RESEARCH & IDEAS

US Competitiveness at RiskPublished: September 20, 2012

America's declining globalcompetitiveness—it ranks No. 7 this year in onerespected survey—began long before thecurrent recession took hold. Harvard BusinessSchool Professors Michael E. Porter and JanW. Rivkin discuss causes and possible solutions.From Harvard magazine.

Editor's note: When did America'sdeclining global competitiveness begin? Onestarting spot might be 2008, the last year thecountry topped the World Economic Forum'slist of most globally competitive nations. Fouryears later, the US has fallen to No. 7—TheNetherlands and Germany moved ahead on thetop 10 leaderboard this year.

But the fact is, America has been slippingsince the year 2000, long before the housingbubble burst and recession swept the country,say Harvard Business School ProfessorsMichael E. Porter and Jan W. Rivkin. Theydetail the reasons for this failure—and whatcan be done to fix it—in the following interview,first published in Harvard magazine's CanAmerica Compete? report.

"That great American jobmachine started sputteringaround 2000"Porter and Rivkin lead the School's U.S.

Competitiveness Project, which collectsexpertise and research from HBS colleaguesand from other institutions with the goal ofcreating strategies to reignite America'seconomic future in the global economy.

Porter is the Lawrence UniversityProfessor, and Rivkin the Rauner professor ofbusiness administration and head of HBS'sstrategy unit.

Harvard Magazine: What prompted youto begin this inquiry?

Michael Porter: There was a clear feelingat Harvard Business School that somethingdifferent was happening in the USeconomy—this was not just a deep recessioncaused by the housing mortgage crisis and soforth. The recession is very real, but somethingmore was going on. This project was born fromthat feeling, and the belief that the school couldconvene and analyze and understand in wayswe had not taken full advantage of.

As Jan and I started looking at the data, awhole set of indicators validated disturbingtrends that began well before the GreatRecession.

Most obvious and most important is thejob-creation machine. For decades, America hasbeen unique among large advanced countries ingenerating large numbers of jobs steadily overtime: roughly 2 percent job growth per year [ona rolling 10-year basis that smooths outshort-term factors]. That great American jobmachine started sputtering around 2000. There'ssomething structural here, because it startedbefore the recent downturn. Moreover, we andothers discovered that virtually all the net newjobs created over the last decade were in localbusinesses—government, healthcare,retailing—not exposed to internationalcompetition. That was a sign that the US wasnot doing well in businesses that have tocompete internationally.

The data also showed what many hadknown—that wages started stagnating well overa decade ago. The participation of Americans inthe workforce peaked in 1997, and workforceparticipation is critical to prosperity because themore people who work as a proportion of thetotal working-age population, the higher percapita income will be whatever the wage level.All of this is threatening the American dream,the idea that each generation will be better offthan the previous one.The question was, "Why did this happen?"What were the causes of the problems, and whatcould leaders do about them?

Jan Rivkin: By many current measures,America looks all right today: we have anenormously productive economy, high wages inabsolute terms in many parts of the economy, alarge share of exports and foreign directinvestment [FDI]. But when you look at thetrajectory over time—job growth rates, wagegrowth rates, changes in export or FDI share,particularly compared to emergingeconomies—the country looks much weaker.We should have been worried before the GreatRecession.

Q: In the 1980s, Americans wereconcerned about the competitive challengefrom Japan. Are current challengesdifferent?

JR: Today, we've got a far more diverse setof global competitors with capabilities that spanthe full set of reasons that customers buy and

companies relocate. We've got a USgovernment that lacks the latitude to move thatit had in the 1980s: large government debts andobligations facing the US now threaten tocrowd out the investments in infrastructure,innovation, and individuals that we need tosustain long-run productivity growth.

MP: And business has become substantiallymore global. The typical US-basedmultinational corporation has a much higherpercentage of its total activity outside the UStoday. Early in our work, we'd talk to businessexecutives and they would say, "I can't justworry about America, I run a global company,we're not an American company anymore." Thenotion in business that this is our country andwe own its challenges has diminished.

