Can the U.S compete? A 10 year outlook.

Over the last decade, the U.S. has fared well in international markets, but significant vulnerabilities remain. According to the Council on Competitiveness analysis, CEOs have their work cut out to boost productivity and investment, and redress workforce deficiencies.

No chief executive with a sense of history can forget the competitive challenge that shook U.S. self-confidence in the mid-1980s. Although the domestic economy was growing, one key industrial sector after another seemed to be losing market share to international competitors. A soaring dollar and sky-rocketing trade deficit had shifted the U.S. from being the world's largest creditor to its largest debtor in just a few short years. The U.S. position in a host of critical technologies looked fragile, while Japan seemed to be gaining unstoppable momentum.

Although the picture has in fact brightened for the U.S. in many ways over the past decade, key questions remain unanswered regarding the rebound: How much has the nation's competitive position really improved? What factors made the most difference? How durable is the comeback? What needs to be done to maintain U.S. leadership?

These questions prompted the Council on Competitiveness to take a systematic look at how the U.S. economy has fared since 1985. Under the guidance of Professor Michael Porter of the Harvard Business School, we analyzed key indicators and surveyed the Council's 150 chief executives from industry, labor, and leading research universities. Our strategic assessment of U.S. competitiveness - presented recently to Congressional leaders of both parties, senior administration officials, and a plenary meeting of the nation's governors - yielded two main conclusions.

First, a pivotal change in the competitive challenge facing American CEOs has occurred in the last 10 years. Market opportunities and manufacturing capacity have shifted increasingly from the world's wealthy countries to a growing number of developing economies. This is the most important change affecting the prospects of U.S. companies in the past half century.

Second, the U.S. response to the new competitive environment looks stronger in the short term than for the long haul. While many CEOs have good reason to take pride in recent gains, the United States will not keep its competitive edge as a nation unless long-term vulnerabilities in saving, investment, research, and education are overcome.

THE NEW FACE OF GLOBAL COMPETITION

The most telling change that has taken place in the global competitive environment over the past 10 years is a virtual explosion of cross-border investment. Foreign direct investment has been growing three times faster than world trade or world output since the mid-1980s [ILLUSTRATION FOR FIGURE 1 OMITTED]. This surge has been triggered by dramatic gains in technology and the almost universal acceptance of market-oriented growth policies in the developing world. According to the World Bank, nearly 4 billion consumers have been brought for the first time into the global marketplace.

The abandonment of failed inward-looking policies throughout most of the developing world has altered the direction of global investment. A growing share of such investment is flowing toward low-wage countries, which have made the acquisition of capital and technology the centerpiece of their development strategies. They have had considerable success in attracting portfolio investment [ILLUSTRATION FOR FIGURE 2 OMITTED]. Stock market capitalization among developed countries has doubled during the last decade, while that of developing-country financial markets has grown more than 10-fold and shows no sign of slowing.

At the same time, the world's advanced economies have committed hundreds of billions of dollars to direct investments in real estate, production facilities, and infrastructure projects. China alone vaulted from being a peripheral factor in the mid-1980s into the world's No. 2 host of foreign direct investment by 1996.

This worldwide shift in resources has decoupled the growth of advanced and developing economies. The world's rich countries are no longer the exclusive engine of global growth that they were once thought to be [ILLUSTRATION FOR FIGURE 3 OMITTED]. The industrialized countries of the West still account for about two-thirds of world GDP, but developing economies are the world's fastest growing markets. Their imports of goods and services have more than tripled since the mid-1980s, surpassing $1 trillion in 1996.

GROWING ON INTERNATIONAL SOIL

What do these watershed changes mean for chief executives? First and foremost, many CEOs have had to revise their vision of future growth opportunities. Until the past decade, the U.S. domestic market was the make-or-break opportunity for all but a handful of large multinationals. Market leaders like Motorola relied on the domestic market for 75 percent of revenues as late as 1985. Since then, however, Motorola's international sales have reached more than 65 percent of total company revenues.

This phenomenal reversal is not an exception but a norm for many of the strongest U.S. companies. CEOs have had to change their mind sets, time allocations, organizations, and business strategies accordingly. Foreign markets have emerged as a dominant focus for CEOs of high-growth companies in services as well as manufacturing. Eastman Kodak CEO George Fisher, a former chairman of the Council on Competitiveness, recently decided to move Kodak's third-ranking executive permanently to Hong Kong. "While the U.S. market remains a critical priority, this move is an expression of our commitment to manage Kodak as a global corporation, not simply a U.S.-based multinational company," says Fisher. It is no longer unusual to see a CEO spending one-fifth or more of his or her time in foreign travel. Management teams and corporate boards are more international than ever.

Adjusting to a future in which foreign market potential exceeds that of the U.S. market cuts to the heart of any organization. And making the adjustment work poses the most telling long-term leadership challenge that many CEOs face.

