Why Winners Go Down: Economies, Firms, or States

I have spent much of my career wondering why winners go down.  Revolutions, of course, my main specialty, are the most spectacular case of winners going down.  The former rulers and dominant classes are overthrown and cast aside, much of what they had built up over decades or centuries being lost.

But there are analogous cases in other fields.  In global economics, leading economies fade and are overtaken by others.  Spain, with its glorious global empire in the 1500s, was overtaken first by the Dutch, then the British, then the Americans, over the next four centuries.  In the process, first Spain, then Holland, then Britain, went from being the richest and most powerful country in the entire world to a condition of near irrelevance in the global hierarchy.

In capitalist competition among firms, there are similarly winners who become losers.  IBM is a great survivor, as are Ford and GM, Coca-Cola and Proctor & Gamble and others.  But who now remembers such once-great iconic firms as Woolworth’s, A&P, Pan American, Kodak or Montgomery Ward?

Today, I am preparing for a lecture tour in Japan to address Japan’s future.  There —  just like in America, but much closer to their own shores — they are looking at the dynamism of China and asking about themselves:  will we be overtaken?  Are we the next “winner” in recent history to become a “loser” in the shadow of China’s spectacular rise?

In thinking about this, I am thinking in general terms about what makes once-great nations, economies, or firms turn into failures, sometimes spectacular ones.

The answer is pretty simple.  It’s as old as the story of Easter Island, or as new as the story of Kodak.  And it’s a well known story; it is just remarkable how difficult it is for people to learn from it.

The simple answer is this: the world is always changing, as new ideas and new markets and new technologies come on the scene.  Some of these are what Harvard Prof. Clayton Christenson calls “disruptive innovations,” because they have the potential to make novel and weaker competitors able to compete effectively with established dominant players.  So in order to stay on top, dominant firms or nations have to periodically re-invent themselves. Whatever advantage made the dominant firms or nations dominant will eventually lose its edge; so to stay on top, the dominant firms or nations need to find new advantages to stay ahead of emerging competitors.

Thus the Spanish advantage, based on heavily armed infantry and caravel ships, which overpowered all competitors in the 16th century, gave way to faster and more powerful warships and much better drilled and armed troops developed by the Dutch, using wealth from innovations in windmill power, commercial grain and dairy farming, cod fishing and processing, warehousing, and finance.  Then the British developed even better navies and more powerful national finance mechanisms and made a better imperial bet: grabbing the markets for Asian manufactures (in India for cotton cloth and in China for ceramics and silk), rather than the Dutch approach of taking a monopoly of spices in Indonesia (raw materials of declining value).  British efforts at creating home-manufactured substitutes for these items led to an unexpected industrial revolution that made Britain supreme.

In each case, the dynamics were similar.  The decision-making elites in the dominant nation were so successful at exploiting the advantage they had, that they couldn’t see their way toward abandoning those advantages to gamble on something else. Worse yet, during their period of global dominance, they were rich enough to afford certain inefficiencies that made their lives easier.  Thus the Spanish could afford tax privileges for their elites; the Dutch could afford to become ever more reliant on finance rather than production, even the British in the wake of their industrial revolution allowed themselves to become reliant on apprenticeships and the success of tinkerers to drive innovation rather than create a modern scientific educational and training system for its workers and industrial research (as Germany did, who soon displaced Britain as the global leader in manufacturing).   These inefficiencies in fact came to be seen, in an error only visible in hindsight, as basic rights or advantages that the elites were loathe to surrender and fought to maintain, even as they condemned their nation to growing impotence and irrelevance.

What we see here is the problem of undertaking short-term pain for long-term gain writ very large.  For an individual, making that trade-off is difficult, but possible.  But for an entire elite class, it often seems truly impossible to convince them that undergoing the pain of giving up much-enjoyed and valued privileges and wealth and easy profits and power, in order to give up current advantages that are fading and find new ones that will assure the future, is worthwhile, indeed essential to their survival.

Part of this is rooted in elite’s attitudes toward inequality.  When a nation or firm is poor or small and struggling to catch up, the inequality that matters to that nation or firm’s leader is often the gap between their country and that of the world leader.  To close that gap, they need to make sure that every person in their country, or their firm, is as productive as possible.  They invest in whatever techniques they can find to boost that performance throughout their economy or firm; in the process they often find some advantage than when honed and developed propels them to become formidable competitors and even to overtake the formerly dominant leader.

But when a nation or firm experiences rapid gains and starts to catch up to, or even overtake its competitors, its elites and leaders may grow attached to the wealth they have gained and the particular techniques and habits that accompanied it.  They become wedded to their privileges and social practices as the foundation of their elite status.  At that point, they may cease to care very much  or at all about the welfare of their ordinary workers and citizens, instead doing whatever they think will best maintain their own wealth and power.  This was the case for Spanish aristocratic army commanders; for Dutch oligarchs and financiers; French noble landlords; and British industrialists.  For a while, they can indeed maintain and grow their wealth by abusing and exploiting the ordinary soldiers, workers, and people of their society or firm; but in the longer run they will lose the enthusiasm and productivity and competitive edge of their society or firm as a whole.  Instead of being able to innovate and draw on the strength of the best workforce or most capable citizenry, they will be thrown more and more on their own devices, and then easily overtaken by firms or nations that have better prepared and empowered their people to innovate and strive to overcome others.

