Assignment

T

~

SIX

STATE-LED DEVELOPMENT

Unlike its red-blooded ideological cousin, lemon socialism is

not the subject of a vast body of literature. In the West, how-

ever, it has resulted in government ownership and control of

major hunks of economies.

Coming out of the Depression and World War II, Western

European governments found themselves by accident and de-

sign with controlling interests in substantial parts of their national financial and industrial sectors. Some of this was deliberate: the

beliefby left-of-center governments that their proper role was

to own and control the "commanding heights" of the economy.

More of this, however, was generally accidental-some losing

enterprises that were deemed too big to fail and some enter-

prises for which privates were unwilling to invest in expansion

on a sufficient scale. In Italy, for example, the government

owned the largest banks; the railways; the radio and TV sta-

tions; and monopolies or major firms in steel, oil, electric

power, telephones, cigarettes, aircraft and airlines, toll highways,

117

~~,-~, "_'.~__~_ ",~""""""'N!""-I

1I8 THE END OF INFLUENCE

insurance, autos, electrical equipment, and even pasta. Some-

thing similar existed in Spain, a heritage of Franco. Giant

state-owned sectors were to be found not only in countries

with Fascist histories, but in other countries as well. In France,

for reasons oflemon socialism, full red-blooded socialism, and

some postwar confiscation of collaborationists' companies (Re-

nault), as late as 1981, the state owned banks that accounted

for about 85 percent of all deposits, and monopolies or major

companies in insurance, railways, autos, railroads, tobacco, ra-

dio and television broadcasting, electricity, gas, telephone, mar-

itime shipping, electronics and many others. Despite, because

of, or with no relation whatever to this dominant economic

role for the state, France modernized and grew quite as fast as

its awesome neighbor, Germany-to the surprise of the world

and especially the French themselves. And state-controlled

firms set the pace and led the way.

For the past twenty-five years, however, these Western Eu-

ropean countries, along with much of the rest of the globe,

have been actively privatizing their state holdings. They have

reduced government ownership. They have pared back their

governments' direct efforts to influence market outcomes.

Privatization and the dismantling of active industrial policy

even took root in Continental Europe, as the English like to

call it, where it was aided by a particular and powerful force.

The European Union's drive to create a single European mar-

ket was a deep, sustained, and far-reaching effort to establish conditions for the free flow of all economic factors across the

European economic space, not just product, but labor, capital,

and management control, and the elimination of institutional

and policy barriers to freer and more vigorous competition

- State-Led Development 119

across national borders. This translated into the persistent dis-

mantling of the principal instruments of national industrial

regulatory policy-subsidization, protection, preferred pro-

curement, and artful standards, rules, and regulations.

Eliminating obstacles to the free flow of capital and com-

petition set Brussels cutting away at state ownership, control,

and attempts to influence outcomes. In the 1990s, the demon-

strable fact that even France had privatized its companies and

pulled back from actively and systematically intervening to affect industrial outcomes boosted international acceptance of

the U.S.-U.K. message: Leave it to the market. The brilliantly

flaunted prosperity of the U.S. economy-and even the long-

ailing British economy-during the 1990sand the early 2000s clinched the case.

The current crisis is beginning with a worldwide reaction

against what are perceived to be both the excesses and the de-

fects of neoliberalism, the "leave it to the market and get the

state's hands out" ideology or universal policy prescription

that had been so triumphant. Whenever and however it ends,

it is likely to end with governments-once again-unafraid

to use the substantial ownership stakes they will have amassed

in a host of distressed national firms in finance and industry.

In their efforts to stimulate their economies, governments are

likely to try to be strategically as well as macroeconomically

smart and to shift their economies toward bright and even

virtuous new directions like clean energy, which is seen by all

governments and investors as huge and good.

Each government will be tempted and pressured to use its

leverage for the national interest, as well as many special in-

terests: to support and strengthen big, distressed industries

...,.--

120 THE END OF INFLUENCE

and to promote investments in new industries. A move by one

country will push others to rush to the same, crowding the

exit ways. After all, if the United States, Germany, or Korea

bails out its auto parts makers or its banks, insurers, or airlines,

then shouldn't France or Italy also do so? If they don't, they

risk letting their companies and workers pay the price of

American or German market-distorting policy. In the current

crisis, all of the industrial countries have lots of big lemons-

offices and factories owned by both national and foreign com-

panies in sectors that had worldwide overcapacity before

demand suddenly collapsed. Ensuring their operations and

survival in one country squeezes the other countries' lemons

all the harder, and around it goes.

