U.S. AND WORLD ECONOMY
Forbes, December 15, 1986
Never mind if the U.S. loses its manufacturing skills; we’ll just import manufactured goods and pay for them by exporting high technology and knowledge-oriented products. Steel in, software out. Autos in, microchips out.
That’s a comforting theory held by a lot of people. Is it workable? Increasingly it looks as if it is not workable. The whole concept is being seriously undermined as U.S. innovations in technology are adopted not only by Japan but also by such fast-developing countries as South Korea, Brazil, Taiwan, even India.
While these countries are more than happy to sell us manufactured goods, they closely control their own imports of technology goods they buy from us. Exports of computers and other high-technology products from the U.S. are still huge, but the long-term prospects are in question. In areas of medium technology, minicomputers in particular, developing countries are adapting or stealing U.S. technology or licensing it cheaply to manufacture on their own. Many of the resulting products are flooding right back into the U.S.
The Japanese developed this policy to a fine art: Protect your home market and then, as casts decline with volume, manufacture for export at small marginal cost. A good many developing countries have adopted the Japanese technique.
Against such deliberate manipulation of markets, what avails such a puny weapon as currency devaluation? Whether the-dollar is cheap or dear is almost irrelevant. Free trade is something we all believe in until it clashes with what we regard as vital national economic interests.
These are the broad trends. Now meet Touma Makdassi Elias, 41, an engineer born in Aleppo, Syria. Elms has a master’s degree in computer science from San Jose State, in Silicon Valley, and a doctorate from the Cranfielt Institute of Technology in England. Grounded in European and U.S. technology, Elias is now a Brazilian.
His company, Microtec, is Brazil’s first and biggest producer of personal computers. Elias came to São Paulo eight years ago to teach night classes in engineering. In 1982 the Brazilian government banned imparts of small computers. Seizing the opportunity, Elias started making the machines in the basement of a supermarket in the industrial suburb of Diadema.
Technology? "We worked from IBM technical manuals," Elias told Forbes. "We had a product on the market by 1983. We started making 20 machines a month. Soon we’ll be making 2,400. Now my brother may be joining our firm. He’s a graduate of the Sloan School of Management at MIT. He’s been managing an investment company in Dubai, in the Persian Gulf, but we need him here. Brazil is one of the world’s fastest-growing computer markets."
There you have it in a nutshell: foreigners, some of them U.S.-educated, copying — stealing, to be blunt —U.S. technology and reproducing it with protection from their own governments. An isolated development! No, this is the rule, not the exception, in much of the world. How, under such circumstances, can the U.S. expect to reap the fruits of its own science and technology?
Time was when technology spread slowly. Communications were sluggish and nations went to great lengths to keep technological innovations secret. In northern Italy 300 years ago, stealing or disclosing the secrets of silk-spinning machinery was a crime punishable by death. The machines were reproduced in England by John Lombe only after he spent two years at risky industrial espionage in Italy. At the height of the Industrial Revolution, Britain protected its own supremacy in tattle manufacture through laws banning both exports of machines and emigration of men who knew how to build and run them.
These embargoes on the export of technology were eventually breached. France sent industrial spies to England and paid huge sums to get British mechanics to emigrate. By 1825 there were some 2,000 British technicians on the European continent, building machines and training a new generation of technicians. A young British apprentice, Samuel Slater, memorized the design of the spinning frame and migrated to the U.S. in 1789, later establishing a textile factory in Pawtucket, R.I. So, in the end, the technology became commonplace, but it took decades, and, in the meantime, England was profiting handsomely from its pioneering.
Not so today, when 30% of the students at MIT are foreigners, many destined to return to their native lands and apply what they learn of U.S. technology. What once was forbidden, today is encouraged. Come share our knowledge.
