(Archived document, may contain errors)

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July 21, 1993

THE NATIONAL COMPETITBVENESS ACT (S. 4): A EftGH-TECH BOONDOGGLE

To Washington I say, please do not help us. The world of technology is complex, fast changing, unstructured, and thrives best when individuals are left alone to be different, creative and disobedient.... Anyone who thinks [raising] corporate taxes promotes employment does not understand the problem. Don Valentine, founding venture capitalist and director ofApple Computer Every dollar that is taxed away from individual investment or corporate R&D will weaken America's high technology companies. Pierre Lamond, founder ofNational Semiconductor, a $1.6 billion computer chip companyl

INTRODUCTION The centerpiece of the Clinton Administration's industrial policy agenda, the National Competitiveness Act (S. 4), currently is working its way through Con- gress.2Although industrial policy can take many forms, this legislation embodies one of its central and most dangerous tenets: that the government is better suited than the private sector to pick winners and losers in high-technology industries. S. 4 is sponsored by Democratic Senator Ernest Hollings of South Carolina, Senate Majority Leader George Mitchell, and others, and contains part of the Sen- ate Democratic Economic Leadership Strategy. According to the bill's stated pur- pose, it would "strengthen and expand the ability of Federal technology programs ... to support industry-led and State supported efforts to improve the technological capabilities, manufacturing performance, information infrastructure, and employ- ment opportunities of the United States." The legislation even promises to ensure within ten years that the U.S. is "second to no other nation in the development, de- ployment, and use of advanced manufacturing technologies." To achieve these

1 Quoted in Donald Lambro, "Keyboarding Budget Action," 7he Washington Times, April 12, 1993, p. El. 2 '-H.R. 820, which is similar to S. 4, passed the House of Representatives by a vote of 243 to 167 on May 19. S. 4 was "ordered to be reported" out of the Senate Commerce, Science, and Transportation Committee on May 25 but has yet to be officially "reported" out of the committee.

goals, taxpayers will be required to turn over more than $2 billion over the next two years to fund a myriad of programs ranging from a manufacturing infrastruc- ture project to wind engineering research. At a time when the Clinton Administration and Congress are poised to enact a record-breaking tax increase on the American people and industry in the name of deficit mductim,.S. 4 wouldalmost.double the size--of the Commerce Department and triple the size of one of its agencies, the National Institute of Standards and Technology (NIST). The legislation would create at least six new programs, two new offices within the Commerce Department, and three new advisory boards. Government agencies spending over $2 billion, however, will not improve American competitiveness and create high-quality jobs. S. 4 will fail in its goals because it is based on the flawed premises of industrial policy. Specifically, the notions:

1) That government bureaucrats have superior knowledge to that of entrepreneurs;

2) That government-led programs have worked in the past-, 3) That the numerous government programs created or expanded by industry policy legislation will use taxpayer funds more pro- ductively than the private sector would; and

4) That these policies will lead to a more competitive, pro-growth U.S. economy.

This legislation will not stimulate innovation in the economy. It will instead spawn new political pork projects siphoning funds from other, more productive ventures. Taxpayer funds will be steered toward projects lobbied for most success- fully by interest groups, and away from better investment opportunities. Bureau- crats, not the marketplace, will decide which new technology or business should gain access to venture funding. The bill completely ignores the real steps that need to be taken to make the U.S. economy more competitive and to create jobs. These steps include reduced gov- ernment spending, across-the-board tax reductions, less regulation, and liability re- form.

Government officials like to think that they can do better than the private mar- ket. The reality is that they cannot. Instead of trying to divide up limited govern- ment funds, they should concentrate instead on how to create the best environ- ment for the market to function.

WHAT THE BILL WOULD DO One of the principal purposes of S. 4 is to "strengthen and expand" federal tech- nology programs ("particularly those of the Department of Commerce") to sup- port industry-led and state-supported high-tech efforts in manufacturing, and to develop an information infrastructure for America. To reach these goals, the legislation would: V Create within the Department of Commerce a "2 1 st Century Manu- facturing Infrastructure Program," which would consist of- (i) a new Advanced Manufacturing Technology Development Pro- gram, to support industry-led efforts to develop and test computer-con- trolled mandfactufing systems; and (ii) a new National Manufacturing Outreach Program, which would create an extension system linking state-run Manufacturing Outreach Centers, NIST Manufacturing Technology Centers, and new efforts by NIST's State Technology Extension Program. V Require the Commerce Department to submit a long-term plan for the expansion of the Advanced Technology Program, which sup- ports industry high-tech projects.

