The forward and backward flow of technology: the relationship between foreign suppliers and domestic technological advance

Technovation 20 (2000) 403–412 www.elsevier.com/locate/technovation

The forward and backward flow of technology: the relationship between foreign suppliers and domestic technological advance Steven G. Craig *, Thomas R. DeGregori Department of Economics, University of Houston, Houston, TX 77204-5882, USA Received 2 June 1999; received in revised form 27 October 1999; accepted 21 January 2000

Abstract This paper discusses the process of technological flows between countries. In particular, we discuss how technology can flow from the originating country to a foreign country, and how in turn direct foreign investment by the recipient foreign country can return technological advances to the originating country. We apply our discussion to the automobile industry in the US, and present evidence that direct investment by Japanese auto firms, and in particular the pioneering involvement in the US of Honda, has improved the rate of technological advance by US manufacturers.  2000 Elsevier Science Ltd. All rights reserved. Keywords: Technology transfer; Automobile industry; Cost; Technological change

1. Introduction Technology transfer has been considered as a unidirectional phenomenon. To economists like Thorstein Veblen, technology transfer was the means by which allowed a borrower of technology to gain economic ascendancy over the lender (Veblen, 1954). In an internationally competitive world, this makes the lender a substantial loser in the battle for domestic and overseas markets. Technology transfer may still have been very much a positive sum game, but the preponderance of gains went to the borrower of technology. This model of technology transfer is in conflict with the otherwise prevailing view of economists that stressed the benefits of an open economy. In this paper we offer a different conceptualization of technology transfer. It is a model that has surprising policy implications for governments and possibly for business enterprises. We illustrate the model with a study conducted on the impact of investment in the United States by a Japanese automobile company, Honda. We contend first that the traditional historical analysis of technology transfer has ignored what we call the “back* Corresponding author. Tel.: +1-713-743-3812; fax: +1-713-7433798. E-mail addresses: [email protected] (S.G. Craig), [email protected] (T.R. DeGregori).

flows” of technology (and the subsequent stream of improvements) which makes the original country better off than they would have been in the absence of the transfer. Second, we argue that in the contemporary global economy with electronic information movements, the backflows can be rapid and substantial. This rapid return of technology gives the lender an enhanced capability of taking advantage of the improvements to regain a leadership position. Being open to trade has long been seen as being of benefit to the leading country or firm but not open access to their technology. This is clearly in line with the way that governments and firms have viewed technology. For governments and firms, technology and even science were assets which must be protected with enforced secrecy. This often included preventing people with specialized knowledge from migrating to another country. This practice has persisted in modern times particularly for weapons scientists and technologists in totalitarian countries. Along with the Scientific, Technological and Industrial Revolutions has come a different conceptualization of the social process of sharing knowledge. In technology, there emerged the idea of a patent. The term literally meant “to open to public inspection.” In theory at least, a patent grants the inventor a period of monopoly rights in exchange for a complete sharing of all the knowledge necessary to replicate the process or

0166-4972/00/$ - see front matter  2000 Elsevier Science Ltd. All rights reserved. PII: S 0 1 6 6 - 4 9 7 2 ( 0 0 ) 0 0 0 0 8 - 0

404

S.G. Craig, T.R. DeGregori / Technovation 20 (2000) 403–412

invention. This provided the incentive to invent and furthered the social process of invention and innovation by allowing the invention and the implicit knowledge contained in it, to become part of the cumulating body of technological knowledge. Similarly in science, there was the emerging idea of the public character of learning. Knowledge was to be shared in the common effort to push back the frontiers of ignorance. Built into the very process of scientific method, research and the sharing and acceptance of it was the concept of replicability. The results of an experiment could only be recognized as valid if the research could be replicated and the outcome could be realized by other scientists. The benefits of sharing and openness also emerged in areas where science, technology and application overlapped. For example, navigation was one of the most closely and fiercely guarded secrets of a country since it involved both commercial and military potential. In the middle of the 19th century, countries and firms began an international sharing of information and thereby laid the foundation for the system we have now. Today, we take for granted that a sharing of navigational knowledge is in everyone’s best interest. Despite these important areas of international cooperation, the dominant mode of thought and policy is one that technology transfer, at all but the most rudimentary level, is harmful to the lender. Intellectual property rights are to be protected. This is generally in the form of prevention of their use rather than for fair compensation. Ironically, there is a real substantive possibility that it may be in a firm’s best interest to have its technology borrowed by another user. This proposition is counterintuitive and difficult to prove, but it should not be dismissed out of hand. Firms, that are unable to take advantage of backflows, are undoubtedly destined for failure with or without technology transfer. A firm which has had its technology borrowed and improved upon when the firm is still potentially innovative and a leader in research, is better able to borrow the technology back than if it were borrowed at a time when it was less innovative or may have fallen behind in other ways. Any user of a technology, particularly a pioneer, is virtually certain to develop blind spots concerning its potential, technological borrowing becomes an essential component of technological progress. Consumers and firms benefit from open economies that facilitate the movement of technology. Firms suffer “a phenomenon that has plagued successful large enterprises since industrialization began: the tendency to react inappropriately to a technology or other kind of radical innovation that threatens their business (Lorenz, 1994).” Some companies fail to notice an innovation until it is too late. Others reject it, re-investing desperately

