November 30, 2006    Volume 13, No. 21

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Council On Competitiveness Says U.S. Has Little To Fear, But Fear Itself; By Most Measures, U.S. Is Way Ahead Of Global Competitors


The United States is the most competitive nation on Earth and policymakers should not view the burgeoning trade deficit as an accurate measure of the nation's economic health, according to the Council on Competitiveness's latest "Innovation Index: Where America Stands."

"A lot of the debate and discussion today is really quite misleading and full of misperceptions of where the United States stands and how to interpret what's going on," said Harvard University professor Michael Porter, the main author of the council's index. The United States is not losing its edge in innovation, nor is particularly important for the nation to worry about the perceived loss of manufacturing. "America is better positioned than perhaps any other country to benefit from the forces that are reshaping the global economy," he writes in the introduction to the index. The number-one competitiveness challenge facing the United States today is education. "Education is perhaps the single biggest threat to future American prosperity," said Porter.

"We believe that it's very important to understand that the United States is now participating in a very radically different global competitive environment than we faced 20 or 30 years ago," said Porter. "What's important for you to understand is that the U.S. in many respects created that new environment. We led it. We drove it. American companies are by far the leaders in prospering in that environment, but that environment has dramatically raised the bar for Americans and American companies. And raising the bar is leading to stresses and strains, insecurities and the dislocation that we feel today."

The U.S. economy faces "serious issues," said Porter. "But often those issues and the implications of what we need to do are not what they first seem."

For instance, there is a sense that China is becoming a world innovation superpower. "Fact: China is virtually nowhere in terms of genuine innovation and patenting," Porter said. "Right now, China is performing relatively low-value-added manufacturing activities often in high-tech industries."

There is a sense that the United States is losing its manufacturing base. Wrong, said Porter. The United States remains the world's largest manufacturing economy. It is not losing manufacturing, it is losing manufacturing jobs, Porter told a press conference in Washington, D.C. "That is a fundamental distinction. Services are becoming much more important in the economy. We used to think of services as flipping hamburgers, now we have to think of services as rocket science. Services are where the high value is today, not in manufacturing. Manufacturing stuff per se is relatively low value. That is why it is being done in China or Thailand. It's the service functions of manufacturing that are where the high value is today, and that is what America can excel in if we have the right kind of workforce and we have the right kind of environment. We have to stop this notion [of believing] that manufacturing is [essential]. It's a real problem because it distorts our thinking. It reflects a simplistic view of the international economy and how companies compete in their overall value chain."

United States multinationals have "aggressively pursued" a new business model built on outsourcing, which has resulted in large investments overseas. But these companies sell three times more through their foreign affiliates than they export. "The old model where we exported stuff -- and that is how we engaged in the international economy -- has been shattered irrevocably," said Porter.

This new economic system of global supply chains producing in the most efficient areas is far more complex than any that has ever existed, but it has not led to the loss of jobs in the United States. Evidence proves that "internationalization is not at the expense of the U.S.," said Porter. "The global economy is not a zero-sum game. There is not a fixed pie out there that we are dividing. An R&D job [created] abroad doesn't mean an R&D job lost at home. We have to not think of the global economy in a zero-sum sense that dominates most of the accounts of globalization. If we do that, we're going to make fatal, horrendous mistakes in economic policy going forward."

U.S. multinationals are successful because they are following growth occurring in overseas markets. "GM is the leading car manufacturer in China," Porter said. "The reason GM is investing so heavily abroad is so they can be the leading car manufacturer in China, which is where the growth market is. The markets are not in the traditionally advanced world in Europe and America."

Furthermore, the trade deficit is not an accurate reflection of the competitiveness of the American economy. The trade balance of negative $800 billion "is not that big by international standards," Porter told reporters during an hour-long lecture on the latest competitiveness index. "There are many other economies in the world that run trade balances at this percentage of GDP for periods of time. It's not epic."

The trade numbers may not even be right, he said. "We are confident that we are under-measuring our exports because it's very hard to capture service exports and intellectual property," he claimed. "It was pretty easy when all you did was export goods. Now what are we exporting? Intellectual property and services. How do you count services crossing borders? The answer is you don't count them very well. So there's a deep concern that the actual measurements we use to measure the trade balance are grossly distorted and incorrect. They're not capturing most of what really matters in international economic flows."