Consider the case of Lisiong Shu Lee, born in Canton, China in 1949, raised in Rio de Janeiro, now product planning manager for SID Informatica, one of Brazil’s big three computer companies. Like many leading Brazilian computer technicians, Lee is an engineering graduate of the Brazilian air force’s prestigious Aerospace Technical Institute near São Paulo. Born in China, raised in Brazil, educated in the US. "When I was only 24," Lee says, "I was sent to the U.S. to debug and officially approve the software for the Landsat satellite surveys devised by Bendix Aerospace." Lee later worked eight years with Digital Equipment’s Brazilian subsidiary.
Like Microtec’s Elias, Lee had learned most of what he knew from the Americans. In teaching this pair — and tens of thousands like them — U.S. industry and the U.S. academies created potential competitors who knew most of what the Americans had painfully and expensively learned. Theft? No. Technology transfer? Yes.
In Brazil over the past few years, the Syrian-born, U.S.-educated Bliss played cat-and-mouse with lawyers representing IBM and Microsoft over complaints that Microtec and other Brazilian personal computer makers have been plagiarizing IBM’s BIOS microcode and Microsoft’s MS-DOS operational software used in the IBM PC. The case was settled out of court. Brazilian manufacturers claimed their products are different enough from the original to withstand accusations of copyright theft.
Where theft and copying are not directly involved in the process of technology transfer, developing countries find ways to get U.S. technology on terms that suit them. They get it cheaply. Before President José Sarney departed for his September visit to Washington, the Brazilian government tried to ease diplomatic tensions by announcing approval of IBM’s plans to expand the product line of its assembly/test plant near São Paulo. IBM will invest $70 million to develop Brazilian capacity for producing the 5-gigabyte 3380 head disk assembly (HDA).
Ah, but there is a tradeoff involved in the seeming concession by the Brazilians. The tradeoff is that IBM’s expansion will greatly improve the technical capabilities of local parts suppliers to make a wider range of more sophisticated products. About a third of the key components in IBM’s HDA catalog will be imported, but Brazilian suppliers will get help in providing the rest, some involving fairly advanced technologies.
But does what happens in Brazil matter all that much? Brazil, after all, is a relatively poor country and accounts for a mere $3 billion in the U.S. $160 billion negative trade balance. Brazil matters very much. For one thing, what happens there happens in similar ways in other developing countries — and some developed ones as well. Brazil, moreover, is fast adapting to the computer age. The Brazilian computer industry employs over 100,000 people. It includes everything from the gay market of São Paulo’s Boca de Lixo district to the highly profitable overseas subsidiaries of IBM and Unisys. Both subsidiaries have been operating in Brazil for more than six decades and, for the time being, have been profiting from Brazil’s closed-market policies. It includes many manufacturer/assemblers of micro - and minicomputers and of peripherals. Companies also are appearing that supply such parts as step motors for printers and disk drives, encoders, multi-layer circuit boards, high-resolution monitors, plotters and digitizers. The Brazilian market is bristling with new computer publications: two weekly newspapers, ten magazines and special sections of daily newspapers.
Brazil is only a few years into die computer age. Its per capita consumption of microchips works out to only about $1.40 per capita among its 140 million inhabitants, vs. $100 in Japan, $43 in the U.S. and about $6 in South Korea. But given the potential size of die market and Brazil’s rapid industrialization, it could e day absorb more personal computers than France or West Germany.
The point is simply this: In their natural zeal to make Brazil a modern nation rather than a drawer of water and hewer of wood, its leaders are determined to develop high-technology industry, whether they must beg, borrow or steal the means. Failing to develop high-technology industry would be to court disaster in a country where millions go hungry. But in doing what they must, the leaders of Brazil and other developing countries run strongly counter to the economic interests of the U.S.
Because of these nationalistic policies, foreign-owned firms are banned from competing in Brazil’s personal computer and minicomputer market. Brazil’s computer industry is not high tech, if that means being near the cutting edge of worldwide technological advance. But it does show the ability of Brazilian businessmen and technicians to shop for and absorb standard technology, without paying development costs. In computers, where knowledge is the most expensive component, it becomes cheap to manufacture if you get the knowledge free or almost free. The U.S. develops, Brazil copies and applies. There are perhaps a dozen Brazils today:
"We’re a late entry and can pick the best technology," says Ronald Leal, 36, co-owner of Comicro, a CAD/CAM equipment and consulting firm. "We don’t waste money on things that don’t work. In 1983 we saw a market here for CAD/CAM done with microcomputers. We shopped around the States and made a deal with T&W Systems, a $10 million California company that has 18% of the U.S. micro CAD/CAM market. T&W helped us a lot. We sent people to train and they came to teach us."