Ships are sitting empty. Prices for ocean shipping have

plummeted as volumes have fallen, while costs are overwhelm-

ingly fixed. Orders for new ships spiked during the shipping

boom of the past few years. Now orders are being canceled as

quickly as possible. Shipyards are in trouble. The Chinese gov-

ernment is responding by pushing its shipping companies to

buy new ships and keep its shipyards operating and their huge

workforces employed. But this further depresses business not

just for shipyards in other countries, but also for shippers for

whom the launching of even more competition means yet

lower prices and bigger losses. Maersk, one of the biggest ocean

shippers, is a Danish company, but how can Denmark or

Greece compete with China in a subsidy race? Something sim-

ilar is happening with aluminum producers. In the short term,

where a company winds up in the triage process has less to do

with better products and greater efficiency and more to do

-

I

I

State-Led Development 121

with which companies have more aggressive, more agile, and

simply more government support.

Although companies may be the conventional category for'

thinking and, especially, talking about these issues, it may be

the wrong unit. In autos, for example, companies now operate

global production portfolios spread out across many countries.

So the target unit is less the company-GM or Daimler-Benz-

than specific facilities and activities, such as plants, design cen- ters, and those of suppliers. The transformation of national

champions into multinationals complicates industrial policy.

Defensive industrial policy-that is, stepping in to support failing industries, or ranching lemons-is not all there is. There

are two other forms: John Stuart Mill's "infant industry" of endeavoring to shape market outcomes to shift national eco-

nomic development onto a new and higher trajectory by pro- moting national firms in specific sectors, and its converse

endeavoring to shape others' national economic development

in directions that support one's own development goals.

Americans like to say scornfully that industrial policy is

about "governments picking winners." Picking winner indus-

tries is not that hard-even for governments. Most countries

trying to climb the ladder of quality and industrial sophistica-

tion through selective promotion compiled pretty much the

same lists at the same time. Even at the leading edge of the

technological frontier, the industries that governments are

tempted to promote are largely the same ones picked by the

analysts and brokers at investment firms such as Merrill Lynch,

Nomura, or Rothschild's. In the past, the picks would have

been semiconductors, computers, mobile technology, or

122 THE END OF INFLUENCE T

biotechnology. Right now, yet again, governments and analysts

alike are all picking clean tech, nanotech, and biotech. Picking

"winner industries" is not the hard part; winning is. It is diffi-

cult to create actual winners, companies that develop into suc-

cessful competitors. It is easy to establish a national champion

company in a winning industry and have it develop into an

inefficient, cash-draining zombie-witness Brazil's and

France's thirty-year losing efforts in computers or, indeed, the

Japanese Fifth Generation computer project. Even the venture

capital firm of Kleiner-Perkins, a great Silicon Valley winner

picker, appears to have on net failed to increase its investors'

money in its picks since 1998 except for one single company:

Google. But sometimes these efforts succeed. Brazil built a national

champion that, after decades of military subsidy, now holds

an honorable niche in regional jets: Embraer. Japan targeted

electronics and succeeded in climbing to a leading position in

that giant industry. A bit later, Taiwan and Korea did the

same. And France also targeted nuclear energy, space rocket

launchers, commercial aviation (eventually, Airbus at the Eu-

ropean scale), and supertrains. It succeeded, for better or worse,

in being a world leader in each of those advanced industries.

All of these not only required patient and massive government

support, but are also, by their very nature, impossible to launch

to scale without such support. They are different-in kind-

from Twitter, Federal Express, Google, Countrywide, Wal-

Mart, Disney, or Apple. Now China is trying to climb up that

greasy, crowded, and possibly buckling pole.

State-led economic development by the developmental states

of East Asia such as Japan and Korea has been a wonder of

State-Led Development 123

the world, cutting decades if not generations off the predicted

times for their emergence as prosperous, modern economies. Governments all over the world seek to emulate these extraor-

dinary development successes. Now that the financial crisis has

freed them from the fetters and blinders of the Washington

consensus and the neoliberal ideology, the governments will

attempt to deploy their market-rigging economic instruments-

their money, their sovereign wealth funds, their stimulus pack-

ages, along with the various nonmonetary instruments at their

disposal-to accelerate their rise to prosperity. Will they suc-

ceed? Probably not. Strategies and institutions that work well

in some times and places fail catastrophically in others. But

they will try.