but usually ineffectively in their existing technology or business. Still others embrace it, but only halfheartedly (Lorenz, 1994). James Utterback, whose work is the basis of Lorenz’s article, argues that “the importance of technological innovation has not been adequately addressed (Utterback, 1994).” He adds: Innovation is at once the creator and destroyer of industries and corporations. Over the years, new technologies have made industrial giants out of many upstart firms, invigorated older ones that were receptive to change, and swept away those that were not. (Utterback, 1994p. xiv) In a section titled “Innovations from Outsiders,” Utterback argues that “industry outsiders have little to lose in pursuing innovations.” Conversely, “industry insiders... have abundant reasons to be slow to mobilize in developing radical innovations.” (Utterback, 1994p. 161) He adds that “a critical pattern in the dynamics of technological innovation... is the disturbing regularity with which industrial leaders follow their core technologies into obsolescence and obscurity (Utterback, 1994p. 162).” In brief, the argument in our paper is that the process of technology transfer is not uni-directional. In particular, if the conditions for allowing technological backflows are in place, such as through direct foreign investment, then originating firms have the potential to make up lost ground.

2. Technology transfer 2.1. Historical perspective The historical process by which the United States acquired technology is instructive and has similarities to the present. As with all countries, the United States was originally a borrower of technology, and built its economic dominance on technology developed elsewhere (Veblen, 1954). The US first acquired applied technology, while lagging in the basic technological research from which it was derived. The lag in research and science lasted a half century or more from about the turn of the twentieth century to the end of World War II. Today, the United States is no longer the unchallenged leader in applied technology even though it is still the leader in research and science. One purpose of this section is to show that while technological leadership may be shared, US competitive policies will help ensure that the US does not fall behind other countries. The process of borrower surpassing the lender is as old as technology transfer itself. In the overall movement of technological borrowing that led to the Industrial Rev-

S.G. Craig, T.R. DeGregori / Technovation 20 (2000) 403–412

olution from the Mediterranean countries to Northern Europe to England to the United States, technological leadership was transferred as well. At no time was this overall diffusion purely linear and unidirectional. There were always interactions such that the lenders, though losing their competitive advantage, are more productive from the backflow of the technology whose transfer they had tried to prevent. In previous eras, countries attempted to implement isolationist policies to prevent the passing of technological leadership. These policies were doomed to fail, as they prevented the emergence of new ideas. For example, from steel making to tin plating to improvements in railroad technology, the United States and Germany used British technology to surpass England in these and other areas of industrial production (for plating, see Minchinton, 1957; Purcell, 1962; for steel, see Rosseger, 1967; Adams and Dirlam 1966, 1964). This phenomenon was observed by the American economist, Thorstein Veblen, over three quarters of a century ago in his book Imperial Germany and the Industrial Revolution in which he also correctly saw the rise of Japan as an industrial power. Veblen spoke not only of the “merits of borrowing” but also of the “penalty for having taken the lead and having shown the way.” As the US is in a position to show, this historic penalty need not be paid if the process is properly understood and policies of openness to change are pursued. After United States independence in 1783, England sought to limit the export of its technological knowledge. Clearly these efforts failed, and failed on two fronts. Technology was eventually transferred from England to other countries, including the US. A famous example is the American Samuel Slater who “smuggled” out a complete working knowledge of a textile factory. A second and even more important failure is that because of its isolation, England was not able to fully reap the advantages of the “backflow” of technology developed by other countries. The United States did more than borrow England’s technology; it also greatly improved it. By improving the technology, the United States was able to surpass England and move to the forefront of industrial nations by the late 19th century. Even though the originators of a technology may fall behind, they may eventually borrow back the improvements and will therefore also benefit from the process of technology transfer. This is as true for individual firms as it is for countries. England may have lost the position of the world’s greatest economic power but its economy has continued to expand throughout this century. Clearly, it would have been better for England to have used effectively the technology that it pioneered. US firms that are downsizing because they have failed to stay ahead technologically still have the opportunity to regain a leadership position if they understand the