Comicro learned fast. Says teal: "We developed new software applications that we’re now exporting to T&W."
Brazil exporting computer designs to the U.S.? Only five years after IBM began creating a mass market for the personal computer, the U.S. home market is being invaded by foreign products — of which Comicro’s are only a tiny part. Technological secrets scarcely exist today.
Aren’t the Brazilians and the others simply doing what the U.S. did a century and a half ago — protecting its infant industries?
If that were all, the situation might not be so serious for the U.S. But pick up any U.S. newspaper these days and count the advertisements for Asian-made personal computers claiming to be the equivalent of the IBM PC but selling at maybe two-thirds of IBM’s price.
According to Dataquest, a market research firm, Asian suppliers will produce nearly 4.5 million personal computers this year. At that rate, they should capture one-third of the world market by next year. Taiwan now is exporting 60,000 personal computer motherboards and systems monthly, 90% of which are IBM-compatible. Of these, 70% go to the U.S. and most of the rest to Europe. Korea, Hong Kong and Singapore together ship another 20,000 each month.
Dataquest says it takes only three weeks after a new U.S. - made product is introduced before it is copied, manufactured and shipped back to the U.S. from Asia.
Thus the U.S. bears the development costs while foreigners try to cream off the market before the development costs can be recouped. That is the big danger. The days when a person could be executed for industrial espionage are gone.
President Reagan recently warned that the U.S. is being victimized by the international theft of American creativity. Too many countries turn a blind eye when their citizens violate patent and copyright laws. In 1985-86 U.S. diplomats successfully pressured Korea, Singapore, Malaysia, Taiwan, Hong Kong and Thailand to pass or at least to draft legislation enforcing patents and copyrights more strictly. Brazil is a major holdout.
The difficulties between Brazil and the U.S. over computers crystallized in the 1984 Informatica law, which Brazil’s Congress passed overwhelmingly near the end of two decades of military rule. The law, in effect, legalizes stealing — so long as the victims are U.S. technology exporters. Complains the head of a leading multinational whose business has been curtailed under the new law: "They want our technology but want to kill our operations. This whole show is sponsored by a handful of sharp businessmen with connections in Brasilia who are making piles of money from their nationalism."
The new law formally reserved the Brazilian micro - and minicomputer market for wholly owned Brazilian firms. It allowed wholly owned subsidiaries of foreign companies — IBM and Unisys — to continue importing, assembling and selling mainframes, but not out of any sense of fairness. It was simply that Brazilian companies were unable to take over that end of the business.
Under the law, joint ventures with foreign firms were allowed only if Brazilians owned 70% of the stock and had "technological control" and "decision control."
The main instruments for implementing this policy were tax incentives and licensing of imports of foreign hardware and knowhow, all to be approved by the secretariat of information science (SEI).
In 1981 Brazil’s then-military government decreed that SEI would control the computer and semiconductor industries and imports of any and all equipment containing chips. The implications are especially ominous for U.S. interests: Brazil’s SEI is modeled, quite openly, on Japan’s notorious Ministry of International Trade & Industry (MITI). Brazil’s computer policy today follows the line of a mid-Fifties report by M1TI’s Research Committee on the Computer.
In the 1950s and l960s MITI used Japan’s tight foreign exchange controls to ward off what its nationalist superbureaucrat of the day, Shigenx Sahashi, called "the invasion of American capital." In long and bitter negotiations in the late Fifties, Sahashi told IBM executives: "We will take every measure to obstruct the success of your business unless you license IBM patents to Japanese firms and charge them no more than 5% royalty." In the end IBM agreed to sell its patents and accept MITI’s administrative guidance on how many computers it could market in Japan. How many Japanese products would be sold in the U.S. today if this country had imposed similar demands on the Japanese?
