere.

This process, in which long-festering problems percolate to the top of the policy agenda,

to be dealt with (or dropped) so that Congress

and the executive can go on to something else,

contributes to the ad hoc decisions and eventual contradictions in U.S. trade policy touched

on above. Domestically too, deregulation can

be seen in part as a consequence of failure by

government to find ways of coping with technological and structural change: pulling back

may sometimes be the easy way out. (The positive side, of course, is that deregulation has

helped many American industries to compete—

e.g., in international banking. ) Nonetheless,

public recognition of the inter-relationships

among international competitiveness, structural adjustment, and the Nation’s standard of

living has been growing. Policy makers seem

more willing to acknowledge the links between

foreign economic policy and domestic policy.

The new GATT round could provide the opportunity for a major reassessment of the U.S. position in the world economy.

Analytical Support

The many proposals for reorganizing the

trade responsibilities of the Federal Government reflect not only a sense of frustration, but

a sense that new sets of institutional linkages

between trade and domestic policy could lead

to a more effective policymaking system. Some

proposals would strengthen USTR, and give it

more responsibility. Others would combine

USTR with parts of the Commerce Department

(and perhaps other agencies] to forma new department of trade, or department of trade and

industry. Several proposals have called for a

White House council on trade to replace or supplement the statutory (but largely inactive)

Trade Policy Committee, As discussed in the

section on “Organization and Effectiveness of

Federal Policymaking” near the end of this

chapter, most of these suggestions focus on the

need to coordinate policy among executive

branch agencies, with the heads of departments

and agencies serving on the council.

Here, the fundamental point is that regardless of the structure of the policymaking system, better analytical capability would be an

antidote to short-term thinking on the complex

problems of trade and competitiveness (Option

3). The Uruguay Round is just beginning, and

a new MTN agreement will probably not take

effect until the mid-1990s. Action during the

100th Congress to provide better analytical support for U.S. trade policy could help the United

States define objectives, weigh possible tradeoffs, and develop alternative negotiating positions as the new round unfolds.

At present, many agencies gather data and

information on trade, but the data become useful to policy makers only to the extent that they

can be placed in a meaningful framework.

Should Congress create a department of trade,

a small analytical unit, comprised of highly

qualified professionals, would be a valuable

addition to the agency. To help assemble the

needed expertise, Congress could exempt the

staff from normal civil service rules.7 Such a

step could also help preserve some of the vitality USTR has exhibited in the past. While it

might be possible to achieve similar ends by

building on an existing analytical group (e.g.,

one of those currently within ITA in the Commerce Department), the real need is for new

approaches and unusually qualified people—

placed close to the center of policymaking.

An alternative—e.g., if trade reorganization

does not come to pass–would be to establish

a separate analytical unit within USTR, or substantially expand USTR’s small existing complement of analysts. Such a group would be in

the right place—close to high-level executive

branch decisionmakers. On the other hand, it

7As OTA has suggested previously —’’Statement of John H. Gibbons, Director, Office of Technology Assessment, Before the Committee on Governmental Affairs, U.S. Senate, May 12, 1983, ”

Trade Reorganization Act of 1983, hearings, Committee on Governmental Affairs, United States Senate, Mar. 17, Apr. 26, May

11, 12, June 24, 29, Sept. 14 and 15, 1983 (Washington, DC: U.S.

Government Printing Office), p. 264.
Ch. 10—U.S. Government Policies: Issues and Options ● 341

would probably be difficult to insulate from

USTR’s day-to-day staffing needs, particularly

at a time of heavy ongoing workload because

of the MTN process itself. If Congress takes this

route, it could help avoid these dangers by ensuring that USTR (and the other agencies involved in the Uruguay Round) have the resources they will need during the GATT talks

(as discussed below). Finally, if Congress establishes a trade council in the Executive Office

of the President, it could encourage the hiring

and retention of highly qualified professional

staff for long-term policy planning and analysis.

By their nature, the centers of policymaking

responsibility in the executive branch have little institutional memory, People come and go;

those that set policy tend to be well-removed

from the analytical groups that do exist. Given

this, any step to improve the analytical support

for policy runs two risks, The group may end

up submerged in the swirl of day-to-day events.

Or it may become irrelevant. The first risk is

unavoidable—if the people are good, those in

charge will want to put them to work on immediate problems. If the people aren’t that

good, they will quickly become irrelevant in any

case. In addition to the quality of the staff, political independence will be necessary: unless

institutional memory can be preserved across

administrations, the analytical function will be

at least a partial failure. And of course, no structural change can do more than make policy support available for decisionmakers who choose

to use it.

Data on Trade in Servicesa

Analysis depends on data, but the U.S. database on services trade is a poor one. Better procedures for gathering data, and for turning it

into useful information, would make for better policy. Indeed, the current database on services trade seems distinctly inadequate for supWhis section reiterates a number of major points from OTA’S

special report Trade jn Ser~’ices: Exports and Foreign Re~’enue,s,

op. cit. The special report, prepared as part of this assessment,

estimates the impa(; t of ser~’ices tracle on the [J. S, balance of pa\-

ments, discusses current data collection procedures and their

Imitations (also see the section on “Measuring Services Trade”

in ch. 2 of this report), and analyzes policy options for impro~ing

the data (pp. 7-I I of the special report).

porting the complex negotiations that would

follow should the Uruguay Round move on to

sector-specific issues.

The statistics compiled by the Bureau of Economic Analysis (BEA, part of the Commerce

Department) seriously underestimate both exports and imports of services. The data are not

only inaccurate, they are incomplete and lacking in detail. When it comes to trade in goods,

BEA compiles data in about 10,000 categories;

the services data can be disaggregated into perhaps 40 categories. The government collects

no information on some types of service transactions, In other cases, collection methods leave

gaps or large uncertainties. Some of BEA’s categories mingle factor income (dividends, interest) and non-factor income (revenues for value-

-added services)—a fundamental conceptual difficulty. The uncertainties impair the ability of

policy makers to gage the importance of services trade—as a whole, on a sector-by-sector basis, or bilaterally—making it more difficult to

devise negotiating strategies and weigh tradeoffs among objectives.

In 1984, Congress amended prior law, giving clear authorization to the President to collect data from American firms on their trade

in services.9 Congressional oversight on the Administration’s progress in implementing the

1984 amendments may be appropriate; in particular, Congress might wish to ask whether

some of the provisions for data collection

should be made mandatory (Option 4).

OTA’s special report, Trade in Services: Exports and Foreign Revenues, included 10 policy options for improving the services database.

Two of the most important were (Option 5):

1. collect information on service transactions

between unaffiliated firms (by implementing BEA’s proposed BE-20 survey, or a

modification);

2. expand coverage in the Census of Service

Industries of overseas sales by U.S. service firms.

‘See, 306 of Public Law 98-573 redesignated Public Law 94-

472 the International In\’estment and Trade in Services Survey

Act, and ga~e the executi~’e branch clear but discretionar~r authorit}’ to collect services trade data,
342 ● international Competition in Services

OTA discusses improvements in the data on

international banking—likewise badly needed—

in a later section of this chapter (see Option 12

in table 59),

Better information on international royalties

and license fees would also help. For reasons

explained in chapter 6, BEA’s current procedures make it difficult to use the licensing data

for examining questions of international technological competitiveness. For example, BEA

lumps technical licensing payments with those

for trademarks and copyrights on books and

recordings, Nor does the agency separate

figures on new licenses in a given year from

ongoing payments under existing agreements.

Better data will do little good unless the government finds better ways to use it, But improving the database is a first step. The costs

would be low, The benefits of better analytical

understanding of trade and investment in the

services, and the impacts elsewhere in the economy, should far outweigh any additional expense to the Federal Government or to industry.

Support for the Negotiations Process

USTR will need adequate resources—both

budget and staff, and including people on loan

from other agencies–to carry the burden of

four years or more of GATT deliberations over
Ch. 10—U.S. Government Policies: Issues and Options ● 343

and above its customary responsibilities. Moreover, if the Uruguay Round goes on to sectorspecific matters, existing mechanisms for funneling information, suggestions, and recommendations from business and labor to U.S.

negotiators will probably need to be expanded.

Staff and Funding for USTR

USTR’s 90 or so professionals get regular help

from other agencies, primarily the Departments

of Commerce and Treasury. Even so, available

resources have not kept pace with the growing

number of issues and industries on the Nation’s

trade agenda. Besides the new GATT round,

a partial listing of USTR responsibilities includes trade-related multilateral negotiations

within OECD and the United Nations Conference on Trade and Development, plus a wide

range of bilateral discussions. The agency also

has the job of coordinating trade policy within

the executive branch, along with Section 301

unfair trade practice complaints and administration of the Generalized System of Preferences, USTR must accomplish all this with a

budget and staff that are small compared to the

resources other nations devote to trade matters.

For example, in the bilateral talks with Canada that began in 1986, fewer than a dozen U.S.

representatives faced more than 80 Canadians,

many of them experts with years of substantive

experience in the issues under discussion.l0

To handle its MTN responsibilities, USTR

will need more people and more money (Option 6). The agency is seeking a modest increase

in permanent staff for fiscal year 1988—from

136 positions in 1986 to about 145, ITA, which

provides most of the assistance from Commerce

during trade negotiations, is seeking 54 new

full-time-equivalent positions for GATT-related

activities, and a $4.1 million increase in its appropriation, Even so, budgetary pressures in

the executive branch could jeopardize the support USTR depends on—not only people detailed on a nonreimbursable basis (16 in fiscal

year 1986, with USTR reimbursing parent agencies for another 6), but the willingness of other

parts of the government to detail highly qualified people under any circumstances.

USTR has other ongoing needs as well—outstanding among them, to continue its development of expertise and experience in negotiating with Japan. For the foreseeable future,

bilateral talks with Japan will have a critical

role in U.S. trade policy. USTR and Commerce

have made real strides since the beginning of

the decade in learning to deal with the Japanese. This capability needs to be maintained

and strengthened.

Service Sector Advisory Committees

Particularly if it becomes necessary to prepare for sector-specific discussions (as opposed

to negotiations concerning an umbrella agreement on the services), U.S. officials will want

information and input from a broader spectrum

of interests, Congress could direct USTR and

other agencies (e. g., Commerce, Labor) to increase the number of advisory groups with

members drawn from service industries and

their employees (Option 7—also see Option 16

in table 59, on the need for a special advisory

committee concerned with telecommunications).

In some cases, representation by users of services might be appropriate,

As figure 50 indicates, USTR’s Services Policy Advisory Committee represents the service industries at the most general level—but the

services are only lightly represented among the

Industry Sector Advisory Committees (I SACS,

which advise both USTR and Commerce), One

ISAC speaks for the services (or two, including that for wholesaling and retailing), compared with 14 for goods-producing industries,

The interests of service industry employees also

seem under-represented compared with other

sectors. The Labor Advisory Committee on

Trade Negotiations and Trade Policy meets regularly with USTR and the Department of Labor, but the one subcommittee for services

(compared with five for goods-producing industries) has met only occasionally,
1

2

3

4

5

6

7

8

9

10

11

12

13

14

Aerospace

equipment

Capital goods

Chemical & allied

products

Consumer goods

Electronics &

instrumentation

Energy

Ferrous ores &

metals

Footwear leather &

leather products

Industrial

construction

materials & supplies

Lumber & wood

products

Nonferrous ores &

metals

Paper & paper

products

Services

Small & minority

business

15 Textiles & apparel

16 Transportation,

construction &

agricultural

equipment

17 Wholesaling &

retailing

I

Agricultural Policy

Advisory Committee

I

Figure 50.—USTR Advisory Committeesa

I

Advisory Committee (or

Trade Negotiation I

1

2

3

4

5

6

Transportation

equipment

Lumber wood paper

stone clay & glass

products

Electronic equipment,

supplies & non

electric machinery

Services

Food, agriculture

Chemical plastic &

rubber products

Textile manufacturing

apparel leather

products & mlsc.

!ndustries

I I

1 I 1 Customs

2 Standards

3 Intellectual property

(established in 1987)

u

ISAC Chairman's

committee

asectlon 135 of the Trade Act of Ig74, as amended, authorized the trade arjvlsory system for the Off Ice of the U S. Trade Representative (USTR)

b~lne ATACS, not listed.

SOURCE Annual Report of the Preslderrt of the United States on the Trade Agreements Program, 7984-1985 (Washington, DC Off Ice of the Un!ted States Trade Representative. February

1986, p 180
.

Non-Tariff Trade Barriers

Domestic regulations

Ch. 10—U.S. Government Policies: Issues and Options ● 345

—

as well as those in foreign countries, would be

frequently act as NTBs, an example and prod to other governments (Options.

sheltering domestic firms from international

competition (ch. 9). Many such regulations

serve important purposes—public safety (licensing of physicians, building codes), protecting

consumers against financial loss (supervision

of banking, insurance, and brokerage firms).

But they may be framed or implemented to discriminate against foreign firms. The United

States—as the party that has pushed hardest to

bring services into GATT–will probably need

to take the lead in identifying and evaluating

regulatory NTBs, including its own. USTR, with

the help of other agencies, could begin by updating earlier work on U.S. regulations. Prompt

action in identifying NTBs in the United States,

Other Trade-Related Issues

Among the narrower trade issues that surface when the subject is competitiveness, Congress has given particular attention to export

promotion and export financing (table 57). The

United States and Foreign Commercial Service

(US&FCS)–lead agency for the Nation’s overseas trade promotion efforts—seems distinctly

understaffed and underbudgeted compared

with its counterparts in other industrial countries. Policy issues in export financing have centered on foreign government subsidies and the

Table 57.—Other Trade-Related Issues

Issue

Compared to many of its trading partners

and competitors, the United States devotes only modest resources to export

promotion abroad

For years, the United States has sought to

tighten a loophole in OECD guidelines on

export credits that permits tied aid subsidies In 1986, Congress authorized a

2-year, $300 million tied-aid war chest as

part of the Export-Import Bank Act

Amendments (Public Law 99-472). Substantially tighter OECD guidelines followed in

1987

The Trade and Development Program (TDP)

finances feasibility studies and planning

services by U S firms for projects in

LDCs Some of these studies lead to further work for U S firms, or to exports of

goods

SOURCE Off Ice of Technology Assessment 1987

Options for Congress

OPTION 9: Increase support for the overseas activities of the United States and

Foreign Commercial Service (US&FCS),

which IS responsible for most of the overseas export promotion undertaken by the

Federal Government Raising the number

of US&FCS officers overseas from current

levels—about 200—to a complement of

300 or more would aid U.S. exporting in

general. Congress could also direct the

Service to provide training for its employees in the special needs and

problems of the service industries,

OPTION 10: Since other governments can always find ways to subsidize exports that

they judge important for national interests, Congress could make plain U.S.

resolve to keep such practices under control by continuing the authorization for the

tied-aid war chest—and by funding it to

match foreign subsidies, if this seems

needed to get other OECD members to

hold to the new agreement.

OPTION 11: Increase TDP support from its

current level of about $20 million

annually—much smalIer than similar programs in several other nations, Congress

could also direct TDP to raise the number

of feasibility studies conducted by U S.

firms on a reimbursable or cost-sharing

basis

Comments

Japan has about 5,000 overseas commercial

officers; the United Kingdom and France

each have 400 or more.

Greater budget outlays for export financing

run counter to attempts to control Federal

spending, As a result, some policy makers

have sought to encourage private Iending

as an alternative to reliance on public

funds. In 1986, Congress authorized a

2-year pilot program called l-Match as part

of Public Law 99-472—a loan subsidy

proposal put forward by the Administration. Under l-Match, private lenders will assume the lending risk, while the

government subsidy—through

Eximbank —reduces the Interest cost to

the borrower. In addition to monitoring the

new OECD agreement, congressional oversight of the l-Match program could determine whether extension of this program,

or other forms of export aid, might be

needed to respond to export financing

initiatives by other OECD nations

TDP has particular relevance for the E&C industry. H.R. 3, as passed by the House in

April 1987, proposed that a further $10

million be transferred to TOP during fiscal

year 1988 for financing feasibility studies

and for new responsibilities the program

would be given.
346 • International Competition in Services

ability of the United States to combat them or

match them—matters that have been under discussion in the OECD since the middle 1970s.

Potentially restrictive U.S. policies–notably the

Export Administration Act and the Foreign

Corrupt Practices Act–have also been widely

debated. Chapter 6 gave brief mention to export controls and the uncertainties in their application. According to spokesmen for business,

the Foreign Corrupt Practices Act, aimed at

stopping bribery by American firms overseas,

has also created uncertainty—in this case over

what American companies can and cannot do

in other parts of the world. There is little evidence, however, suggesting much impact on

U.S. exporting or competitiveness.11

Overseas Promotion of U.S. Exports

The US&FCS maintains offices both in the

United States and abroad, the latter mostly at

embassies and consulates. The Service currently operates in over 60 countries, stationing nearly 200 commercial officers overseas

and supplementing them with about 500 foreign nationals.12 Officers in foreign countries

supply marketing information to American

firms and seek to promote U.S. exports. Among

the service industries, engineering and construction probably stands to gain the most from

the work of the US&FCS; commercial officers

have also helped some American insurance

companies win new business. Early involvement plays a crucial role in gaining new E&C

1l.C+e Tecbno]ogyTransfer to the Middle East (Washington,

DC: Office of Technology Assessment, September 1984), pp. 557-

559. Among the services, complaints over the Foreign Corrupt

Practices Act come most often from E&C firms.

IZThese countries account for some 90 percent of U.S. exPOrts—

“Information submitted by the Department of Commerce for the

Hearing record,” Departments of Commerce, Justice, and State,

the Judiciary, and Related Agencies Appropriations for 1987,

hearings before a Subcommittee of the House Committee on Appropriations, U.S. House of Representatives, Part 9 (Washington, DC: U.S. Government Printing Office, 1986), pp. 482-489.

In some 77 nations without a US&FCS officer, State Department

economic/commercial officers have responsibility y for export promotion, usually on a part-time basis. The State Department’s Office of Business and Export Affairs estimates that its export promotion activities in these countries account for about 105

person-years annually—36 person-years on the part of foreign

service officers, and 69 by foreign nationals.

contracts—personal contacts, knowledge of the

local business environment, information on

projects still in the planning stages.

Compared to other major trading nations, the

United States devotes relatively few resources

to overseas trade promotion. Table 58—which

excludes State Department export promotion

activities—shows that Japan has at least 20

times as many overseas officers as the United

States; France and the United Kingdom have

twice as many. Even including State Department personnel, only Italy, of the countries

listed, stations fewer people abroad. Given current budgetary constraints, U.S. export promotion efforts could decline still further relative

to our competitors without congressional action (Option 9).

Tied Aid and Export Financing

The Export-Import Bank of the United States

(Eximbank) has primary responsibility for U.S.

Government export financing programs, Eximbank extends loans to overseas purchasers of

U.S. goods and services, provided the prospective U.S. exporter faces competitors supported

by foreign governments. In 1983, Congress

amended the Bank’s charter, the Export-Import

Bank Act of 1945, to specifically authorize loans

for exports of services (Public Law 98-181). The

Bank’s Engineering Multiplier Program (EMP)

—its major services-related activity—provides

medium-term loans to foreign purchasers of

U.S. architectural and engineering services.

Over the past few years, Eximbank’s programs have been criticized by American firms

as comparing unfavorably with loan packages

available from other OECD governments, An

OECD gentleman’s agreement originating in

1976 (and modified several times since) covers

subsidized export financing, but many member countries have taken advantage of a loophole exempting certain forms of tied aid (aid

that requires purchases in the donating country); governments have been able to circumvent

the agreement by increasing the grant portion

of tied-aid financing packages. The French,

who apparently originated this so-called mixed
Ch. 10—U.S. Government Policies: Issues and Options ● 347

Table 58.—Overseas Commercial Services Compareda

Number of

countries in

Number of Total which commercial Number of

overseas overseas representatives commercial

Country officers personnel are stationed posts

United Statesb 

. . . . . . . . . . . . . . . . . . . . 192 723 64 125

Japan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,000 6,000 58 79

United Kingdom . . . . . . . . . . . . . . . . . . . . . 400 1,300 130 200

France. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 475 1,325 120 180

Italy ., . . . . . . . . . . . . . . . . . . . . ... . . . . . 150 600 73 80

Federal Republic of Germany . . . . . . . . . . 241 NA 111 85

Canada . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 262 460 78 102

NA = Not available.

aAs of 1985

blncludes uS&FCS only excludes US management overhead

SOURCE United States and Foreign Commercial Service Department of Commerce

credit mechanism (because it mixes development aid and export credits in the form of

loans), have used it quite aggressively. Italy and

Japan, among others, have also looked to mixed

credits to support their E&C industries.

In response to concerns raised by U.S. exporters, Congress included in its 1983 amendments to Eximbank’s charter a provision calling on the bank to be fully competitive with its

foreign counterparts, and established tied-aid

programs to be jointly administered by Eximbank and the Agency for International Development (AID, the Federal agency responsible

for channeling development assistance to LDCs).

In part because of the differing mandates of

the two agencies, the programs proved ineffective. l3 Most recently, as part of the ExportImport Bank Act Amendments of 1986 (Public

Law 99-472), Congress provided for a separate

tied-aid credit program and fund. The $300 million war chest authorized for fiscal years 1986

and 1987—to be administered by Eximbank in

accordance with recommendations from the

IJThe first Eximbank mixed credit package to be accepted came

in May 1986, following 11 offers over the previous 7 months—

“Eximbank Announces First Successful ‘Mixed Credit’ Deal,

Clinching Contract in Gabon,” International Trade Reporter, May

28, 1986, p. 709. In direct response to offers by the French and

]apanese, the Bank agreed to pro~ride $8.4 million at 2 percent

interest, with an 8%-\’ ear grace period followed by a 20-year re[,a}-

ment schedule, coupled with a guarantee for a $12.8 million commercial loan. AID did not participate.

On the lwlarch 1987 OECD agreement, below, see ‘‘OECD Nations Ratifj Agreement To I,imit (-’se of Tied Aid in Subsidized

official Credits, ” International) Trade Re~orter, hlar. 18, 1987,

p, 366.

Overseas

operating budget

(millions of dollars)

$29

NA

150

98

46

NA

30

Secretary of the Treasury (and thus bypassing

AID)—has been viewed as a defensive weapon,

intended to create a sufficiently credible matching capability to persuade other nations to limit

their own use of tied aid and other export subsidies. Subsequently, in March 1987, the OECD

membership accepted a new and much more

restrictive agreement on tied aid. Even so, continuing progress will probably require that the

United States maintain pressure on other OECD

countries (Option 10).

