1. Macro views (a): faster growth, lower inflation
    Macro views (b): competitiveness
    Macro views (c): job growth
    Macro views (d): new demographics, new politics?

2. Micro views: new economy, new firm?

3. Digital divide: the new economy as a Kondratieff Wave
   

1. The coming Japanese conquest (ca. 1989)

2. The rise of the wild-west companies

3. The break-up of the old computer industry, 1985-1990

4. The U.S. comeback, 1989-1994

5. The Internet and new companies in the 1990s

6. The location of the top 100 I.T. firms in 1997

7. Europe's potential in the net-centered era

1. Biological analogies: from Marshall to Schumpeter

2. Models and metaphors today

3. Regional Science: open, multidisciplinary, technical, and pragmatic

Notes & References

There's a macroeconomic version, able to keep on growing rapidly without inflation. There's a microeconomic version, apparently driven by a new kind of firm.There's the digital version, likely to be identified with an Information Age. Then there are variants that focus on management, labor relations, sustainable development, and other topics as well. (Here's an aggressive version of the thesis from the economics editor at Business Week. And here's economist Hal Varian's authoritative site on the whole topic.)

What most new-economy approaches have in common is the idea that computers and in particular networked PCs have changed things in a fundamental way. That is the common denominator we will encounter as we look at the macro, micro, and digital versions of the new economy hypothesis in turn.

I conclude that there really is something new about the economy, as tends to happen every 50 years or so. Also, the new economy is in some relevant sense a "reborn" economy. That is, it has successfully weathered what could be termed a maturity crisis (or, as the British call it, a "climacteric") and defied the predictions a decade ago of inevitable U.S. economic decline. What has helped all this along is the nation's unique regional geography, a product of its continental scale.

But you don't have to arrive at these same conclusions to get something out of the grand tour we're about to take.

1. MACRO VIEWS (A): FASTER GROWTH, LOWER INFLATION

The crux of the macroeconomic version of the new economy is the idea that information technology (I.T.) creates higher productivity growth, which in turn permits faster growth in output without a rise in the rate of inflation. The awkward fact that measured productivity growth has not gone up by much is downplayed, and is sometimes viewed as an artifact of measurement problems.

Federal Reserve Board Chair Alan Greenspan himself seems to believe that things have dramatically changed. (Clicking on the hyperlink will take you to his testimony of February 24, 1998. We quote here from paragraph 6.) In his words, …our nation has been experiencing a higher growth rate of productivity—output per hour worked—in recent years. The dramatic improvements in computing power and communication and information technology appear to have been a major force behind this beneficial trend. Indeed, in a recent report, The Emerging Digital Economy, the Department of Commerce presents a graph that shows I.T. reducing the rate of inflation by one full percentage point over what it would be in the absence of I.T.

There is no question that the macroeconomic picture has been a thing of beauty in the late 1990's. A useful indicator to show the improvement is the misery index, the sum of the inflation and unemployment rates. It used to be said there was an inescapable tradeoff between the two, a tradeoff portrayed in the Phillips Curve. In the late 1990s, however, with unemployment down to 4.5% and inflation below 3%, the index for the U.S. looked better than in three decades. (FIGURE 1.)

Generalizing, Bernard Weinstein (1997) offered the following list of new-economy attributes:

--An economy that continues to expand without a pickup in inflation.

--An economy constantly restructuring itself for greater efficiency and productivity.

--An economy replenishing and revitalizing itself through new technology and

   capital investment.

--An economy that functions without excessive debt, either public or private.

--An economy that maintains a balanced budget.

--An economy that is increasingly globalized and export driven. Professor Weinstein concludes, "Not to suggest that inflation is dead, the business cycle extinct, and the stock market destined to rise forever. But, with good macroeconomic management, we believe the economy can grow virtually without interruption for the foreseeable future."

Mark Zandi of Regional Financial Associates, a forecasting firm, described the new economy at a Boston conference in May 1998. "The new economy adjusts more quickly to exogenous shocks, and it does not generate an environment that leads to recession." In his view, (1) globalization, (2) faster technological change, (3) securitization, and (4) deregulation have together introduced new variables that have yet to be included in conventional forecasting models of the economy. (Miara 1998)

TRUIMPHALISM?

Zandi offers a fuller treatment of the macroeconomics of the new economy is his "Musings on the New Economy" (in Regional Financial Associates's Regional Financial Review, March 1998, pp. 4-10). There he describes it as "part real and part surreal."

Similarly, many economists would conclude that the improvement in the misery index is as much as can be said for any macroeconomic version of a new economy. For example, an exchange in the May/June1998 issue of Foreign Affairs turns on whether America's long expansion in the1990s signals a true restoration of the nation's bygone glory.

In "A Second American Century," Mortimer Zuckerman (a real-estate developer and publisher) contends that the U.S. triumph reflects "deft managers, technological innovation, and a culture that values rugged individualism—all fueled by finance capital that can nimbly meet the needs of a globalized, rapidly changing economy" (p. 1). Accordingly, he concludes, the present U.S. lead relative to Europe and Asia will if anything increase in the next century.

Paul Krugman's rebuttal, "America the Boastful," views all this as a triumphalist caricature. As background, Krugman has long since declared the New Economy dead. Here he points out in a lucid analysis that while productivity growth may be faster than the official measurements show, that has always been true. He notes that technically, the growth of real output is limited by the sum of (1) the increase in employed workers plus (2) the rate of growth of productivity, or output per worker. Instead he sees the U.S. ascendance as the result of a sustained cyclical expansion here, which looks all the better next to difficulties in Europe, Japan, and emerging Asia. Everything could change once the U.S. has another recession, and economies elsewhere revive. He concludes, "Future historians will not record that the 21st century belonged to the United States" (p. 45).

Similarly, Alan Blinder speaks of "lucky shocks," as the reason for the reduction in the rate of inflation while the unemployment rate also falls. Among them are lower prices for oil and for imports generally, a slowdown in the rise of health costs, and—last but for our purposes not least—the relentless fall in computer prices. (Louis Uchitelle, "Economists Reject Notion of Stock Market 'Bubble,'" The New York Times, January 6, 1999, p. C2.) (In general, you can read the Times on-line, provided only that you register with them for their free service.)

A similar dismissal of the macro version of the thesis appeared in a Silicon Valley magazine, Red Herring, whose editor concludes,

 …the argument for a new economy does not make sense. Digital technologies
 have not dramatically increased productivity; international competition doesn't
 have much effect on prices; and the economy cannot grow by more than the sum
 of the increase in productivity and the increase in new workers. (Jason Pontin,
"There Is No New Economy," Red Herring Magazine, September 1997.)

More generally, Krugman chides new economy advocates for a lack of historical perspective. His point is that there is nothing new about technological change. Now, Krugman knows what he is talking about on these questions. (For a look at his influential writings, popular and more technical, see his site, which The Economist Magazine recently cited as the top economist's web site in the world. Of particular interest to us at this point is "Requiem for the New Economy," from way back on 10 November 1997.)

But economic history yields an alternative view as well. In hindsight, we could say that there were two great economic questions of the 20th Century. One was about the effectiveness of communism as an economic system. That was answered decisively with the collapse of the Soviet Union after 1989.

The second great economic question of the 20th century has been the adaptability of what might be termed mature capitalism—above all as practiced in the largest mature economy, the U.S.

The big question was whether the U.S. had to endure the decline that afflicted the world's first industrial nation, Britain, at the end of the 19th century. As Moses Abramovitz asked in a Presidential Address to the American Economic Association in 1980: "Can we mount a more energetic and successful response to the challenge of newly rising competitors after 1970 than Britain did after 1870?"

INDICATORS OF A U.S. COMEBACK IN THE WORLD ECONOMY

In that light, it is precisely Britain's historical precedent that makes the U.S. comeback in the world economy such an unexpected event.

The Swiss competitiveness ranks. Consider, for example, the annual press releases from Davos, Switzerland, where an organization called the World Economic Forum publishes ratings of the world's economies in terms of their "competitiveness." Any single index of competitiveness is bound to be in part arbitrary, and this one has met its share of criticism. But in the past couple of years Jeffrey Sachs and Michael Porter of Harvard have helped refine the measure. What it shows in each recent year is a ranking for the U.S. (3rd, after Singapore and Hong Kong) higher than for any other major economy. And by the subjective appraisals of business executives polled by the Forum, the U.S. actually ranked first in both 1997 and 1998. (See Table 6 of the Executive Summary.)

Industrial output. One reason for the business leaders' view may be that the U.S. manufacturing sector has surged in the 1990s. This is not always understood, partly because downsizing and layoffs still occur and indeed accelerated in 1998. In addition there is a lingering "post-industrial fallacy," which in one version measures the sector's role by employment—or in another uses current instead of inflation-adjusted dollars to track manufacturing output as a share of GDP.

An example of the fallacy is a recent New York Times column: "The Economy Grows. The Smokestacks Shrink." There we read, "Manufacturing has been losing momentum for decades, with its share of the gross domestic product dwindling to just over half of what it was in 1953…." (Louis Uchitelle, 29 November, 1998, 3:4.)

In real terms manufacturing's 1996 share of GDP reached its highest value in a generation, 19.1%, vs. previous peak values of 18.3% in 1989 and 18.7% in 1979. (See Table 1231 of the Statistical Abstract of the United States 1998, and the corresponding tables in earlier editions.)

At about 3% a year since 1975, manufacturing's productivity growth is much faster than in the rest of the economy. (As Table 689 of the Abstract shows, output per hour rose 65% from 1980 to 1997, vs. 21% in the non-farm private sector as a whole). Therefore manufacturing output can grow rapidly over time without adding more workers—or even with fewer workers, as in agriculture at the beginning of the century. Faster productivity gains also mean costs and prices rise less rapidly in manufacturing than in other parts of the economy. For that reason, when measured in current dollars manufacturing as a share of output lags. But the shrinkage is an illusion of prices.

U.S. productivity levels in manufacturing are the highest in the world. While the Netherlands and Sweden come close, and other countries have higher levels in specific sectors (e.g., cars in Japan), the aggregate U.S. lead remains. In 1996, output per hour worked in manufacturing was half again as high as in Canada or the U.K, and a third again as high as in Japan. (That is, the index values relative to 100 in the U.S. were 68 for Canada, 67 for the U.K., and 74 for Japan. See Tables 1374 and 1375 of the Abstract.)

The U.S. share of world exports in manufactures rebounded from a 10.7% share in the late 1980s to 11.5% in 1995. Faced with the rapid expansion of exports from China and the Asian Newly Industrializing Countries (NICs: Hong Kong, South Korea, Singapore, and Taiwan) other advanced economies lost ground. The former West Germany's share fell from 14.6 to 12.2%, and Japan's from 12.4 to 11.4%. (Table 1244.)

What all this adds up to is that the U.S. has had a faster expansion in industrial output since 1980 than any other advanced economy. FIGURE 2 tells the story, tracking the percentage growth in output for manufacturing, mining, and electric and gas utilities. The U.S. increase of 56% exceeded Japan's 51%, virtually all of which occurred in the 1980s. Mexico and Canada are not far behind, with Europe's major economies trailing. (See this CIA table for industrial employment counts over time by country.)

In short, it is not obvious that the U.S. has been de-industrialized, or that its manufacturing sector is shrinking relative to the rest of the economy, or that it has lost its industrial competitiveness.

LIVING STANDARDS

As a result of its economic revitalization, the U.S. continues to have the world's highest average living standards. Economists compare living standards across countries by output per person, assuming that the more output is produced per year, the more will be available for consumption by the population. The usual measure of output is gross domestic product, GDP, defined as the market value of currently produced final goods and services during one year. For any given year, then, a country's average living standards are gauged by per capita GDP.

For the U.S. in 1997, this figure, $28,740, equals a GDP of $7.7 trillion divided by a population of 268 million. I'm reading these numbers off a printout from the excellent (and recently overhauled) World Bank site, specifically from Table 1 of the statistical appendix to the Bank's World Development Report 1998/99. (While you are there, you might tour the terrific slide show, Knowledge for Development.)

Comparing per capita GDP across countries requires one more step. Except for the Euro group, which rallied around a single currency on January 1, each country has its own currency whose value depends on supply and demand in world markets. Therefore an adjustment must be made for something called "purchasing-power parity" (PPP). The adjustment corrects for any discrepancy between a currency's domestic purchasing power and its exchange rate, to give a more accurate index of living standards.

The benchmark value in their Table 1 is the U.S. figure in 1997 of $28,740. That placed it a close second to tiny Singapore's $29,000. The U.S. figure was, for example, 23% higher than No. 6 Japan's $23,400 and 31% higher than No. 10 Canada's $21,860.

To be sure, any such average value says nothing about income distribution, which is becoming more unequal in the U.S. and in other industrial economies. In addition, there are various other measurement and quality-of-life issues that make per capita GDP a crude yardstick at best.

The UNDP human development index. For skeptics, the United Nations Development Program provides an interesting alternative measure of well-being. Their Human Development Index (HDI) factors in not only per capita GDP but also life expectancy at birth and average educational levels. As the UNDP explains, "a composite index, the HDI thus contains three variables: life expectancy, education attainment (adult literacy and combined primary, secondary and tertiary enrolment) and real GDP per capita (in PPP$)." By this score the U.S. ranks No. 4, behind Canada, France, and Norway. (France had lower education and output values, but a higher life expectancy, 78.7 vs. 76.4 for the U.S., in 1995.) Japan ranked No. 9, the U.K. No. 14.

Revising real growth upward. How does all this square with the view that U.S. living standards have not improved much over the past quarter-century? Much has been made of the fact that after about 1973, productivity growth and the rise in living standards slowed.

But it turns out that the official numbers have given too pessimistic a picture. The distortion stems from the way the year-to-year changes in output and income are adjusted for inflation. According to the Boskin Commission (chaired by Michael J. Boskin and including the luminaries Ellen Dullberger, R.J. Gordon, Zvi Griliches, and Dale Jorgenson), inflation rates have been overestimated by about 1.1% a year for some time. The technical reasons inflation has been measured at too high a rate come under four headings: product substitution, retail outlet substitution, quality, and new-goods biases.

Thus about 1% too much has been subtracted from each year's measured per capita GDP for perhaps the past two decades. Living standards, thought to be stagnant, have actually risen by something closer to 2% a year. That would still not be as high as before 1973, but it is respectable for an economy that already had the world's highest absolute productivity levels.

For perspective, let's view the change in terms of the " rule of 72 ." It says that the time it takes an amount growing at compound growth rate r% to double can be found by diving 72 by r. Living standards would thus double in 36 years at 2% a year, vs. 72 years at 1%.

Labor-force outcomes. A look at labor-market conditions may be found in a recent on-line report from the Progressive Policy Institute, a Democratic Party think-tank. The report, What's New about the New Economy?, organizes a variety of useful indicators. In combination the findings (some of which are quoted directly below) suggest a less secure economy—but one teeming with opportunity:

       1. Low-wage jobs are growing, but higher-wage jobs are growing even faster.

       2. Manufacturing has not disappeared, it has been reinvented.

       3. In the last 9 years, three million new managerial jobs have been added.

       4. Fewer workers are unemployed and under-employed.

       5. Modest increases in worker displacement.

       6. The wage premium for skilled jobs is growing.

       7. Modest increases in contingent (part-time, contract, temp) work.

       8. Workers experience less job stability.
 

In a similar analysis, Michael J. Mandel, economics editor of Business Week, observes that since March, 1991, "real wages have risen at an annual rate of 1 percent," a big improvement over the 0.2% average for the expansion of the 1980s. Mandel also provides a chart on page 9 of his report showing that over two-thirds of the new jobs created in the economy between 1995 and 1998 are "good jobs," in managerial, professional , and skilled-production occupations. As he puts it, "The benefits are especially apparent for young people graduating from college, who are coming into a world of soaring salaries rather than [the] dim prospects many had expected."
 

MACRO VIEWS (C): JOB GROWTH

Not that it is new, but we should make explicit another feature of the U.S. economy that is familiar enough by now that we tend to take it for granted.

Since 1980, the U.S. has experienced net employment growth of about 30 million new jobs. What puts this achievement in perspective is the fact that over the past generation, the major industrial economies of Europe have had virtually zero job growth. (FIGURE 3.) As a first approximation, the national economy spawns large numbers of new jobs of all types because of the rapid growth of both large and formerly small states in the South and West—not only Florida and Texas, that is, but also Arizona, North Carolina, and Washington. (MAP 1).

CORE LEGACY: THE MANUFACTURING BELT AND THE PERIPHERY

For historical perspective, let's relate the Census Bureau's definitions of regions to the timing and geography of American economic development. (For data reasons, I use the Census definition of regions, with their 9 component divisions, rather than the Bureau of Economic Analysis definitions, which contain10 divisions.)

