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News Report on Public Confidence
in the State of the Nation
2013
The Future of American Democracy Foundation
Book Excerpts
From the book In China’s Shadow: The Crisis of American Entrepreneurship by Reed Hundt (Yale University Press, 2006).

Reviews of the book
"A remarkable book about America's response to China, one which should change the terms of the national debate in Corporate America, Washington, and Wall Street. It is deeper than any of the policy-oriented books I have seen, totally original in its focus, and extremely well-written to boot."
- Jeffrey E. Garten, Juan Trippe Professor of International Trade and Finance, Yale School of Management

“Reed Hundt casts a sober and objective eye on the subject of globalization. The results are a powerful call to action. The solution he advocates—changing the culture surrounding innovation—is daunting.  But, as he points out, nothing less than the future of the United States is at stake.”
- Andy Grove, Former Chairman, Intel Corporation

"Reed Hundt offers provocative and intriguing prescriptions for America, as it faces China—its greatest challenge in decades. Offering a unique perspective that combines the role of law, technology, and entrepreneurship, In China's Shadow should be read from Silicon Valley to the White House."
- David B. Yoffie, Max & Doris Starr Professor of International Business Administration, Harvard Business School

"In China's Shadow draws a path for an American Renaissance in response to China's rapid rise. Reed Hundt's new book combines lessons from history, technology and optimism with insights on every page."
- Eric Schmidt, CEO of Google

Selected excerpts:

Introduction
“Or set upon a golden bough to sing
To lords and ladies of Byzantium
Of what is past, or passing, or to come."
       William Butler Yeats, Sailing to Byzantium

“Men are we, and must grieve when even the Shade
Of that which once was great is passed away.”
       William Wordsworth, On the Extinction of the Venetian Republic

China challenges the American economy more than any other nation has ever done. Through a unique and oxymoronic combination of communism and capitalism, China is launching millions of firms into global competition with American firms. At the same time, it is putting hundreds of millions of low-paid, increasingly high-skilled people into competition with American workers. If Chinese firms win big shares of most markets and Chinese labor provides much of the goods and services produced by Americans today, then the American Dream of ever-increasing wealth for everyone who works hard will become a forgotten reverie.

Like the movement of tectonic plates, China’s impact on the United States reveals itself in occasional business quakes and labor market shudders, and over time it will realign the relationship of continents. A Chinese computer maker buys its American rival. A batch of Chinese software engineers takes work from an American team. A Chinese search company enjoys a Google-like rocket trip to an astral market capitalization. The Chinese government talks of creating unique standards for technology products and perhaps even a unique national Internet. Most Americans scarcely notice such events. The rest apply an anodyne “free market” philosophy to their discomfort. Nevertheless, the American Dream rests on a fault line created by the emergence of China’s firms and citizens into the global economy. In one or two generations, the United States may find that China leads the world economy, and historians then will trace the pattern of causation to actions taken and not taken now, in the first decade of the twenty-first century.

China is becoming the world’s center for enthusiastic business creation. It manufactures start-ups. It is fertile ground for entrepreneurship in virtually every market. Already, the businesses in China number about 12 million, approximately twice as many as the United States. Many are very small; perhaps only about three million own a personal computer. But China is one of the fastest growing computer markets in the world, and in less than a decade all its businesses will do business online. From that point, the step toward participation in global markets is short and inevitable.

The possibility of Chinese global success is rooted in vigorous domestic competition among Chinese entrepreneurs. The Chinese winners bring well-honed efficiency and aggressiveness to competition in America and other foreign markets. Because the Chinese domestic market is so huge—the country is already first among nations in annual purchases of many technology products—winners in that market obtain economies of scale that permit them to offer products at very low prices in export markets.

Instead of organizing Chinese entrepreneurship, the government allies with it. Although the state still owns or controls many businesses, it has little capability to fashion a national business strategy. The Communist Party encourages some favorites and exercises control over such important sectors as media and communications. However, for the most part it has relinquished control over the business sector to regional governments and free-ranging capitalists. For their part, Chinese entrepreneurs neither disrupt nor operate outside governmental authority. They partner with the state, even when they are dismissive of its bureaucracy. They are creating a new hierarchy of wealth cemented with political power. By creating domestic markets in a country where only skimpy economic activity existed when Mao Zedong died in 1976, Chinese entrepreneurs are composing a new domestic order in China. At the same time, they are disrupting the existing global order. An important part of their wealth creation at home comes from their attempt to conquer American firms, take control of American markets, and wrest employment from American workers.

