Germany apparently has not been at a disadvantage in producing basic knowledge. As The Economist observes, " Western Europe has no shortage o f capital or educated people."32 * However, the fundamental character o f tacit knowledge, which involves high uncertainty, knowledge asymmetries, and a high cost o f transacting that knowledge, makes it difficult for the holders o f that knowledge to appropriate its value. As The Economist also points out, "Yet (Europe) is not creating enough entrepreneurial firms.1,33
For example, a software firm that was founded in Bavaria, FAST, needed more capital to fund product development. But after being continually refused from financial institutions and non-financial institutions, the founder Matthias Zahn is not only planning an Initial Public Offering on the NASDAQ, but also to move the company's headquarters from Bavaria to Redwood City, California.34 This is no isolated example. Scores o f entrepre
neurs in newly emerging industries, ranging from computer software and hardware to biotechnology and visual reality have engaged in a kind o f Auswanderung, or emigration, in order to appropriate the expected value o f their technological knowledge.
Economists speak o f static economic welfare loss, but this is a type o f dynamic economic welfare loss in the form o f forgone technological knowledge and the economic externali
ties that would otherwise have been accrued. That such technological knowledge in its early stage flows from Germany, as elsewhere on the continent, to selected locations in the United States may reveal differences in institutions. These institutions make it either relatively more easy or more difficult for people to pursue new innovative ideas. It may be that the institutions o f Germany, ranging from finance to the labor market and even to education were developed and excel in the transfer and application o f technological knowledge in traditional industries but not in emerging industries. These types o f institu
tions are conducive to channeling resources into economic activities where it is more or
"Small, But Not Yet Beautiful," The Economist, 25 February, 1995, 88-89.
Ibid.
"Germaninnovation: No Bubbling Brook," The Economist, 10 September 1994, 75-76.
33 34
less known what is to be produced, how it should be produced and who should produce it.
For example, a proclaimed virtue o f the German banking system and financial system in general is that by allowing bank ownership o f private companies, the companies avoid the types o f liquidity constraints more commonly experienced by their counterparts on the other side o f the Atlantic. While this may be true, it is also a double-edged sword, because it tends to be the large, incumbent companies -- which are typically tied to exist
ing technological trajectories — that receive a generous flow o f cash from the banks.
What has been overlooked is the difficulties that outsiders and entrepreneurs with new and different ideas about doing something differently have in procuring funding. At the same time there has been only negligible venture capital and informal capital markets developed to channel finance into projects involving new and different technological tra
jectories. It is not surprising that one o f the most repeated phrases on the pages o f the business news over the last few months has been what Helmuth Gümbel, who is research director o f the Gartner Group in Munich observed,35 "Put Bill Gates in Europe and it just wouldn't have worked out."36
Equity investment in small firms in new industries is scarce. Although the stockmarket established a "regulated bourse" for small firms in 1987, only seven small companies floated shares last in 1993 and just four in 1994. Venture capitalists are rare, in part because they cannot sell their stakes on the stockmarket.37
Labor market institutions also may tend to impede the development o f new firms pursu
ing different ideas. As The Economist observes, "SPEA Software is the sort o f company Germany wants to create. Based near Munich, this developer o f multimedia equipment boosted its sales by 60 percent last year to about DM 180 million and got Germany's biggest-yet injection o f venture capital. SPEA's success will, however, worry one group:
Germany's embattled union leaders. SPEA's 130 employees are not unionized, and it does not yet belong to an employer's association. It is thus not part o f the centralized system o f labor relations to which most o f German industry belongs."38
Similarly, the tax laws force the chief executive officers o f new companies to start paying out dividends from earnings almost as soon as they appear, pre-empting high re-invest
ment policies. And bankruptcy laws in Germany make it clear that to start a new business and to fail is socially unproductive. After two bankruptcies the entrepreneur is legally left only with the option o f becoming an employee. He may not legally rely upon his experi
ence from the bankruptcies to start a third enterprise.
35 "Where's the Venture Capital?" Newsweek, 31 October, 1994, p. 44.
36 Similar sentiment was expressed by Joschka Fischer, parliamentary leader of the Green Party in Germany, who laments, "A company like Microsoft would never have a chance in Germany"
("Those German Banks and Their Industrial Treasures," The Economist, 21 January, 1995, 77-78.
