Trade War Victim : A One-Time Winner Is Out of Chips
Some reporters had to strain to hear what Malcolm Baldrige, soft-spoken commerce secretary and cowboy of the Reagan Cabinet, had to say that frosty March morning over breakfast at the Sheraton Carlton Hotel. But his measured words reverberated across Japan.
Baldrige, who once observed that “cowboys don’t talk unless they’ve got something to say,” had more on his mind than employment and economic forecasts that morning: Fujitsu, a Japanese electronics company, was trying to buy Fairchild Semiconductor, a pioneer of American high-technology.
And Baldrige didn’t like it. Neither did America’s other computer chip makers, many of them financially ailing and worried about which of them might be the next acquisition target. Even members of Congress, hard-pressed to describe a semiconductor, were expressing concern.
For more than four months the issue had been hotly debated within the Reagan Administration. Baldrige had found prominent allies in U.S. Trade Representative Clayton K. Yeutter and Asst. Secretary of Defense Richard N. Perle, who saw the deal as a threat to the nation’s long-term economic vitality and the technological leadership needed to sustain its military independence.
They took their plea for Administration intervention to the Committee on Foreign Investment in the United States (CFIUS), an obscure interagency panel chaired by the Treasury Department. There, the “techno-hawks” were led by Baldrige aide Bruce Smart; Ambassador Michael B. Smith, the deputy trade representative, and the Pentagon’s “prince of doom and gloom” Stephen D. Bryen, deputy undersecretary of defense.
Backers of Deal
On the other side were those who mind the financial and diplomatic affairs of the government, aides from the Treasury and State departments, the National Security Council and others from the Defense Department.
They insisted that the United States stay out of the deal, because America needs foreign investment. Blocking the sale on political grounds, they said, could scare off international investors, especially the Japanese, who underwrite much of America’s national debt. It also would undermine the Administration’s long campaign to get other countries to remove trade and investment barriers, they argued.
Emotional, even angry, debates before CFIUS had ended in a political impasse. The Cabinet had been scheduled to resolve the conflict in a private session of the Economic Policy Council to be held two weeks after Baldrige went to breakfast with reporters.
That’s why Administration officials were surprised and angered when the commerce secretary told reporters on March 11 that he would fight the transaction, portraying the Japanese bid as a national security threat.
By virtually all accounts, the Baldrige faction had been losing at that moment. The Cabinet was expected to endorse the Reagan open investment policy that welcomes foreign capital.
But Baldrige’s bold move, what his opponents in the Administration called a preemptive strike, dealt a fatal blow to the deal.
The move also insulted the Japanese, sent a drastically devalued Fairchild back onto a depressed market and may have altered the course of U.S. foreign trade and investment policies for years to come.
Mac: A True Believer
Mac Baldrige, the only member of the Reagan Cabinet who could rope a rodeo calf in nine seconds, came to the Administration knowing that the commerce secretary wasn’t a first-tier position on the Cabinet.
Besides, Baldrige wasn’t a Reagan man to begin with--he had worked for the George Bush presidential campaign. While he shared most of Reagan’s pro-business philosophies, there were some fundamental differences: Baldrige advocated a tough trade stance sometimes in conflict with Reagan economic policies on free trade.
Despite the differences, Baldrige had brought the commerce secretary’s office to new prominence before he was to die in a rodeo accident last July. Most notably, he directed America’s hardening response to trade conflicts with Japan.
When Japanese companies ignored pressure to stop “dumping” computer chips on world markets, Baldrige filed unprecedented legal action on behalf of injured American companies. He used the threat of import penalties to win trade concessions from the Japanese government. And he led a reluctant Cabinet to impose unprecedented sanctions after Japan failed to abide by terms of a 1986 semiconductor agreement.
Nudged along by a persistent Semiconductor Industry Assn. lobby, Baldrige had come to view the U.S. chip industry as the key to America’s progress.
“Semiconductors are the future,” Baldrige said. He blamed unfair Japanese trade practices for running U.S. companies out of the memory chip business, and he warned that “the country that controls semiconductors . . . is going to control computers in the future.”
Baldrige was a true believer.
“Commerce increasingly has seen the world as we see it,” said Michael Maibach, a lobbyist for Intel Corp., who also said that Baldrige had become so attuned to what the industry wanted “he was completing our sentences for us.”
During negotiations with Japan on the 1986 semiconductor trade agreement, industry officials were invited to call Baldrige at his home. “Mac kept telling me over and over that if we weren’t satisfied with the terms, he wasn’t going forward,” recalled George Scalise, a former SIA lobbyist. “Mac was fighting the battle with us.”