While the failure to counter foreign financing packages has cost American E&C firms (and

telecommunications equipment suppliers)

some sales to developing countries, government

financing has seldom been important for exports by other service industries. Even for the

E&C industry, it is not clear that financing—as

opposed to factors like labor costs and the decline in Middle East oil revenues—accounts for

that much of the overall decline in foreign business. But the primary point is a simple one: controlling the use of export subsidies means first

persuading other nations that the U.S. Government is willing to match their subsidized financing packages.

Trade and Development Program (TDP, Option 11)

The TDP program finances planning and feasibility studies conducted by U.S. firms for developing nations (with up to 20 percent subcontracting to firms in the host country). TDP

priorities have shifted over time, reflecting LDC

development objectives; in 1985-86, much of
348 ● International Competition in Services

the money went for studies on agribusiness,

telecommunications, and hazardous waste management.14 The program is intended to exploit

“’’Congressional Presentation, Fiscal Year 1987, United States

Trade and Development Program, ” Hearings on Foreign Assistance and Related Programs Appropriations for 1987, Committee on Appropriations, U.S. House of Representatives, Part 1,

p. 1828. The 1987 TDP budget is about $20 million; program officials estimate that France and Japan fund similar efforts at levels

over $100 million and more than $2oO million, respectively, H.R.

3, as passed by the House in April of 1987, would substantially

expand TDP’s role in export promotion and export financing

for bilateral projects involving development aid.

Currently, about 30 U.S. companies are supplying services and

another 47 are providing goods for projects that have followed

from TDP-financed feasibility studies—’’’rest imony of Christian

linkages between feasibility studies and future

exports in the design and construction phase

of E&C projects (ch. 4), thereby stimulating U.S.

exports. According to program officials, 166

feasibility studies over the period 1980 to 1983–

which cost the government $29 million—had, by

1986, led to U.S. exports totaling $516 million.

Holmes, Director, U.S. Trade and Development Program, FY

87 Appropriations Request,” Foreign Assistance and Related Appropriations for 1987, hearings, Subcommittee on Foreign Operations and Related Agencies, Committee on Appropriations, U.S.

House of Representatives, Part 4 (Washington, DC: U.S. Government Printing Office, 1986), p. 440.

DOMESTIC POLICY AND INTERNATIONAL COMPETITIVENESS

Many of the service industries, historically,

have been heavily regulated. Because regulation serves public policy objectives widely

regarded as legitimate and necessary, government policies will—despite the deregulation of

recent years—continue to influence sectors like

banking and telecommunications more heavily than typical manufacturing industries.

Furthermore, the nature of the underlying policy objectives—e.g., consumer protection—

almost guarantees that policy makers and regulators will pay more attention to the domestic than the international environment.

While government regulations—and deregulatory choices—influence the international

competitiveness of American industry in many

ways, policy makers seldom focus on these impacts, When they do, it is mostly in the direct

and obvious cases—allocation of international

air travel routes, telecommunications rates. But

indirect impacts are pervasive as well. Banking regulations, by determining what American

banks can and cannot do, constrain and mold

the strategies of financial institutions. In the

wake of the AT&T breakup, competition among

U.S. telecommunications firms has become in

part a contest to influence the newly emerging

regulatory system, with each firm seeking advantages with respect to its domestic rivals, As

the new regulatory system solidifies, telecommunications firms will turn more of their attention to marketplace competition.

This section examines banking and telecommunications more closely. Both illustrate issues

that surface in many other service sectors (table 59).

The Example of Banking

Since the 1960s, international banking, driven

by technological change and deregulation, has

grown at an explosive rate (ch. 3). The business

has changed much more rapidly than the regulatory and supervisory apparatus. While Congress has on occasion addressed questions of

international competitiveness—notably in the

1978 International Banking Act (Public Law 95-

369)—which extended national treatment to foreign banks operating in the United States, other

issues have dominated ongoing debates over

banking policy, Of several hundred bankingrelated bills introduced in the 99th Congress,

most dealt with domestic financial services—

or with such international issues as multilateral

lending, the Third World debt crisis, and exchange rates, With very rapid international expansion by Japanese banks, policy makers here

may begin giving competitiveness a higher

priority.

As a first step, Congress could direct the

Administration to improve the data on international banking compiled by Federal agencies.

In its present form, the government’s database

does not even provide a clear indication that
Ch. 10—U.S. Government Policies: Issues and Options ● 349 —

Table 59.—issue Area II: Linkages Between Domestic Policies and International Competitiveness

Issue Options for Congress

A. EXAMPLES FROM BANKING AND FINANCIAL SERVICES

Current data collection procedures fail to OPTION 12: Direct the Commerce Departprovide a clear picture of banking exports ment’s Bureau of Economic Analysis to

and Imports. Relatively minor changes in improve its database on international

existing surveys could appreciably im- banking and financial services, in consulprove the database at little cost to the tation with the Federal Financial lnstituFederal Government or to financial service tions Examination Council, and its

firms. member agencies (e. g., the Federal

Reserve Board).

Decisions made by the many Federal and OPTION 13: Direct the Administration to proState agencies that supervise and regulate vide an explicit mandate for an office of

banking can affect International competi- international competitiveness in banking

tiveness, creating a need to build con- to serve as a focal point for such issues,

sideration of these impacts into in particular the international ramifications

policymaking processes of domestic policies.

Domestic authorities, here and in other OPTION 14: Use oversight and reporting recountries, have been hard pressed to keep quirements to begin evaluating alternaup with rapid changes in international tives for greater international coordination

banking and financial services. Greater in- of banking policies. One possibility would

ternational coordination of bank supervi- be to direct U.S. agencies that serve on

sion and regulation may be needed, along the Basel Committee to explore ways of

with an expansion to cover securities expanding the Committee’s present acmarkets. tivities.

B. EXAMPLES FROM TELECOMMUNICATIONS

Restrictions on trade in both telecommunications equipment and services have hindered or halted the efforts of U.S. firms

seeking to enter foreign markets.

To prepare for sector-specific negotiations

on telecommunications, policy makers will

need input from the full range of stakeholders While telecommunications firms

already have representation on some advisory committees, USTR currently has no

separate advisory committee on telecommunications trade

Because telecommunications is a vital portion of the infrastructure for the world

economy, government policies have competitive impacts not only for equipment

manufacturers and service providers, but

also for users (including U.S.-based

manufacturing companies, banks, and

other service firms).

OPTION 15: Congress could establish formal

U.S. negotiating objectives for GATT and

other forums dealing with telecommunications services and equipment.

OPTION 16: Direct USTR and Commerce (in

cooperation with other Federal agencies

involved in telecommunications policy) to

establish an Industry Sector Advisory

Committee on telecommunications. The

ISAC should include representation for

users of telecommunications services and

employees of telecommunications firms,

as well as service providers and equipment manufacturers.

OPTION 17: Direct all Federal agencies with

responsibilities for telecommunications to

take into account in their regulatory and

other decisions the interests of U.S. firms

which are users of international telecommunications services, as well as suppliers

of equipment and services. If Congress

restructures the Nation’s regulatory apparatus (e.g., by returning more authority

to the FCC), it could take that opportunity

to provide such directions.

Comments —

Specific possibilities:

● modify Federal Reserve Board reporting

requirements to collect data needed for

calculating banking exports;

● add questions on receipts for services

to the quarterly surveys of the asset

levels of foreign banks operating here,

● include financial service firms i n BEA’s

benchmark and annual surveys of inbound and outbound direct Investment.

The Treasury Department, which has already

undertaken Interagency studies on national treatment, would be an appropriate

place for such an office. Congress could

direct the Administration to establish a

new group, or to expand Treasury’s exlsting Office of International Banking and

Portfolio Investment

Congress could also direct Federal agencies

to examine and report on the desirability

of creating a new international body for

addressing issues of International coordination and harmonization of reguIatory

and supervisory policies.

Examples of possible objectives Include

that U.S. firms be allowed to compete on

an equal basis with host-country firms

where foreign governments permit competition in telecommunications services:

that, as users of foreign telecommunications services, U.S.-based firms not be

subject to discriminatory terms, rates. and

conditions.

Because the interests of equipment

producers, suppliers of services, and

users often diverge, it might be desirable

to create three subcommittees reporting

to a telecommunications ISAC (A

separate private sector advisory process

already exists to help the Department of

State in preparing US. positions at the

ITU—see Option 33 in table 61),

It will be up to Congress, in the end. to

redefine the roles of Federal agencies in

telecommunications policy. Whatever the

choices, it will be critical that the new

structure give questions of international

competitiveness high priority Congress,

for example, might give particular attention to the prospective role of the FCC.

as an independent agency, in dealing with

foreign governments and international

bodies concerned with telecommunications,

SOURCE Off Ice of Technology Assessment, 1987
350 . International Competition in Services

— —

liberalization of trade in financial services

would benefit the United States. Congress could

also consider giving the executive branch a

stronger mandate for addressing issues of competitiveness on a continuing basis, Finally, it

seems time to seek greater coordination of bank

supervision and regulatory policies among nations, building on the groundwork laid by major banking nations at such forums as the Basel

Committee. (Ch. 3 discusses a number of other

policy issues related to the competitiveness

of U.S. banks, including such questions as

whether to relax or maintain the current separation between commercial and investment

banking.)

Data on International Banking

While Federal agencies collect a great deal

of information from banks, they do not collect

it so that trade in international financial services can be measured and compared on the

same basis as for other industries.l5 The result?

It is impossible to assemble a clear picture of

U.S. exports and imports of financial services—

by value or by type of product.

Improving the database would not require

large expenditures by government, nor much

additional paperwork on the part of banks. Several Federal agencies, including BEA, the Federal Reserve Board (FRB), and the Treasury Department already collect much of the needed

information. Expanding the FRB’s quarterly

monitoring of the U.S. branches of foreignbased banks to include receipts would greatly

improve the data on imports of financial services. As another example, it would take only

minor modifications in FRB reporting requirements to begin collecting information on services provided within the United States by the

foreign branches of American banks (relative

to their functions as overseas sales outlets). Because BEA compiles most trade data, Congress

may wish to direct the Bureau, in cooperation

with the FRB and other banking agencies, to

improve its database on international financial

services (Option 12, table 59).

IsTrade jIl SerL,jces: E.xPorts and Foreign Re\renues, op. cit.,

pp. 8-9, 53-58, and 77-79.

Raising Priorities for International Competitiveness

Few of the agencies that exercise regulatory

or supervisory authority over financial services

institutions pay much attention to competitive

impacts. In addition to the FRB, these agencies

include the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation (FDIC); the Securities and Exchange

Commission, the Department of Justice, and

State regulatory bodies also have some measure of responsibility for financial services. Enhancing the international competitiveness of

the U.S. industry has never been the primary

objective of any of these agencies, nor should

it necessarily be. Yet as discussed in chapter

3, regulatory decisions can affect costs quite

directly, while in other cases regulatory agencies provide services to banks; the FRB’s clearing and settlement functions help make the U.S.

banking infrastructure the best in the world.

These and other examples suggest that banking agencies need to be concerned with the impacts of a broader range of international competitiveness issues than, say, the question of

whether U.S. banks operating abroad get the

same degree of national treatment and competitive equality as extended to foreign banks here

under the International Banking Act.

Perhaps the most direct approach for fostering this broader perspective would be for Congress to charter a special office in the executive branch to serve as a focal point for

integrating competitive impacts into policymaking and for coordination among agencies

(Option 13). The function would, for example,

fit logically into the Office of International

Banking and Portfolio Investment in the Treasury Department. Treasury has coordinated past

congressionally mandated analyses of foreign

government policies as they affect U.S. financial services firms—the national treatment

studies first called for by the International Banking Act.l6 If assigned this broader task, the ofIesee “NatiOnal ‘1’reatrnent Study: Report to Congress on Foreign Government Treatment of U.S. Commercial Banking and

Securities Organizations, 1986 Update, ” Department of the Treasury, Washington, DC, December 1986 (like earlier studies in 1979

and 1984, prepared in conjunction with the Department of State,

the Federal Reserve Board, the Comptroller of the Currency, and

the Federal Deposit Insurance Corporation). The 1986 report includes, for the first time, coverage of the securities industry,
Ch. 10—U.S. Government Policies: Issues and Options . 351

—

Photo credit: Chicago Board of Trade

Futures trading

fice could continue monitoring restrictions imposed by other countries, as well as analyzing

the international competitive position of the

American industry and the effects of U.S. banking policy on competitiveness.

International Coordination

Rapid expansion and new financial products

—particularly in lightly regulated offshore

markets—create possible new sources of instability in the international banking system, as

discussed in chapter 3. With world financial

markets more tightly coupled, it will be increasingly difficult for any one country to maintain

an independent banking policy. The implication? Greater international coordination of supervisory and regulatory policies may benefit

all countries. Even more, harmonization of such

policies may be necessary for ensuring the stability of the system.

In other sectors where interdependence has

been a fact of life, international organizations

have evolved where nations can meet to discuss rules and resolve disputes. GATT provides

these functions for trade in goods. For more

than a hundred years, the ITU has done so in

communications. Bodies like the International

Maritime Organization and WIPO are wellestablished fixtures on the world scene. In contrast, the international regime for financial services seems undeveloped, GATT has more than

90 members, the ITU 160, but the so-called

Basel Committee—the most influential of the

analogs to such organizations for banking—

consists of central bank representatives and supervisory authorities from only 11 countries.

(The proper name of this group, which meets

at the Bank for International Settlements, is the

Committee on Banking Regulations and Supervisory Practices. ) Formed in 1974, the Committee’s meetings are confidential, with little in-
352 ● /international Competition in Services

formation available to the public. The OECD

does address related issues, including securities. Its Committee on Financial Markets established an Expert Group on Banking in 1980 to

examine changes in banking practices and regulations. Several regional groupings of bank supervisors also exist—e.g., within the European

Community (EC).

Much of the work of the Basel Committee has

concerned supervision and regulation of foreign banking offices .17 Operating by consensus,

with recommendations having no legal force

in member countries, the Committee has

nonetheless been able to make progress in some

areas—for example, by establishing the principle that all foreign bank offices should be subject to supervision, and agreeing on the division of supervisory responsibilities between

parent and host countries.

Strengthening and expanding the Basel Committee, or otherwise developing a framework

for international coordination of banking policies, promises to be a long-term endeavor. The

special relationships between governments and

financial institutions–which stem in part from

the role of banks in implementing monetary

policy—lead to sensitivities not found in other

sectors, Furthermore, many governments have

used their banking systems as instruments of

industrial or social policies—e.g., to steer resources to favored sectors of their economies.

These governments might fear, quite naturally,

that a more open system would threaten their

ability to achieve national goals. Because of

such sensitivities, the Basel Committee has gone

to some lengths to stress that it is simply an

organization of central banks (or supervisory

authorities), not of governments.

OTA’s analysis of recent trends in international financial markets and the implications

for stability points to a need for better international coordination. Congress, on occasion, has

called on U.S. banking agencies to work toward

such coordination.l8 As a next step, Congress

~T1nternatlona] Banking—~nternationa] Coordination of Bank

Supervision: the Record to Date, GAOINSIAD-86-40 (Washington, DC: U.S. General Accounting Office, February 1986).

IBFor example, in the International Lending Supervision Act

of 1983 (Public Law 98-181), Congress emphasized the imporcould request a study of the effectiveness of possible mechanisms for harmonizing banking regulations among countries (Option 14). It could,

for example, ask whether a new international

institution might be desirable, or whether the

Basel Committee (or perhaps the OECD) could

provide a suitable venue. Congress might direct

Treasury or other Federal agencies to report

on these questions, and to discuss alternatives

with foreign countries (while recognizing the

reasons for the confidential nature of the Basel

Committee’s proceedings, and the secrecy with

which some governments conduct banking policy). International coordination of regulations

that affect the securities industry should be part

of this process. Although the analysis in chapter 3 suggests that it maybe desirable to move

toward supranational regulation and supervision of financial services, greater coordination

of current practices is the necessary first step.

The Case of Telecommunications

With the AT&T breakup, the United States

opened its markets to foreign equipment suppliers without seeking reciprocal actions by other

countries. Meanwhile, deregulation helped

stimulate the emergence of new U, S.-based suppliers of telecommunications services (e.g.,

value-added networks, or VANS, ch. 5). Many

of these companies are interested in selling

abroad, contributing to pressures for greater

access by U.S. companies to foreign telecommunications markets for both services and

equipment.

But a focus simply on suppliers of equipment

and services would undervalue the significance

of telecommunications to U.S. firms. With

telecommunications becoming a central element in corporate operations and strategy, the

regulatory practices of foreign governments

have implications for competitiveness in many

industries. In most parts of the world, PTTs—

government post, telegraph, and telephone

authorities—not only monopolize domestic

markets for basic telecommunications, but also

tance of assuring consistent supervisory policies for international

lending, directing Federal banking agencies to consult with other

countries on measures for achieving this.
Ch. 10—U.S. Government Policies: Issues and Options ● 353

limit and/or regulate entrants seeking to provide enhanced services like VANS. Sometimes

PTTs make it difficult or expensive for MNCs

to operate dedicated international networks.

From the perspective of competitiveness, primary U.S. interests include:

1.

2,

3.

4.

access for American firms to public

switched networks on reasonable and nondiscriminatory terms (e.g., rates roughly

reflecting actual costs, freedom to connect

advanced equipment to public networks);

minimal transborder data flow (TBDF) restrictions, such as requirements for local

storage or processing of data;

freedom for users to resell or share leased

lines, or otherwise bypass portions of the

public infrastructure (particularly important for smaller companies that otherwise

might find wide-area networks prohibitively expensive);

openness to foreign investments by U. S,-

based service suppliers; and

5. reductions in barriers to trade in telecommunications equipment (including restrictions on the equipment MNCs can install

to support dedicated applications and internal networks).

These issues have the potential to affect a wide

array of users, including host-country firms.

Some of the latter could prove helpful allies in

efforts to loosen foreign government restrictions.

Numerous bills dealing with trade in telecommunications have been proposed in recent Congresses. Many deal with equipment, others address services, some cover both, H.R. 3, as

passed by the House in the spring of 1987, included a separate title on telecommunications

hardware and services. The bill would direct

USTR to identify countries with barriers to U.S.

telecommunications exports and enter into negotiations with their governments. Failure to

reach agreement could lead to countermeasures by the United States.

At this point, however, the U.S. Government

does not appear very well organized to pursue

such issues. Predictably enough, no one Federal agency has authority for international

telecommunications policy. A half-dozen or

more bureaus and offices within the FCC have

some degree of international responsibility; in

1981, a new position—Assistant to the Chairman for International Affairs—was created to

oversee their activities, along with an International Telecommunications Coordinating Committee, Even so, most of the FCC’s responsibilities remain focused on the domestic scene,

where regulations remain in flux in the wake

of the AT&T breakup.

An array of other government agencies share

in representing U.S. interests internationally,

USTR has the lead role in GATT. The State Department represents the United States in the

ITU and its Consultative Committee for International Telephone and Telegraph (CC ITT).

Within the Commerce Department, ITA and the

National Telecommunications and Information

Administration have responsibilities, respectively, for analysis of the telecommunications

industry and for advising the President on policy. The Administration has also set up an interagency group for telecommunications policy

that meets on an ad hoc basis. Finally, bodies

like the Cabinet-level Economic Policy Council (E PC) have an occasional say in matters related to telecommunications trade. Domestically, Judge Harold Greene’s court continues

as primary overseer of the AT&T settlement

agreement—which itself has international ramifications, in part simply because of the many

uncertainties that remain concerning the future direction of regulatory policy in the world’s

biggest market.

Again, the primary needs seem to be, first,

providing sound analysis in support of policy,

and second, ensuring adequate coordination

among Federal agencies. Both are prerequisites

for taking prompt advantage of opportunities

as they emerge internationally. For example,

the primary thrust of past U.S. trade policies,

as related to telecommunications, has been to

seek open markets for U.S. equipment, While

desirable, and consistent with the overall thrust

of U.S. trade policy, it would seem appropriate to raise the priorities for telecommunications services at least as high. With many for-
354 ● International Competition in Services

eign governments determined to continue

protecting their equipment markets—and quite

able to do so for years, if they wish—greater

progress may be possible on the services side.

A legislative statement of negotiating objectives could lead to a clearer sense of priorities

within the government, as well as emphasizing U.S. resolve to other countries (Option 15,

table 59). Because the interests of equipment

manufacturers, service providers, and users frequently diverge, it also seems appropriate to

broaden the advisory process for telecommunications trade: Congress could direct USTR

and Commerce to establish an I SAC solely for

telecommunications, with representation from

the full range of interested parties, including

users and labor (Option 16). Such a step would

become especially important if sector-specific

negotiations on telecommunications begin during the current GATT round; it could also help

lay groundwork for deliberations in other

forums.

Resolution of the currently unsettled regulatory environment in the United States could

have major impacts on competitiveness. Since

the AT&T antitrust agreement, domestic regulatory authority has been shared by the FCC

and Judge Greene’s court, together with the Justice Department. At some point, new legislation will necessarily replace these makeshift arrangements. An Administration-supported bill

proposed but not enacted in the 99th Congress

(S. 2565) would have redefined FCC authority

in light of past legal decisions, reestablishing

the Commission’s primacy with respect to domestic telecommunications. With the stakes for

contending U.S. firms so high, any new legislation promises to be highly controversial; it

may take years to resolve such matters, Here

the point is simply that domestic telecommunications regulations do affect international

competition, but that at present the impacts

probably get too little attention (Option 17).

A final set of questions stems from the possibility that telecommunications carriers (both

in the United States and abroad) may move

toward different technical standards for Integrated Services Digital Networks (ISDN, chs.

5 and 9). Incompatible standards could raise

costs and substantially reduce benefits to users.

Prior to the AT&T breakup, most of these technical matters could be left to the deliberations

of standard-setting bodies, Now, with competing companies here and abroad seeking to

shape standards to give them an edge over their

rivals, technical questions once viewed as arcane by the policy community have entered the

wider political arena. As discussed in a later

section of this chapter on “Technical Standards, ” policy makers will need to monitor the

evolution of ISDN both here and abroad on a

continuing basis (see Option 30 in table 61).

