China marriage, a Harvard debate, and future US prosperity

Why is the coming reunion of Hong Kong and China so fascinating to contemplate? A political geneticist (if there were such a creature) would probably say it's an intriguing chance to study what offspring will emerge from a marriage that betroths one of the most productive, untrammeled free-enterprise systems in the world to the most massive communist economy in the world.

But it's symbolically more than that. For most of the post-World War II era, the tribes of mankind on Planet Earth have been divided into three camps. For convenience we have called them the first, second, and third worlds.

The first and second worlds - free-market and communist - offered competing political, economic, and military systems. The third-world nations shopped around between the two in deciding how to organize their own politics and economies.

Almost unnoticed, that shopping process has shifted from one of trying to choose an ideology or a political system to one of trying to find an economic system that works. And Moscow's product is not selling.

Interestingly, the world's five most successful economies in terms of growth, of export success, and of growing market share in advanced technologies are either part of classical China or near neighbors. Those are the so-called mini-dragons - Hong Kong, Taiwan, South Korea, Singapore - and Japan.

Two of these, Hong Kong and Taiwan, are, by historic definition, Chinese. Each of the two exports more today than all of Latin America put together. (So does South Korea.) And none of the Asian Five has any resource base to speak of. So the consequence of what might happen in the next century if China assimilates some of the lesson, as well as the territory, of Hong Kong is staggering. (Peking may, of course, destroy the exuberant economy or draw no lesson from it.) Of course, Soviet economists - wary of China and torn over how to reform its overcentralized, slowing Soviet economy - are apt to pay increasing attention to Peking's results, as it tries to graft Western competitiveness onto its communist system.

But the older industrial democracies of the US and Western Europe cannot afford to ignore the lesson of the Asian Five, either - whether or not Peking learns anything from it.

Two professors at the Harvard Business School, Bruce Scott and George Lodge, recently completed a 21/2-year study of America's competitive position in the world economy. They produced a thicket of statistical analyses comparing American (and West European) productiveness and growth with that of the Asian Five. They surveyed labor costs; capital costs; research and development costs; investment per employee; incentives to work, save, and invest; manufacturing industry decline; export market share in new industries; comparative growth rates; share of the national pie going to consumption versus investment; and share of the pie going to the nonworking (retired, welfare, or unemployed) versus the working.

The results are so densely documented, I cannot hope to summarize them all in this space. But the basic Scott-Lodge argument is that: (1) The US economy, although still a great continental market, is increasingly dependent on world trade. (2) The economy's competitiveness is declining relative to that of the Asian Five and any who may imitate them. (3) If continued, this could mean a lower standard of living in America in the decades ahead. (4) The US, following Britain and much of Western Europe, is concentrating on distributing the fruits of the economic pie rather than on baking a larger pie. (5) Most economists are not paying enough attention to this phenomenon because they are dealing with premises about trade, investment, and production that are no longer valid.

Lodge, Scott, and colleagues report wide agreement on their diagnosis among business and labor leaders who have seen their study. But they admit that some remedies they now propose are controversial. Among their proposals: Cease subsidizing industries (like housing) that are already naturally protected from foreign competition; shift from incentives to borrow to incentives to save; create incentives for longer-term investment instead of short-term speculation; move to make labor costs more competitive (i.e., lower); trim back huge executive salaries, particularly in declining industries; create a quasi-independent agency to research and publicize questions of international competitiveness; have government help industries set trade goals and assist in long-range planning; consider measures to create a new kind of corporate charter that formally recognizes the stake of labor and others as well as stockholders; use federal intervention to help save only the strongest units in a declining industry sector while job retraining is under way; change labor-management relations in the direction of an American version of the Japanese system.

Some of the items in the latter half of this list resemble proposals put forward by Robert Reich and the so-called industrial policy school of economists. Scott and Lodge try to steer clear of association with that controversial program for joint government-management-labor guidance steering of American industry. But they have drawn fire nevertheless.

Martin Feldstein, recently returned to Harvard from telling Messrs. Reagan and Regan things they didn't want to hear about debt and deficits, believes that the Scott-Lodge analysis underemphasizes the role of the strong dollar in reducing America's trade competitiveness. His Harvard colleague, Benjamin Friedman, agrees.

Professor Friedman is of interest because he provided some of the research on deficits, the national debt, and their effect on investment that for the Scott-Lodge study uses. Friedman, like Dr. Feldstein, believes that the current strong dollar is a major cause of America's trade deficit and weakened competitiveness. ''Fifty percent of the problem is attributable to the dollar being out of whack,'' argues Friedman. Only 10 or 15 percent of it, he says, is due to the Asian success formula.

Scott counters that when the dollar subsides the problem of competitiveness will continue to grow because of the way the Asian Five have organized their total government-private effort (1) to lock up their market shares even if it means low initial profit margins and (2) to keep their export industries abreast of new technologies.

Despite such strong differences, both sides agree that the US needs to cut deficits and create incentives for saving and investment, which in turn would improve productivity, help exports, and improve the future standard of living.

What specific incentives to save and invest are available to congressional tax reformers? One is to follow the Japanese example and make savings interest tax deductible, totally or partially, from taxable income. Another is to phase out the tax deductibility of mortgage interest on second and third houses, to put a ceiling on deductibility for a first house, and/or to phase out deductibility of credit-card interest. These are contentious ideas that nevertheless merit consideration.

Congress could also help competitiveness by passing existing legislation to encourage joint research-and-development efforts by high-tech and old-tech industry groups. The method: exempt from antitrust action computer companies or steel companies that do joint research on new processes that all could use to compete in world markets.

No one should suggest that the US (or Britain) become a giant Hong Kong (or South Korea). Those nations have not yet achieved some of the systems the West has developed for maximizing the pursuit of happiness. But the pursuit of happiness for coming generations is also important. So lessons for maximizing competitiveness, for enlarging the pie, are welcome from any quarter.

European governments puzzling over why their societies do not generate the kind of entrepreneurial spirit that exists abundantly in America might also make reforms. One is relief from the legal penalties placed on failure (i.e. bankruptcy). Nothing dampens the entrepreneurial spirit as much as the knowledge that if things go wrong, much of your future can be impounded.

In the past decade governments on both sides of the Atlantic have moved gingerly and sporadically away from welfare-state slicing of the pie and toward steps to create more pie. But in general, programs such as indexing pensions and subsidizing house-buying and consumer credit have hampered the shift. The US, with its attempt to be global policeman as well as welfare distributor, stretched its budget dangerously when it used tax cuts to stimulate saving and investment.