S. 4's New Government Creations (Programs, Offices, Advisory Committees)

New Programs (all created in the Department of Commerce) 21 st Century Manufacturing Infrastructure Program Advanced Manufacturing Technology Development Program Manufacturing Extension Partnership State Technology Extension Program Technology Financing Pilot Program Wind Engineering Research Program Technology Training Clearinghouse Information Technology Applications Research Program New Offices (within the Department of Commerce) Office of Technology Monitoring and Competitiveness Assessment National Quality Laboratory New Advisory Committees Manufacturing Advisory Committee ("Led by industry officials" but of sixteen members, six are government officials, including the chairman, two are from small business, and the other eight are supposed to be appointed from industry, worker organizations, technical and professional societies, state technology agencies, and academia) Commerce Technology Advisory Board (at least seventeen members who are "exceptionally qualified to analyze and formulate policy that would improve the global competitiveness of industries in the United States") High-Performance Computing and Applications Advisory Committee (to provide the National Institute of Standards and Technology with advice and information) I/ Create a new Commerce Department Office of Technology Monitor- ing and Competitiveness Assessment, to provide better information on the technological capabilities and industrial targeting practices of America's major trading partners. V Establish a coordinated interagency program, including a five-year plan, 4-o ime momthe development..of computing.applications in edu- cation, manufacturing, health care, and libraries. Set up a pilot program to assist venture capital firms.

In addition, the legislation contains an assortment of provisions to set up pro- jects or address particular issues related to trade and industry. These include: V a Wind Engineering Research Program intended to result "in new technologies for wind-resistant construction, broader application of such technologies to construction, and ultimately decreased loss of life and property due to extreme winds." V an authorization of $167 million for the renovation of National Insti- tute of Standards and Technology (NIST) research facilities. V a prohibition against fraudulent use of "Made in America" labels to any non-domestic product sold in or shipped to the U.S.

DOES THE GOVERNMENT KNOW BETTER THAN THE PRIVATE SECTOR? The bill declares that it is based on the assumption that if a nation leads in high- technology development it will lead in economic growth and high living stan- dards. It also alleges that the U.S. "has not done as well as it should in commer- cializing and manufacturing new inventions." Therefore, according to the legisla- tion, the government needs to step in and help industry speed the development of new technology. Of course, this assumes that the government is well-suited to assist industry in undertaking such tasks as developing high-performance work organizations and finding better manufacturing and computer-controlled technologies. If history is any guide, however, lawmakers should be very skeptical about government's abil- ities. Several recent examples illustrate the government's poor track record in pre- dicting and encouraging new industries. EXAMPLE #1: Sematech In 1987, the Pentagon's Defense Science Board predicted that U.S. semiconduc- tor firms soon would no longer be able to compete individually "against world- class combinations" of foreign governments and academia. 3 To address this sup-

3 Deborah Walker, "The Government's Poor Record in Picking Winners and Losers," in Stuart M. Butler, ed., The Folly ofIndustrial Policy (Washington, D.C.: The Heritage Foundation, 1993), forthcoming. posed problem U.S. semiconductor producers convinced the government to help subsidize a research and development consortium they formed in March 1987, known as Sematech, to help U.S. producers develop state-of-the-art technology in semiconductor manufacturing. But after spending over $500 million in taxpayer money, Sematech now is losing member firms and has been left behind by small, entrepreneurial firms which have concentrated on innovative chip design instead 4 of manufacturing technology. In this case, Washington bureaucrats claimed to know that the key to long-term success was for the U.S. to channel financial resources into improving the manu- facturing process for semiconductors. Meanwhile, small U.S. entrepreneurs ar- gued that this was not the direction to go. And while the U.S. government was ig- noring these entrepreneurs and throwing taxpayer money into manufacturing tech- nologies, these small, entrepreneurial ventures found and developed a new niche for U.S. firms: innovative designs for semiconductors or chips. The small U.S. companies moved ahead with remarkable success. As T. J. Rodgers, president and CEO of San Diego, California-based Cypress Semiconductor Corporation, ex- plains:

America once again leads the world in semiconductors. In each of the last three years, the United States has won back market share from Japan. In 1992 our worldwide share actually exceeded Japan's share for the first time in a decade. 5 EXAMPLE #2: The Synthetic Fuels Corporation The Synthetic Fuels Corporation (SFC) was created by the Energy Security Act of 1980 in order to reduce U.S. dependence on the Organization of Petroleum Ex- porting Countries (OPEC) for crude oil. The SFC was tasked to purchase commit- ments and price guarantees to companies that developed synthetic fuels. This would induce firms to make the large capital outlays required to build the plants and equipment necessary to produce synthetic fuels.6 The Energy Security Act laid out precise targets for the SFC: 500,000 barrels of synthetic fuels-or "synfuels"-per day by 1987, and 2 million per day by 1992. 7 However, these goals were based on faulty forecasts. As Heritage Founda- tion analyst Milton Copulos later pointed out, "A major factor in this sense of ur- gency was the assumption that world oil supplies were in imminent danger of ex- haustion. The failure of these assumptions to materialize has been a severe blow to the infant synthetic fuels industry."8 By 1985 it became clear that there was not

4 See Brink Lindsey, "Drain Scam: How the United States Built an Industrial Policy on Sand," Reason, February 1992, and Walker, op. cit. 5 T. J. Rodgers, "The Road to High-Performance Computing: An Entrepreneur Endorses the Invisible Hand," Cato Policy Report, May/June 1993, p. 11. 6 Walker, op. cit. 7 Linda R. Cohen and Roger Noll, The Technology Pork Barrel (Washington, D.C.: The Brookings Institution, 1991), p. 289. 8 Milton R. Copulos, "Salvaging the Synthetic Fuels Corporation," Heritage Foundation Backgrounder No. 423, an oil crisis and that synfuels were not the answer. The SFC was abolished in 1986.

The SFC is just a recent example of the government's general inability to pre- dict future trends when it tries to encourage new industries that the private sector has "failed" to develop. The case of the SFC is quite typical. It began with the govemment's faulty diagnosis of wby no synthetic fuels industry existed. Accord- ing to a 1974 memorandum by former Commerce Secretary Frederick B. Dent, "private industries had not developed synthetic fuels based on oil shale and on coal liquefaction or gasifaction because of 'high initial cost and market uncer- tainty. "' One hundred million taxpayer dollars later, the government learned that there was no market failure. There just was no market. EXAMPLE #3: Clinch River Breeder Reactor

The Clinch River Breeder Reactor project, authorized by Congress in 1970, was located on the Clinch River near Oak Ridge, Tennessee. It was hailed by some at the time as the solution to the nation's energy problems. The hope of the joint venture between government and the electric power industry was that the demonstration project would show that so-called fast-breeder nuclear power plants could produce cheap electricity at a time when the United States was being squeezed by the OPEC oil cartel. But because of long delays (no work was begun at the site until the fall of 1982), cost overruns, and changing demands for power, the program was killed by Congress in 1983 after $1.5 billion had been spent on the project.9 In a 1991 Brookings Institution study, The Technology Pork Barrel, by Linda Cohen and Roger Noll, the authors referred to the Clinch River project as "the quintessential example of a technological turkey by the time it was mercifully put to rest in 1983."10 The project represented yet another case of the government fail- ing to forecast properly the potential commercial benefits of a new technology, underestimating its costs, and resisting attempts to cut the taxpayers' losses be- cause of local political considerations. In the process, the government's huge cost overruns drew money away from other research and development projects. The Clinch River fiasco ended up costing taxpa ers $1.5 billion-without ever @ I achieving its goal of producing cheaper electricity . The project's sorry history suggested to Cohen and Noll that the program "should have been abandoned no later than 1977, and probably a year or more earlier." The Brookings study cited three warnings that should have led to cancellation, but were ignored by government. First, the factors which suggested the need for