We believe that that corporate perception isill-advised. It may be true that more of acompany's activity is global, but that doesn'tdiminish the importance of US vitality to itsvitality. The first reaction to globalization wasoften, "It's wonderful that we can relocateanywhere. If we have a skill shortage here inAmerica, we can just go somewhere else. If wecan get a better tax deal there, we'll go there."But that thinking is changing. One of theoptimistic findings of this project is theenormous readiness of many in the businesscommunity to roll up their sleeves and do thingsin their communities and companies to makeAmerica more competitive.

JR: An important notion is what we call the"business commons" from which companiesdraw: a skilled workforce, an educatedpopulace, vibrant local suppliers, basic rule oflaw, and so on. Historically, Americanbusinesses invested in these resources deeply,and that helped to build many of America'sstrengths.

Then, in a world of increasing geographicmobility, many businesses took that commonsfor granted in America. Interestingly, theyactually invested in building the commonselsewhere because they realized itsimportance—but in the process, over a numberof decades, the commons got run down inAmerica. The good news is, we see a largenumber of business leaders who recognize theimportance of reinvesting at this point.

Q: In this context, you advance anunusual definition of competitiveness. Is thatreally the fulcrum for your whole project?

JR: We define US competitiveness as the

COPYRIGHT 2012 PRESIDENT AND FELLOWS OF HARVARD COLLEGE 1

ability of firms in the US to succeed in theglobal marketplace while raising the livingstandards of the average American.

The second part of that definition isimmensely important. Sometimes you hearpeople saying the US would be morecompetitive if only wages were lower or we hada cheaper dollar. But if we took a national paycut in that fashion, we'd hardly applaud it as agreat success of US competitiveness. To thecontrary, that's an indicator that we have tochoose between being able to sell our productsto customers and paying our citizens well.

"The ultimate goal ofnational policy has to belong-term productivitygrowth"

A competitive economy does both. The onlyway you can do both is by satisfying customers,shareholders, and employees. You can do thatonly by raising productivity—being better atchanging inputs into valuable outputs than theother guys. So the ultimate goal of nationalpolicy has to be long-term productivity growth.

That may sound obvious, but the rhetoricthese days is all about jobs, jobs, jobs. It's easyto understand why: if you lack a job, it is allabout jobs. But if you set out simply to createjobs for their own sake, you wind up investingin areas not where you're productive, but whereyou can create a lot of jobs quickly. Yes, weabsolutely want jobs. But we want competitivejobs that can last in a demanding globaleconomy.

MP: The sectors where you can generatethe most jobs quickly tend to be in things likehealthcare and construction—inherently localactivities. But any economy is an interestingcombination of what we call "tradedbusinesses"—like manufacturing, sophisticatedservices, and tourism that are exposed tointernational competition—and local ones. Forany large population there are a lot of localneeds—food, housing, utilities—but ultimatelythe vitality of an economy is heavily determinedby the traded part. That's where we find theopportunities for much higher productivity thatcan support high wages. You want to growthose areas where you can be highly productiveand serve the world market. Where you can't beproductive, you need to import. You want localneeds to be met efficiently, but the ultimatewealth that feeds the local economy derivesheavily from the traded economy.

Therefore, the US economy's inability togenerate net new jobs in the traded sector forthe last decade is deeply disturbing. Also, theability to raise wages, particularly in the tradedsector, is being capped by the enormousimprovements going on in other countries. Itused to be that the wages of US workers rose inline with domestic productivity, but the two

became decoupled. Some attribute that todeclining unionization. That may be part of it,but much has to do with the fact that employerscan hire an equally skilled person in anotherlocation at a lower wage. Other countries havebeen improving their game with good skillscompared to us and have better infrastructure insome cases than we do.

We believe the US retains its core strengths,but we have allowed ourselves to fail toprogress rapidly enough to continue to justifyour standards of living, at least during the recentdecade.

JR: The things America is great at—highereducation and entrepreneurial capacity andscientific and technical infrastructure—are veryhard to replicate. The things that we're bad atnow are largely the results of choices we made.

GE Healthcare employees assemblemagnetic-resonance imaging machines inBeijing. In 2011, the highly global companymoved its x-ray unit headquarters staff toChina-a major, rapidly growing market.

Q: The US today seems to have troublefocusing on major policies in pursuit ofoverarching goals such as enhancedproductivity. What does it mean forbusinesses and the government—in their ownspheres and together—to be strategic andcomprehensive in pursuit of making the UScompetitive again?