HUMAN RESOURCES POLICIES

The international competitiveness of Amer- lations and interactive videodiscs lead to imican industry depends ultimately on human provements in the quality of training/retraincapital, and thus on human resources policies. ing programs? To greater productivity and

Beyond this, rapid economic change, placing lower costs? How can reform of public educanew demands on firms and their employees, tion contribute to flexibility, and to the ability

brings new needs for education and training. of people to continue learning during their

Rapid structural change also brings new ques- working lives? What would broader based posttions: In what proportions should companies secondary vocational curricula, suited to the

and workers share in retraining costs? Will evolving needs of the service industries, look

educational technologies like computer simu- like?
Ch. 10—U.S. Government Policies: Issues and Options ● 355

—

Rapid and often wrenching change has become a hallmark of the U.S. economy, American companies, more exposed to international

competition than in the past, must adapt in order to survive. As these firms restructure and

automate, some workers lose their jobs, Others

find themselves asked to move into fundamentally different kinds of work. Flexibility for the

employer may bring uncertainty if not instability for the employee, illustrated by the many

cases in which U.S.-based firms have responded

to competitive pressures by hiring greater numbers of part-time and temporary workers (ch.

7), or by moving production offshore, Policymakers, here and in other industrialized countries, find themselves seeking to balance conflicts between job security and a flexible and

efficient labor market.

When it comes to education, training, and

skill development, the questions look much the

same inside the service sector or outside it.

Broadly similar patterns of computer utilization exist in the services and in manufacturing; problem-solving and learning skills will be

much the same (ch. 8), As more firms reorganize

work and incorporate computer-based systems,

more Americans will be faced with worklife

adjustments and transitions—in a word, with

the need for retraining.

Demographic shifts promise to make some

of the coming adjustments more problematic.

The aging of the baby boom generation will be

felt for years to come: by the year 2000, half

the Nation’s labor force will be middle-aged (35

to 54), compared to about one-third today, In

the past, some companies have been reluctant

to retrain middle-aged employees. Meanwhile,

many older Americans have been reluctant to

seek out adult education and (restraining on

their own. Companies confronting a shrinking

pool of recent graduates with the latest specialized training may be forced to strengthen their

internal training and retraining programs.

Reevaluation of Human Resources Policies

Adapting the American education and training system—primary and secondary schools,

community colleges and universities, continuing education, retraining for displaced workers—to emerging needs may pose real difficulties. Over the past few years, more than a dozen

commissions and study groups have called for

educational reform. No consensus has emerged

on what needs to be done. Indeed, it is hard

to see the outlines of a meaningful debate

through the slogans. Distasteful as it may be

to suggest more studies, this seems necessary:

OTA’s analysis indicates that a more fundamental reexamination and debate than yet seen—

one focusing on specific changes in human resource policies that might best serve the U.S.

economy in years to come—would serve decision-makers well (those in the private sector,

as well as in Federal, State, and local government).

To be useful, such a reexamination will have

to address a broad range of issues—education

and training in their deep as well as obvious

senses:

●

●

●

●

What should be the nature of a liberal education in the 21st century? If the need for

work declines, can we educate people in

ways that help them find satisfaction in

other ways?

What is the character of the skill base on

which industrial competitiveness depends?

Even “unskilled” workers must possess a

wide range of abilities: social and communications skills; some kinds of problemsolving capabilities. More highly skilled

workers rely on broader and deeper stores

of tacit know-how (anticipating problems,

troubleshooting). How do formalized programs of education and training contribute to the skills people actually use in the

workplace?

In terms of industrial competitiveness,

what kinds of skills will be most vital in

the future? How will postindustrial skills

differ from those of the past? Can a postindustrial economy have a true oversupply of technically skilled people?

To what extent can improving the skills of

the U.S. labor force, or changing the mix

of skills in the labor pool, help drive economic growth, thus mitigating structural

unemployment and underemployment?
356 • International Competition in Services

—

● Will the invisible hand provide for future

skill needs? Will the existing U.S. education

/training system respond quickly enough

to shifting needs? Will gaps between those

with skills and those without become more

difficult to bridge?

Beyond such questions, the debate needs to include labor law and employee benefit policies.

Congress could launch such a reevaluation

if it wishes (Option 18, table 60). One approach

would be to assign the task to an existing body

within the executive branch. Alternatively,

Congress might create an independent forum

(e.g., a council or institute, with a mandate to

report and make periodic policy recommendations to Congress and the President). If Congress establishes an industrial competitiveness

council or similar advisory organization (as has

frequently been proposed), it could explicitly

direct the council to include human resources

and human capital among the policy issues addressed.

Adult Education and Training19

Already large, the U.S. system for adult education and training continues to grow. But despite its breadth and scope, the system does a

poor job of meeting the training and retraining needs of those with non-professional and

non-supervisory jobs. This is true in both the

services and for blue-collar workers in manufacturing.

In many respects, the system helps those who

need it least. Managers, administrators, and

professionals have many opportunities to maintain and improve their skills; so do some skilled

workers and paraprofessionals, Companies are

much less likely to provide training for those

having low skills to begin with, while few of

these adults look to vocational institutions—

whether profit-seeking trade schools for barbers

and computer programmers, or community and

junior colleges—for help in adapting to changing job conditions or in making career shifts,

l~see, in genera], Technolog\~ and Structural Unt?mPloyment:

Reemploying Displaced Adult; (Washington, DC: Office of Technology Assessment, February 1986), pp. 274-289.

Congress has been aware of this problem, and

in several recent laws has authorized programs

to broaden opportunities for work-related adult

education and training:

●

●

In 1982, Congress created a major new program for displaced workers under Title III

of the Job Training Partnership Act (JPTA,

Public Law 97-300). Title III provides funds

to States for projects that offer displaced

workers reemployment services, including

vocational skills training and remedial education. 20 Although the broadest Federal

program for displaced workers, Title III

reaches fewer than 5 percent of those eligible. Most of the State programs seek to

place people in new jobs as quickly as possible, rather than providing training. Remedial education gets little attention, even

though perhaps 20 percent of JTPA participants have trouble with reading, writing,

and arithmetic. 21

The Carl D. Perkins Vocational Education

Act of 1984 (Public Law 98-524) allows

States to spend part of their basic Federal

grant for vocational education on adult

training for those who are currently employed, as well as those who are seeking

jobs (or are threatened with displacement).

The Act also authorizes special grants (as

yet unfunded) to States for adult training

and industry-education partnerships for

training in high-technology occupations.

Despite such initiatives, the U.S. Government

provides less support for adult education and

training than other industrialized countries

such as Canada and France. In its previous

work, OTA has examined policy alternatives

for adult training, retraining, and education in

detail—an analysis suggesting a more active and

~OTWbnO~ogy and structural Unemployment: Reemploying Djsplaced Adults, op. cit., pp. 163-165. The Administration, as part

of President Reagan’s competitiveness package (the Trade, Employment and Productivity Act of 1987, H.R. 1155 and S. 539),

has proposed a Worker Readjustment Assistance Program to replace JTPA Title III (and other programs).

zIA recent survey found most Americans aged 21 to 25 to be

literate, but only a relatively small proportion were proficient

at literacy tasks of any complexity—a finding with discouraging

implications for the future of knowledge-based service industries. See 1.S, Kirsch and A. Jungeblut, Literacy: Profiles of

America Young Adults (Princeton, NJ: National Assessment

of Educational Progress, 1986).
Ch. 10—U.S. Government Policies: Issues and Options ● 357

Table 60.—lssue Area Ill: Human Resources

A. EVALUATION

Despite numerous commissions and task OPTION 18: Call for a fundamental reexamiforce reports, no consensus has emerged nation of human resources policies, and

on adapting education, training, and other an evaluation of specific steps to enhance

human resources policies to the new cir- the ability of Americans to adjust to shifts

cumstances resulting from U.S. immersion in labor market and workplace conditions

in the international economy. resulting from international competition.

B. ADULT EDUCATION AND TRAINING

A work force with good skills IS essentia l OPTION 19: Direct the Administration to unfor maintaining U.S. competitiveness dertake pilot and demonstration projects,

While some companies provide broad in cooperation with business and industry,

based education and training for their em- on new approaches to training and retrainployees, others do Iittle or nothing. ing of active workers, Involvement by organized labor would also be desirable,

Such programs would not require new

authorization

Demonstration projects alone will not lead

to major Increases in training for employed adults Cost-sharing with business.

es (either directly or indirectly) might

Increase training opportunities, but — in

the absence of alternative funding mechanisms—would run counter to deficitreduction objectives.

Many service jobs, including those for which

a high school degree once sufficed, now

require specialized vocational-techntcal

training Beyond job- or occupation -

specific courses, general vocational curricula that would provide a foundation for

continuing (re)training could help people

in the knowledge-based industries adapt

to future workplace changes

C. INSTRUCTIONAL TECHNOLOGY

The Federal Government, especially the military, has developed a great deal of technology and Instructional material for

training. Some of this could be useful to

the private sector and the schools, but

only limited information has been easily

available to educators and private sector

trainers.

Transfer of training technology from the

government to schools and to the private

sector may involve several agencies, as

well as requiring modifications to course

materials

OPTION 20: Consider alternatives to increase the national commitment for training and retraining of the adult work force,

including Incentives for employer-provided

education and training and new sources

of funding

OPTION 21: Direct the Department of Education, in cooperation with the Department

of Labor, to fund demonstration projects

for broad-based vocational curricula,

focusing on generic skill development for

the knowledge-based services. Grants

could be made available to both public

vocational-technical schools and

proprietary (trade) schools

OPTION 22: Direct the Administration to

give priority to timely completion of the

feasibility study for an Inventory of federally funded training software called for by

the Federal Technology Transfer Act of

1986. Should it seem appropriate once the

feasibility study has been completed,

direct the Administration to proceed with

the Inventory.

OPTION 23: Instruct Federal agencies to

place more emphasis on transfer of training technology and course materials to

public institutions and corporations, initially through technology transfer mechanisms as authorized in Public Law 96-480

Congress could follow with oversight to

determine whether new mechanisms

should be created specifically for diffusion of training technologies.

Congress could charter an Independent

council or institute to report and make

specific policy recommendations. Or it

could ensure that human capital issues

get a prominent place in the mandate of

any council or other body established by

Congress to examine and make policy

recommendations on international competitiveness,

In its 1986 amendments to JTPA (Public Law

99-496), Congress authorized the Secretary

of Labor to fund pilot projects for training

people “threatened with loss of their jobs

due to technological changes, Internation.

al economic policy, or general economic

conditions. ” As an alternative, the Carl D

Perkins Vocational Education Act of 1984

(Public Law 98-524) provides for a special

State grant program for adult education

and retraining —including training designed cooperatively with employers—

which has never been funded Congress

could fund this program, and specify that

part of the appropriation be used for

broad-based training of employed adults

Proposed alternative funding mechanisms

have Included: increased direct Federal expenditures for cost-sharing; tax credits for

firms that provide certain kinds of training; a payroll-based tax to fund retraining

services for workers; and a small uniform

tariff, imposed on all imports (after seek.

ing GATT acceptance) to fund worker adjustment programs.

Business and industry should be actively involved in any such experimental and

demonstration projects The Carl D Perkins Vocational Education Act of 1984 provides a suitable vehicle—through the

authorization for cooperative demonstration programs, or for special State grant

programs for industry-education partnerships. Congress would need to earmark

funding if it proceeds with this option

Congress called for the feasibility study in

the Federal Technology Transfer Act (Public Law 99-502), which amended the

Stevenson-Wydler Technology Innovation

Act of 1980 (Public Law 98-480) If the

feasibility study—due in October 1987—Is

done well, it should help Congress determine whether to direct the Administration

to proceed with the inventory Itself.

Examples of executive branch efforts to

transfer training technology Include a

computer-assisted reading program developed by the Navy and transferred to

some libraries. On a larger scale, the

Departments of Defense and Education

have been cooperating on methods of

transferring the Army’s computer-based

basic education program
358 ● International Competition in Services

Table 60.— Issue Area Ill: Human Resources—Continued

Issue - Options for Congress Comments —

Realizing the long-term potential of instruc- OPTION 24: Increase funding for research, Federal funding for such a program—which

tional technology will require continuing

research on teaching and learning. Beyond R&D and the development of new

teaching and training materials, dissemination of new methods—including computer-based training—will require ongoing

Federal support,

development, evaluation, and dissemination of instructional technologies—

including adult education and training.

One approach would be to direct the

Department of Education to establish and

provide partial funding for a research

center concerned specifically with adult

learning, and including R&D on instructional technologies,

SOURCE Office of Technology Assessment, 1987

more positive Federal role that

steps such as:22

●

●

●

●

Greater funding for outreach

might entail

and delivery

of services under the Adult Education Act,

as amended in 1984 (Public Law 98-511).

This is the largest Federal program that

supports State and local adult basic and

secondary education; with more funding,

a wider array of basic skills programs

geared to workplace needs, and involving

companies and labor unions, could be

offered without reducing services to those

not at present in the labor force.

More effective outreach programs at the

community level on postsecondary educational opportunities for adults.

Targeted Federal assistance for retraining

workers with jobs in contracting or vulnerable industries, aimed at avoiding some displacement problems to begin with (i.e., by

increasing both lateral and vertical mobility within the Nation’s labor market).

Making it easier for people with jobs to

qualify-for Federal financial assistance to

continue their education on a part-time

basis.

Any and all of these steps would help, but

perhaps the single most pressing need is to find

ZZTeChnc)lOgy and structural Unemplo&yment: Reemploying Displaced Adults, op. cit., ch. 2.

In addition to programs like those outlined above, the Federal

Government has permitted employees to deduct expenses for

education directly related to their current job, and to omit from

taxable income qualifying educational benefits provided by their

employer. The 1986 Tax Reform Act (Public Law 99-514) retains

the second of these provisions only through 1987; it will need

to be reauthorized if it is to apply in later years.

might be the responsibility of the Department of Education’s Office of Educational

Research and Improvement—could be

kept modest by requiring matching grants

from foundations and the private sector,

which stands to benefit substantially.

Congress, in the Higher Education

Amendments of 1988 (Public Law 99-498),

called for a national program of research

on adult learning—without, however,

authorizing funding. —

ways of stimulating company-run education

and training programs for lower-level employees. As outlined in chapter 7, many American

companies have sought to adjust to new competition by relying more heavily on a contingent workforce—e.g., temporary and part-time

employees—rather than seeking to improve the

skills and flexibility of existing employees.

When companies do provide training for lowerlevel workers, the programs tend to be narrowly

focused (e.g., instruction in the use of new

equipment). This not only keeps costs down,

but reduces the chances that employees will

take a job with another firm, perhaps a competitor. Companies safeguard their investment

—at least in the short term—by concentrating

on job-specific and firm-specific know-how,

rather than transportable skills. But society as

a whole might reap greater gains from a broader

and deeper approach.

How can Federal policies address these disincentives, and encourage more comprehensive company programs for continuing education and training? Demonstration projects for

experiments with new ways of integrating work

and learning offer one approach (Option 19),

Far more comprehensive proposals have also

emerged. Title V of H.R. 3 (as passed by the

House) would enact the Education and Training for American Competitiveness Act of 1987,

with provisions ranging from grants for literacy improvement to programs for teacher training and graduate education. S. 406, as introduced in January 1987, would authorize $100

million for special State grants under the Perkins Act, Other bills propose tax credits for
Ch. 10—U.S. Government Policies: Issues and Options ● 359

company-run programs that go beyond training the employer would provide anyway. As

Option 20 suggests, the prerequisite for more

extensive adult education and training seems

to be money, not ideas.

Vocational and Paraprofessional

Education and Training

For many jobs where a high school degree

once sufficed, companies now seek entry-level

people with specialized training (chs. 7 and 8).

But where technical change is rapid, as it is

in many of the knowledge-based service industries, training can quickly become obsolete. Absent shifts in public policy that would encourage companies to provide more training or pay

a greater share of the costs, heavy burdens will

continue to fall on individuals and on community colleges and vocational-technical schools.

Occupational titles for the knowledge-based

services—customer service representative, data

gatekeeper, para-legal or para-tax accountant

(table 43, ch. 8)–suggest the kinds of generic

skills needed:

●

●

●

●

●

generalized troubleshooting and problemsolving;

planning under conditions of limited resources and uncertainty;

the interpersonal process in sales;

negotiation and complaint encounters;

retrieving, formatting, and analyzing data.

Programs including such training might or

might not entail an extra span of coursework.

It should be possible to do without some morespecialized courses, keeping programs to current lengths, if generalized approaches to skill

development prove successful, and if employers

could be encouraged to take care of narrower

training needs themselves. Graduates of 2-year

colleges and technical schools that offer broadlybased vocational curricula imparting the kinds

of skills listed above should be better prepared

to avoid obsolescence.

Much as for adult education and training, pilot and demonstration projects could help explore the merits of new and more general vocational curricula, Such projects should include,

not only curriculum development, but evaluation and dissemination of results. Demonstration grants, with the active involvement of both

the Departments of Education and Labor,

should probably be contingent on participation

by business and industry. Participation by organized labor would also be desirable. Congress

could direct the Administration to proceed with

this alternative as a cooperative demonstration

program under one of the special grant provisions of the perkins Act (Option 21).

Instructional Technology

Productivity in teaching and training has

changed little over the years, Educational technologies hold great potential—as yet mostly

unrealized—for improving both the effectiveness and the productivity of instruction, of

nearly all kinds and at nearly all levels, 23 This

section focuses on two specific issues: 1) transfer of training technologies developed with government support; and 2) the Federal role in development and dissemination of new

instructional technologies.

Transfer of Training Technologies

Federal agencies, notably the Department of

Defense (DoD), fund the development of a wide

range of instructional materials and technologies. Because military systems have grown so

complex—and because repair and maintenance

personnel turn over relatively quickly-DoD has

sought to develop computer-based teaching

methods, The Army, for example, plans to

spend $27 million over the period 1984-1990

on interactive videodisc training materials (and

another $100 million on hardware). Other agencies, especially the Department of Education

and the National Science Foundation (NSF),

also support R&D on instructional technologies.

nzn forma tjona] Techno]ogj, and Its Impact 011 A ITI eri[,”an Education (Washington, DC: Office of Tech nologl Assess m e n t, R’( E

\’ember 1982] examines instructional technologies in primary

and secondary schooling. Techno)ogj’ and Structural Unemplo.tment: Reemplo~’ing Displaced Adults. op. cit,, co~’ers adult education and training. The discussion belo~~r dra~t’s on pp. 96-IO I

and pp. 299-302 of the latter report, updating its findings. OTA

is present l}” condu(; ting an assessment entitled “Educational

‘1’echnology: An Assessment of Practice and Potent ial. ”
360 ● International Competition in Services

—.

While some of the training materials developed by DoD to meet its own needs might be

quite useful to the public education system, or

to private industry, mechanisms for evaluating

and transferring these materials have proven

less than adequate. Federal agencies seldom address such questions as: Which course materials are relevant to education and training outside the government? What modification would

be needed? Nor have Federal agencies made

the instructional materials themselves easily

available for others to try out.

Congress has called for a first step, in the Federal Technology Transfer Act of 1986 (Public

Law 99-502), which directed the Secretary of

Commerce to submit a report on legal barriers

to transferring Federally-funded computer software, and on the feasibility and costs of compiling a comprehensive inventory of Federallyfunded training software (Option 22), (Public

Law 99-502, one of two bills enacted in the 99th

Congress which amended the Stevenson-Wydler Technology Innovation Act of 1980, gets further discussion in the section below on technology policy.)

A more ambitious approach, in Title V of the

House-passed version of H.R. 3 (sections entitled “Transfer of Education and Training

Software”), would create an office in the Department of Education to transfer course materials to State and local agencies, and to the

private sector, Another proposal in the 100th

Congress, S. 406, would (as introduced) place

a training technology transfer office in the Department of Commerce. Alternatively, it would

be possible to rely on existing technology transfer mechanisms, rather than setting up a new

office; Congress could, for example, direct Federal agencies that have established offices of

research and technology application—charged

under the Stevenson-Wydler Act with technology transfer—to devote part of their effort to

training technologies and materials (Option 23).

Research, Development, Evaluation,

and Dissemination

Over the longer term, realizing the potential

of new instructional technologies will require

continuing research on learning, as well as the

development of better instructional techniques

and teaching materials. Teachers will themselves have to be retrained, as recently stressed

by the National Task Force on Educational

Technology. 24 Although the task force focused

on the public schools, a number of its recommendations are equally appropriate for adult

education:

develop a long-term Federal Government

R&D agenda for instructional technologies,

in collaboration with school officials and

the information industry;

designate a highly visible and widely respected Federal agency to support peerreviewed R&D on the application of information technologies to education;

support State centers for evaluating and

implementing computer-based instructional technologies.

Computer-based systems create opportunities

for radically different approaches to education

at all levels—opportunities that have been anticipated for years, and that may finally be nearing fruition, Taking full advantage will require

Federal R&D support—including evaluations

of the effectiveness of new methods, and programs for disseminating results and training

teachers in the use of new instructional techniques and teaching materials. Federal research

funds appear particularly critical for adult education, which has received little attention in

the past.

Congress, in Title I of the Higher Education

Amendments of 1986 (Public Law 99-498) called

for establishment of a national program of research on adult learning. However, it stipulated

that no money be appropriated during fiscal

years 1987-91. Meanwhile, funding for educational laboratories and centers administered by

the Department of Education’s Office of Educational Research and Improvement (OERI) has

remained at the $30 million level since fiscal

year 1974, The Department also supports research through other programs, but OERI (forz4TranSfOr1n jllg A merjcan Education: Reducing the Risk t[) tht?

Nation, A Report to the Secretary of Education by the National

Task Force on Educational Technology (Washington, I)C: office of Educational Research and Improvement, Department of

Education, April 1986), p. 24.
Ch. 10–U.S. Government Policies: Issues and Options ● 361

—

merly the National Institute of Education) is ration of new approaches to teaching and trainthe largest. Given that R&D on instructional ing based on new technologies will probably

technologies must compete with other needs, require a substantial boost in support (Option

many of them well-established, adequate explo- 24),

INDUSTRIAL AND TECHNOLOGY POLICIES

Competitiveness depends on technological

innovation, among other things, and innovation depends on R&D and the technology/science base (again, among other things). Certainly

true for manufacturing industries, does this

causal chain hold for the services? From the

evidence presented in the sector chapters, the

answer is yes. Not only do the service industries depend on much the same technology/science base as manufacturing, but services and

manufacturing depend on one another in many

ways; technology policy should be seen from

a vantage point encompassing both.

As discussed in chapter 9, governments encourage R&D and technology development both

directly and indirectly. Some place more emphasis on commercial technologies than does

the United States. In a few countries—notably

Japan–government appears to have a deeper

appreciation of the ways in which the knowledge-based services, in particular, can stimulate economic growth. This section begins with

the need for better understanding of R&D in

the service industries, and goes on to the U.S.

environment for technological innovation and

diffusion of commercial technologies–a subject that OTA treats quite broadly, in part because the analysis of technical licensing patterns in chapter 6 reveals cause for concern in

the Nation’s technology infrastructure as a

whole.

