Building Wealth by Lester C. Thurow - EXCERPTS

Building Wealth: The New Rules for Individuals, Companies, and Nations in a Knowledge-Based Economy. Lester C. Thurow.

EXCERPTS

In the new man-made brainpower industries of the twenty-first century, all of Europe is an also-ran. Nowhere is it an industrial leader.

For in the end, it is productivity growth (the ability to produce more output using fewer inputs) that ultimately drives real wealth creation.

At the end of the twentieth and beginning of the twenty-first centuries, six new technologies – microelectronics, computers, telecommunications, new man-made materials, robotics, and biotechnology – are interacting to create a new and very different economic world.

Knowledge is the new basis for wealth … Exactly how one controls (owns?) knowledge is in fact a central issue in a knowledge-based economy.

Just as the second industrial revolution moved us from local to national economies, so the third industrial revolution is moving us from national economies to a global economy … The existing international institutions – the International Monetary Fund, the World Bank, the United Nations, the World Trade Organization – were not meant to deal with a global economy.

In short, no one is going to set up a global government in the foreseeable future – regardless of whether it is or is not needed. As a result, the world is going to have a global economy without a global government. This means a global economy with no enforceable, agreed-upon set of rules and regulations, no sheriff to enforce codes of acceptable behavior, and no judges and juries to appeal to if one feels that justice is not being done.

In the twentieth century as local economies were replaced by national economies, national governments gained power. They needed to be given the powers necessary to control national economic systems. A global economy reverses this process.

To have great wealth is to have it all. It is not surprising that get-rich-quick books sell, even though the buyers know the books will convey nothing helpful. They are the modern equivalent of alchemy. Neither exists, but it would be so nice if they did that many are willing to suspend their critical faculties and believe in the unbelievable. Fairy tales both sell and give comfort – even when they are know to be fairly tales.

RULE ONE: No one has ever become very rich by saving their money. The rich see opportunities to work and invest in situations where large disequilibriums exist. This was as true for John D. Rockefeller as it is for Bill Gates. In both cases heir lifetime savings constitute a small fraction of their total wealth. Carefully saving one’s money and investing in normal equilibrium situations can make one comfortable in one’s old age but never really wealthy.

Big old firms understand, and often even invent, the new technologies that transform the world, but they have a structural problem that is almost impossible to solve. When new breakthrough technologies come along, old firms must destroy themselves to save themselves. They must cannibalize themselves, but they cannot.

“Entertainment” shopping will be able to compete with electronic shopping or some products, but no one knows which products. Which customers will be willing to pay more if they buy in an entertaining environment and which ones just want to buy at the cheapest possible price? Those who figure it out first will become rich.

Studies show that productivity falls sharply if workers telecommute for more than a day or two per week, but companies save most of their money by not having offices for the telecommuters.

If one takes a wide definition of culture (all leisure activities), culture is the world’s biggest industry.

New technologies mean change. Change means disequilibrium. Disequilibrium conditions create high-return, high-growth opportunities. The winners understand the new technologies, are lucky enough to be in the right place at the right time, and have the skills to take advantage of these new situations. They become rich.

The problem with wealth generated from sociological disequilibriums is that it usually reflects more a transfer of existing wealth rather than a generation of new wealth.

RULE THREE: Business that would grow rapidly with high profit margins must take advantage of technological disequilibriums, exploit developmental disequilibriums, or create sociological disequilibriums. All other activities are slow-growth, low-rate-of-return commodity businesses.

For some unknown reason the third industrial revolution simultaneously created great market wealth and a miserable productivity performance.

If countries attempt to protect their companies in home markets, their companies are increasingly shut out of global markets, and for most big companies global markets are now more important than home markets.

The wealth pyramid begins with social organization. Social organization constitutes the great building stones at the bottom of the pyramid. Think of any of the world’s poorest countries – Haiti, Bangladesh, central Africa, Albania. All are characterized by chaos, disorder, and an inability to organize themselves socially. They cannot maintain public order. They cannot build or repair infrastructure. They cannot organize and staff village schools. They cannot deliver health services.

The Americans invented mass universal public education, were its leaders for a century, and used it to create their twentieth century success. But an educational system that once led the world is no longer world-class. America has to reinvent itself if it doesn’t want falling wages for a poorly skilled bottom two-thirds of its workforce.

With the onset of the third industrial revolution, the ability to rapidly open up the new and close down the old became the central characteristic needed for economic success. The American system was built to open up the new and close down the old. That is what it does best.

Having tried to set up one’s own business, even if one fails, is the mark of a good potential employee – works hard, creative, takes risks, knows how the world works.

Capitalism is a process of creative destruction. The new destroys the old. Both the creation and the destruction are essential to driving the economy forward.