The great successes in industrial policy were achieved by

countries that didn't have to invent their future but only had

to catch up with it-what Thorstein Veblen famously first

called the "advantages of backwardness." Japan's industrial

planners could select an industry to target from a set of fully

studied candidates and later, from the vantage of a higher

rung on the development ladder, could similarly select the

next ones: first steel and ships, then machinery and autos, then

electronics. The Japanese succeeded in all of these, one after

the other, beyond their wildest initial ambitions. But they

didn't do quite so well with technologies and industries that

had not yet been invented elsewhere or had yet to take proper

industrial form, such as advanced computing, biotech, and In-

ternet plumbing and applications. Nonetheless, many govern-

ments will probably have a go at another round of smart

industrial policy. After all, the same list of big next new things

is on everyone's desk. And now the governments have the I I I I I I I I I

124 THE END OF INFLUENCE

money plus the compelling need to "stimulate" their wracked economIes.

Consider an earlier pair of very big, well-known next new

things-commercial jet aircraft and semiconductors. They en-

compass technology; just about all new (nonbiological) tech-

nologies go into big jets, and semiconductors go into, or into

the production of, most everything. Though rarely acknowl-

edged in good economist company, at no time-from their

first origins through the present moment-in the relatively

short histories of both of those industries was some government

not intervening to affect competitive outcomes and the location

of value added. And it was the United States that secured early

dominance in both those industries. Would it really be shocking

to learn that China might take a run at a lead position in pho-

tovoltaics or wind turbines, or stake itself to a place in regional

and then big commercial jets, an industry now shared by Boe-

ing and Airbus?

Will these likely efforts, backed by the new redistribution

of the money, threaten the absolute, or relative, position of the

American economy? Quite possibly yes.

The danger is not that countries with money will purchase

American companies (directly or through their national com-

panies)-which they will-and make off with the "shareholder

value," which they won't. The real danger has to do with

where the spillovers of innovation go.

Recall that innovation has over the past fifty years provided

more than half of all real economic growth in the United States and that almost all of the benefits from invention and innova-

tion spilled outside the innovating company. The classic ex-

--

I

State-Led Development 125

amples are AT&T and Xerox, whose UNIX project and Palo

Alto Research Center (PARC), respectively provided proof-

of-concept running code for almost the entire software industry.

But if AT&T made a dollar off UNIX, we would be very sur-

prised. And Xerox lost a fortune at PARCo There is a story-

probably false-that when Apple was jostling Microsoft, Steve

Jobs complained to Bill Gates about Microsoft's copying Apple's

interface: "It's like you broke into my house and took my TV

set!" "That's not true, Steve," was Gates's apocryphal reply.

"We had a rich neighbor named Xerox, and we both took Xe-

rox's TV set-you just took it first." There is nothing immoral

or illegal or destructive and a great deal that is advantageous

for long-run economic growth in the flow of knowledge from

firm to firm in and beyond Silicon Valley and other such com-

munities. Communities of innovation and of engineering prac-

tice are how leading-edge economic growth happens. Such

flows of knowledge have always happened since before the

philosopher Thales of Miletus is supposed to have made some

suggestions for improving the efficiency of the olive presses of

Caria. Johannes Gutenberg's invention of movable type quickly

spread across and then beyond Mainz; Ford's innovation of

the assembly line quickly benefited GM, GE, and Westing-

house and then spread around the world.

. Usually, at least in the past, the spill overs have tended to

cluster, at least initially, in tight physical propinquity to the

actual invention and innovation; regional industrial growth

poles have been a powerful force since the first one was es-

tablished in Lancashire at the start of the nineteenth century

(or perhaps in Florence at the start of the eleventh). But will

126 THE END OF INFLUENCE

regional propinquity be that essential in our future of always-

on, ubiquitous, instantaneous, worldwide communications?

And what will happen when governments with ownership

stakes in firms think that it would be nice if they would tune

things so that the spillovers happen not where the operations

are currently located, but rather where the government would

prefer the spillovers to be? And this growth can be shifted.

Money helps. It can try to shift many things, including the gen-

erators of yet more money. It can take totally new technologies

out of the start-up companies that create them and attempt to

shift them back home for next stage development into full-

scale production, growth, and development into yet newer

products and processes. Some such efforts will succeed. Most

will probably fail. But when they fail, they will still have inflicted

damage on the innovating economy. And a great many attempts

will be made. Like the shift in political power represented by

the relocation of the money, this is an unpleasant possibility to

contemplate, especially from the heartland of innovation.

Defensive industrial policy-lemon socialism-can have a

similar growth-shifting effect. Think of American football.

The helmet was defensive at first, to protect players' brains.