405

realities of technological change and sustain the basic scientific and technological capability to innovate or utilize the latest in technology wherever it is developed. We will attempt to show that open and competitive conditions are the requirements for avoiding the fate of England. The movement of technology from Europe to Asia, or the trans- Pacific transfer of technology throughout this century, has been in part a return of some technologies to their region of origin (DeGregori, 1985a). In recent decades the direction of the flow of technology transfer has again reversed, and the movement of technology is more multidirectional. A central thesis of this paper is that the multidirectional movement of technologies and the continued expansion of international trade has benefitted all those who are participating in this process. What is exciting about the current situation is that, by learning from the history, the benefits of technology transfer can be realized and the costs avoided. A reasonable definition of technology would include not only nuts and bolts, but also all the intellectual and organizational processes which facilitate and enhance the productivity and production. Today, Japanese firms are transferring practices such as “continuous improvement” (or kaizen) and the “worker as expert,” that are consistent with a basic understanding of technological processes. Even more profoundly consistent is the movement in the United States towards creating a more open competitive economy operating in a global marketplace. It offers the potential of basically changing the nature of technology transfer and of increasing the benefit to all participants in the process. In particular, in a modern open economy with sophisticated communication and information systems, the technological flows can very quickly become multi-directional. Thus an open economy allows “backflows” of technology from the former borrowers back to the original lenders. This backflow of technology allows former lenders an opportunity to regain a leadership position. It is in the best interest of the United States to promote policies that allow access to technologies which can further be developed with the existing research capability. By using foreign investment as an essential component of its open competitive economy, the United States has enhanced the potential for domestic firms to gain from technology transfer. The location in the United States of foreign firms significantly accelerates the process of technology transfer. This results in domestic firms having a vastly better potential for using the new technology to remain competitive, and to even become dominant again. This is particularly true for the United States where it is recognized that we have a clear, and some suggest commanding, lead in scientific and technological research in universities and in private and public institutions. Virtually any major US firm has command of the research and engineering capability to reap the

406

S.G. Craig, T.R. DeGregori / Technovation 20 (2000) 403–412

benefits of technologies returned from abroad. This return to technological leadership provides an essential ingredient for the continuation of leadership in scientific and technological knowledge. Once seen as a loss to the lender, technology transfer with rapid backflows can now be seen as highly beneficial to both the original leaders and the borrowers. Borrowers of technology play a vital role in technological progress by exploiting new potential in existing processes, and by innovating technologies which others including the original lender will quickly follow. 2.2. Transmission mechanisms for technological backflows One lesson from our historical look at technology transfer is that many firms have to be forced to innovate. There are few more effective spurs to innovation than competition within ones’ own cultural and political boundaries. There are innumerable potential “explanations” for the economic and technological success of foreign competitors, such as differences in culture, differential wage, interest rates, or raw material prices, and overt or covert government subsidies, which may be sufficiently plausible to justify existing barriers to change. When the competition is domestic, even if externally owned, then these “explanations” lose their effectiveness, making firms more likely to recognize that they must either adapt or die. As a practical matter, it is far more difficult to erect legal barriers to competition against domestic trade than against foreign trade. When competition is external, domestic firms are tempted to use policy strategies such as barriers to trade to defend their markets. Even a proportionately small reliance on policy options to defend domestic markets can be highly detrimental to a firm’s long term ability to compete domestically and internationally. When the competition is located within the domestic economy, technological competition becomes the only viable strategy. The result is improved quantity and quality of output. A more closed economy may for a period of time “protect” its industries. In protecting them from competition, it also prevents them from receiving transfers of technology. When the economy is forced to be more open, the previously “protected” firms are now much further behind technologically and will find it more difficult to remain economically viable while catching up technologically. New agreements expanding regional and international trade allow less protection, firms have to be more competitive to survive. US automobile manufacturers find themselves more viable and competitive because of the US location of firms such as Honda. Some studies show that American firms are now more competitive than are many European automobile manufacturers that “enjoyed” a more protected market in the 1980s (McKinsey Global Institute, 1993). With European auto-

mobile firms establishing facilities in the United States, it is reasonable to conclude that they are coming in order to gain greater proximity to what is now more productive technology. Irrespective of the reasons for European entrance in the US, Honda has shown them and others the potential success of locating automobile production in the United States. Policy actions taken in the United States towards creating a more open competitive economy reflect learning from the history of technology. A more open and competitive economy allows the United States to benefit from the technology of foreign based firms that operate in the domestic market. The movement of producers to the US facilitates effective, accelerated technology transfer to the benefit of other domestic producers as well as consumers that reside in the host country. Technology has often been described primarily in terms of its material components. Technological software, however, such as the organizations, skills, knowledge, and behavior, is arguably the most critical for development (DeGregori, 1985a). The developing world is replete with examples of material technology being transferred in the form of plant and equipment without the software essential to its sustainable functioning (DeGregori, 1969; DeGregori, 1985b). The result has too often been enterprises that drain the government budget with no prospect of efficiently producing a profitable output. An emphasis on the technological software does not deny the importance of its embodiment in material technology or hardware. It is one thing to understand the theory and another to translate it to an operational machine. There is an interplay between a theory, its attempted material embodiment, overcoming difficulties, and the knowledge gained from this problem solving effort (Ayres, 1944). This is what is called “learning by doing” and is a central component of the Japanese practice of continuous improvement. Technological change, whether in hardware or software, is a continuous process. The practice of “continuous improvement” is very much in line with the history of technological change. The relatively continuous chain of small improvements establishes the condition by which a particularly significant change gives rise to the designation of “invention” (DeGregori, 1985a). Watt’s steam engine was preceded by nearly three centuries of continuously improved steam driven atmospheric pumps which were themselves preceded by over a millennium and a half of steam operated objects. This continuum of small transformations is more likely to occur when those who work with a technology are in position to innovate. The Renaissance scholar/craftsmen used knowledge from working the furnaces in the development of chemistry and metallurgy. This represented a sharp break from the practice of the ancient Greeks. Those who worked the furnaces were

