Experimental Capitalism: The Nanoeconomics of American High-Tech Industries

Experimental Capitalism: The Nanoeconomics of American High-Tech Industries

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Overview

For much of the twentieth century, American corporations led the world in terms of technological progress. Why did certain industries have such great success? Experimental Capitalism examines six key industries—automobiles, pneumatic tires, television receivers, semiconductors, lasers, and penicillin—and tracks the highs and lows of American high-tech capitalism and the resulting innovation landscape. Employing "nanoeconomics"—a deep dive into the formation and functioning of companies—Steven Klepper determines how specific companies emerged to become the undisputed leaders that altered the course of their industry's evolution.

Klepper delves into why a small number of firms came to dominate their industries for many years after an initial period of tumult, including General Motors, Firestone, and Intel. Even though capitalism is built on the idea of competition among many, he shows how the innovation process naturally led to such dominance. Klepper explores how this domination influenced the search for further innovations. He also considers why industries cluster in specific geographical areas, such as semiconductors in northern California, cars in Detroit, and tires in Akron. He finds that early leading firms serve as involuntary training grounds for the next generation of entrepreneurs who spin off new firms into the surrounding region. Klepper concludes his study with a discussion of the impact of government and the potential for policy to enhance a nation’s high-tech industrial base.

A culmination of a lifetime of research and thought, Experimental Capitalism takes a dynamic look at how new ideas and innovations led to America’s economic primacy.

Product Details

ISBN-13: 9780691169620
Publisher: Princeton University Press
Publication date: 12/29/2015
Series: The Kauffman Foundation Series on Innovation and Entrepreneurship
Pages: 280
Product dimensions: 6.00(w) x 9.40(h) x 1.00(d)

About the Author


Steven Klepper (1949–2013) was the Arthur Arton Hamerschlag Professor of Economics and Social Science at Carnegie Mellon University. Klepper was a founding member of the Doctoral Colloquium of the Consortium for Competitiveness and Collaboration, and served as director of CMU's program in Strategy, Entrepreneurship, and Technological Change. Serguey Braguinsky is associate professor of economics, David A. Hounshell is the David M. Roderick Professor of Technology and Social Change, and John H. Miller is professor of economics and social science, all at Carnegie Mellon University.

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Experimental Capitalism

The Nanoeconomics of American High-Tech Industries


By Steven Klepper

PRINCETON UNIVERSITY PRESS

Copyright © 2016 Princeton University Press
All rights reserved.
ISBN: 978-0-691-16962-0



CHAPTER 1

INNOVATION AND THE MARKET


Howard Florey arrived in New York on July 2, 1941 along with a member of his research team, Norman Heatley. Florey was the chair of the pathology department at Oxford University in Britain. For the previous few years he had been conducting research on penicillin with Heatley and Ernst Chain, a Jewish refugee from Germany. Alexander Fleming, a British doctor, had discovered penicillin in 1928. As was his custom, Fleming left out petri dishes in his laboratory that were inoculated with bacteria. A mold, later identified from the Penicillium family, contaminated one of the dishes, inhibiting the growth of the bacteria. Fleming dubbed the active substance secreted by the mold "penicillin" but was unable to separate it from the broth in which the mold grew to assess its therapeutic potential. Florey's lab picked up on Fleming's research roughly ten years later. Using a sample of Fleming's mold, they managed to isolate minute amounts of impure penicillin and test it in mice. Encouraged by the results, they next tried it out on a few dying patients.

Times were different, and human trials were much easier to arrange. They found an Oxford policeman who was near death. A simple prick from a rose thorn had caused him to contract an infection that led to the loss of an eye and abscesses that had spread all over his body. After getting an injection of penicillin, a miracle seemed in the offing as his condition greatly improved. But sufficient supplies of penicillin were lacking to continue his treatment. The situation got so desperate that they collected his urine and transported it by bicycle to the laboratory to extract unmetabolized penicillin in an effort known as the P-Patrol. Supplies ran out, however, and he died. But penicillin's potential was clear, which was reinforced by the next patients they treated.

