The man who works exclusively or primarily with his hands is the one who is increasingly unproductive. Productive work in today’s society and economy is work that applies vision, knowledge and concepts – work that is based on the mind rather than on the hand.
Peter Drucker, Landmarks of Tomorrow, (1959)
Amazingly, Peter Drucker authored this at a time when expensive computers filled rooms and functioned as little more than accounting machines. Also at a time when America dominated the world in manufacturing through powerhouses such as General Motors, General Electric, IBM and US Steel.
Further describing knowledge workers in other writings, he made these observations: Knowledge workers are professionals who must be self-motivated. Heavy handed, bullying tactics will not work. Rather, the job of the manager is to assist the employee (who inevitably knows more about the subject matter than the boss) in growing the knowledge base of the organization as a prerequisite to its success. Similarly, the central command and control structure fails in this paradigm and needs to be replaced by more rapid, decentralized decision making. This is critical because knowledge is perishable and quickly stales out.
Most telling is the division that he anticipated in warning that the ideal of America as a classless society would be undermined by the emergence of two classes: Low wage service economy jobs and better paid knowledge workers. He was hoping that society would resolve this bifurcation – as he wrote six decades ago – by 2010 or 2020.
Instead, this is exactly what has befallen us. Recent events demonstrate how much we have missed the mark, as areas that are the hubs of knowledge work thrive economically but must cope with expensive home prices and clogged traffic. Areas that have been unable to participate, particularly those who excelled in the industrial era, have stagnated and are plagued with drug abuse and crime. These regions appear to fail to create and sustain viable knowledge work or even service economy jobs that pay above minimum wages.
The current bitter partisan conflict can be easily seen as thoroughly rooted in this dichotomy. The purpose of this article is to assess our position in the Knowledge Economy and to analyze what we are doing to maintain leadership as other nations, particularly China, work relentlessly and successfully to overtake us. The United States possesses the genesis and the leading innovation hub of the Knowledge Economy in Silicon Valley – a seemingly wide moat. However, as Mary Meeker points out in her latest report, the moat is shrinking:
China is catching up as a home to the world’s biggest internet companies. Currently, China is home to nine of the world’s 20 biggest internet companies by market cap while the US has 11. Five years ago, China had two and the U.S. had nine. Mary Meeker, Internet Trends 2018, May 30, 2018
It is becoming quite clear that whoever dominates the Knowledge Economy will dominate the Global Economy. Unless we make a major course correction, our time is limited.
Underpinnings of the Knowledge Economy:
To determine current and future leadership of the knowledge economy, it is important to consider the key building blocks that underpin success. It is assumed that success equals the strongest wealth and job creation capability going forward. The building blocks of leadership are:
- An educated populace
- Research: Basic and Applied
- Commercialization Vehicles: Transforming Knowledge into Wealth and Jobs
- Addressable Markets: Seizing Prime Mover Advantage
An analysis of this list short of a doctoral thesis is inevitably shallow and incomplete, but even a cursory review will demonstrate the astonishing progress China has made in the last few decades. They have carefully but rapidly positioned themselves as a strong contender to the United States and appear to be accelerating their momentum while we dither.
Lost in the current boundary turbulence with China centered over tariffs and intellectual property is the fact that they are focused on the long term, in essence building the infrastructure for domination of the Knowledge Economy through strategic investments in each of the four areas above. The measure of their ability to move swiftly is demonstrable in that earlier plans permitted 600 million Chinese to be lifted out of poverty since 1981.
1. An Educated Populace
International students still think U.S. schools are much less challenging than schools in their home countries and that American teens are more focused on success at sports compared to their peers back home. 2017 Brown Center Report on American Education: Survey of Exchange Students
It is both disheartening and confounding to revisit America’s standing in the world of primary education. PISA, the Programme for International Student Assessment, ranks the U.S. 39th in Mathematics in contrast to China, which ranked 6th. We did somewhat better in the other two areas of assessment: science, ranking 25th and reading, 24th. As a nation it seems that we have been dissatisfied with our performance for decades in an area we once led but have failed to sustain. This, despite spending the most money per student.
Our failing performance has been recognized for years and numerous solutions have been developed but rarely enacted and sustained. Just in this century, programs such as No Child Left Behind and The Common Core have attempted to get better results but seem to stall in the process. The current administration has not made education a priority, but has mused on the idea of closing the Department of Education and killing the Common Core. Their emphasis appears to be on devolving educational standards to individual states despite a very mobile society as well as promoting Charter Schools, including those that operate for profit.