R&D in the Services

As pointed out in box FF in the preceding

chapter, Federal Government statistics greatly

understate the contribution of services to total

U.S. R&D spending. Science Indicators, the

principal government compilation of R&D data,

suggests that nonmanufacturing industries account for a bit over $2 billion in annual spending—less than 3 percent of all U.S. industrial

R&D. This is far below the alternative estimate

for services-related R&D in table 48 (ch. 9)–

about $26 billion, one-quarter of U.S. industrial

R&D. Such a figure—while a rough approximation—demonstrates that R&D in the services has

been much more important than commonly appreciated. Services-related expenditures have

been under-reported for largely historical reasons (including definitions oriented toward

manufacturing); but with technology development by U.S. service suppliers exceeding the

total R&D budgets of most countries—and with

some of the money coming from Federal sources

—policymakers plainly deserve better information (Option 25, table 61).

Research, Development, and Diffusion of

Commercial Technologies

This and other OTA assessments have pointed

to the need for more systematic attention to

commercial technologies in the United States—

to the technology base itself, and also to mechanisms for diffusing existing knowledge to

firms that need it. Few companies have the resources—people as well as dollars—to learn

everything they need to know on their own. By

helping companies move from research to commercial production more quickly, greater Federal support for pre-competitive technology

development could strengthen U.S. competitiveness in emerging fields such as information

services and biotechnology; in mature industries, it could help improve productivity and

manufacturing efficiency. Because the technology and science base for service industries overlaps that for manufacturing, Federal policies

aimed at reversing the decline in U.S. technological advantage would help the services quite

directly.

Beyond mission-oriented R&D directed at

needs such as national defense and health care,

the Federal Government funds basic research—
362 ● International Competition in Services

Table 61 .—Issue Area IV: Technology Development

Issue Options for Congress Comments

A. R&D IN THE SERVICES

OTA finds U.S. R&D related to services to

be much greater than reported in the

usual Federal Government data series.

Better information would make for better

R&D policy choices.

B. THE U.S. TECHNOLOGY BASE

The services depend on much the same

technology base as manufacturing. Leaving aside national defense, the Federal

Government provides relatively little funding for technology development.

Congress has called for more emphasis on

diffusion of technology to American industry through such laws as the Stevenson-Wydler Act (Public Law 98-480). The

Administration, however, has only implemented parts of the legislation.

The United States, no longer the unquestioned leader in technical knowledge, will

need to do a better job of learning from

foreign technology in years to come. This

may entail devoting more resources to

locating, evaluating, and translating foreign technical literature, encouraging

more U.S. participation in overseas R&D,

and seeking reductions in barriers that impede access to foreign technologies.

Policy adjustments may be needed to

capitalize on the potential of defense

spending for enhancing the competitiveness of commercial industries. While

such issues have been raised in the past,

not enough is known to guide policy development,

OPTION 25: Direct Federal agencies—

specifically, the National Science Foundation—to develop new criteria for identifying and collecting information on R&D

and technology development related to

the services.

OPTION 26: Increase Federal R&D support

for commercial (i.e., non-defense) technologies by expanding initiatives such as

NSF’s Engineering Research Centers, and

ensuring continued funding for existing

programs such as the Center for Building

Technology at the National Bureau of

Standards.

OPTION 27: Alternatively or in addition to

the steps in Option 26, Congress could,

under the 1986 Federal Technology Transfer Act (the 1986 amendments to Public

Law 96-480), authorize, provide funding

for, and direct the Administration to offer

grants for Centers for Cooperative

Research. For greatest effectiveness,

these centers should be charged with

technology diffusion as well as development.

OPTION 28: Emphasize congressional commitment to implementation of the

Japanese Technical Literature Act of 1986

(Public Law 99-382) through early oversight and full funding. If Congress wishes

to place more emphasis on screening and

evaluation, or to direct the Administration

to fund translations of interest to university-based researchers, it could direct

the Commerce Department to share responsibility with agencies having more experience in technology and science—e.g.,

the National Science Foundation.

OPTION 29: Increase support for exchanges

of U.S. technical personnel with those of

other nations. Congress could fund fellowships that would send graduate students in engineering to countries like

Japan, as well as considering programs

that would provide partial support, in conjunction with employers, for industrial engineers and scientists working abroad

temporarily (in industry or in universities).

OPTION 30: Make equitable access to foreign technology a formal U.S. negotiating

objective, and call for reductions in restrictions on access for U.S. citizens to

publicly-supported R&D projects in other

countries.

OPTION 31: Investigate and evaluate policies for maximizing the positive impacts

of defense-related R&D and procurement

on the international competitiveness of

American industries.

Technology development in the services seldom fits very comfortably into traditional

views of R&D, Services R&D has been underreported for reasons similar to those

for the underreporting of services trade in

the U.S. current account—outdated and

unexamined procedures, many of which

simply omit service activities.

In addition to the 11 existing ERCs, NSF

has funded two new centers starting in

fiscal year 1987; one more is under consideration for this year.

Should Congress choose to create an Advanced Civilian Technology Agency or National Technology Foundation—as has

been proposed in a number of bills introduced in recent years (e.g., S. 1233 in

the 100th Congress) —cooperative technology centers would fit naturally into its

role and function. Technology diffusion

programs could be cost-shared between

the States and the Federal Government.

The Commerce Department, which is already

spending $1,8 million on related tasks,

plans to implement the law by reprogramming $300,000 from its existing budget.

Sending more engineers and scientists to

work temporarily abroad could help

change corporate attitudes in the United

States, and would give American industry

more rapid access to foreign technologies

as they emerge. To maximize the value of

such programs, those awarded fellowships should get language training—e.g.,

in Japanese—before going overseas.

Pursuit of this objective (included in H.R. 3

as passed by the House in May 1987)

would need to be consistent with U.S.

policies on foreign access to results from

government-supported R&D projects here.

Analysis of the linkages between the military and civilian sides of the economy

might also lead to policy changes making

it easier to adapt commercial technologies to military systems.
Ch. 10—U.S. Government Policies: Issues and Options • 363

—

Table 61 .—Issue Area IV: Technology Development—Continued

--

Issu e

—

Options for Congress Comments

C. TECHNICAL STANDARDS

Before the AT&T breakup, a single company

dominated the process of setting technical standards. Today, the process Involves

many firms in competition with one

another. Because implementation of ISDN

(Integrated Services Digital Networks) will

involve multiple actors, finding ways to

minimize Incompatibilities among different systems—and the associated costs to

users—takes on new significance.

Developing U.S. positions at the ITU has become far more complex since the AT&T

breakup Future ITU deliberations may

well define a global framework for ISDN,

with Impacts on equipment sales as well

as services U.S. positions at the ITU and

OPTION 32: Direct the National Bureau of

Standards (in cooperation with the National Telecommunications and Information

Administration) to set up an ISDN testing

and demonstration laboratory to help

government agencies make purchasing

decisions and take advantage of emerging

technical capabilities, and to help pave

the way for a smooth transition to ISDN

in the United States.

at other forums (e. g., GATT) will need to ●

be carefully worked out and coordinated.

●

OPTION 33: Congress could anticipate the

possibility that incompatible standards for

ISDN will be proposed both internationally

and within the United States, and begin to

take preparatory steps to address such issues. Specific actions might include:

oversight to review U.S. preparations

and negotiating positions for upcoming

ITU meetings (e. g., WATTC-88), and the

implications for U.S. positions at GATT

and in other trade negotiations dealing

with telecommunications;

request of a comprehensive study to

review prospective ISDN standards and

implementation, with a view to laying

groundwork for future policy decisions

(e.g., if it appears that U.S. telecommunications carriers might adopt dissimilar approaches that would be costly for

users),

SOURCE Office of Technology Assessment, 1987

much of it through NSF, and mostly in universities. But government agencies have preferred

to stay out of technology development related

to commercial products and processes. Civilian applications do follow quite directly from

some Federal spending, Defense-related R&D

and procurement stimulated the early growth

of the U.S. computer and semiconductor industries. Basic research funded by the National Institutes of Health helped fuel the take-off of the

biotechnology industry. But these are the exceptions.

The Reagan Administration has held that support for basic research should suffice to rebuild

the Nation’s technological competitiveness.

OTA’s analysis indicates that judicious support

for generic or pre-competitive technologies—

those that can be applied by all companies in

a given industry (or making use of a given field

of knowledge) —would also pay off, Where the

benefits to any one firm tend to be indirect and

elusive, companies have little incentive to invest. But much as for basic research, the social

NBS’s Institute for Computer Sciences and

Technology already has related work underway on OSI (Open Systems Interconnection). An ISDN laboratory could

provide independent assessments to support Federal procurement decisions, and

also disseminate information to private

sector users of telecommunications services. If industry were willing to donate

equipment, Federal funding for the laboratory could be kept modest.

The State Department coordinates and

presents U.S. positions at the ITU The

Department relies heavily on the private

sector, through committees, for advice on

U.S. recommendations concerned with

standards. The State Department IS also

at work on the U.S. position for the 1988

World Administrate Telephone and Telegraph Conference—the first WATTC since

the AT&T breakup—and the plenipotentiary ITU meeting scheduled for 1989,

benefits can be considerable. The analysis in

chapter 4, for example, indicated that Federal

R&D funding for construction technologies—

where companies traditionally have conducted

little R&D on their own—would have benefits

both domestically and internationally. A second example: R&D aimed at improving productivity in the design and development of computer software (ch. 5). Progress here would help

not only the software industry, but computer

hardware manufacturers, companies that embed machine intelligence in their products, and,

indeed, software users throughout the Nation’s

economy. But at present, only a few large companies conduct much research on software

productivity.

In recent years, Congress has taken steps to

stimulate R&D and technology development

both indirectly and directly. R&D tax credits

have been the primary indirect instrument. Unfortunately, for reasons explored in box HH,

tax credits are seldom very effective in encouraging firms to undertake R&D they would
364

/

WY2’zd

‘~TAaS!

not ot~eS~ise pursue” ‘“ rpoltant direct meas u

re’ Con[

a more active ~e~era~ role ill

~ercia~ tec~n”~ogies when it 1

son-WYd~er Tec~nO~Ogy ~nno’

(P~b\i~ ~a~ 96-48°~-a}aw ‘he

has implemented only se~ec

execu

tively”

in 1983, the ~-~

the rules covering ters aut~[

nology Cen .ll~stit

~vdler Act~.:

Im ~e~hapS itS ~osi ‘~-

greSS a~i~orize~

supporting cOm-

?a!%ed the StevenVation Act Of 198° ~ive branch

-- ..n A~~in~slrdLiOn @Oke~

~rantS for in~@sia~ iec~-

~Or@~ by theerce StevensOn- DePartUting a CoFm

~~nt initia~iii”Wbic~ supP1ies Information ‘ntended to inspire firlns tobandtogether in ~&Il

current antitrust po~-

@S fO1’ pIW-cOmpeti- --(20 ~it~ few
exceptions, has been tepid. The reasons seem

plain enough: on their own, companies that normally compete will cooperate only on quite visible, indeed obvious, research problems—those

they can agree on and hope to solve relatively

quickly. The centers envisioned in the Stevenson-Wydler Act would have addressed this

quite predictable feature of the technological

landscape through government-industry-university partnerships, with the expectation that

much of the leadership would emerge from the

university research community. Perhaps the

greatest shortcoming of the Act as originally

passed was that it called for the centers to eventually become self-supporting. Past analysis by

OTA suggests that continued cost-sharing by

the Federal Government would not only provide stability, but extend the R&D time horizons

beyond those of the private sector. 26

Recently, the Administration has also created

a program of Engineering Research Centers

(ERCs), with funding from NSF, along with a

DoD undertaking entitled University Research

Initiatives (URI), The first two years of the ERC

program saw 11 university centers established.

Through fiscal year 1992, NSF proposes a $160

million commitment to the program (private

sector sources also provide support); current

plans call for a total of 25 centers by 1989. While

the objectives include strengthened linkages between universities and industry, the ERCs are

properly seen as centered on the universities.

Nor is it likely that DoD’s URI program will

provide much immediate help on the civilian

side of the economy; the program is still in its

early stages, but it seems plain—and quite

natural—that most of the support will go for

technologies that DoD research managers view

as necessary for meeting future mission requirements. 27

‘d’’ fle~’elopmerrt and Diffusion of Commercial Technologies:

Shoulc] the Federal Government Redefine Its Role?” staff memo

randum, C) ffic. e of “1’echnolog\ Assessment, Washington, DC,

hlarch 1984.

The short-term orientation of L1 .S. industrial R&D has been

one cause of technology gaps. Industry’ cooperati~res generally

have time horizons somewhat longer than those of indi~idu,]l

firms, but still relativeljr short—a problem the Commerce Department’s information program does not address.

27 S[; C, f. r ~;,xa ~ple, the 1 ist of resea rc tl topics 1 n ‘‘“rhe 1le Pa ‘trnen t of Defense F}’ 1986 L’ n it’ersity Resea r(:h I n itiat ii’e Program

olerview, December 1985.

Ch. 10—U.S. Government Policies: Issues and Options ● 365

NSF’s ERC program plainly represents a step

in the right direction. To encourage R&D that

would strengthen the technology base for

American industries, Congress could ensure

continuing support for the ERCs, as well as existing programs for generic technology development (e. g., those at the National Bureau of

Standards, NBS) (Options 26 and 27). Directing the Administration to fund centers as envisioned in the Stevenson-Wydler Act would

help move university research agendas closer

to the needs of industry. Support for programs

that transferred R&D results to the private sector would enable American companies in many

industries to compete more effectively. (As

noted in ch. 4, more effective technology transfer mechanisms would help the E&C industry

benefit from technologies developed through

DoD funding for construction-related R&D,

which totals about $270 million per year. )

Access to Foreign Technology

Given rough technological parity in many

fields, American companies now have a good

deal to learn from overseas. This will take new

attitudes by corporate managers, but Federal

policies can also contribute. In part because

the United States has been ahead for so many

years, both the public and the private sector

have neglected mechanisms for locating, evaluating, and translating information on foreign

scientific and technical developments. Congress has made a start on this problem, most

recently with the passage of the Japanese Technical Literature Act of 1986 (Public Law 99-382,

like the Federal Technology Transfer Act of

1986, an amendment to the Stevenson-Wydler

Act). Among other things, this law directs the

Commerce Department, through the National

Technical Information Service, to monitor technical developments in Japan and consult with

users on their needs for information concerning Japanese engineering and technology,

Commerce is to translate Japanese publications

(on a cost reimbursable basis) and prepare annual reports on scientific and technical developments in Japan.

Although a significant step, the new legislation goes only part way in meeting U.S. needs
366 • International Competition in Services

for foreign technical information (Options 28-

30). Given the costs of translation, and the

limited budgets of the Nation’s universities, it

seems logical that the Federal Government pay

for translations covering the results of basic

research—which will generally be of more interest to university than to corporate engineers

and scientists. Beyond this, some foreign developments are much more significant than

others: given huge quantities of information on

foreign technology and science, it would be

logical to develop screening procedures for

identifying and evaluating the more important

foreign work. Screening could benefit the government directly—e.g., through locating foreign

technologies with potential applications in public works projects or military systems.

Personnel exchanges provide notably effective mechanisms for technology transfer, while

also helping lay groundwork for long-term

working relationships among researchers in

different parts of the world. Many foreigners

visit U.S. R&D installations, and many foreign

nationals study at U.S. universities, but few

Americans go abroad to conduct research.

Among those who do, the language barrier

means that only a tiny number go to Japan. This

situation has begun to change, with new university programs that send American graduate

students in engineering and science to work

in Japanese laboratories. The U.S.-Israel Binational Industrial R&D Foundation also deserves mention, along with AID’s Program for

the Advancement of Commercial Technology.

Federal support for the university programs

could be particularly useful.

Finally, Congress could direct the Administration to seek increased access to foreign technology through the trade negotiations process.

For example, H.R. 3, as passed by the House,

would establish equitable access to foreign technology as a formal negotiating objective. In

earlier years, barriers in foreign countries such

as restrictions on technical licensing were of

little concern, but now that other countries have

strengthened their technological capabilities,

it stands to reason that they be as open as the

United States was in the past.

Military R&D; Federal Government Procurement

The U.S. Government played a crucial role

in the rise of the information industries through

research funding and purchases. Federal procurement and contracting policies have aided

developments in software through standards

for computer languages, Government purchases

of services (and goods) can guarantee markets,

reduce uncertainty, and stimulate growth. (See

box II on the E&C industry.)

When it comes to more recent programs—

e.g., DoD’s Strategic Defense Initiative (SDI),

and its Strategic Computing effort—Congress

could seek to identify and implement policies

aimed at maximizing favorable impacts on the

civilian economy. Despite a great deal of rhetoric concerning the spinoffs from military

spending (and space), remarkably little is

known about the interactions and possible

trade-offs between defense R&D (and procurement) and international competitiveness. Thus

policy guidance would seem to demand, as a

first step, a reopening of a fundamental set of

questions in technology policy (Option 31)—

questions that include:

How do procurement and R&D expenditures by DoD (and the National Aeronautics and Space Administration) affect the

development of civilian, commercial

technologies—not only through the products and processes that emerge, but

through contributions to technical knowledge and engineering design/analysis procedures?

How has Federal spending benefited commercial industries (e.g., information services) in recent years? What, specifically,

are the probable spinoffs from SDI? Will

the most important of these be engineering methods or products/processes themselves?

What is the balance of benefits and costs

from technology development aimed at defense and space? Do military and space

programs claim the best and the brightest

among American engineers and scientists,

weakening civilian industries?
Ch. 10—U.S. Government Policies: Issues and Options ● 367

Box U.-Federal Procurement pf ad Construction Services

Buy-American preferences and set-asides enmwe~ @od deal of overseas workfoz U.S. E&C firms.

In 1983, Congress amended the Foreign %rvice B@.@@g&4@l -a~W $8-If% s=. 136) to give

a 10 percent bidding preference to American co~paM@s=@ akm to fa~i~ firms whose governments extend reciprocal preferences to US. contracttw& ~measure, iii?e#sdti to open up bidding

processes in other countries as much as to aid Arn@can IUkC-ffrms, ap@i4s to projects costing $5

million or more. Similarly, Section 116 of the Nfihtary ~onsttuctfon A~prupriatkm Act, 1986 (Public

Law 99-173), required that all contracts for military cxm&mr@’on in NATO countries and Japan valued at greater than $1 million go to American companie~.~ The ~~h Diplomatic Security and

Antiterrorism Act of 1986 (Public Law 9%399), which authorizes $2.5 billion through fiscal year 1990

to improve security abroad, could prove a substantial boon for U.S. firms. The embassy security program restricts contracts of more than $5 million to AXw@xm contractors, or majority joint ventures.

The law also provides for small-business set-aside~. .

Although Congress could further expand prefimkmea and mtNasbbs on U. S*-funded construction

projects in foreign countries, such steps—while providing assistance to an Ammican industry experiencing competitive difficulties—would generally mean high coats for the taxpayer (leaving aside

cases like that of the new Moscow embassy). Moreover, diplomatic considerations and existing agreements will often limit such preferences. Both the embassy security program and the Foreign Service

Buildings Act exempt projects in countries where cuxfmt policies bar U.S. contractors, while the

Foreign Service Buildings Act gives the Secretary of Stat@ latitude “in the interest of bilateral relations.” But the most significant drawback to such pdicitw is simply that bidding preferences fail to

address the fundamental competitive weaknesses of U.SAmsed M!42 firms. They would do little to

improve competitiveness beyond providing finanoiai xppom unless coupled with other steps that

helped the industry improve its competitive positiun-i.e., programs for technology development.

As chapter 4 points out, innovation in the U.S. ccmstrucdon industry has bean slow. Federal procurement policies that worked to encourage imovation could contribute to strengthening the industry’s

international competitiveness. Congress might dir@ Federal agencies to expwinwnt with perforrnancebased contracting procedures, rather than rigid specifications that discourage use of new construction methods.

IJoint ventures with host nation firms are permitted. The appropriatiorts act for fiscal year 1987 (Public Law 99-591) lowered the threshold

to $500,000, while also giving American contractors a 20 percent coat preference for military construction projects on Kwajalein Island, in

U.S. territories such as Guam, and for military dredging operation in the Indian ocean.

Congress has also looked to the Defense Department for indirect support of f.L% E&c exports. in 1964, Congreae instructed DoD to designate

an ombudsman to help U.S. firma get contracts for NATO-funded projecta in Europe, end to require that all NATO-approved projects over

$5 million be advertised in the Commerce Business Dslfy-Houae Conference Report 98-1159, to accompany H.J. Res. 648 (Public Law 98-473),

Continuing Appropriations for fiscal year 1985. Language in House Report 99648, to accompany H.R. 5052, Military Construction Appropriations Bill, 1987, increasea the threshold to $15 million. While about 50 U.S. firms have been certified to com@e for NATO Projects, the first

16 months of the program sew only one bid, anf! that unsucceasfid-” U.S. Contractor Participatiort in Overseas NATO Construction,” fact

sheet prepared by W.L. Harper, Office of the Assistant Secretary of DeferdAcquisition and L@etl@, Department of Defense, 1986.

Although some in the E&C industry have argued that the government should routinely reserve construction paid for by the United States

in non-NATO countriea for American contractors, other policy considerations work against this. Many mifitarybasing agreements, for example,

require that contracts go to host country firms.

• Given that the United States will continue Technical Standards

to spend large sums on defense-related

technologies, how can the positive impacts Standards sometimes become non-tariff baron the civilian economy be maximized? riers (ch. 9). On the other hand, they can also

How can the United States speed the trans- contribute to stable and predictable market confer and adaptation of military technologies ditions, and thus to the spread of new technolto commercial industries? ogies, As mentioned earlier in this chapter, in
the section on telecommunications, an important set of questions revolves around future

standards for ISDN. Open Systems Interconnection (OSI) standards for computers—a related matter—have also surfaced in international discussions.

In terms of domestic U.S. policies, the primary concern—partly one of standards, partly

regulatory—lies in the implications of the AT&T

breakup for compatibility in the Nation’s

telecommunications infrastructure. In the

newly competitive environment, technical

standards might easily become a weapon for

companies seeking an advantage over their

rivals, Is it possible that the regional holding

companies (RHCs) will seek to introduce differing and incompatible ISDN standards as a

shield against external competition? If so, the

costs to users of services provided over the

telecommunications infrastructure could be

high. Questions of technical standards also remain for videotext/teletext services. While the

United States has national videotex standards

in place, these may need revision as computerbased videotex systems supplant services supplied through television broadcasting. Again,

it seems desirable to ensure that the RHCs do

not implement incompatible standards—especially since they may eventually be allowed to

expand their role in delivering such services.

