Richard Rosecrance and the Virtual State

Richard Rosecrance is a professor of Political Science and the director of the Center for International Relations at the University of California, Los Angeles. Previously in the Policy Planning Council at the State Department, Rosecrance has had full professorships at Berkeley, Cornell as well as at UCLA. He is currently working on a book tentatively entitled Global Economic Transformation: The Rise of International Services and the Virtual State.

by / December 31, 1997
Q: You have been investigating what might be described as the rise of the virtual state -- the political counterpart to the virtual corporation. For instance, you suggest that developed nations are now putting aside military, political and territorial ambitions and are downsizing -- becoming tighter, more vigorous units capable of sustaining the pressures of worldwide competition. Can you explain how you came to this conclusion?

A: It really goes back to the Cold War period and changes that took place then. Fundamentally, what happened there was that many states began to move in a virtual direction by concentrating on international trade and by setting up production based outside their own countries. These states found this was a very efficient way of doing well economically. This was a lesson that finally got through to the major powers, particularly to the Soviet Union, who looked at South Korea and said, "Gee, it would be nice if we could even be as good as South Korea." They weren't even trying to be as good as Japan.

So if you look at the early Gorbachev, he is talking about the "uskorine" -- the Russian word for acceleration. The notion was that everything in Russia had slowed down. Their gross national product was only growing 1 or 2 percent per year, and later, even less than that. So they wanted to find another way of doing things, a more successful example to emulate. The trading state began to have a lot of credence. Countries that were, in essence, trading states -- rather than manufacturing states -- were doing extraordinarily well. On the other hand, the political military states, like America and the Soviet Union, which had huge military expenditures, were using up their investment capital and were spending too much in terms of government deficits. Therefore, their rates of return on investment and their rates of growth were lower than of many of the east Asian states. In the Korean case, they were spending 6 or 7 percent of GDP, relatively high for Asia, but still manageable. But in the Japanese case, it was less than 2 percent, barely over 1 percent. And in most of the other east Asian cases it was very low as well. So those countries started to do extremely well because the investment capital that might have been put into the military was instead put into civilian investment. And the returns, as everyone knows, have been just fantastic. The inputs just led to very high rates of growth. So I think this is when the whole thing started.

Since then, a subsequent switch has occurred, where the emphasis has not only been on international trade as a stimulus, but also on international production. In other words, you don't necessarily want to produce everything at home for a variety of reasons, including labor costs and access to another market. You want to produce abroad. It was this that started the notion of the virtual state -- a country which has diversified most of it production abroad and is now concentrating on high-level international services. The classic and most obvious case is Hong Kong. And even though it is now technically part of China, I think it is still continuing in the same vein. And other countries are moving in the same direction.

I have been collecting a tremendous amount of data on the role of services in GDP -- trade-in service in GDP -- and it is rising dramatically. In the U.S., it is over 70 percent of GDP and manufacturing is now less than 20 percent. And in most other countries, you have similar trends. In Europe, East Asia, Japan, all are moving in the same direction. These countries are doing something very different from what they did in the past. Their reliance upon international trade is very great. And not just trade, but international finance and capital movements, and production abroad. In fact, there is the World Bank study which points out that the countries that have done the best are actually the countries which have nothing -- no raw materials, no water power, no large agricultural land, no oil, no other kind of special natural geographic endowments. All they needed to do well was a very well-trained and smart labor force and a very good management. And so these are the states that have really moved more and more in a virtual direction, similar to corporations.

Q: As part of this trend, you also talk about government downsizing of territorial-based production as one aspect of the logical emancipation from the land.

A: My argument is that if you just look at returns on land, as compared to the returns on manufacturing capital or the returns on services -- at least in recent years -- the returns to land have been lower since World War II than the returns to manufacturing. And the returns to manufacturing have, since 1970, been lower than the returns to high-level services. So actually, in moving up this scale, if that is what it is, many countries have benefited from not focusing on manufacturing, which is something that no one seems to have realized. Of course, manufacturing matters. But I don't think it matters nearly as much as it did in the past, and it will probably matter even less in the future. I think there is a very important trend in this; a trend that emphasizes high-tech and focuses on very important additions to the productive process, even though you don't necessarily carry them out in your own country. You are still designing the products, still doing the R & D and providing the technological know-how that you are contributing to the productive process.

If you look at the poundage of American exports, it has never been lower. That is because the information content of American exports is now just very, very high. You can now get hundreds of millions of dollars of exports in a single 747. So that suggests again that the knowledge or technological content is the important thing.

Q: Can you more clearly delineate what the characteristics of the virtual state might be, how it operates and what its differing priorities are?