But a Washington attorney who represents Japanese clients complained: “They got Baldrige to help them throttle the Japanese.”
Baldrige and the U.S. chip industry became close despite industry frustrations with the Administration’s early conciliatory approach to the Japanese.
During the early 1980s, for example, Baldrige helped convince impatient U.S. manufacturers to hold off filing anti-dumping lawsuits against Japanese companies while the Administration negotiated trade concessions from Japan. But while Tokyo eliminated its chip tariffs, it reneged on pledges to open Japanese markets to increasingly exasperated U.S. chip makers.
The SIA began to emerge as a Washington lobby force at about the same time Baldrige joined the Reagan Administration. Executives and lobbyists sounded a consistent theme: “America’s chip industry is special and vital.”
It was a message Washington had heard over the years. The steel and textile industries had made such claims. Even the work glove industry had asserted it was “essential to national security” in a bid for protection from foreign competition in the early 1970s.
The relatively small semiconductor industry, built on an arcane technology that few outsiders really understand, succeeded in generating a political visibility seemingly out of proportion to its size. By the end of 1986, there was hardly an agency of government that hadn’t participated in a study, survey or report attempting to gauge the importance of the semiconductor industry.
Daryl Hatano, government affairs liaison for the SIA, regarded the accomplishment as all the more impressive because the $11-billion domestic chip industry “isn’t much bigger than the disposable diaper industry.”
When Fujitsu made its bid for Fairchild, Washington didn’t have to be told the SIA position on the deal. It was government opponents of the sale who went to SIA members for help. Industry lobbyists advised officials on strategies to defeat the deal, even as the SIA maintained its public neutrality.
Like Fighting Arson
Fujitsu was up against what Robert Herzstein, one of its attorneys, would later call “neutrality with a vengeance.”
And as the political opposition erupted on various fronts other representatives of Fujitsu and Fairchild said they got the feeling they were fighting arsonists. “Somebody was lighting fires all over town,” complained one attorney.
A spark for some of those fires could have come from a then-secret report for the Defense Science Board prepared by a task force of government, military, academic and industry leaders, some of them SIA members. The report, wending its way through government offices, took no position on the Fairchild sale to Fujitsu but said the loss of semiconductor manufacturing capacity to Japan was “ominous” for the national interest.
Calling the trend a threat to the nation’s economy and the technological superiority of its military forces, Charles A. Fowler, chairman of the Defense Science Board, warned that domination of the industry by foreign manufacturers could someday be regarded regretfully as “a turning point in the history of our nation.”
While the report regarded Japan as “a strong and essential ally,” it said that the economic interests of the two nations differ enough that “it would appear unwise for the U.S., a nation with worldwide interests and obligations, to accept . . . dependence upon foreign countries for critical military hardware or technology.”
The report’s principal recommendation was that the Pentagon should subsidize an American chip-manufacturing consortium with $1 billion. It proved to be a critical boost for Sematech, a chip manufacturing consortium project championed by Charles E. Sporck of National Semiconductor Corp. And it undermined the Fairchild sale as the findings were used by opponents in CFIUS.
But the most telling blow was Baldrige’s public opposition to the Japanese purchase. He told reporters “it’s really bad policy” to permit Japan to buy an important U.S. technology firm, especially when many Japanese markets still were virtually closed to American competitors.
Some saw his opposition as more than an attempt to pressure Fujitsu. It apparently also was intended to press Japan on various trade fronts--especially to open its supercomputer markets to U.S. companies.
It was clear to many of the CFIUS combatants that Baldrige “played his media card” because he knew he couldn’t win at the Economic Policy Council. Even if his fellow Cabinet secretaries didn’t bless the Fairchild-Fujitsu deal, they were nonetheless expected to stay out of it.
Japanese officials accused Baldrige and other U.S. government opponents of improperly “sticking their noses into a commercial deal” and warned that such “obstructionist comments” could impede the free flow of investments. The warning reflected exactly what angry financial and diplomatic officials in the Administration feared most.
In Tokyo, Fujitsu called an emergency meeting.
Asst. U.S. Trade Representative Mike Smith, negotiating a pharmaceutical agreement with Brazil, was at the U.S. embassy in Rio de Janeiro when news arrived from home that Fujitsu had dropped its Fairchild offer. The deal was dead.
Smith jumped from his chair, thrust both fists high over his head in a traditional Japanese salute and trumpeted: “Banzai! Banzai!”