S.G. Craig, T.R. DeGregori / Technovation 20 (2000) 403–412

“rightly dishonored” for their blackened faces — according to the Xenophon (Burkhardt, 1952). The modern technological society realizes that those who work with a technology are able to see emerging technological possibilities or scientific embodied processes (Farrington 1944, 1947). One of the key benefits of the American location of production facilities of foreign based firms is more rapid transmission of their manufacturing technology to traditional American producers. This section discusses technology, the mechanisms for its transfer from one firm to another. In our case study, we found that technology transfer to the rest of industrial America was facilitated by three effects: 앫 The Demonstration Effect. This effect acknowledges the positive productivity impact of the first automobile firm to utilize successfully technologies developed in Japan for production in the United States. 앫 The Communication and Location Effect. This effect shows the processes by which a foreign firm has facilitated technology transfer to other domestic US producers. The key aspect is that the costs of transmitting technology are much lower due to the firm’s US location for its productive facilities. 앫 The Policy Effect. This effect discusses the impact of a foreign firms’s US location on the competitive strategies of traditional US producers. It also presents evidence on the effectiveness of government intervention in the competitive market. The first two effects describe in detail the processes by which technology is transferred to others. We develop an estimate of the third effect directly, by looking at the economic losses suffered by American consumers (and employees) when competition does not take place on the basis of the products being offered for sale. Finally, we attempt to estimate the impact of the transfer of technology to the other three traditional American automobile manufacturers. 2.3. Foreign firms in America and technology transfer We have identified four essential components of a foreign firm’s technology that are important for the automotive industry. Once these technologies have been presented, we discuss the mechanisms by which these technologies are transferred throughout the economy. The firm’s contributions can be analyzed in the following categories: 앫 Supplier relations. The close working “partnership” of Japanese automobile firms with their domestic suppliers has been an effective mechanism for technology transfer to these firms. The close relationship has

407

made the domestic suppliers more competitive, domestically and internationally, and facilitated an increase in production efficiency. This close cooperation helps suppliers to improve the quality of their output. This is evident in a recent study that found suppliers to Japanese firms are more efficient than suppliers to traditionally domestic automobile firms (McKinsey Global Institute, 1993). It is also evident from the successful efforts of US and, although less so, European firms to adopt Japanese practices in supplier relationships (Bennet, 1994; Done, 1994). There is however some debate on the profitability of the adoption of just-in-time methods in England (Baxter, 1994). 앫 Design partnership. Some Japanese firms have devolved responsibility for aspects of parts design to their suppliers. Firms are sharing responsibility for quality control with their suppliers, and are helping the suppliers to adopt new techniques such as “quality circles.” Honda also works closely with suppliers on overall product design. These practices have extended suppliers’ productive capabilities and opened new opportunities for profitable endeavors. Thus the suppliers become more independent, and therefore better business partners for other productive enterprises either domestic or foreign. The enhanced ability that the suppliers obtain from their close relationship with foreign based firms gives them a greater potential for innovation, efficiency and competition in other areas of production. Recipients of a firm’s technology form a suppliers’ network across the country allowing firm’s software technology to permeate the entire economy. Technology is further diffused as direct suppliers (tier one) work with their suppliers (tier two). Labor turnover at any of these levels intensifies technological diffusion. 앫 Organizational technologies. Japanese organizational technologies, particularly in viewing the worker as the “expert” and in mechanisms for continuous improvement, embody principles of technological change which are now understood to be essential conditions of technological progress. Our paper notes that technological progress results from the cumulation of incremental changes and not the momentous inventions described in textbooks. The system of continuous improvement is widely copied by firms that consider it to be effective (Bessant et al., 1994). 앫 Business technologies. Japanese firms introduced to the US automotive industry a variety of business and organizational technologies. Among these are “justin-time” inventory supply and “quality circles.” These practices and others improved economic performance, efficient use of financial resources, and the quality of output. There are three major types of technology transfer mech-