But it then developed into the hard-shell helmet, an offensive

battering ram. Distressed traditional industries do not consist

entirely of petrified wood. They often contain high-growth,

high-value bits and technologies that will generate substantial

growth in sales, jobs, skills, and knowledge. These bits can be

moved to a new home, leaving the aging hulk in the United

States. And you don't have to close down the plant and ship it

overseas: It can all happen at the margin, in the location of

1

I

I

State-Led Development 127

production for the next product, or the location of the next

factory, or the decision on where to close excess capacity. Lots

of factors-not just efficiency-can influence that choice: "We

will bail you out and plough money into the plant right here,

but we can't have our money going into supporting jobs at

some foreign plant" is a governmental refrain that locates pres-

ent and future economic activities, not just the dead weight of

permanent losers. Politicians feel that using their taxpayers'

money to subsidize jobs in other countries "isn't justified," as

France's outspoken president, Nicolas Sarkozy, said point-blank.

Most political leaders, especially in countries with traditions of

free-market rhetoric, don't dare to speak so matter-of-factly.

What to do? One bad possible reaction is to vet all foreign

purchases that could be of concern to the United States not

just for reasons of military security-as we already do-but

also for economic security. The U.S. government would have

to discriminate, on a case-by-case basis, among foreign investors

and even look through their American partners to identify

them. This would not be easy even for a Korea, Japan, or

France, which have well-established bureaucratic capabilities

and which know the game. It would be especially difficult for

the United States. The American government should never

try to micromanage; it cannot. It has political and administra-

tive structures that, compared with these countries, are partic-

ularly ill suited to vet foreign investors and investments, one

by one, to differentiate among individual cases-not broad,

legally defined categories The attempt by Dubai Ports World

to purchase P&O port facility operations on the East Coast of

the United States produced a political furor at the highest

128 THE END OF INFLUENCE

levels. Congress and the press rose up in outrage. The great

and the good swiftly portrayed this reaction as ominous, xeno-

phobic protectionism. But it was not a simple case of protec-

tionism, of wanting to keep foreigners out, and most, though

alas, probably not all, of the congressional outbursters knew

it. It was a complex case of preferring one foreigner to another.

Those against the purchase did not want one most-acceptable

corporate foreigner, the venerable British company P&O, to

sell a U.S. asset that looked as though it could have security

implications to a particular other foreigner. This foreigner was

owned and controlled by the government of Dubai, a hot spot

for all kinds of transactions and comings and goings not all of

which involved hot U.S. architects and Wall Street salesmen.

It was a political effort to discriminate against an Arab gov-

ernment, not foreign investors in general. It was a security concern-wise or foolish.

The United States was not able to handle this sort of ques-

tion deftly. We magnified it outrageously, transformed it into

another kind of question, and burst it into fiasco. You can't do

that sort of thing on an ongoing basis. And it is much harder

to handle when the question concerns not the outright purchase

of a company or facility, but the adroit, day-to-day transfer of

the economic potential of an innovation.

The problem is not foreign ownership per se. It cannot be,

because ineluctably, there will be more and more of it. After

all, they have the money. All classes of our assets-real estate,

government and corporate bonds, minority holdings of cor-

porate stock, and control of companies-will shift to foreign

owners. Real estate poses zero problems despite the fearful

1 State-Led Development 129

cries that followed the Japanese purchase of Rockefeller Center

when Japan, briefly, had the money. You can't pick up a build-

ing and move it. Nor do bonds and truly minority stock hold-

ings pose problems: All you can really do is buy them or sell

them. But some controlling interests in some companies might,

sometimes, pose some real difficulties. The problem is how to

handle a nearly endless series of who, what, and how. The

prognosis for an effective U.S. response here is poor, possibly

hopeless.

There are, however, calming considerations. First, this is

nothing new. America has already been through all this and

survived it. All by itself, albeit with some assists from Asian

governments, the market system has been doing a rather fine

job of encouraging American companies to relocate substantial

portions of the benefits of innovation to Asia. Second, most

sovereign wealth funds do not come with this danger. Funds

from countries like Norway do not do that sort of thing, but

then again, there are not many Norways. The giant pots of

money in the Gulf don't pose that kind of threat. No one,

themselves included, seriously thinks that the Gulf states can relocate innovations back home and sustain and harvest their

growth potential. With the Europeans, there is a lively back-

and-forth in the location of technology, ideas, plants, and in-

novative people. It has been very roughly in balance with few

problems on the horizon.

The Asian manufacturing nations, trying to move up into

higher and higher technology and value added, are successful

industrial-policy countries that seem highly unlikely to kick

the habit, especially now that they have a fine new tool: cash,

13° THE END OF INFLUENCE State-Led Development 131

vast piles of wealth that need at some point to be moved out of

dollars to be shielded from the risks of substantial exchange-

rate depreciation. One shift will be into strategic investments

by Asian sovereign wealth funds or national companies with

access to that money to try to relocate the locus of development.