American firms in low value-added markets have long experienced Chinese rivalry, but American high-technology businesses know that Chinese firms are coming after them too. Chinese entrepreneurs are not nearly as well-equipped to compete in high-technology markets. In those markets, the Chinese labor cost advantage is not as important as the sophisticated processes and proprietary techniques of American firms. Nevertheless, bolstered by large government support for technical education, a lawless disregard for intellectual property rights, and a favorable exchange rate, Chinese entrepreneurs are aiming at the single biggest piñata of wealth in the global economy, the American information sector. From 1998 to 2003, the United States captured 98 percent of all global economic growth, netting declining regions like Africa against gaining regions like Southeast Asia. Even though the information sector of the American economy represented less than 10 percent of the whole, it accounted for about a third of the American economic success story in the Golden 90s. It continued to create much new wealth even after the market bust of the early 00s. Little wonder then that Chinese entrepreneurs intend to take a piece of the information sector pie, as well as going after share in the global markets for textiles and toys, cars and carbon.

The Uprooting of American Business
“What we’re trying to do is outline an entire strategy of becoming a Chinese company.”
- John Chambers, CEO of Cisco Systems, Inc.

American firms see that China’s new culture is giving birth to entrepreneurs who will attack their markets. In response, they could fight a competitive battle in China. Or, they could stay at home and negotiate joint ventures or other alliances that in practice amounted to a division of geographical markets. Alternatively, they could hollow out their activities, turning themselves into American retail stores for products invented, designed, and made in Asia.

The first choice—competing in China’s domestic market—is the path for most American information technology firms. To win in global competition, American technology businesses are replanting themselves far from their home ground. Firms are moving investment funds, jobs, and executive attention to China and other big new Asian markets. They realize that national boundaries have become as useless a defensive position as the Maginot Line had been for France. Technology products have a high value per ounce and can be shipped for a small percentage of their worth. Therefore, they are traded in a global market. Computers, for example, are assembled in a global supply chain. Moreover, to win sales in China firms have to build plants and install equipment in China. They need to learn the territory. They have to be as adept in competing in China as any purely Chinese-origin firm. Ironically, this means that the American employees of a firm taking on Chinese rivals in China should want their country’s businesses to invest in and move jobs to China. If some in their ranks lose their jobs to offshoring, the rest will benefit from working in a globally successful firm.

If American firms compete successfully in China, they will deny their Chinese rivals the opportunity to obtain economies of scale in China. American firms succeeded with this tactic in the past and know better than to confer this advantage on their Asian rivals. By hiring in China, American firms can lower their average labor costs and more easily justify higher wages for their remaining American employees. Finally, American firms can earn new revenue in China, and at least some of their increased profits might go to their American employees. By choosing to participate in the Chinese market—as well as exporting into it—the American firms expand their own prospects for survival.

Because American firms in the 00s focused more on high-value, traded products, and because the fall of the Soviet Union opened more markets to capitalism, the portion of the American economy involved in global trade increased from below 10 percent in 1990 to about 25 percent in 2003. The traded portion of the American economy grew at twice the rate of the entire global economy. Eventually, the percentage of American firms competing globally, measured by value of output, will rise to the levels of Britain (55 percent) or Korea (75 percent). Therefore, the percentage of American firms entering the China market will increase.

As the global economy grows and the first phase of development in Asia comes to an end, the total demand for engineering skills might exceed supply. By 2015, every engineer in the world might enjoy wage gains. That prospect can cheer the hearts of American engineers only if they start, or find work at, an American firm that is more likely than not destined to succeed in global competition in the future. Working at a successful American technology firm means working for a firm that captures a handsome share of the growing Chinese market.