Regardless of outcomes in the United States,

setting international ISDN standards promises

to be contentious. A complex institutional structure exists to define and recommend international telecommunications standards, centering on the ITU (more specifically, the CC ITT).
Ch. 10—U.S. Government Policies: Issues and Options ● 369

The EC, which evidently plans to seek early

CC ITT agreement on ISDN standards favored

by Community members, set forth a working

program at the end of 1986, Intended as a step

toward Community-wide standards, the eventual aim is no doubt to establish competitive

advantages for European telecommunications

firms as equipment markets emerge.

In the United States, standards-setting processes have become more complex with the end

of the unified Bell System, USTR has recently

established an expert group on ISDN in conjunction with the EC. Two private organizations,

the American National Standards Institute

(ANSI) and the Exchange Carriers Standards

Association (ECSA, created in 1983 to develop

common technical standards for U.S. telephone

companies) have also turned their attention to

ISDN, In preparations for meetings of the ITU

and the World Administrative Telephone and

Telegraph Conference scheduled for 1988 and

1989 (WATTC, ch. 9), the State Department and

other Federal agencies will rely heavily on

ANSI and ESCA.

The U.S. Government-the world’s largest

consumer of telecommunications, computer,

and data processing services—has a direct stake

in the evolution of ISDN. Procurement decisions by DoD and the General Services Administration (GSA), the two major government purchasers of telecommunications and related

services, will help shape ISDN standards. Both

agencies are currently evaluating their needs,

and examining possible evolutionary paths to

ISDN. GSA plans to replace the government’s

private intercity telephone network (called FTS)

with commercial services under its FTS 2000

proposal. 28 Meanwhile, the Defense Communications Agency is seeking to determine whether

ISDN standards driven by civilian needs would

also satisfy military requirements.

Given the many actors already on the scene—

and bearing in mind that the RHCs may eventually be permitted to engage in equipment

manufacturing—there seem good reasons for

a strong Federal role in steering ISDN choices

so as to minimize incompatibilities. As one

alternative, Congress could appropriate funds

for an ISDN demonstration laboratory and testing facility, perhaps at NBS (Option 32). In any

case, Congress may want to stay abreast of the

evolution of ISDN, both internationally and in

the United States—e.g., by directing appropriate Federal agencies to monitor and analyze

ongoing technical developments here and

abroad. With total expenditures on ISDN expected to run to many billions of dollars, policy conflicts are bound to arise. These could

range from trade friction involving sales of

equipment to a possible renewal of concern

over TBDF restrictions. As stressed in chapter

9, technical matters that once could be left to

specialists have now become important policy

matters—for the United States and for our trading partners (Option 33),

2B’’FTS 2000 Ser\’ices: A Request for Prop(j+il\ ‘[’o R[’l)lat e thr

1+’ecieral Telecommunications System, ” sf;( on(j d ra i t—-()[:tohcr

1986, CSA DC-8911 700203, General Serii[,f>s .I\(] ]~1 i n istr,)tion,

Wtl~hiIlgton, DC GSA expe[;ts to let a 1 ()-} f>ar ~:’r,$-200(1” (:1~11-

lract in 1988, with the new’ serkices-to in(l(](i(> \OI( (~, IIat;l. ;IO{I

video- migrating to ISDN and conforming Lt i t h n a t i ( J II a I [I r) ( ]

international standards as the} (le~’clo[),

ORGANIZATION AND EFFECTIVENESS OF FEDERAL POLICYMAKING

USTR has set the stage for negotiations on representatives of both labor and business will

services in GATT, Getting results, in the Uru- need to be strengthened. As the experiences of

guay Round and bilaterally, will require that the Kennedy and Tokyo Rounds demonstrate,

other agencies be brought fully into the proc- a politically acceptable agreement depends on

ess, along with parties whose interests will be a domestic political consensus built and mainaffected by the outcomes. Priorities will have tained during the negotiations process; attempts

to be set, and the inevitable trade-offs managed. to put such a consensus together later risk failIt seems clear that mechanisms for drawing in ure, as the Kennedy Round showed.
370 ● International Competition in Services

—

Recognition of the many links between domestic industrial (and technology) policies and

trade has come relatively slowly in the United

States. The policymaking process is still adjusting, as reflected in the hundreds of bills introduced in Congress over the past few years

concerned in some way with problems of competitiveness, trade, and structural adjustment.

Some of the proposals have dealt with a perceived need for greater coordination and integration in the Nation’s policymaking system—

institutions and mechanisms better attuned to

the realities of international competition and

the changing U.S. place in the world economy.

But if recognition of the need has been growing, agreement on specifics seems only a little

closer. This is evident in the diverse approaches

proposed in the 99th Congress (and thus far in

the 100th)-proposals that included, among

others, bills to strengthen USTR, to create a

White House council on trade, to establish an

independent council on industrial competitiveness, to reorganize agencies with trade-related

functions into a new department of trade. There

have also been proposals for a department of

science and technology.

Policy outcomes always depend to some extent on organizational forms; in exceptional

cases, the structure of government will determine the course of policy debates because of

the way information is channeled and decisionmaking authority distributed. But in the United

States, the built-in dispersion of authority

guarantees conflicts and ambiguity—as well as

access for interested parties. The structure lets

debate sprawl, rather than channeling it. More

than 30 government bodies—ranging from Cabinet councils to line and regulatory agencies

to special commissions—have significant policy influence when it comes to the service industries, Predictably, coordination is occasional.

Congress passed the International Trade and

Investment Act of 1984 (Title III of Public Law

98-573, referred to earlier) partly to strengthen

policy coordination, The Act gives both USTR

and Commerce major responsibilities. With

change in such matters always slow, it is not

clear at this point how well inter-agency coordination is working. Nor is it clear how well

the Department of Commerce will be able to

fulfill its new responsibilities for analysis of

competitiveness in the service industries, and

for policy development; these have not been

Commerce’s strengths in the past.

Accompanying the calls for better coordination have been periodic proposals for trade reorganization. Those who advocate reorganization believe the fragmentation of responsibility

in matters concerned with trade has gone too

far, and that seeking better coordination among

existing agencies is a vain hope; indeed, some

might say that, should efforts at coordination

lead to another administrative layer, the cure

could be worse than the disease. The most common reorganization plans would create a department of trade (or department of trade and

industry), Many bills proposed but not acted

on in the 99th Congress called for some variant of the trade department theme. Most would

move USTR and at least some parts of Commerce into a new department, perhaps joined

by elements of other agencies. Those favoring

reorganization believe such a step would help

integrate trade-related policies at higher levels

of the Administration, placing the new department’s secretary in a position to deal with issues of both domestic and foreign economic

policy—while also helping with the problems

of an overloaded USTR, which must rely on

other agencies for staff support.

The opponents of reorganization point out

that a secretary of trade would be faced with

a large department having numerous line

responsibilities, entrenched operating procedures, and well-established political and bureaucratic relationships. Such an organization

does not move quickly or easily. The secretary’s

room for maneuver would inevitably be limited;

closeness to the president can counter such tendencies only so far. As those who look with disfavor on reorganization say, shuffling boxes on

the organization chart won’t accomplish much,

Moreover, reorganization would be counterproductive if USTR—a small agency with a

well-defined purpose and proven capabilities—

loses some of its effectiveness, As a relatively

elite group within the Federal Government,
Ch. 10—U.S. Government Policies: Issues and Options ● 371

USTR has been able to attract outstanding

employees—a major reason for its success.

Finding and keeping good people might prove

more of a problem in a larger, more cumbersome agency.

Although a plausible case can be made that

creating a new department would reduce some

of the overlap between USTR and Commerce,

reorganization would have less effect when it

comes to the many other agencies with a say

in trade policy. The Departments of Agriculture and Defense, to take only the most obvious examples, would not quickly or easily cede

influence over policies they view as important.

Treasury jealously guards its macroeconomic

responsibilities. As the number of trade complaints rises, the U.S. International Trade Commission becomes more influential in determining the Nation’s de facto trade policy; the

Commission is an independent agency. Nor is

it likely that a trade department could (or

should) take on functions now the province of

the independent regulatory agencies (e.g., the

FCC, the FRB)—so important when it comes

to service industries.

The potential drawbacks to the reorganization plans, then, are many. Still, OTA’s analysis suggests that—even given widespread agreement on policies at high levels in the executive

branch—it may no longer be possible for the

United States to develop and implement trade

and foreign economic policies in consistent and

coherent fashion. The international economy

has changed radically over the past two decades; the structure of the U.S. Government has

not kept up. Currently, the Administration may

not have the analytical capability to develop

sound policies, nor the tools to pursue them,

The problems have two fundamental

dimensions–with prospective solutions that

could be pursued independently or jointly:

analysis and decision support—long-term

planning, better institutional memory, and

analytical guidance for trade-related decisions that Federal officials must now make

on what is essentially a day-to-day basis;

policy integration—mechanisms for developing broad consensus on overall policy

objectives, and for managing the interagency process of policy implementation,

OTA addressed the first of these questions in

the section above entitled “Trade Analysis and

Information” (see Option 3 in table 56). Earlier

portions of the chapter also discussed the need

for coordination among Federal agencies,

When it comes to high-level policy development and integration—the second of these

questions—there are a number of alternatives

short of full-scale trade reorganization. The Reagan Administration has placed trade policy under the aegis of the Economic Policy Council,

an informal cabinet-level group chaired by the

Secretary of the Treasury. Other members of

the EPC—which has no statutory basis—include

the Secretaries of Commerce, Labor, Agriculture, and State, along with the U.S. Trade Representative and the Director of the Office of

Management and Budget. In recent years, the

Trade Policy Committee (TPC, an interagency

group established under the Trade Expansion

Act of 1962 and headed by the U.S. Trade Representative) has met only rarely, although its

staff committees and subcommittees continue

to function under USTR and EPC direction,

Congress could direct the Administration to utilize the statutory TPC, rather than leaving trade

policy subordinate to informal bodies like the

EPC. Alternatively, Congress could replace or

supplement the TPC with a new council on international trade within the Executive Office

of the President, charged with formulating

trade and foreign economic policy at the highest levels of the Administration.

Informal cabinet councils like the EPC have

responsibilities that often shift over the course

of an Administration, as well as between Administrations, If Congress were to create a statutory trade council, a president might or might

not give it real authority. But the existence of

such a council would provide a ready-made focal point for a chief executive who sought to

implement a coherent trade policy. Legislation

establishing such a council could symbolize

congressional resolve to raise the priorities for

trade policy to a level in keeping with its significance for the U.S. economy.
372 ● International Competition in Services

——....—.

By itself, creation of a department of trade

or a statutory trade council within the Executive Office of the President (or both) would do

little to help the Nation’s service (or manufacturing) industries maintain their competitiveness. Plainly, the effectiveness of a department

or council would depend on how well the details were handled, and on how the president

chose to proceed once the legislation had been

passed. But given the growing importance of

the service industries, Federal agencies with

both domestic and trade responsibilities will,

one way or another, have to redirect at least

some of their activities over the next 10 or 15

years.

At many places in this report, OTA has

stressed the interdependencies between services and manufacturing. This means that policymaking must also be integrated at some level

between these two sides of the economy. If the

100th Congress decides to reorganize the trade

functions of the government, it might build deliberate linkages into the legislative framework,

not only between trade policies and domestic

policies, but between policies affecting the services and those affecting manufacturing.

CONCLUDING REMARKS

Many of the policies that would help U.S.

service industries maintain their international

competitiveness could also help the Nation’s

manufacturing industries. American software

and information services firms owe much of

their competitive ability to a large installed base

of computer hardware, to knowledgeable customers who have been aggressive in pursuing

new computer applications, and to hardware

manufacturers who have remained at the technological frontiers. In turn, good software helps

sell U.S.-made computer systems. Government

policies contributing to low entry barriers,

abundant venture capital, and high employee

mobility have helped spur the entrepreneurial

vigor characterizing both software and information services in the United States. More

broadly, advances in computer applications

have helped many U.S. manufacturing companies improve their productivity and maintain

their international competitiveness. And

computer-based training methods hold out opportunities for teaching people how to learn,

so that lifelong education can become a reality

rather than a slogan. These are not the only examples: parallel if less far-reaching relationships hold between business services (advertising, accounting, management consulting)

and their customers. Deregulation of domestic air travel has led to lower passenger fares,

hence market expansion and new orders for

airframe and engine manufacturers. Deregulation also helped open up international air

travel, contributing to

made passenger jets.

The linkages between

exports of Americanthe services and manufacturing create a complex institutional challenge.

Starting in the 1970s, the service industries

made use of their access to the policymaking

apparatus (nothing unusual for industries like

banking or insurance, but new for the service

sector as a whole) to help push GATT negotiations on services toward the top of the Nation’s

policy agenda—an effort arising in part from

a feeling that policy makers had not been very

responsive to the interests of the service side

of the economy. Certainly the international

ramifications of domestic policies have seldom

received much consideration. But there is more

than a question of responsiveness here: OTA’s

analysis suggests that it is the blurring of boundaries between services and manufacturing,

rather than the special nature of services, that

gives them much of their new importance, Still

more broadly, recognition has grown that slackening international competitiveness—occuring

more or less simultaneously in so many American industries—marks a real turning point in

the U.S. position in the world. This has brought

an intensified debate over trade policy. So far,

the services have not had much prominence
Ch. 10—U.S. Government Policies: Issues and Options ● 373

-.

in the debate, but this may change—particularly

if the Uruguay Round negotiations make rapid

progress on their services track.

Many bills in recent Congresses have sought,

in one way or another, a tougher negotiating

stance vis a vis the Nation’s trading partners.

The ostensible premise has been that equalizing the rules of the game would help U.S. industry compete, and bring exports and imports

into closer balance. Other legislative proposals,

focusing on the domestic causes of declining

U.S. competitiveness, have proposed changes

in education and training, or in technology policy. Most of the bills reflect, in one way or

another, tensions between two powerful forces:

• the tradition of U.S. leadership in advocating open markets internationally, and unfettered competition;

• dawning realization that American firms

face real trouble in competing in those

markets—markets that U.S. policies have

helped create.

In the services, where U.S. competitiveness remains generally high, this tension has been less

apparent than in manufacturing (although plain

enough when it comes to the E&C industry);

liberalization of trade and investment would

help some (not all) U.S. service industries.

Agreements in GATT and elsewhere will not

be easy to reach; many of the barriers in the

services consist of domestic regulations that

few governments regard as fair game for discussion and negotiation. Although the United

States has partially deregulated a number of its

service industries over the last 15 years, some

regulation will plainly continue—to protect

public health and safety (air travel), to safeguard

consumers and investors (financial services),

In the past, Federal agencies have seldom

taken much account of impacts on international

competitiveness when pursuing regulatory or

deregulatory goals—even when these impacts

are quite direct. And indirect impacts are important too: government regulations not only

constrain companies, they condition management decisions more subtly (e. g., through expectations concerning future regulatory actions). Moreover, the impacts of deregulation

can be negative as well as positive. Relaxation

of antitrust enforcement, for instance, if carried too far could threaten industries—including the majority of traded services—in which

domestic competition has honed the international capabilities of American firms. This

might seem a worry for the future more than

the present. But it is certainly legitimate to ask

if the U.S. semiconductor industry would have

come into existence in anything like its current

form if today’s antitrust climate had been in

place 30 years ago. The 1956 AT&T consent

decree, which caused Bell Laboratories to diffuse its technology widely, shaped many aspects

of an industry that remains a major source of

technological and competitive strength for the

United States, despite recent battering by the

Japanese.

As many examples in this chapter have

shown, with the U.S. economy increasingly integrated into the world economy, Federal Government decisions can no longer be viewed

solely in a domestic context. Policy makers and

regulators will have to pay more than sporadic

attention to international competitiveness.

The United States finds itself remodeling its

policymaking system when the need becomes

great enough, pressures build to high levels.

With realization growing that the U.S. position

in the world economy has altered irrevocably

from that of two or three decades ago comes

a shift in the ways Federal agencies formulate

and implement policy—a shift that is underway

but far from complete.

For Congress, perhaps the next step is simply to seek enhanced visibility for the impacts

on competitiveness of executive branch decision-making—to build international competitiveness into the policymaking process. Better

data and analysis would help move things

along. Congress could seek to strengthen the

linkages between service industries and manufacturing through support for their common

technology/science base; indeed, simply ac63-527 0 - 87 - 14
374 . International Competition in Services

knowledging that technology plays a critical

role in maintaining a competitive group of service industries would be a start.

Coordination among Federal agencies will be

an ever-present need, no matter the choices

made by Congress. Jurisdictional disputes, traditions and habits–constants of the U.S. policymaking system—will not change overnight.

But with time and accumulated experience, coordination between domestic regulatory policies and U.S. foreign economic policy should

become somewhat easier. And Congress may

decide the time is right to make more substantial changes in Federal policymaking structures.

While ad hoc policymaking may have worked

in the past, today—with shrinking or vanishing sources of advantage in global competition—the United States seems to need a new

framework, as well as a new set of tools, for

dealing with shifts in international competitiveness and their consequences.

APPENDIX IOA: EFFECTS OF TAX POLICY ON

INTERNATIONAL COMPETITIVENESS IN THE SERVICES

Tax policies can affect competitiveness in many

ways—for instance, by influencing the attractiveness of consumption relative to investment. Taxation also influences business decisions more

directly; almost inevitably, investments in some economic sectors will be favored over others because

of differing effective tax levels across the economy.

Because international competitiveness depends on

the outcomes of competitive rivalries within the

economy, as well as those between U.S. and foreign firms (ch. 2

), a micro-level view of taxation

often proves most illuminating.

This appendix gives a number of brief examples

drawn selectively from service sectors covered in

earlier chapters. The examples highlight some of

the provisions of the Tax Reform Act of 1986 (Public Law 99-514), a fundamental change in U.S. tax

law, and one with impacts that will not be fully evident for several years.

Financial Services

Banks in the United States have typically paid far

less of their income in taxes than companies in other

industries—to some extent a quid pro quo for accepting lower rates of return on tax-free investments

such as municipal bonds. But to the extent that low

effective taxes (actual taxes paid divided by income)

represent something other than compensation for

lower returns before taxes on activities the government wishes to favor, favorable tax treatment has

made the banking industry more attractive to investors. Indeed, low taxes have been one of the factors leading foreign banks to enter the U.S. market.

The 1986 tax act could substantially raise the taxes

that banks pay. While the international effects will

be indirect—none of the provisions directly change

the taxation of foreign as opposed to domestic

business—American banks may well be induced to

emphasize fee-earning services relative to lending

(a trend already well underway] because they will

not be able to claim tax losses on loans as easily.

In addition, a major source of income for banks—

buying tax-exempt securities with borrowed money,

the expense of which reduces taxes—will be largely

eliminated. Finally, the Tax Reform Act, by eliminating the investment tax credit, may cut into revenues from the leasing businesses that many financial institutions have established.

With higher taxes, U.S. banks may lose some international business they might otherwise get on

straight lending because they will have to increase

their net interest margins slightly. Fewer safe profitgenerating activities domestically means a narrowed range of strategic options internationally.

Engineering and Construction

Tax policies have long been a concern of U.S. E&C

firms operating overseas, and their employees. The

income taxes that Americans stationed abroad must

pay influence the wage levels they expect, hence

the costs to their employers. Furthermore, when

U.S. E&C companies invest in foreign countries,

they must generally pay taxes on their profits to both

the U.S. Government and the host nation. The primary question has been the extent to which U.S.

tax obligations will be reduced as a consequence

of foreign tax payments.
Ch. 10—U.S. Government Policies: Issues and Options ● 375

For individuals, Section 911 of the Nation’s tax

code has excluded the first $80,000 of overseas

wages from Federal income taxes. Although E & C

companies, along with others that station Americans abroad, have argued for an increase in the level

of exclusion, the 1986 tax act reduces it to $70,000.

As a result, U.S. firms that send highly paid employees overseas—e.g., managers and engineers—

will find themselves at a slightly greater labor cost

disadvantage relative to many of their foreign competitors.

Other tax policies that affect the E&C industry include the levies on technical assistance that some

countries impose. These are taxes on professional

services produced outside the country but sold

within its borders. In most cases, the cost of this

tax is simply passed along to the client. Because it

then appears as part of the E&C firm’s revenues,

the cost of the local tax itself is subject to U.S. taxes.

Legislation proposed in the 99th Congress (H. R,

3494) would have permitted American companies

to deduct or credit taxes paid to a foreign government on construction services carried out in the

United States for an overseas project. This would

probably not make much difference for competition.

The E&C industry has been slow to take advantage

of tax incentives that are already available for

promoting exports. For instance, even though architectural and engineering services for foreign construction projects were specifically included in legislation establishing tax-sheltered Foreign Sales

Corporations, E&C firms have yet to make use of

this mechanism.

More favorable tax treatment of international

E&C activities could help cash flow positions and

profitability levels, and might marginally lower the

bids that American firms enter on some projects,

By themselves, however, changes in tax policy

would not have much effect on the cost disadvantages U.S. E&C firms must contend with in many

foreign markets.

Information Technology Services

Entrepreneurial startups have been responsible

for much of the vigor in this sector. Venture capital

supplies for startups depend, among other things,

on tax treatment of capita] gains. Because the 1986

Tax Reform Act raises effective capital gains tax

rates, startups may become somewhat less attractive. It remains to be seen how great the impact will

be, because other factors–primarily converging technological and market opportunities—have an even

stronger influence on entrepreneurial industries.

A second tax issue—relating only to computer

software—illustrates the sometimes circuitous

routes through which taxation can affect competition, In the past, the Internal Revenue Service (IRS)

has sought to treat software firms as passive holding companies when a large proportion of their revenues came from licensing. While the 1986 tax bill

specifically exempts software firms from classification as passive holding companies, the example

remains instructive. Some software suppliers

choose to license their products, in both domestic

and foreign markets, because other forms of protection for intellectual property rights fail to provide adequate protection (box GG, ch. 9). If a licensee makes illegal copies or otherwise breaks the

agreement, the software firm can revoke the license.

Revenues, however, come not from sales but from

licensing fees. Because of this, the IRS had proposed

to tax software firms as passive holding companies

—subject to higher rates than active operating companies. Such a classification would have done considerable violence to the nature of this industry.