A: Basically, the virtual state has learned either to be small or to think small. The key thing is the mastering of international flows rather than production at home -- sort of controlling flows of purchasing power and capital, labor, technology and so on from one country to another that will earn the highest return. It is not just trying to maximize the stocks that are located in one place. The countries that have done this are really doing surprisingly well. Take England, which obviously isn't a complete virtual state yet because it still has a manufacturing base. But more and more of its returns are really being earned on high-level services -- insurance, finance, transport, R & D, the medical area -- where English and Scottish innovations in cloning are just leading the world. And the returns on things like this, the products developed on the basis of this, are just going to be very, very large. English growth rates have been very good relative to the rest of Europe, as have been English employment rates. English inflation rates have been low. So obvious countries can do this without mainly focusing on a manufacturing sector. I think the same thing is gradually beginning to happen in Holland. It has already happened in Switzerland. And it is catching on in Germany, although I think Germany is a little slower to move in this direction than some of the other countries.

Q: You also talk of the division of the world into "head" and "body" nations.

A: Well, I did that in part to get people's attention. Somehow, if you don't characterize it in terms that are fairly broad-brushed, somehow people don't see the process that is going on. Nonetheless, I think there is a lot to be said for this, especially for this period of time. There are going to be a series of nations which are going to be, essentially, producing nations, like China. That doesn't mean that they won't eventually develop a head of their own, just like South Korea and Japan did. But I think, for the short term, they are going to be mainly producing things that other people tell them to produce on the basis of marketing strategy and financing strategies that have been devised by other people. So it is going to be a while before they get into high-level services.

People don't realize how important all this is as a part of the gross national product and foreign trade. If you look at the British in the 19th century, the last year in which the British had a surplus in merchandise that was visible trade was 1822. All the rest of the century, right up until 1913, they had a continuing surplus on current account, but it was made up because of a surplus in international services that compensated for their deficits in visible trade. I think this is a direction the United States has to think more and more about going in. Not that we should give up our exports. Of course, those are terribly important. And some of these are even exports of products from the land and are very important to us. But nonetheless, I think we have to think more and more in terms of exporting high-level services. That is why opening up the world economy to things like telephonic transmission, data transmission of all kinds, the information technology revolution -- this is where, in the long term, we are going to earn our surpluses. We are already earning surpluses on services even though we have an overall imbalance on current account. But the services part, the non-physical part of our exports, are definitely in the plus category. And I think they are going to continue in that way.

Q: You mentioned Hong Kong as the archetype of the new virtual state. You suggest that, whereas Great Britain may have been the model for the 19th century, Hong Kong will be the model for the 21st.

A: Well, Hong Kong for years did make textiles and toys and clocks and other things it exported. But then, as its labor costs rose, and as it got more into finance, it began to recognize that it was quite inefficient for it to use its relatively high-wage labor at home to produce these things. So it began to decentralize its production into Dongnan province in China. And now, a great deal of the production in Dongnan province is really owned by Hong Kong or worked out in terms of arrangements with Hong Kong. When I was there in December, they told me it was very interesting because now that wages in Dongnan province were going up, they were shifting their production apparatus further inland, further upstream where wages were lower, which I think is a continuation of the same policy as before. Hong Kong is still designing the products and still saying where those products should be produced. And Hong Kong is still financing them and creating the marketing strategies.

Q: You say a well-trained labor force is the essential resource for the virtual state. This naturally leads to education, which you have argued has been tremendously undervalued in America, socially and economically.

A: It's funny, because normally the assumptions are that anything which is valuable will be priced at the level of the social contribution that it makes. There may be some other cases where that isn't true, but I think it is obviously not true now in education, especially as education creates the essential basis of our competitiveness internationally. There is some disagreement about which part of our educational apparatus is the one that is crucial. Is it K through 12? Is it the first two years of college education? There are disagreements and different studies that show different parts of the educational process as more important. But I think that all the studies show that unless you have an educated population, you really can do nothing. One of the surprising things about the United States is that we had not realized this until very recently. If you look at American production after 1945, through the 1950s and perhaps into the 1960s, a very high education wasn't necessary because even a high school education -- and not even a good high school education -- was still good enough to put bolt number-36 on to a chassis in a production line. The reason we could get along with not a very highly educated population was that the amount of capital per worker was so incredibly high that what was left to do on the assembly line was essentially just routine operations. But now we are moving away from economies of scale to economies of scope; where on a single production line, you may switch over production from one item to another very rapidly. And this requires the kind of labor force which will be able to quickly change the computer programs and robots and all the rest that contribute to the process. You can't get on with someone with a bare high school education in doing that. This is no longer just a routine operation. Ultimately, you need a very high-level manufacturing population that knows a lot, that understands some degree of mathematics, can read tables and instruction books and can do calculations. So I think this is the direction in which we ultimately have to move.