April 12, 1985, p. 3. 9 Congressional Quarterly Almanac, Vol. XXXIX, 1983 (Washington, D.C.: Congressional Quarterly Inc., 1984), pp. 362-364. 10 Cohen and Noll, op. cit., p. 255. 11 Bob Davis, "Clinton's Team Still Vows to Help Commercialize New Technologies but Worries More About Pork," The Wall Street Journal, December 15, 1992, p. A20. the technology had all changed-the key one being the recognition that the gov- ernment had wrongly forecast power demand. Second, the government should have understood that regulatory requirements made commercial licensing very dif- ficult because of the uncertain environmental and safety questions surrounding the facility. And third, the government had grossly underestimated the costs of the program, which skyrocketed in the early 1970s. The private sector understood these factors, and-haflost interest early in-the-program, leading to the Clinch 12 River project coming completely under the control of the government in 1975. The government should have taken its cue from the private sector, realized the program was a mistake and terminated it by 1977. But, typical of government- funded technology, the project took on a life of its own, due to pork barrel poli- tics. Cohen and Noll underscored this by examining the congressional voting pat- tem supporting the program, and concluded that support-not surprisingly-was strongest among those whose districts benefitted from large contracts, representa- tives of states with a strong nuclear industry, and among committee members overseeing the project. 13

S. 4: HIGH-TECH PORK Besides the lesson from the examples above that government systematically misreads the "failure" of the market to develop an industry, there is another clear message from these cases: these ventures quickly become political pork projects, drawing funds from more worthwhile endeavors. By subsidizing particular industry projects, S. 4, if enacted, will continue the pattern. Government support for projects no doubt will generate praise for law- makers who "won" funds for their district, but the result will be misleading invest- ment signals in high-technology industries. Public and private financial resources will move to where government bureaucrats decide, not where market signals in- dicate. Private money will be diverted because S. 4 proposes to "provide financial support to large scale joint ventures requesting $20 million or more a year in De- partment funds"-subject to matching funds requirements. When the government tells firms or educational institutions that it will provide funds for certain projects if they generate matching funds, these projects become more attractive, not be- cause they suddenly appear more profitable from a consumer demand point of view, but because government subsidies make them more attractive. This means valuable private resources are drained from projects that ordinarily would be con- sidered attractive (that is, potentially more profitable) and into government-subsi- dized projects that otherwise would not be undertaken. Moreover, explains Linda Cohen, "pork takes on a life of its own," in that once public funds are committed, pressure develops for more tangential uses of govern- ment money. For example, in last year's appropriation for Sernatech, Congress

12 Cohen and Noll, op. cit., pp. 238-240. 13 Ibid., pp. 241-254. SUMMARY OF AUTHORIZATIONS IN S. 4 (millions of current dollars)

FY93 FY94 FY95 (approp.) "''Ddparthient df-Commerce Technology Policy 5 15 22 NIST Research Service 193 250 320.7 NIST Facility Renovation 105 62 105 NIST Manufacturing Extension 18 120 220 NIST Advanced Technology Program 68 200 468 NIST 'Quality" Programs - 2 2 NIST Wind Engineering - 1 3 Technology Training Clearinghouse - 2 3 Intelligent Manufacturing Experiments - 10 Technology Financing Pilot - 2 50 Information Infrastructure - 14 36

Total 389 678 1,229.7 National Science Found. Manufacturing - 50 75 Information Infrastructure - 64 120

Total 0 114 195 National Library of Medicine Information Infrastructure - 30 50 NASA Information Infrastructure - 28 38

GRAND TOTAL 389 850 1512.7

As "ordered to be reported" out of the Senate Commerce, Science and Transportation Committee

mandated that ten percent of the consortium's $100 million 1993 budget be used for environmental research-hardly part of Sematech's original mission. 14 When public funds are available as a carrot, the boundaries of congressional dis- tricts seem to play an important role in decisions over which community, com- pany, or university is picked for a project. To give a recent example, a small com- pany, Optical Imaging Systems, Inc., located in Flint, Michigan, this April was awarded up to $50 million to lead the U.S. effort in building advanced flat-panel

8

video screens. The Pentagon's Advanced Research Projects agency, which is sup- posed to promote high technology, wants to help the U.S. flat-screen industry compete with Japan. Why this company? And why Flint? Some critics of the award see the decision as the result of successful lobbying by the Michigan con- gressional. district, not a rational investment decision. They contend the company is too small to lead the U.S. effort. 15

