The Interlinked Economy

Forget us versus them. The world is becoming increasingly interconnected and we will eventually be part of one large, global community.

October 1 1990 by Kenichi Ohmae


The United States takes great pride in the Declaration of Independence, but now it is time for the U.S. to join the interdependent and borderless interlinked economy (ILE) forming around the world. We have to recognize that in today’s world, the notion of national boundaries is not clear anymore. To which country does Honda-USA belong? To whom does IBM-Japan belong? IBM-Japan is a $10 billion company with 20,000 employees and last year reported a $2 billion profit, which corresponds to almost one third of IBM’s global profits. So does IBM-Japan belong to the Americans or to the Japanese?

The truth is, it belongs to neither. IBM-Japan is IBM and Honda-USA is Honda. They exist because they have the support of their customers and appreciation for their employees. They have connections with vendors and dealers, not with governments. Corporations survive as long as they serve their purpose and act as “social entities.” Therefore, the concept of national borders-treating American-born companies as carrying the stars and stripes and Japanese-born companies as belonging to Japan-will soon become obsolete or irrelevant.

The fundamental reason for the obliteration of national borders is the power of information. Consumers today can tell which personal computer or laptop is best for them, whether made by Toshiba or Compaq. In the old days, international enterprise followed an exploitative system; in the case of Japan, once a foreign manufacturer received a production license from the government, he could exploit the consumer because he knew there would be no competitors. This kind of system still exists in developing countries, unfortunately, but in most developed countries, access to information is giving people the ability to choose the best quality for the best value. Therefore, the role of the government is no longer as integral or as powerful, nor should it be.

UPDATING JAPAN

In this context, the Japanese government is one of the most backward. The government has brought up the Japanese per capita GNP from $500 after the war to the current $26,000, but it still wants to sit in the driver’s seat. The government should now let the people be in charge. In my book, Zero Based Organization, I analyze each of the Japanese ministries and propose a new constitution.

I discovered, for example, that the reason why Japan cannot communicate with the rest of the world lies with the Ministry of Education. In Japan, English classes teach literature, composition, and grammatical rules, instead of how to speak English. After six years of English education, students are still afraid to speak up and cannot even introduce themselves properly. American or British teachers could come to Japan and teach proper English, but they usually cannot speak Japanese, which is required for obtaining the Ministry of Education’s license for teaching English. As long as the ministry maintains this bureaucratic attitude, the Japanese will not be able to communicate with the rest of the world.

I also looked at the Japanese Ministry of Health and Welfare, which oversees the pharmaceutical and medical electronics industries and certifies drugs. Should patients have adverse reactions to a drug, however, the government denies any responsibility. There are many lawsuits against the ministry protesting the approval of problem drugs. My recommendation is that if the ministry does not want the responsibility, it should not interfere but simply approve any drug certified by American or European authorities. Also, if a medical doctor is certified by an accredited institution of a developed nation, he or she should be allowed to practice in Japan based on those credentials.

In order to fulfill the notion of a borderless economy, we have to change regulations and systems which are remnants of the nineteenth century nationalistic, mercantilist world.

WHAT IS AN IMPORT TODAY?

There are 2,000 U.S. companies operating successfully in Japan. Texas Instruments is the largest memory chip producer in Japan. TI once closed its Texas plant for memories (now reopened) and moved its memory chip production as well as its headquarters to Japan. Hewlett-Packard and AMR also make large profits from their Japanese operations. Coca-Cola comprises 70 percent of Japanese soft drink sales, is Japan‘s largest producer of canned coffee, and has many other successful product lines. The collective production and sales of the U.S. companies in Japan amount to $50 billion annually. But none of this is reflected in trade figures because these products are not imported into Japan. IBM Japan’s $10 billion output is produced in Japan. Texas Instruments is Japan‘s largest exporter of memory chips. Still the U.S. government looks at memory chip imports from Japan and complains. Another aspect that is ignored: A large slice of Japan‘s exports to the U.S. these days is comprised of American companies’ shipments to their parent companies and Japanese auto components for Detroit‘s Big Three.

The Japanese, like people elsewhere, buy products based on their comparative value and not their nationality. Per capita spending of the Japanese on U.S. goods is twice the U.S. per capita spending on Japanese products. Why do people not know this? The Japanese bureaucrats believe that silence is golden and have decided that when Americans are so upset, it is best to just listen to them; instead of solving a problem they prefer to swallow it.