Entrepreneurs are risk takers, organizers, and doers, not usually thinkers and inventors. The characteristics needed to create new knowledge are very different from the characteristics necessary to bring that knowledge into active use.

Sustainable long-run competitive advantage can be had only through an advantage in skills, education, and knowledge. Yet this is precisely where Europe has its greatest competitive advantage. If ratings were given for top to bottom skills, Europe would get the best ratings. It is more creative at the top than Japan and better educated at the bottom than America. Relative to any comparatively sized group in the rest of the world it is the best educated. Europe is a continent rich in human capital. Why, then, is it a laggard when it comes to the creation of wealth?

Western Europe has not solved its unemployment problem because it won’t adopt policies to accelerate growth or to lower wages.

RULE SIX: There are no institutional substitutes for individual entrepreneurial change agents. The entrepreneur winners of the game become wealthy and powerful, but without entrepreneurs, economies become poor and weak. The old will not exit; the new cannot enter.

In the United States, where payroll taxes are low, the underground economy is small. In Western Europe, where payroll taxes are high, the underground economy is large.

Knowledge generates the basic breakthroughs in technology that create the disequilibrium conditions in which high returns and high growth rates are possible.

Creating technological disequilibriums is an art form that not all societies have mastered. Even within creative societies, creativity is not spread equally. American Jews win far more than their proportional share of America’s Nobel Prizes. (But Israelis win almost none.) America’s great research universities are not evenly spread across the country. Every area of America does not have its Silicon Valley or Route 128.

Creativity does not occur when it has to challenge authority. Creativity occurs when there is no authority to challenge – when there is an empty space without order where creativity can grow unmolested. But to many, an empty space without order is chaos – and chaos must be suppressed.

Einstein dropped out of high school at fifteen; renounced his citizenship one year later; lived on the margins socially, economically, and morally; called himself a gypsy and was considered a bohemian by others. His life was in some sense a search for order in disorder, both scientifically and sociologically. Great creativity requires hard facts, wild imagination, and nonlogical jumps forward that are then proved to be right by working backward to known principles. Only the rebellious can do it. Curiosity and the desire to explore can be enhanced. Useful curiosity requires individuals who have mastered the existing body of knowledge but are not paralyzed by it. Enhancing curiosity is what really good graduate education is all about. Societies that value and honor curiosity produce curious people.

The reason manufacturing does most of the R&D spending is that historically it has been impossible to make money on innovations unless one made and sold the products that were the fruits of that new knowledge. Selling knowledge so that others could make the products that came from it has never been a profitable strategy.

To be useful, inventions usually need a well-educated workforce that can absorb the technology and acquire the skills necessary to employ it. If this skill base does not exist, the invention lies unused. This is why well-educated inventors in the developing world often move to the United States. Because their fellow citizens are undereducated, they can’t get their invention to market in their home environment.

While there are obviously individual exceptions, technological breakthroughs aren’t usually made by older researchers who have been looking at the same things in the same ways for long periods of time. New ways are usually conceived by those who haven’t accepted the old ways.

Whatever the process for establishing clear, enforceable property rights, capitalism does not work unless who owns what is clear. The private ownership of productive assets and the ability to appropriate the output that flows from those assets lies at the heart of capitalism. This principle is what gave capitalism its name. To make capitalism function, legally enforceable ownership rights have to be established.

Capitalism cannot deal with pollution because it cannot establish the ownership rights to clean air and water.

The source of any retailer’s future success is apt to be buried in the software of its electronic information and logistics systems rather than in its advertising or the novelty of its products.

Without a clear, workable, enforceable system of intellectual property rights, knowledge-based capitalism is not going to work. No one is going to invest the necessary sums in research and development if they cannot garner the resulting gains.

The prevailing wisdom among those who earn their living within our system of intellectual property protection is that some minor tweaking here and there will fix the problem. Much of this wisdom flows from nothing more profound than the belief that to open up the system to fundamental change would be equivalent to opening Pandora’s box. All can vividly see themselves as potential losers. Few consider the private and public gains that might accrue from a different system. The prevailing wisdom is wrong. The time has come not for marginal changes but for wide-open thinking about designing a new system from the ground up. This is never going to happen if the problem is left to those who make their living operating the current system. They have too many vested interests in preserving it with the fewest possible modifications.

The differentiation must start with distinctions between fundamental advances in knowledge and logical extensions of existing knowledge. Each deserves a different kind of patent.

In nineteenth century capitalism, human skills weren’t seen as that important. Labor was a rented, hired-and-fired, marginal factor of production. Socialism arose as a response to the secondary position of labor in capitalism, promising to give labor a central position in the economic system. This is what gave it its political appeal. Interestingly, just as socialism and communism were dying, technology was elevating humans to a more central position in the productive framework of capitalism. Capitalism was being forced to put human skills and knowledge, rather than machinery, at the heart of its system.