The fierce interagency battle was ended: Victory belonged to the trade hawks.
Washington, Tokyo and Silicon Valley were quick to credit Baldrige with the lethal blow, but behind the scenes Fujitsu may have been cooling toward the Fairchild deal for months.
According to people close to the transaction, some Fujitsu executives were having second thoughts about the $200-million price tag. Others were worried about hostile political reaction in Washington. And grinding delays in the antitrust review process had left the deal dangling precariously in the councils of Fujitsu.
There also were reports that other Japanese high-technology firms were concerned about Fujitsu being a lightning rod for anti-Japan trade sentiment in the United States.
Late in February, Fairchild’s French-controlled parent company, Schlumberger, had literally pleaded with the Japanese to ignore the delays and insults to keep the deal alive, sources said.
“The company was very sensitive. It was being portrayed as a scheming, grasping Japanese giant trying to grab an American institution,” said a Fujitsu source.
As delays mounted, Administration officials came to know that Fujitsu was wavering, that support for the Fairchild deal inside Fujitsu “could be balanced on the edge of a dime.” A serious problem to the Japanese firm was a sweeping demand for information about its supercomputers from the Justice Department, which was looking into antitrust implications of the transaction.
“Justice was going after all sorts of confidential documentation delving into areas that were well beyond the scope of an antitrust review,” a source said. The company was afraid of losing its supercomputer secrets to U.S. agencies, including the Pentagon and CIA, and that its competitors might ultimately get access to the data.
To Fujitsu, the value of the Fairchild deal “paled in significance compared to what Fujitsu stood to lose in the way of supercomputers,” according to Donald W. Brooks, the Fairchild chief executive who had initiated sale negotiations with Fujitsu.
“It came down to two concerns: Fujitsu was asking is the deal worth antagonizing the (U.S.) government and, second, can we get around the (massive Justice Department) request?” Brooks said.
The request seemed to reflect official U.S. concern over possible domination by a merged Fairchild-Fujitsu of markets for specialized supercomputer chips.
Bryen at the Pentagon and others in the intelligence community were particularly concerned that Fujitsu, which also makes supercomputers, could deny its U.S. competitors access to the most advanced chips. They were worried about the impact on Cray Research Corp., a Minneapolis-based company that provides supercomputers to the National Security Agency and other defense programs.
Brooks, however, had tried to allay those fears by offering to provide its chip manufacturing technologies to outside companies so that supercomputer makers would be assured alternate sources of supply.
In fact, by early this year government officials knew that Cray and Fujitsu had secretly agreed to a contract guaranteeing the Minnesota computer company a five-year supply of the Japanese firm’s most advanced chips.
An Administration economist said the guarantees should have resolved what he called “the only argument of merit” that critics of the deal had raised. However, those efforts to satisfy government concerns failed to speed the antitrust review.
At Fairchild, alarm over the delays filtered down into staff and engineering offices. Early in March company employees circulated a petition calling for a lawsuit to challenge the government’s meddling in the transaction.
But then Baldrige blew more cold air on the deal over the breakfast with reporters.
“Big international investment decisions are like orchids in a green house--it only takes a temperature change of two or three degrees and you lose the blossom,” a Fujitsu source said. “I’m not sure Baldrige knew how fragile Fujitsu’s commitment was.”
But that became clear to everyone five days later when Fujitsu withdrew its offer.
In Washington, Baldrige was informed of the Fujitsu decision by an aide. The commerce secretary simply “smiled a little” at the news. Cowboys don’t shout “banzai.”
Fujitsu’s withdrawal on March 16 left Fairchild and Schlumberger officials scrambling. Fairchild had continued to lose money throughout the long, frustrating government review process. Schlumberger was as desperate as ever to be rid of the drain.
“The trouble is you can’t sell a failing semiconductor company in a depressed market to Sears & Roebuck. There are only a few buyers to whom this asset has value,” said a disgruntled official who had been involved in the Fairchild-Fujitsu negotiations.
At a press conference the morning after, Brooks tried to put the best face on the situation--saying, for example, that Fujitsu was still interested in pursuing technology exchanges with Fairchild.
Most significantly, however, he said that he and his management team would submit a proposal to buy Fairchild from Schlumberger. Fujitsu might even help finance the management buyout, Brooks said--if it could do so without further inciting the wrath of Baldrige et al. Fairchild would be kept alive.