Money is just one power available to those governments,

especially China. There is also the power of access to, and suc-

cess in, the Chinese market. For example, there is Huawei's

use of what at first seemed to Cisco to be Cisco's own technology,

or the awaited denouement of China's experiment with a Eu-

ropean very fast train that ludicrously zips from Shanghai air-

port to Shanghai. Will a foreign company get the contract for

the real runs-beginning with Shanghai to Beijing-and hold

on to its technology, or will the real runs have a Chinese com-

pany either providing something that strongly resembles the

European (or Japanese) technology, or as a major technology-

sharing and market-sharing partner?

And what if the Chinese simply copy the technology? Or,

. through deals that can't be refused-a big piece of the world's

best and biggest market-squeeze the technology for the very

fast train out of the Europeans? How could they fight back?

The European train makers have had, to say the least, -very

strong assists from their governments. Should the German or

French governments choose to defend them, what could they

really do? Threaten the Chinese with some kind of retaliation?

Doubtful. After all, they have Airbuses to sell, and China is

the biggest likely buyer, and those same governments are deeply

involved in Airbus. It is not at all clear that they could do

much of anything, except work oUt some kind of reasonable

deal: OK, you make off with the technology, use it at home,

but you give us half of the China market. And what about

China exporting it? Economics talks a lot about market power,

but little about the power of a market if you control access to it.

The interventionist approach has a long history. Industrial

policy is a whispered word in Japan, a common usage in France,

and a portmanteau pejorative in America. There are major

differences in how governments tried to promote their winners.

Japan and Korea are shining examples of long-term, large-

scale success of very active, sectorally focused industrial policy.

Over time, they succeeded in willfully changing the composi-

tion of their economies and the structures of their comparative

advantage. Japan didn't invent its way into electronics, nor

did Korea. Government targeted the industries, protected in-

fant firms, supported them by steering lots of patient capital

and customers their way, and kept at it for years. The same

government attention propelled the development of the nations'

enormous and enormously successful steel, shipbuilding, ma-

chine tool, and auto industries. France, a more open economy,

a proudly high-wage establishment, and a more graceful player,

made a similar sustained effort at government promotion of

key industries. And despite this effort, or in part because of it,

France is still high up on anyone's list of the richest countries in the world.

The best and biggest successes occurred when determined,

strong, and well-organized governments could plainly see what

they were aiming at. Industrial policy that aims at capturing

the next new thing is, however, a fundamentally different

132 THE END OF INFLUENCE State-Led Development 133

game from catch-up. It requires very different and much less

well-understood capabilities.

Targeting "industries of the future"-not just your future

but the world's-is precisely where clarity is hard to come by,

and when it comes, it is sometimes merely will-o'-the-wisp.

Fusion power is the clearest example: For the past two gener-

ations, the industry of the future; most likely, for the next two

also. It is all about uncertainty-not simple risk. It is not about

playing the odds with portfolio theory; it is about not knowing

the odds. But it is not a game lacking eager players; the payoffs,

if you can snatch and hold them, are huge. It is generally ac-

cepted that when a government directs its money and efforts

at the level of scientific research, in clear-cut precommercial

stages-that is, basic research-it is very much treated as the

right and proper role of government. The support is considered

infrastructural, like roads, bridges, and education. But this is

a costly, slow, and very uncertain business. Even if there are

commercially valuable results, it is now much harder than it

used to be to hold those benefits in the national economy.

One alternative approach is simply to come in late, after

the scientific uncertainty has crystallized out, and seek to gain

a good chunk of the economic benefit of innovation-no matter

where the innovation occurs-and plant it for large-scale

growth into the home economy. Many companies in innovative

businesses such as biotech or electronics have set up research

centers in places such as Scandinavia, Israel, and, of course,

Silicon Valley to get their noses and fingers into clusters of in-

novative activity. Eager countries with a well-developed in-

dustrial policy apparatus can do the same thing, most often

through their own companies, which they can always back

with steroidal doses of money, but also, should they choose, as direct cash investments from their wealth funds.

Innovation is generally not as mysterious or idiosyncratic

as it is so often portrayed, the work of an isolated, driven,

lonely genius. Rather, it happens in clusters, groups, or com-

munities of innovators busying around some major, enabling

scientific development that is well known globally. The inno-

vations that open commercial applications happen within these small communities of innovation and slosh around its constit-

uent people, institutions, and firms. No one can really know

who will hit the winning combination, but it is a fair bet that

someone will, most likely more than one. At this point, some-

thing more than luck, inspiration, and perseverance will count:

Money is a likely candidate. That is why venture capital firms

have such redundant portfolios: One firm in this charged space

will likely hit it; we just can't know which. And deep money

can help one firm out-invest and prevail over its competitors.