MP: The challenge of the whole issue ofcompetitiveness and productivity is that it'sinfluenced by a vast array of factors: schools,roads, regulatory complexity, almost everythingmatters—not just the traditionalmacroeconomic policies. If you don't have agood public-education system, for example, youlack the foundation for productivity. If youdon't have people who are healthy and canafford good healthcare, you lack thatfoundation. If you don't have a governmentalsystem that works effectively and delivers goodpublic services, that's a drag on productivity.

The United States used to be a uniquelyproductive place to do business, and not onlyfor entrepreneurship where we still havestrengths. For example, we used to haveamazingly efficient logistics. Because we'vebeen so committed to open competition, wetended to have efficient producers anddistributors throughout the economy. A lot ofother countries were saddled with specialinterests and monopolies. We've been able topreserve the long-term strengths Jan justmentioned—we stay ahead in those areas.

But ironically, we've lost out on some thingsthat seem more basic. For instance, do we havea regulatory environment that makes it easy toconduct business? The World Bank's "DoingBusiness" report ranks every country on theease of doing business. Twenty years ago, theUS would have been by far the easiest place.Now we're well down the list—not in the top10. In other countries, I've participated in some

government-established working groupsdedicated to improving their rankings. Lately,the US just hasn't been improving the basicsnearly as fast as some other countries.

It's a knotty problem becausecompetitiveness is sort of everybody's agenda.That's one reason you have to be strategic: thereare so many things to work on that if you don'thave a clear sense of priorities and sequencingand a sustained effort, you don't make progress.Our single-issue focus lately works against us.

There's also a tremendous mismatchbetween the time horizons of politics and ofcompetitiveness. Most things that matter forbuilding competitiveness take a decade ormultiple decades to improve. But we have apolitical system that's increasingly about today'snews. This mismatch has probably gotten worsein the last 10 or 20 years. The politics ofeconomic policy is never easy, but we used tobe better at overcoming political differences.

JR: Two elements make buildingcompetitiveness vexing. The first, which Mikeemphasized, is that there are so many relatedelements. The second is that the lag timesinvolved are very long. Investments inimproving K-12 education have an impact adecade, two decades, from now. That meansyou need to make sets of choices that areholistic and farsighted—and I think you canargue that in both public policy and on thebusiness side, we have moved towardfragmentation and near-term thinking.

MP: It's particularly hard to pursue theagenda in the United States. This is a very largecountry, very spread out, very complex, thereare 300-million-plus people—so it's just moredifficult to think strategically and long termhere as opposed to in South Korea or Singapore.China has had the luxury, or curse, of a highdegree of centralization that makes long-termthinking much easier.

Q: One issue that is in businesses'purview is the research you've done on firms'location decisions. Could businesses be doinga better job of that?

MP: American businesses should belocating certain activities abroad because thatmakes them more competitive by enabling themto better penetrate international markets. Insome cases, producing offshore also savesunnecessary costs of shipping goods to distantmarkets, or allows better adaptation of productsto local circumstances. So globalization at onelevel has enhanced the competitiveness ofUS-based companies and will support theirgrowth in the US.

"Today, the politicalsupport for business hasbecome very polarized"That said, our research revealed that

offshoring and constructing global supply

HARVARD BUSINESS SCHOOL | WORKING KNOWLEDGE | HBSWK.HBS.EDU

COPYRIGHT 2012 PRESIDENT AND FELLOWS OF HARVARD COLLEGE 2

chains is really complicated—it is challengingto accurately figure out the total costs oflocating in China or another country versus inthe US We found that many activities shouldhave gone offshore, but some probably shouldnot. In making their location decisions, somemanagers failed to understand hidden costs ofoffshoring, such as indirect costs of hiring andretention, supervision, and intellectual-propertyprotection.

We also identified some trends that areworking in favor of the US for locationdecisions—some for reasons we should beunhappy about. For example, wages are risingmuch more rapidly in China and India than theyare here. We want China's wages to go up—wejust would like ours to go up faster, justified byour productivity. Also, the US dollar hasdepreciated.

Other trends favoring the US areunambiguously good news. For instance, it hasbecome significantly more expensive to movegoods, so if you want to tap America's market,the largest single market in the world by aconsiderable margin, you're more likely toproduce here.