If Americans in Seattle write a software program, they can sell one copy or a billion copies without incurring significant additional costs. The more customers they have, the more products they can make at an average cost that continually drops. Therefore, if those Seattle software writers capture a share of the huge Chinese market, they will make increasing returns on their investment of time. They then will earn higher wages. If they are confined to the relatively slow-growing American market, they will have to watch Chinese software makers capture the increasing returns from China. In that case, their Chinese competitors will enjoy rising wages, while the Americans experience falling wages. Moreover, if the American software writers cannot generate enough sales to obtain increasing returns, then they cannot generate the cash to adopt new technologies that in turn will give them increasing returns. Microsoft has to sell successfully in China if it is to pay higher wages in Seattle.

By selling into the big Chinese market, firms also create big network effects. By selling chips in China, an American chip maker will gain hundreds or thousands of local developers who design other computer pieces and complementary software that use those chips. Many Chinese firms will thrive, but the American chip maker will survive. It then can pay its American employees more money. In effect, the Chinese developers will create extra value for the American chip maker’s American employees. The American firm also can more easily defend its domestic market share, if it battles successfully in China against its rivals.

Because of increasing returns and network effects, winning firms in information technology tend to win almost completely. Except insofar as rivals can obtain some market share by developing specialized products (like Apple’s graphics and convenient interface), the winner will take most of the profit in the market. Winners are only as good as their next product, but they have more money and momentum with which to tackle the next product challenge than do their rivals. For these reasons, if American employees do not support their firms’ efforts to win competitive battles, their employers might totally abandon America or go out of business entirely.

The Up and Down of Entrepreneurial Culture in America
“One cannot bear to join the madness
But if he does not do so
He will not share in the spoils
And will starve as a result.”
       Traditional Balinese poem, quoted in Clifford Geertz, The Interpretation of Cultures

“Private rites of magic send
The temple prostitutes to sleep;
All the literati keep
An imaginary friend.”
       W.H. Auden, The Fall of Rome

Thinking about new jobs that will raise incomes for all Americans, everyone suffers a failure of imagination. Jobs, income growth, and economic health cannot come from arm-twisting big firms to “keep your best jobs here.” The better the high-paid jobs, the more transient they are. Many service jobs will stay in the United States, but that is no obvious cure to the American workers’ plight. To gussy up the average income for this sector, the U.S. Trade Representative lumps tour operators and insurance adjusters in with doctors and bankers. This fit of egalitarianism cannot obscure the fact that in constant dollars the wages for most service jobs are falling.

Scientific breakthroughs can lead to new goods and services. Jobs in these new high-value markets should pay high wages. But what sciences? What breakthroughs will create new jobs? What firms will emerge to lead in world markets, hiring thousands of Americans as profits soar? Leaders quail at the prospect of picking the winners of the future. They should not be fainthearted. They should have the courage to give up this task. They need to stop trying to make too much sense out of the ferment of entrepreneurship.

No commissions or select group of leaders can or should invent the new jobs or select the new industries. The only adequate response to rising Asia lies in the cultural reform that will vastly increase entrepreneurship. Leaders need to encourage broader (more markets) and deeper (more entrepreneurs) new initiatives without knowing what specific results will follow. They need to focus on architectural changes that support the culture of entrepreneurship. Then American society will see the creation of start-up technological companies in more numbers and in more markets—because increases in the scale (bigger efforts) and scope (more fields of endeavor) of entrepreneurship are required to meet the challenge of rising China. Entrepreneurial firms will stimulate, aggregate, and replicate the unpredictable creativity that lies in everyone. Acting formally or informally together, individuals will make new goods, services, markets, and jobs that are no more imaginable today than eBay or Amazon was before it started. While the Chinese ruling elite try to copy the American economy of the past, American citizens should change their economy, and export their “new new things” to China.

In most underdeveloped countries, ruling elites can encourage national champions without challenging incumbents, because their economies have not produced powerful enterprises, outside of the state itself. In the United States, the serried ranks of highly productive capital stand as a massive barrier to entrepreneurial rivals. In the face of incumbent power, the United States should emphasize change, experimentation, high tolerance for failure, and rapidity of capital turnover as the key characteristics of its economy. This is entrepreneurship, American style. It is also the only viable choice for the American economy, because it already comprises too many markets, and each has too much complexity, for a top-down, centralized authority to implement a detailed plan for job creation. Well-funded special interests in any case would thwart or capture any government plan to favor national champions. The American culture has a long history of leading the world in change: building on that strength follows the sensible rule of doing what one does best.

