DARLA MOORE
SPEECH TO THE ECONOMIC OUTLOOK CONFERENCE

COLUMBIA, SOUTH CAROLINA
DECEMBER 13, 2004

Last year at this very same event, Professor Michael Porter, from Harvard, mesmerized an audience of over 400 as he assessed the competitive position of South Carolina and pointed to the key challenges and opportunities we face in improving the economic wellbeing of our state. It was truly a remarkable event. Rarely do you put over 400 businesspeople, politicians, and academics in one room, particularly that close together, and keep their individual attentions for over an hour. Professor Porter achieved such a feat because the basis for his analysis was so compelling. As he reported, average wages in South Carolina were 80.5% of the U.S. average, our wage growth was lagging behind the U.S. average, the gross state product per worker was 80.2% of the U.S. average, our patents per employee were well below the national average, venture capital in South Carolina was $3 per worker compared to the national average of $155 per worker, and South Carolina's $2.56 small business innovation research award dollars were below the U.S. average of $8.50 per worker. Most important, his research clearly demonstrated that the old model or traditional way of relying solely on the government driving economic development through policy decisions based around abundant, low cost labor, and high financial incentive would not work. He pointed to a new model with the focus on economic development being a collaborative process led by the private sector involving companies, including competitors, government at multiple levels, teaching and research universities, technical education colleges, and new institutions for the sole purpose of collaboration.

Professor Porter based these findings on the critical issue of how we defined "competitiveness." As he explained, "in today's global, knowledge-based economy, competitiveness is not low wages or low taxes, but it is productivity."

He went on to explain productivity as not a measurement of units produced per worker, but as value produced or added per worker. Productivity as it relates to competitiveness depends as much, if not more, on the value of products and services (higher quality, uniqueness) as it does on the efficiency with which they are produced. It is not what industries you have in a cluster but how the firms in these industries compete, which is important. That is worth mentioning again because many of you have misconstrued Professor Porter's remarks to mean certain industries like manufacturing do not fit in the new knowledge-based economy, and we should not waste our time with them. Quite to the contrary, Professor Porter believes any industry cluster can be successful if based upon the productivity of its product versus trying to compete based on lower wages and cheaper products.

The bottom-line for Professor Porter, and, hopefully, South Carolina, is simply this -- a highly productive workforce, created around hubs of innovation through collaboration between the public, private, and academic communities, will attract new companies to a state, allow existing companies to grow, and lead to job creation. In other words, it will be our productivity which will determine South Carolina's standard of living.

Finally, Professor Porter gave us a roadmap based upon the concept of clustering, which he believed could help our state develop and implement a successful, long-term, strategic plan for economic development for South Carolina. But, he was very candid in his assessment of whether we would succeed or not. First, he made sure we understood this effort was not a sprint with a quick fix, but a marathon which would take a concentrated effort over a long period of time. Second, he told us in no uncertain terms, based upon his analysis, South Carolina had both the assets and capacity to become more competitive but the question was: did we have the will to change? If we demonstrated the will to change directions and implement the changes necessary to become competitive, he wanted to continue to be involved with our effort. If we did not demonstrate such will, then he would simply turn his attention to other projects.

Well, let me begin my assessment of where we are a year later by announcing that Professor Porter has accepted an invitation to speak in January to a group of legislators, who want to honor him for his assistance to our state, and to the Greenville Chamber of Commerce.

I not only take his acceptance as a good sign, but I also believe we have made excellent progress. Mind you, we have a long road to go, but we are making progress. To support the development and implementation of a new economic strategy capable of raising prosperity throughout the state, the South Carolina Council on Competitiveness was formed. The Council is Co-Chaired by Governor Sanford, and Ed Sellers, CEO of Blue Cross / Blue Shield of South Carolina. It consists of a central leadership group of approximately 50 individuals from business, government, and academia, as well as a number of task forces and cluster committees.

The immediate purpose of the Council is to implement the recommendations developed by the Monitor Group and Professor Porter. Over the long-term, the Council will act as a critical and sustainable infrastructure that is motivated, trained, and organized to carry out a long-term economic strategy for South Carolina.

A number of Issue Task Forces and Cluster Committees are now executing on a new strategy. For example:

• The Cluster Activation Task Force has helped activate and support a number of new industry-clusters: apparel, textiles, hydrogen and fuel cells, agriculture (e.g., recreation tourism, turf and ornamentals, row crops and animal agriculture) and is supporting efforts of regional alliances (e.g., Upstate, Central, Charleston, Aiken) to activate clusters;
• The Education and Workforce Task Force is overseeing the allocation of $3.5 million in funding for technical college education and workforce investment, resubmitting Pathways to Prosperity Legislation and developing a strategy to pass this legislation in 2005;
• The Research Task Force is taking inventory of the research strengths at universities and centers across the state, communicating these capabilities to local companies, supporting legislation for the creation of Innovation Centers, and developing legislation to encourage both public and private-sector investment in R&D;
• The Start-Ups and Local Firms Task Force is working with the Kaufmann Foundation to spread their widely regarded Fast-Track program on entrepreneurship to regions across the state, developing legislative recommendations to encourage investment in local firms (e.g., Angel Tax Credits), and conducting interviews of entrepreneurs and small business owners to support the development of a more comprehensive Task Force agenda;
• The Measuring Progress Task Force is identifying the appropriate metrics to track for both the state overall and each working group, taking baseline measures, and has launched a survey to support progress measurement and drafted the first version of the South Carolina Innovation Index;
• The Textile Cluster Committee is convening textile executives to discuss competitive challenges facing the cluster, changing executives' perspectives as to how they can best compete in a changing global market, and developing legislation to encourage investment in the upgrading of local plants;
• The Travel and Tourism Cluster Committee has established subcommittees and chairpersons focused on four key areas: upgrading the product offering, improving air service, linking tourism education programs with companies, and enhancing services, and has completed a review of tourism curriculum at education institutions across the state;
• The Agricultural Cluster Committee has recruited a large number of companies and organizations to the effort and has formed numerous subcommittees and assigned leaders to each: Education, Support Groups, Animal Agriculture, Row Crops, Processing / Packaging, Regulatory / Legislative / Environmental, Forest Products, Recreation Tourism and Turf and Ornamentals;
• The Apparel Cluster Committee has held two all-day statewide conferences of 20+ companies and 10 support organizations and launched both a "members only" website and the first website to sell directly to the consumer;
• The Fuel Cells Cluster Committee recently broke ground on the Center for Hydrogen Research, a 60,000 square foot campus that will house researchers from the Savannah River National Laboratory (SRNL) and industry.

Even beyond the work of the Council, I am happy to report today that I see progress being made not only by the business community but also by our policymakers. As everyone better understands the stakes which are at risk for South Carolina, a new attitude is developing about what South Carolina has to do to become more competitive. At the very least, we are talking in the right terms. When we first started this effort, most people did not know what a cluster was much less believe South Carolina had any. Now, every industry thinks they are a cluster. They may not be totally accurate in their assessment of what a cluster is, but I love the attitude. The State Chamber, which is a critical conduit for the business community, has rewritten their mission to reflect the new model for economic development and the importance of productivity in South Carolina. For the first time, four major organizations with substantial ties to the business community - the State Chamber of Commerce, the Palmetto Business Forum, the Council on Competitiveness and the Palmetto Institute - have the same agenda based on the new direction and are speaking as one on critical issues. All over the state, regional groups are working to find ways to improve the productivity and innovation of their areas through cluster developments. The research universities are playing much stronger roles in the economic development of our state. This effort is not confined to just the strong metropolitan areas. Rural areas are also seeking help in finding ways they can collaborate to identify and build upon their assets to improve the quality of life for their citizens. We are all recognizing the vital role educational attainment must play in developing a productive workforce.

So, the answer to the question of whether we are making progress is a resounding "yes." However, before we all stand and sing a verse of "Hallelujah," let me say a word of caution. Too many times in the past, we have identified a problem in our state, developed a plan of action to address the problem, and then immediately turned it over to someone else to handle - the General Assembly, some government agency, or some "other" organization. We cannot allow ourselves to take such an approach this time. Understand, as we try to make South Carolina more competitive, no one else, not our neighboring states or our foreign competition, is standing still to wait for us to catch up.

The Research Triangle business community in North Carolina just raised $5 million to create 1,000 new high paying jobs in 5 years. In 2003, the Florida legislature made a $310 million commitment to Scripps Research Institute for Scripps to locate its first branch office in the State just for research and development. In Indiana, $75 million was committed for the 21st Century Research and Technology Fund to bolster the commercialization of university research. In early 2004, the Wisconsin General Assembly approved legislation intended to create $62 million in new funding for start-ups.

Both China and India are producing more college graduates in math and science than the United States. China now has a very successful program to lure back its citizens who have gone to prestigious schools in other countries to obtain advanced degrees with promises of greater research dollars than many universities in the United States and other countries can offer.

So, for us, the battle has just begun but it is one we must wage every day. When you hear we are making progress, or the state's economy is improving, or the General Assembly will have a great deal more money to spend this year, do not believe the battle is over. Let me implore you to pause and ask yourself two questions: First, how are we doing in the measurements which really count, for example, average wages, gross state product, wage growth, venture capital investments, and patents created? Then ask how are we doing compared to our competitors? I believe the answers to those two questions will drive you to work even harder.

At the Palmetto Institute, we also recognize that the effort to make South Carolina more competitive is not only a long-term commitment but a multi-faceted task requiring improvement in many areas of our economic foundations. That is the reason we have launched a major study of the tax structure of our state. We believe it is critical when developing a long-term strategy for economic development to have a fair, equitable, stable tax structure which can be relied upon to support such strategy. We want a structure which will encourage individuals and corporations to move here, live here, grow here, and invest in our state. Over the last 40 years, our economy has dramatically changed. We have moved from a goods economy to a services economy. We now transact a growing percentage of our business through e-commerce. The demographics of our population are shifting. The issue for us is, does our existing tax structure fairly and equitably reflect these changes and, at the same time, encourage a growing economy? We have retained the Strom Thurmond Institute and the Rockefeller Institute along with several distinguished economists in South Carolina to undertake a comprehensive review of these issues. We also want to develop a set of reliable, comparative measurements we can use on an annual basis to compare our tax structure with other states to make sure we are competitive.