Nonetheless, the IRS had threatened firms with bills

for back taxes—as much as $30 million in one case.

Technical Licensing

Relative tax levels here and abroad affect decisions

on exploiting proprietary technology—whether to

produce at home and export or to license companies abroad, whether to negotiate licenses with unaffiliated firms or only with affiliates. Other things

the same, a multinational will attempt to arrange

its internal transactions to minimize tax liabilities

on a global basis. International differences in taxation give MNCs many opportunities for doing so.

At the most obvious level, royalties from unaffiliated

firms will be taxed as income, whereas royalty flows

from affiliates can be treated as intracorporate

charges, exempt from taxation. Of course, the taxcollecting authorities of each country will attempt

to ensure that they get their fair share—one reason

for the tax treaties that governments negotiate with

each other.

In the United States, the IRS requires that fees

and royalties from intracorporate licensing approximate revenues that would be earned in arms-length

transactions. U.S.-based multinationals are likewise

expected to allocate R&D expenditures on a reasonable basis between the parent firm and foreign

subsidiaries. This prevents companies from, say,

loading all R&D costs onto the U.S. parent’s income

statement so as to lower domestic earnings and

hence the firm’s IRS bill, Other possibilities arise
376 ● International Competition in Services

because U.S. law permits deferral of taxes on foreign earnings until the income is repatriated to

the United States. In the absence of IRS rules governing allocations of expenses, MNCs would be

tempted to transfer income to subsidiaries located

in countries with low corporate tax rates—by, for

instance, permitting their subsidiaries to use U. S.-

developed technologies at no charge. After paying

foreign taxes on income from the technology, the

company could then repatriate the funds as untaxed

capital flows. Existing tax laws are intended to prevent indirect transfers of this type, but it is hard

to say how well they work; regardless of the extent

to which MNCs comply with the letter and spirit

of IRS rules, they will always have considerable latitude in using license agreements as vehicles for

moving funds internationally.

Many host governments tax international transfers involving royalty payments. While this can

dampen licensing activity, managements have alternatives here too. They may, for example, inflate the

fees they charge their subsidiaries by the amount

of the tax. In such cases, the host government is

likely to know perfectly well what is going on. If

it wishes the technology transfer to take place, the

host country can set a tax, perhaps for political purposes, and accept the fact that fees will be inflated.

If it wishes to stop the practice, the government can

always set ceilings on maximum royalty rates. This

narrows the MNC’s room for maneuver; if the firm

cannot find another financial conduit, it may decide to leave the market.
Appendixes
Appendix A

Glossary

ACH, automated clearinghouse: An electronic

funds transfer system linking banks with one

another, and often with non-financial institutions

as well.

affiliate: As defined by the U.S. Government, 10

percent or more equity interest suffices to make

one firm an affiliate of another (other countries

may use different percentages). The U.S. Government does not distinguish between minority (10

to 50 percent) and majority ownership. [See FDI.)

AI, artificial intelligence: Computer systems with

the ability to learn and improve in performance

as a result of experience. More broadly, systems

that mimic aspects of human reasoning are sometimes termed AI even if no learning is involved.

(See expert system.)

AID, Agency for International Development: Principle U.S. Government organization for channeling economic aid to less developed countries.

back-to-back loans: Two parties in different countries make loans to one another, of equal value,

each loan denominated in the currency of the

lender and maturing on the same date.

banker’s acceptance: A negotiable instrument drawn

on and accepted [i. e., guaranteed) by a bank—

e.g., for financing the export, import, shipment,

or storage of goods.

Basel Committee: The Committee on Banking Regulations and Supervisory Practices, also known

as the Cooke Committee, an advisory group of

representatives of central banks and bank superviso r y authorities from 11 countries. The Committee meets at the Bank for International Settlements in Basel, Switzerland.

BOCs, Bell Operating Companies: Local telephone

companies grouped into regional holding companies (RHCs) since the AT&T divestiture.

CAD/CAM, computer-aided design/computer-aided

manufacturing: CAD refers to computer automation of architectural and engineering design, primarily in the sense of geometry, CAM refers to

automated manufacturing, with applications of

numerically controlled machine tools the most

common case,

CADD, computer-aided design and drafting: Automated processes for generating drawings (and

auxiliary information such as parts lists), with the

emphasis on automation of the drafting function

rather than on engineering.

capital ratio: A bank’s ratio of capital on hand to

total liabilities. Regulatory authorities impose

minimum capital ratios on banks.

CCITT: The Consultative Committee for International Telephone and Telegraph of the international Telecommunication Union (ITU).

CHIPS, Clearing House Interbank Payments System: A computerized network for arranging transfers of U.S. dollar payments among 140 depository institutions with offices in New York City.

CO (central office) switch: A large telephone exchange, today typically computerized.

commercial bank: Sometimes called full-service

banks, the traditional basis for commercial banking has been the acceptance of short-term funds,

mostly demand deposits, and the financing of

term loans. (See investment bank and universal

bank.)

commercial paper: A company’s short-term unsecured promise to repay a fixed amount (equal to

the borrowed funds plus interest). Some commercial paper is also backed by a third party (e. g.,

a bank that agrees to repay the loan if the original borrower defaults).

Comsat, Communications Satellite Corp.: A private company, U.S. signatory to and part owner

of Intelsat (International Telecommunications

Satellite Organization).

COS, Corporation for Open Systems: A nonprofit

organization of American and some foreign computer and telecommunications firms, established

to work toward technical standards for computer

net works.

cross-licensing agreement: An arrangement whereby

two firms agree to share technologies of specified types, including those as yet undeveloped.

currency swap: A financial transaction in which

the parties exchange specified sums in two different currencies.

design-bid-build: Contracting arrangements in the

engineering and construction industry in which

separate contracts are let for design (which may

include architectural design) and construction,

Specifications developed in the design phase become the basis of a request for bidding on construction.

design-construct: Contracting arrangements covering an entire project; the contractor carries out

the design and engineering work, construction,

379
380 ● International Competition in Services

and may also handle installation of equipment (resulting in a turn-key project).

DP: Data processing.

E&C: Engineering and construction.

EC, European Community; EEC, European Economic Community: Belgium, Denmark, France,

the Federal Republic of Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Spain,

Portugal, and the United Kingdom. The EEC provides a common market; the EC comprises the

EEC, the European Coal and Steel Community,

and the European Atomic Energy Community.

EMP, Engineering Multiplier Program: Extends

U.S. Export-Import Bank loans to foreign parties

for the purchase of architectural and engineering services from U.S. firms.

Eurobond, Euronote: A bond or note sold in a market outside national regulatory frameworks for

financial transactions; Euronotes are short-term

bonds, Originally, the major offshore or external

markets were located in Europe (specifically, London); now they also exist in other world financial centers. (See offshore market.)

Eurodollar: Dollar deposits, bond holdings, and

other dollar-denominated financial instruments

not subject to the normal regulatory control of

the United States,

Euroyen: Yen deposits, bonds, and other yen-denominated financial instruments not subject to the

normal regulatory control of Japan.

Eximbank: Export-Import Bank of the United States,

a federally chartered institution with responsibilities centering on the financing of U.S. exports.

expert system: A computer system exhibiting a

form of artificial intelligence (AI) in which the

system’s software embodies the knowledge of one

or more human experts. The system can then act

as a decision aid or automate a process that would

otherwise require active participation by a human expert. In practice, expert systems have

much more limited capabilities than the name

might seem to imply, typically performing at

rather rudimentary levels of competence.

FDI, foreign direct investment: Assets wholly or

partially owned by foreign residents (individual

or corporate), and including real estate or other

property as well as equity holdings in corporations. under U.S. Government definitions, ownership levels of 10 percent or more qualify as FDI,

less than 10 percent as portfolio investment.

fiber-optics: Refers to systems using thin glass

fibers to transmit communications signals via

light (rather than electricity).

fourth-generation computer language: One in which

the programmer specifies the desired outputs, but

need not define the coding on a line-by-line basis.

FRA, forward rate agreement: To protect against

future movements in interest rates, two parties

agree on an interest rate for a future financial

transaction. No commitment is made by either

party to lend or borrow the principal amount of

the transaction; exposure is-limited to the interest difference between the agreed and actual rate

at the time of settlement.

FRN, floating-rate note: A medium-term security

carrying a variable or floating rate of interest, adjusted at regular intervals (typically every 3 or 6

months) with respect to a reference rate (commonly the London Inter-Bank Offered Rate).

futures: Contracts, traded on exchanges, generally

calling for delivery of commodities or financial

instruments at some future date.

GATT, General Agreement on Tariffs and Trade:

An organization-and set of rules under which 9 2

nations negotiate trade agreements and seek to

resolve trade-related disputes.

Generalized System of Preferences: By international agreement, industrial nations—including

the United States, Japan, and the members of the

European Community—grant preferential tariff

treatment to goods from specified developing

countries.

Giro payment, Giro system: A system for financial

payments based on-standardized forms that authorize transfers of funds from the payer’s account to the payee’s, widely used in some European countries for transactions such as consumer

billings.

Glass-Steagall Act, the Banking Act of 1933: Its

best known provisions require a separation of

commercial and investment banking activities.

IBF, International Banking Facility: Permits U.S.

financial institutions to legally provide deposit

and loan services from their domestic offices to

foreign customers free of reserve requirements

and other regulations that apply to their business

with U.S. customers.

Intelsat, International Telecommunications Satellite Organization: Created in 1964 by international treaty, and jointly owned, Intelsat supplies

nearly all cross-border satellite communications

services.

interest rate swap: A transaction in which two parties exchange ‘interest payment obligations of

differing character. Examples include: coupon

swaps—fixed rate to floating rate in the same cur-
App. A—Glossary . 381

rency; basis swaps—one floating rate index to

another floating rate index in the same currency;

and cross-currency interest rate swaps—fixed rate

in one currency to floating rate in another.

investment bank: An intermediary between those

seeking capital by issuing securities (government

bodies as well as private firms) and those with

money to invest. In recent years, investment banking has expanded rapidly into such related activities as leasing, mergers and acquisitions, and financial advisory services.

ISAC, Industry Sector Advisory Committee: Set

up under the Trade Act of 1974 to convey the

views of particular industry sectors on trade negotiations and related matters to the Office of the

United States Trades Representative and the Department of Commerce,

ISDN, Integrated Services Digital Network: Telecommunications systems able to handle voice,

data, facsimile, and video signals over common

channels,

ISO, International Organization for Standardization: Membership includes some 75 countries,

represented through their national standards bodies. Countries without a standards association

participate as correspondent members.

IT services: Information technology services, including telecommunications, data processing,

and computer software.

ITA: International Trade Administration, part of

the U.S. Department of Commerce.

ITC, International Trade Commission: An independent government agency, the U.S. International Trade Commission has responsibilities that

center on the investigation and disposition of

complaints alleging violations of the Nation’s

trade laws.

ITU, International Telecommunication Union:

Membership of about 160 countries; has the status of a treaty organization. (See CCITT an d

WATTC.)

JTPA, the job Training Partnership Act: Enacted

in 1982, Title 111 of JTPA offers services to displaced workers, including counseling, job search

and placement assistance, and vocational training. The Federal Government provides JTPA

funds to be administered at the State and local

level.

junk bonds: High-yielding bonds, generally rated

below Baa by Moody’s or BBB by Standard &

Poor’s. Sometimes used in corporate takeovers

or buy-outs.

LANs, local area networks: A computer network

linking machines in a single building or similarly

limited setting.

LDC: Less developed country.

letter of credit: Most commonly, a guarantee by a

bank to make payment on behalf of its client, usually an importer.

MAP, Manufacturing Automation Protocol: A set

of technical standards for linking computerized

manufacturing equipment.

MITI: Japan’s Ministry of International Trade and

Industry.

mixed credits: Financing that mixes export credits

in the form of loans with grants for development

assistance, the latter usually taking the form of

tied aid credits.

MNC: Multinational corporation.

MTN: Multilateral trade negotiation.

national treatment: Equal treatment by government

of foreign-owned and domestic firms.

NIC, newly industrializing country: NICs have

higher levels of national income than LDCs.

NTB, non-tariff barrier: Examples include import

quotas and subsidies for domestic firms.

NTT, Nippon Telegraph a Telephone Corp.: Japan’s

largest telecommunications company, formerly

a public corporation and monopoly supplier of

services. Forty-nine percent of NTT’s stock is

now being sold to the public.

OECD, Organization for Economic Cooperation

and Development: A group of 24 industrialized

countries, including the United States, Japan, and

the major European economies.

off-balance-sheet activities: That part of a bank’s

business, typically fee-based, that does not involve

taking deposits and booking assets. Examples include arranging swaps and providing letters of

credit.

offshore market, also external market and Euromarket: A market for bonds, deposits, credits,

and other financial instruments not under the

normal regulatory control of any country.

onshore market: That part of a financial services

market in which foreign-owned firms participate

alongside domestic firms (and under the regulatory and supervisory control of the national government).

OSI, Open Systems Interconnection: A reference

model for computer network architectures.

proprietary technology: Unique knowledge and expertise under the control of a particular firm.

PTT: Post, telegraph, and telephone authority, in

most countries, the monopoly provider of services.

repatriated earnings: Income from foreign investments that a firm returns to its headquarters

location.

reserve requirements: U.S. commercial banks must

keep a portion of their funds in a reserve account
382 ● International Competition in Services

at a Federal Reserve Bank (or other designated

institution), Other countries follow similar practices.

retail bank: Financial institution that supplies a

wide range of services to individuals (as compared to a wholesale bank that specializes in services for, say, corporations).

RHC, regional holding company: One of the seven

regional telephone companies formed with the

breakup of AT&T, each consisting of several Bell

Operating Companies (BOCs).

securitization: Refers to the development of markets for negotiable instruments, such as commercial paper and floating rate notes, as a means of

borrowing (e.g., as an alternative to bank loans).

Used more narrowly, securitization refers to the

conversion of bank assets such as mortgages and

other loans into negotiable securities for purchase

by other financial institutions or by non-bank investors.

software: Computer program(s), the instructions

that tell a computer (or any system embodying

a digital processing unit) what to do.

standby letter of credit, SLC: An agreement by a

bank to extend credit should other prospective

lenders decline to do so.

Strategic Computing Program: Managed by the Defense Advanced Research Projects Agency of the

U.S. Department of Defense, the program aims

at developing AI-related technologies with applications to military systems. Examples include pilot’s aids and automated land vehicles.

swap: See currency swap, interest rate swap.

SWIFT, Society of Worldwide Interbank Financial Telecommunications: An international network for communications among banks, jointly

owned by the members.

TBDF: Transborder data flow.

TDP, Trade and Development Program: U.S. Government program that finances planning and feasibility studies undertaken by American firms in

Third World countries offering U.S. export opportunities.

Teletel/Minitel: French videotex system operated

by the government and making use of the telephone system to supply services, most of them

originating with private firms, via small specialized terminals,

tertiary services: As used in this assessment, refers

to a subset of traditional service industries (e.g.,

shipping, retailing) that depend less heavily on

technology and know-how than knowledge-based

services (including banking and information technology services, among others).

tied aid: Development assistance restricted (or tied),

typically by requirements that goods and services

be procured in the donor country. See mixed

credits.

universal bank: A financial institution active in

both commercial and investment banking (permitted in many parts of the world, but not in the

United States).

U.S. International Trade Commission: See ITC.

US&FCS: United States and Foreign Commercial

Service, trade promotion arm of the Department

of Commerce.

VAN, value-added network: A computer/telecommunications network that provides enhanced

services—i. e., services over and above the provision of a communications channel. The added

value comes through provision of some further

service, such as electronic funds transfers or access to a database.

videotex; videotext/teletext: Information services

provided over communications networks that

range from news reports and teleconferencing to

on-line shopping. Typical videotext services combine text and graphics interactively, usually over

the telephone network to a computer or a terminal. Teletext consists of one-way transmission of

text. Collectively, videotext and teletext are called

videotex.

WATTC, World Administrative Telephone and

Telegraph Conference: Meetings of the International Telecommunication Union (ITU) called to

consider changes in that body’s regulations.

WIPO: World Intellectual Property Organization,

administers the Berne Convention for the Protection of Literary and Artistic Works.

zero coupon bonds: Long-term securities calling for

a single lump-sum payment at maturity, rather

than periodic interest payments.
Appendix B

Analyzing Competitiveness in the Services

Given the usual assumptions of international

trade theory, nations should be able to gain individually and collectively by specializing in goods that

each can produce with greatest efficiency. 1 T h e

United States produces and exports food and aircraft, among other things. South Korea produces

and exports television sets and steel. Does the theory of comparative advantage, developed originally

for goods depending on static resource endowments

—-wheat, cotton, cloth—apply to trade in services?

The answer is yes. The theory, after all, simply provides a framework for explaining observed patterns

of trade. So long as the framework remains an open

one, capable of accommodating dynamic effects—

shifting economies of scope and scale, learning, development of new technologies—trade in services

fits just as well as trade in goods.

Indeed, trade in services exemplifies what is perhaps the principal feature of dynamic comparative

advantage: efficiencies resulting from experience

that accumulates over time, Agriculture, mining,

and some kinds of manufacturing (steel if not computers) depend heavily on inherent, thus static, resource endowments. Services like banking or health

care depend on know-how and expertise—technology, broadly defined—on human resources rather

than natural resources. At least in theory, liberalization of trade in services should help increase

global economic efficiency. Moreover, because of

the dynamic learning effects, countries that currently have inefficient service industries should be

able to improve quite rapidly by bringing in people

and technology from more efficient foreign industries; competition will serve as a spur to domestic

firms, while the foreign-owned firms will enlarge

he pool of know-how that all can draw upon. -

Influences on Competitiveness2

When OTA began studying the competitive standng of U.S. industries in 1978, no one had a very

clear idea of how to do this, Economists tended to

rely on output-side indicators—trade balances and

market shares, employment and profit levels—in

many respects little more than symptoms. The need

was to get at causes, to grasp the dynamics of

change in industries as varied as microelectronics

and steel, and to sort long-run competitive trends

from short-term events. This means understanding

the internal workings of firms and industries: how

business decisions are made; where investment capital comes from; how new products are developed.

As a result, OTA has stressed factors that affect

competitiveness on the input side—i.e., as influences on the behavior of firms, In particular, OTA

has attempted to understand competitive strategies

in various parts of the world as affected by the many

forces that condition management decisions (table

B-l). Direct and indirect impacts of Federal policies

—taxes, regulations, trade measures—have been

central concerns, along with foreign industrial

policies,

Note that all the factors listed in table B-1 are, to

considerable extent, sector- and firm-specific. In

any economy, sectors compete with one another to

attract skilled labor, to push government regulations

in directions that will benefit them relative to other

industries. Within sectors, firms compete in much

the same way, BankAmerica and Chase share some

interests that differ from those of, say, insurance

companies; in other cases, one bank may seek regulatory decisions that will help it against others.

Thus, as the table suggests, OTA’s approach begins

with the internal workings of firms and industries.

The approach concentrates on forces with differential impacts across industrial sectors. While control of the money supply, for instance, influences

economic conditions, the impacts, though not necessarily identical, remain much the same across the

economy. In contrast, the corporate tax code treats

economic sectors in quite different fashion. The

Economic Recovery Tax Act of 1981, while decreasing average corporate tax liabilities, widened the

spread in effective tax rates across sectors. The effects of the Tax Reform Act of 1986, which represents a more sweeping set of changes in U.S. policy, have not as yet become fully apparent (the

appendix to chapter 10 illustrates a few of the probable impacts on service industries).

While analysis of individual service sectors demands a relatively detailed approach, analogous to

that suggested in table B-1, the forces listed in the

table can nonetheless be summarized under two

main categories: those under the control of the firm,

and those subject to public policy influence but

largely beyond the control of individual companies

(table 7, ch. 2).

383
384 ● International Competition in Services

Table B-1 .—Influences on Competitiveness

in the Services

Factor/examples

1.

2.

3.

4.

5.

6.

7.

8.

9.

Industry and market structure: Number of firms, their size

and market power, financial resources; market size, rate

of growth, degree of saturation.

Labor force: Labor costs; availability of skilled employees;

government support for training and education; incentives

for corporate training programs; labor mobility, vertically

as well as geographically; labor-management relations; unionization; mechanisms for employee participation.

Managerial work force: Education and training; attitudes

and value structures; characteristic approaches (e.g., in

terms of risk taking) to developing, marketing, and exporting services.

Inputs: Stability of costs and supplies for inputs to the production process (data processing hardware and software,

telecommunications links); domestic availability v. dependence on imports; delivery schedules.

Supporting infrastructure: Vendors, subcontractors, and

other suppliers, including those who provide services such

as equipment maintenance; basic research organizations;

government support for military and for generic, pre-competitive R&D as these may affect the services.

The environment for innovation and technology diffusion:

Interactions and synergies among firms, within an industry and across national boundaries (mobility of personnel,

licensing and other technical exchange agreements, openness to inward transfers of technology and management

know-how); clusters of know/edge and ski//s, as in major

banking centers; intellectual property law.

Business and economic conditions: Overall economic prosperity as indicated by gross national product or gross domestic product, levels of disposable income, inflation

rates, costs of capital, exchange rates; less tangible factors such as consumer confidence, political stability, social welfare.

Government policies and interactions with the private sec.

for:: Regulations affecting the workplace and products, as

welI as resource supplies; tax policies; antitrust enforcement; less tangible factors including traditions of cooperation or conflict among government, business, labor, and

other interest groups.

International trade relations: Policies enacted by domestic and foreign governments affecting imports, exports, and

foreign investment; non-tariff barriers; taxes on overseas

profits; the role of international agreements and organizations such as the GATT (General Agreement on Tariffs and

Trade) in providing frameworks for policy and mechanisms

for dispute resolution.

SOURCE Office of Technology Assessment, 1987

Cost-Competitiveness in the Service Industries

Fundamentally, international competitiveness depends on the ability of companies in various parts

of the world to develop, produce, and distribute

services and goods in competition with one another,

When the products are more or less the same (e.g.,

a bank loan), the comparison reduces to one of costs.

Of course, companies differentiate their products,

even when they are nominally quite similar (checking accounts, life insurance, air travel].

Trade and foreign investment result because costs

for producing services differ across countries.

These costs include:

●

●

●

●

●

investments in physical capital (e.g., buildings,

office equipment, airplanes);

wages, salaries, and fringe benefits;

human capital premiums, over and above other

labor costs, paid to attract highly skilled employees;

natural resource costs, often important for

goods, but seldom for services; and

costs for developing or acquiring proprietary

technology (firm-specific know-how, patented

or otherwise protected technology).