To meet the challenges of rising China, Americans need purposefully to expand the scale and increase the pace of productive change. The society needs both to lose and gain job classifications at a faster rate. Individuals need to work at more, not fewer, firms during their careers, staying shorter times with each employer. Stability in a particular job at a single firm is not a goal for anyone, much less for the average person. Americans need to speed up the pace of evolution toward an ever more productive economy.

An entrepreneurial economy probably will create new, more challenging jobs and destroy old, easier jobs. According to Cato Institute, from 1993 to 2002 the private sector in the United States added 327.7 million new jobs and lost 309.9 million. In effect, everyone in the workforce moved from an old job to a new job twice during that time, and the total number of jobs increased by about 20 million more than in the previous decade. The job classifications changed even more extensively. Even jobs with the same title at the beginning and end of the decade had new and more complex duties. In successful firms the new jobs, with or without new titles, probably implied increasing income, opportunity for promotion, constant learning, and more interesting challenges. No one escapes risk in an entrepreneurial culture. Firms competing in high-value technology markets cannot count on long, useful lives. In the decade from 1995 to 2004, 184 firms were added (and of course 184 firms dropped) from the NASDAQ-100 list, which is generally reflective of the computer hardware and software and telecommunications sectors. On average, then, about 20 percent of the information technology list turned over annually. The prevailing weather in that sector is stormy. The normal conditions are uncertain forecasts, unforeseen threats, and inevitable calamities. As the employees in information technology know well, entrepreneurial Americans must learn to survive like Odysseus, “the man of twists and turns driven time and again off course.”

Some advise the next generation of Americans to learn Mandarin. Six months of an immersion course are said to open up a career avenue. In the United States population more than two million speak some Chinese language, a larger group of foreign-language speakers than any other, except of course the nearly 30 million Spanish speakers. The country has more than enough Chinese speakers to meet any foreseeable business need for that facility. The United States hardly needs to create millions more Mandarin speakers. In any event, sending ambitious Americans to work overseas would ape Europe’s unfortunate reaction to the rise of the United States in the late nineteenth century: shipping its would-be entrepreneurs abroad. Bad outcomes will occur for any country that keeps its timid or ill-equipped citizens at home, while shipping its ambitious and gifted people abroad.

Yet how should the young American select a career? One might become a canny sea captain or an adroit radio repairman yet never find a good employer for those skills. Those fields of work have gone fallow for a reason. No entrepreneur will create a start-up demanding those skills. No philanthropist will endow a research laboratory to discover better ways to sail the oceans or fix broken radios. The secret to personal business success as always lies in acquiring an ability to solve the complex problems of the era. There is no shortage of knots to untie; the unraveling, however, may take as long as Penelope’s wait. That is the challenge of entrepreneurship.

The principal purpose of a nation’s economic policy, stated Harvard Business School professor Michael Porter, is “to produce a high and rising standard of living for its citizens.” However, large-scale national success results from victories by individual firms and their employees. Americans cannot enjoy a high and rising standard of living on average, or at the median, unless many individuals obtain increasing income in ever-changing jobs provided by rapidly evolving firms that win new competitive battles in any and all country markets. Americans, therefore, need to work at technology firms that invest in, compete in, and eventually hire in China.

Through the last half of the twentieth century, successful firms grew in scale and scope. Firms important to job growth started small but did not stay small. Britain, not the United States, deserved the label of “a nation of shopkeepers.” Japan’s economy, not America’s, rested on mom-and-pop stores. Indeed, by the mid-00s half of Americans worked in firms that had 500 or more employees. Firms of size suited the scale of the country. To become meaningful employers, new business start-ups have to defeat big firms in domestic competition. If they cannot survive locally, they cannot challenge globally. To win, they need to build capable teams quickly, and to hire and fire rapidly until they have the right skills and firm culture. They have to attract individuals from other companies, universities, consulting firms, and even law firms.

