Real World Economics
When he talks to most CEOs, Harvard Business School professor Michael Porter's hourly rate runs into five figures. But when the chief executive is the president-elect, he waives his fee. And at the economic conference in Little Rock, Bill Clinton got what he paid for.
Porter gave him data that were out of date and conclusions that were out of touch. And Porter wasn't alone. When they look at the international economy; too many of Clinton's advisers neglect new information, overlook new trends, and ignore uncomfortable realities.
Take the Porter fallacy. On "the firing line of international competition," Porter declared, "success depends on relentless investment by companies." He showed graphs to illustrate that "American industry as a whole is simply being outinvested—dramatically." The data were from 1990. That year, U.S. companies spent $524 billion on physical capital, while Japanese companies spent $586 billion.
But a lot has happened in the intervening two years. Japan's bubble has burst. The stock-market boom that made capital look free to Japanese companies has ended in a crash, leaving them scrambling to cover debt that bondholders are no longer interested in converting to stock.
And not all those investments are turning out well. When the cost of capital is zero, you don't scrutinize projects very carefully. And contrary to the apparent Clinton philosophy, investing "relentlessly" without regard to the payoff is foolish.
"Examples of wasteful Japanese investment range from fancy new headquarters buildings and brand-new laboratories without the qualified staff to fill them to spending on every sort of staff amenity—shiny new corporate dormitories for employees, swimming pools, saunas, and so forth," writes Christopher Wood in his new book The Bubble Economy. And, reports The Wall Street Journal, Nissan and Mazda both have expensive new plants that are running "well below capacity."
Now Japanese companies are cutting capital spending substantially. And they are undergoing wrenching restructurings. They can no longer afford to build market share for its own sake, or to follow competitors into every market rather than find strategic niches, or to assume that demand will expand to absorb any new production. The simple-minded philosophy that McKinsey & Co. consultant Kenichi Ohmae criticizes as "do more better" has become too expensive to sustain.
But nobody has told Bill Clinton. His advisers aren't paying attention.
And despite their vaunted interest in productivity, they're also ignoring fascinating new data on exactly that subject. In October, McKinsey Global Institute released a massive international study of service-sector productivity, vetted by such Clinton supporters as Nobel economist Robert Solow and Martin Baily of the University of Maryland. The study also reports new data on manufacturing productivity gathered by economists at the University of Groningen in the Netherlands. Among the report's results:
• Manufacturing productivity in Japan and Germany is about 80 percent of that in the United States. From 1950 to 1979, productivity in those countries grew much faster than in the United States. But from 1979 to 1989 (the most recent year for which data were available), West German productivity grew by a mere 1.1 percent a year while U.S. productivity growth accelerated to 3.5 percent a year (compared to only 0.9 percent from 1973 to '79), approaching the Japanese rate of 4.6 percent.
• Productivity in four service sectors—airlines, telecommunications, retailing, and retail banking—is higher in the United States than in Germany, France, the United Kingdom, or Japan. Restaurant productivity is higher only in France. And the major reason for higher U.S. productivity is the greater competition and flexibility permitted by less government regulation.
This information didn't make it to Little Rock. Nor did anyone tell Clinton that the U.S. semiconductor industry is flourishing; that Japan has school choice and little preschool training; or that the major reasons Japan spends so much more on infrastructure than the United States are that land is much more expensive, construction is much less efficient, and politicians are funneling pork to rural districts to build roads, bridges, and bullet-train lines to nowhere.
Nobody told Clinton that income inequality is increasing worldwide—before taxes and even within professions. This phenomenon is of great interest to serious scholars and may have profound social consequences. But analyzing it carefully detracts from bashing "trickle-down."
International comparisons can be valuable analytical tools, whether for executives looking for more effective business practices or scholars seeking to understand the mysteries of economic life. But such analysis can easily fall into error, usually by mistaking correlation for causality.
Not so long ago, many Americans believed the key to Japanese business success was the loyalty created by lifetime employment and daily calisthenics; the company song made an appearance in every "what we can learn from Japan" article. More recent analysis points instead to techniques of quality manufacturing and also notes that not all Japanese companies do well. Toyota and Ford have more in common, for instance, than Toyota and Isuzu. And Japan's white-collar workplaces have more to learn from American business than vice versa.
When business people draw the wrong conclusions from international comparisons, they lose money. When scholars do, they lose academic reputation. In both cases, they bear the burden of their mistakes.
Policy makers can also learn from the international scene. But they, too, will make mistakes—no matter how smart or careful or well-meaning they are. And their mistakes will have far greater consequences, because they are playing with other people's money and other people's lives and because a mistake, once written into law, is hard to correct.
The interventionist ideologues who populate the Clinton administration don't understand their own limitations. In their common conviction that the government must direct the economic choices of the nation, deciding where and how much to invest, they are substituting their monolithic decision making for the experimentation of thousands of businesses. By doing so, they are increasing both the risk and the cost of error. And, judging from the Little Rock conference, there will be errors aplenty.