The surprising thing, except for President Clinton, few have been fully aware of this. I think the amount we are doing to improve education is still very little compared to what we must do over the longer term. Basically, my judgment is that, while it would be really good to have better student/ teacher ratios and that sort of thing in the classroom, we basically need a much higher-level teacher than we have now. It is interesting that during the period when we discriminated against women, we had a better educational system than virtually any of our competitors. And we did it, of course, by insisting that women who would otherwise have gone to law school or business school, could only have jobs teaching high school or grade school. So we had, without paying for it, an incredible infusion of great female talent in our schools. Now, especially since the returns to high school or grade school teaching are so low, we are getting -- I hate to say it -- inadequate men instead of extremely good women. And somehow this has got to be turned around and a greater priority put on what we do as a nation in the educational field. There is no reason why we should be so far behind Singapore and Taiwan and Japan and other countries.

Q: In one article, you also wrote, "Though peaceful in its international implications, the rise of the virtual state portends a crisis for democratic politics." Can you explain what you meant by this?

A: Up until fairly recently, even though we didn't have a closed international economy, we basically had an economy where most of our industries didn't have major competition. The chemical industry did not; the auto industry for a long time did not; the electronics industry did not. For most consumer electronics, you didn't have competitors. So it was very easy for us to simply get people jobs. Everyone knew they would get a job and would probably get a lifetime job they would continue for a very long period without having to worry about switching jobs or low wage rates. But this period is now over. International competition means that people do not necessarily have jobs for a very long period of time. If they lose their job, they may have to take a job that is less well paid than the one they had before. They may have to take two jobs rather than one. And the result of this is a good deal of uncertainty among the American and other electorates that face similar problems, where people are starting to recognize that the state cannot solve the problem for them. And when they think the state can't do it, they are tempted, at least for a while, to think that maybe there may be some other kinds of loyalties to other types of organizations -- cultural, ethnic, political -- that might give them more sense of community, more sense of support than the state can now provide. So I think there is an intrinsic period of anomie or alienation from government that stems from this. Now I don't think this is a long-term problem, because just as was true after the industrial revolution in England, the people who lost jobs, maybe they were not immediately re-employed in something else, but certainly the jobs did come back in other categories and real wages did not decline in England. And I don't think real wages are going to decline in the United States either, even though they have hit a plateau now and haven't been rising recently. So I do think, in time, people will be able to find adequate jobs, but again, that will be on the basis of slightly higher educational qualifications than they have at the moment. But for this period of time, I think there will be a period of malaise, a period of alienation from the state, [and] the feeling that maybe someone else can do better for us than our country has done.

Q: You also talk about the United States remaining introverted politically and culturally. Is this part of the same process?

A: Yes. As long as you think you can do everything for yourself, and you don't have to pay attention to what is going on outside and that the welfare state can provide for you, then it is a luxury to have to learn any other language. It is a luxury to have to work abroad. It is a luxury to have to think in terms of globalization and its effects upon you personally. I think we have had, at least as compared to Europe, a very, very national and culturally oriented country as a whole. I just came back from three months in Florence, and you can't say the Italians believe that their society is going to provide for them in every respect. They have to worry about German and French and Mediterranean competition of all kinds. And they are prepared to move abroad. They are prepared to go to Spain, or Germany, or France to find jobs that they cannot find in Italy. In our case, you ask: How well prepared are our people to go somewhere else if they need to find a job? And I think the answer is: Not very well prepared.

Q: Americans don't even think about moving overseas as a possible necessity to doing well.

A: Exactly. Whereas European workers think about it all the time. They think about learning the languages that are necessary to making that kind of shift. Even Turks have learned perfect German and have worked in Germany for twenty years. And Americans don't seem to be able to do this, in terms of learning French or Spanish or other languages. They are not just culturally prepared by our schools to do this kind of thing.

Q: With the rise of the virtual state, where do you see local and state government fitting in? For example, we are starting to recognize that the global economy is actually made up of region economies with strong global cities at their core.

A: Obviously, the region argument is correct. There is now a power house developing on the Mexican border that is both Mexican and American, and a lot of Latin American workers are gravitating there. You have many examples of regional economies in east Asia. I think in terms of our state governments, we have done a lot to try to bring in outside capital and outside production. And I think we are going to have to continue to do more, because inevitably we are going to lose even more of our production base than we have up to now. And if we are going to make up for it for the current generation of workers, the only way we can do that is to give incentives for other countries to produce in our market. And of course, with exchange rate changes, there may very well be good reasons for them to do this because they may have difficulty selling abroad to the United States over very highly valued Japanese and German currencies. But entirely aside from that, on a state basis, I think the thing you really want from state government is a much, much better educational system than we have right now. The short term answer is to get BMW to produce in the South or Mercedes or whoever it might be. But in the longer term, it is educational response that is the crucial one. It is human capital that is the most important capital for the future.

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Blake Harris Editor