Costs associated with human capital and proprietary technology are closely related, because people

develop and transfer technology; much of a firm’s

proprietary know-how resides in its more highly

skilled employees. The remainder of this appendix

outlines some of the factors that complicate cost

comparisons internationally, beginning with exchange rate fluctuations.

Exchange Rates

For qualitatively similar products, actual selling

price becomes the critical factor in commercial

competition. Everything else the same, a free checking account will attract more customers than one

with a monthly service charge. For internationally

traded services, it is landed, tax-paid prices in the

country of sale that matter. prices for imports must

cover transport costs, if these exist. In addition, the

price of an imported service will reflect the rate of

currency exchange between the country where the

service was produced (wholly or partially) and the

country of sale.

When the U.S. office of an American engineering and construction (E&C) firm prepares a bid on

the design of an airport—say in Egypt—it will typically compile its cost estimates in dollars. The company may plan to carry out some or all of the design work in the United States. The people working

in its U.S. offices must be paid in dollars, So must

the expenses for the equipment they use, the buildings they work in, and other overhead costs. Similarly, an E&C firm in Japan bidding on the same

project would denominate its costs in yen. If the

American company entered a bid for the design

work priced at $10 million, the Japanese firm bid

2000 million yen, and the rate of exchange were $ 1

= 200 yen, the bids would be equivalent. If the ex-
App. B—Analyzing Competitiveness in the Services ● 385

change rate later dropped to $1 = 150 yen, the

American firm would have an advantage of 33 percent; the Japanese company’s bid of 2000 million

yen would then convert to $13.3 million. Likewise,

if the dollar rose to $1 = 250 yen, the American

firm would find itself at a disadvantage.

Note that these comparisons assume the actual

costs to the E&C firms in the two currencies to be

independent of the rate of exchange—an assumption that is usually valid over the short term, With

time, as prices and wage levels in a national economy change, exchange rates normally adjust in sympathy. If prices rise in the United States, the value

of the dollar should drop compared to other currencies (so that prices would remain about the same

when denominated in these currencies). But the

parisons. While a rank ordering by industry of a

nation’s structure of comparative advantage cannot yield predictions of trade flows, such a listing

does give insights into the gains to be expected from

trade: for instance, transactions involving goods or

services at the far ends of a nation’s ranking lead

to much greater benefits than for goods or services

near the middle. In the extreme, potential gains

from non-competitive imports (where no domestic

production exists) can be very large, Technical

licensing, for example, can be a great help for an

importing nation unable to develop comparable

technologies on its own.

Transportation Costs

point of the example is a simpler one: to compare Modes of transport for the services are not so obcosts or prices internationally, they must be ex- vious as for goods, Sometimes consumers move to

pressed in the same currency. One or more con- the source of the service; sometimes producers must

versions will be required; the bids could be com- be transported to the point of consumption, Leased

pared in dollars, in yen, or in Egyptian pounds, equipment may have to be shipped overseas, then

returned (though the leasor may choose to sell it

Determination of Comparative-Cost Advantage locally after expiration of the lease, rather than shipFor a given rate of exchange, then, prices can be

compared, and relative costs inferred. These costs,

particularly their indirect components, will depend

on factors including human capital requirements

and technology (table B-1), Not all countries can produce all services; some lack the necessary skills (or

other inputs). It is impractical if not impossible to

perform heart transplant operations in Ecuador, or

to conduct much international banking from a base

in Nigeria, A wealthy resident of Ecuador would

travel to another country for such an operation;

Nigerian firms procure international financial services from branches of foreign banks in Lagos or

through the correspondent relationships of Nigerian

banks.

Trade barriers, in one way or another, raise costs

for imports compared with domestic goods and

services: this is their purpose. A tariff is the simplest example—as a tax levied only on imports, it

raises the costs of products entering the country

compared to domestic output. Barriers to services

trade tend to be indirect, with impacts less obvious

than for direct barriers like tariffs (chs. 2 and 9).

Nonetheless, to be effective, indirect or non-tariff

barriers must have impacts on relative prices. Thus

subsidies for domestic firms permit them to lower

prices, while quotas drive up prices for imports,

Relative costs say nothing about the volume o f

trade, But because costs generally drop with output, trade volumes themselves will affect cost comping it back).

When service products consist of information that

can be transported or transmitted in the form of images, text, or data, the transmittal costs are sometimes (though not always) small compared to the

value of the information. New communications and

information processing technologies have helped

break down the constraints that in an earlier era

required services to be produced close to the customer or end-user. But much more may be involved

than simply transmitting information. Licensing

transactions typically entail substantial expenses for

transferring knowledge, as well as for the protection of know-how (ch. 6). Negotiating tightly written

contracts for safeguarding proprietary knowledge

can be viewed as part of the process of packaging

technology before sending it overseas. Licensers

may send technical specialists to the importing

country to help train the licensee’s work force, or

aid in startup operations—one of many examples

where cheap air transportation has helped firms

move people to markets in order to supply service

products across national boundaries.

At an opposite extreme, when transportation

costs would be large compared to the value of the

product, the service becomes effectively non-transportable, and can be viewed as non-tradeable. Many

tertiary and personal services (table 6, ch. 1) fall in

this category; not many people cross national borders

to get their hair cut. Where either the consumers

or the producers of services do travel, it is usually
386 ● International Competition in Services

for high-value-added services: tourism; medical

care; education; business services such as accounting, For tourism particularly, a nation’s exports normally rise if travel costs—e.g., air fares—drop.

Flexibility in Pricing and Production

An empty hotel room, a vacant airline seat—both

represent irretrievably lost production. While a factory that is shut down this week may be able to run

double shifts next week, little or no flexibility exists in capacity utilization for service businesses like

hotels or restaurants; capacity that goes unused

means revenues that can never be regained. In such

industries, profits depend critically on occupancy

rates and load factors; an airline may lose money

if its planes operate at an average load factor of 6 0

percent, make a healthy profit if it can fill 70 percent of its seats.

At the same time, many costs of production in

the services tend to be fixed, leading to a good deal

of flexibility in pricing. Because manufacturing

firms purchase not only labor, but raw materials,

energy, and, in many cases, substantial volumes of

components and subassemblies, they will generally

have a higher ratio of variable to fixed costs (e.g.,

plant and equipment) than service firms. The major U.S. automobile manufacturers buy parts and

components from thousands of suppliers. Service

firms, in contrast, may buy or lease equipment such

as computers, but otherwise purchase little in the

way of goods and services—certainly compared

with manufacturing firms having comparable payrolls, (Construction is perhaps the major exception;

projects of any size normally involve many subcontractors, Of course, a bridge or a building fits few

of the usual criteria for a service products) An automaker can shut down for a week to adjust its inventory levels, while an airplane flies with a full

cockpit even if half-empty. Moreover, the airplane

will burn about as much fuel carrying 100 passengers as ZOO. And, while much manufacturing labor

can be treated as a variable cost—because people

can be put on short hours or laid off if demand

drops—the salaried professionals in, say, a computer software or legal services firm normally get

paid even when business is bad. Thus, more of the

bill for wages and salaries in a service firm may effectively be fixed.

.

31 f designing a bridge or a hospital seems more undmbigrrously a ser\-

ice than carrying out the construction, the plans, drawings, and bills of

materials are nonetheless quite tangible; they can be stored, transmitted

from place to place, and modified during the (,ourse of construction. The

package of information constituting the design—or a computer program

(Jr a n ad~wrtlsing campaign-has a permanent phj slcal existence, unlike

many of the servi(:es provided by a trial law~er or a bank[)r

When fixed costs are high compared to variable

costs, the firm has more room for maneuver in pricing decisions. A company must pay its variable costs

as they are incurred; an added unit of output means

added costs. No matter the short-run competitive

pressures, it cannot cut prices below variable costs

without losing money. But fixed costs, by definition, neither rise with added output nor fall when

output is cut back. A computer software firm with

mostly fixed costs can cut prices deeply while still

covering variable costs.

This relative freedom in pricing opens a range

of marketing strategies seldom available in manufacturing, Airlines not only offer cheaper fares for

advance purchases to help keep their planes full,

they charge different fares at different times of the

day and different times of the year. When they slash

fares for travel on Thanksgiving and Christmas, the

rationale is simple. The planes will be flying anyway. In the past, fewer than half of all airline seats

had been filled on these 2 days. Any revenue gained

by selling more tickets helps pay for the fuel, flight

crews, and other expenses that will be incurred in

any case. Different fares depending on the day of

the week illustrate the same point: market conditions determine fares more than costs. In the winter, air fares may be lower to Chicago on the weekend, but higher to Miami, because business travelers

(who fly mostly during the week) go to one city and

vacationers to the other; the airlines are simply trying to fill empty seats.4

Service firms where production is in the hands

of skilled or professional employees also gain extra

latitude in pricing because they can ask people to

work overtime without paying them more. In industries like banking or law, salaries may be high

but the added costs of extra output are small–and

the added profit may be large. (At some point, of

course, the bank will have to hire more loan officers

or the law firm add more attorney s.) Furthermore,

the greater the reliance on salaried employees, the

greater the firm’s discretion in allocating costs and

setting prices. Labor costs on a factory assembly

line can more easily be traced to output than in the

loan department of a bank. While the differences

may be matters of degree, if costs cannot be allocated directly to each unit of output, then the notion of cost-based comparative advantage becomes

less useful, Likewise, discretion in allocating fixed

costs suggests that dumping—selling abroad at less

4A staff of 90 people handle Amerucan Airlines” future fare stru(, tu r(;—

at any one tirnc, a matter of more than half a rnlllion future flight~ ( 1,600

per day, for sso days ~head-li. Schmitt, “The Art of fhrising Alr F’(ires, ”

A,’f?w }’ork ‘J’lmfj.\, \l ar 4. I 987, p, D 1
App. B—Analyzing Competitiveness in the Services ● 387

than domestic prices or costs—will be more diffi- ruptcy, The point is simply that, all things considcult to prove for service firms than for manufactur- ered, service firms tend to have more freedom than

ing firms, a difficulty compounded when service manufacturing firms in setting prices. They can cut

outputs are non-standard and differ qualitatively. prices when entering foreign markets, or to keep

Of course, any firm must, over time, cover its to- imports out of their home market.

tal costs, not just its variable costs, else risk bank-
Index
Index

ADP (Automatic Data Processing, Inc.), 182

Adult Education Act, 1984, 358

Adult education and training, 356-359

technologies, 359-361

vocational and paraprofessional, 359

Affiliates, overseas, revenues, 191, see also Foreign

affiliates

Alvey program, U. K., 306, 307-309

American universities:

engineers, scientists, 198, 199

Antitrust enforcement, U. S., see also AT&T breakup

and licensing agreements, 203

illegal licensing practices, 215-216

Arms-length licensing, 193-194

U.S. to Japan, 201-203

Army Corps of Engineers

construction technology R&D, 148-151

Artificial intelligence, 261, see also Expert systems

expert systems in construction, 139

Assets, world’s largest banks, 86

AT&T breakup, 18, 29, 30, 158, 216, 244, 313, 352,

368

impacts of antitrust policy, 216

international repercussions, 171

Automation, and services employment, 229

Baker Plan, loans to developing countries, 111

Banker’s acceptances, 98

Banking and financial services

congressional options, 27, 348-351

expert systems, 91

fee-earning services, 87, 96-99

foreign regulatory policies, 312, 314

innovations, 94-95

international competition, 79-116

international, data for analysis, 111-112

major banks, international assets, 11

new and growing product markets, 94-99

policy, U. S., and international competitiveness,

348-352, 349

retail, overseas, 100-101

trade and competition, summary, 10-13

U.S. banks, foreign branches, 87

U. S., international competitiveness, 12, 84

U.S. international competitiveness, priorities,

349-351

Banking regulations

international coordination, 13, 83, 110-113, 351-352

Banking regulations, U. S., 12, 108-111

commercial v. investment banking, 108-109

interstate, 109

Banking, U. S., infrastructure, 109-110

Banks, income

fee v. interest, 93

profitability, 94

Basel Committee, 83-84, 351-352

Bidding, engineering and construction, 123

“Big Bang,” U. K., 114, 313, see also Deregulation

Biotechnology, 120

engineering and construction, opportunities, 145,

146

overseas licensing, 210, 212

Brazil

perspective on liberalization, 70

telecommunications, regulation, 174-175

Bretton Woods Agreement, 77

Bridging, international competition, 143

British Telecom, 174

Bundespost, 172

Bureau of Economic Analysis

improved trade data, 337

international banking data, 349, 350

licensing, data, 195-197

procedures, 25

royalties data, 191

services, U.S. imports and exports, 58

trade data, inadequacy, 341

Bureau of Labor Statistics, 228

Canada, U.S. banks in, 100-101

Capital

commercial v. investment banking, 108

external markets, 82

Carl D. Perkins Vocational Education Act, 1984, 356,

357

Carter Administration, antitrust standards, 215-216

Cash management services, banks, 92-93

computers, 113

restrictions, 93

Center for Building Technology, National Bureau of

Standards, 29

Federal support, 149

Center for Fire Research, Federal support, 149

Central office (CO) switching equipment, 157

New York Telephone, 244

“Channelization” or product organization, 281,

282-283

CHAPS, 91

CHIPS (Clearing House Interbank Payments System),

91, 110

Claims adjustors, insurance, computer use, 264-265

Coalition of Service Industries, 335

Commercial banking, see also Banking and financial

services

competitive strategy, 101

onshore retail banking, 100-101

profitable markets, 100-103

Commercial lending, 101

Japan, 101

391
392 ● International Competition in Services

Commercial technologies, 361-365

R&D diffusion, 216

support, Administration, 363, 364-365

Communications systems, see also Telecommunications applications and use, 263-272

effects on international banking, 81

strategic applications, 269

Competition

effects on U.S. employment, 231-232

Computer-aided design/manufacturing, 188, 274

Computer-aided design and drafting (CADD)

engineering and construction, applications, 120,

139

partially automated fine grading, 141

piping in construction, 125

Computer hardware

international standards, 271

Computer industries

foreign government support, 309-310

Computer-integrated production, new model, 261, see

also New-model firms

implications, 285-286

macro level, 268, 269, 269-272

macro level, U.S. firms, 271

micro level, 268, 269, 272

Computer languages

international standards, 316

Computers

applications in engineering and construction,

139-141

management decisions on, 260-261

technology/science base for the services, 38-39

technology, uses, 39-41

Computer software, see Software

Computer systems

applications and use, 39, 139-141, 263-272

business applications, 265-266

corporate networks, 270, 270

in banking, 91-93

insurance industry, 263, 264-265

links between firms, 268-269

occupations, characterization, 275, 277, 278, 278

systems design and people’s skills, 272-278

technological advances, 267

Computer technology, effects on international

banking, 81

Comsat, 170

Concrete technologies, 143

Congress

domestic banking legislation, 111

education, reevaluation, 356

education and training, 356-361

international banking, 348-352

involvement in trade negotiations, 335-337

ISDN, 369

policy options, 327-376

R&D and technology development, 362-369

recent trade bills, 334, 373

summary, 330, 331

telecommunications, 353-354

trade data analysis, 339, 340-341

USTR, 340-341, 343

Construction

international market, 130-132, 131

labor costs, 136

overview of the industry, 124-127

productivity, 141-143

U.S. competitiveness, 132

U.S. firms as technology brokers, 143-144

U. S., new, 126

Construction technologies, 120

R&D support, 148-151

Contingent workers, 227, 243-249, 255-256

manufacturing, 247

part-time, 246, 248-249

self-employment, 246, 248

Contractors

international, 126, 129

U. S., largest, 131

costs

computer applications, strategy, 267-269

determining international competitiveness, 47-49

shifts, in new-model organizations, 284

Counterfeiting of products, 318-321

Credit card services, international, 100

Credit-generating innovations, 50-51

Credit-risk-transferring instruments, 50

Cross-1 licensing agreements, 209, 211

Currency, home, advantages of dealing in, 97

Custom programming, Japan, 163-164

Database and information services, 183-186, 183, 184,

186

Data processing, 181-186

Citibank, 282-283

corporate, early years, 266

firms, examples, 182

industry revenues, 159, 181, 183

international opportunities, 181-183

services, industry, 181-183

strategic applications of systems, 269

technological advances, 267

Dematuration of industries, 188

Department of Defense

R&D funding, 305

R&D in construction, 138

Deposit insurance, 110-111

Deregulation, 22

and U.S. policymaking, 340

forcing new technologies, 72

Deregulation, financial industries, 11

and bank profitability, 94

and innovation in banking, 50, 51, 95-96

barriers between commercial and investment

banking, 109

effects on international banking, 81

financial markets, 114

impacts, 373

Japanese banks, 96, 114-115

limits of, 108
Index . 393

Deregulation, telecommunications, 158, 170, 171-175,

188

New York Telephone reorganization, 244-245

Design and construction, examples of American

projects, 122

Design-bid-build contracts, 122-123, 143

technical qualifications, 138

Design-construct contracts, 122-123

Design firms

international business, 124, 126, 133, 134

U. S., computer use in international competition,

139-141

U. S., overseas work, 132-133, 132, 134

Design, in engineering and construction, 121

Design of work

rigid v. adaptive, 275, 277, 278, 278

Development strategies, 302

policy tools, 311-321

Doctoral degrees, science and engineering, 198, 199

Dollar

role in international banking, 97

Earnings, 233, 235, 236

by industry, 238

pay scales in new-model organizations, 281

service jobs, 253

unreported, see Underground economy

Economic adjustment, service industries, 76-78

government policies, 77

EDS (Electronic Data Systems)

General Motors corporate computer network, 178

Education, see also Adult education and training

and career mobility, 253-254

and earnings, 234

career prospects for service workers, 236

credentials for new service industries, 287

entry-level employees, 240-243

foreign engineering students in U. S., 198, 199

future demands, 261

instructional technologies, 359-361

Japan, engineering graduates, 204-205

R&D, funding, 360-361

reevaluation, 355-359

training for high-skill jobs, 275

Education and Training for American Competitiveness Act, 1987, 358

Electronic databases, 159-160

Electronic funds transfer, 81

automated clearinghouses, U. S., 92

Electronic networks, banking, 91-93

Employment, U. S., 223-256

career prospects for new service workers, 240

characteristics by occupation, 239

dependence on trade in services, 5

growth by industry and sex, 231

immigrants, mobility, 251, 252

mobility, 238-243

part-time workers, 248-249

self-employment, 246, 248

shifting patterns, 255

temporary, 247-248, 247

trends, 225-256, 229

women, 231, 253

Engineering and construction, 7, 13-16

competitive future, summary, 13

competitive strategies, 136-148

contract linkages, 127-128

foreign firms, computer use, 139

foreign firms in the U. S., 120, 135-136, 136

industry structure, 121-136

international competition, 119-153

international market, 124, 128-136

new technologies, examples, 140-141

specialization, 121

Engineering and construction, U.S. firms

competitiveness, 13-16, 119-153

contracting practices, 147-148

international consortia, 120

managerial expertise, 120

new products, 146

professional services, 119

projects, examples, 122

strategies, 144, 145-147, 150-153

tax policies, U. S., impacts, 374-375

technology, competitiveness, 14, 150

Engineering Research Centers, National Science

Foundation, 29, 365

Equity, stock

onshore markets, 87, 88

ESPRIT (European Strategic Program for Research in

Information Technology), 306, 307, 309-310

Eureka, 306, 310

Eurobonds, 10, 96

by country, 97

Euroequity, 87

Euromarket, 81, 87, 95, 99

Euronotes, 96

Europe, technology development, 200-203, 205-206

European Community

technology development, 305-306

U.S. service exports, 60

European Patent Convention, 206

Euroyen market, 104

Expert systems, 161, 267

application to design and construction, 139

investment decisions, 261

Export financing, 346-347

Export-led growth, national development, 302

Export-Import Bank of the U. S., 137, 346-347

Exports, U.S.

BEA figures, 58-59, 59

composition, figures, 61

confusion with foreign revenues, 63

controls, 215

promotion, 345

External patenting, 205-206, 206

Fabricated steel structures, international competition,

143

Feasibility studies, 121
394 • International Competition in Services

Federal Deposit Insurance Corporation, 83

deposit insurance, 110-111

dual role in U.S. banking, 109-111

services to U.S. banks, 109-110

Federal Highway Administration, construction technology research, 149

Federal Republic of Germany, see West Germany

Federal Reserve Board, 83, 109, 113

decisions, investment banking, 99-100

monetary policy, 108

Federal Technology Transfer Act, 1986, 29, 360, 362,

365

FedWire, 92, 110

Fiber-optics, 175, 180

competition for satellite circuits, 170

Fifth-generation computer project, Japan, 163,

165-166, 217

Financial services firms, see Banks

Financial services, U.S. tax policies, impacts, 374

Financial system, safety and stability, 110-111

Financing

engineering and construction, 136-137

FIRE (finance, insurance, and real estate) industries

education of workers, 234

new jobs, 233, 234

Flexibility, organizational

competitiveness, 260

computer systems design, 273

contingent workers, hiring, 243-246

Floating rate notes, 96, 108

Floats, 92

Food and Drug Administration, 212

Foreign affiliates

in service industries, 35

revenues, 191

sales, 62-65

to serve foreign markets, 46

Foreign bonds, onshore markets, 87

Foreign direct investment, 194, 201

coverage in GATT, 299

government objectives and policies, 299

Japanese expansion in international banking, 106

negotiations in GATT, 338-339

risks and technical licensing, 208-209, 211

Foreign government policies, 22, 293-325

and international construction market, 132

and U.S. licensing strategies, 208

developing world, strategies, 302

economic policymaking structures, 31

effects on U.S. trade policy, 334

foreign direct investment, 218-219

intervention in engineering and construction contracting, 135, 137, 147-148

Japanese Government, banking concessions, 102

procurement, European telecommunications equipment market, 171, 175

regulatory policies, 312-315

technical standards in services industries, 316-318

technological innovations, 303-306

technology, 305

technology licensing, 218-219

trade and investment barriers, 74-75, 296-298

Foreign nationals, in U.S. engineering work force,

198-200

Foreign-owned banks in the U. S., 90, 114

lending, 88

reasons for investment in U. S., 90

Foreign revenue services, OTA estimates, 63, 67

Foreign students, engineering degrees in U. S., 198,

199

Foreign technology

licensing by U.S. firms, 18-20, 214

payments by U.S. firms, 197

purchase by U.S. firms, 192

Fourth-generation software, 161, 285

France

technology development policies, 306, 309-310

telecommunications, regulations, 172-173

Franchising, foreign, in U. S., 54

GEISCO (General Electric Information Services Co.),

182

General Agreement on Tariffs and Trade (GATT), 4,

25, 46

Agreement on Government Procurement, 311-312

escape clause, 77

problems of non-tariff barriers, 74

services discussions, opposition, 298-300

strengthening by Uruguay Round, 339

U.S. concessions, 332

U.S. services initiative, 298-300

General Motors, 33

corporate computer network, 178

Glass-Steagall Act, 99, 100, 108, 109

Goods, U.S.

exports, for overseas construction projects, 127-128,

128

Grade-Way Construction Co., 140-141

Greene, Harold, U.S. District Court Judge, 315, 353

Health services, job creation, 233

High technology, Uruguay Round, 295-296

Human capital, 287, 332-333

U.S. competitiveness in services, 20-22, 260,

354-361

Human resources

policies, 23, 24, 334-361

Illegal immigration, 251-252

I-Match, 345

Immigrants in the U.S. labor force

by occupation and industry, 250-251

illegal aliens, 250, 251-252

professionals, 250

Immigration and Nationality Act, 250

Import substitution, national development, 302

Imports, U.S.