S. 4 bulges with money for communities to obtain by mobilizing lawmakers and lobbyists. Just some examples: The Advanced Technology Program. S. 4 increases funding for grants (made on a matching funds basis) to firms specializing in such fields as electronics, ad- vanced manufacturing, information, and biotechnology. The bill appropriates $200 million in FY 1994 and $468 million in FY 1995 for this program. The program's appropriation in FY 1993 was just $68 million. Under this expanded program, one of the many activities the bill proposes to fund is the testing of new technologies. When allocating these "Testbed Awards," the Secretary of Commerce "shall give particular consideration to applicants that have existing computer expertise in the management of busi- ness, product, and process information .... .. Unlike private venture capitalists, who are prone to seek breakthroughs by new companies, the language of S. 4 indicates that the government will tend to subsidize established firms. When existing firms are being subsidized by government, and especially when a con- dition of subsidy is that private funds also are to be raised, it becomes much more difficult for new, innovative firms to enter the picture The National Manufacturing Outreach Program. Under this program, "Government and private sector organizations, actively engaged in technology or manu- facturing extension activities, may apply to the Secretary to be designated as Manufacturing Outreach Centers." The eligible recipients include everything from government agencies to worker organizations to universities. Each center will "disseminate its technical and information services to United States manufacturing firms." S. 4 authorizes $30 million in FY 1994 and $80 million in FY 1995 for these centers (and related activities). Past history indicates that the grant pro- cess will be highly political. The experience of the Small Business Develop- ment Center program, which provides professional and technical advice free of charge to small business, indicates that these centers will grow in number as Members of Congress want them for their own districts. In the past five years, the funding for Small Business Development Centers has grown from $45 million to $71 million and the number of centers has increased from ap- proximately 600 to 934.16

15 John Carey, "Industrial Policy, or Industrial Folly?" Business Week, May 17, 1993, p. 36. 16 House Report 103-157, p. 65, and the Small Business Administration. The House Appropriations Committee recommended a $71 million FY 1994 funding level for the SBDC program. The full House has yet to vote on the bill. THE DUPLICATION OF EXISTING PROGRAMS Not only does S. 4 create such pork-prone programs, but it duplicates an exist- ing Small Business Administration (SBA) program. Of course the bill does not terminate the SBA program to free funds for a supposedly better program. As originally introduced, S. 4 would have authorized the Secretary of Com- me rce to'mak6 loa ns to small and medium sized businesses "engaged in research, development, demonstration, or exploitation of advanced technologies and prod- ucts" and to provide financial assistance to "critical technology investment compa- nies." After objections from several quarters, the loan program was scaled back in Committee to a pilot program. However, the House version of the legislation still contains the full-scale loan program. This duplicates the SBA's Small Business Investment Corporations (SBICs). Like the new Commerce Department program, the SBICs provide venture capital to small businesses.

Before duplicating the SBA program, lawmakers would be wise to consider whether the taxpayer investment in the SBA program has been a success. A re- cent review by The Wall Street Journal should make Congress hesitate:

The SBA's investment-company program was started 35 years ago, after the Russian Sputnik rocket was launched, to fund high technology start-up businesses. But beginning in 1986, many of the investment companies that the program sponsored ran into serious financial trouble. The SBA had to liquidate the assets of 191 of these concerns. Investigators blamed the problems on the recession and poor SBA oversight. 17

Moreover, the Department of Commerce itself does not have a good track re- cord in the loan department. Columnist George Will noted recently that, "more than half the almost $1.2 billion lent by Commerce in the last two decades is in default."' 8 Commerce Secretary Ron Brown disputes Will's assertion that Com- merce should not be involved in promoting high technology, but did not argue with his loan figures. 19

WANTED: A REAL, PRO-GROWTH COMPETITIVENESS STRATEGY The government can play a role in promoting U.S. competitiveness. But that role is not to pick and subsidize new industries. The government instead should be creating an environment for risk-taking and removing artificial barriers-usu- ally ones it has created.