Moreover, CEOs confront a widening array of global choices at every phase of the production of goods and services. Many of the low-wage countries that have opened up their economies during the past decade have set their sights far beyond traditional exports of natural resources and simple labor-intensive goods. They are moving aggressively to put in place the infrastructure, educational systems, and policies to make themselves attractive sites for the production of sophisticated components, services, and finished products. They want the high wages that come from the high-value end of the production chain.

The coming of age of emerging economies has added a new dimension to global competition, making it not just a fight for market share among firms but also a battle for location involving firms and governments. The site decisions that CEOs now have to make over research facilities, product design, outsourcing, support services, manufacturing, and marketing are more numerous and complex than they have ever been. All of these decisions have profound implications for a CEO's U.S.-based work force. They stand out as the most demanding tests of business strategy that chief executives face.

Further, American CEOs have to figure out just where the competitive advantage of their U.S.-based operations lies. Their edge is unlikely to be in the production of standard goods and services that reduce U.S. firms to competing on costs. Instead, U.S. competitive edge will be in developing innovative products and services that command a premium in international markets. Here U.S.-based operations can draw upon powerful assets: a science and technology base that is second to none, an entrepreneurial climate, capital markets that support innovation, and strong domestic demand from sophisticated consumers.

The CEOs of the Council on Competitiveness are upbeat about their capacity to meet the challenges of the new competitive environment. Most believe that the most serious national competitors of the 1970s and '80s - Japan and Germany - will do no better than stay on even ground with the U.S. in the next 10 years. Only one-quarter expect their strongest foreign competition in the future to come from advanced industrial economies. It's the emerging economies that will gain ground - with. China, Korea, India, Brazil, and Mexico topping the list.

But our members see the closing of the gap between advanced and developing economies as an opportunity rather than a threat. Eighty percent see their greatest growth opportunities coming from foreign markets. And they are confident that U.S. firms can provide exactly what developing economies want most: business services, telecommunications, information technology, biomedical products and services, environmental technology, and high-end manufacturing components.

Our members also do not think that these high-end capabilities are within easy reach of foreign competitors. Half of the Council's CEOs expect their most serious rivals over the next 10 years to be U.S.-based. If so, intense domestic competition will certainly help assure that U.S. firms hold their own internationally.

THE STRENGTHS OF THE U.S. OPERATING PLATFORM

CEOs are clearly justified in seeing the U.S as a solid operating platform, above all when U.S. performance is benchmarked against other advanced countries. Our 10-year look not only shows that the nation has enjoyed a longer period of sustained expansion than any other G-7 economy, but that it has led the way in a host of other performance indicators:

Global Market Share. U.S. goods and services have met the test of international markets since the mid-1980s. Figure 4 indicates that U.S. exports grew at a rate three times that of Japan and five times that of Germany, while trailing the export growth of Asia's developing economies by a wide margin.

Trade Performance. Despite a continuous rise in the U.S. surplus in services, the nagging trade imbalance has persisted - but it has declined by almost 50 percent as a percentage of GDP.

Per Capita GDP. Contrary to the gloomy forecasts of the mid-1980s, which foresaw Japan surpassing the United States economically, the U.S. living standard have remained the highest in the world on a per capita basis. [ILLUSTRATION FOR FIGURE 5 OMITTED]

Employment. Net job creation in the United States has exceeded that of all other G-7 countries combined [ILLUSTRATION FOR FIGURE 6 OMITTED] and the U.S. unemployment rate has dropped below that of every major industrial economy except Japan.

Budget Deficit Reduction. The United States has achieved the lowest budget deficit as a percentage of GDP of any G-7 economy, lowering real interest rates and stimulating growth.

What factors account for these widely hailed gains in U.S. competitiveness? The Council CEOs believe that the lion's share of the credit should go to the private sector. They see gains in product, process, and management innovation as the key forces driving the comeback of U.S. industry. In their eyes, what has mattered most is the focus on quality and customer needs, the shortening of product cycle development times, and the restructuring of organizations. Success in these areas has made a bigger difference than changes in exchange rates or the cost of capital. "U.S. industry has been shaken from its complacency during the past decade and has shown a revolutionary change in mind-set at all levels of our organizations," says Don Beall, chairman and CEO of Rockwell International. "Today, it is championing a desire to be 'the best' and eliminating activities that fail to add value for our customers."

In contrast, three-fourths of Council members view the role of the federal government over the past decade as neutral to negative. Even with progress in budget deficit reduction and deregulation, the only area where Washington gets high marks for boosting U.S. competitiveness is trade expansion. "Trade's enormous role in the U.S. economy is well-understood 'inside the Beltway' and in corporate boardrooms," says Boeing CEO Philip Condit. "Washington decision-makers know that the number of export-based jobs grew at a rate four times that of overall job growth. That audience knows that export-based jobs pay more than the national average."