But for all of Brooks’ reassurances, he was still reeling from the blow. And his bitterness showed. He angrily accused his Silicon Valley neighbors--U.S. semiconductor industry leaders--of “kindling the fires” of opposition that eventually consumed the deal.
“Fairchild was victimized,” Brooks said. “Fairchild’s employees were victimized.”
But the chief executive still believed that Fairchild could “return to prominence in the industry” that it pioneered. For Brooks, the rescue mission launched when he joined Fairchild in 1983 continued.
A Fire Sale
The crowd that spilled out of the open amphitheater and sprawled up a grassy hillside beyond all wore the familiar identification badges of National Semiconductor. As Charlie Sporck surveyed the audience from the small stage that late summer day he must have reflected on how far his company had come in 20 years.
In 1967, when he left then-giant Fairchild to take over this small, struggling chip-maker, National Semi had about 100 employees in the Silicon Valley. Today he faced 9,000 employees on the lush grounds of the company park--another 20,000 were scattered around the world. Two decades earlier the company reported annual sales of $7 million. Now it was approaching $2 billion. The company had been on the brink of bankruptcy in 1967. It was about to rejoin the international Top 10 in 1987.
The 6-foot-5 Sporck was a tower of good news. The recession was easing. After two years of losses, he was reporting the second consecutive quarterly profit.
And National Semi was buying Fairchild.
The surprise acquisition would strengthen the company, Sporck told his employees. National Semi would be better positioned to compete with the Japanese conglomerates that had been steadily gaining world market shares. Some of Fairchild’s most advanced computer chips would fill voids in National Semi’s product lines. It was a good fit.
And it was a good price: $122 million.
Brooks and the Fairchild management team had offered $185 million. But their bid, dependent upon the parent company financing much of the debt, was rejected by Schlumberger.
“When I heard the ($122-million sale) price I was absolutely devastated,” Brooks said.
In fact, the price shocked the industry. Market analysts called it a steal. Given the fact that Fujitsu was buying only 80% of Fairchild for its $200 million bid, the National Semi offer for all but two foreign plants represented a significant bargain discount--and it came less than six months after the higher offer had evaporated under political pressure.
It could have been called the Malcolm Baldrige Fire Sale.
“Wittingly or unwittingly the U.S. government undermined the value of Fairchild and left Schlumberger holding a white elephant,” a technology policy adviser to the Defense Science Board said.
“The result is the U.S. government gets the price down for the benefit of a U.S. company; it winds up helping National. That’s a pernicious thing,” he said.
But Charles Ferguson of the Massachusetts Institute of Technology, an early opponent of the Fujitsu purchase, countered: “I hope there’s a lot more cases like that. I hope there’s more $100-million price cuts. I hope it sends a signal to the entire U.S. semiconductor industry that they can’t bail out of difficult competition by selling out to the Japanese.”
Fujitsu emerged from its battle for Fairchild so gun-shy about offending the United States that last August it seemed uncertain whether the U.S. government would welcome, or resent, its plan to build a $70-million semiconductor plant in Gresham, Ore.
Before announcing the news in Gresham, where the creation of 350 jobs was sure to win cheers, Fujitsu insisted that officials in Washington be asked first if they had any objections.
One who received such an inquiry was Smith in the trade representative’s office, who assured Fujitsu there would be no negative U.S. reaction.
“The world got turned upside down,” said an incredulous former trade official. “Fujitsu was asking Washington’s permission to spend $70 million in Oregon.”
But, like Fujitsu, there were others who sensed that things had changed in Washington. And the change was coming even before Fujitsu abandoned its Fairchild bid. The conflict itself had what some called “a serious chilling effect.”
One former White House aide said that while the transaction was still under CFIUS review he received calls on the same day from two different New York banks asking who in the government they should contact for approval of an investment by foreign clients.
“That is simply wrong--it’s not the way the U.S. government is supposed to work,” said the former aide, who had participated in Administration efforts to foster unrestricted U.S. investments abroad. “We lose our clean hands.”
And after Fujitsu bowed out there was a marked increase, according to a Pentagon official, in the numbers of foreign investors--"Japanese, Italians, Brits"--seeking advance clearance from the Department of Defense.
“I tell them if the company doesn’t do defense work, don’t worry,” said the Pentagon aide. “But there are lawyers all over town who are telling all their foreign clients now that this is a three-stop town: Commerce, Defense and Justice.”
Treasury officials said such perceptions have damaged U.S. interests. Fujitsu’s treatment was noted by trade negotiators from Canada and Brazil, for example, during sensitive talks with the U.S. over open trade and investment issues.
