Panel IV
Moving Offshore: The Software Labor Force and the U.S. Economy

INTRODUCTION

Mark B. Myers

The Wharton School

University of Pennsylvania

Opening the session, Dr. Myers called the attention of the audience to the absence of economists on this panel, which was to address the timely topic of offshore outsourcing. Its speakers, he noted, represented the business and policy communities. He then proceeded to introduce Wayne Rosing of Google, who in his long experience in Silicon Valley had traversed many prominent companies, among them Caere Corporation, Sun Microsystems, and Apple Computer.

HIRING SOFTWARE TALENT

Wayne Rosing

Google

Dr. Rosing took the occasion to present some facts about Google in hopes of dispelling what he alleged to be myths that had grown up around the company



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Measuring and Sustaining the New Economy: Software, Growth, and the Future of the U.S. Economy - Report of a Symposium Panel IV Moving Offshore: The Software Labor Force and the U.S. Economy INTRODUCTION Mark B. Myers The Wharton School University of Pennsylvania Opening the session, Dr. Myers called the attention of the audience to the absence of economists on this panel, which was to address the timely topic of offshore outsourcing. Its speakers, he noted, represented the business and policy communities. He then proceeded to introduce Wayne Rosing of Google, who in his long experience in Silicon Valley had traversed many prominent companies, among them Caere Corporation, Sun Microsystems, and Apple Computer. HIRING SOFTWARE TALENT Wayne Rosing Google Dr. Rosing took the occasion to present some facts about Google in hopes of dispelling what he alleged to be myths that had grown up around the company

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Measuring and Sustaining the New Economy: Software, Growth, and the Future of the U.S. Economy - Report of a Symposium during its nearly 6 years of existence. About 40 percent of the company’s 1,000-plus employees were software engineers, a figure it wanted to increase to 50 percent; 7 of 11 executive-staff members were engineers or computer scientists, a reflection of Google’s identity as an engineering company. Talk of finance and other business topics tended to be crowded out of meetings of the executive staff by its members’ focus on “designing things.” Dr. Rosing named four keys to the success that Google had enjoyed to date: a brilliant idea—an algorithm called Page Rank that created a better way to organize, rank, and rate sites on the Web—which had been conceived by two Stanford students and out of which had come a better search engine; a motivating mission statement, which put forth as the company’s aim organizing and presenting all the world’s information and trying to make it universally accessible and usable. “That’s one of the few corporate mission statements that I believe is actually realizable in, maybe, the next decade,” declared Dr. Rosing, who underscored his use of the word “all” in qualifying “the world’s information;” a business model fueling an extraordinary level of reinvestment in the business, which was very capital intensive, owning large numbers of computers; and a practice of hiring large numbers of engineers—“a feedback loop that we keep pushing on.” Dr. Rosing launched his discussion of the panel’s topic, which he reformulated as “selective hiring,” by stating that Google was “working on some of the hardest problems in computer science” in search of its “Holy Grail[:] … that, someday, anyone will be able to ask a question of Google, and we’ll give a definitive answer with a great deal of background to back up that answer.” This vision, whose fulfillment the company was not predicting for the near future, was carrying it far beyond the technical problem of searching Web pages. In its pursuit, Google had designed and built, and was running, what it believed to be the world’s largest distributed computer. At the time of the conference, Google was beginning what was essentially the fourth rewrite of its code, which was constantly being rewritten. The company had two basic hunks of code: (1) Google.com, the familiar search engine, and (2) a set of code for its advertising system and monetization. The company kept the two separate because it had a policy of not selling the ability to get into its index; Google robots had to find a site or information, which was then ranked algorithmically. Employees working on these two code bases were kept apart as well, although they did at times need to interact. “The Best Minds on the Planet” The task on which Google was embarked was too difficult to outsource, said Dr. Rosing, adding, “Rather, what we need to do is to pull together all the best