Economic geographers see the historical development of the nation's regional structure in terms of an industrial core and a less-developed periphery. We can bundle the 9 Census Bureau divisions accordingly. We start from the Census's four main "regions": the Northeast, Midwest, South, and West. As a map on the inside front cover of the Statistical Abstract of the United States 1998 shows, there are then 9 divisions:

• Northeast: New England and Middle Atlantic divisions
• Midwest: East North Central and West North Central divisions
• South: South Atlantic, East South Central, and West South Central divisions
• West: Mountain and Pacific divisions

The other six divisions constitute the South and West, a label masking enormous diversity. Though an approximation, this core-periphery approach has proved useful. A wide range of variables (e.g., city growth, attitudes toward unions, ethnicity) display contrasting values as between the old industrial core and the developing periphery.

For example, TABLE 1 shows that when we rank the 9 divisions by the timing of their industrialization, a standard measure of state "business climates" for the year 1980 aligns closely. Similarly, of the states with "right-to-work" laws that forbid union shops (requiring workers to join unions at unionized job sites), all 20 are in the five "younger" divisions, and not one is in the four divisions that industrialized earlier.

Reflecting high costs and such political and institutional variables, manufacturing employment in the core has declined steadily since the late 1960s. (FIGURE 4.) The core had 10.8 million in 1970, but only 7.7 in 1997. Offsetting much of that decline, the South and West gained 2 million jobs over the interval, most of it by 1980. For the U.S. as a whole, the count peaked at 21.0 million in 1979 and has dropped by one million in the 1990s, from 19.7 to 18.8 million. All in all, the U.S. has fared far better on this score than Europe (which has lost over 5 million manufacturing jobs). The reason is the job growth in new manufacturing activities in the South and West (R.D. Norton, 1997).

Hidden from these sweeping comparisons is a remarkable industrial resurgence in the Upper Midwest. During the 1990s, after a generation of painful adjustment, the Lakes states have displayed an impressive comeback. It is based on the division's traditional cluster of "heavy-meal" and vehicles—and on another staple activity, agriculture. The effects are less evident in manufacturing than in total employment. In terms of total (non-farm) payroll employment, the triumph of the resurgent Midwest is that it has added jobs at about the national rate during the 1990s.

The Midwest recovery can be gauged in TABLE 2. It shows that the states with job growth at rates above the 15% U.S. average are all in the South and West—with two notable exceptions. Wisconsin and Michigan grew slightly faster than the national rate and together added over 1 million new jobs.

The divisions hit hardest in the 1990s have been New England and the Mid-Atlantic. As FIGURE 5 shows, the Northeast lagged far behind the rest of the U.S. in job growth in the 1990s. In the early part of the decade, the traditionally slow-growing Northeast was hit especially hard by (1) defense cuts, (2), corporate downsizing (which rocked the region's headquarters complex in New York City, New Jersey, and Connecticut), and (3) the rapid shift of American computing to the West.

Cuts in defense spending after 1989 had a huge impact on such states as Massachusetts, Connecticut, and New York—and on the West Coast, California. FIGURE 6 tells one version of the story. Among the six states with the largest absolute cuts in defense spending between 1984 and 1993, the states with the largest percentage cuts in defense spending had virtually no growth in total payroll employment between 1990 and early 1997. Texas, by contrast, had the smallest percentage cuts among the six and the fastest 1990s growth in non-farm payroll jobs.

Nevertheless, by the beginning of 1997 the state and regional job picture had reached a new stage, in which, for example, Massachusetts would add employment at about the national rate. By that point the Northeast had ridden out its various shocks, and the region's strengths in finance, health care, and software gave it a new lease on growth.
 

MACRO VIEWS (D): NEW DEMOGRAPHICS, NEW POLITICS?

Some 90% of the growth in the U.S. population since 1970 has registered in the states of the South and West. Each state has two U.S. senators, of course. But by the doctrine of "one man, one vote," the Constitution requires reapportionment of the House of Representatives every 10 years to reflect the changing distribution of the population.

Both regional and city-suburban shifts thus require a redistricting after every census. The result is to redistribute power from older cities and from the Manufacturing Belt—which as late as 1980 accounted for half of the House of Representatives. Since the Electoral College (which technically determines the outcomes of presidential elections) reflects congressional redistricting, presidential politics are at stake as well.

We offer now a brief overview of regional population shifts, after which we return to the question of how they change the nation's political environment.

REGIONAL POPULATION SHIFTS: A PRIMER

A valuable checkpoint for state population trends is a Census Bureau news release posted on the last day of 1998 as an update on the 1990s. It features two maps of population changes by state, one for 1990-1998, the other for 1997-1998. These are classic examples of what good maps can do. They show patterns that the numbers for individual states do not. And they allow quick visual comparisons of how the most recent year (1997-1998) aligns with or differs from the 1990-1998 pattern. You can compare the two maps now by going to the site and clicking each in turn.

The 1990-1998 map shows most of the states in the South and West growing faster than the U.S. average of 8.7%. Most of the states in the Northeast and Midwest are growing more slowly. The slow-growth region sweeps from Maine to Oklahoma and up to North Dakota, which (like Connecticut and Rhode Island) actually declined. Anomalies are slow-growth Louisiana and brisk New Hampshire.

Now compare the pattern for 1997-1998. Relative to the U.S. average (as it happens, 1.0%), the basic regional pattern is unchanged. But now, for example, Alaska, Washington, and Oregon are closer to the average, and California has surged ahead. On the downside, Pennsylvania and West Virginia lost population in the most recent year.

Why, then, do the states of the South and West typically add population faster than those elsewhere? Without getting into deeper chicken-and-egg theories of job-seeking vs. amenities-induced migration, we can take a quick look at the definitional components of population growth.

For the nation as a whole, by definition

(E.1) Population Growth=the Natural Increase (Births – Deaths) + Net Immigration

Click on item 2 of the news release, State Population Estimates and Demographic Components of Population Change: April 1, 1990 to July 1, 1998. The first row shows that the U.S. population rose 21.5 million to 270.3 million between 1990 and 1998. The increase of 21.5 million=(32.9 million births – 18.6 million deaths) + 6.7 million net foreign immigrants. (The discrepancy of .5 million reflects the unlisted net gain as a result of returning U.S. military and government employees from abroad during the year.)

The U.S. thus adds nearly a million people a year through legal (and illegal) immigration. This, plus the higher birth-rates among recent immigrants (especially Hispanics), is what gives the U.S. higher rates of population growth than Japan or Europe.

For states and regions, we have to add domestic migration. To see why a state or region is growing at a higher or lower rate, find the natural increase (births – deaths) and then add the two migration entries. The first, as for the U.S., is NIM (net international migration). The second is NDM (net domestic migration). In practice, domestic migration has for a long time tilted the population increasingly away from the Northeast and Midwest, to the South and West.

The effects of net domestic migration flows can be seen visually in FIGURE 7. For each of the 9 divisions you can scan the role of foreign and domestic migration. (Every division had a positive natural increase, births - deaths.) Four of the divisions lost migrants to the rest of the U.S., as indicated by their "below-the-line" bars in the chart.

We can compare two divisions on the East Coast that had offsetting numbers of domestic migrants. The Middle Atlantic division attracted 1.5 million net foreign migrants but lost 2.3 million people to other U.S. regions. Its natural increase, 1.5 million (=4.5 million births – 3 million deaths), was therefore reduced by over .8 million net migrants out of the region. All in all, its net increase in population was less than 700,000, for a population growth rate of only 1.8%.

As an example of a fast-growing division, the South Atlantic (which includes Florida and North Carolina) added 5.4 million people, for a rate of 12.3%. The increase consisted of a natural gain of 2.3 million, plus net foreign immigration of 1 million, plus 2.2 million in-migrants (job-seeking and sun-seeking both) from other parts of the U.S.

In the far West, a similar comparison might be drawn between the Pacific Division, dominated by the flight from California in the early 1990s, and the Mountain states. Visually (just as with the Mid-Atlantic and South Atlantic divisions), the number of domestic out-migrants from the Pacific was roughly matched by the number of domestic in-migrants to the Mountain states.

California aside, these tendencies are broadly similar to the prior two decades, the 1970s and 1980s. A fuller treatment of population growth by state and region is in the Statistical Abstract of the United States 1998. Using the Adobe Acrobat reader provided there, you should move to Table 29, p. 31, "U.S. Resident Population, by Region and Division: 1970 to 1997."

There you find that from 1970 to 1997 the U.S. population grew by 64.3 million, an increase of 32%. (Owing to legal and especially illegal immigration, the rate is noticeably higher than in Europe or Japan). Less than 10% of the 64.3 million additional people registered in the Manufacturing Belt: New England, the Mid-Atlantic, and the East North Central divisions. Over 90% of the increase in the U.S. population between 1970 and 1997 occurred in the South and West.

That brings us back to the politics of demographic realignments.

POWER SHIFTS

As early as 1969, the Republican theorist Kevin Phillips titled his book on electoral demographics, The Emerging Republican Majority.Before the reapportionment required after every decennial census, the 1980 delegation from the North in the House of Representatives was 225 (or 50% of the 450). It fell to 208 in the 1980s, and again to 193 after the 1990 census. By no coincidence, virtually every major committee in the House is chaired today by a Republican from the South or West.

Population shifts count ideologically because most states in the South and interior West are more conservative than most states in the North, the Manufacturing Belt. The South and interior West were historically less urban and industrial and today remain attached to rural and conservative values. In general, new residents not only add to a growing state’s electoral count but also tend to acquire the political coloration of the new environment.

The thesis that the South and West hold decisive power in choosing presidents was formulated again in 1975. In a prescient glimpse of the Reagan Revolution yet to come, Kirkpatrick Sale wrote that the U.S. was experiencing its fifth fundamental political Power Shift:

• …first [was] the consolidation of federal control at the turn of the eighteenth century,
• …second…the introduction of Jacksonian democracy in the early nineteenth century,
• the third…the expansion of Northern industrialism after the Civil War, and
• the fourth [was] the establishment of Rooseveltian welfarism in the 1930s.
• The rise of the Southern Rim marks a fifth.

Not that the regional pattern implies a one-party presidency. As Jimmy Carter and Bill Clinton proved, centrist or new or Third-Way Democrats can still get elected president. But the geographical dispersal of people and power forces Democratic candidates for president to the center of the political spectrum.
 

THREE ECONOMIES?

A struggle among three spatially overlapping but ideologically distinct economies has been provocatively sketched out by David Friedman, who directed the New Economy Project in California in the mid-1990s. In Friedman's words, the innovative, bureaucratic, and provincial economies display the tensions that exist between the new and old economies:

The Kluge [bureaucratized] economy. Slang for Rube Goldberg-like computer code that barely, if ever, achieves its purpose, the Kluge describes the economy of major media, public-sector bureaucracies and universities that dominates urban politics.

The provincial economy. The rapidly growing Southern and Intermountain Western regions of the country that now dominate national politics. (Quoted from Friedman, "The Fate of a Nation," Los Angeles Times, August 20, 1995, p. M1.)
  Regionally, both the wired and Kluge economies are centered in the urban, high-wage states of the Manufacturing Belt. These industrialized states have nearly half the nation's employment, about one-sixth of which is in the opinion-defining core bureaucratic sector: government, education, and social-service activities.

The provincial economy, in Friedman's view, occupies the South and Mountain West. It accounts for about 35% of the workforce. Despite its rapid-growth image, on the whole it specializes still in slower growing industries and the footloose incomes of, for examples, retirees.

As to party realignments, the party of the bureaucratized economy is the Democrats and that of the provincial economy is the Republicans. The innovative economy (as in the Tofflers' Third Wave model) has no clear alignment but tends to prefer Republicans as noninterventionist.

Within this imaginative (if oversimplified) framework, geographical dispersal plays a key political as well as economic role. On the one hand, the urban underclass remains concentrated in the Manufacturing Belt and in such dispersed cities as Los Angeles and Atlanta. On the other hand, the job-generators in the innovative economy can escape the political hostility and regulation of the core's bureaucratized players by heading for greener grass elsewhere.

As these comments suggest, population shifts are also reshaping the political process on another axis, not only away from the long-industrial states of the North, but from cities to suburbs. The combination of regional and suburban realignments is the subject of a 1998 policy memorandum by two consultants to the Democratic Party.

CITIES, SUBURBS, AND NEW REALITIES.

In "Five Realities that Will Shape 21st Century Politics," William A. Galston and Elaine C. Kamarck view the future of the Democratic Party through the prism of demographic and geographic change. For brevity, the five realities are synopsized here.

(1) "The New Economy Favors a Rising Learning Class over a Declining Working Class." The new economy holds new realities for party politics, away from class-based legacies of the New Deal. The new key determinant of economic position is family structure. Unions have shrunk so much that they are no longer pivotal. "In the Information Age political power will rest on the ability to compete in the marketplace of ideas" (p. 10).

(2) "The New Deal Generation Gives Way to the Skeptical Generations." Whereas the New Deal generation saw government as a solution to the problems of the industrial age, and Baby-Boomers have mixed emotions based on Watergate and Vietnam, the formative Generation-Xers hold the key to the future. They are even more skeptical than Boomers, because they have come of age in a time of economy insecurity, in which government seems as much a problem as a solution. In their view, "large-scale politics is a blunt and ineffective instrument for addressing key social problems…." (p. 13.) But they can be recruited to programs for education and the environment.

(3) "Power Continues to Shift from the Cities to the Suburbs." The key comparison here is that 25 years ago, "there were roughly equal numbers of urban, suburban, and rural districts in the U.S. House of Representatives. Today, suburban districts outnumber urban districts by more than 2 to 1, and rural districts by almost 3 to 1" (p. 14). If the Democrats want to find a demographic power-base comparable to the cities in the New Deal, it will have to be the suburbs, where relevant issues will be education, crime, sustainable development, and the environment (p. 16).

(4) "More Children from More Diverse Backgrounds Will be Concentrated in a Shrinking Percentage of Households." The paradox that comes out of changes in family structure is this: "The needs of children will be increasingly central…but the percentage of families with minor children will continue to shrink" (p. 17). In other words, there will be an empathy problem on the part of the majority of the electorate.

(5) "A New Diversity Brings the Challenge of National Identity Politics." Whereas the old politics were about black/white divisions, immigration is changing the picture. From an immigrant low-point in the 1960s, today 11 percent of the population is Hispanic and another 3 percent Asian by birth. (This combined share of the foreign-born exceeds the African-American share, 12 percent.) Such tendencies are likely to accelerate. The challenge will be so appeal to the American Dream as a unifying message to offset the politics of ethnic identities.

2. MICRO VIEWS: NEW ECONOMY, NEW FIRM?
 

To sum up our exploration so far: the macroeconomic debate over a new economy is about changes in growth-inflation tradeoffs in the macroeconomy. A number of skeptical top economists (Krugman, Blinder, or Brad DeLong, for example) hold fast to what might be termed The Casablanca Rule: "The fundamental things apply, as time goes by." On the other hand, Fed Chairman Alan Greenspan, no fad-chaser himself, is a convert to the idea of a new economy.

Our topic now is the "new firm" and its regional coordinates. As background, let's take a light look at the 1998 Forbes Magazine list of the 400 richest people in the U.S. (TABLE 3.) This list is largely a creature of stock-market valuations at any given month or year, since truly monumental fortunes (the ones denominated in billions) in the U.S. nearly always reflect ownership of large corporations. (To see which stocks have most enriched the Forbes 400 recently, check The Forbes Forty.) The 1998 list appeared in the October 12 issue, when the stock market was in a temporary slump. Still, and allowing for these and other vicissitudes in the wealth estimates, the top ranks of the list tell quite a story about the American economy in the late 1990s.For one thing, the top 14 people on the list all live outside the Manufacturing Belt. In general, there are no old-fashioned smokestack industrialists among the top 15 (and not many among the top 50). True, the 15th member of the list, Sumner Redstone, is from Newton, Massachusetts, but he is a media magnate (his Viacom owns Paramount, UPN, MTV, and Blockbuster Video), not an industrialist or denizen of Route 128. Except perhaps for John Werner Kluge (founder of Metromedia and developer of the nation's largest cell-phone network in the 1980s), the top 14 appear to live in the regions where their fortunes originated. (Barbara Cox Anthony's came from Cox Communications, an Atlanta media company; she lives in Honolulu.)

These fortunes emanate from I.T., Wal-Mart, and media. (Warren Buffet, the investor, is a possible exception; it would depend on his portfolio.) Five of the top15 are high-tech entrepreneurs, from Seattle, Austin, and Silicon Valley. Five are members of the Arkansas Walton family; their vast wealth derives from founding-father Sam Walton's controversial innovations in the organization of retailing. Four (Kluge, Redstone, and the Cox sisters) owe their fortunes to media empires of one kind or another. And one (ranked second with $29 billion) is Warren Buffett from Omaha.

While far from definitive, this list would seem to be consistent with the thesis of a new economy. What are its implications?