“It’s been thrown back at us. It’s a step down from the high-minded principles we’ve been trying to get other countries to embrace,” said R. A. Cornell, deputy assistant treasury secretary and a top CFIUS aide.
He said it was especially damaging that opposition to Fujitsu was “based on nationality.” Not only was it “an insult to Japan,” Cornell said, but it sent a signal to all foreigners that nationality might become an obstacle to their U.S. investment plans.
There also is lingering concern “in the bowels of the Treasury Department” that anti-Japanese sentiment reflected in the Fairchild-Fujitsu controversy could affect the U.S. treasury bond markets where the Japanese are prominent investors.
“What would make (Treasury Secretary) Baker and (former Federal Reserve Chairman Paul A.) Volcker sit bolt upright in bed in the middle of the night is the nightmare of the Japanese staying out of the bond market. We’d have to pay our own national debt,” said a Washington attorney.
Political conflicts over foreign investment are expected to grow as the United States relies increasingly on foreign money to finance huge budget and trade deficits and to underwrite business expansion. Foreign investments have doubled in the last five years.
Federal economists warn that the further politicization of such investments could put the United States on the same path as France--a country with investment-inhibiting policies and an ailing economy to show for it.
But Robert Herzstein, one of the Fujitsu attorneys and the undersecretary of commerce during the Carter Administration, said it is clear from the Fairchild case “that we already have limits on foreign investment--even if they’re just in our guts, not in our laws.” He said the government needs to “better articulate our views on foreign ownership and define the standards.”
Silicon Valley executive W. J. (Jerry) Sanders III was sympathetic. He said Fujitsu “was blind-sided” by what he called an ad hoc U.S. policy that punished one Japanese company for the misdeeds of many. He said that if the government opposed Fujitsu’s investment because the Japanese company had dumped chips, then it should have said so and made that policy clear. It did not, he said.
“Fujitsu got it in the neck this time, it seems to me, just because they are Japanese,” Sanders said. “It smacks of racism. It smacks of retaliation which I think is misdirected.”
Another legacy of the Fairchild-Fujitsu deal is ambiguity.
“I wish it could have been settled by the Cabinet instead of having the deal aborted,” said Cornell. “The fact that we didn’t resolve the policy questions means we will have to revisit the issues again in future cases.” He predicted CFIUS will be called to investigate cases with increasing frequency in the months ahead.
Meanwhile, there is investment-screening legislation pending in Congress that the Administration strongly opposes. Baldrige, while maintaining that some foreign investments should be blocked, testified against a trade bill amendment by Sen. J. James Exon (D-Neb.) that would grant broad authority to the President to block foreign acquisitions in “essential commerce,” including electronics or other products needed for a defense-industrial base.
For some at the Pentagon there is lingering regret that an opportunity may have been lost to improve the U.S. defense-industrial base with an infusion of Japanese technology. At the time Baldrige attacked Fujitsu’s bid for Fairchild, the Defense Department was seeking a “political commitment” from the Japanese firm to back up informal guarantees that it would share technology and other resources.
“We thought we’d get benefits from the sale without making other Japanese companies nervous about investing in the U.S.,” said a disappointed Pentagon official.
One clear loser was Schlumberger, the French parent company that sold Fairchild for about $80 million less than Fujitsu would have paid. Some U.S. officials worry about French reaction. “What’s going to happen the next time a U.S. company tries to sell its French subsidiary?” a Treasury Department official said. “Are they going to remember that we cost one of their companies $80 million? The French have long memories.”
But to the U.S. chip industry, the outcome was a complete victory. The fragmented American industry was further consolidated, a step toward stronger competitive positions versus the Japanese, and Fujitsu did not buy another beachhead in the U.S. market. “We dodged a bullet,” said SIA lobbyist Warren Davis.
Last month, the Fairchild sale to National Semiconductor was concluded. It was an uneventful closing. The Justice Department’s antitrust review took only the minimum 30 days. There were no objections from Washington or the Silicon Valley.
At company headquarters in Cupertino, Donald W. Brooks ended his long efforts to rescue Fairchild. He cleared out his office, “cleaned out everything” and said his good-byes. Fairchild employees shared a small cake and tears.
And Fairchild ceased to be. All that remained was the legacy--of technology that changed the world, of an industry that became a national treasure and, finally, of an international controversy that will live on beyond the name of Fairchild.
Also contributing to this story were library researchers Barclay Walsh in Washington and Susanna Shuster in Los Angeles and bureau assistant Katsumi Kobayashi in Tokyo.