We are forever rediscovering old economic truths. Consider the case of Michael Porter, a respected observer of corporations who teaches at the Harvard Business School. He undertook a huge study of 10 nations to determine the secrets of economic success. The result is a book called "The Competitive Advantage of Nations." And so, what creates national advantage? Porter's answer is essentially the same as Adam Smith's: competition.
You should skip Porter's book if you think Japan's export prowess stems mainly from a shrewd alliance between industry and government. Far more important, as he shows, is the ferocious rivalry among Japanese firms in their home market. In 1987 there were nine major Japanese auto companies, 14 suppliers of copiers and 15 of cameras. These companies constantly brawl to increase sales in Japan. The pressures to lower costs, increase quality and introduce new products translate into export success.
Contrast that with the situation in the United States. Until the late 1970s, the Big Three auto makers dominated the industry. Xerox owned the copier market. Caterpillar reigned in construction equipment. Lax competition and the conceit of longstanding success bred complacency. Naturally, these companies became vulnerable to imports.
Competition obviously isn't everything. There are other determinants of nations' economic well-being: workers' skills and motivation, technology, natural resources and management quality. But these strengths can be improved -- or squandered -- by the state of competition. Paradoxically, Japan again makes the point. Despite superb export industries and a highly educated work force, the Japanese have only about 75 percent of the purchasing power of Americans. The reason: large parts of Japan's economy (farmers, retail stores, some industries) are sheltered from competition and therefore turn out relatively costly products.
Effective competition means more than having lots of small firms trying to destroy one another. Small firms make sense in some industries. But in other industries, only big corporations can generate the huge sums necessary for large-scale production, risky research and global distribution. Genuine competition also consists of more than direct combat between similar companies. Porter argues that two other elements are essential: demanding buyers and sophisticated suppliers (this refers to suppliers of machinery, components, raw materials and business services).
Everyone pushes everyone else. Buyers want better products with new features. Companies insist that suppliers help them cut costs. Suppliers strive to have customers do things differently. "Industries and firms prosper because they're forced to," says Porter. Adversity often spawns success. In postwar Italy, steel companies lacked raw materials, faced high energy costs and had little investment capital. So they pioneered mini-mills, which use scrap steel as a feedstock, consume less energy and require lower investment than larger mills.
These market pressures create clusters of closely connected industries that constantly drive innovation and gains in efficiency. The United States has this sort of cluster in computers, software and telecommunications; Japan has it in consumer electronics and electronic components; Italy has it in ceramic tiles and related machinery; Germany has it in printing presses and paper machines. The ultimate payoff is higher national living standards: companies -- and their workers -- develop the skills to create better products and services at lower cost.
The great virtue of the competitive caldron is that it compels companies (and, by extension, entire societies) to renew themselves repeatedly. Communist economies are now being abandoned because they can't accomplish this feat. But the process can't be controlled, precisely because it depends on so many different parts of the system affecting each other in endlessly complicated and ever-changing ways. There are no magic wands.
Claims to the contrary are often self-serving pleas for government handouts. Corporate America, for example, always wants new investment-tax incentives. It argues that the "cost of capital" is too high and that the resulting low investment hurts living standards. In fact, business investment has been rising. In the 1980s it was 12 percent of gross national product compared with 11.1 percent in the 1970s, 10.3 percent in the 1960s and 9.9 percent in the 1950s (measured in inflation-adjusted dollars).
When industries falter, the problem is usually the "waste of capital" -- bad or poorly managed investments. A new study by economists Richard Caves of Harvard and David Barton of the Commerce Department finds (once again) that corporate diversification hurts efficiency. Porter correctly complains that relations between U.S. companies and their suppliers are too often hostile. "Skill transfer and sharing of market insights take place only sporadically," he writes. The troubles of two major U.S. supplier industries -- machine tools and semiconductor process equipment -- are partly explained by poor relations with major customers (auto makers and chip makers).
The United States is a competitive society, and policies that spur competition work. The deregulation of the trucking and railroad industries created annual benefits of $20 billion, reports a new study from the Brookings Institution. The Caves-Barton study concludes that competition from imports improves the efficiency of U.S. companies. That's the good news. The bad news is that two underlying trends threaten our well-being. The first is the erosion in educational standards and performance. Companies can't be better than their workers.
The other problem is the cannibalistic nature of modern America. We are such a wealthy society that our competitive juices -- the urge to get ahead -- are often dissipated in struggles to protect or win some of the existing wealth. The results are costly litigation, widespread financial speculation, everyday (and legal) tax evasion and lobbying to gain government favors. We are so busy fighting over what we have that we may undermine our capacity to make more.