• First, the growth sectors of the U.S. economy—at least as perceived and valued by Wall Street—have shifted to new activities.
• Second, there is a preliminary suggestion here of heightened entrepreneurial performance in younger regions.
• Third, it appears that firms (Dell, say, or Wal-Mart) can spring up from nowhere and catapult to great size within the span of a generation or two.

To attack this question, let's first develop an introductory vocabulary on business organization in the U.S. in the 1990s. Then we can turn to a related but different topic of how firms influence the adaptations of their home regions to changing environments. We'll conclude our inquiry with a look at the notion of the network enterprise, as defined by Manuel Castells (1996).

HEADCOUNT

There were about 22 million companies (in Section 17, "Business Enterprise," of the Statistical Abstract) in the U.S. in the mid-1990s. (FIGURE 8.) One way to look at their makeup is in terms of the three forms of business organization described in introductory economics textbooks. These are (1) the proprietorship (a single owner), (2) the partnership (two or more owners), and (3) the corporation. As a matter of sheer numbers, the proprietorship dominates, accounting for some 16 million companies in 1994. (FIGURE 9.) Next come some 4 million corporations, a number swelled by the large number of small professional practices (doctors or accountants) incorporated for tax reasons. Third, partnerships number another 1.5 million.
(These data are based on tax filings, which is why they are a few years old before they reach the Abstract.)

One can also describe the population of firms in terms of market structure, i.e., as examples of monopoly, perfect competition, oligopoly, or monopolistic competition.

• The competitive firm (selling a standardized product, in an industry with free entry and many sellers) can hardly be found outside agriculture, where small firm size and a standardized product are still observable.
• The monopoly, the only seller of a particular product (e.g., the local cable company or, allegedly, Microsoft), is observable but numerically rare.
• More common are oligopolies: firms in industries dominated by only a few sellers (because capital requirements make entry difficult) such as the U.S. auto industry or laundry detergents. Roughly speaking, these are the firms on the Fortune 500 list, or any such tabulation of the nation's largest firms.
• Nevertheless, what economists classify as monopolistic competitors are overwhelming the most numerous types of business organization, encompassing not only virtually all proprietorships and partnerships, but most corporations as well. These are firms like restaurants or laundries that are in industries easily entered (because it doesn't take much capital to get started), and in which each firm is somehow differentiated if only slightly (and often by its location) from its competitors. That is, it faces a downward sloping demand curve: it can raise prices without losing all its customers.

But what about the other representative category, not small business but Big Business? One way to put big business in perspective is to look at the profit (net income) figures, which are dominated by a relatively small number (fewer than 5,000, say) of corporations in (1) manufacturing, and (2) finance, insurance, and real estate (FIRE). (FIGURE 10.) In 1994, these relatively few corporations had over two-thirds of the $550 billion in total business profits in the U.S.

The upshot, as a first approximation, is that we live in a dual economy of millions of small firms (a relative handful of which will become large) and a few thousand large corporations. More will be said below as to how this duality plays out spatially, but for now we can settle for a comparison of large and small firms in the resurgent Rust Belt and in defense-dependent California.

HOW REGIONS ADAPT: THE MIDWEST AND CALIFORNIA IN THE 1990S

Conceptually, we can think in terms of three channels of change open to any region that has been hit by adversity (and that means every region, from the Midwest in the 1970s to Texas in the oil-bust 1980s to California in the early 1990s). To wit:

• Established firms in stable or declining industries can do the same thing as before, only better, to claim a larger share of a fixed or shrinking pie.
• Established firms can convert to new, faster-growing product lines.
• New firms can do new things, and small firms can grow rapidly.

At first blush, the story of the Midwest comeback is "the more things change, the more they stay the same." But things are not entirely the same, as explained in "The Midwest Turnaround: Internal and External Influences," by William Testa, Thomas Klier, and Richard Mattoon, three researchers engaged in a project on the Midwest comeback done at the Federal Reserve Bank of Chicago . In particular, while the Midwest in 1996 had four more auto plants (31) than it had had in 1979, the increase masked the closing of 9 plants and the opening of 13 others.

The technologies and organization of the workflow in the new plants bear little resemblance to what had gone before. The region's watchword today is lean manufacturing. In other words, the comeback took place only after an agonizing restructuring over the past generation, as marked in part by the adoption of Japanese techniques and practices. The result is to extend the earlier recoveries of New England and the Mid-Atlantic divisions to the western end of the old core, the Manufacturing Belt.

CALIFORNIA: CONVERSION VIA REALLOCATION OF TECHNICAL TALENT

California poses a direct test case of how a regional economy adapts to the sharp downsizing of some of its largest companies—in this case, defense cutbacks after 1989. Did existing defense firms shift to new product and service lines, the second channel of conversion? Or did conversion require new firms and the expansion of firms in other sectors, the third possibility?

In "California’s Recovery and the Restructuring of the Defense Industries," Luis Suarez-Villa analyzes the state’s surprisingly strong mid-decade rebound from the doldrums of the early 1990s. How important was "defense-conversion" in fostering that recovery? He concludes that it wasn’t a factor. "Rather, California’s recovery was a product of the upswing in the national economy, which boosted demand for many of the state’s products, and of the rise of many small and medium-sized firms in a few…very dynamic sectors…." The growth-industries included civilian high-technology, wholesale trade, the film industry, and producer services.

The level at which "conversion" occurred in California was therefore less within defense firms than via the market-based recycling of technical talent from defense companies to more entrepreneuerial firms. This process is symbolized by California’s striking share (25 percent) of all the nation’s firms that doubled in size between 1989 and 1994. In general, such firms are known as gazelles .Also see gazelles.

Suarez-Villa concludes that conversion occurred not within firms but through the rise of new enterprises and the expansion of existing non-defense sectors. What may look like conversion at the level of the firm is typically some constructed mix of downsizing, mergers, and acquisitions.

Instead, conversion occurs as workers are released from downsized defense firms and re-employed in expanding (civilian) activities. In this process, entertainment employment in Los Angeles over the past decade has expanded rapidly enough to offset losses in the area's defense sector. More specifically, some high-skilled workers released from defense activities wound up finding high-paid jobs in the entertainment sector.

The conclusion? The links between companies and regions are diverse and not easy to summarize. From this comparison, it is tempting to conclude that "big is good, and small is good, too." On the other, there are deep and rich literatures that explore the connections between companies and regions, today and in the past, in the U.S. and in other nations. We return to this topic in Part C, Spatial Clusters.

What can be said at this point is that companies of all sizes and in all locations are going through changes that reflect breakthroughs in communication technology.

THE GOSPEL ACCORDING TO MANUEL

"A new economy has emerged in the last two decades on a worldwide scale."
                                           ;                        (Manuel Castells, 1996, p. 66.)

Perhaps the most influential guru of the new economy among scholars (especially non-economists) is Manuel Castells, a Berkeley sociology professor born in Barcelona in 1942. Following a 1989 book, The Informational City, Castells has written a massive trilogy between 1996 and 1998 on The Information Age: Economy, Society, and Culture. Volume one is The Rise of the Network Society. It lays out a worldview and describes "the information technology paradigm." And it contains long chapters on "the network enterprise" and "the space of flows" (i.e., as distinct from "the space of places").

Castells' logic and rhetoric are traditional, though not quantitatively analytical. (In other words, the numbers are used to illustrate, but they don't prove anything.) Without claiming to do justice to the range and ambition of Castells' magnum opus, I will sketch out the main lines of his argument on the new firm here.

In a nutshell, the new firm is the Networked Firm. As such, it is neither small nor large, neither start-up nor corporate, neither digital nor industrial. Instead, it can be any combination of the foregoing, provided it uses computer networks to adapt and compete.

FRAMEWORK: THE INFORMATION TECHNOLOGY PARADIGM

Castells offers a framework for "the material foundation of the informational society" (p. 61). The key features he lists refer not to all the influences the new technologies exert upon society, but only to economic factors, "the material foundation."
Five characteristics define the information technology paradigm:

• In contrast to earlier technological revolutions, this one is about technologies that "act on information."
• Since information is a part of all human activities, all aspects of life are affected.
• Any system or organization using information technologies has a network logic, a logic which in turn has become more powerful because of computers.
• The paradigm is accordingly based on the flexibility that networks provide. As he puts it, "Turning the rules upside down without destroying the organization has become a possibility, because the material basis of the organization can be reprogrammed and retooled" (p. 62).
• The fifth property is the technological convergence of such formerly separate sectors as computers, telecommunications, and biology.

The information-technology paradigm, writes Castells, is informed by (but not the same as) "complexity theory." The descendant of the "chaos theory" of the 1980s, the complexity school is centered in the Santa Fe Institute, which derives from the nuclear laboratories at nearby Los Alamos, New Mexico (now in the news for an espionage story linked to China). A hallmark of complexity theory is its focus on how simple systems in nature and in the economy generate spontaneous order, i.e., operate as self-organizing systems.  Putting it differently, a broader school of thought links not only (1) complexity, but also (2) fractals (self-replicating geometric patterns in nature, as in the leaves of a tree),  (3) self-organizing systems, and (4) emergent computation.  In any case, as a perspective for understanding diversity, complexity theory has a part in Castells'  paradigm—whose defining qualities he lists as "Comprehensiveness, complexity, and networking" (p. 65).

By way of distancing himself from the morality of the new information technologies, Castells concludes this discussion of his organizing framework with a famous maxim from the technologist Melvin Kranzberg. "'Technology is neither good nor bad, nor is it neutral.'" (Kranzberg, 1985, p. 50, emphasis in Castells, p. 65.)

THE NETWORK ENTERPRISE

Castells also posits a "new organizational logic." This he sees as common to all organizations, whereas their contexts may vary with circumstances and cultures. In his view the 1980s saw a "recapitalization of capitalism" (p. 85) that restored the preconditions for investment that capitalist economies require for growth. One hallmark was the much-heralded "transition from mass production to flexible production, or from 'Fordism' to 'post-Fordism'" (p. 154). Another is the "crisis of the large corporation, and the resilience of small and medium firms [SME's]…." (p. 155). A third is a new style of management, most evidently around the Japanese practices that reduce uncertainty by opening up communication between workers and management, and between suppliers and customers.

In addition, three other sets of arrangements that give firms new flexibility derive from networks. One concerns a variety of networked relationships among SME's. Another encompasses the various practices large corporations use to subcontract and license production to smaller firms. Finally, a sixth arrangement is the "intertwining of large corporations in…strategic alliances" (p. 162).

From all this emerges the horizontal corporation. The organizational innovations just listed can be understood is as a response to the crisis of the bureaucratic, hierarchical corporation—the corporate dinosaurs decried in the late 1980s and early 1990s. Nor is the horizontal corporation necessarily "lean and mean," since it became clear in the 1990s that "large corporations had to become primarily more effective rather than more thrifty" (p. 164).

Instead, the meaning of the horizontal corporation within what Castells terms the informational/global economy is as a "network enterprise." Following the French theorist Alain Touraine, Castells distinguishes here between static and evolving organizations. The first type has as its goal self-reproduction. In the second type, the organization's goals lead to endless structural changes. "I call the first type of organizations bureaucracies; the second type enterprises" (p. 171).

The network enterprise is the new form of organization adapted to the informational/global economy. Why? Not only because it is what we see in the various corporate success stories of the 1990s. On a more intellectual plane, the successful organizations are those able to generate knowledge and process information efficiently; to adapt to the variable geometry of the global economy; to be flexible enough to change its means as rapidly as goals change…; and to innovate, as innovation becomes the key competitive weapon. These characteristics are indeed features of the new economic system…. In this sense, the network enterprise makes material the culture of the informational/ global economy: it transforms signals into commodities by processing knowledge (p. 172, emphasis in the original).

3. DIGITAL DIVIDE

Many observers have believed that a developed capitalist economy tends to slow down and even stagnate over time. In that context, a "new" economy becomes a welcome thing. In hindsight, however, it turns out that new economies have emerged in the U.S. and world economies about every half-century or so. Today's New Economy, in other words, is one of a progression of new economies over the past two centuries, beginning with the high Industrial Revolution in Britain in the late 1700s.

In that light, the issue becomes, what does this new economy replace? What was the Old Economy? We might jot down a working list of some of its stylized features:

• The vertically integrated corporation, mass-producing goods within the U.S.
• Political party coalitions forged in the New Deal.
• A hyper-industrial Manufacturing Belt, shipping goods to other U.S. regions.
• After 1950, a mainframe culture: big computers in big organizations.
• A military-industrial complex.

A COLD-WAR ECONOMY?

A diverse tradition in the history of economics concluded that advanced capitalist economies inevitably tend to stagnate. Stagnationists like the Marxists Paul Baran and Paul Sweezy and the Keynesian Alvin Hansen (who all witnessed the transition) may well have viewed post-World War II America as a case in point. From 1939 to 1989, military spending justified both (1) Keynesian budget deficits and (2) an implicit technology or industrial policy. Pump-priming there was, along with any number of infrastructure and R&D projects justified in the name of national security.

The cold-war economy was without question a new stage of American economic development. For example, President Eisenhower was elected in 1952 on a pledge to end the Korean War—which he did in 1953. But the arms budget grew relentlessly anyway through the 1950s. Alarmed by this unprecedented "peacetime" build-up, Eisenhower uttered a famous warning on leaving office in 1961:

The conjunction of an immediate military establishment and a large arms industry is new to the American experience. …In the councils of government, we must guard against the acquisition of unwarranted  influence…by the military-industrial complex . The potential for the disastrous rise of misplaced power exists and will persist. (Dwight David Eisenhower, 17 January 1961, in T. Augarde [Ed.], The OxfordDictionary of Modern Quotations [London: Oxford University Press: 1991], p. 73.)

And it is true that today we tend to forget the shock to the economic system that ensued with the end of the Cold War. After the post-Vietnam retrenchment, the Reagan arms build-up of the mid-1980s had given new life to the military-industrial complex. But between 1987 and 1995 defense spending fell from 6.4 to 3.9% of GDP. In those same years the U.S. lost over a million well-paid, defense-related jobs: more than one in three. Hard-hit though a few key states, were, however, by the mid-1990s the transition was complete. The proof? Today's unemployment rates below 5% in every region.

What happened to make the economic exit from the Cold War relatively smooth? A partial answer is that the private sector was more resilient than many had thought. In particular, a new core sector had been forming for some time, one capable of driving the economy to a subsequent basis for expansion.

INFORMATION GOODS AND THE NEW ECONOMY

In a 1989 essay, "The Triumph of Capitalism," Robert Heilbroner, perhaps the best known American historian of economic thought, declared the stagnation thesis dead. "The long-term process of expansion has bypassed saturation by discovering or creating new commodities." (Heilbroner, quoted in Jonathan Schlefer, "Making Sense of the Productivity Debate," Technology Review, August/September 1989, p. 33.)

What were these "new commodities," so powerful that they could swamp any tendencies the economy had toward stagnation? Today, of course, the answer is obvious. They were information goods , old and new, that can be digitized.

But how have such information goods become so prominent in the economy? The answer entails three landmark events: the invention of the microprocessor in 1971, the introduction of the IBM PC in 1981, and the commercialization of the Internet in 1994.

For purposes of understanding the transition of the 1980s, in which the old economy expired and the new one gathered its forces, we can focus on 1981.

THE PC REVOLUTION

Before that year there were three major technology industries: mainframe computers, electronic components, and medical instruments. These, plus a few other activities employing high proportions of scientists and engineers, used to constitute the "high tech" sector of the economy. The market for computers per se had only two components. Fortune 500 companies used big computers to compile databases for customer billing and employee records. The federal government (where the Defense Department and NASA relied on mainframes and supercomputers for military and space programs and the Census Bureau kept counting) was the other.

The IBM PC broadened the market from corporations and the federal government to include all manner of businesses, large and small, and households as well. The definition of I.T. changed accordingly.

Today, due in large part to that one significant product introduction in 1981, virtually every person, company, and government is a customer for technology products. The definition of technology industries has expanded from large computers to include personal computers, software, semiconductors, semiconductor equipment, communications (both telecommunications and data communications), and medical technology (biotechnology and medical devices). (Michael Murphy, 1997, p. 47.)

                    (1) large computers,

                    (2) personal computers,

                    (3) software,

                    (4) semiconductors,

                    (5) semiconductor equipment,

                    (6) communications, and

                    (7) medical technology (biotech and instruments).

What was so revolutionary about the personal computer? The microprocessor, as put to use in the Apple II and then the IBM PC, carried the world from an analog to a digital mode of representing ideas (language, numbers, images and sounds). Five basic ingredients in this change are

• Digitization
• Moore's Law
• A law of increasing bandwidth
• Metcalfe's Law
• Packet-switching

In that light, it is striking to find that U.S. Commerce Department data ( Figure 6 of the on-line version of The Emerging Digital Economy) on I.T.'s share of corporate investment in business equipment show sharp jumps after both the PC and the Internet. The data show the I.T. share jumping from about 10 percent in 1979 to 25 percent in 1985 and again with the Internet from about 33 percent in 1994 to 45 percent in 1996. (Department of Commerce, 1998.)