This was shown most clearly on the battlefields of 18th century Europe.  Over the 17th and 18th centuries, noble commanders grew ever more distant from their conscript troops; the latter fought only under duress and with little enthusiasm for any cause or loyalty to their commanders, seeking mainly to survive.  When Revolutionary France changed this equation by recruiting troops to preserve a republican regime that made them citizens, led by officers chosen and promote for merit, they overcame every army thrown at them by other still-aristocratic European monarchies.

But Japan taught the same lesson to comfortably inefficient American manufacturers in the 1970s and 1980s — by empowering workers, raising their education and human capital, Japanese manufacturing overtook American giants in regard to both cost and quality, bringing American firms in numerous industries to their knees.

America survived by restructuring its old industries (although many went bankrupt or nearly so and never regained their global domination), but mainly by pioneering in new information and computer and materials industries.  America’s great research universities, and the ease of forming new companies to exploit their discoveries, allowed America to retain its place in the world economy despite the loss of its former dominance in much traditional manufacturing, where Japan and Germany and Korea (in many high end industries) and China (in most low-end industries) took over.

But today, both Japan and America again risk fading away.  American elites have created a system of income and wealth inequality and expensive private-financed education that is gutting the state universities and making private university education unaffordable for the vast majority of the population, along with K-12 education that is, as a whole, among the worst in the developed world.  Tolerating a stagnation in wages and decay in relative human capital (recent tests of 15 and 20 year olds show that American high schoolers and college graduates rank toward the bottom of the 20 leading industrialized nation in skills), American firms will struggle to compete against firms and countries with much more capable talent.  For the last thirty years, America’s competitiveness has relied heavily on the skills of the baby-boom generation (including Bill Gates, Steve Jobs, and many others) and immigrants (Sergey Brin and numerous Asian founders of high tech and financial firms).  As the baby-boomers, who were at the time the best educated population in the world, fade away, and the doors to immigrants close tighter and tighter except for the family members of existing Americans, the overwhelming advantages that America had over other nations will fade as well.

Japan has a different problem but one just as profound.  Japan still has the world’s best educated population — by all tests its high schoolers and recent college graduates have the best literacy and numeracy of all advanced nations.  Yet Japan has its inefficiencies as well that are crippling it today: a respect for the elderly that keeps control of key institutions in the hands of 70 and 80 year old leaders while it is difficult for younger people to start their own firms to compete; and a confining view of marriage that makes women choose between family and career and makes choosing a family unattractive.  The latter has resulted in drops in marriage and fertility that are causing the size of the youth and working-age populations to plummet, starving Japan’s domestic market demand and labor force.  At the same time, Japan is opposed to immigration, and severely lagging other advanced nations in English language skills, so that it is unable to draw in talent from outside its own shrinking population.  Despite the quality of its young work force, Japan is thus starving itself of the numbers of young people and families it needs to sustain its own growth.  Unless it can change these aspects of its social practices, it too will continue to fade in global competition with more dynamic societies.

The statues of Easter Island are mute testimony to what happens when elites continue to place maintenance of their own positions above the welfare and productivity of the ordinary citizens of their society, and are unable to wrench themselves out of old habits.  But history shows us that this is the norm, not the exception.  Winners become losers; that may be as true of America and Japan today as it was in so many places across the centuries past.

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About jackgoldstone

Hazel Professor of Public Policy at George Mason University
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3 Responses to Why Winners Go Down: Economies, Firms, or States

  1. Marco Ronchese says:

    Dear Jack,

    Please ask your programmer to insert a link that will allow your steadfast readers to share what you have to say on their Face book timelines, and to like you.

    This is a great way to increase your readership and export your very valuable intellect and genius and the clear and concise way that you get the message across.

    Yours,

    Marco

  2. Tim McCandless says:

    Jack,
    Another thought-provoking piece and thanks for sharing!
    In Japan’s case, I believe culture should be very central to your evaluation of Japan’s future as a world power. Japan’s pure and monolithic culture impedes its ability to evolve and stay relevant within the modern context of global change. Japan’s fate is likely to be similar to France’s defeat in WWII and use of its Maginot Line.
    There are so many good examples of this failure in military history and this phenomenon is routinely studied at our “war colleges”. In military speak, we actually have an acronym for this– RMA = Revolutions in Military Affairs. My favorite example in land warfare is the French Maginot Line (which the French developed after witnessing WWI’s trench warfare) Versus the Tank and the German Blitzkrieg. It’s interesting to note that the Brit’s actually invented the tank and used it first in WWI but discarded the idea ostensibly because it got bogged down in mud and didn’t go very fast or shoot accurately. In truth, it was probably British Army culture that doomed the tank from the start. The strong culture of the British cavalry was such that it rejected any new ridiculous ideas that didn’t involve horses and fancy uniforms and the colonels and generals who were the decision-makers simply squashed the idea. For their part, the French who had witnessed first-hand the horrors of WWI’s trench warfare built the Maginot Line in order to contain Les Bosches. For their part, the Germans immediately understood the military value of the tank and what was to become “maneuver warfare” — avoiding a frontal engagement and encircling the enemy thus cutting off their lines of communication and supplies. Of course, the U.S. employed such a strategy very effectively against Iraq in Desert Storm.
    Many focus on disruptive technologies that fundamentally change the game but I think the effect of culture is undervalued. I think you should focus on the Japanese monolithic culture as an impediment to change.
    Best wishes, Tim McCandless

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