37 German Innovation: No Bubbling Brook," The Economist, 10 September, 1994, 75-76.
38 "Out of Service?" The Economist, 4 February, 1995, 63-64.
The institutional structure — or what some prefer to call the national system o f innova
tion --o f Germany seems to have been designed for industrial stability and the application o f new technological knowledge only within the existing technological trajectories. And yet, as the comparative advantage o f the nation increasingly becomes based on the earlier stages o f the industry life cycle, the underlying knowledge conditions associated with tacit knowledge, such as greater uncertainty, asymmetries, and costs o f transaction, dic
tate not stability, but rather mobility. Individuals and organizations embodying knowl
edge have to be as little impeded as possible to seek out ways o f combining with com
plementary knowledge inputs in order to appropriate the value o f their knowledge. And this means more movement, both o f individual economic agents — that is workers — and firms. Germany apparently had the comparative advantage in moderate-technology and traditional industries during the last two decades. This meant that diffusing technology along existing technological trajectories was sufficient to preserve the international com
petitiveness o f firms and a rising standard o f living for the domestic population. H ow ever, a shift in the comparative advantage o f Germany and other countries in Western Europe away from such traditional industries has left a void. The economic challenge confronting Germany at the turn o f the century will be to shift its industrial structure away from mature industries and products and towards newly emerging technologies and industries.
Such a shift has apparently occurred in the United States. According to Business Week,
"In recent years, the giants o f industry have suffered a great comeuppance — as much from the little guys as from fierce global competition. IBM continues to reel from the assaults o f erstwhile upstarts such as Microsoft, Dell Computer, and Compaq Computer.
Big Steel was devastated by such minimills as Nucor, Chaparral Steel, and Worthington Industries. One-time mavericks Wal-Mart Stores and The Limited taught Sears, Roebuck a big lesson. Southwest Airlines has profitably flown through turbulence that has caused the big airlines to rack up $10 billion in losses over the past three years. And a brash pack o f startups with such names as Amgen Inc. and Centocor Inc. has put the U.S.
ahead in biotechnology — not Bristol-Myers, Squibb, Merck, or Johnson & Johnson.“
The industrial landscape o f the United States has been radically transformed in a rela
tively short period o f time. A number o f corporate giants such as IBM, U.S. Steel, RCA and Wang have lost their aura o f invincibility. Only slightly more than a decade ago Peters and Waterman, in their influential best-selling management book, In Search o f Excellence'. Lessons fro m America's Best Run Companies, identified IBM as the best-run corporation in America and possibly in the entire world. At the same time has come the breathtaking emergence o f new firms that hardly existed two decades ago, such as Microsoft, Apple Computer, Intel, Dell, and Compaq Computer. In the 1950s and 1960s it took two decades for one-third o f the Fortune 500 to be replaced. In the 1970s it took one decade. In contrast, in the 1980s it took just five years for one-third o f the Fortune 500 firms.
Perhaps even more impressive than the handful o f new enterprises that grow to penetrate the Fortune 500, are the armies o f startups that come into existence each year — and typically disappear into oblivion within a few years. In the 1990s there are around 1.3 million new companies started each year (Audretsch, 1995). That is, the modern
econ-omy is characterized by a tremendous degree o f turbulence. It is an econecon-omy in motion, with a massive number o f new firms entering each year, but only a subset surviving for any length o f time, and an even smaller subset that can ultimately challenge and displace the incumbent large enterprises.
Change is more the rule and stability the exception. But F.M. Scherer (1992) notes that the "findings from economic research on Schumpeter's 1942 conjectures seem strangely at odds with recent developments in national policy. Theory and empirical evidence sug
gest that Capitalism, Socialism and Democracy provided faulty guidance concerning the industrial structures most conducive to technological innovation. Yet, especially in the United States, it has been argued with increasing frequency that domestic enterprises are too small to maintain technological leadership in an increasingly global marketplace, and that antitrust policies aimed at maintaining competitive domestic market structures dis
courage innovation."