In a global economy where employers arbitrage the world looking for the lowest wages, people’s pay is not based on whether they live in a rich or a poor country but upon their individual skills. The well-educated living in India make something that looks like American wages, while the uneducated living in America make something that looks like Indian wages.

Older workers sell experience and skills of an earlier vintage. Young workers sell newly acquired skills. Experience is just less valuable. Over the past quarter of a century the returns to experience have been going down for every level of education.

In the twenty-first century, no country that wishes to be rich can leave some of its citizens uneducated. This applies to women as well as men. Any society that does not educate women (the Taliban in Afghanistan) is not going to be successful … Successful societies will educate women because they contribute needed talent to the workforce, but they will also do so because uneducated mothers seldom have well-educated sons. A knowledge economy requires two interlocking but very different skill sets. Knowledge creation requires highly educated creative skills at the very top of the skill distribution. Knowledge deployment requires widespread high-quality skills and education in the middle and bottom of the skill distribution. The same country need not lead in both.

Looking at how wages rise as years of education go up, big economic payoffs exist for the first few years of education and the last few years of education, but only very small economic returns accrue per year of education in between these extremes.

An extra year of college education has very little positive effect on earnings if the student does not complete a degree program. From an economic perspective the right advice is “Get a degree or don’t go.”

Publicly financed education spreads the costs across the entire population (not just those with kids) and across each individual’s lifetime. Spread out in this way, the costs don’t seem so overwhelming.

Age discrimination laws can protect older employees against being unfairly dismissed by their old firms, but they cannot get them a good job at a new company. Employers get to decide whom they will hire. In a fast-changing world, older employees too often bring obsolete experience and out-of-date skills. There are always a lot of possible young employees who look better and are better. Older job seekers do not suffer from discrimination. They are objectively economically obsolete.

RULE TEN: The biggest unknown for the individual in a knowledge-based economy is how to have a career in a system where there are not careers.

Under capitalism those who own tools are the decision-makers, and market wealth consists of the ownership of tools and the output that flows from them.

Current consumption expenditures on the health care and pensions of the elderly (over 50 percent of the federal budget now goes to the elderly) are driving investment spending out of the federal budget.

Rising stock market values cannot be used to finance investment in new tools. The money received by those who sell stock must be equal to the money given up by those who buy stock. It is a zero-sum transaction as far as investments are concerned. It generates no new funds for building tools. Only holding consumption below earnings can provide the necessary resources to build tools.

In America, all of our social conditioning is now leading not just toward the primacy of individual consumption but toward the view that nothing else matters at all. Billions are spent advertising the benefits of different consumption goods. Little or nothing is spent advertising the importance of investment goods. When he first came into office in 1992, President Clinton was debating whether his new administration should focus on health care, education, or infrastructure. He chose health care, a form of public consumption, rather than education or infrastructure, both forms of public investment. He did not just make a political mistake. He focused Americans on a consumption problem when he should have focused them on investment problems. Even if he had succeeded in reforming health care, it was the wrong problem to address. He could and should have focused us in a very different direction.

In cities that have developed since the onset of the auto age, population densities simply aren’t high enough to justify the frequency of service that makes mass transit competitive with the auto in cost or time.

Market prices measure what is happening to the relative supplies and demands of natural resources. What has happened to oil is happening across the spectrum of other energy supplies, minerals, and agricultural products. Reductions in demand plus new technologies have created a world where natural resource availability is growing far faster than demand.

It is not possible to have American standards of living at home without at the same time having American production standards at work.

Americans want more than they have, but with marketable wealth of just $1.3 million invested in riskless government bonds, one could have those dreams without ever having to work, without ever touching one’s principal, and at death be able to leave one’s children $1.3 million in wealth.

In all countries, wealth is much more unequally distributed than earnings.

Falling equity in one’s own home is also the principle reason why the wealth of the median household is going down in absolute terms. When it comes to the wealth accumulation of the median family, home equity loans (something first allowed in the mid-1980s) have been a disaster.

Great wealth does not depend on personal savings, but modest wealth does. With lower savings rates in America, less wealth for those with lower savings rates should come as no surprise. Americans have a more unequal distribution of wealth because they have chosen to have more current consumption and less wealth. America’s greater inequality is simply a matter of different tastes.

Acquiring great wealth is best seen as a conditional lottery. Luck is necessary. One does have to be in the right place at the right time. Great wealth is created during times of change – the second and third industrial revolutions. Capitalizing on existing disequilibriums (technological, sociological, or developmental) is the name of the game.

Wealth is created in the financial markets but not by the financial markets. Financial markets capitalize the value of eliminating technological, developmental, or sociological disequilibriums.

