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Monday, December 13, 2004 - Page updated at 12:00 AM

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Part Two: Economic revolution throttles inventor

Seattle Times business reporter

Second of two parts

PACIFIC — By the mid-1970s, Harry Rasmussen was riding about as high as any small-business owner could.

He was worth millions, had a red Maserati sports car in the driveway of his comfortable Fife home and owned several private airplanes to indulge his daredevil hobby: aerobatic flying.

Despite a national bias toward big businesses, he had turned a small startup that made better wall sockets for phones into a profitable factory churning out phone-related switches and gizmos.

After 22 years at Pacific Northwest Bell, he had broken free of the AT&T bureaucracy that had stifled his entrepreneurial drive. The fact that his own small company, Crest Industries, prospered alongside a giant monopoly only added to his glee.

But like so many mavericks, Rasmussen, who was in his 40s, couldn't rest easy.

So he began work on his grandest product yet, a two-line phone that would revolutionize the industry — and run smack into a global economy gathering strength all around him.

A new kind of phone

Rasmussen spots a golden opportunity as the government moves to break up AT&T.

Rasmussen had already invented a simple retrofit kit that enabled a standard Bell phone to handle two lines, dispensing with the bulky, expensive equipment AT&T used to do the same job.

But he wanted more. And he saw his chance in the government's antitrust case against AT&T. Breaking the monopoly on renting phones would allow third-party phones into the market. And his would be the best because of his unique — and patented — two-line feature.

Feverishly, Rasmussen and his team designed a box-shaped desk model — the now-familiar rectangular shape with the receiver on the left and buttons on the right. He named it the Tracer and tooled up his factory in the late 1970s to make it. The new phone carried six of the 18 patents he has received.

What Rasmussen and others didn't know was that the U.S. economy was on the verge of a sweeping liberalization that would nearly destroy his business and render his patents virtually worthless. As free markets spread around the world, other countries would compete to make products ever more cheaply. The resulting competition would spur enormous economic growth but also hasten the decline of manufacturing in the U.S. and speed the outsourcing of a wide range of jobs to workers overseas.

Shifting the economy

An economic revolution glorifies deregulation at home and free trade throughout the world.

After decades of control by big government and stodgy boardrooms, the U.S. economy was ripe for an overhaul. By the mid-1970s, unemployment hovered above 8 percent. The oil shock helped tip the U.S. into "stagflation" — stagnant growth with prices rising 13 percent a year. President Carter spoke of "malaise," and once-stalwart Chrysler needed a bailout.

In this climate, a group of libertarian and neoconservative thinkers saw a chance to alter the nation's economic course. They sought to shrink government, promote markets and blast away regulations that constrained business. Doing so, they said, would unleash economic vitality by forcing companies, workers and products to respond to market forces and competition.

Carter started by deregulating airlines in 1978. President Reagan cut taxes in the '80s, saying wealth would "trickle down" to workers in what became known as supply-side economics.

This return to the notion of laissez-faire capitalism, which existed before the New Deal, encouraged entrepreneurs and industrial giants alike, fertilizing the soil of the future tech boom and helping reverse a decline in small-business employment that had persisted since the 1950s.

After years of dismissal, small businesses were once again seen as a "spark plug" of the economy, generating innovations "that big firms turned into global products," said Joe Sobota, assistant advocate at the Small Business Administration in Washington, D.C.

At the same time, trade talks gathered steam, cutting tariffs that had slowed global commerce since the 1930s. In 1995, the talks created a permanent trade forum based in Geneva, Switzerland, called the World Trade Organization.

Unions' power waned. Early in his term, Reagan fired thousands of federal air traffic controllers who had staged an illegal strike demanding higher pay and a shorter workweek.

"That sent a new message to American business that you really ought to get a spine," said Lawrence Reed, an economist and president of the free-market Mackinac Center for Public Policy in Michigan. "What it said to the unions was, 'Don't expect to make almost any demand and get it. We can't do that or we're going to go broke as a nation.' "

The changes helped put control of the economy back into the "invisible hands" of the market, said Daniel Yergin, co-author of "The Commanding Heights," an economic history. Survival of the fittest became the new economic law. Businesses that innovated and cut costs reaped huge profits. Failures landed on the scrap heap.

Opportunity and chaos

Foreign knockoffs of Rasmussen's new phone hit U.S. shelves.

There was perhaps no greater symbol of this new economic order than the 1984 breakup of AT&T, with a million employees the world's largest company.

At first, slicing Ma Bell into seven regional "Baby Bells" looked perfect for Rasmussen's ambitions. It freed the Bells to sell the two-line phones that his company, Crest Industries, was starting to manufacture. Sears and Radio Shack sold them, too, as customers overcame the fear that installing their own phones was like pirating cable.