Many U.S. companies have expanded into Mexico also, and when their goods come back into the U.S., they are registered as imports from Mexico. Again, Congress worries about lost competitiveness. A trade deficit is not the result of loss of competitiveness; it is the corporate decision to produce or procure elsewhere.

Corporations can migrate between countries because customers look for the best and cheapest products as long as supply is stable. And supply is stabilized when goods are produced within the market. That is why U.S. corporations represent one fifth of European corporate activities. But the U.S. government, at least that part of it which publishes statistics, chooses to ignore this fact. The government does not track down U.S. corporations worldwide; instead, it remains within the borders and only measures the ins and outs of the measurable transfer of goods. In effect, it remains in the last century.

NEED FOR STABLE CURRENCY

The nineteenth-century trade model looked at export and import in terms of how many tons of goods crossed national borders. Nowadays, not just goods but money is transported across borders as a result of corporate activities. IBM’s return on equity out of Japan was 120 percent last year; in other words, in a single year they recovered 100 percent of the equity they invested. No merchandise traveled across national borders, but statistics suggest there is a trade imbalance. By the old macroeconomic model, a trade imbalance drains the country’s wealth. But this is also incorrect, because America does not use foreign currency for payments. In this sense, the U.S. has no foreign trade per se, only domestic purchases. When buying goods from Taiwan, Japan, Korea, or Mexico, the U.S. pays in dollars, which means that these commercial activities are identical to buying California oranges or Louisiana tea. America does not have “foreign” trade and foreign currency reserves, but statistically it is supposed to be involved in foreign trade, making government officials worry about the “trade deficit.”

The U.S. is probably the only country that does not have to worry about foreign currency reserves because the government can simply use its high-speed printing presses to finance the purchase of foreign goods and services. America can buy easily from abroad because the dollar is and will be nearly universally accepted, as long as its value does not decline significantly.

During the Plaza meeting, Secretary of State James Baker and his advisers suggested that the dollar be weakened to gain competitiveness and correct the trade deficit. This kind of thinking is based on the antiquated models of David Ricardo and Adam Smith, which worked in the days when commodities were traded and price was elastic. Today, however, price elasticity is low. More fundamentally, to increase international competitiveness, we need to improve productivity and quality, not adjust currency. The manipulation of currency acts as a handicap, which lowers motivation. The U.S. government gives corporations a 20 percent handicap overnight in the form of a currency adjustment. So neither productivity nor competitiveness is improved.

Furthermore, the devaluation of the dollar has made America itself the most competitively sought-after product: the buildings, the corporations, the real estate. When Baker made his proposal, the exchange rate was 240 yen to the dollar; within several months the dollar dropped to 120 yen. This has not changed the trade balance, but it has made America a bargain because assets-both tangible and intangible-are also tradable. At 120 yen to a dollar, if you could collateralize the city of Tokyo, you could buy the entire U.S. and all its corporations. If you could collateralize the Japanese Imperial Palace, you could buy the whole state of California. The trade deficit amounts to only 0.4 percent of U.S. GNP, but when you change the currency exchange rate, you make a fundamental aspect of a country (i.e., the assets) cheap. In the borderless world, Rockefeller Center does not have to be transported to Tokyo to be owned by the Japanese.

The economies in Japan and the U.S. have been steadily growing 2 to 4 percent per year for the past eight years. Inflation has been unchanged at 2 to 3 percent, which means that the currency exchange rate between the two countries should also have been rather stable. Each time the exchange rate changes, this means something went wrong, and economists erroneously attribute this to factors such as the trade imbalance, which is minuscule compared with the size of our economies.

ECONOMICS UNBOUND

With the disappearance of national borders, everyone can participate in everyone else’s real estate market as well as stock market. Therefore, currency exchange rates should be set to equalize purchasing power of goods, assets and financial fundamentals (the expectation of return on certain investments), reflecting the differences in inflation rate and interest rate. This also requires political providence, because politicians can have a tremendous influence on the foreign exchange rate. Some $600 billion changes hands every day over the markets of Tokyo, New York and London, compared with $20 million of goods traded among Japan, the U.S. and Europe. Hence, the impact of these currency exchange rates is enormous, especially because currency traders do not really understand the workings of the economy. The markets, however, have not properly reflected the tradability of assets.