Nor are the trade measures capturing the hundreds of billions of dollars per year American companies are making in profits from their foreign subsidiaries, Porter pointed out. "Hundreds of billions per year. How does that show up in the current accounts? The answer is not very clearly. So how we measure whether we have a current account deficit has been complicated well beyond our capacity to understand these complicated issues."

Nonetheless, the United States cannot sit idly by as it suffers from a "massive theft" of intellectual property, said Porter. "In copyrights alone, the best estimates are around $20 billion a year. That's got to be too low and there are many more kinds of IP besides copyrights. The problem we have in the U.S. is the stuff we sell, others are not paying for."

The United States needs to "call a spade a spade and take a more forceful role in making sure the international system is fair to us because we're more exposed to it and more open to it and we have to work harder to enhance the economic prospects of other nations," Porter said.

Globalization has inflicted Americans with a tremendous sense of unease, Porter noted. "Today, there is a sense that Americans are struggling, but if you actually look at the data, Americans have prospered over the last 20 years remarkably compared to most countries." (Though there is no measure in the index of Americans' indebtedness over that period.)

The sense of growing insecurity is the "consequence of the new competitive environment" that has been created by the success of American companies adopting the new global supply model. That insecurity also has been created by growing wage inequality. "Inequality has clearly gone up, but what you must understand is that it has gone up pretty much everywhere," said Porter. "This is not a unique American phenomena. It's not due to unique American policies. It's not particularly due to tax changes. It's happening in all advanced economies in the world and it's happening because the bar is rising. It means those who have education and skill do better and prosper more. Those who don't are struggling more and more and more, even if they happen to be in America."

Inequality is overwhelmingly affected by educational achievement and this "is getting more and more true every day," said Porter. "We have to face the fact that it is the underlying issue we have to address. The least skilled are the most vulnerable to the new global economy and therefore need the most help and support. Educational access is crucial. Access to college is crucial. Help in financing college is crucial and the success of our education system is crucial. All of those are areas where we are falling down."

The United States remains the wealthiest country in the world. Japan got as close as 85 percent of U.S. per capita income in 1991, but it has fallen back to 72 percent. Europe has gotten less prosperous compared to the United States, due to the extraordinary performance of the productivity of the American economy. Seventy million Americans have 401k plans, which have grown in value from $500 billion in 1996 to $2.5 trillion in 2005, a five-fold increase during a period when incomes have gone up by only 30 to 40 percent. "So wealth has increased faster than income," Porter noted.

Jobs have been plentiful. The United States has one of the lowest unemployment rates in the world and it has trended downward over the past 20 years. "Compared to other countries, we look really quite amazing," said Porter. The problem is not jobs, but the skills workers have for better jobs, he added.

Churn in the American job market is another reason for growing insecurity. The United States created 31 million jobs last year, but destroyed 29 million. "This is very uncomfortable," said Porter. "This is very unsettling. The chances are if you lose a job in the United States, you'll get another job within 12 months. The odds are very high -- almost everybody does it, but this process leads to insecurity, particularly with the health benefits issue, it creates even greater insecurity."

But the dynamism in the job market and the flexibility of America's labor pool is what constitutes America's great success as an economy. "Can we stop this?" Porter asked. "Probably not. Do we want to stop this? Probably not. But we have to create a system in this country and a set of rules and institutions that allow all of us to compete successfully with this reality."

Economic growth in the country has been "remarkable" over the past 20 years -- an average annual rate of 3.1 percent. The United States has grown faster than any advanced economy in the world -- "despite our extraordinary high per capita income," Porter explained. "This is nothing short of astounding."

This growth has been driven by improved productivity, rapid adoption of information technology, outsourcing that has led to a more efficient way of organizing production, innovation, high skill levels and a thriving level of entrepreneurship. Over the past 20 years, the United States has accounted for one-third of all growth in the global economy.

"Now that has led to some imbalances for which we are paying the price and is creating some concern," Porter said. "This is unhealthy. The U.S. should not be driving one-third of global economic growth. We should have other countries like Japan, China and India driving global economic growth. That would be a much better thing for the U.S. economy and the world economy."

The United States is by far the most popular place in the world for foreign investment. "Inbound FDI is twice as high as anywhere else, and six times as high as in China," said Porter. "That is because we have such an extraordinary favorable productivity business environment. Everyone wants to be here to do business and to do R&D."