By 1983, Rasmussen's factory in Edgewood, Pierce County, was running two shifts, turning out 200 phones a week, recalls Paul Bartlett, Crest's purchasing manager. Morale was high. Bell South, GTE and others appeared ready to sign big Crest orders.

Then, some of Rasmussen's customers sent his phones to Asia to be copied. Knockoffs of Crest's $250 phone soon turned up in stores for $59.

Global outsourcing had come calling.

Orders slowed. Before long, more than a dozen companies were copying Rasmussen's design. The work of the factory had essentially moved overseas, where labor was cheaper. Rasmussen realized his reputation for top-quality products was of little use in a world that now chased the cheapest supplier.

Rasmussen and his employees found the change hard to fathom. "We were in denial," says John Hoskinson, who worked on the circuit boards for the phones. "We thought, 'Naw, this can't be happening.' "

Bartlett kept buying supplies, and the factory filled its shelves with phones. "We still had turn-around optimism," he says. "We were going to make this a success. Everybody believed."

For a while, the Bell companies ran ads showing imported telephones breaking down. "Then they gave up and just started buying them," Bartlett said. Bell South and GTE backed away from their big Crest purchases. "All of a sudden, orders just stopped."

Crest's sales, which had topped $8 million in 1983, fell to $4 million by 1987. The company that gave free gasoline and $1 lunches to its employees suddenly had trouble paying its bills.

"It was touch and go every day," recalls Millie Shultz, Crest's former office manager. "Harry was pretty upset. His idea he'd been working on all those years was gone. They stole it."

Why buy American?

Rasmussen gives up an expensive, and perhaps futile, patent fight.

This was the side effect of the nation's economic liberalization. Instead of competing in a regulated monopoly, or even in a more laissez-faire U.S. market, companies were competing around the globe, in Asia, Latin America and later Eastern Europe, where wages were lower and laws more lax. Foreign copying wasn't new, of course. But it increased as economic growth and trade blossomed in the 1980s and '90s.

On July 9, 1987, the soft-spoken Rasmussen vented his outrage at a congressional-subcommittee hearing on a bill to help small companies fight foreign copies. After spending years and millions of dollars developing and patenting his switches, phones and other products, Rasmussen fumed, a U.S. company had ordered copies from Taiwan "and actually submitted letters to our distributors — six of them — saying, 'Why are you buying Crest when you can buy a copy for much less?' "

Like the owners of many companies, Rasmussen had filed a case with the International Trade Commission to stop the copies. But even though his patent had taken several years to obtain, it was poorly written and offered little protection.

"Our first [legal] bill was $50,000," he told the committee. "They said that this wasn't even starting. $250,000-$300,000 was the next thing we heard. ... We dropped the case."

He predicted a dim future for innovative factories such as his unless the laws changed. "The American manufacturer cannot afford to spend that kind of money to develop a product and to make the marketplace, and then have somebody walk in to our distributors and just take the product," Rasmussen told the committee. "Their investment is nothing. I can't keep doing that over and over and over again."

Today, after much reflection, Rasmussen regrets dropping the suit.

But he had little choice. His company was too small to fight, and a stronger patent "wouldn't have made much difference," he says. "You can have the best patent in the world, but if you're a small business you don't have the money to protect it."

By choosing not to fight, however, he "was in essence giving away his intellectual property," said John Preston, professor at MIT's Sloan School of Management. "He was making his patent worthless."

The bill Rasmussen testified about died. And so did Rasmussen's phone business. He laid off 60 workers, half his factory. He realized he would never recoup what he had invested in the phones. And gradually he let the rest of his employees go as knockoffs whittled away sales of all his products over the next few years.

Today, manufacturers in China, Japan and Taiwan still make copies of his products. Phones based on Rasmussen's design sit on display shelves at Office Depot.

"I don't walk through there anymore," Rasmussen says. He sweeps his arm across an imaginary shelf. "I'm liable to — arrgh!"

The next new thing

Beaten but not bowed, Rasmussen turns his inventive nature to the field of encryption.

Rasmussen was soundly beaten. He lacked the temperament to fight a legal battle, preferring to innovate.

The irrepressible inventor already had a new idea, one that would leapfrog him once again to the forefront of a shifting economy.

In 1990, Rasmussen, now in his 60s, was tinkering with computers and grew intrigued by encryption.

He quickly saw that the chief element wasn't the method of scrambling the data but the key used to unlock it. Most systems used one key for an entire session. But the longer a key is used, the easier it is to intercept and break.

Rasmussen found an innovative way to manage keys. He used a virtual "one-time pad" that generated random keys from an astronomical number of possibilities — billions more than could be stored in computer memory — and discarded each key after only one use.