These experiments established that penicillin could be a powerful weapon to treat infection, but it would have to be produced on a much greater scale to be useful. Florey tried to get British firms involved in the effort, but they were preoccupied with World War II and were unreceptive. So he turned to the Rockefeller Foundation in the United States, which earlier had supported his research. He was given a grant of $6,000 to come to the United States to interest U.S. firms and the U.S. government in the mass production of penicillin (Neushul [1993, p. 167]). Thus, on the eve of Florey's trip to America in 1941, penicillin showed promise of being helpful in the fight against infection but could only be produced in minute amounts.

Within three years all was about to change. Dramatic clinical developments would prove that penicillin was a wonder drug, effective against an extraordinary range of conditions, including childhood killers rheumatic fever and pneumonia, venereal diseases syphilis and gonorrhea, and deadly infections incurred by burn victims and wounded soldiers. By D-day in June 1944, enough penicillin would be produced to meet all of the military's needs. A year later, penicillin would be widely supplied to civilians. All these developments would usher in a new era of medicine and with it a whole new industry. But when Florey embarked for the United States in July 1941, these possibilities could hardly be imagined.

Soon after they arrived, Florey and Heatley were directed to a government laboratory in Peoria, Illinois, that was exploring the use of deep fermentation techniques to develop new uses for surplus farm products. The lab conventionally used corn steep liquor, which is a by-product of the corn starch manufacturing process, in all of its fermentation efforts. It was discovered that corn steep liquor was an ideal medium in which to grow the Penicillium mold, increasing the output of penicillin twelvefold (Sheehan [1982, p. 67]). And it could be grown in a submerged medium rather than in shallow layers in flasks, bottles, or pans, which it was estimated would have had to stretch from New York to San Francisco to meet the U.S. military's needs during the War (Brockman and Elder [1970, p. v]).

The findings regarding corn steep liquor were conveyed in a meeting in December 1941 with research and corporate heads from pharmaceutical companies Merck, Squibb, Pfizer, and Lederle. The meeting was organized by a committee appointed by the Office of Scientific Research and Development (OSRD), which was set up to coordinate scientific research for military purposes during World War II. Prior to the meeting, Merck, Squibb, and Pfizer had been experimenting in a desultory way with producing penicillin using the shallow culture approach (Sheehan [1982, p. 69]). Hearing about progress at the lab from the head of its fermentation division, Robert Coghill, galvanized their work on penicillin. Coghill later remarked that as a result of the lab's discoveries a new pharmaceutical industry was born.

The OSRD sponsored an ambitious program involving several hundred scientists to synthesize penicillin in the laboratory, which at the time seemed like the more promising route toward the large-scale manufacture of penicillin. A sister federal agency sponsored research at a number of universities on various challenges associated with producing penicillin by growing the Penicillium mold, and it continued to support efforts at the government's Peoria lab to improve the natural production of penicillin.

The War Production Board, which was set up in 1942 to regulate production and allocation of materials during World War II, was also enlisted to help increase penicillin production. A program was set up to finance new production plants for qualifying firms and to allow for accelerated depreciation for private investments in penicillin production. More than 175 companies were considered for support. Twenty-one were elected based on their ability to contribute to the wartime effort. A total of $7.5 million ($108 million in 2015 dollars) 1 was spent by the Board on the construction of new plants and $22.6 million ($324 million in 2015 dollars) was invested by firms, much of which qualified for accelerated depreciation (Federal Trade Commission [1958, p. 52]). Firms were given regular reports on progress at the Peoria lab and other efforts supported by the OSRD and agreed to exchange information about their findings.

By 1943 penicillin's therapeutic properties had been established and the military recognized the benefits of using it on the battlefield to treat soldiers. By the second half of 1944, U.S. firms were widely producing penicillin using the submerged — or deep vat — method. Enough penicillin was produced to treat almost 250,000 patients per month, which was adequate to meet the military's demands on D-day and thereafter. Pro- duction tripled from the second half of 1944 to 1945, and by March 1945, producers and distributors were allowed to sell penicillin through normal channels. In contrast, in 1944 British firms were able to produce less than 2.5% of American production. They did not adopt submerged production until 1946, and only with U.S. help (Bud [2007, p. 49]). After the War, U.S. firms vaulted into the forefront of the antibiotics revolution that penicillin had wrought.