While we are at it, other indicators in the report show similar shifts in the economy toward digitized products and processes. For a quick introduction to the Commerce Department report, The Emerging Digital Economy, go to chapter 1, "The Digital Revolution," and check Figures 1-5. For the White House web site on digital commerce, including the famous White Paper's guidelines for regulation, see ecommerce.

LONG WAVES AS NEW ECONOMIES

And yet, to repeat, this is not the first or even the second or third new economy. On the contrary, and from one point of view, world development unfolds through a succession of "new economies." The roughly 50-year rhythm of the sequence can be seen in TABLE 4. The table is based on a review by Nobel-Prize-winner Simon Kuznets of Joseph Schumpeter's 1939 book, Business Cycles: A Theoretical, Historical and Statistical Analysis of the Capitalist Process. The waves labeled "Kondratieff" refer to Nikolai Kondratieff, the great Russian economist of the early 20th-century who first posited and explored such 50-55 year cycles—and died at the hands of Stalin. (Kuznets, "the father of national income accounting" in the U.S., was also Russian-born.)

The first was the beginning of the Industrial Revolution and the factory system, the second had as its symbol the railroads, the third electricity and automobiles, and the fourth (for the U.S., at least) the military-industrial complex of the Cold War. The fifth wave, the Information Age, is today's new economy. (TABLE 4.)

The series of five "new economies" corresponds in its logic to Schumpeter's theory of creative destruction. In Capitalism, Socialism, and Democracy (1942, 1962, p. 83), he wrote that innovation "incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism" (p. 83). In a footnote, he points out that the years of "comparative quiet" can make us miss out on the longer rhythm:

                  These revolutions are not strictly incessant; they occur in discrete rushes which
                  are separated from each other by spans of comparative quiet. The process as a
                  whole works incessantly, however, in the sense that there always is either
                  revolution or absorption of the results of the revolution, both together forming
                  what are known as business cycles. (Schumpeter, 1942, p. 83.)

Strictly speaking, not many economists today view such long waves as technically measurable. Numerous attempts to quantify and measure price and output fluctuations to validate more formal Kondratieff Cycles have proved unsatisfying. But then the same thing is true of "business cycles" of any duration: economists have come to doubt any regular cycle of business fluctuations over time. In any case, in this softer version, as labels for distinct technology regimes through the stages of the Industrial Revolution, long waves seem useful constructs. By this I mean that they can provide a framework for understanding other seemingly autonomous (i.e., seemingly independent or free-standing) changes that catch our attention.

Consider, for example, globalization. One of the organizers of the World Economic Forum in Davos, Switzerland, sees globalization as the hallmark of the 1990s. In turn, globalization in her view awaited the end of the Cold War. When the U.S.S.R. was dissolved in 1991, she says, "That unleashed all the capital and energy that had previously been locked in this global power struggle" (Maria Livanos Cattaui, in Diana B. Henriques, "Sewing a Label on a Decade," The New York Times, 4 January 1998, p. C3.)

Fair enough. Globalization seems on the surface to be "what the 1990s are all about." (My phrase, not hers.) But what is it in the 1990s that has stepped up the pace of global communication? As a commentary in Newsweek put it in September, "Globalization has become the decade's most overused word. But at its heart, it embodies a real truth: technology has made this a planet of shared experiences." (Quoted by Seth Stevenson, "In Other Magazines, Slate, September 1, 1998.)

Here we have it. In the 1990s, "Technology has made this a planet of shared experiences." The technology in question is digital.

The next section of the chapter is a case study on the birth of the digital economy, as it unfolded geographically. The theme to be developed now is that the presence of younger regions (regions of creativity, one might say), gave the U.S. geographical sources of rejuvenation not available to its competitors in the world economy.

Radical advances in technology can dislodge established regions or nations from the top ranks of wealth and power. In the late 19th century, Britain famously lost its lead to Germany and the U.S. when the key sectors in the world economy shifted from steam power and textiles to electricity and chemicals. Whatever Britain had done right in the earlier era, after about 1870 it was no longer enough to keep the first industrial nation ahead of its newcomer rivals.

Something similar happened within the U.S. when the microprocessor was invented at Intel in 1971. The outcome of that basic breakthrough would be to strike down the established information technology (I.T.) giants of the American Northeast, in favor of younger companies in such western states as California, Texas, and Washington.

As American computing evolved from the mainframe and minicomputer to the PC and the Internet, the centers of design, strategy, and control that were initially combined at IBM's headquarters at Armonk, New York, scattered far and wide. The sequence of industry stages in FIGURE 11 is from researchers at Morgan Stanley, an investment bank. I have added characteristic home-regions to the mainframe, mini, and PC eras. These are New York State for mainframes, Boston's Route 128 for minicomputers, and the West generally for the PC era. The current stage, Internet-Enabled Systems, began about 1994. Its home-region remains an open question.
 

Our theme is that in the PC era the younger firms in the West revolutionized world computing and in so doing won back a leadership role that was rapidly shifting to Japan. Two quick comparisons help put this idea in perspective:

• The decade after 1987, the period of the unexpected U.S. resurgence vis-à-vis Japan, saw a reversal in the market valuations of America's leading I.T. firms. (TABLE 5.) The West's Intel and Microsoft leapfrogged the Northeast's IBM and DEC (Digital Equipment Corporation). (Norris, 1997.)
• More generally, by a recent ranking 9 of the world's top10 I.T. firms are American, and 8 of the 9 are from the three western states.

This case-study links the American comeback in information technology in the 1990s to the regional realignment that marked the PC era. The module unfolds as follows:

1. The coming Japanese conquest (ca. 1989)

2. The rise of the Wild West companies

3. The break-up of the old computer industry, 1985-1990

4. The U.S. comeback, 1989-1994

5. New companies in the Internet Era (1994-)

6. The location of the top 100 I.T. firms in 1997

7. Europe's potential in the net-centered era
 

As background, we need to recall how different the world looked a decade ago.

1. THE COMING JAPANESE CONQUEST (ca. 1989)

(1) Semiconductors. Japan had caught the U.S. in its output of semiconductors by 1986, and by 1988 and 1989 it was supplying over 50 percent of the world market. Despite a partial captive market (e.g., IBM producing its own chips for its own computers), "merchant" memory chips for sale in the open market had been largely taken over by Japan.

That left mainly microprocessors for the U.S.—but even this creative side of semiconductor chips was being bought up by Japanese firms. According to M.I.T.'s (the university, not the Japanese ministry) Made in America, "Without some dramatic realignment of the American merchant industry, its decline is likely not only to continue but to accelerate." (Michael Dertouzos et al., 1989, p. 261.)

(2) Computers. The shift from desktop microcomputers to portables seemed to signal a shift toward Japanese leadership. The flat screens in laptop and palmtop computers had liquid-crystal-diode (L.C.D.) displays, a Japanese strength. (This was also another example of a U.S. discovery—at R.C.A. in 1963—which only the Japanese had seen fit to commercialize, for use on digital watch faces and video games). Hence the evolution of the industry toward laptops was thought to help Japan. Charles H. Ferguson thus wrote, "Some say: 'Japan will make the commodities and the U.S. will profit from design, software, and marketing.' This is fantasy." (1990, p. 66.) His prescription: U.S. government-industry consortia along Japanese lines.

(3) Software. Even in software, the Fifth Generation project (artificial intelligence, or AI) Japan initiated in 1982 was still being touted as a locomotive coming through the tunnel. This was the accepted outlook despite Japan's language and other handicaps in software. If MITI could make it happen in VCR's, the prevailing view then intoned, why not software too?

(4) HDTV. In 1989 lobbyists for a U.S. high-definition television (HDTV) effort to counter Japan's were making major inroads within the Executive Branch of the federal government. They converted Robert Mosbacher, the Secretary of Commerce, and Craig Fields of the Pentagon's Defense Advanced Research Project Agency, DARPA (now ARPA), to the view that the U.S. was hopelessly behind Japan and could only catch up in this "critical" (i.e, to national security) technology with help from the government. While not central to I.T., HDTV was nonetheless feared in the U.S. as an advanced technology that would permanently guarantee Japan's supremacy across consumer electronics and home entertainment generally.

But a funny thing happened on the way to Japan’s inexorable conquest of the world’s I.T. sector. The conquest fell apart on all fronts: chips, boxes, software, television—and , for that matter, telecommunications as well. You name it: if it required creativity and a rapid response, Japan lost it. They lost it, as a rule, to U.S. companies headquartered in the Western states, in an arc from Texas to Seattle.

Who were these companies? Why did they spring up in the western half of the U.S.? How did they defeat Japan's bid for leadership in I.T., the world's premiere growth sector?

2. THE RISE OF THE WILD WEST COMPANIES

One way to answer these questions is to list a series of examples in which old-style companies in the Northeast (call them "managerial corporations") bungled opportunities to innovate. In the vacuum, younger and more innovative firms (call them "entrepreneurial corporations") took advantage of the figurative wide open spaces of the West to move the industrial system to its next stage of development.

This section is a narrative account of the regional realignment. (Other issues of interpretation are touched upon below in Section 3, in connection with cluster theory.)

CASE 1: FAIRCHILD SPAWNS INTEL (1968)

In contrast to mainframes and minicomputers, personal computers are blown up from thumbnail-sized microprocessors. Silicon Valley started with transistors, moved on to memory and logic (or microprocessor) chips, and evolved into a complex producing the whole I.T. spectrum. Its origins as a semiconductor center would ultimately give the Valley a decisive advantage over Route 128.

In this sense, it can be said that Silicon Valley is "a place that was invented one afternoon in 1957 when Bob Noyce and seven other engineers quit en masse from Shockley Semiconductor" to found Fairchild Semiconductor. This was a division of the established Syosset, New York firm, Fairchild Camera and Instrument. (Robert X. Cringely, p. 36.) The path leads from New Jersey's Bell Labs to a moment in 1968 when Noyce and crew would again leave, this time from Fairchild.

Background: The Origins of Silicon Valley. A key technological moment in the Valley's development was William Shockley's arrival in 1955 from Bell Labs. Shockley had been a co-inventor of the transistor in 1947 for Bell Labs, which would later garner him a Nobel Prize. In 1955 Shockley returned from New Jersey to his home state to start a transistor company in Mountain View, near Stanford. (Bell Labs is now Lucent.)

He called it Shockley Semiconductor because the transistor could be switched on or off to register a 0 or 1 in binary code, depending on whether it was in a conductive or non-conductive mode. This "semiconductor" property is present in the minerals germanium and silicon. Years later, in 1971, a newsletter writer named Don C. Hoefler accordingly coined the term, "Silicon Valley." (Rogers and Larsen, 1984, pp. 25-26.)

Shockley moved west to Mountain View in part because it was his home ground and his mother still lived there. But business logic also favored the move. Two key components were already in place to create a seedbed for new enterprises. One was the Stanford Industrial Park launched in 1951 and followed in 1954 by the Stanford Research Park. The impetus was not economic development but the desire to make money from real estate the university owned yet (by the terms of Leland Stanford's gift) could not sell.

The second keystone was Hewlett-Packard , started by the two Stanford students on the eve of World War II to manufacture electronic oscillators, under the guidance of an electrical engineering professor studying negative feedback, Fred Terman. The two components had come together in 1954 when H-P took a lease in the Stanford Research Park and served as the anchor for subsequent tenants. (Rogers and Larsen, chapter 2.)

The Traitorous Eight. Shockley had barely started his semiconductor company when it foundered on a legendary spin-off, which would eventually beget Intel. It has been said that Silicon Valley is "a place that was invented one afternoon in 1957 when Bob Noyce and seven other engineers quit en masse from Shockley Semiconductor" to found Fairchild Semiconductor, as a division of the established Syosset, New York, firm Fairchild Camera and Instrument. (Cringely, 1993, p. 36.)

Fairchild's Traitorous Eight, (as Shockley saw them) share credit with Texas Instruments (TI) for inventing integrated circuits (ICs). Germanium ICs were designed by Jack Kilby at Texas Instruments (TI) in Dallas, but he lacked a method of layering transistors on a flat surface. Jean Hoerni, one of the Fairchild Eight, came up with a "planar" technique to embed rather than stack component layers.

Noyce carried the idea through to create complete circuit maps on a single silicon slice, clearing the way for photolithography (or "burning" the circuits into the slice) and thus for batch production. TI and Fairchild both announced the breakthrough in 1959. ICs came into production within two years, for use by the U.S. government at $100 apiece to miniaturize the future Apollo moon rocket's onboard computer (Palfreman and Swade, 1991, pp. 87-91).

Intel. A decade later, Noyce, Moore, and others jumped ship again to found Intel, a more egalitarian company than Fairchild's eastern owners would permit. As a minister's son from Iowa, Noyce did without dress codes, reserved parking places, closed offices, executive dining rooms, and the other status trappings of more hierarchical and bureaucratic mature U.S. corporations. The remote control thus foundered on the divergent philosophies of Syosset and Silicon Valley:

Noyce's brush with the Northeast’s resistance to change was repeated at Xerox PARC, this time over bringing new products to market. In 1970, the eastern copier firm, Xerox, founded Palo Alto Research Center (PARC) as a flat organization of some 50 creative researchers whose mission was to create "the architecture of information."

As PARC'S web site puts it, they responded "…by inventing personal distributed computing, graphical user interfaces, the first commercial mouse, bit-mapped displays, Ethernet, client/ server architecture, object-oriented programming, laser printing and many of the basic protocols of the Internet." Preoccupied with copiers, however, the New York-based Xerox failed to bring any of these potentially breakthrough technologies to market. That remained for such western firms as Hewlett-Packard, Apple, and Utah's Novell.

CASE 3: IBM AND DEC IGNORE THE COMPUTER-ON-A-CHIP

Noyce and his colleagues thus formed Intel in 1968, as a spin-off (like its competitor National Semiconductor and some 50 other companies) from Fairchild. Intel made its mark on the world in November 1971 when it announced a triple breakthrough: the microprocessor, dynamic random access memory (DRAM), and erasable programmable memory (EPROM) for software. (George Gilder, 1989, p. 101.) Here was the package to make personal computers a reality.

But the big computer companies of the Northeast were not interested: "IBM and DEC...decided there was no market. They could not imagine why anyone would need or want a small computer; if people wanted to use a computer, they could hook into...time-sharing systems." (Palfreman and Swade, 1991, p. 108.) Thus microprocessors languished, scorned by the mainframe and mini- establishments—and not pushed by Intel—for another three years.

What would it take to bring the new firepower into play? The answer came with the now legendary January 1975 issue of Popular Electronics, whose cover showed the MITS Altair kit for a home-made microcomputer based on an Intel 8080 processor chip. Inspired, Steve Wosniak devised the Apple 1 to impress the hobbyists at the Homebrew Computer Club in Palo Alto. When Steve Jobs entered the picture the result was the Apple II, which found a ready market.

Wosniak's hardware breakthrough was matched on the software side by the 19-year-old Seattle-ite, Bill Gates. Using a DEC PDP 10 minicomputer at Harvard to emulate the MITS Altair, Gates and his high-school friend from Seattle, Honeywell programmer Paul Allen, devised a modified version of Dartmouth's mainframe BASIC programming language. Moving to New Mexico to be near the MITS facility, they formed Microsoft to market MITS BASIC, their microcomputer version of the mainframe programming language. Over the next five years, Microsoft would then develop, market, and license other languages for microcomputers, reaching $2.5 million in sales and 25 employees by the end of 1979.

In other words, the four seminal figures in the PC industry after 1975 (when IBM in New York and DEC in Massachusetts saw no future in it) were barely 21 on average and hailed from the San Francisco Bay area and Seattle.

Microsoft—like Compaq in Houston, Dell in Austin, Texas Instruments in Dallas, and WordPerfect and Novell in Utah—is a reminder that the technological transformation of American computing ranged from Texas to Seattle. If Silicon Valley was the West's capital, it sometimes followed the lead of the provinces.

The next episode was played out not in the West at all, but in Florida. Yet the theme remains the same: new territory as a spur to innovation.

CASE 4: THE PC'S ROOTS IN BOCA RATON, SILICON VALLEY, AND SEATTLE

Microsoft's initial takeoff following the New Mexico start-up brought the company to IBM's attention. In the mid-1970s, IBM had actually introduced an expensive PC-like machine that drew little response from its corporate customers and was quickly abandoned. By 1980, as microcomputer sales by Apple, Radio Shack, Atari and Commodore generated over $1 billion, IBM decided to try again.

This time IBM's development team was placed far from Armonk, New York, headquarters in Boca Raton, Florida, with a one-year project deadline. The crash-program deadline, unprecedented at IBM, forced the PC project chief, Bill Lowe, to design a machine built from other people's components—another radical departure for IBM.