Rather than attempt to deal with the many complex programs that have been put forward over recent decades and which have apparently failed or prematurely dropped, the author wishes to highlight three areas which are potential and simple, if not inexpensive, remedies:
- We lag globally in areas such as early childhood education, a proven program for children ages three to five, with only 43% of kids enrolled versus 73% for other developed countries.
- Computer based curricula, such as provided by Khan Academy, are not well integrated into the classroom, depriving students of self-paced learning and excellent diagnostic tools. They are also a great resource for parents who are attempting to tutor their kids.
- Extending the school day and year – US students average 180 days in school, one of the shortest in the developed world. KIPP Academies in low income American neighborhoods have demonstrated great success by incorporating a longer day (7:30 to 5:00) as well as a longer year. Incidentally, this is the same school day as in China.
Each of these programs would cost money, although a more effective leverage of technology could provide substantial savings. Given the importance of a knowledge based economy, this investment is critical.
Colleges and Universities
In 2000, American 15-year-olds scored slightly above the international average. While American college graduates are far more knowledgeable than American non-graduates, creating a substantial “wage premium” for diploma holders, they look mediocre or worse compared to their college-educated peers in other nations. The New York Times, June 28, 2014, “Americans Think We Have the Worlds Best Colleges. We Don’t.”
Despite the most expensive tuition prices in the world and $1.5 trillion in student debt, US college graduates test below average in math versus developed nations. This finding was developed by the Program for the International Assessment of Adult Competencies (PIAAC).
Top private colleges have passed $70,000 annually for 2018 in total cost of attendance, and with the four decade old tradition of passing price increases along ahead of inflation, the full sticker price for a degree will exceed $300,000. Colleges maintain that they offer generous aid to offset this huge cost, but the massive student debt load contradicts that assertion. Only a relative handful of schools are truly “needs blind”, which means ignoring the family’s financial circumstances and meeting the full cost of bloated tuitions. Most private colleges are “merit based” which frequently means discounting tuitions to attract better students from well-to-do families.
Public universities have tuition costs well below privates, but these costs have risen far faster in the recent decades. States have reduced subsidies and actively seek out-of-state students at higher tuitions to subsidize fewer from in-state.
China has come out of virtually nowhere to develop a post secondary system second only to the US. In fact, during Mao’s Cultural Revolution, professors were regularly humiliated, beaten and occasionally killed to root out “elitism”. In a stunning turnaround, it is now educating one fifth of the world’s undergraduates, including 200,000 international students. The Times Higher Education rankings put 72 Chinese Institutions in the top 1250 schools worldwide. Tsinghua University is rated number twenty-two and described as having one of the most beautiful campuses in the world.
Tuition at Tsinghua is $1800 annually. International students appear to pay more but are frequently granted aid by the Chinese government.
Perhaps more alarming is that, according to the National Science Board, of the 7.5 million degrees awarded in 2014 in science and engineering globally, China had 22% while the US only 10%. And yet even more alarming is that 80% of our graduate students in Computer Science and Electrical Engineering are international. According to a National Science Foundation Survey, similar numbers occur in other STEM fields. Our current policies as well as posturing may cause this well of talent to leave sooner and to stop coming.
China is likely to pass the US in research and redevelopment spending by the end of this year, a top American science body has said, underlining that Beijing has increased its spending in the sector at an average of 18 per cent per year between 2000 and 2015. The Business Line, June 4, 2018
According to UNESCO data, the United States leads the world in spending on research and development. In 2016 the US spent, or more accurately invested $511 Billion – a huge number that was roughly a quarter of the world’s total. However, as the above note suggests, we are about to be passed, because our rate of growth is 4% versus China that invests at an 18% growth rate.
An important example of our leadership in research is the National Institutes of Health. NIH is home to over 20,000 scientists and support staff. Its numbers have included over 150 Nobel prize winners for research on disease and prevention.
In constant dollars, funding for NIH peaked in 2003 and has been stagnant since then. Sequestration garroted spending until it fell by over 20% by 2015. It has subsequently increased to $39 Billion, but is still below 2003 when accounting for inflation.