This way of thinking about innovation and its transformation

into industry is a kind of Silicon Valley view: Success comes

from high-energy, new firms full of kids with stock options-

kids who snort pizza and coke and rock koans after midnight

at their work stations. Imagination, ingenuity, and speed are

all-important; massive amounts of patient capital don't much

count. Sometimes this view fits reality, especially when what

is involved is pushing around bits, not atoms, that is, low

capital costs to enter the market, low capital costs for expansion,

huge economies of scale (or exponential network economies), and even lock-ins.

134 THE END OF INFLUENCE

But quite often, the next new thing doesn't come about this

way, and can't. France's list of big-time industrial policy suc- cesses illustrates this other route. None of them-nuclear en-

ergy, big commercial jet aircraft, space rockets and satellites,

and high-speed trains-unlike, say, personal computers, MP3

players, Google, Craigslist, or hybrid cars, can be developed

into something big without extensive and prolonged govern-

ment involvement. By extensive, we mean not just government

financing of research and development over many years, but

also government organization of a market, government or

government-controlled entities directly providing a launch

market at the necessary scale, which is huge, and government

creating the rules and regulations necessary for that market's

operation. Launching all of these new industries required not

the lightweight speed, smarts, and agility of the Silicon Valley

model, but this kind of deep and extensive government incu-

bation. And all of them got it. And each of them-except the

last, very high-speed trains-was developed and initially dom-

inated, not by France, but by America.

AMERICAN INDUSTRIAL POLICY .

America doesn't "do" industrial policy. We don't like it. We

don't approve of others doing it. We think that when they do,

it hurts us and usually ends up hurting them as well. Further-

more, we're just not set up to do it. Unlike the situation in

some other countries, the institutional design deeply embedded

in American political, legal, and administrative structures is

quite unsuitable for selective, discretionary, and sustained in-

---

State-Led Development 135

tervention by government bureaucrats. Ideological conviction

and an overall judgment on results reinforce this position. Gov-

ernment is, and ought to be, the referee in the market game,

not the coach, linemen, and quarterback. In brief, the American

view as expressed in its domestic politics, in its positions in in-

ternational forums, and in the discourse of its economists is

that industrial policy is largely a form of cheating. At best it

unfairly free-rides on the overall system, and usually it backfires

and ensnares the intervening government into taxing the

healthy parts of its economy to support losers. We don't do it.

Proper Europeans older than fifty will eagerly tell you that

this insistently proclaimed American view is disingenuo.us.

Americans didn't call it industrial policy; they called it defense.

There is considerable truth to this smirking assertion. In the

post-World War II period, the Department of Defense (DoD)

put into place its huge and permanent budget; its daunting dis-

cretion in determining its technological and industrial needs;

its extended time horizon, replete with twenty-year projects;

its cadres of well-trained technology bureaucrats in special tech-

nology-industrial development agencies such as DARPA (De-

fense Advanced Research Projects Agency); and its family of

technologically sophisticated, if not quite market-responsive,

supplier firms such as Raytheon, Lockheed, Boeing, United

Technologies, GE, General Dynamics, Collins, and Harris.

DoD's industrial activities were complemented by related agen-

cies such as the Atomic Energy Commission, the commission's

successors, and NASA. This Pentagon economy was protected

from economics as well as politics. Economics stopped at the

Maginot Line: The defense sector was bracketed and removed

136 THE END OF INFLUENCE

from the usual concerns for market performance and efficiency.

It was, in many ways, a separate economy operating by separate

rules and criteria, and concern with optimal market outcomes

was certainly not one of them.

From 1955through 1985, military spending in the United

States averaged about 7.5 percent ofGDP. No other non-Soviet

bloc country came even close; France was second, averaging

about half the U.S. rate, and Japan about one-seventh.

Determining or even opining on whether defense spending was a boon or a bane for the U.S. economy is not our concern.

But we do assert that it played a powerful and consequential

role in promoting specific technological/industrial capabilities

that developed into significant areas of American competitive dominance in the world economy. The Pentagon did not set

out to reform the U.S. economy, certainly not with the goal of

making it more competitive internationally. Instead, DoD set

out to supply its own, ever-evolving technological requirements,

ambitions, and dreams.