Today we can literally see the forming of an ILE; people and corporations routinely crisscross between national borders. The emergence of a gigantic ILE, which behaves in a totally new and complex way, renders existing macroeconomic theories obsolete and requires our rethinking and reshaping of models and standards. Lower interest rates traditionally stimulate the economy, but in the borderless world, if the U.S. economy increases, jobs are created in Korea, for example.

In Keynes’s day, there were national economies modified only by export/ import. Hence, if his theories do not accurately describe current economic conditions, it is the fault of contemporary scholars who are still applying the nation-state model to changed circumstances. Instead of realizing that a new and more global model is required, they simply try to adjust the Keynesian model by adding modifications and writing academic papers about them. What happens if money supply gets tight in a country in today’s world? It comes in from abroad in the form of, say, impact loans. In 1988, 90 percent of the new bonds of Japanese corporations were issued in Europe. If the government raises the interest rate, cheaper capital comes in from abroad.

SPECULATIVE MARKETS

Interest-bearing instruments have lost much of their allure these days; speculative ones such as real estate and stocks, which do not bear interest, have become more compelling. The largest of these financial instruments is the foreign exchange market itself, which, as mentioned before, moves $600 billion daily. Without this kind of “pocket” in the form of the speculative market, the money created by the governments’ sloppy money supply policies, known as superliquidity, would flow into the real market, causing tremendous inflation. Politicians and bureaucrats say we have learned how to curb inflation, but this is not true. The money is simply routed into a much more speculative and risky market instead of the inventories in the real marketplace. Inflation is measured by misleading indicators, the Consumer Price Index and the Wholesale Price Index, neither of which is based on prices of speculative items.

In the old days, when speculative instruments were not available, the excess money bought up goods for the future. Excess liquidity created inflation. Now we have speculative instruments which absorb the excess money and prevent the symptoms of inflation, though we actually live in an enormously inflationary world (50 percent per annum in some speculative markets). Tokyo‘s real estate market has gone up five times in five years. Now Osaka real estate is going up. Toronto‘s market is going up because Hong Kong is moving in. The speculative market knows where the activities are, and currently, they are burgeoning on a global basis. This is another characteristic of the ILE: Even inflation is restrained by being contained within these speculative market “pockets.” After the crash of the Tokyo Stock Exchange in early 1990, the money migrated to New York and Frankfurt. Eventually, it will go to France and Italy.

JUST SAY PARTNER

In a recent book, The Japan That Can Say No, by Sony Chairman Akio Morita and politician Shintaro Ishihara, the authors are mistaken. The book is based on the old mentality that it is America versus Japan and Japan can’t say no in this relationship. America, however, is an abstract noun. Does Morita mean to say no to Rep. Richard Gephardt (D-Mo.)? Probably not. There is no such thing as America saying yes, Japan saying no. A country is an abstract entity. One must distinguish between various parts of a country-Osaka and Tokyo are both in Japan but are quite different from each other.

Americans think that all Japanese are out to punish America. But in Japan, as in the U.S., there are vast differences of opinion among residents. In the same way, when Rep. Helen Delich Bentley (R-Md.) smashes a Toshiba radio, the Japanese think all Americans want to smash Toshiba radios. Our two countries have lived together for over a century now and yet, when it comes to Japan-U.S. issues, we do not have the prudence to examine the fine structures of this relationship. But more and more leaders realize that we have to start doing so, and we will come to see that most Japanese attitudes are not very different from many American attitudes; the Japanese are also beginning to enjoy the benefits of the ILE.

We have to establish that the real economy is the entire world and devise new guiding principles accordingly. Some parts of the economy are completely international while others are very provincial, so not everything crosses national borders and the borders are not perfectly permeable. Yet money moves easily across borders. We have to figure out appropriate theories and frameworks to deal with this complex ILE. We also have to work out a “Declaration of Interdependence” and devise a super-governmental structure to regulate this new economic environment, geared toward the year 2005, around which time we can expect the ILE to take full shape. Under the new structure, even the tax I pay in Japan will not end up 100 percent with the national government: one third may go outside of Japan, one third to Japan, and one third to my local community. We are all global citizens. We should be citizens of the interlinked world first, before we are citizens of a specific country.


Kenichi Ohmae, Ph.D., is the director in charge of McKinsey & Company’s offices in Japan, the author of The Borderless World and a past contributor to Chief Executive.