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Measuring and Sustaining the New Economy: Software, Growth, and the Future of the U.S. Economy - Report of a Symposium minds on the planet and get them working on these problems.” Unlike the task itself, attracting the world’s best minds to Google was “very simple.” In 2003, the company had received a total of 35,000 resumes. As a first step they were culled, mainly by Google engineers but with some recruiters also taking part. From a pool made up of those whose resumes had been selected and prospects who had been referred by employees, the company screened 2,800 applicants. Of those, about 900 were invited to interview, and from that set Google hired around 300, about 35 percent of whom were from the group referred by employees. While the vast majority of Google’s employees had graduate degrees from U.S. institutions, they hailed from all over the world, a fact reflected in the makeup of the group of new hires. “So you hire good people,” Dr. Rosing observed, and “they know other good people. That’s the best source of people.” Of the qualities sought by the company in its hires, Dr. Rosing placed “raw intelligence” first; applicants were likely to be asked their SAT scores, a practice not necessarily common in the corporate world. Second, he named strong computer-science algorithm skills, evidence of which was a degree in computer science from Stanford or the University of California at Berkeley with a superior grade-point average. Google also looked for very well developed engineering skills, as indicated by an applicant having written a program on the order of 10,000 lines in length. “Culture fit” was considered highly important as well, because Google had very little management; 18 months before, Dr. Rosing said, the company had had more than 200 software engineers, and all had worked for him. Really good people, he stated, do not need to be managed, they just need to be given clear goals. Workers Needed Around the Globe Google’s outstanding problem, Dr. Rosing lamented, was that “there just aren’t enough good people.” Too few qualified computer science graduates were coming out of schools in North America, including the United States, and in Europe. Short term there was no limit on how many engineers Google was prepared to hire as long as they measured up—and if they could be found. Additionally, pointing out that broadband and other technologies were being deployed faster in many other countries than they were in the United States, he noted that Google’s business required having capable employees around the world. Language-specific software skills and, in many cases, a high degree of cultural sensitivity were necessary. The company had begun to hire people abroad, and those people were needed in their own cultures, so it was not practical to bring them to the United States. Raising a related issue, Dr. Rosing said that Google’s in-house immigration specialist had written a memo only days before stating that the H-1B visa quota for the current fiscal year had been filled. Instead of the approximately 225,000 H-1B visas that had been authorized for prior years, the number had been capped

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Measuring and Sustaining the New Economy: Software, Growth, and the Future of the U.S. Economy - Report of a Symposium at 65,000 in fiscal year 2004—which, he remarked, was an election year. Unable for this reason to hire some people it had in its pipeline to work domestically, Google was opening engineering offices outside the country where foreign employees could be placed after they had been educated, “presumably at taxpayer expense,” in the United States. “Now I must ask, why [is this country] doing this?” he said. Google had “smart people, global reach, and scope; and … we’re intellectually intensive, we’re consumed with aggressive reinvention, and we try to automate to the limit to maximize the gross margin per employee.” It was, in fact, an example of the type of company that the New Economy was supposed to produce and that would fuel the growth of the nation’s economy. Yet the policies in place were limiting the growth of companies such as Google within the nation’s borders, something that did not seem to him to make sense. DISCUSSION James Socas of the Senate Banking Committee agreed that Google exemplified the company that, kept in the United States, would benefit the country. But he also listed some benefits that the company had derived from the country: employees trained at universities supported by taxpayer dollars; the U.S. regime of property protections; the money of U.S. investors, upon which it would rely when it went public; and the very capitalist system that had given the company life and helped get it through its first 6 years. In light of this, couldn’t Google go above and beyond efforts it might otherwise make to hire U.S. engineers who, presumably, would be able to compete with those the company was hiring abroad if given an opportunity on the same footing? Often heard on Capitol Hill, Mr. Socas noted, was: “ ‘Google and companies like it have benefited so much from this American system, from this American community—is it so much to ask that Google in [its] hiring look first to U.S. workers? What is it that Google owes back to the country?’ ” Dr. Rosing answered that, in recognition of the benefit of its having been born in the United States, Google had the responsibility of trying to build a company based in the United States, which he said it was meeting. “We will hire every qualified person we can find in engineering, full stop,” he reiterated. “I put no qualification on that. And we can’t find enough of them.” Saying that the educational system and various factors in society were leading Americans to see other professions as more attractive than science and engineering, he asserted that Google by itself could do little more about this “fundamental problem” than, by going public, create interest and excitement that might inspire others to emulate the company’s founders. All Google could do otherwise was to keep hiring and to continue working on the problem of building better search technology. Asked about attrition at Google, Dr. Rosing placed the rate at well below 1 percent for engineering employees. While speculating that this very low figure might be related to the phase of development in which the company then found