408

S.G. Craig, T.R. DeGregori / Technovation 20 (2000) 403–412

anisms by which the processes identified above are transmitted to the rest of the US economy. The first is the “demonstration effect,” which discusses how foreign firms’ US location challenges its competitors by showing their automotive technologies can succeed in the US. The second is the “communication and location effect” which recognizes the importance of low cost information flows for technology transfer. Third is the “policy effect” which discusses how competitive strategies are altered when costly and ineffective governmental policies cannot be pursued. 2.3.1. Demonstration effect Prior to the significant arrival of foreign based automobile firms, the assumption in the US was that Japanese methods of automobile production were operable only in Japanese society. The simple fact, elaborated below, is that their US success proved that these “Japanese” techniques could work here. Since many of these principles were already well known, the impact was relatively independent of the size of the operation, and was instead dependent on being successful in production activities in the US. The US operations of Japanese firms initiated a process of technology transfer that had an impact far beyond that of direct contact or specific industries. To bring the technology to the US, these firms had to adapt both the hardware and software. They not only showed that the automobile manufacturing technology could work in the US but they showed how the technology could be made to work here successfully. Indications of the power of the demonstration effect are not simply the vast changes being undertaken by traditional US auto producers, but the steady stream of both Japanese and German automotive firms into the US. 2.3.2. The communication and location effect Though history shows that technology transfer overcomes barriers of language, culture and distance, it is greatly facilitated by a common language and culture. Attributes of the local environment that ease the technology transfer process include being able to work in the local language, the local context for understanding other employees, suppliers, and written instructions, and the common environmental, cultural, and legal framework. It is like reading a book. It is easier to do if it is in ones’ own primary language. For the United States, the first foreign automobile investors have both written and translated the book of technology so that it is accessible across the spectrum of enterprises. In addition to the ease of communication, the domestic location of a foreign firm lowers the cost to others of acquiring the knowledge concerning their technologies. For example, when advanced technological processes are located overseas, only a limited number of firms can afford the cost and have the potential benefit

to send observers to learn from it. When the advanced processes are located in the domestic economy, then the cost to others of visitations is much reduced. Much more important than simply cost, however, is the domestic location of Honda’s supplier network. There are two potential methods by which technology is transferred. The first potential method of technology transfer is labor turnover. Because both the firm and its suppliers are in the domestic US economy, they hire from the domestic labor pool. Even with relatively low labor turnover rates, nonetheless each person that leaves a foreign firm or one of its suppliers to seek employment elsewhere in the economy is a vital carrier of technology to the rest of the economy. The most important mechanism of technology transfer, however, is most likely the direct interaction among firms. One great advantage to the US of firm’s domestic location is the creation of a network of suppliers. Tier one suppliers sell directly to the firm, while tier two suppliers sell to firm’s direct (tier I) suppliers. Some of these suppliers located to the US from Japan or other foreign countries. Many of them brought new technology, and also formed joint ventures with traditional domestic suppliers. The domestic location of the supplier network has two impacts. First, American firms acquired technology either by being trained by the foreign firm or by observing the practices of firms formerly located in Japan or elsewhere. This process holds for tier one firms, or for traditional tier two domestic firms that supply firms using advanced practices imported from abroad. A second process of supplier interrelations for technology transfer is that the tier one and tier two firms supply other firms such as traditional domestic automobile firms. These suppliers are then able to teach their customers, formally or informally, about the new techniques that they have learned. At the level of both tier one and tier two firms, new technologies would be expected to radiate throughout the economy. 2.3.3. The policy effect The United States has the historically unique opportunity of borrowing back technology while it still retains its lead in research and science. The key to this opportunity is the maintenance of an open competitive economy. In particular, successful implementation of new technologies in the US by foreign firms is important because of the impact on the policy choices of government. One of the central attributes of a foreign firm’s location in the US is that US firms have had to recognize that import regulations are no longer able to protect them from competition. Consequently, the American manufacturers’ long term best competitive strategy is to move towards the adoption of both hardware and software manufacturing technologies that are now demonstrated to be successful in the United States. The beneficiaries