Some U.S. economists are describing the result of the Japanese policy as the "home market effect." They mean that protectionism in the home market tends to create an export capability at low marginal cost.
"Home market protection by one country sharply raises its firms’ market share abroad," says MITI’s Paul Krugman, reporting the results of computer simulations of international competition in high technology. "Perhaps even more surprising, this export success is not purchased at the expense of domestic consumers. Home market protection lowers the price at home while raising it abroad."
Brazil surely has similar intentions. IBM and other U.S. computer companies are transferring technology to Brazil as never before.
The Brazilians may have gasped a reality that the U.S. has been unable politically to address: that while there is no way to cheek the fast dissemination of technology today, the real prize in the world economy is a large and viable national market — a market big enough to support economies of scale and economies of specialization. In short, while a country can no longer protect its technology effectively, it can still put a price on access to its market. As owner of the world’s largest and most versatile market, the U.S. has unused power.
Taiwan. Korea, Hong Kong and Singapore, lacking large internal markets, could develop only because they had easy and cheap access to the rich U.S. market.
Why doesn’t the U.S. reciprocate? The Reagan Administration has threatened to restrict imports of Brazilian exports to the U.S. by Dec. 31 if Brazil doesn’t 1) protect software with new copyright legislation, 2) allow more joint ventures with foreign firms, and 3) publish explicit rules curtailing SEI’s arbitrary behavior.
But the Brazilians are hardly trembling in their boots. Brazilian officials hint that if Brazilian exports to the U.S. are curbed, Brazil won’t be able to earn enough dollars to service its crushing external debt. Diplomats of both countries want to avoids showdown, so they keep talking. And while they talk, the Brazilians do what they please.
U.S. Customs has responded to manufacturers’ complaints by stopping pirated products at the border. But the Taiwanese now have such cost advantages that they can easily afford to license technology that they have already copied. The Koreans are more scrupulous, but pirated technology not reexported to the U.S. is very hard to control.
More than three years ago Edson de Castro, president of Data General, told a Commerce Department panel that foreign nations’ computer policies "threaten the structure and future of the U.S. computer industry." De Castro explained why: "U.S. computer companies are reliant on international business and derive a substantial portion of revenues from exports. Because of the rapid pace of technological development, the industry is capital intensive. Growth and development rely heavily on an expanding revenue base. This can only come from full participation in established and developing global markets. Reliance upon domestic markets is not enough."
Yet after resisting the Brazilian government’s demands for a decade, de Castro’s Data General is selling technology for its Eclipse supermini to Cobra, the ailing government computer company. Other U.S. computer manufacturers are following suit.
Hewlett-Packard, in Brazil since 1967 with a wholly owned subsidiary to import and service the company’s products, has just shifted its business into partnership with Iochpe, a Brazilian industrial and finance group. A new firm, Tesis, 100% Brazilian-owned, will make HP calculators and minicomputers under its own brand name.
"Only a few years ago HP refused to enter joint ventures, but now we have ones going in Mexico, China, Brazil and Korea," says a company executive. "In the past we felt, since we owned the technology, why share the profits? Then we found we couldn’t get into those foreign markets any other way."
Harvard Professor Emeritus Raymond Vernon, a veteran analyst of international business, says of world technology markets: "Except for highly monopolistic situations, the buyer has a big advantage over the seller. Countries like Brazil and India can control the flow of technology across their borders and then systematically gain by buying technology cheaply."
Vernon draws an ominous parallel: "A century ago the multinationals were in plantation agriculture and electric power. Now they’re all gone because their technology and management skills were absorbed by local peoples. The same thing is happening in other fields today, including computers."
This is why it makes little difference whether the dollar is cheap or dear. In this mighty clash between nationalism and free trade, nationalism seems to be winning. Where does this leave the U.S. dream of becoming high-technology supplier to the world? Rudely shattered.