As reported in Michigan Medicine reported last year:
American scientific teams still publish significantly more biomedical research discoveries than teams from any other country, a new study shows, and the U.S. still leads the world in research and development expenditures. But American dominance is slowly shrinking, the analysis finds. as China’s skyrocketing investing on science over the last two decades begins to pay off. Chinese biomedical research teams now rank fourth in the world for total number of new discoveries published in six top-tier journals, and the country spent three-quarters what the U.S. spent on research and development in 2015.
It is also important to address the perception and reality that the US has developed a posture of being anti-science in the last few decades after earlier, successful efforts to win the race to the moon. Anti-science efforts include the undermining of teaching evolution in the class room to the hampering of DNA research and the dangerous denial of climate change.
3. Commercialization Vehicles
If you are so smart, why aint you rich? Ancient taunt recorded by Eudora Welty, 1941
Before the advent of Silicon Valley and related outposts such as Route 128 in Massachusetts, great American companies such as AT&T, IBM and Xerox had well funded laboratories staffed by Nobel prize winning scientists conducting groundbreaking research. Most of what they discovered made it only as far as the patent office as their parent companies had little incentive to quickly obsolete wonderfully profitable product lines.
That changed with entrepreneurs like Steve Jobs, who legitimately gained access to Xerox Parc and saw much of the technology that became the Macintosh Computer. He cut the Xerox price point, which was aimed at corporate buyers, from $20,000 to $2,500, opening the mass market. He also ruthlessly simplified functionality, making the Mac far easier to use than its peers, and therefore far easier to adopt. It is the entrepreneur that takes someone else’s invention and makes it a commercial success by refusing to accept the status quo, therefore disrupting existing markets and businesses.
America leads the world in the pace of innovation in large part because of a partnership of entrepreneurs and venture capitalists who together seek prime mover advantage. This is the belief that whoever first wins dominant market share will preempt future competitors and become billionaires. Silicon Valley brings together a huge pool of Venture Capital and a seasoned workforce that draws priceless experience from both the triumphs and the more frequent failures. It can also draft young, tireless talent from Stanford, Berkeley and other universities that source the best and brightest globally. This combination has led to decades of huge successes epitomized by the “FANG” companies: Facebook, Apple, Netflix, Google.
However China is once again in the business of overtaking us.
In 2017 US VC’s backed venture rounds of $76 billion. China ranked second at $65 billion, and according to TechCrunch, may pass us in 2018. The investments span applications in Fintech, Green Energy and logistics to core technologies such as Artificial Intelligence. Significantly, Chinese venture capitalists appear to be looking internationally while US VC’s focus more on the proven domestic market.
Leading Chinese companies Tencent and Alibaba have over 1000 investments between them with many focused on emerging markets. In contrast Apple and Microsoft have spent billions buying back their own stock.
China also has a cadre of successful entrepreneurs led by Jack Ma, founder of Alibaba, who is worth $37 billion and thought to be the richest man in China. Alibaba is a business to business marketplace that permits Chinese factories to market their low cost products to distributers anywhere in the world – it operates in 240 countries. Alibaba provides a safe and trusted payment system that removes uncertainty between distant trading partners, an otherwise major stumbling block. As such it is a formidable vehicle for further commercialization of China’s huge manufacturing advantage.
If that were not enough, Beijing is driving an ambitious plan called Made in China 2025. According to The Council on Foreign Relations, it is:
A blueprint for for Beijing’s plan to transform the country into a hi-tech powerhouse that dominates advanced industries like robotics, advanced information technology, aviation and new energy vehicles. www.cfr.org/blog/why-does-everyone-hate-made-in-China-2025
The brilliance of American inventions such as the iPhone is in no small part due to China’s ability to manufacture it at huge scale with flawless quality and at a low price. One estimate is that 700,000 Chinese employees are involved in the making of Apple’s products in contrast to the 80,000 Apple employees in the US. It also appears that China is not satisfied with merely making brilliant products but wants to move further up the value chain. An example is that of Korea’s Samsung, moving from a parts supplier for Apple to a direct, head on competitor. In 2017, Samsung sold 310 million Galaxy phones or 21% of the market. Apple was second at 15%. Ominously, two Chinese companies, Huawei and Oppo, secured 10.8% and 7.6% share, with several others in the top ten.