The United States remains an innovation powerhouse. It is not losing its lead in R&D, despite the widespread perception that it is, Porter said. U.S. companies are offshoring R&D, "but guess what? There's more foreign R&D operations coming to the U.S. than U.S. operations offshoring to other countries," Porter told reporters. The ratio of R&D taking place in the United States relative to the amount of R&D overseas has stayed roughly the same. "U.S. companies are growing their U.S. R&D just as much as they're growing their offshore R&D. So isn't the impression we have wrong if we simply read the press accounts every day?"

The global share of R&D being conducted in the United States has gone down, but "do we think that is a problem?" Porter asked. "No. It's astounding if it wouldn't have taken place. It's a good thing for other countries in the world to do R&D and have scientists. Again, the global economy is not a zero-sum game; it's a positive-sum game. If everybody can improve their productivity, everybody can get more prosperous."

The growing number of scientists and engineers in China and India is also a misleading indicator of America's flagging competitiveness, said Porter. "When you look at the sheer numbers of scientists and engineers in India and China, you have to be very, very careful," he said. "Careful studies show that many Chinese engineers don't have the capability [to] work in world-class companies in a multinational setting." Only 10 percent of Chinese engineers have the skills suitable to work for a multinational enterprise. Most of the R&D being done by U.S. multinationals in these overseas markets is "focused on market access -- how do you facilitate market access in China to adjust products and improve their features and translate software into the local language," said Porter. "Basically that's its thrust."

The U.S. share of global patents has dropped by only 2 percentage points from 54 to 52 percent. U.S. universities account for 17 of the world's top 20 research universities worldwide, with only Cambridge (second place), Oxford (10th) and Tokyo University (19th) making the list.

Poverty is down dramatically over the past 20 years, but the country has hit a plateau and is "now facing headwinds," said Porter. "The global economy has raised the bar, raised the skill level, raised the standard to participate in the economy, and therefore future gains in poverty reduction are going to be a bit harder."

The American economy faces four primary challenges: education, energy, health care and legal costs. The U.S. tort laws are "a disadvantage" particularly to small- and medium-sized companies, Porter said. The tort system "is broken and we need to change it." Health care also needs to be restructured. The country has to get serious about improving energy efficiency. But education remains the number-one weakness of the U.S. economic system, Porter claimed.

"My view is we have to make structural changes, we can't just tinker here." If this is the case, then what is Harvard doing to restructure itself, Mfg. & Tech. News asked Porter. "The university system in America is not the problem, it's K-12," he responded. "That's not to say that the Georgia Techs, Harvards and Yales can't do better. But by and large, many universities are investing aggressively today and changing the way they do business, including Harvard."

When asked if the Council On Competitiveness is a mouthpiece for the multinationals, given that there is paltry representation on its board from small- and medium-sized domestic manufacturers and labor leaders involved in manufacturing industries, Council President Deborah Wince-Smith said: "Absolutely not. I am very proud that I have revitalized the relationship we have with labor. We have a very, very dynamic vice chairman, Doug McCarron, the head of the United Brotherhood of Carpenters and Joiners. If you go to his training facility in Las Vegas, it's the most advanced in the world. This is a union that is building big manufacturing plants, big hotels -- highly skilled. Ed McElroy, the new head of the American Federation of Teachers, is very much engaged with us and is going to be working very hard on how to deal with the challenges of pay for performance for teachers."

Porter was also asked how it is good for U.S. competitiveness for there to be 120 major chemical plants being built worldwide but only one being built in the United States -- and for there to be 28 major semiconductor fabs being built in China and only two in the United States. Porter's answer: "A lot of those fabs and chemical plants are probably located in those locations because that is an efficient way to serve international markets as opposed to exporting stuff from the United States and that is why we're seeing a lot of localization of activity."

Porter said he is a "supervisor" on the board of Taiwan Semiconductor Manufacturing Co., the largest chip foundry in the world with 14 fabs. "The Taiwanese investor in fabs is not convinced they can find the talent pool in the United States to compete with Taiwan for those investments," he said. "The hard cold truth is we have to deliver value if we're going to attract investments. What would be unfortunate is that some of those investments go offshore not because of efficiency or productivity but because of some artificial regulatory or other barriers that are driving them outside the U.S. unnecessarily. The answer to a question like that is we have to see it in a textured way. We have to see it in the context of this international global competitive environment. Most of these things raise issues, but they raise issues that are very specific and very focused and very actual."

The latest Competitiveness Index was funded by the Department of Commerce's Economic Development Administration, foundation support and the Council on Competitiveness's National Innovation Initiative Leadership Council. A copy of the 102-page document is available at

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