Let me emphasize this study is not about rates but about structure. We cannot have a changing, growing economy without a reasonable, predictable tax structure which supports such economy. We are looking forward to the study giving us some direction as well as a baseline we can use to judge our progress in the future.

Now, for one final issue which is a personal one but one I believe the business community should not only be aware but be concerned. I am speaking of the state's pension fund investment structure. Improving South Carolina's competitiveness is not an easy task. We not only need to work hard to change the direction of our state economically, but we also need to demonstrate to constituencies outside our state that we are worthy of their confidence. Among the most important indicators that outside businesses as well as Wall Street follow are those which give a clear indication of our state's business acumen and sophistication in the handing of the state's financial assets. The management of the State Retirement Systems' assets is the single most telling indicator given it is our largest financial asset at $24 billion. Unfortunately, the structure of our existing investment system raises serious concerns with many financial consultants and pension managers I have spoken with about the South Carolina investment framework. It is a structure which, if not addressed, will prevent us from coordinating the management of our assets with our liabilities as well as maximizing our investments over the long-term and that is a serious problem. Make sure you understand what I am saying. We have excellent people managing our system. The Investment Board for equities has done an outstanding job. The problem, quite bluntly, is that our structure prevents them from having the tools necessary to manage the system to its fullest capacity.

Now, let me try to explain the problem for our state in practical terms and why it is important that we address this issue now. The $24 billion is the combined assets of all the state's retirement systems which pay benefits to some 98,000 individuals with another 215,000 South Carolinians actively participating in these retirement plans with the anticipation of being paid benefits in the future. That is over 300,000 of our fellow citizens. These are our neighbors, your kids' teachers and principals, my father and others. The annual benefits paid to these retirees put over $1.5 billion back into the South Carolina.

Recently, it was reported that, as early as 2006 and for the first time in recent history, the South Carolina Retirement System will likely not be able to pay a cost-of-living adjustment to its retirees and beneficiaries. The reason the cost-of-living adjustment cannot be paid by the fund is it would increase the unfunded liability to a level which is not actuarially acceptable. So, the Budget and Control Board will be faced with four possible options: (1) Do not pay a cost-of-living increase to the roughly 98,000 retirees drawing benefits; (2) raise the contribution level of the state, which is presently 7.55%; (3) raise the contribution level of the employees; or (4) raise the contribution levels of both the state and the employees. All of these choices force difficult decisions. If you do not pay a cost-of-living increase to the retirees, their buying power is reduced. Add to that the increase in their health care insurance costs, and their quality of life has been negatively impacted. If you increase the contribution by the state, you are taking away revenue which could be going for education or health care. If you raise the contribution of the employees, you have reduced their take-home pay. As you see, it is a dilemma for the Budget and Control Board and the General Assembly.

South Carolina has already fallen behind other states in growing our trust fund due to a constitutional prohibition of investing in equities not being lifted until 1997. Yet, based upon an evaluation of the system by Independent Fiduciary Services commissioned by the Retirement System in 2000, "the current organizational structure threatens to impair the Retirement Systems' investment program and practices." The report by IFS went on to report:

• That the current program is fragmented and "The Retirement Systems currently suffer from a lack of coordination between the equity portion of the portfolio and the fixed income portion." Currently, 60% of the assets are in fixed income (bonds) and the remaining 40% are in equities. They are managed by two separate groups who don't coordinate with each other. Without a common strategy for the entire portfolio, you're guaranteed suboptimal performance of the whole.
• "The Retirement Systems also currently suffer from a lack of coordination between management of their assets (investment program) and liabilities (benefits administration). While the B&CB is theoretically responsible for integrating the investment portfolio with the structure and timing of benefit payments, in fact, there is no person or mechanism who performs - or is responsible for performing - this function."

Make sure you understand, these are the findings of a reputable, independent consultant hired by South Carolina to audit the state's pension investment plan. I emphasize this point to make sure you understand the problems with the structure of the system are not just my opinion but the findings of an independent study. I might add, I have also shared these findings with other outstanding pension managers and experts, and they agree. The bottom-line is that the existing structure is not allowing us to manage the system to its fullest capacity. If we take steps now to correct this problem, we will give ourselves a much better opportunity in the future to fund cost-of-living adjustments from the trust fund.

The IFS Report has a number of recommendations. But, the most important is the call to establish an autonomous Investment Board that would be statutorily denominated as the fiduciary for the Systems. The need for this change along with necessary constitutional and statutory changes to create flexibility for dynamic asset management is compelling and immediate. I hope you will concur with me that action is needed now.

I appreciate your attendance today. While it is obvious South Carolina has major issues which must be addressed, we are making progress. Your presence tells me you share our desire to improve the prosperity of this wonderful state we call "home." Our commitment and work are just beginning. But, now, we at least have a roadmap. I assure you the Palmetto Institute is fully committed to this effort.

Thank you.