S.G. Craig, T.R. DeGregori / Technovation 20 (2000) 403–412

of traditional domestic firms adopting “best practice” technologies are, as always, the consumers. The workers are also beneficiaries because increased productivity protects their jobs which might otherwise be lost. To understand the magnitude of the policy effect, the recent experience of the United States with the Voluntary Export Restrictions (VER) program is telling. The VERs were introduced in 1981 to limit the exports of automobiles from Japan into the United States. Surprisingly, perhaps, for a temporary policy, the VERs lasted 13 years until 1994. Economists have carefully studied the VER program to ascertain its effects on the automotive industry in the US.1 Three potential impacts are possible. First, prices in the US of automobiles produced in Japan would be expected to rise as the quantity is artificially restricted. The increase in price would be expected to also encourage the traditional US producers to raise their prices as well. While VERs would be expected to reduce the quantity of automobiles imported from Japan, their second effect is on the quantity of automobiles produced by traditional US producers. In particular, the quantity protection of the VERS may not result in increased production by traditional US producers because of the impact on higher prices. The third potential effect of the VERs is on European producers that also have significant market presence in the US. Changes in price and output of European producers would be expected to follow the changes for traditional American producers. That is, their prices are sure to rise, and the change in quantity is uncertain depending on the response to the price increase. An economic study by Feenstra (1985) shows that the price rise in an average Japanese produced automobile was over $700 per car in the first year of the VER, and rose substantially in the years immediately following ($1271 by 1984). Whinston and Associates (1987) show a smaller initial rise (about $313), but a much larger subsequent price rise (over $2500 per car by 1984). These price increases, multiplied by the number of cars produced in Japan but sold in the US represents a straight transfer of money from US consumers to Japanese producers because of the VER. In addition, all studies also show a price rise in the prices of traditional American producers (Feenstra finds that prices rose by $797 per car in 1981, and higher afterwards). This price rise, however, is a transfer from American consumers to American producers. What causes economic losses, however, is that the output of traditional American producers responded very little according to Dinopoulos and Kreinin (1988), and may have even fallen according to Whinston and Associates (1987). Further, Dinopoulos and Kreinin also show

1 In addition to the studies cited below, see the discussion on the costliness of the VER program in Fuss and Waverman (1992).

409

that the European producers significantly raised their prices without increasing output. The aggregate loss to the US economy, excluding the transfer from US consumers to US producers, is conservatively estimated to be over $4 billion per year in 1982, and higher in subsequent years. The result of this transfer from US consumers to foreign auto producers has been no discernable increase in US automobile manufacturing jobs. For example, Dinopoulos and Kreinin estimate the cost of the VER to be $180,000 per US auto job saved in 1981 and 1982. They are not able to estimate the cost per job saved in later years because the number of jobs actually fell. Similarly, Whinston and Associates find that the number of US auto production jobs fell as a result of the VER. In summary, the economic studies of the VER program show that this program has been a very misguided attempt to save US automotive production jobs. The costs have been very high, and the public benefits have been negligible, and perhaps even negative. 2.4. Measurement of the transfer of technology: a case study of Honda Honda’s pioneering move to the US, begun with the opening of the Ohio motorcycle plant in 1979, has apparently had the benefit of reducing the pernicious effects of this misguided public policy. Further, Honda’s impact on the technology of other American industrial firms appears far-reaching. Quantification of the impact of this technology transfer is rather problematic. Nonetheless, it is important to obtain an idea of the potential magnitude of the effect. The most direct impact is to be expected on the automotive manufacturing sector, even though many of the management and productive procedures of Honda are applicable to firms in other industries. This section thus presents two alternative measures of the acceleration in technical change among traditional domestic manufacturers that can at least partially be attributed to Honda’s US presence. The 1993 release from J.D. Power and Associates (1993) shows that automobiles originating in Japan improved from 112 defects per 100 vehicles in 1989 to 92 defects per 100 for 1993, a 21.7% decrease in defects over the five year period. For traditional US firms, however, the improvement in quality is much more dramatic. Defects per 100 vehicles went from 159 in 1989 to only 113 in 1993, a drop of over 40.7%. The gap between Japanese and American firms narrowed from about 42% in 1989 to 22.8% in 1993. Not all of the change in the apparent quality of products manufactured in the US can be attributed to Honda. Nonetheless, through the three effects outlined above, Honda’s presence in the United States has made it easier for the traditional US firms to acquire the technology to achieve these impressive gains. Similarly, Honda’s US presence has also increased the

410

S.G. Craig, T.R. DeGregori / Technovation 20 (2000) 403–412

incentive for the traditionally domestic firms to improve the quality of their products. In a parallel fashion to the quality improvement documented above, the costs of traditional US firms have also fallen. The goal of this part of the report is to quantify the reduction in costs of traditional US firms due to technological improvements. There are, of course, many factors that affect the costs of any firm. The method used by economists to isolate the influence of each factor is the statistical analysis of a cost function. A cost function relates how input prices,2 the output mix, and technological change affect the costs of a firms’ output. We attempt to estimate, using a cost function, the change in costs of the three traditional US firms due to an unexpected increase in the rate of technological change. A study by Whinston and Associates (1987) publishes an estimated cost function for the three traditional US auto firms, using data from 1955 to 1983.3 The results of this study are broadly consistent with another major cost function study, Fuss and Waverman (1992).4 This time period is appropriate, because Honda began manufacturing automobiles in 1982. Thus the rate of technological change estimated by Whinston using the data through 1983 does not account for the presence in the US of Honda.5 We replicate the data set used in the Whinston study for the year 1993, and the year 1983. That is, we obtain data from the same sources as used in the study, and scale the data to reflect the magnitude of the data used in the actual study. Our purpose is to use the 1993 data to predict the total costs of each of the three traditional manufacturers using the published cost function. The published function will not incorporate any increase in the rate of change in technology due to Honda’s US presence. Differences in the rate of technological change from the time period of study to 1993 will be shown by differences in the predicted costs and the actual costs. We use the cost function to compare actual and predicted costs with the 1993 data, but assuming that technology is at the 1983 value.6 The difference in actual and predicted costs is compared to the difference using 2 The use of input prices controls for the quantities of inputs used. Examples of input prices are the costs of labor, the cost of raising investment funds, and the cost of materials. 3 We use this study because the authors are well known, and because the study is published under the auspices of the highly respected Brookings Institution. 4 Fuss and Waverman use a more complicated approach, although they find equivalent general results. We replicate the Whinston study, therefore, because it is equally reliable and somewhat easier to implement. 5 That is, the traditional firms were only beginning to realize any technological gains from Honda’s presence, and these gains would reflect a very small share of the 1955–83 data set used in the Winston study. 6 That is, technology is captured by a series of time trend variables, and we set these variables to their 1983 values.