Enter Microsoft. Lowe's plan for IBM was initially just to buy Microsoft BASIC, a standard feature of existing microcomputers, and to run it over a CP/M operating system from Gary Kildall's Digital Research of Pacific Grove, California. But when negotiations with Kildall misfired (because he did not show up for the meeting in Pacific Grove), Lowe turned to Microsoft for the operating system as well. Gates replied that IBM should use a 16-bit microprocessor, the new Intel 8088 chip. But since Gates had no operating system for a 16-bit processor, Microsoft now had to come up with one.

Gates' solution was to spend about $50,000 to buy an existing 8088 operating system, QDOS ("Quick and Dirty Operating System") from Tim Paterson's Seattle Computer Products and to rename it MS-DOS. In August 1981 the IBM PC appeared on schedule, featuring MS-DOS (called "PC-DOS" by IBM), and Microsoft BASIC, with available Microsoft versions of FORTRAN, COBOL, and PASCAL.

The package was thus equal parts hardware from Boca Raton and Silicon Valley's Intel and system software from Seattle. The creative points of origin were far removed from Armonk, New York.

Such was the beginning of the IBM-Microsoft collaboration that ended in 1990 with a complete reversal of fortunes, symbolized by IBM's plummeting employment, from 395,000 in 1984 to 243,000 in 1994. Microsoft's standard-setting strategy succeeded to the point where its stock-market value, like Intel's, surpassed IBM's by 1993. (Not the least colorful aspect of the reversal is that IBM unloaded stock in Microsoft and Intel that, if retained, would have been worth $18 billion by 1996.)

In the meantime, it wasn’t just IBM who took a tumble in the 1980s. Something comparable was also happening along Boston's Route 128, where the big four minicomputer companies (Digital, Wang, Data General, and Prime) had entered the 1980s as giant-killers, Davids to IBM’s Goliath.

CASE 5: THE FALL OF THE ROUTE 128 MINICOMPUTER COMPLEX

The reindustrialization of New England from the early 1970s to the mid-1980s was an amazing story (one I sketched in an analysis published by the Federal Reserve Bank of Boston). The linked article, "The Role of Services and Manufacturing in New England's Economic Resurgence," is based on a simple technique known as shift-share analysis .

In the study I contended that (in contrast to New York City's comeback at about the same time), New England's resurgence was powered by manufacturing. The technique allowed a graphical portrayal of manufacturing's role, as initially lagging, then surging ahead on its own, then bringing other sectors along, then collapsing in the mid-1980s. It should be added that the services sector played a nonetheless crucial part in New England's reindustrialization, because two of the three key catalysts to the comeback were venture capital and higher education—service activities.

In any event, after about 1985 the two outwardly similar high-tech clusters, Boston’s Route 128 and California’s Silicon Valley, moved in opposite directions. Along Route 128, the "Massachusetts Miracle" (as touted by defeated presidential candidate Michael Dukakis) collapsed in a heap, wiping out tens of thousands of jobs across New England. But Silicon Valley kept on adding employment, despite California’s high taxes and housing prices.

A little-noted reason for this eclipse was management failure along Route 128. All the key players in the New England complex saw the handwriting on the wall in the early 1980s. The future of computing was the PC, not minicomputers, let alone mainframes. Yet not one of the successful and profitable companies (DEC, Wang, Data General, Prime), had the boldness to cannibalize their profitable minicomputer lines to shift to a PC strategy.

What could account for this collective failure of nerve? Technologically, Route 128's minicomputers were actually mainframe computers shrunk down, not microprocessors blown up, like the PC. For that reason it was much harder for the Route 128 companies to introduce new and uncertain personal computers. Putting it differently, the economies of scopefavoring Silicon Valley’s microprocessor-based complex were missing along Route 128. Facing the technology barrier, managers along Route 128 stayed too long with cash-cow, proprietary (or closed) systems in minicomputers.

The long-term outcome would be a default I.T. role for Route 128 as a software and now Internet specialist, a role MIT's presence more or less guarantees. But the immediate result was for hardware production to move west, to Silicon Valley and then to Texas.

CASE 6: HOW TEXAS BECAME THE PC STATE

Today Texas has the two leading PC producers in the world, Compaq and Dell. How did the Lone Star State become the PC State?

Texas Instruments. Compaq's provenance traces a fairly precise lineage of industrial evolution. In the 1930s engineers with a new instrumentation technology for seismographic oil exploration came from the Northeast to Dallas to found Geophysical Services. In 1951, the original firm gave way to Texas Instruments (TI). As we have seen, the technologies TI employed led naturally to semiconductor research and in 1959 to the co-discovery of the integrated circuit by Jack Kilby, a TI engineer. Military and space contracts from the federal government spurred the company's ascent to one of the top semiconductor manufacturers in the U.S. by the 1970s.

Compaq. In 1982 four TI engineers from the company's Houston facility broke away to form a spin-off. Their leader was Rod Canion, and the company was Compaq. The breakaway team patiently reverse-engineered the then new IBM PC, so that it could legally invent its own BIOS (or interface) chip to emulate the PC for 100-percent software compatibility. Their success created Compaq's breakthrough as the legitimate king of the PC clone-makers. Compaq rose from its inception to Fortune 500 status in only four years—a record Dell would itself later break.

What is the meaning of the TI-Compaq story? The link between resource endowments and innovative capacity. Historically, the development of technological strength in an American region can typically be traced to the region's resource base. (Perloff and Wingo, 1961.) A given resource endowment either generates or fails to spark a related set of resource-processing activities that in turn encourage the development of new skills and technologies. (Norton and Rees, 1979.) The link between iron and coal endowments and metalworking, via the machine tools industry, was how the Manufacturing Belt of the Northeast and Upper Midwest became the nation's seedbed for innovation in the century from 1850 to 1950. The 60-year path from oil exploration to Compaq's world leadership in PC production displays a similar logic.

Dell. In contrast, Dell's meteoric rise in the 1990s has no such precisely traceable lineage. Instead, Michael Dell's strategy has been to devise a new distribution system to "mass-customize" the PC to order and to get the product delivered in a matter of days through the mail. "Because Dell holds very little inventory, it takes advantage of lower component costs and is always selling a fresher product, which can command a higher profit margin." (Fisher, 1998.)

This comment by a journalist in August 1998 accompanies robust earnings announcements that show Dell moving into the position of No. 2 desktop computer seller in the U.S., i.e., moving ahead of IBM and Hewlett-Packard. (Compaq remains in first place.) It would be hard to find a better illustration of the triumph of the Texas PC producers over their rivals in other regions.

3. "THE BREAK-UP OF THE OLD COMPUTER INDUSTRY" (1985-1990)

To recap, Intel’s invention of the microprocessor in 1971 set the stage for the PC—which the Northeast’s computer firms then failed to develop. That task was left to newcomers, adolescent or 20-ish prodigies from California and Washington State. After several failures, IBM finally managed to emulate Apple’s success, but only by moving the PC project’s design far from Big Blue’s headquarters, to Boca Raton in Florida, and only by using components from Intel and Microsoft.

By the mid-1980s, as Japan moved into the I.T. passing lane, IBM summoned its PC management back to its Armonk headquarters, where the PC was smothered—partly by jealous competition from IBM’s mainframe managers! Meantime, the initial outsourcing to Intel and Microsoft meant that clones using the same components were now taking away larger and larger shares of the PC market. IBM was about to fall, and Japan was ready.

Moreover, Japan had by the mid-1980s seemingly wrested the semiconductor lead from Intel. Intel had lost money in 1983 and 1984 in the face of heightened Japanese competition in DRAM memory chips. Andrew Grove, Intel's Hungarian-refugee CEO has since said, "There is at least one point in the history of any company when you have to change dramatically to rise to the next performance level. Miss the moment and you start to decline." (Andrew Grove, 1993, p. 58.) At Intel the moment came in 1985. (FIGURE 12.) The company surrendered memory chips to Japan and turned solely to microprocessors (at the time, 286s).

What happened between Intel's company-saving decision and 1990 Grove describes as "The breakup of the old computer industry... [which] gave Intel its chance and made the mass-produced computer possible." The change can be described in terms of Grove's sketch of vertically integrated companies vs. new horizontal tiers differentiated by component. (FIGURE 13.) The old system had self-contained, relatively closed and proprietary systems a la Route 128 and IBM. "These vertically integrated companies would compete against [each other]...and buyers had to commit to the whole package of one manufacturer or another." (Grove, p. 57.)

OPEN SYSTEMS

By contrast, the new model of competition is based on open (i.e., published) technical standards and full compatibility between every component-maker's products and every other's. In FIGURE 13, for example, each horizontal line represents a product axis along which companies in a particular segment of the market (systems software, monitors, printers, software applications, etc.) compete. The products from each segment must be fully compatible with those on every other horizontal tier--or customers will not buy them. This new system Grove terms "industrial democracy," in the sense that "It resists central guidance. Nobody can tell anyone else what to do." (P. 57.) In contrast to the old regime, choices abound and competition drives prices down.

Consumers also benefit from an accelerated pace of technological change. In a demonstration of the "Arrow effect," IBM had notoriously restricted the pace of technological change with a view to maximizing its profits over time. Its mainframe installations were known for "golden screwdriver" techniques, in which a demand for more performance (at higher rental rates) would prompt a visit from an IBM technician who would insert a few lines of code into existing software and unlock new power in the machine. (James Carroll, 1993, p. 217.) Similar restrictions of hardware potential marked IBM's missteps with its PC-AT in the mid-1980s.

The new rules force the pace of technological change and translate lab potential into product. Grove’s analogy is skis. "Any ski boot works with any binding. Any binding fits any ski. That permits innovation to take place independently in boots, bindings, and skis." (Grove, p. 57.)

STANDARD-SETTING

But who makes the profits required for high levels of sustained R&D? Charles Morris and Charles Ferguson contend that the key to profitability is to control the standards, protocols, and formats by which the different parts of an information system are linked. Put the other way around, we find a (perhaps belated) recognition that Japan is only human.

As Grove observes, "A leading-edge product requires leading-edge manufacturing capability, and you can't buy it." (Grove, pp. 57-58.) It requires massive investment, which requires massive profits, which come from competition via standard-setting.

That is the puzzle the successful Wild West firms solved in the 1990s. In turn, their ability to handle the pace of innovation given by Moore's Law while still maintaining continuity of standards created shock waves worldwide. It gave the U.S. a second wind as the race with Japan carried into the 1990s.

4. THE U.S. COMEBACK, 1989-1994

In every one of the four I.T. sectors sketched in the introduction to this case, what actually happened was more or less opposite what most people had expected in 1989.

(1) Semiconductors. Timelines show Japan taking the lead in 1985, pulling far ahead by 1989, then being overtaken by 1993. Not only has U.S. pressure from the high-markup microprocessor end of the chip spectrum hurt Japan. Korea has attacked from the commoditized memory-chip end, in a bid reminiscent of that country's success vis-a-vis Japan in steel and shipbuilding.

(2) Computers. Computer "boxes" have also displayed a surprising U.S. resilience since 1989. One indicator is the failure of Japanese microcomputers to make much of an inroad into the U.S. market. Following a jump from 9 to 13 percent between 1989 and 1990, Japan's U.S. share fell back to 6 percent in 1991. Commenting on this reversal, Steve Jobs observed in 1992 that "The United States computer manufacturers have re-invented themselves and are holding on to the most desirable market in the world." (Quoted in Markoff, 1992.) The result finds Japanese firms supplying U.S. computer makers with flat screens and memory chips, but struggling to sell the U.S. markets the actual computers.

(3) Software. As to software, point one is the demise of Japan's Fifth Generation project. After 10 years, MITI gave up the ghost in mid-1992. "The problem for Japan is that the computer industry shifted so rapidly that the technological path the Fifth Generation took—which seemed a wise choice in 1982—turned out to be at odds with the computer industry's direction by 1992." (Andrew Pollack, 1992.) The lack of interest in the software that resulted led MITI to give it away free, though few took them up on the offer.

Equally important is the triumph of Microsoft's Windows platform, an exercise in cumulative standard-setting that has given an edge to U.S. computer companies relative to, say, NEC or Toshiba, which were late to commit to the standard.

(4) HDTV. As with the Fifth Generation project's commitment to the wrong technological trajectory, so too with HDTV. U.S. companies have developed digital approaches that appear to have leapfrogged Japan's analog approach. Thus "...enlightened federal regulation, rapidly advancing digital technology and cooperation between competing organizations have combined to vault the late-starting United States into a clear lead in the race to develop practical high-definition television." (William J. Cook, 1992, p. 14.)

In 1994 the director general of broadcasting in Japan's Ministry of Posts and Telecommunications conceded as much. He created a furor by revealing that his ministry was contemplating withdrawing support for Japan's HDTV program. The announcement was taken to signal "The triumph of American-style HDTV, something almost unimaginable five years ago...." (Andrew Pollack, 1994.)

CAN INDUSTRIAL POLICY HURT COMPETITIVENESS?

These four distinct sectors suggest that industrial policy can retard change in a dynamic technological environment. Pollack comments that the HDTV episode is especially telling: "...Japan's plan for HDTV showed the drawbacks in this country's system of Government-backed cooperative industrial development. The system allows for great staying power and steady progress down a particular path, but does not adjust well when the technological road turns." (Emphasis added.)

By the mid-1990s, such second thoughts about MITI and the role between Japan’s bureaucrats and its giant firms had become widespread. The failure of the Fifth Generation software project and of the HDTV campaign, combined with Japan’s distant lag in its over-regulated telecommunications sector—all these stand in contrast to the diversity and dynamism of the U.S. technological landscape. What had seemed to work so well for Japan in the automotive and consumer-electronics sectors in the 1970s and 1980s looked strangely dated today.

LESSONS

We have considered six examples of tensions between the old computer industry of the U.S. Northeast and more entrepreneurial actors in the South and West. We also compared the dismal 1989 prospects and startling U.S. comebacks during the 1990s in computers, software, semiconductors (more specifically, microprocessors), and HDTV. The counterparts were surprising setbacks for Japanese efforts in each of the four components of Information Technology, as well as in the related sector of telecommunications.

The logical link between these two sets of events is what Andrew Grove termed "the breakup of the old computer industry" between about 1985 and 1990. The relentless drumbeat of 18-month product cycles for chips given by Moore’s (and Joy’s) Laws required quick responses by players throughout the I.T. sector. The technology’s momentum in effect required entrepreneurial agility. Agility’s nemesis is bureaucracy—which in the mainframe culture of IBM would slow decision-making to a standstill as Microsoft heated up the system-software design wars of the 1980s. In a parallel quest, Intel’s radical bet-the-company reinvention after 1985 wrested standard-setting leadership for microprocessors away not only from IBM but from Japan as well.

The new business model that took hold after 1985 spawned competition via open (published) systems, compatible components, and uniform technical standards across vendors. In addition, the characteristic PC firm was specialized in a particular slice of the sector:

The competitors that succeeded under the new rules were not only American, but from the West. "From a global perspective, this change in vendor business models led to an even more dominant U.S. competitive position. Most of the companies that mastered the horizontal model turned out to be American, usually from the western half of the country." (Moschella, p. xi, emphasis added.)

Without the regional realignment, the history of the U.S. computer sector would have remained the preserve of IBM and Route 128 (the aging upstarts). Japan would likely have taken outright leadership in the I.T. sector from the U.S. Its great electronics companies, notably Fujitsu and Hitachi, but also Toshiba and NEC, gave every indication in the 1970s of knowing how to catch and overtake Big Blue. Instead, that would fall to such standard-setters as Intel and Microsoft.

To be sure, some observers still viewed the U.S. resurgence as only temporary. Eamonn Fingleton, for example, wrote a 1995 book with the uncompromising title, Blindside: Why Japan Is Still on Track to Overtake the US by the Year 2000. But as 2000 approaches, the forecast seems a bit strained. Perhaps a more plausible comment on the state of the world’s I.T. sector today came from a Czech computer expert commenting on software in March 1996. "Americans are showing an unbelievable burst of creativity. By relying on sophisticated tools, Americans have shifted the competitive arena from sweat labor to imaginative design."

With the arrival of the Internet in 1994, the creativity factor would play an even larger role.

5. NEW COMPANIES IN THE INTERNET ERA (1994-)

 
"Put simply, the story of computer industry competition has been one of new waves of technology, led by new waves of vendors, rapidly overpowering much of the existing order. …[T]he network-centric era will result in market and supplier restructuring every bit as great of those of the PC revolution." (Moschella, 1997, pp. vi-vii.)

In a useful simplification, the Internet or network-centric era can be dated from 1994, the year the barriers finally came down to the creation of a "network of networks." The Defense Department's ARPANET had been around since 1969. By the mid-80s the National Science Foundation had helped it evolve into a university research network based on the Pentagon's software standard, Transmission Control Protocol/Internet Protocol (TCP/IP). In 1989 Tim Berners-Lee, a British scientist working at the physics research lab CERN in Switzerland, had devised the hyperlink system of document linkage and access—an example of which you are now reading. The problem remained, however, how to hook up and standardize the numerous proprietary networks (e.g., AT&T and MCI) competing for corporate and consumer business.