BEA figures, 60-61, 61

Independent contracting, 248
Index . 3 9 5 — — —

India, software industry, 168

Industry Sector Advisory Committees, 23, 343

InfoBase Corp., 185-186

Information flows, computer application, 269-270,

270

Information services, 16-18, 159-160, see also Database and information services; Information

technology

new markets, 185-186

products, 183

U.S. markets, 183

U.S. tax policies, impacts, 375

Information technology, services industries, 157-188

Innovation, financial services industry, 50-51, 114

Institute of New Generation Computer Technology

(lCOT), Japan, 165

Insurance industry

automation, 231

computer systems, 263, 264-265

Integrated production systems, 262, 285-287

new model, 278-282

Integrated Services Digital Networks (lSDN), 17-18,

29, 158, 177, 187, 267

congressional options, 363, 367-369

international standards, 316-317

Integration and expansion, 53-55

common management structure, 54

global, U.S. firms as leaders, 54

Intellectual property protection, 196, 215

international, 318, 321, 324

software, 318-321

trade issue, 319-320

Intelsat, 170

Inter-American Development Bank, financing of design contracts, 122

International Banking Act, 1978, 90, 112, 312-313

International competitiveness, U.S.

determinants, 45, 47-52

service industries, major influences, 49

International consortia, U.S. engineering and construction firms in, 147-148

International financial services, 10-13, 81-116

assets of largest world banks, 86

growth and competition, 85-94, 101-102

growth compared to world trade, 85

International Organizations for Standardization (ISO),

315

International Telecommunication Union (ITU), 18,

25, 170, 316

International Trade and Investment Act, 335, 370

Interstate banking, 109

Investment banking, 99-100

Glass-Steagall Act, 99

growth, 84

separation from commercial banking, 108-109

investment income, 6 5

Invisibles

account, components, 59, 62, 64

account, contribution to total U.S. exports, 32

surplus, 58

Involuntary part-time employment, 225-226

Japan

banking deregulation, 96

challenge to U.S. banks, 82-83

competition in the financial services industry, 84-85

computer utilization, 260

external patent applications, 205-206, 206

future competition in services, 7-9

information technology, government support,

309-311

international technical licensing, 204

licensing from U. S., 202-203

services deficit, 70

software industry and market, 163-166

software technology, 164-165

technology development, 200-208

technology imports, 201

technology imports into U. S., 220

technology, policymaking, 303-305

telecommunications equipment, 173

telecommunications, regulation, 173-174, 314

trade barriers, software, 166

Japanese banks

banker’s acceptances, 98

expansion abroad, 106

international competitiveness, 104, 106

scenarios for future competition, 102-108

Japanese corporations

computer applications, 271-272

computer integration, micro level, 272

desire for deregulation, 104

expansion abroad, 106

financing, 102

multinationals, 54-55

work organization, 284

Japanese Government, see also Ministry of International Trade and Industry; Ministry of Finance

financial liberalization questions, 107

role in competitiveness of Japanese banks, 103-108

telecommunications regulation, 173-174

Japanese language, software difficulties, 164-165

Japanese Technical Literature Act, 1986, 29, 362,

365-366

Job creation, 253

by industry, 232, 233-237

by occupation, 237-238

competition and structural change, 231-232

dynamics, 232-233

Job Training Partnership Act, 1982, 356

Joint development, engineering/construction and

manufacturing, 147-148

Joint ventures, U.S. firms

in construction, 137

motives, 213-214

Kiosque, 172-173

Knowledge-based industries

foreign revenues, 63, 67

integrated production systems, 278

new-model organizations, 278-282

poor services trade data, 63-64

stratification in jobs, 254
396 • International Competition in Services

Knowledge-based services characteristics, 36, 37

jobs, compared with high-technology manufacturing, 262

OECD nations, 71

shift in U.S. strength toward, 46

Labor

constraints on U.S. construction firms, 144-145

construction costs, 136

overseas hiring for construction projects, 127

Labor force, U.S.

characteristics, 233, 235, 238, 239

contingent workers, 227, 243-249, 255-256

demands of flexibility and efficiency, 261

growth, 231

immigrants, 250-252

job creation, 230-238

jobs in the services, 223-256

mobility, 238-243

Labor unions

and new forms of work organization, 282

decline, 225

non-manufacturing employees, 236

representation by industry, 236

Less developed countries (LDCs)

concerns over services liberalization, 300

construction financing, 136-137

economic growth, 128-130, 130

engineering and construction firms, 119

engineering and construction market, 128-130

intellectual property protection, 318-321

lending risks, 85

lending to, history, 102

Letters of credit, 97

Liberalization, trade in services

and national development strategies, 302

benefits, 46, 72-73

Brazil’s perspective, 70

effects on U.S. current account, 71

indirect benefits to U. S., 75-76

possible gains through, 70-75

sectoral questions, 71-73

Licensing, technical, 191-221

arms-length, 193-194, see also Arms-length licensing

international, 194-197

pricing, 195, 196

protection for intellectual property, 196

revenues, reasons for increase, 195

the license agreement, 196

U.S. international competitiveness, 192-194

Licensing agreements

management attention, 196

restrictive clauses and antitrust enforcement,

215-216

Licensing, European firms, 201

Licensing fees

U. S., international, 191-192, 191

Licensing strategies, 208-214, 220-221

integration, 208-212

joint ventures, 213-214

licensing foreign technologies, 214

Licensing, U.S. firms, 189-221

circumstances of overseas licensing, 209, 210-212

complex strategies, 220-221

illegal practices, 215-216

newly industrializing countries in Asia, 206-207,

207

policy environment, 215-216

pricing, 202-203

response to Japanese competition, 212

revenues, 210

revenues and R&D spending, 210, 211

strategies, see Licensing strategies

to Japan, 202-203

U.S. receipts and payments, 191-192, 195-197, 197

Liquidity-enhancing products, 50

Litigation

and cross-licensing, 211-212

Local area networks (LANs), 158

Macy’s, restructuring and employment, 242-243

Management technologies

construction, 125

consulting, 57

in transition, MetroBank example, 288-291

strategies for U.S. engineering and construction

firms, 146

Manufacturing jobs, 253, 262-263

vertical/lateral mobility, 238-243

worker earnings by age, sex, and education,

233-236

Merchandise, downstream linkages in design and

construction, 127-128

Mercury, U.K. telecommunications, 174

MetroBank, reorganization, 263, 283, 288-291

changing jobs, 288-289

computer enhancement of people’s skills, 273

new products, 288-289

Microwave transmission, 158

Ministry of Finance, Japan

liberalization of financial markets, 104

Ministry of International Trade and industry (MITI),

Japan, 104, 301

and technological innovation, 303-305

technology support, 310-311

Ministry of Research and Technology, West

Germany, 306

Mixed credits, 346-347

construction financing, 137

Models, mathematical, in service industries, 38

Monetary Control Act, 1980, 110

Multinational corporations

cash management services, banks, 92-93

computer applications, 267-269

foreign direct investment and foreign governments,

218-219

information flows, 270

licensing, 191, 192-194, 208-214

U.S.-based, competitive advantages, 55

National Science Foundation, 29, 217

construction technology, support, 149

R&D statistics, 308
Index ● 3 9 7

-.

National security and technology trade, U.S. policy,

215

Naturalized citizens in U.S. engineering work force,

198

Negotiatiions

international forums, 321-323, 323

objectives, banking, 111-112

New Austrian Tunneling Method, 140

Newly industrializing countries (NICs)

Asia, technology development and licensing,

206-208

concerns over services liberalization, 300

engineering and construction firms, 119

intellectual property protection, 318-321

lending risks, 85-86

R&D spending on technology, 207-208

services in development strategy, 302

New-model organizations, 278-282, 283

characteristics, 261, 279-281

cost structure, changes, 284

impacts on competitiveness, 282-283

knowledge/skill requirements, 279-280

macro, micro levels, 285

manufacturing firms, 279

New York Telephone, organizational changes and

employment, 244-245

Nippon Telegraph & Telephone Corp., 166

preferential purchasing policies, 311

regulation, 173-174

Non-tariff trade barriers, 9, 74-75, 296-298

and negotiations, 297, 345

effects on transfer of knowledge, 72

examples, 296-297

professional licensing, 317-318

rationales, 297

regulations as, 312-313, 312

standards and licensing requirements, 315, 315

types, 74-75, 297-298

U. S., as trade issues, 338

Off-balance-sheet items, banking, 99

Office of International Banking and Portfolio Investment, 350

Offshore banking, 87-89

definition, 87

Offshore production, 231, 232

Offsite prefabrication construction, 141-143

Oil prices and engineering and construction projects,

119

Onshore banking, 82, 87-89

definition, 87

direct investment, 88-89, 88

retail, 100-101

Open Systems Interconnection (OSI), 316-317, 368

Operations and maintenance services, opportunities

for engineering and construction firms, 145

Organization for Economic Cooperation and Development (OECD), 9, 15, 25

design and engineering, market among members,

133

growth in international banking, 8 5

services exports and imports by member nations,

66, 69

telecommunications issues, 304

world service exports, 65, 68

Packaged software, 157-158

benefits, 160

Packet switching, 304

Partially automated fine grading, 140-141

Part-time work, 248-249, 249, see also Contingent

workers

by industry, 249

involuntary, 248

Macy’s, 242

Passenger fares

export figures, 59

imports, 60, 64, 65

Patents

international, 205, 206, 206

in U.S. by foreigners, 200

in U.S. by Americans, 200, zoo

licensing rights, 196

software, 320-321

Pay and benefits, 225

service jobs, 225

Personal computers, 259

business purchases, 266

market in Europe, 168

software, 157-158

Piping, management technologies, construction, 125

Pharmaceutical industry, licensing, 210

Policy, foreign government, see Foreign government

policies

Policy, trade, see Trade policy

Policy, U. S., 22-31, 327-376

affecting U.S. competitiveness in international

banking, 82-83

banking, future, 111-113

consistent position in negotiations, 322-323

development and integration, alternatives, 371

development of human capital, 287

domestic and trade, linkage, 296

financing of engineering and construction projects,

120-121

handicaps, 325

industrial and technology, 361-369

information technology, 186-188

institutional memory, 341

linkage of foreign and domestic, 322-323

linkages with international competitiveness, 23, 24,

27, 49, 52, 108, 330, 333, 348-354, 373

organization and effectiveness, 369-372

R&D, technology, 193, 197, 216-217, 361-367

services, coordination, 332, 336, 370

short-term view, effects, 339-340

subsidized financing for international projects, 152

tax, examples, 374-376

technical licensing, 215-217

technology development, options, 23, 24, 30, 203,

215-217, 305
398 . International Competition in Services

telecommunications, 353-354

trade, services in, 333-348

Post, telegraph, and telephone authorities (PTTs), 18

competition from, 179-180

telecommunications tariffs, 304-305

Postal savings system, Japan, 104, 115

Postwar period

foreign investments by U.S. firms, 195

growth of international banking, 81, 113

Pound, British, 97

Price-risk-transferring products, 50

Problem loans to developing countries, 111

Procurement, Federal Government, 366-367, 369

and U.S. competitiveness, 367

Product-centered organizations, 281

Citibank, 282-283

Production costs, and international competitiveness,

47

Productivity

and employment, services, 229-230

computer software, 161

construction, 141-143

Professional jobs, services, 226

v. manufacturing, 262

Professional services, engineering and construction,

Us., 119

Protection for intellectual property, see Intellectual

property protection, Patenting

Qualitative comparisons, services, 48

Reagan Administration

R&D funding, commercial v. military, 217

R&D support, 149

Reciprocal market access, Japan, 107

Regulatory policies, foreign government, 312-315

Relationship banking, 102

Reputation

advantages in integration and expansion, 54

in selling services, 48

Research and development

comparative funding, U.S. and foreign firms, 19

construction-related technologies, Federal support,

149

construction technology, Japan, 144

construction technology, U. S., 144

engineering and construction, 15, 121, 138

engineering and construction consortia, 151

foreign, 200-208, 217, 307

international cooperation, 324-325

international joint ventures, 213

joint industry/government, Japan, 165-166

productivity, 193, 200

proprietary technology, 192-193

services, U.S. spending, 39, 308, 309

software, 161-162

spending, Japan, 201, 203-205, 205

spending, other nations, 201-205, 205, 306-311

tax credits, 363-364

U. S., 198-200, 199, 216-217, 361-367

U.S. policy, 361-367

U.S. military, 30, 148-151, 216-217, 366-367

Responsibility, employee and new-model organizations, 279-281, 285-287

MetroBank example, 289-291

Retailing, career paths, 242

Royalties and licensing fees

data needed, 342

regulation by foreign governments, 218-219

U. S., international, 191-192, 191, 202-203

Second-sourcing, microelectronics, 210-211

Securities Industry Association, 99

Securitization, 10-11, 82, 89, 93

changes in competitive environment, 84

reduced demand for traditional financial services,

89

Self-employment, 246, 248

Service industries

competitiveness, 47-57

economic adjustment, 76-78

employment, 225-256

employment stratification, 241-245

growth and new jobs, 254

high-growth, 234

U.S. national study for GATT, 298

vertical/lateral job mobility, 238-243

Service occupations

employment, 225-256

Services

deindustrialization, 301

development strategies, policy tools, 296, 311-321

dominance in new jobs, 232-233, 232

exports, expansion, 58

external purchases, 56-57

foreign revenues, 63

government monopolies, 75

heterogeneity, 35-36

imports, by region, 65

in the world economy, 43-78

leading exporters, 66, 69

leading importers, 69

need for a foreign presence in marketing, 52-53

negotiation forums, 4, 321-323

OTA import/export estimates, 62, 66

policies affecting, 296

post-industrial view, 301

providers, classified by markets, 36

public procurement, 311-312

R&D spending in U. S., 308, 309, 361-367

trends in employment, 228-230

U.S. balance of payments surplus, 61

U.S. comparative advantage, 70

U.S. political agenda, 334-335

world trade, 65-69, 68, 69

Services and goods

evolving industrial structure, 31-42

Service sector advisory committees, 343-344

Services exports

definition, 57
Index ● 3 9 9

distribution by region, 60, 63

OTA estimates by industry, 62, 66

Services trade

balance, U. S., 65

barriers, 73-75

data, 61, 63, 112, 341-342

data, OTA estimates, 61-65

database, options, 341-342

measuring, 57-59

Service workers

earnings by age, sex, and education, 233-236

skills, 237-238

Sheltered industries, effects of liberalization, 72

Site management, construction, 123-124

Skills, 276-277

computers, job deskilling, 273

computers, job upskilling, 273-275

data gatekeeper jobs, 278, 279

lateral job movement, 240

Macy’s restructuring example, 242-243

MetroBank example, 289

new-model organizations, 261

service jobs, 226, 237-238

social, 276

Small businesses

{commercial lending to, 101

overseas licensing strategies, 208

Societe International de Telecommunications

Aeronautiques (SITA), 177, 179

Software, 10, 157-169

benefits of liberalization for U. S., 71-73

copyrights, 166

European market and industry, 166-168, 167

foreign competition, 162-163

France, market, 166, 167

intellectual property protection, 166, 318-321

international standards, 271

Japanese language, 164-165

Japan’s industry and market, 158, 163-166

pirating, 318, 320-321

productivity in generation, 161-162

R&D, 161-162

standardized applications packages, 157-158, 266

technological advances, 39, 267

trade barriers in Japan, 166

U.S. competitiveness, 16-18, 73

U.S. firms in Europe, 166-168

[J. S. industry, 162-163, 162

West Germany, market, 166-167, 167

world market, competition, 168-169

South Korea

engineering and construction, 119, 132, 133

technology development and licensing, 206-207

U.S. joint ventures, 213

U.S. technical licensing, 212

Specialists

external, services purchased, 56

Specialization

purchases of overseas technology, 214

U.S. engineering and construction firms, 138

Specialized skills

hiring patterns, 240

new-model organizations, 279

Standby letters of credit, 98, 99, 110

Stevenson-Wydler Technology innovation Act, 1980,

29, 360, 364-365

Strategic Defense Initiative, 188, 306

Stratification

knowledge-based service industries, 254

labor market, services, 226

new-model organizations, 261, 287

Supercomputers, 267

data processing, 181

Super-regional banks, 109

Swaps, 98, 99

SWIFT (Society of Worldwide Interbank Financial

Telecommunications), 91, 177, 179, 316

Systems design, 285

and people’s skills, 272-278

Tax payments, foreign, 374

Tax policy, U. S., effects on international competitiveness in services, 374-376

Tax Reform Act, 1986, provisions, 374-376

Technical licensing, 18-20, 191-221

U.S. tax policies, impacts, 375-376

Technology

computer applications in the services, 257-291

construction productivity, 141-143

engineering and construction, 14, 138-144

foreign, access to, 365-366

in banking, 50, 81, 91-93

international standards, 315-317, 324

military R&D and civilian benefits, 366-367

R&D, U.S. policies, 361-367

science base in the services, 37-38

standards, U.S. policy, 363, 367-369

U.S. advantages, 37-42, 197, 198-208

use, summary, 37-42

Technology brokering

U. S., (construction, 143-144

Technology trade, 189-221

licensing strategies, 208-214

[J. S. licensing overseas, 204

U.S. licensing with Asia, 206-207, 207

U.S. receipts and payments, 195-197

TELEBRAS, 174

Telecommunications, 169-180

banking, 89, 91-93

benefits of liberalization for U. S., 73

competitive environment, 169-175

domestic policy and international competitiveness,

349, 352-354

deregulation, 158, 170

equipment market, Japan, 173

foreign regulatory policies, 172-175, 313-315, 314

General Motors/EDS planned network, 178

international tariffs, 304-305

international standards, 354

management decisions, 260-261
400 . International Competition in Services

market changes and New York Telephone, 244

multinational banks, 92

pricing, volume-based v. time-based, 304-305

revenues, international, 169

suppliers, procurement policies, 171, 175

technology, history, 176

U.S. trade policy, 180

Temporary employment, 56, 247-248, see also Contingent workers

by industry, 247

Federal Government, 247

Telenet, 176, 179

Teletel/Minitel, 159, 171, 172-173

Teletext, 159, see also Videotex

Tertiary services, 20, 36, 37

foreign revenues, 63, 67

industries, 228

technology, 262

work reorganizations, 286

Texas Instruments, 211-212

cross-licensing with Japan, 220

Tokyo Round negotiations, 4

congressional involvement, 335

non-tariff barriers for goods, 75

Tokyo Stock Exchange, 312, 313

Tourism, 53

import figures, 60, 64

Trade and Development Program, 26, 345, 347-348

Trade and Tariff Act, 1984, 335

Trade barriers, see also Non-tariff barriers

licensing strategies, 208

lower, adjustment to, 77

services, effects, 73-75

Trade financing, 96-99

letters of credit, 96-97

standby letters of credit, 98

Training technologies, 359-361

Department of Defense, 359-360

Transborder data flows, 17, 187

international issues, 304-305

Transportation

export figures, 59

Travel

export figures, 59

Turn-key projects, 122

Underground economy, 249, 252-253

categories, 252

size, 252-253

United Kingdom

Alvey program, 306, 307-309

technology policies, 306

telecommunications regulations, 174

United Nations Industrial Development Organization,

300

United Nations Council on Trade and Development,

300

Universal banks, 99

Unreported earnings, see Underground economy

Up/Down construction, 140

Uruguay Round, 3, 4, 23, 32, 70

foreign direct investment, 299

foreign government policies, 293-325

intellectual property protection, 215, 318

trade barriers in the services, 73

U.S. and Foreign Commercial Service (US&FCS), 23,

26, 345-346

U.S. balance of payments, 58-61

history, 58

OTA estimates, 61

services v. goods, 6, 8

U.S. banking regulations

impacts on U.S. international competitiveness, 82

shifts, 83

U.S. banks

future outlook, 115-116

restriction abroad, 112

U.S. construction firms, international market,

130-132, 131

U.S. economy

employment and structural change, 228-238

jobs, 225-226

occupations, 230

U.S. International Trade Commission, 127, 212

U.S. Trade Representative, 10, 25, 26, 322, 325

congressional options, 336-337

resources for Uruguay Round, 342-345, 344

policy, 16

Value-added networks (VANS), 159, 176-180

foreign government restrictions, 179-180

in banking, 91

markets, 176-180

ties with database services, 183

United Kingdom, 174

U.S. firms, 177-179

Value-added services, 176-180

Videotex, 159, 180, 183

Teletel/Minitel, 171, 172-173

United Kingdom, 174

U. S., 180

Western Electric, 171

West Germany

services deficit, 70

telecommunications regulations, 172, 314

Word processors, Japanese language, 165

Work organization, 257-291

and deskilling/upskilling, 278

groups, supervisory control, 280-281

macro level, 260

micro level, 260

rigid v. adaptive, 275, 277, 278, 278

tasks, jobs, and skills, 276-277

trends, 285-286

Work reorganization

Citibank, 282-283

insurance industry, 264

Macy’s, 242-243

MetroBank, 263, 288-291

New York Telephone, 244-245
World Bank, 111

disbursements for construction, 133, 135

financing of design contracts, 122

World economy

benefits of reductions in trade barriers, 4 6

change, effects on U.S. trade policy, 333-334

services in, 43-78

World Intellectual Property Organization (WIPO), 9,

25, 319-320

Index • 401

World services trade, 65-69, 68, 69

exports, by type, 69

exports, origin by region, 68

individual countries, 66, 68, 69

Yen, 97

growing prominence, 107

in international transactions, 104