the actual 1983 data. If the rate of technological progress has accelerated, we would expect that actual costs in 1993 would be lower relative to the predicted costs than is the case for 1983. That is, using the estimated cost function, costs are estimated to decrease on average by 1.81% per year at the values of the 1993 data. This means that if all prices and output levels remain constant, the traditional domestic auto industry would be expected to see its costs fall by 1.81% per year over the decade 1983–93.7 We then compare the actual costs to those predicted by this rate of technological change to discern if costs have, in fact, fallen faster than predicted. The cost function prediction indicates that actual 1993 costs are significantly below what would have been expected if technology had continued to evolve at its expected pace. Our precise method is to compare the difference between actual to expected costs using 1993 data relative to the difference using 1983 data. We find that the costs for GM are not lower, relatively, for 1993 than for 1983. Ford and Chrysler, however, have significantly lower costs. On average, we find that technical change for Ford and Chrysler occurred at a 4.74% rate per year over the decade since 1983. This is 2.93% per year faster than was expected based on the estimated cost function. For the two manufacturers together, an accelerated rate of decrease in costs at the 2.93% rate compounded over the ten years means that traditional US firms have saved over $10.43 billion compared to the case if the rate of technological advancement had not accelerated. This economic impact has been calculated only for the actual automobile manufacturers, and not for their suppliers. To the extent that this $10.43 billion can be attributed to Honda, the outcome of Honda’s US presence is the creation of more formidable competitors, as Honda perceives no direct advantage from the spread of technology beyond its suppliers. It is impossible, of course, to directly attribute the $10.43 billion in accelerated technical change to Honda’s US presence, just as it is not possible to directly attribute the improvement in the traditional automakers’ quality of product to Honda’s US presence. Nonetheless, the channels of technical change we outline above show the process by which Honda’s presence affects these other firms. And to the extent that firms in other industries have benefitted, that economic impact is not quantified. We therefore believe that an estimate of the effect of technology transfusion is conservatively estimated using the $10.43 billion figure.

7 There is a separate rate of technological change for each of the three firms. If the average is weighted by firm size, the result is 1.66%.

S.G. Craig, T.R. DeGregori / Technovation 20 (2000) 403–412

3. Conclusion and policy implications The benefits from free trade, and from allowing the maximum technological advance, have been well known. Our paper here shows these two ideas are linked, because free trade enhances the transfer of technology. One of the interesting aspects of this idea, however, is the backflows of technology into the originating country. That is, it is difficult to retain technological leadership, for either an individual industry or an entire country. As other industries and countries imitate the leaders, they will innovate, and eventually overtake the original leaders. What we illustrate is the continuous flow in this process. Free trade, by allowing the imitators to participate in direct foreign investment in the previously leading country, will then transfer innovations back. We have illustrated the importance of technological backflows by a study of the automobile industry. We find there are three processes by domestic firms respond to technological innovations in other countries; the demonstration effect, the communication and location effect, and the policy effect. All three effects arise because of direct foreign investment here. The communication and location effect is, in essence, the direct transfer of technology. This effect occurs because of the interaction between firms, and because workers are mobile between firms. The other two effects work in concert, and we believe are equally important. Simply demonstrating a technology can be successfully adapted in the US is certainly a spur to traditionally domestic firms, and would thus provide motivation to learn in whatever ways are available. The policy effect is in some sense key, however, because government policy can defeat all the benefits of technological advance. Domestic protectionist policy in the auto industry was primarily the VER program. We discuss that the cost of this program to US consumers was over $4 billion per year, and may have in net protected zero domestic automobile jobs. Despite this mis-guided attempt at industrial management, however, the US economy remains open to direct foreign investment (and ironically, the VER policy may have spurred direct foreign investment). Direct foreign investment had two effects on the VER policy. First, the VER policy became less effective at protecting traditional domestic manufacturers, since the VER policy did not apply to domestically produced autos from Japanese companies. Second, demand for the VER policy by traditionally domestic producers fell as their ability to compete with Japanese firms increased. The increased ability to compete comes from, at least in part, the technology Japan brought here. And in fact, unlike many temporary policies enacted by the US government, the VER policy was actually allowed to lapse. An important, although surprising, implication of our study is that speed is important in the international transmission of technology. If technological backflows are

411

rapid enough, the previously leading country will have sufficient technological infrastructure to rapidly incorporate the new technologies, and thus remain at the forefront of productive processes. If government policy retards information flows, and retards free trade needed to facilitate those flows, then the originally leading country may lose its capacity to incorporate the foreign innovations.