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Measuring and Sustaining the New Economy: Software, Growth, and the Future of the U.S. Economy - Report of a Symposium itself, he stated that Google’s interviewing process was very biased against false positives. “Frankly, we probably miss good people by being so careful,” he said, “because it’s very difficult to manage people out in the company and, especially when you have very little management, that’s a very expensive process.” Although the company had added managers, it remained “picky”; avoiding false hires had, in any event, served it well. Why the Shortage of Qualified U.S. Graduates? John Sargent of the Department of Commerce noted that the dot-com bubble’s collapse had ended the era in which it was difficult to find skilled employees in the information-technology area and, in fact, had left unemployment rates at record highs in almost all IT occupational specialties. If Dr. Rosing was in fact suggesting that the United States was not graduating enough students with skills adequate to meeting Google’s needs, would this be because U.S. students were inferior in quality to those trained elsewhere, or because the skills they were being taught in U.S. institutions were incompatible with industry’s needs. According to Dr. Rosing, neither of the two alternatives applied. The United States probably remained one of the world’s top areas for computer science education, producing very good graduates. But there weren’t enough people going through the system and coming out at the master’s and Ph.D. levels to satisfy the needs of the new Information Economy that was the presumed basis for America’s competitiveness in the post-industrial world. The fundamental problem—given the excellent quality of the graduates coming out of Stanford, UC-Berkeley, and other U.S. institutions—was that not enough people were going into them. He stressed that he was speaking specifically about computer scientists and not about information technologists in general, a distinction he regarded as subtle but very important. Dr. Myers then introduced Jack Harding, the Chairman, President, and CEO of eSilicon and a veteran of 20 years of executive management experience in the electronics industry. CURRENT TRENDS AND IMPLICATIONS: AN INDUSTRY VIEW Jack Harding eSilicon Corporation Mr. Harding introduced his firm, eSilicon, as a three-year-old venture-backed semiconductor company that produced custom chips for its customers in the same way that a general contractor might build a house for an individual. eSilicon implemented its customer’s chip specifications by integrating its deep domain expertise with the capabilities of a global, outsourced, tier-one supply chain and delivered a packaged, tested custom chip in volume with the customer’s name on

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Measuring and Sustaining the New Economy: Software, Growth, and the Future of the U.S. Economy - Report of a Symposium it. Among the millions of parts eSilicon had shipped were chips used in the Apple iPod and in a Kodak digital camera. Of the company’s 85 employees, about one-third were of Indian descent, one-third of Chinese descent, and one-third of “European or American” descent. As such, he said, “the notion of outsourcing and offshoring is alive and well in our business, and we deal with it in many dimensions every single day.” Mr. Harding said he would frame the problem of outsourcing vs. offshoring from the business person’s rather than the economist’s point of view, then talk about some of the challenges and trends he and his U.S. competitors faced. He began by citing a recent statement by Autodesk CEO Carol Bartz that he called a “wonderful backdrop” to a discussion of the topic: “When you can get talent at 20 percent of the costs, it isn’t about waving the American flag. It’s about doing what’s right to have a good company.” This and a statement by Hewlett-Packard [the then current] CEO Carly Fiorina that “there is no job that is America’s God-given right anymore” typified the attitude prevailing in the commercial sector and expressed in various ways by previous speakers: “Hiring here in the United States is important, as is supporting one’s nation, but we have businesses to run and that’s going to dominate our thinking.” This thought process was being “proclaimed throughout Silicon Valley,” and echoed, although “more quietly, around the rest of the United States.” Growing Complexity Spurs Outsourcing The driving force behind outsourcing, as behind other phenomena characterizing the information-technology sector, was complexity. As complexity grows, a firm is forced either to stay ahead of the power curve as long as it can—which means to “sprint like crazy”—or to “step aside and let somebody else do that part of the work.” Those areas that are not part of a company’s core competency are the first to go. To illustrate, Mr. Harding cited Motorola’s decision to spin off its semiconductor business—a business the company had not lost interest in but would have had to recapitalize at a cost of $10 billion in order to stay competitive with outsourcing firms in the industry. “At the point that you’re unable to compete by virtue of cost structure or lack of overall efficiency,” Mr. Harding stressed, “you are forced to outsource.” Extending this model to the computer industry, he recalled the period some 15 years before when IBM and DEC dominated the PC business as vertically integrated companies. The two rapidly disaggregated across a wide variety of companies to buy memory and processors, to the point that dozens of firms had come to participate in the PC supply chain, whose makeup was changing constantly (See Figure 28). It was as a function of complexity growth that manufacturers needed to find specialists that could fill a particular gap or solve a particular problem. This decision to outsource, he said, was the first step down a “very slippery slope” leading to offshoring. Manufacturers typically began by saying,