How did this happen, and happen so quickly? Technological advances were made on numerous fronts. The Penicillium mold was adapted to grow in a submerged medium. Ways of sterilizing fermentation tanks from the outset and maintaining them free of foreign microorganisms for many days were developed. Better strains of molds were discovered. Precursors were added to the fermentation broth that increased yields and targeted new types of penicillin. Improved methods of isolating and purifying penicillin from the fermented broth were devised. The list goes on (Greene and Schmitz, Jr. [1970]).

Key to all these advances was the penicillin program sponsored and coordinated by the U.S. government. John Sheehan was working on penicillin at Merck during the War and later went on to successfully synthesize penicillin in the laboratory after everyone else had given up the effort. Reflecting on the developments that occurred during the War, he wrote:

Only the federal government could have organized such a massive cooperative effort involving thirty-nine laboratories and at least a thousand chemists. Only the federal government could have eased the restrictions of anti-trust regulations that might have prevented the collaboration of otherwise competitive industries in their efforts to investigate penicillin and, eventually, produce and sell the wonder drug. Merck, Squibb, and Pfizer — the Big Three of the pharmaceutical industry — were the largest and most influential companies in this effort. They were not alone, however. Once the basic research was under way, another twenty or so pharmaceutical and chemical companies entered the field to produce penicillin and the chemicals needed for its production. Without a carefully defined working relationship among all these companies, the penicillin production program simply would not have taken place. (Sheehan [1982, p. 201])


Penicillin was the first of the antibiotics that unleashed a revolution in medicine and propelled U.S. firms to the forefront of the pharmaceutical industry. It is one of many triumphs in the United States in innovative industries. The term high-tech will be used to refer to the sector of the economy where technological progress is at the heart of competition among for-profit firms. This book is about the high-tech sector and how it operates in the United States.

The penicillin story that opens this book raises deep questions about how high-tech industries get started. Surely one of the great strengths of the United States in the high-tech sector is its reliance on the market. Government has to perform some basic functions such as providing for the common defense, educating the populace, funding basic research, and investing in infrastructure like roads and the Internet. But when it comes to high-tech products, where does the government's role begin and its responsibility end? Fleming and Florey's work was funded publicly in Britain. Without the wartime penicillin program sponsored and coordinated by the federal government, it seems doubtful that U.S. firms would have been in the vanguard of the antibiotics revolution unleashed by penicillin. But if private firms in the United States were making little progress on their own in penicillin and in just three years this was all transformed by a government effort, what does it say about the efficacy of the market in high-tech industries?

Questions like these abound about the high-tech sector in the United States. To answer them, six products that I have studied over the last two decades will be used as a laboratory to explore the high-tech sector: automobiles, pneumatic tires, TV receivers, semiconductors, lasers, and penicillin. Using a methodology that in many ways is a throwback to Darwin and evolutionary biologists, all the firms that ever produced these products are traced, including where they came from and how they performed. Marshaling evidence from many sources, I demonstrate that these six industries exemplify the highs and lows of American high-tech capitalism and buried in them are deep and important lessons about competition and technological progress. Indeed, I hope to convince readers by the end of the book that understanding these lessons can not only make us better workers and entrepreneurs but also show us how to shape and use public policies to make the high-tech sector perform better, to take it to new heights.

What is it about these products that drew my attention and on which I will base my claims? In their time, all of them were quintessentially high-tech and to a large extent still are. When each of the products was first produced, they were extraordinarily primitive yet sold for such high prices that few wanted or were able to afford them. But through continual innovations over many years in the products and the processes used to produce them, they became widely purchased. For example, consider the automobile industry. In 1908 Henry Ford introduced the Model T at a price of $850 (about $20,000 in 2015 dollars) when comparable cars sold for $2,000 to $3,000 (roughly $50,000 to $70,000 in 2015 dollars). Six years later the price of the Model T had been reduced by over half, to $360 ($8,400 in 2015 dollars), driven by a stream of production innovations culminating in the moving assembly line that reduced the time required to build auto chassis from twelve-and-a-half hours to less than two hours and more than doubled the number of automobiles produced per worker. But the industry was much more than Ford and the Model T. Just nine years later, in 1923, the number of automobiles produced per worker had more than doubled again through widespread innovations in equipment, machinery, body construction, and painting, among other factors. These advances took an industry that sold 23,000 cars in 1904 to one that sold 1.7 million cars in 1919 and 5.3 million in 1929, more than any other country or comparable region in the world (Klepper and Simons [1997]).