Consider several significant examples of Pentagon industrial

policy. Examples should not automatically be dismissed as mere anecdotes. Sometimes, they are economically consequen-

tial in their own right, and industrial policy, an ongoingeffort

at sectoral selection and upgrading, is precisely about conse-

quential "examples." The Pentagon's early role in promoting

U.S. industrial capabilities in commercial jet aircraft is not

merely illustrative, but also economically very significant in

its own right, opening the way for the United States to seize world dominance in a critical industry. It is also the target for

venting European "truth squads" each time Boeing and the

State-Led Development 137

U.S. government bring charges that Airbus is hugely subsidized

and constitutes unfair competition according to international norms and treaties. After artful denials that Airbus is somehow

subsidized, which, of course, it was and at fabulous amounts,

the Europeans climb onto firmer ground and charge that the

Boeing 707 commercial airliner, the plane that gave Boeing

market dominance, is really the Air Force K-135 tanker with

windows. It came down the same assembly line, which was

built by U.S. Air Force money; it was shaped by the same spe-

cialty machine tools, which could fashion specialty metals into

twelve-dimensional Brancusi-like shapes and which were de-

veloped with U.S. Air Force money; it was powered by jet en-

gines also developed-at whopping costs-under air force

contracts that extended back even to the developments in met-

allurgy needed to make those engines. Boeing's commercial

jet business-the world's dominant leader until Airbus's long

climb to parity-is a spin-off from, or an application of, the

Pentagon's technology and procurement policy.

The transistor was not invented by some kids in a Silicon

Valley garage; it came out of Bell Labs, the sheltered research

laboratory of the government-regulated telephone monopoly,

AT&T, also a defense contractor. The appeal of semiconductors

instead of big, hot, forever-blowing-out vacuum tubes in the

tight cockpit of a fighter plane is obvious, once you see the tech-

nology and have it in hand. The early development of the

semiconductor into something that was a useful, reliable prod-

uct that could be produced at industrial scale was powered by

DoD procurement contracts. Even the proliferation of small,

competing semiconductor firms in what became Silicon Valley i I

: I

~ \ I

: I

138 THE END OF INFLUENCE State-Led Development 139

is in part due to DoD insistence on dual sourcing and cross-

licensing: The Pentagon was not going to count on the success,

or even the survival, of start-up firms. The breathtaking im-

provements in semiconductor performance a la Moore's Law

and the development of myriad applications, like desktops,

laptops, cell phones, appliances, automotives, machinery-

everythingl--owes little, indeed nothing, to DoD. These cas-

cading advancements were driven by the competitive structures

and energies of Silicon Valley and later, of course, by the Japan-

ese, who availed themselves handsomely of the transistor tech-

nology for which, at the technology's infancy, the U.S.

Department ofJustice forced wide licensing.

Computing followed a similar soaring trajectory. U.S. pro-

ducers-and, just as important, users-forged well ahead of

everyone else, thanks in no small measure to powerful and

very early assistance from DoD. We all learned how the first

computers-versions of EN lAC-filled enormous rooms and

required nursing staffs of dozens of people constantly running

about, replacing popped vacuum tubes. Who would buy one

of those monsters? Pretty much only Uncle Sam: the Weather

Bureau, the Census, and, of course, DoD. Defense efforts to

spur computing and to create a computer industry, or cap:rbility,

as the military conceived of it, extended way upstream; DoD

even created and supported pioneering university programs

in computer science. This was truly bold and farsighted in-

dustrial policy that paid off royally for DoD's own mission of

deploying compUting power vastly superior to that of any for-

eign rivals, and for the U.S. economy.

The Internet had a maiden name: DARPA-net. Created by

DARPA, the network was designed to deal with a problem

that the agency posed to itself: how to assure communications

if the Russkies nuked Chicago, a giant node for telephone, as well as rail lines. DARPA's solution was to create a communi-

cations network with no indispensible central nodes, the basic

architecture of the Internet. At first, the DARPA-net linked

major government laboratories such as Los Alamos and some

major research universities, such as MIT, Caltech, and Berkeley.

This was the giant beta test. It was also, for those few early

years, a uniquely great place to buy a used Volvo or a golden

retriever, and to locate a sabbatical rental or swap. The network

then grew and grew and grew at a pace and to an extent that

no one had ever imagined. A few additional innovations were

needed before it evolved into the Internet that we all know:

the browser, which was invented at the U.S. government's

Fermi lab in Illinois (no locus of entrepreneurial firms) and

then picked off by Jim Clark, a Silicon Valley entrepreneur, rechristened Mosaic, and floated on the stock market for a

fabulous return as Netscape. Similarly, the hypertext markup language-HTML, or click to link-came not out of the en-

trepreneurial sector, but from CERN, the European atomic energy laboratory located astride the French Swiss border near

the evocatively named town, Fernet- Voltaire.