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Measuring and Sustaining the New Economy: Software, Growth, and the Future of the U.S. Economy - Report of a Symposium FIGURE 28 Outsourcing leads to offshoring. “I can’t do it myself any longer, and so I’m going to hire somebody nearby so that I can look over them; I really don’t want to have them in a different time zone.” Upon locating a better supplier “in another county or the next state or the next country,” however, they would find themselves embarked on offshoring. Complexity and efficiency working together were, from the business person’s perspective, critical to understanding what to outsource and why; when and then where to do so; and whether doing so is worth the challenges that arise with distance. Displaying an outsourcing/offshoring matrix he said would help illustrate two points central to the ongoing policy debate, Mr. Harding called the audience’s attention to the box labeled “captive-offshore” (See Figure 29). That was the locus, he speculated, of “a lot of the political pushback of its being ‘un-American’ to take jobs to—fill in the blank—Mexico, Taiwan, China.” He cautioned those in the policy sector against relying on “a simple formula to understand the ‘un-American’ aspects of outsourcing or offshoring,” emphasizing that specific attributes and market segments merited attention. Activity that could be placed in the “outsource-offshore” box of the matrix, meanwhile, was marked by a trade-off: diminished control against very low variable costs with adequate technical expertise. Recalling the days when “made in Japan” implied questionable quality, he observed that “as you grow up, you realize that also implies things such as IP protection, bootlegged software, [and] cutting the tops off of chips.”

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Measuring and Sustaining the New Economy: Software, Growth, and the Future of the U.S. Economy - Report of a Symposium FIGURE 29 Out/Off matrix. Hurdles to Accomplishing Specialized Tasks In-House Offering an admittedly “simplistic” model that nonetheless might aid understanding of business’s outlook on the outsourcing of specialized tasks, Mr. Harding identified general hurdles—such as budget or immigration constraints, or raising the bar too high—that could limit the acquisition of specialized capability in-house (See Figure 30). Specific to companies under $1 billion in size were problems associated with having a specialist on the payroll who could not be kept busy year-round: (a) it was wasteful, and (b) workers of sufficient quality might well reject a position that would not keep them engaged full time. Such factors might incline firms to look outside for expertise needed to get a job done. “There is a fundamental notion,” he stated, “that one outsources in order to achieve a specialty skill, regardless of whether it is on- or offshore.” Although the historical reason for going offshore, and the goal implied in the statements of Bartz and Fiorina, was to manage costs, that was not always the motive (See Figure 31). Texas Instruments, for example, had gone to India 20 years before to access a well-educated software pool, which it had managed on a captive basis since. In fact, however, the “vast majority” of the small to medium-sized companies with which Mr. Harding had come into contact were talking about going offshore to save money. Although there might be exceptions to the rule, a software company seeking venture money in Silicon Valley that did not have a plan to base a development team in India would be disqualified as it walked in the door. It would not be seen as competitive if its intention was to hire

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Measuring and Sustaining the New Economy: Software, Growth, and the Future of the U.S. Economy - Report of a Symposium FIGURE 30 Business drivers: outsourcing. FIGURE 31 Business drivers: offshoring. workers at $125,000 a year in Silicon Valley when comparable workers were available at $25,000 a year in Bangalore. Morgan Stanley had predicted that the outsourcing market overall would grow to approximately one-third of the $360 billion semiconductor industry by the end of the decade, a big jump from around one-seventh of a $140 billion market in 2002 (See Figure 32). To suggest the role of offshoring in this change,