The industries that arose to produce the other five products went through similar transformations, providing a window into understanding the forces governing technological progress and economic growth in the United States. But it is the way that these forces played out in the six industries that makes them so compelling. For example, in the automobile, tire, TV receiver, and penicillin industries, a small number of firms came to dominate them for many years. Capitalism is built on the idea of competition among the many, but these industries gravitated away from this model. Why did this occur? Did it have something to do with innovation and technological change? Did it affect technological progress — did it eventually diminish the incentives of firms to innovate? Did it alter the character of innovations — did firms become more conservative and less aggressive about generating breakthrough innovations? Fortunately, the industries that were most dominated by a few firms did not start out that way, which provides an opportunity to analyze the forces that led to their domination. Some surprising conclusions emerge about how innovative competition shaped the structure of these industries and in turn promoted technological progress.

A majority of the industries also experienced great turnover in their leading firms, with famous firms like General Motors, Firestone, and Intel emerging out of the turnover. Indeed, the United States is famous for its entrepreneurial zeal that has led to the creation of so many successful firms in the high-tech sector. To understand this phenomenon, the origins of the leading firms in each of the six industries and the impetus for their formation are investigated. This reveals a process akin to biological evolution in which new firms are born (involuntarily) out of existing firms and inherit traits that influence their performance. As successful as the United States has been in generating great new high-tech firms, questions are raised about how policies adopted by states might be inhibiting the formation of such spinoff enterprises and the technological progress they generate.

Today, the most celebrated high-tech sector in the world is Silicon Valley in Northern California, which got its name from the semiconductor producers that concentrated there. Every region would like to be "the next Silicon Valley," and every country in the world would like to grow its own Silicon Valley. But how did Silicon Valley become the center of the semiconductor industry? It is hard to point to any feature of the region that made it advantageous for semiconductor producers to locate there. Two of the other six industries also heavily concentrated in one region early on — autos around Detroit, Michigan, and tires around Akron, Ohio. Neither of these regions also had any compelling natural advantages for auto and tire producers to locate there. Indeed, between Silicon Valley, Detroit, and Akron we have three of the most famous industrial clusters without an obvious geographic rationale. This fact provides a unique opportunity to study whether similar forces were at work in the evolution of all three clusters and what if anything governments might do to replicate these forces.

While Silicon Valley is the envy of the world today, Detroit is the opposite — a once great region that has fallen on hard times and is the scene of great economic devastation. Its decline has paralleled the decline of the U.S. automobile industry and its three great firms, General Motors, Ford, and Chrysler. These firms were on the top of the world for over 40 years but have all declined precipitously in recent years, with the government recently stepping in to manage the bankruptcies of General Motors and Chrysler to avert an apocalyptic collapse. Remarkably, two of the other industries — TV receivers and tires — went through similar if not more extreme declines, providing an unusual opportunity to study industrial extinction.


(Continues...)

Excerpted from Experimental Capitalism by Steven Klepper. Copyright © 2016 Princeton University Press. Excerpted by permission of PRINCETON UNIVERSITY PRESS.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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Table of Contents

Editors’ Preface ix

Chapter 1 Innovation and the Market 1

Chapter 2 Once Upon a Time 15

Chapter 3 The Best and the Brightest 62

Chapter 4 The Valley That Shockley Built and the Schoolmaster of Motordom 109

Chapter 5 The Greatest Good for the Greatest Number 149

Chapter 6 The Harder They Come, the Harder They Fall 179

Chapter 7 The Best of Times, the Worst of Times 207

Notes 241

Afterword 247

References 249

Index 259

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