The problem was effectively solved in 1993 by programmers at the University of Illinois (the source also of the widely used free e-mail program, Eudora). Headed by Marc Andreeson, they came up with a good graphical-user-interface (GUI) browser, MOSAIC. Then Andreeson decamped for Silicon Valley and helped launched Netscape Navigator for profit in 1994.

At this juncture Metcalfe's Law kicked in. To repeat: the costs of adding users to a network increase linearly, while the benefits expand quadratically. If a network's users increase in number from 99 to 100, for example, the costs to the network go up by the incremental cost per node, the same as if the number increased from two to three users. But the number of additional two-way connections go up by 99, vs. only 3 more when a third subscriber is added. The larger the network, the greater the value to existing users of new members.

The smaller, isolated proprietary networks of the 1980s had failed to break through to the threshold that was now accessible via the Internet and a Mosaic-class browser. After 1994, any such constraints would be rent asunder. The shockwaves are with us still, as the new communications links redefine every sector of the economy.

NEW FUNCTIONS, NEW COMPANIES

The Internet permitted a blending of computing, communications, and entertainment in the mid-90s that, like the PC before it, changed the rules of the I.T. game. As to the pattern of regional advantage, one indicator of the new regime is the appearance of new companies. Another is the re-making of existing ones.

To get a sense of these tendencies, we can turn to a recent list of the world's top I.T. firms, then look at specific firms and their locations.

The July 1997 PC Magazine list of the world's 100 "most influential" I.T. firms appears as TABLE 6. The criteria for the list are subjective, but plausible. Perhaps the main caveats are (1) the list is American, and biased to that extent, and (2) these are the top firms from the perspective of a PC magazine, not from the standpoint of mainframes, telecommunications, or biotechnology. The list may well be open to debate as to exact ranks of companies, and its makeup and rankings will change from one year to the next. For our purposes, however, it appears sufficiently reliable to serve as a roadmap for the new geography of I.T.

The impact of the Internet can be gauged by the fact that 15 of the most influential 100 I.T. firms in 1997 had not existed in 1989. (TABLE 7.) In addition to Netscape, these included such firms as PointCast , U.S. Robotics, DeLorme Mapping (Maine), Progressive Networks (Ohio), Yahoo! and Firefly Network (Massachusetts). Eight of the 15 new firms from the 1990s were located in California, three in the Northeast, two in the Midwest, one in Texas, and one in Kentucky.

In addition, a number of other companies on the list are labeled as telecommunications- or Internet-related. They include AT&T, idealab!, MCI, CompuServe, SAP AG (Germany), Hayes, 3Com, Santa Cruz, Number Nine Visual Technologies, Quarterdeck, Creative Technology (Singapore), Cisco Systems, Macromedia, America Online, Bay Networks, Madge Networks (the Netherlands), Cabletron Systems, and Ascend Communications (recently acquired by Lucent).

It is important to recognize that every company on the list of 100 (like most companies regardless of industry) experiences the Internet as a revolutionary technology. Tables 6 and 7 are more specific. They include companies that either sprang into existence to take advantage of the Internet or that qualify as I.T. companies because they have expertise in communications or media.

Beyond these two sets of firms, of course, the firm that leads the list, Microsoft, did a drastic change of course after 1995 to try to catch up with and overtake Netscape in the browser market. Without going into the antitrust case now being heard, we should nevertheless touch upon one aspect of the Microsoft vs. Netscape-AOL-Sun Microsystems conflict that is now taking shape.

FROM ILLINOIS TO SILICON VALLEY TO VIRGINIA

Has the Internet had much impact on the pattern of regional specialization in I.T.? The events of late 1998 offer a new angle on this question, in that they reveal the inability of Silicon Valley companies to set the agenda for the Internet era.

Not only is PC production centered in Texas. Not only has Microsoft set the software standards for the world to follow. Now it turns out that the struggle for commercial leadership on the Internet will take place between a Seattle-area firm and one based in Virginia: America Online. That is the implication of AOL's $4 billion takeover of Netscape, as bolstered by the Valley's Sun Microsystems.

As a columnist for the San Jose Mercury News observes,

Now we are on the eve of legal (antitrust) and technological (Open-Systems software, exemplified by Linux) challenges that seem likely to destroy Microsoft's position as a standard-setting natural monopoly. Would it be too nostalgic to recognize the possibility that the PC and the Internet explosion benefited from the Windows standard that Microsoft created—and from the Wintel duopoly Microsoft and Intel shared?

6. THE LOCATION OF THE TOP 100 I.T. FIRMS IN 1997

One way to sum up the impact of the regional realignment of information technology is to say that for the moment, Seattle, Silicon Valley, Texas, and now Virginia make the rules, and the rest of the world adapts to them. That statement used to hold for IBM. Then, in the late 1980s, it looked to everyone as if Japan's great electronics companies would replicate earlier triumphs in home electronics and automobiles. But that did not happen. Once again the U.S. holds a clear lead in I.T. The difference is that the sector's dynamism comes not from a company with a dress code (IBM), but from a variegated spectrum of younger enterprises in the West.

As we said, Silicon Valley dominates the list numerically—but not strategically. TABLE 8 shows the distribution of the 81 American firms on the list among U.S. regions. Within the U.S., 54 of the 81 are in the West. Numerically, 44 of the 53 western entries are from California. In terms of ranks, Washington (whose only firm on the list, Microsoft, leads it) and Texas (with 5 entries, but two in the top 11), are also prominent. (The absence of Amazon.com, another Seattle-area firm, must be an artifact of the timing of publication of the list, in mid-1997.)

In keeping with the theme of the new firm—the entrepreneurial vs. the managerial corporation—the ages of the 100 firms become younger as we move west. The firms founded before 1960 are more likely to have a location in the Northeast or outside the U.S. In the Far East (as it were), among Japan's 10 entries, 8 were founded before World War II, and the average founding date is 1927. (The remaining elder statesman on the list is Philips Electronics of the Netherlands, founded in 1891.)

While they made the list, few among these mature firms could be said to thrive in the new game. The only two stars from among the19 are IBM (which has risen from the grave in a new incarnation) and Hewlett-Packard—which is also the sole California firm among those on the list founded before 1960. Many of the other entries on the vintage list are struggling. In particular, three of the four great Japanese electronics combines are losing money in 1998, an unprecedented sign of weakened competitive positions.

It is surprising how extensive the U.S. comeback in I.T. has been. Only 19 of the top 100 firms are from outside the U.S., and Toshiba, at number 10, is the highest ranking of them. Indeed, 43 of the top 50 are American. The role of U.S. firms is thus even more dominant than the 81 percent share suggests, since most of the 19 non-U.S. firms ranked below number 50. (TABLE 6.)

The nationalities of the 19 firms are mainly Asian, with Canada and Europe hosting three each. Japan accounts for 10 listings: Toshiba (number 10), Softbank (21), Canon (27), Sony (43), Seiko (51), Matsushita (57), Sharp (60), Fujitsu (61), Hitachi (62), and NEC (63). Canada has three: Corel (17), Matrox Graphics (66), and ATI Technologies (77). Europe has three (the Netherlands' Philips Electronics, the U.K.'s Madge Networks, and Germany's SAP), but none in the top 50. In Asia, Taiwan's Acer is ranked at 34, Singapore's Creative Technology at 40, and Korea's Samsung/AST Research at 55. Of all the companies mentioned, perhaps the only one that today strikes fear and envy in the U.S. is Germany's SAP ("systems analysis and program" development). (Deborah Claymon, 1998.)

7. EUROPE'S POTENTIAL IN THE NET-CENTERED ERA

How does this episode in the history of technology relate to earlier crises of national competitiveness? One way to interpret the issue is to view the U.S. as a nation of country-sized regions at different stages of economic development. In that light, the I.T. sector experienced an internal, regionally focused maturity crisis in the Northeast a la 19th-century Britain. (R. D. Norton, 1986.) The difference was that the newcomer companies, created by entrepreneurs in younger regions, were still American.

By the same token, one reason for the eclipse of Europe's I.T. sector seems to be the smaller role played by entrepreneurs, relative to mature firms. The result, as Lester Thurow (1998) observes, is that Europe dropped behind Japan and the U.S. in the world's growth industries:

When breakthrough technologies occur, it is very difficult for old large
firms to lead. They have to cannibalize themselves to save themselves,
and that is simply very difficult to do. If one looks at the 25 biggest firms
(based upon stock market capitalization) in the United States in 1960 and
again in 1997, six of America's twenty-five biggest firms either did not
exist in 1960 or were very small. In contrast, in Europe all of the twenty-
five biggest firms in 1997 were big in 1960. In the past four decades
Europe has been able to grow no new big firms that could lead the world
technologically.

One characteristic of the transition is the shift in what he terms supplier structure away from the current horizontal value chain toward a communications chain. Apace with this he sees a corresponding shift in supplier leadership from U.S. made components to national telecommunications carriers. In other words, he assumes that national governments will retain control over major telecommunications suppliers, preventing complete globalization in this sector. The upshot is a localization of the present unified global market in which competitive advantage is gained through sheer design or cost efficiency.

In an ingenious application of Michael Porter's diamond model of national competitiveness, Moschella assigns number grades (in the form of stars) to the U.S., Japan, and Europe in a variety of categories he deems important for the next few years. The detailed evaluations are listed in TABLE 9.

The bottom line is a better outlook for Europe than for Japan. Summing over Porter's categories of (1) factor conditions, (2) related industries, (3) demand sophistication, and (3) domestic rivalry, Moschella computes aggregate ratings. The scorecard finds the U.S. with 4 1/2 stars (out of a maximum of five), Europe 3 1/2, and Japan 2 1/2. By this reading, however preliminary, we are about to turn the page to a new chapter in which Europe plays a larger part.

So much for the regional origins of the digital economy. Our next step is to interpret the geography of innovation and entrepreneurship from the standpoint of metropolitan areas, or clusters.

In "The Valley of Money's Delight" (The Economist, March 29, 1997), John Micklethwait cites economic cultures as the catalysts that determine whether networks communicate. As he observes, "Research has increasingly concentrated on clusters—places (such as Hollywood or Silicon Valley) or communities (such as the overseas Chinese) where there is 'something in the air' that encourages risk-taking."

He lists 10 features of Silicon Valley's economic culture that help explain the area's dynamism. Together they add up to loyalty to the place, rather than to the firm:  

1. Tolerance of failure.

2. Tolerance of treachery.

3. Risk-seeking.

4. Reinvestment in the community.

5. Enthusiasm for change.

6. Promotion on merit.

7. Obsession with the product.

8. Collaboration.

9. Variety.

10. Anybody can play.

One of the virtues of this list is that is instantly conjures up the range of issues and values that come into play when we talk about the ties between companies and places. As the following survey suggests, cluster theory is the growth industry of regional analysis in the 1990s. What it reveals to us remains as yet an open question.

THE REDISCOVERY OF MARSHALL'S INDUSTRIAL DISTRICTS IN THE 1980S

In classical industrial-district theory, as spelled out a century ago by Alfred Marshall, external economies encourage the agglomeration of firms in a particular place or region by lowering firms' costs of production. Marshall's widely quoted formulation is that specialized agglomerations of firms and craftsmen create "something in the air" that perpetuates a place's skill-set, lore, and competitive advantage relative to other places.

The conventional part of Marshall's theory rests on external economies. The more firms in the same industry gather in a single locality, the larger the "common pool" of the factors of production it uses. (Inputs or factors of production here can be understood to include not only land, labor, and capital, but more specifically energy, transportation, and specialized resources like venture-capital firms.) The larger the supply of such inputs in the area, the lower the costs of production to all the firms in the industry. Also, as these inputs become more specialized, they may become more productive. So each firm in the area is more competitive than if it operated in isolation.

Marshall's industrial-district model was updated in 1984 in The Second Industrial Divide by Michael Piore and Charles Sabel. Piore and Sabel highlight "flexible specialization" as the developmental stage succeeding "Fordism" or mass production. They emphasize the virtues of the "Third Italy" and its industrial clusters specializing in high-fashion, design-intensive goods. They see virtuous networks emerging among rival firms, which manage to cooperate around activities of mutual benefit such as training, marketing, and market research.

In such an environment of geographic proximity and economic decentralization, networking and cooperation provide a fertile milieu for innovation. Accordingly, "Flexible production is marked by a decisive geographical re-concentration of production, and by the resurgence of the industrial district" (Storper and Walker, 1989, p. 152).

In a U.S. context, this theme seemed to harmonize with a resurgence of cities like Boston and New York, which, after losing large numbers of people in the 1970s, rebounded in the 1980s. Boston's core propulsive cluster comprised minicomputers and software. New York City's was producer services. In both, the growth sectors more than compensated for the decline of older industries.

PORTER: CLUSTERS IN THE DIAMOND

In 1990 Michael Porter presented a fresh and independent look at the role of metropolitan regions as industrial incubators in advanced economies. He asked why the world's newer (i.e., innovation-driven) industries tend to be identified with firms in a particular country. From Schumpeterian premises, he recast this question in terms of innovative capacity. "Why do some firms, based in some nations, innovate more than others?" (p. 20).

Porter viewed the managerial corporation as an inertia-bound and hence obsolescent entity. Left to themselves, big companies will grow fat and sluggish, lose their competitive edge, and stagnate. His view was summed up pungently in a review by the head of The Economist Group, a consulting firm. "The natural tendency of a company doing well is to rest on its laurels; only the spur of constant competition leads it to innovate, change, and overcome organizational inertia (or 'stability,' as managers prefer to call it)" (Gordon, 1990).

In that context, Porter's answer to the question of why firms in some nations are more innovative than in others builds on his analytical "diamond." Its four corners are

• demand conditions,
• factor conditions,
• rivalry-strategy,
• industry clusters.

In practice, success stories in specific industries are often also the stories of urban agglomerations. Focusing in particular on point (4) of the diamond, industry clusters tend to take root in specific places. As he puts it, "Successful firms are frequently concentrated in particular cities or states with a nation" (p. 29).

In the U.S., for example,  

 … many of the nation's leading real estate developers are based in Dallas, Texas;
oil and gas equipment suppliers in Houston; hospital management chains [around]
Nashville, Tennessee; carpet producers in Dalton, Georgia; running shoe
manufacturers in Oregon; mobile home producers in Elkhart, Indiana; and minicomputer companies in Boston. Something about these locations provides a fertile environment for
firms in these particular industries. (Porter, 1990, p. 29.)

What is this "something" about specific cities that nurtures clusters of firms on their way to world leadership? Porter's answer is that both (1) information flows and (2) rivalry between firms are more intense in a tight geographical locale. Each nutrient is redoubled by local media, banks, and universities, and face-to-face contacts.

Thus Porter and the new regionalists came independently to the same conclusion. To the regionalists, post-Fordist competition, highlighted by flexible systems and quick responses, bolsters the economic base in resurgent and generative cities. To Porter, anything that speeds the information flow becomes a source of competitive advantage. Either way, urban-industrial clusters hold center stage. (See also Krugman, 1991.)

CLUSTERS AS REGIONAL NETWORKS

AnnaLee Saxenian used cluster theory to compare Silicon Valley's adaptability with Route 128's decline as a minicomputer center. Her 1994 work, Regional Advantage: Culture and Competition in Silicon Valley and Route 128, highlights differences in communications patterns between the two clusters. A useful image for her thesis is the Wagon Wheel, a Santa Clara "watering hole" where engineers and other technical types from sometimes competing companies gather to drink and talk shop. No such oasis is detected in Route 128's more buttoned-down, up-tight corporate landscape.

Saxenian calls Silicon Valley a "network-based industrial system." The term refers to a project-oriented adaptive mode of production that may be seen not only in Silicon Valley but also to the south, in Hollywood. As she puts it in a 1998 interview,  

You have these very fluid labor markets and these communities of highly skilled
people who recombine repeatedly. They come together for one project--in this
case a new film, in Silicon Valley it would be a new firm--and then they move on. The system allows a lot of flexibility and adaptiveness. …Information about new markets and new technologies flows very quickly. This sustains the importance of geographic proximity, despite the fact that, theoretically, the technology allows you to be anywhere. (John Cassidy, p. 125.)

WHO RULES? THE CORPORATE-DUALISM REBUTTAL

Some observers offer less enthusiastic appraisals of the workings of Silicon Valley. The late Bennett Harrison, for example, questioned any notion of the Valley as an industrial district a la the Third Italy. (Harrison, 1993.) What Harrison viewed as new in the Italian district theory is trust—an outgrowth of experience. As he put it, this interpretation of the new wellsprings of regional growth "runs from proximity to experience to trust to collaboration to enhanced regional growth."