Acknowledgements This research has benefitted from the useful comments of Janet Kohlhase, and from the excellent research assistance of Julie Sakowski, Alan Satterlee, and Roberto Trevino.

References Adams, W., Dirlam, J.B., 1964. Steel imports and vertical oligopoly power. American Economic Review 54 (5), 626–655. Adams, W., Dirlam, J.B., 1966. Big steel, invention and innovation. Quarterly Journal of Economics 80 (2), 167–189. Ayres, C.E., 1944. The Theory of Economic Progress. University of North Carolina Press, Chapel Hill, North Carolina. Baxter, A., 1994. Just in time to fuel the debate. Financial Times, London, August 10. Bennet, J., 1994. Detroit struggles to learn another lesson from Japan: Chrysler has come the farthest in working closely with its suppliers. The New York Times, June 19. Bessant, J., Caffyn, S., Gilbert, J., Harding, R., Webb, S., 1994. Rediscovering continuous improvement. Technovation: The International Journal of Technological Innovation and Entrepreneurship 14 (1), 17–29. Burkhardt, F.H. (Ed.), 1952. The Cleavage in our Culture: Essays in Scientific Humanism in Honor of Max Otto. Beacon Press, Boston. DeGregori, T.R., 1969. Technology and The Economic Development of the Tropical African Frontier. Case Western Reserve University Press, Cleveland, Ohio. DeGregori, T.R., 1985a. A Theory of Technology: Continuity and Change in Human Development. Iowa State University Press. DeGregori, T.R., 1985b. Technology transfer: a problem solving process. A Consultant Report to US. AID, May. Dinopoulos, E., Kreinin, M.E., 1988. Effects of the U.S.–Japan auto VER on European prices and on U.S. welfare. Review of Economics and Statistics 70 (August), 484–491. Done, K., 1994. The challenge is clear: Change or die. Financial Times Survey: World Automotive Components. Financial Times, London, July 12. Farrington, B., 1944. Greek Science. Penguin Books, London. Farrington, B., 1947. Head and Hand in Ancient Greece. Studies In The Social Relations Of Thought, London. Feenstra, R.C., 1985. Automobile prices and protection: The US.– Japan trade resistant. Journal of Policy Modeling. VII (November), 49–68. Fuss, M.A., Waverman, L., 1992. Costs and productivity in automobile production: The Challenge of Japanese efficiency. Cambridge University Park, New York. Lorenz, C., 1994. Learn the lessons of history. Financial Times, London, June 17. Mckinsey Global Institute, 1993. Study on Manufacturing Productivity.

412

S.G. Craig, T.R. DeGregori / Technovation 20 (2000) 403–412

Minchinton, W.E., 1957. The British Tinplate Industry. Clarendon Press, Oxford. Purcell, C.W. Jr., 1962. Tariff and technology: the American tinplate industry. Technology and Culture 3 (3), 267–284. Rosseger, G., 1967. Steel imports and vertical monopoly power: comment. American Economic Review 7 (3), 431–443. Utterback, J.M., 1994. Mastering the Dynamics of Innovation: How Companies Can Seize Opportunities in the Face of Technological Change. Harvard Business School Press, Boston (MA). Veblen, T., 1954. Imperial Germany and the Industrial Revolution. Viking Press, New York. Whinston, Cifford and Associates, 1987. Blind intersection? Policy and the automobile industry. The Brookings Institution, Washington, DC. Steven G. Craig is a Professor in the Department of Economics, University of Houston. His research primarily focuses on the expenditure behavior of state and local governments, and has been widely published in both academic and policy journals. Prof. Craig has conducted numerous economic impact studies for the business community and government. His recent research has examined the economic shape of cities, and how urban economics affects the relationship between city governments and their suburban competitors.

Thomas R. DeGregori is a Professor in the Department of Economics, University of Houston. He is the author, co-author, or editor of numerous books, articles, development reports and reviews. His research interest focus on technology, science, and economic development. Prof. DeGregori has served and is serving as a member of numerous editorial boards, including Technovation, on the Board of Directors of scholarly organizations, on Advisory Boards of professional groups and donor organizations in development. His work as a development economist and policy advisor has involved him in over forty countries in Asia, Africa, and the Carribean.