And you can add another wild card: thewhole energy situation. The US suddenly has apotential surplus of energy through theproduction of oil and especially natural gastrapped in shale. This development is apotentially transformational asset, and majoractivities in chemicals and other industries canmove back to the US because we now havelow-cost energy.

JR: Mike described some issues that makelocation choices a hard problem formultinational corporations—particularly,hidden costs that don't appear until years in thefuture. A second difficulty is that there is atendency to take a static view of the USenvironment. It's very easy to assume that thestate of the business environment here is agiven. In fact, businesses can improve theenvironments in which they operate—byinvesting in the local workforce, by mentoringlocal suppliers, and so on—but that's hard toinclude in your calculations correctly.

Q: You use the vivid phrase "Improve,not move" as a way of describing businesses'options.

MP: One of the myths aboutcompetitiveness is that it is driven mostly bygovernment policy and that the solution tocompetitive problems is government action.The more we've gotten into this, the more weunderstand that business can influence many ofthese things that constrain US competitivenesswithout the president signing a new law.Businesses—both individually andcollectively—can make major contributions byenhancing skills, improving the supplier base,and taking other steps.

JR: Just as it's an error to think governmentis the only solution, it's also an error to thinkgovernment is exclusively the problem. Youcan trace some of the weaknesses in the USbusiness environment right back to things thatbusinesses have done in their narrowself-interest. How did we get such anincoherent, complex corporate tax code?Because the IRS wanted loopholes? No,because businesses pleaded for loopholes thatbenefited them.

MP: And legislators saw a great way to getcampaign contributions.

Q: What reaction have you heard fromthe business community?

MP: Very little disagreement on thefundamental diagnosis. Most people feel in theirgut that something is going wrong in oureconomy. When we're in the company ofpolitical leaders and public figures, there areoften statements of optimism, of not wanting tobet against America—and we share thisperspective. We think this is a fixable problem,that the US could make rapid improvements. It'sgoing to take time, but we believe America iseminently capable of renewing itscompetitiveness.

We are discovering an increasing awarenessin the business community: they have a role inAmerican competitiveness. They want to dosomething constructive and be part of thesolution. But one of the things that is differentnow from 30 years ago is the public perceptionof and attitude toward business. There's a lot ofskepticism, and frankly, some of it is deserved.

JR: I've met very few business leaders whoconclude, "There's no problem, and we'll justride this one out." At the same time, I've metvery few who feel the situation is so bad it can't

be fixed.Most people we've talked with feel we've

got a real problem, it can be fixed, but itrequires action. They're asking about the rightsteps to take. Even the leaders we see takingaction are asking, "What more can we do?"There's a search for better answers.

MP: That said, there's an almost universalview that our federal political system is one ofthe greatest threats to our economicfuture—because of its inability to tackle someof these issues. There are some federal policiesthat a great majority of those in the privatesector agree are necessary. They defylabels—they're not Republican or Democratic,not liberal or conservative policies.

Almost everybody agrees we've got tosimplify the corporate tax code: statutory ratesare too high, the code is riddled with loopholes,deductions need to be reduced. The right policyis to lower the rate substantially and end mostdeductions. That's a policy economic theorysupports, and almost everybody in the privatesector agrees with—though some will losecherished deductions.

The US also has an unusual system oftaxing our companies on foreign income, whichhas led to dozens of companies moving theircorporate headquarters offshore and Americancompanies holding more than a trillion dollarsof cash abroad rather than repatriate it. Almostall agree that a better system would harmonizeUS practices with those of other leadingcountries.

On immigration reform, pretty mucheverybody agrees we need increased skilledimmigration. And there are many other areaslike these, yet the US can't seem to make anyprogress on them.

It's not that we haven't had partisanbickering in the past, but at the end of the daywe came together and compromised on keypolicies for education, infrastructure, andsupport for science [see the conversation withDavid Moss ]. America believed in businessand entrepreneurship. Today, the politicalsupport for business has become very polarized.This is a key reason we're just not makingprogress on some of the fundamentals.

Reprinted by permission of Harvardmagazine. Copyright ©2012 Harvard MagazineInc. All rights reserved.

HARVARD BUSINESS SCHOOL | WORKING KNOWLEDGE | HBSWK.HBS.EDU

COPYRIGHT 2012 PRESIDENT AND FELLOWS OF HARVARD COLLEGE 3