The modest microwave oven, an example of much smaller

spin-offs, came out of Raytheon, a defense contractor then spe-

cializing in radar. One day, Raytheon engineers realized that

you could cook with radar. Thus was born the "radar range,"

as it was first called. Almost twenty years later, after a try at li-

censing, Raytheon went into commercial production as Amana,

with a product designed for home use. Soon thereafter, the

Japanese took dominance. This highlights one of the weaknesses

14° THE END OF INFLUENCE State-Led Development 141

I

in DoD industrial policy: It was aimed at DoD's needs, not

those of the economy. The Pentagon was necessarily aware of

broader economic possibilities, but spin-offs were the route

out of the defense economy into the commercial economy. For

development and production, DoD typically relied on its family

of contractors, mostly giant, technologically sophisticated firms

like Lockheed, General Dynamics, and Raytheon, all of whose

internal workings were geared to the Pentagon's way of doing

business: rigorous and costly testing and documentation; heavy,

lengthy, and not-very-cost-sensitive procurement procedures

and cycles; and, usually, cost-plus pricing.

On its own turf---competing with other militaries, especially

the Soviets-DoD was unbeatable, but it was not aiming at

producing products and firms that were well adapted to com-

petition in civilian markets vigorously contested by the agile.

For rockets, satellites, jet engines, aircraft, mainframes, and

supercomputing (the latter two now quaint terms), this was

not a problem. It became a problem, a serious one, in electron-

ics. By the 1980s,spin-~ff was losing the race to "spin-on" (i.e.,

sourcing from the commercial sector) in electronics, the critical

defense technology. The commercial sector innovated, embod-

ied innovation, and made it reliable much faster than did-the

defense sector; commercial entities produced at vastly greater

volumes and at far lower prices. DoD increasingly had to

source vital components of military systems-semiconductors,

lasers, flat panel displays, optical storage, etc.-from the civilian

economy. Increasingly, this meant relying on Japanese, not

American, mass producers.

In 1986, DoD went public in its Defense Sciences Board re-

port, "The Use of Commercial Components in Military Equip-

ment." The document revealed that commercial electronics

such as computers, radios, and displays were just as durable,

even in harsh environments, one to three times more advanced,

two to ten times cheaper, five times faster to acquire, and more

reliable than their military equivalents. For the foreseeable fu-

ture, the report concluded, "commercial-to-military 'spin-ons'

are likely to boom while military-to-commercial 'spin-offs'

decline," Even beyond electronics, DoD's spin-off industrial

policy was beginning to show its structural defects or, more

precisely, the commercial ironies of its successes. In the 1950s

and 1960s,DoD had sponsored the creation of very advanced,

numerically controlled machine tools for use in aircraft pro-

duction. And it got them. But, in doing so, it had also shaped the American machine tool industry. By the 1980s, the defects

of this unrivaled excellence were becoming apparent in the

steep decline of that industry in the face of foreign competition.

DoD-inspired technology was proving to be too expensive and far too complicated to operate under normal industrial condi-

tions than the simpler, cheaper machines that came out of Ja-

pan's industrial policy, which focused precisely on tools for

ordinary industrial applications, or German high-end, factory- friendly machine tools.

Like an intelligent military recognizing the limits of its

forces, DoD has ~ontinued to push ahead on the spin-on, going

so far as to establish its own venture firm in Silicon Valley to

monitor, access, and assist interesting new technologies in start-

up companies. Truly new technologies such as computing, biotechnology, or even, long ago, electric motors take consid-

erable time to move, at scale, from laboratory to market; twenty

years is rather a norm. It is possible that spin-offs from relatively

I i I ,~ I P- i ~1 ;s

I ~

il

142 THE END OF INFLUENCE

recent DoD projects will find important, driving roles in the

American economy in the near future. But the contrast between

the commercial successes of spin-offs from DoD projects of

the 1950s and 1960s and those of the 1980s and 1990s brings

American assertions that we don't do industrial policy a lot closer to God's honest truth.

SEVEN

CONC,LUSION: OTHER

COUNTRIES' MONEY

After almost a century, the United States no longer has the

money. It is gone, and it is not likely to return in the foreseeable

future. The American standard of living will decline relative

to the rest of the industrialized and industrializing world: For

the past ten years, America has been consuming more than it

produces and living beyond its means by borrowing. For Amer-

ican households, borrowing will no longer be an easy option.

The United States will lose power and influence. Its gov-

ernment will no longer be able to act the role of the unique,

multidimensional superpower that pays attention to other gov-

ernments only when it wishes. Whether this should be rued

or applauded by Americans and by other peoples is an open

question. Money is a key fact of power. When a great nation

becomes a massive debtor, it loses considerable freedom of ac-

tion, and that is a fact with consequence. The United States

will remain a world power and, perhaps, the leading nation; it

143