17 Jeanne Saddler, "SBA, Commerce Square Off on High Tech Financing," The Wall Street Journal, June 9, 1993. 18 George F. Will, "Government as Venture Capitalist," The Washington Post, June 10, 1993, p. A23. 19 Ronald H. Brown, letter to the editor, The Washington Post, June 22,1993, p. A 18. What firms in the United States need in order to be competitive in world mar- kets are fewer regulations, fewer barriers to trade, and lower taxes-especially on venture capital. Government policy should enhance the general process of compe- tition, not become a player in it. If Congress wants to strengthen U.S. competitive- ness and foster the growth of new industries and better-paying jobs, it should enact the following ten-point competitiveness plan. 1) Cap domestic federal spending at 2 percent annually. This will increase the amount of private savings available for job-creating private investment. 2) Avoid costly health care "reform." Congress should adopt health care reform legislation that addresses why insurance costs are rising. It should not simply push the cost of comprehensive health coverage onto employers through expensive new payroll taxes. 3) Reduce tax rates on labor income and capital formation. Enacting reductions in payroll and income tax rates, and other tax relief to reduce the cost of hiring workers and introducing new equipment, would stimulate savings, investment, and productivity. Unlike targeted subsidies, general tax relief would cause private funds to flow to their most productive uses. 4) Pass product liability reform and other tort reform legislation. America's current tort system drains the economy of possibly hundreds of billions of dollars annually and hinders product innovation. Reforms are needed to limit punitive damages and streamline court procedures to encourage settlement. 5) Enact regulatory reform. Many regulations directly increase the cost of employing workers and act like a hidden tax on job creation. The President and Congress should establish a federal regulatory budget and estimate the employment impact of regulations before they take effect. A regulatory budget means that the government would place a limit on the total estimated cost imposed on the economy each year by all federal regulations. 6) Adopt legislation promoting true school choice and other education reforms. American schools need to do a better job of educating children to be the productive, high-skilled workers of tomorrow. Children from all income levels need to be able to learn the basic reading and writing skills so that they can be successful in the workplace. 7) Overhaul antiquated U.S. antitrust laws. Outdated trade laws left over from the turn of the century make it difficult for firms to enter into joint production alliances generally permitted in other countries. Among the needed reforms is greater legal latitude to enable U.S. firms to form alliances to finance research programs or develop and market new products. 8) Enact NAFTA and negotiate other free trade agreements. Congress should ratify the North American Free Trade Area agreement, which will create jobs, spur economic growth, and make the U.S. more competitive with Japan and Europe. After implementing the NAFTA, the Administration should negotiate trade agreements with any country wishing bilateral open markets.

9) Reform U.S. financial and banking laws. Restrictions on interstate banking force many U.S. banks to remain small and uncompetitive and unable to provide both commercial and investment services. Congress should reform the McFadden Act of 1927 and the Bank Holding Company Act of 1956, which restrict interstate banking. In addition, the Glass-Steagall Act of 1933 should be repealed. This outdated law limits the services banks can offer and 'the types-of investments -they unmake. 10) Permit the "Baby BelW' to enter the long-distance market. Congress should allow the regional Bell operating companies to enter the long-distance telephone business, to manufacture telephone equipment, and to own video programming and other businesses. They have been prohibited from doing so by the court decree that broke up the Bell system in 1982, and by the 1984 Cable Communication Policy Act. Removing these restrictions will promote competition, create jobs, and help build data highways.

CONCLUSION The National Competitiveness Act would spend more than $2 billion on a wide array of programs, in the hope that an infusion of government investment can as- sure U.S. leadership in advanced manufacturing technologies. But such past exam- ples as the ill-fated Synfuels Corporation, Sematech, and the Clinch River Breeder Reactor program show that government bureaucrats have not succeeded in forecasting future trends, picking the technologies of the future, or estimating the costs of government-funded projects. Government-sponsored manufacturing outreach centers, state extension net- works, wind engineering research programs, and similar activities will not pre- pare the U.S. economy for the future. Such projects will simply become high-tech political pork projects, which will take on a life of their own. Manufacturing cen- ters, for instance, will tend to be located in districts of the most powerful Con- gressmen, rat 'her than where they are needed. And one high-tech project will be fa- vored over another because of its political friends, not because of market needs. Instead of adopting this legislation, Congress should work to create an environ- ment in which high-tech industries and business can thrive. New businesses will not grow when they are overtaxed, or burdened by excess litigation and regula- tion, or when they face an uncertain future due to mandated employee benefits. Correcting these problems will sharpen U.S. competitiveness and spur new tech- nologies. Outreach programs run by the Department of Commerce will not.

Susan M. Eckerly Deborah L. Walker Walker Senior Policy Analyst Associate Professor of Economics, in Economics Loyola University 1992-1993 Bradley Resident Scholar, The Heritage Foundation