The best way for Americans to respond to the emerging competition from China and other Asian countries is to intensify and expand the competitive process. Imagine that venture capital funded 1,000 firms in 20 markets, that 100 firms in 10 markets created value for venture investors, that 10 firms in 5 markets created more value for later stage investors, and that 2 firms in 2 markets survived for a decade, employed more than 5,000 people each, and became winners in global competition. That funnel of failure, with a few big companies squeezing through the aperture of success, resembles venture capital in Silicon Valley from the 1960s to the 2000s. In the future, the United States should increase every number in the sequence: more start-ups in more markets, with more value creation at every stage, and ultimately more global winners in more markets. What can expand potentially infinitely is the number and size of markets, so that American start-ups become the world leaders in, say, solar power (of trivial size in the 00s) and quantum computing (not commercial in the 00s). American policy should be to intensify and amplify a culture of entrepreneurship to create and capture value in the future in ways scarcely imaginable in the present.

The government cannot order people to start new firms. No technology can send them through a production line. No leader can describe the thousands of new firms needed by Americans. The culture, however, can produce a great upsurge of entrepreneurship, as occurred in the 1990s. American citizens can depend on a brand new day of job creation if they can remember how law, technology, and leadership created an entrepreneurial culture in the last decade of the rapidly receding twentieth century.

America the Hopeful
An America that graduated both Bill Clinton and George W. Bush from college in the famous year of student revolt, 1968, and then twice elected each of them president plainly has some explaining to do. Are Americans so dazed and confused that when the electoral coin comes up heads they go one way, and when it comes up tails they follow another leader in a completely different direction? Apparently, at least since the collapse of the Soviet Union, the United States has lacked a center to its politics. It was simpler to describe the national purpose when an enemy with enough bombs “to make the rubble bounce” threatened the country’s survival. If the country cannot share common ideas about itself, it cannot reform its culture to meet the China challenge.

As president, George W. Bush has tried to renew cold war verities by uniting the country around a war on terror. Certainly, ever since twentieth century technologies produced an armory of weapons of mass destruction, anyone’s worst fears have had plenty of grounding in reality. As far as imagination can see into the future, people will have reason to dread the harm others may cause them. However, the terrorist cause presents no challenge to America’s culture. The nihilism and horror of terrorism can never have an appeal beyond a desperate few in broken societies. Only if the reaction to terrorism distracts the country from addressing its problems will America find its values at risk.

Nor is China an enemy of the United States. China will send battalions of entrepreneurs to compete with American firms. All of Asia will launch armies of workers to compete with Americans. But China has no need to threaten America militarily. Nor does the prevailing Chinese culture, whether it is statism, fascism, or neocommunism, present an appealing alternative to the American system of wealth creation and individual freedom. At present, the Chinese challenge is economic, not cultural. In that sense, it is no different than the broad Japanese challenge of the 1980s or the many market rivalries between European and American firms for the last half-century.

To meet the challenge of China, and the other economic rivals that inevitably will rise up, the United States will have to address its own problems in more benign ways than through war. Increasing inequality of income and opportunity threaten the nation’s ability to reform the architectures of culture. Leaders need to bring the country to a new agreement about its purposes.

For more than three decades, the generation of ’68 has disagreed over American culture. The ground, however, has shifted under the feet of that generation’s leaders. Both Bill Clinton and George Bush grew up in a middle-class country, although they were born on the opposite sides of that broad swath. That definition of the United States is evaporating. The two presidents were raised to choose between democratic capitalism and authoritarian communism. China does not fit in either category. Nor does the emerging American information society, with increasing returns and winner-take-all results, follow the rules of either industrial or state-directed economies. Who will redefine the essence of the American culture?

As America looks for leaders in the current century, the generation of ’68 may not necessarily provide them. Younger Americans may step forward. However, from wherever the new leaders come, to succeed they will need to adopt the one truly sound idea that had its heyday in 1968 and has rooted itself deep in the Internet: the renewed belief in the transcendent value of finding one’s individual identity. That is the central animating principle of any reform agenda for America. That is the chief purpose of entrepreneurship in social, business, or personal life.

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