The desire to “move up the value chain” from the factory floor, manned by lower wage jobs to the knowledge workers who design, engineer, market, and account for products is very similar to the path taken by the Japanese auto manufacturers entering the US market 40 years ago. Toyota and Nissan used their quality and cost advantage to first win the sub-compact car market and then assiduously moved up to create luxury brands that eclipsed all but the high end German products. Today, US manufacturers debate abandoning sedans entirely for the truck and sport utility markets because of their inability to compete in the former. China has purchased the bankrupt and stodgy Volvo brand and is in the process of revitalizing it with exciting new vehicles as well as a commitment to ending the use of fossil fuels.
By 2022, 550 million people in China will be considered middle class. That would make China’s middle class alone big enough to be the third-most populous country in the world.
Kim Iskyan, Stansberry Churchouse Research, August 27, 2016
In developing a business plan for a start-up, a key concept is that of the addressable market, which is the potential size of the market, generally the number of businesses or consumers for the new product or service. Because this is an inexact science, typically a number is developed such as dog owners in the US or women aged thirty to fifty. An estimate is then given of what percent will – hopefully – pay for the new widgets and how much. A spreadsheet then extends this math into pro forma financials by year for the next three to five years and dimensions the funding that must be raised.
Obviously the bigger the market that can be credibly addressed, the more likely investors will provide the necessary funding to launch and sustain a start-up. With its huge middle class, the United States has a long history of advantage in this critical variable which goes back decades. Hollywood, for example, has leveraged the US market of middle class consumers to underwrite the cost of a film production – this before tapping an even larger global market. A movie made in Scotland or Argentina has a much more difficult path to large scale profitability despite how brilliant the production company might be.
Definitions of middle class status vary in both the US and China, with the latter having a threshold of $9,000 to enter, because of equivalent purchasing power. Given that, the Chinese middle class is growing at 6% per year versus the US at a stagnant .5%. It will more than triple the US market of 165 million in size by 2022 and therefore have an even more robust domestic market to buttress its international sales. It will be the largest addressable market in the world with India second. The US will fall to third.
The primary assumption of this article is that the Knowledge Economy will generate more wealth and quality employment for the citizens of the nations which dominate it. As Drucker foresaw in a post-industrial world, there will be two classes of workers: those employed in low wage service jobs such as flipping burgers or washing cars and those employed in high wage professions that demand continuous learning to exploit rapidly growing bodies of knowledge.
The United States has been well positioned to benefit from the emergence of the Knowledge Economy over the last six decades but is about to cede its leadership to China. To recap each of the building blocks described above:
- Education….We continue to slip in in K through 12 schooling with our rank in mathematics at a truly pathetic thirty-ninth, in contrast to China at 6th. Our colleges and universities produce graduates that perform in the middle of the pack internationally. At the graduate level our top research universities conduct outstanding STEM research but do so with graduate students that are 80% international, raising concerns about how much of the knowledge gained is actually retained in the US or is available to be exploited elsewhere.
- Research…China is about to pass the US in funding of research and is increasing its level of investment at 18% annually to our 4%. This overlooks the damage we did to organizations such as the National Institutes of Health during the recent sequestration budget slashing and increasingly anti-science policies of Republican administrations.
- Commercialization Vehicles….The partnership between entrepreneurs and venture capitalists has powered US start-ups to dominance in critical areas such as the internet, but as noted earlier by Mary Meeker, China has moved from having only two companies in the top twenty globally to now having nine in just five years, We currently have eleven. Additionally, China is about to pass us in the funding of new ventures, which include the most desirable areas such as Artificial Intelligence, Green Energy, FinTech and emerging markets.
- Addressable Markets…In one of the most astonishing developments in human history, over 600 million Chinese were lifted out of extreme poverty between 1981 and 2018. A like number is moving into the middle class based on purchasing power – a population more than triple the US. As can be expected in a country that is four times larger, it will continue to grow. Having such a huge marketplace is an inherent advantage globally.
Today we are engaged in a trade war with China with very uncertain outcomes. As part of a rebalancing we seek more access to Chinese markets and protection of our intellectual property among other areas. We should, however, look past these issues to fundamentally strengthen our position where our lead appears to be evaporating. The real challenge is much more strategic: to shake off our complacency and reassert leadership in areas that were the source of our advantage. This should benefit not only the United States but the rest of the world, just as our leadership has in other decades.