Does Silicon Valley measure up to Harrison's criterion of trust? Alas, no. The spectacle of Valley firms suing each other at every opportunity (usually over intellectual property rights) rules this particular cluster out as an example of post-neoclassical trust and harmony. In his view, firms that rely on each other through informal agreements and cumulative collaboration do not wind up in court.

More generally, in a 1994 book, Lean and Mean, Harrison disputed the whole idea of a new wave of economic development led by clusters of smaller firms. He contended that Fortune 500-type multinational corporations still make the rules and set the direction of advanced economic development. In a core-ring network strategy, large firms at the core benefit from flexible production systems, while making use of a dependent exterior ring of smaller firms employing low-wage workers.

This corporate-dualism theory of economic development differs from the industrial-district theory in its perceptions of what is happening in spatial clusters (Kuniko Fujita and Richard Child Hill, 1998, p. 184):
 

1. The key is the large vertically integrated company, not the networked place.

2. Large firms call the shots, not small ones, which are typically dependent.

3. New technologies emanate from large firms, especially in process innovations.

4. Employees of large, core firms fare better than those in smaller, ring firms.

5. Spatially, the growth of districts mirrors the hierarchical core-ring division of
labor. Smaller, networked dependent firms typically employ low-wage young
women, often in remote (multinational) locations.

6. Districts formerly led by small firms are now giving way to core-ring
production systems, marked by large-firm out-sourcing wherever possible.

7. Over time, small-firm characteristics such as dependency, a technology lag,
and lower earnings are intensifying, not fading.
 
 

In any case, just because firms are near each other (i.e., clustered) does not mean they will cooperate. Even Saxenian had pointed out that Route 128's cluster of minicomputer firms showed much less willingness to interact with other firms than in Silicon Valley. Now a similar finding is reported for electronics firms in the polycentric Los Angeles metropolitan area. (Suarez-Villa and Walrod, 1997.) In other words, L.A. is not only a cluster for entertainment and film—but also for "electronics," in which the cluster dynamics are more or less opposite.

As the authors tell the story, the Los Angeles Basin (as approximated by Los Angeles, Orange, and Ventura counties) had 12 million people in 1990 and would qualify as the world's 11th-largest economy if it were a separate nation. This three-county entity extends 95 miles along the Pacific coast and some 35 miles inland. It is polycentric in the sense that it contains 129 municipalities and 19 major business centers. Owing largely to the proliferation of big defense firms and their sub-contractors in World War II and after, the area has become one of the largest concentrations of electronics activities in the world. But by electronics, we now mean "components" more than "computers."

Using Dun & Bradstreet data for 1994, the authors mapped the locations of 1126 manufacturing establishments (i.e., plants, not companies) in three industry groups. These were telecommunications (SIC 3661 and 3663), electromedical equipment (SIC 3845) and advanced computer equipment and devices (SIC 3571, 3572, 3575, and 3577). Of the

1126 establishments, 500 were classed as clustered, because they were within one-quarter mile of another plant. The 500 divided among a dozen clusters (including, say, the Orange County Airport and the City of Industry but not central Los Angeles). The other 626 plants were classed as dispersed.

This mapping permitted the authors to compare R&D, production costs, sub-contracting, and just-in-time (JIT) production methods as between clustered and dispersed plants. In general, land costs and transportation access were roughly comparable for most plants, regardless of location. "It would therefore seem that internal strategic considerations regarding the organisation of production, in such crucial areas as outsourcing, support for R&D or the use of JIT methods, may have been uppermost in the decision to locate in a cluster" (p. 1350).

The authors conclude from a variety of careful and fine-grained statistical tests that the clustered plants did not perform as district theorists might have predicted. In particular, the results refuted any expectation that clustered plants had superior innovative capacity based on proximity to other plants. Paradoxically, locating outside a cluster was associated with higher levels of R&D, perhaps because more research-intensive plants sought secrecy.

The general conclusion the authors reach is that un-clustered establishments could find whatever external support they needed by being in the vast and diverse Los Angeles Basin itself. Given the larger area's abundance of technical and financial resources, the advantages of locating within a smaller cluster were not apparent. In addition, plants outside clusters derived greater savings from outsourcing and JIT methods, freeing up resources to provide more support for R&D.

The Los Angeles Basin may be a special case. Other industrial districts might yield results showing that clustered establishments share R&D and have greater capacity to innovate than isolated ones. But the authors conclude that it is also possible that the advantages of clustering have been exaggerated.

LONDON AS A FINANCIAL CLUSTER

On the other hand, financial services and in particular the prominence of such global financial centers as London and New York provide convincing evidence of the continuing value of face-to-face communication.

In a May 1998 article, Ben Edwards assesses London's staying-power as a financial center. ("Capitals of Capital: Financial Centres Survey," The Economist, 347:8067, p. 8.) Some of his analysis smacks of Marshall's writings a century ago on the industries of northern England, highlighting the role of specialized skills. "Developing financial markets requires a wide range of talents, and clusters make it easier to co-ordinate them. Lawyers must ensure... Accountants must check.... As long as these people prefer to meet in person to co-ordinate their work, there will be a need for financial centres."

"But even if business must be done centrally, why do it next to your competitor?"

The answer to this question, a matter of localization economies , not urbanization economies, draws on Porter's theme of information flows. Being near your competitors and mutual suppliers enhances your knowledge of their operations, a prod to innovation on your part. It also permits raids on their employees, who may have just the skills you are looking for. ("So, in New York, Wall Street investment banks routinely poach credit analysts from their rating-agency neighbors, Standard & Poor's and Moody's….")

Two distinct logics of location are emerging in London and other financial centers. One image is hub-and-spoke. The image refers not to the relationships between large and small firms, but to the location of activities within a firm. "Hub businesses are centralised: strategic planning, project management , product development, and risk-taking activities such as trading and cooking up exotic financial derivatives. Spoke activities--such as sales, marketing and company analysis--keep the business in touch with the customer and with good information. With globalisation and improved communication, spoke operations are becoming leaner."

The second location principle is to scatter whatever operations can be scattered to lower-cost sites. In a classic pattern reminiscent of Raymond Vernon's 1960 analysis of New York City, back-office (i.e., administrative and number-crunching) activities can be housed in remote locations where wages and land rents are low and commuting is easy. Only the functions requiring frequent face-to-face contact (mergers and acquisitions, raising capital, fund management) must be kept in the center. A mixed case is trading, which in the age of the Internet is up for grabs.

DIALECTICS

What does all this add up to? An abundance of vigorously argued research (the volume of which I have only hinted at here) and two classic tensions which can never be fully resolved.

The first tension concerns the relative importance of big and small companies in economic development. Beyond concluding that both archetypes are central, no single simple statement can be made (except possibly this one), as the corporate-dualism literature reminds us.

The second tension is between centralizing and decentralizing forces, each of which will always be with us, since the need for face-to-face contact will persist regardless of what happens on the technology front.

On these two points, as elsewhere, the answer comes down not to one side or the other, but to striking the right balance. Of course, that is much easier to say than to do.

In a 1996 book, The Future of Capitalism, Lester Thurow makes skillful use of two metaphors from the natural sciences. The first is the concept from biology of punctuated equilibria . The second metaphor is the image of tectonic plates, the geological layers whose largest versions are continental in scale, which lie beneath the surface of the earth and drift an inch or two a year, causing the earthquakes and volcanoes that are visible to us.

Thurow's argument is that the world economy has arrived at a moment of sudden change, marked by five "tectonic" underlying forces. To wit:

  (1) the end of communism,

(2) the arrival of a truly global economy, owing to communications advances,

(3) the end of America's technological advantage relative to the rest of the world,

(4) the end of America's economic, military, and diplomatic leadership, and

(5) demographics including migration and the aging of the world's populations.

1. BIOLOGICAL ANALOGIES: FROM MARSHALL TO SCHUMPETER

Thurow is not the first economist to use a biological analogy to chart capitalism's trajectory. The logic of punctuated equilibria accords with Joseph Schumpeter's famous chapter, "The Process of Creative Destruction" in his Capitalism, Socialism, and Democracy (1942, 1962, pp. 81-86). "The essential point to grasp," he wrote there, "is that in dealing with capitalism we are dealing with an evolutionary process (p. 82)." The driver he saw was innovation—not only technological, but organizational as well. "The fundamental impulse that sets and keeps the capitalist engine in motion comes from the new consumers' goods, the new methods of production or transportation, the new markets, the new forms of industrial organization that capitalist enterprise creates" (p. 83).

The biological metaphor lies at the core of Schumpeter's vision of capitalism. In addition to technological innovations in the steel industry, in energy conversion, and in transportation,

The opening up of new markets, foreign or domestic, and the organizational
developments from the craft shop to such concerns as U.S. Steel illustrate
the same process of industrial mutation—if I may use that biological term—
that incessantly revolutionizes the economic structure from within, incessantly
destroying the old one, incessantly creating a new one. This process of Creative
Destruction is the essential fact about capitalism (p. 83).

In "Biological Theory and Technological Entrepreneurship in Marshall's writings," Laurence Moss has shown that Marshall's fondness for evolutionary imagery had a finite life-cycle. As Moss writes in beginning his account, "it is instructive to begin with Schumpeter's views on economic development because Alfred Marshall's views are exactly the opposite" (Moss, p. 3). As we noted, Schumpeter believed that nature (economic nature at least) moved not only in leaps, but in revolutionary bursts of creative destruction, driven by entrepreneurial innovation.

The story Moss tells us reveals a great deal about the politics of evolutionary metaphors. Darwin's theory of evolution via natural selection implied long, smooth, continuous adaptations of a species to its natural environment. When this view was challenged in the early years of the 20th century by Mendel's earlier genetic experiments, Marshall lost his appetite for evolutionary metaphors.

By that time, Darwin's notion of survival of the fittest had long since been snatched by Herbert Spencer to provide a justification for the extreme inequalities of wealth that accompanied the Industrial Revolution. Spencer propounded a theory of Social Darwinism, i.e., to the victor belong the spoils. The victor, in this context, is the industrialist best adapted to his economic environment. John D. Rockefeller, Andrew Carnegie, and the other Robber Barons were rich because they were best endowed. (From a subsequent perspective, that of Schumpeter, the Robber Barons were also entrepreneurs, hence authors of creative destruction, the engine of progress.)

The political thorn in Social Darwinism cuts more deeply when it strikes the system's losers, ordinary people. In Spencer's scheme of things, they were less suited to the environment, but, alas, that was nature's way, as it were. To this extent, Spencer accepted the ideological baton from Thomas Malthus, whose policy message in works such as his at first anonymous Essay on the Principle of Population (1798) was that it is useless to help the poor, since they will only reproduce themselves in larger numbers. On the scale of the world economy, similar reasoning justified imperialism, and the domination of "inferior races" by whites (and in Asia, by Japan).

What, then, was Mendel's heresy that dislodged Marshall from his love of (Darwinian) evolutionary metaphors? In retrospect, the answer is surprising. While Mendel's genetic "laws" modified Darwinian "natural selection" in basic ways, nothing in Mendel's genetic laws is necessarily "mutationist." Instead, what Moss notes is that an interpreter of Mendel's theory, one Hugo de Vries, pushed the mutationist emphasis because it suited his tastes. The mutationist (and therefore discontinuous) interpretation of Mendel popularized by de Vries seems to have put a chill on Marshall's interest in biology.

What is clear is that Marshall backed away. In a footnote quoted by Moss, Marshall distances himself from the vulgarity of a "great-man" theory of economic change as follows:  

This conclusion…will remain valid even if further investigation confirms the
suggestion, made by some Mendelians, that gradual changes in the race are
originated by large divergences of individuals from the prevailing type. For
economics is a study of mankind, of particular nations, of particular social
strata; and it is only indirectly concerned with the lives of men of exceptional
genius or exceptional wickedness and violence. (Marshall, 1920, p. 844.)

Not that contemporary biology still holds to a mutationist view of evolutionary change. As summarized by Daniel Levinthal in a 1998 article (p. 218):  

The modern perspective, introduced by Gould and Eldredge…hinges not on
single mutational event but on speciation—the separation of reproductive activity.
The initial speciation event is minor in the sense that the form does not differ
substantially from its predecessor. However, as a result of a separate reproductive
process driven by genetic drift and a possibly distinct selection environment, the
speciation event may trigger a divergent evolutionary path.

2. MODELS AND METAPHORS TODAY

Why does any of this matter for our purposes? The metaphor is being used to help us understand the way technologies evolve. As Levinthal writes, "These ideas are applied here to provide insight into the pace and nature of technological change." In his view, "As in the process of punctuation in the biological context, the critical factor is often a speciation event, the application of existing technological know-how to a new domain of application" (p. 218).

In turn, the application of the metaphor can reveal something about human agency, the role of entrepreneurs in advancing the pace of technological change. That, at least, is the goal. As Levinthal observes, "The process of 'creative destruction' occurs when the technology that emerges from the speciation event is successfully able to invade other niches…." (p. 218). The case he explores is the development of wireless communication technology. His conclusion, consistent with the speciation theme, is that the great events in the 20th century history of wireless were not dramatic technical breakthroughs but rather applications of existing techniques to new commercial domains.

IS THE NEW ECONOMY A BIOLOGICAL ECOSYSTEM? (PROBABLY NOT)

On the other hand, metaphors can mislead. Or they can obfuscate. (Come to that, watch out for fabricated quotes attributed to an imaginary Darwin.)

Kevin Kelley's useful book, New Rules for a New Economy, advocates the use of biological metaphors to understand the new economy:

Change in technological systems is becoming more biological. This will
take a lot of getting used to. Networks actually grow. Evolution can really
be imported into machines. Technological immune systems can be used to
control computer viruses. This neobiologicalism seeps directly into our
new economy. More and more, biological metaphors are useful economic
metaphors (p. 114).

This rhetoric helps Kelley explore the ramifications of Metcalfe's Law. Recall that the law says that (unlike costs, which are linear) benefits to the N users of a network increase quadratically (N x N) as the number rises. The threshold effects that result lead to images of increasing returns, meaning not the economist's increasing returns to scale, but positive feedback. As Kelley puts it, "In networks we find self-reinforcing virtuous circles. Each additional member increases the network's value, which in turn attracts more members, initiating a spiral of benefits" (p. 25).

Kelley's book is worthwhile, and a real clarification of some of the preliminary ideas that appeared in the on-line version at Wired, where he is the top editor. For example, he has reduced his controversial "12 rules for the New Economy" to 10:

  1. Embrace the Swarm (Embrace "the decentralized points of control.")

2. Increasing Returns (As in Metcalfe's Law, with positive feedback added.)

3. Plenitude, Not Scarcity (Software and net firms can have low variable costs.)

4. Follow the Free (Software, e.g., with zero marginal costs, can be given away.)

5. Feed the Web First ("Unless the net survives, the firm perishes.")

6. Let Go at the Top (Be ready to cannibalize your success and go for it again.)

7, From Places to Spaces (We see disintermediation and "new mid-size niches.")

8. No Harmony, All Flux (Keep innovating to survive.)

9. Relationship Tech (As in "high tech, high touch": the winning mix.)

10. Opportunities before Efficiencies (Do the right thing, not just things right.)

On the other hand, a book like Michael Rothschild's Bionomics: Economy as Ecosystem (1990) is for some tastes, at least, over the top. The metaphor permits countless biological examples that may or may not shed light on economic relationships. Mostly, by my reading, they do not. But many business people seem to find his comparisons useful as an aid for thinking about competition (as in survival-of-the-fittest).

Two points about metaphors are worth making in this context. One is that, as just noted, they can stimulate new thinking. "A metaphor achieves its effect by holding in tension two incompatible meanings that reveal some new insight." Or, "A metaphor expresses an is/is not tension that creates meaning." (Both quotes are in a spectacularly constructive essay on deconstructionism and post-modernism by William Grassie.)

The second point is more elusive. It is that metaphors are mental models, just as mathematical models are in a sense metaphors. You will recall from high-school English classes that a metaphor is one form of "trope," or figure of speech. It says that one thing is something else, so as to make a point. A simile, in contrast, says that one thing is like something else. Either trope, metaphor or simile, is intended somehow to get at an as yet undefined property of an object, relationship, or idea.

Mathematical models in science have the same function. We need not go into this point here, as later in this textbook you will find an abundance of beautiful mathematical models to help you test your visions of the world. Suffice it here to tell you Paul Krugman's punch-line when he addressed the European Association for Evolutionary Political Economy in November, 1996. "In short, I believe that economics would be a more productive field if we learned something important from evolutionists: that models are metaphors, and that we should use them, not the other way around."

As a student of the "real" evolutionary literature, Krugman can also be scathing about the mis-use of evolutionary metaphors. And yet it would hard to find a more informative exploration in the field of complexity theory (based on the study of pattern in nature) than his 1996 book, The Self-Organizing Economy. This lively little book, a counterpoint to Brian Arthur's work, reappraises much of urban economics and recasts it using models of self-organizing systems.