His random generator also threw random text into a message, scrambling each character in a transmission and making it impossible for code crackers to find patterns.

This time, the economy appeared to be on his side again. The tech boom created demand for secure chatter across the Internet, as well as stronger protections for patents and intellectual property.

Even so, Rasmussen was obsessed with protecting his new invention. He put the encryption software on a computer chip and molded the chip in an indestructible plastic block. Anyone who melted or cut the block to extract his software code would destroy the chip trying. He geared up to make the device, but government restrictions on exporting such a strong encryption system forced him to weaken it, and sales suffered.

Taking aim at the growing Internet market, Rasmussen then designed his encryption to work with Microsoft Internet Messenger, one of the leading programs that allow users to send messages in real time around the globe.

For Rasmussen, this new software product contained a crucial difference: He didn't need a factory. He simply hired a few programmers to write code. He even did a little outsourcing of his own, hiring Validio Software, a Bellevue company, to help write portions of his interface with Internet Messenger. Founded by a Russian immigrant in 1994, Validio often ships work to programmers in Ukraine.

The fall of communism in 1989 had opened up a new world of highly educated workers in Eastern Europe who could write code for a fraction of what U.S. workers earned. Like workers in other poor countries, East Europeans had joined the global economy. Their skills and the spread of open economies further allowed production to move overseas.

The tradeoff from trade

Some question whether long-term benefits outweigh the costs to society.

The rise of the global economy over the past 20 years has raised questions about trade's benefit that are resonating deeply in the U.S. Most economists think countries gain by trading, as the theory of comparative advantage suggests: Countries do best by making what they're good at and buying the products that are difficult for them to produce.

Imported goods provide wider selection at lower cost, and global companies enjoy wider profit margins that cheaper production allows.

More open economies coincided with higher economic growth. Since 1980, the U.S. has churned out 50 percent more goods and services than it did in the previous 35 years, when economies were more closed. The U.S. stock market has made the longest bull run in its history — a gain shared by a growing pool of middle-class stockholders.

The growing world economy also helped the U.S. eliminate in the 1990s the budget deficit caused by Reagan's "trickle-down economics," which in turn brought down interest rates and further spurred business.

But labor unions, environmentalists, activists and some economists argue that the open-market policies may not serve the U.S. well in the long run.

Recently, Nobel laureate Paul Samuelson, a towering figure in American economics and author of a widely used economics textbook, said the belief that the gains of free trade always outweigh the losses is "only an innuendo." The theory, he said, "is dead wrong about the necessary surplus of winnings over losings."

When an innovation is copied abroad and the resulting goods are imported, the loss of jobs can be more substantial than the gain from that trade, he said. And he expects the loss of U.S. jobs to continue. "I'm just trying to be realistic about what has been happening to American society and what is going to continue to happen," Samuelson said in an interview.

Even so, countries keep joining the world trade game. And to participate, countries that once ignored U.S. patents and copyrights are signing WTO agreements for such protection. Japan is setting up a court to handle patent cases, a far cry from swiping Rasmussen's designs 20 years ago.

But these changes have not stopped phone copies — or pirated software. As Rasmussen makes plans to sell his software over the Internet, he is once again risking that his invention, the fruit of 14 years' work, could show up in a sidewalk stall or Internet file-sharing service.

Still dreaming

As Rasmussen turns to new possibilities, he lets go of pieces of the past.

It's midmorning, and the little blue screen lights up on Rasmussen's cellphone. It's the University of Texas calling to ask about buying rights to the encryption software. "They say it's a billion-dollar product," he says.

Having lost his fortune on Crest phones, he's enthusiastic about his new company, CresTech, which consists of him, Bartlett and a Web site, www.crestechims.com.

His ambition is undiminished. And he's also keenly aware that his retirement will be uncomfortable unless he can sell this latest invention. He figures it can be bigger than Crest ever was: 1,000 sales a day at $25 would bring in $750,000 a month.

He doesn't need a factory to make his new invention. He can sell a million copies and carry the factory in his briefcase.

He snaps the phone shut and climbs back into the cab of his forklift. Revving the pedal, he inches forward through the scent of propane exhaust, slipping the forklift's twin prongs under a machine that once made him wealthy, and that he built his life on.

He pulls a lever and the machine rises, perfectly balanced on the fork. Rasmussen gently sets it down on a trailer and backs the forklift away.

He's finally ready to let go of his old beloved machines. They'll be torn down and the parts sold or scrapped.

And he has his eye on a new toy: a small, hand-built jet that can go 520 miles an hour.

"Oh, yeah," he says with a twinkle. "When I make my first million."

Alwyn Scott 206-464-3329 or ascott@seattletimes.com

Copyright © 2004 The Seattle Times Company

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