Our data highlights another factor that has contributed to U.S. competitive performance - slow growth of unit labor costs. The combination of productivity gains and relatively low wage growth has kept growth in U.S. manufacturing unit labor costs the lowest among the G-7 countries [ILLUSTRATION FOR FIGURE 7 OMITTED]. The resulting price advantage, reinforced until the past 18 months by the decline of the dollar from its highs in the mid-1980s, has given a real edge to U.S. exporters. Today CEOs worry that this advantage is being eroded as labor markets tighten and the dollar strengthens.

The one vital factor in competitiveness where U.S. performance does not seem to measure up is productivity; here CEO perceptions do not jibe with official statistics. Whereas our members point to significant gains in output per worker in their own companies and others they know well, government data indicate lackluster U.S. performance over the past decade [ILLUSTRATION FOR FIGURE 8 OMITTED]. Low productivity in services is often cited as the culprit, yet the United States is more internationally competitive in services than any other country.

The gap between hands-on CEO experience and the official view of U.S. productivity leaves our members scratching their heads. Most believe that U.S. performance has been substantially stronger than the numbers show.

All in all, there is no question that the CEOs' U.S. operating platform has been strengthened over the past decade in areas where market forces and public demands exerted pressure for immediate action - corporate restructuring, total quality management, product development, international market access, and budget deficit reduction. These gains alone, however, will not sustain a position of strength over the long haul.

LONG-TERM VULNERABILITIES

Our analysis highlights four areas of concern for CEOs of U.S.-based companies as well as foreign subsidiaries operating in the United States.

First, U.S. saving and investment rates are far lower than might be expected of the world's largest economy. Despite progress in putting the U.S. financial house in order, the net national saving rate actually declined during the past decade. In fact, it is the lowest among the G-7 countries [ILLUSTRATION FOR FIGURE 9 OMITTED].

This shortfall in national saving reduces the pool of resources to invest in future growth and compels the U.S. economy as a whole to borrow from abroad to meet its investment needs. As a result, it is no surprise that investment by CEOs in U.S. plant and equipment to make workers more productive has remained less than in Germany and Japan as a percentage of GDP [ILLUSTRATION FOR FIGURE 10 OMITTED]. At the same time, despite being at the center of international financial markets, the United States has remained a huge and chronic borrower. This situation is fundamentally unsound.

Second, the U.S. is not making the kinds of outlays or developing the base of talent to assure long-term leadership in science and technology. "Our strong technology base helped the U.S. regain its competitive edge during the last decade," says Paul Allaire, chairman and CEO of Xerox Corp, and former chairman of the Council on Competitiveness. "Erosion of that base now poses a real threat to a U.S. economy that more and more must compete in a world of awakening giants." Although the U.S. lead is unquestioned today, budgets are tightening in government, universities, and industry just as economies in Asia and Europe are ramping up their capabilities. And while the U.S. remains dominant in terms of total R&D spending, its long-term real growth was 11.4 percent between 1985 and 1994, the lowest among the G-7 [ILLUSTRATION FOR FIGURE 11 OMITTED].

Third, there are clear deficiencies in the quality of the U.S. workforce. Although U.S. workers are the world's most productive in absolute terms, our CEOs rank worker capabilities as the most serious competitiveness challenge they face over the next decade. Even though the United States outspends all other G-7 economies on education, test scores at the secondary level have failed to improve since the mid-1980s, and international comparisons reflect weak U.S. performance in basic science and math skills [ILLUSTRATION FOR FIGURE 12 OMITTED]. "There is a dramatic need to educate children in math and science and physics, or we're not going to have people to drive our economy forward in these industries," says William Hambrecht, chairman of venture capital firm Hambrecht & Quist and current chairman of the Council on Competitiveness. "We have to address it or we will lose our edge."

Fourth, wage inequality has become more pronounced in the United States than in any other industrial country. Highly skilled American workers are thriving in a global economy that is increasingly knowledge-driven, but lower skilled workers are being left behind as they "compete" with other less-skilled workers from around the world [ILLUSTRATION FOR FIGURE 13 OMITTED].

Globally-minded CEOs know how much is at stake in meeting these challenges. They realize there is no substitute for a strong U.S. operating platform if they are going to succeed internationally. That's why so many are deeply committed to improving K-12 education, strengthening the skills of workers, and maintaining U.S. leadership in science and technology.

Clearly, none of these challenges has a quick fix; all require broad public support to make progress. And, most certainly, they warrant the strategic focus of all U.S. CEOs.

John Yochelson is president of the Council on Competitiveness, a Washington, D.C.-based non-partisan forum of chief executives from the business, university, and labor communities working to sustain U.S. economic leadership.