Someone has said that the history of mathematics can be understood as progressing from place to pace to pattern. "Place" refers to Euclidean geometry in the ancient world. "Pace" refers to the discovery of calculus by Newton and Leibniz in the 17th century. "Pattern" is the current mode in science, as buzzwords and phrases like chaos, complexity, emergent properties, and self-organizing systems make clear. It is just this new emphasis on pattern (as distinct from formal hypothesis-testing using simple refutable statements to be tested with data) that makes metaphor an increasingly prominent instrument in science.

ECONOMIC GEOGRAPHY AS A STUDY IN "THE FALL OF SCIENCE"

What was the scientific method? In a 1996 book, the geographer Trevor J. Barnes highlights the dance between logic and evidence:

From the 1920s to the late 1950s and early 1960s, the received view within the philosophy of science was the hypothetico-deductive model of explanation. Before then the inductivist model prevailed. But because of a fatal logical flaw first recognized by David Hume—that an empirical regularity observed in the past need not logically continue into the future—inductivism was supplanted by a deductive model at the turn of the century. It was not until 1948, though, that the H-D method was formally codified in a well-known paper by Hempel and Oppenheim. They argued that all scientific explanation is characterized by the same logical structure, one combining hypothesized laws with the deductive syllogism.

Within four years, Harvey reappeared as a full-blown Marxist geographer, advocating an almost completely different system of thought. Eventually, in 1989, the year the Cold War ended, Harvey would move on to a post-Marxist stance, in The Condition of Postmodernity: An Inquiry into the Origins of Cultural Change. In Barnes' view, Harvey's 1969 version of the scientific method was already dated when it appeared, having been eclipsed by the "strong program" in the sociology of scientific knowledge (SSK) at the University of Edinburgh, a view that makes knowledge claims in science a matter of social relations.

Harvey's 180-degree transformation could be described in the cliché as a "paradigm shift." The word paradigm derives in practice from a hugely influential 1962 book by Thomas Kuhn, The Structure of Scientific Revolutions. The concept has been extended in academic circles to mean that "all belief-systems are arbitrary," artifacts of one's socially derived framework and implicit assumptions. That Kuhn himself was in some fundamental way confused is suggested in a powerful recent downgrading of his book, Steven Weinberg's 1998 essay, "The Revolution that Didn't Happen."

The upshot is that to an outsider, at least, economic geography today appears polarized as between pragmatic empiricism and ideological abstraction. Consider in this regard a recent working paper on "The New Regionalism," posted on the site of The Economic Geography Research Group. John Lovering of Cardiff University, in "Theory Led by Policy: The Inadequacies of 'The New Regionalism' in Economic Geography Illustrated from the Case of Wales," critiques the "New Regionalism in Thought." That is, he disputes "that sub-set of ideas in policy-related economic geography which converge on the claim that 'the region' is displacing the nation-state as the 'crucible' of economic development." (p. 5).

Lovering contrasts Sophisticated New Regionalism and Vulgar New Regionalism:

By the same token, Vulgar New Regionalism lends itself to refutation:
(VNR) assumes or implies that theoretical categories can be read-across to real-
world empirics. It derives its force from concrete empirical claims, and its
vulgarity arises from the fact that many of these are crude, over-generalised,
or just plain inaccurate. In other words, regional development in the case in
question is not in reality shaped by the processes upon which it focuses,
but is in fact shaped by other factors altogether.

3. REGIONAL SCIENCE: OPEN, MULTIDISCIPLINARY, TECHNICAL, PRAGMATIC

So when it comes to evidence and belief, it depends on what you are trying to do.

Regional science can be understood as a tolerant safe haven for people from other, more formally controlled or method-constrained disciplines—such as neoclassical economics.

Yet from its inception in 1956 at the University of Pennsylvania, regional science has had a hard-scientific bent to it. The Penn Ph.D. program in regional science began when Walter Isard and Benjamin Stevens came there from MIT, where Isard had been Stevens' dissertation supervisor. (You can read this story in a more graceful version on the Ben Stevens Memorial site, in a biography written by Ronald Miller, who for many years edited the discipline's flagship journal, The Journal of Regional Science, along with Isard and Stevens.) A snapshot of Ben (in the hat) and Walter at a regional science conference a few years ago has kindly been provided by Robert C. Douglas, who took the picture.

Stevens was a renegade scion of the J.P. Stevens textile empire. After a year at Cornell, followed by a year working in a factory in Mexico (at local wages), he came back to Georgia Tech for a degree in mechanical engineering. He arrived in 1952 at MIT's Economics Department (then as now, as good as it gets) fully credentialed in the quantitative arts.

Now one might ask why, when Stevens showed up mathematically legitimate at the nation's top economics department, he got a degree instead from MIT's planning program. The answer, perhaps, is that economics as then practiced in the very best departments had no room for space as a variable. As Paul Krugman has said recently,

The first big effort to get space into economics came in the 1950s, under the
leadership of the redoubtable Walter Isard. Isard was and is a man of huge
energy and vast learning; he performed an invaluable service in making the
previously inaccessible German tradition available to monolingual economists
like myself; and he created an interdisciplinary enterprise, regional science,
which has been of considerable practical importance in the real world. But
the aim he set himself in his magnum opus, Location and Space Economy,
to bring spatial concerns into the heart of economic theory, was never attained.
(Paul Krugman, 1995, Development, Geography, and Economic Theory, p. 55.)

What needs to be understood is that regional science began as a science. Ron Miller's biography on the Stevens site observes that in 1957 Stevens added space to the domain of linear programming just as Isard had already done with input-output analysis:

His first published article …"An Interregional Linear Programming Model"…
infused the linear programming framework with a spatial dimension in rathe
the same way that Isard's article on regional input-output analysis had done
for input-output models some seven years earlier. …Ben continued to explore
the ways in which mathematical developments in economics, operations
research and related disciplines could enrich the field of regional science.

What, then, is regional science today? Krugman's conclusion is on target:

…what Isard ended up creating was an eclectic applied field: regional science.
Regional science is not a unified subject. It is best described as a collection
of tools, some crude, some fairly sophisticated, which help someone who
needs an answer to practical problems involving spatial issues…. (p. 57).

In putting together the Stevens memorial site, I had occasion to compile two sets of links to do justice to the discipline that Isard and Stevens and Miller created. One list is long, a kitchen sink. The other I dubbed Supersites in regional science. It is short and selective: a dozen sites that are intended to convey the range and power of the discipline. Someone else could come up with a different list, perhaps an entirely non-overlapping one. In any case, this selection may give you a place to start your explorations.

Have fun!

The Role of Services and Manufacturing in New England’s Economic Resurgence:

The economic revival of the Northeast has focused attention on the services sector’s role in economic development. Two stories emerge. One emphasizes the role of export services. As it is best illustrated by the clustering of finance and administration in Wall Street and midtown Manhattan, it can be called the "Manhattan effect." New York’s role as a world city during an era of increasing global financial integration appears to have enabled the city to overcome the effects of a decline in manufacturing jobs. Not only has the city prospered, but also the Manhattan effect has rippled out in all directions, as high rents have driven some office activities into the boroughs and to neighboring states—even as far afield as South Dakota and the Caribbean.

A second, almost opposite, scenario has been played out in New England. Services activities have also been crucial to New England’s comeback after its dismal economic performance in the first half of the 1970s. However, they have played an indirect role, as a catalyst contributing to the revitalization of the region’s manufacturing sector. Despite the shrinkage of New England’s industrial employment in the mid-1980s, the region managed a radical turnaround between 1975 and 1984. The driveshaft for growth in this period was not services, but manufacturing—high-tech, export-oriented manufacturing.

Thus, the services sector has played two largely contrasting roles in the Northeast’s economic revival—one directly, in the Manhattan effect, and the other as an infrastructural catalyst, in New England’s reindustrialization. This paper focuses on the New England story. It makes the case that New England’s turnaround has been "industrial" in character—and not at all like the Manhattan effect. Nonetheless, such elite services activities as higher education and venture capital have been strategically central to the region’s reindustrialization.

I. Services and the Export Base

Traditionally manufacturing for export has been seen as the driving force behind urban and regional development. An extreme version of the view that goods are basic while services are derivative runs as follows: Goods production is a community-forming or basic activity because goods can be exported beyond the local area. Non-basic activities are the consumer services and local manufacturing activities organized to serve the labor force assembled to produce goods for export. Services activities are inherently local, not exportable, because they require face-to-face interactions, as in beauty shops and schools.

To repeat, goods are exportable, therefore basic, and consumer services are not exportable, and therefore non-basic. The relationship between the two types of activities is summed up in the employment multiplier, a rule of thumb that one new factory job will create several (commonly two) new jobs in the metropolis overall. Why? Because each factory worker and family will make retail purchases that will create employment in the retail and services sector.

Among the objections to this view of the world, three merit mention here.

(1) Debunking exports as the sole source of growth, Charles Tiebout pointed out years ago that exports are but one source of demand stimulus, the others being consumer, business, and government spending. Economic development also occurs because of changes in production capabilities, for example, through changes in technology and in labor force.

(2) Producers’ services such as accounting, advertising, legal, and administrative activities may cluster in a few regional or national centers, becoming in the process "export services."

(3) The way declining older export industries have given way to dynamic younger product lines varies from one city to another, and depends crucially on the character of the local industrial mix and information infrastructure.

The second point is the essence of the Manhattan effect, while the third point is especially relevant to New England.

II. Elite Services and New England’s Industrial Evolution

Some years ago, Wilbur Thompson observed that services activities facilitate the replacement of older, fading export activities by newer, growing ones.

But what is the justification for arguing that New England’s adaptation was based on manufacturing, with services playing a catalytic role, rather than on exports of services, as appears to have been the case for New York’s turnaround? The answer lies on a comparison of the growth in New England and the nation in major employment categories. The comparison is made using shift-share analysis. This technique involves the computation of shift effects, which equal the difference between (1) a sector’s actual job gain or loss within a region, and (2) its hypothetical gain or loss, assuming the sector had grown at its national rate of change. From the pattern and timing of these shift effects, inferences can be made about the key sectors in New England’s resurgence.

III. Post-Industrial New England?

The American economy has for a considerable time been described as "post-industrial." While the term lacks precision and means different things to different people, as a description of employment growth it is certainly defensible. As can be seen in the upper panel of figure 1, the service-producing sector accounted for almost all the growth in U.S. wage and salary jobs from 1969 to 1985. Manufacturing employment actually declined. For New England the pattern is almost identical: (1) a slight decline in manufacturing jobs; (2) minor job creation in mining, forestry and fisheries, and in transportation and public utilities; and (3) most job growth occurring in trade and services. About the only difference is the lower ranking of government as a source of new jobs in New England. Otherwise, the 1969-85 story seems "post-industrial" for both the region and the nation.

Yet the foregoing bland comparison is almost totally misleading. The 1969 and 1985 benchmarks have the effect of hiding a tumultuous sequence of three and perhaps four distinct sub-periods, each clearly different from the others: (1) "the crash" between 1969 and 1974, when the region lost many jobs that its unemployment rate shot up to levels unmatched elsewhere in the nation; (2) recovery via high-tech reindustrialization after 1974; (3) consolidation and expansion from 1979 to 1984; and (4) severe job losses in manufacturing, with overall job growth slowing to national rates since late 1984

IV. Reindustrialization as an Alternative Scenario

Figure 2 shows for the period 1969 to 1985 and for each of the first three sub-periods the difference between (1) the change in New England’s employment in each major industry and (2) the change the region would have experienced if employment in each industry had increased at the same rate in the region as in the nation. For the period as a whole, this comparison of shift effects reveals a slightly greater rate of job creation in wholesale trade and manufacturing in New England than in the nation, but slower rates of job creation in services, retail trade, and the other categories. On balance, the region did a little better than the nation for the period as a whole in manufacturing, and a little less well in non-manufacturing sectors, but the differences seem slight. In both region and nation, post-industrialism seems to sum up the story. The story changes, however, when one looks at the sub-periods.

(1) The Crash: 1969-74

Consider first the crash. Between 1969 and 1974, manufacturing employment declined more precipitously in New England than in the nation. The difference was equivalent to almost 18,000 jobs per year in the region. As population and income growth stagnated, retail and construction job creation also lagged far behind the national rate. Though not as dramatically, so also did the performance of the services industries and finance, insurance, and real estate.

This was the setting in which New England’s unemployment rates soared to the highest level in the nation. It represented a bottoming out after a half-century of industrial stagnation. And it was spearheaded by the decline of the region’s mature manufacturing industries. In sum, the weakness of the New England economy in the early to mid-1970s reflected a crisis within the manufacturing sector. The services industries and finance, insurance, and real estate failed to compensate for the deindustrialization.

(2) High-Tech Reindustrialization: 1974-79

The heart of the "New England Miracle" was the resurgence of the region’s manufacturing sector in the late 1970s. Alone among all the major sectors, the region’s manufacturing industries experienced notably stronger growth than the national average. The main reason was the stellar export performance of the high-technology industries of the Route 128 complex in the Boston area and southern New Hampshire.

To repeat, relative to U.S. rates of job growth, the manufacturing sector sharply outperformed all other sectors. Growth in services just matched the national rate, but trade and finance, insurance, and real estate lagged. Construction fared the worst relative to the national experience with a regional job deficit of almost 10,000 annually. Houses were not being built at the same rate as in other parts of the country and the office boom was yet to come.

The positive shift effect for manufacturing after 1974 was not a case of the region’s manufacturing sector expanding to meet the needs of a rapidly growing population. While import-substitution activity spurred the industrialization of the South and West, New England had only modest population growth and a fully served regional market. The large positive shifts recorded after 1974 for New England are therefore signs of increased production for national and world markets—that is, exports.

The implication is that exports of manufactured goods, particularly high tech, accounted for the New England turnaround. Job creation in non-manufacturing lagged behind in the late 1970s.

(3) The Golden Age: 1979-84

In the early 1980s, as the United States was mired in back-to-back recessions, New England outperformed the nation across the board. In the wake of cutbacks in response to Massachusetts; property tax limitation measure Proposition 2 ½, government employment lagged far behind the national trend, but it was the only sector in the region to do so.

Having already lost so much employment in its older industries, New England now proved less vulnerable to recession than the nation. Spurred by growing computer applications and the defense buildup, the region’s high-tech exporters surged forward. Compared with a positive shift in the late 1970s of fewer than 5,000 jobs per year, the shift effect in manufacturing between 1979 and 1984 exceeded 18,000 annually.

The favorable confluence of the 1981 tax act, buoyant demand for new office space, and soaring housing prices caused growth in the region’s construction sector to outpace the U.S. rate by the equivalent of over 10,000 jobs per year. Despite slow population growth, New England experienced a positive shift effect in retail trade almost as large as that in construction. And where were producers’ or export services in all this? The services industries and finance, insurance, and real estate were lost in the crowd, registering modest positive shift effects that were greatly overshadowed by shift effects in the manufacturing sector. Putting it another way, they performed slightly better than the national average, but not much better.

Conclusion? The full flowering of New England’s comeback was paced by manufacturing. In outperforming the national industries, New England manufacturing was joined belatedly by other sectors, in a pattern that suggests a lagged response by nonmanufacturing activities to manufacturing exports.

(4) Afterglow? Since 1984

Since 1984 New England’s manufacturing employment has plummeted, reflecting both the continuing competitive difficulties of the region’s mature industries and an excess of capacity and a softening of world demand for high-tech goods. From December of 1984 to June of 1987, New England’s manufacturing job count fell 8.1 percent, while U.S. manufacturing employment fell only 2.4 percent. New England’s stellar industrial job performance came to an abrupt halt in late 1984. (See Table 1.)

Despite the weakness in manufacturing, overall employment growth in the region matched that nationally in this period. As can be seen in the table, the negative shift effect for manufacturing was offset by large positive shift effects for construction and trade. Finance, insurance, and real estate had a small positive shift effect, but the region’s share of national employment in services industries declined. Thus, the sectors that have sustained New England’s prosperity in the face of manufacturing weakness are not those typically associated with the Manhattan effect but construction and trade, industries that are usually regarded as more locally oriented. This might reflect a lagged response to the earlier vigor in manufacturing — the afterglow of the region’s reindustrialization.

In conclusion, it seems clear that the region’s dramatic turnaround was powered by an export surge in manufacturing. The services sector helped usher in the high-tech export industries, and the export goods themselves ere "knowledge-intensive" and often embodied inputs from information workers in a manner distinct from more traditional manufacturing goods. Yet New England’s resurgence drew only indirectly on the services sector. Compared to the New York case, with its more direct reliance on export services, New England’s recent success appears traditionally "industrial." Whether the region’s manufacturing sector can regain its export prowess is thus a central question for New England’s economic future. (1987)

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