For example, in 1986 the U.S. Secretary o f Commerce, Malcolm Baldridge asserted,
"We are simply living in a different world today. Because o f larger markets, the cost o f research and developments, new product innovation, marketing, and so forth...it takes larger companies to compete successfully." Baldridge pointed out that the American share o f the largest corporations in the world fell considerably between 1960 and 1984.
He warned that programs promoting large scale enterprise must "not be stopped by those who are preoccupied with outdated notions about firm size."39 Acting on this vision o f the industrial structure, the Reagan administration proposed emasculating the antitrust statutes, particularly those in the areas o f mergers, collusion, joint ventures, and coop
erative agreements, and promoting horizontal mergers as a means o f enhancing the inter
national competitiveness o f U.S. firms.40 It was argued that American corporations needed to "combine and restructure...to meet new competition from abroad, because if our industries are going to survive, there have to be additional consolidations to achieve the needed economies o f scale."41
With Servan-Schreiber's (1968) prescriptions in mind, one has to wonder what would have happened to the U.S. computer and semiconductor industries had IBM been se
lected as a national interest say around 1980 and promoted through favorable treatment as well as protected from threats like Apple Computer, Microsoft, and Intel. What would have happened to the international competitiveness o f the United States in the computer, semiconductor, and software industries? While Robert McNamara's proclamation, "What is good for General M otors is good for America" may have sounded sensible for the 1950s, the analogy may not hold into the 1990s. It may be that the industrial structure has shifted sufficiently from being better characterized as static and stable to dynamic and turbulent.
39 Statement of the Honorable Malcolm Baldridge, Secretary, Department of Commerce, in Merger Law Reform: Hearings on S.2022 and S.2160 before the Senate Committee on the Judiciary, 99th Congress, 2nd Session, 1986.
40 For a more academic plea for these proposals, see Jorde and Teece (1991).
41 "Making Mergers Even Easier," New York Times, 10 November, 1985.
It should, however, be emphasized that there is to date no evidence that the industrial structure has actually become more turbulent over time, even if that may be true. With
out undertaking the painstaking statistical research to compare the degree to which the structure o f industries is characterized by turbulence has changed over long periods o f time, such conjectures remain just that -- conjectures. After all, the observation that the structure o f industries, at least in the United States, tends to be remarkably fluid and tur
bulent is not new. Before the country was even half a century old, Alexis de Tocqueville, in 1835, reported, "What astonishes me in the United States is not so much the marvel
ous grandeur o f some undertakings as the innumerable multitude o f small ones."42
6 Conclusions
The publication o f Davis, Haltiwanger and Schuh (1996) and Davis and Haltiwanger (1996) has injected considerable ambiguity into a literature that had been converging towards a consistent finding that small and new firms create most o f the jobs in most developed countries over most recent time periods. But after correcting for regression- to-the mean, Davis, Haltiwanger and Schuh find that this does not hold for United States manufacturing. Taken together with the findings by Brown, M edoff and Hamilton (1990) that wage and non-wage compensation tend to be positively related to firm size, which have been confirmed across a wide spectrum o f countries, time periods, and data bases, there are reasons to think that the continued shift in economic activity away from large enterprises and towards smaller firms may not be welfare enhancing. Paradoxically enough, many scholars now cite these studies as the conclusive evidence that small firms do not generate most jobs precisely at a time when politicians across Europe, and cer
tainly in Germany, as well as in North America are claiming that it is small firms and not large enterprises which provide the engine o f job growth.
But to a considerable extent, focusing on the issue o f small versus large is somewhat misleading and theoretically misplaced. What is theoretically significant is not that certain enterprises are small or large, but that they are young or mature. Economic theory sug
gests that enterprise age may be more relevant than size, because firms are typically cre
ated as an experiment to pursue a new idea. If that idea succeeds the firm will tend to grow and create jobs. If that idea is not viable the firm will tend to stagnate and ulti
mately exit. Thus, the problem inherent in the small versus large debate is that the focus is inevitably static, when the most relevant economic relationships are, in fact, dynamic.
Thus, while the evidence overwhelmingly, although not unambiguously, suggests that it is indeed small and new firms that provide the engine o f job creation in most developed countries, research needs to shift the analytical focus away from a static to a dynamic lens, in order to examine more carefully the manner by which firms and industries evolve over time.
42 Quoted from Business Week, Bonus Issue, 1993, p. 12.
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