Will the system crash as IBM goes to pieces?

IT IS a nice juxtaposition that the new president should be inaugurated the day after IBM declared the largest loss in American corporate history. Bill Clinton's success was underpinned by a sense of the United States's economic failure: the sense that the country was being outpaced by Japan and even Europe. That feeling seemed to be mirrored in the decline of IBM.

In 1980 it was valued on the markets as the largest corporation in the world. It had been in the hi-tech Seventies and Eighties what US Steel had been at the beginning of the century, what Ford and General Motors were in the Fifties boom.

Yesterday IBM was worth about pounds 18bn - an impressive sum in absolute terms, but less than, say, Britain's largest pharmaceutical group, Glaxo, or indeed our much-maligned British Telecom. It is still a giant, but a gravely wounded one.

The downgrading of what used to be the US's most admired company may be a measure of the frustration that many American citizens feel with their country, but it may also become a symbol of America's extraordinary ability to renew itself. For parallel to IBM's decline has been the rise of Microsoft, which may soon exceed IBM in market value. Software replaces hardware. Any country can produce things: the only way rich nations such as the US can justify their standard of living is to produce ideas.

The tale of the rise and fall of IBM can be swiftly told. It was founded in 1911 by an Ohio farm boy, Thomas Watson, a generation before the invention of the computer. Watson became National Cash Register's chief salesman and, in the tradition of corporate America, was duly sacked for his efforts. He took over the Computer-Tabulating-Recording Company, which produced a punch-card information system developed for the 1890 US census. The name IBM (International Business Machines) came in 1924, and by the Thirties IBM dominated the US market for clocking-on machines and punch-card tabulators.

Then came the computer. In 1951 Remington Rand developed Univac, the first computer for commercial use. IBM saw the threat and fought back. It hired the best people and developed a series of computers, supporting them with a brilliant sales force. By the Sixties and Seventies it had 80 per cent of the market.

Then came the personal computer. Instead of living in air-conditioned rooms tended by white-coated boffins, computers became commonplace in the home. Anyone with a modern PC now has more computing power in their house than an industrial giant had in 1970. IBM, with its investment in large computer systems, was slow to respond. But when it did in 1981 with its PC, it used its brilliance to produce a world beater, the PC that set a standard for the world.

Alas, it bought in the key chip from Intel and used software from a small company called Microsoft, both of which were able to sell to other companies. While its PC sales boomed in the early Eighties, it was creating a new industry for the reverse engineers of the Far East. Now most people do not buy IBM PCs; they buy clones.

The result has been a corporate catastrophe. Sales have stagnated since the late Eighties; the company has made a loss for the past two years and has had to abandon its policy of lifelong employment, much admired in business school literature as a sign of its long-term view of the world. It is now considering a radical restructuring which involves breaking itself up into quasi-independent companies that compete against each other.

The first obvious question raised by the decline of IBM is whether the disaster could have been avoided. The answer is that while the company might have slowed its decline by retaining control of its operating software, and might have slimmed more quickly, some decline was probably inevitable.

Another question is whether the company's present strategy of splitting itself into competing units is sensible. Here the answer is almost certainly not, for the idea falls between two stools. Either IBM should remain a single entity and learn to manage the necessary contraction in a controlled way, or it should split into several companies, each with a different stock-market quotation. Trying to become a company that fights against itself is a recipe for further disaster.

But there are much more fundamental questions. One is: does the decline of IBM matter? It matters for the employees, of course, and it matters for the shareholders. But provided other corporations, such as Microsoft, can grow up and flourish alongside the rump of IBM, then the US economy as a whole will retain its vigour. If the US were Germany or Japan (or Britain in the Seventies) there might be an attempt to shore up the stricken giant, using taxpayers' money or import restrictions. In fact, if the market answer is to break up IBM, then the US capitalist system is capable of doing it. The market answer may simply be to allow a gradual decline, but to create many more Microsofts in IBM's place.

Perhaps the most interesting question is how mature industrial countries such as the US, or Britain, or Germany, or indeed Japan, should reshape their industries to meet competition from the newly industrialised countries of East Asia and, for the future, from China. What can we do that equally well educated, equally or better motivated, but worse paid people in China cannot do just as well for a fraction of the price?

What happens to the American computer industry is a test. It is a problem for Mr Clinton; it is a problem for IBM; but it is also a problem for the mature industrial world. If the American genius can find a way of expanding other parts of the computer industry to offset IBM's decline, then there is an answer. If it cannot, then the industrial world will have to step back from yet another area of present activity and think of other ways of justifying what for most citizens is a rather comfortable standard of living.