With electronic shopping, where products are delivered to the home rather than carried home by the buyer, maybe the profits will be made by the delivery companies (UPS, Federal Express) and not by those that run the Internet stores. For what new, never-before-delivered services will people be willing to pay premium prices? What will have to be done to preserve those premium prices?

In the long run market wealth cannot grow unless productivity grows. Productivity is the putting together of the basic building blocks of the wealth pyramid so that humans with finite lifetimes and limited energy levels can produce ever greater levels of output. New technologies are staffed with new skills organized in new ways using new tools powered by new sources of energy to make new things. The difference between output and input growth is what causes wealth to increase.

Slower rates of growth in the capital-to-labor ratio inevitably mean slower rates of growth in productivity.

The antitrust suit against Microsoft is a dramatic case in point. It illustrates a type of regulatory chaos that doesn’t make sense in a well-ordered society. It’s a suit that would not have been brought in any other country in the world. In a short period of time Microsoft has become the most valuable company in the world, with a dominant global market position. It is precisely the kind of company that every country wants. Anywhere else it would be protected like a crown jewel. Other governments would ask what they could do to help it – not what they could do to hobble it … But such erratic, nonsensical actions reflect a type of regulatory chaos that does create economic space for other firms – even if those other firms are apt to be in other countries. American industry has too much chaos, but too much is clearly better than too little when a country reaches America’s position on the wealth pyramid. A high degree of chaos leads to economic creativity.

Revolutions cannot be organized from the top by those running the old system. Revolutions are always frightening to those with vested interests. Those at the top of any successful system, whether political or industrial, have vested interests.

Leaders are not entrepreneurs. Leaders are the order part of the system. Entrepreneurs are the chaos part of the system. Both are necessary, but neither can play the role of the other. Creativity cannot be organized. It is a product of disorganization. In very successful societies, creativity requires some chaos, but not so much chaos that there is not enough order to use what has been invented.

Large bureaucracies, whether government or private, always have too many vested interests in the old to be pioneers of the new technologies that will destroy the old … Capitalism’s only advantage is that death is easier if big firms are privately owned … Socialism never figured out how to kill its dinosaurs; they just went on using up resources until the system collapsed.

Big companies are where managers of the new companies learn the management skills (make mistakes on other people’s money) that allow them to start up their own companies with fewer mistakes.

Centrally organized economic change is theoretically possible but in practice impossible. The economic losers who already exist are always politically stronger than the potential winners who have yet to come into existence.

Capitalism does not work when assets have to carry debts whose value is greater than the market value of the assets themselves. Capitalism only works when profits can be earned.

If countries cannot do what is necessary, economic stagnation looms over their futures. But the causes of that stagnation are not in the economy. They lie in an unsolved political crisis – an inability to act when action is required – that leads to disastrous economic consequences.

Judges don’t think about what makes sense from the perspective of accelerating technological and economic progress. Their concern is with how new areas of technology can be inserted into the legal framework with the least disruption to existing legal interpretations.

As monopoly power wanes, and social interest in encouraging the development of new intellectual property grows, the balance in our system should shift toward encouraging the production of new knowledge and be less concerned about the distribution of existing knowledge. Tighter or longer-term patents and copyrights are warranted.

If someone cannot think of how a legal right can be enforced, it should not be a legal right.

The system must be able to determine rights and resolve disputes quickly, efficiently, and cheaply. Many of the problems with the current patent system flow from the lack of consistent, predictable, rapid, low-cost determinations about intellectual property rights and a means of quick, cheap dispute resolution.

To accomplish society’s interest in expanding knowledge as rapidly as possible, certain classes of knowledge ought to be in the public domain and freely available to everyone. The use of basic scientific knowledge is central in an era of man-made brainpower industries because it allows breakthrough technologies to be developed.

Because of low salaries, elementary and secondary teachers tend to come from the bottom of the education distribution. Americans are asking people who were not themselves good students to teach others to place a high value on being a good student.

Part of the American workforce will have the skills necessary to take advantage of the new technology-intensive global economy. They’ll march on to economic success, joining a global team and leaving the rest of the American workforce behind. The problem isn’t that this model won’t work. The problem is precisely that it will work … The problems are basically moral. Is one living in a good society if that society knowingly lets a major fraction of its citizens drop out of the first world and effectively become third world wage earners?

Governments can increase investment by spending more of their own funds on infrastructure tool-building … The tax system could be shifted from an income/payroll-based system to a consumption-based one in which citizens are taxed only on what they take out of a system (consumption) and not on what they put into it (tools or work effort).

The returns to capital are up and the returns to labor are down. On a global basis labor is more abundant relative to capital than it is in the developed world. As a consequence the earnings of capitalists grow, and the earnings of labor fall. Similarly the returns to skills are up and the returns to raw unskilled labor are down.