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Measuring and Sustaining the New Economy: Software, Growth, and the Future of the U.S. Economy - Report of a Symposium FIGURE 32 Outsourcing trend: semiconductor revenue by source. SOURCE: Morgan Stanley Research. Mr. Harding showed a graph tracing the growth of India’s software industry from almost nothing to $10 billion in around the same number of years and noted that it had shown no signs of slowing down. The strength of the offshoring trend, he said, made imperative that the United States find a way to become comfortable with it, both from a business and from a public-policy perspective. Moving Software Development Offshore Mr. Harding then showed a matrix whose purpose was to organize discussion of the specific topic of moving software development offshore (See Figure 33). Starting with the quadrant defined as “offshore-captive,” he pointed out that placing only large enterprises there most likely represented an inaccuracy. While historically it had been companies like TI, Motorola, and Microsoft that hired software developers in India or elsewhere abroad, having a foreign presence had become incumbent even on startups seeking venture capital, as mentioned above. He said that every company he knew of, without exception, was in the process of moving software development to some degree to the Indian marketplace, and that it was inconceivable that any firm would rule such a move out. Although eSilicon itself, a hardware developer that provided its customers with hardware design from time to time, did not yet have an offshore facility up and running; it had made the decision only 2 weeks before to start one. “I consider myself a laggard in that respect,” he said. “I’m looking around and saying, ‘I’m the last guy on the block to do this.’ ”

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Measuring and Sustaining the New Economy: Software, Growth, and the Future of the U.S. Economy - Report of a Symposium FIGURE 33 Offshoring software. Offshore-outsourced software development worked first and foremost because of low costs: While costs were increasing compared to previous years, it was still cheaper per person to build software abroad, even taking productivity issues into account. There was a large supply of graduates outside the United States, and the number of graduates at home had diminished to the point that it was difficult to hire good people. Mr. Harding agreed with Dr. Rosing that neither U.S. education nor the students it produced were at fault, but that with the number of graduates down employers were forced by competition for their services into paying them too much. “You’re paying master’s-level grads out of a fine school around $100,000 to come in and be an apprentice, essentially, for the first 3 years,” he commented. “That’s not a sustainable model.” The other key factor in favor of offshore-outsourced software development was that the tools involved were, effectively, a commodity. They were robust, had a broad user base and well-developed support infrastructure, and benefited from strong standards. This was significant because, with each advancement of a software product, 18 percent of functionality was lost owing to inability to manage the bugs associated with it. From his days as head of a large software company, Mr. Harding recalled that every time the firm released a new product, it enabled new bugs even as it fixed bugs that were on its customers’ top-ten lists. “It’s a never-ending process,” he lamented. Hence the advantage of having the tools that, while not perfect, was ubiquitous and could be operated effectively by millions of people. Mr. Harding then paused to offer a comparison between offshore outsourcing of software and offshore outsourcing of hardware that left the former looking in

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Measuring and Sustaining the New Economy: Software, Growth, and the Future of the U.S. Economy - Report of a Symposium year to work at its facility in Thousand Oaks, Calif. In the interests of comparison, he also posted the positions of assistant professor of economics at his own institution, which pays $60,000, and of post-doctoral fellow in the biological sciences at Johns Hopkins, whose $30,000 salary level “might explain why a lot of people in America aren’t too happy doing post-docs in life science.” But it was the low level of the salaries being paid to workers from abroad that so many U.S. IT workers found problematic. “If work needs to be done in the U.S., it should be done by domestic workers unless you can’t find a domestic worker,” he stated, although he conceded that “maybe you can’t find a domestic worker for $21,000.” Also, the firms above the bar, all offshore outsourcing firms, are importing orders of magnitude more foreign workers on H-1Bs than firms like Rockwell Scientific. Dr. Myers then introduced William Bonvillian, the Legislative Director and Chief Counsel to Senator Joseph Lieberman of Connecticut. OFFSHORING POLICY OPTIONS William B. Bonvillian Office of Senator Joseph Lieberman Mr. Bonvillian36 began by posting what he called “two fighting quotes from the current times,” one from Gregory Mankiw, the chairman of the President’s Council of Economic Advisers (CEA), and the other from Intel Corporation Chairman Andy Grove (See Figure 41). Mankiw, after loosing a “storm in Washington” with his pronouncement, had all but disowned it, but the points he had made initially were nonetheless classic defenses of outsourcing tendencies: that outsourcing was just a new way of doing international trade; that many things were more tradable than they had been in the past, which was good; and that outsourcing was on the rise and should be viewed as a plus for the economy in the long run. 36   Mr. Bonvillian’s views are further elaborated in his article, “Meeting the New Challenge to U.S. Economic Competitiveness,” Issues in Science and Technology, XXI(1):75-82, 2004. See, also, Office of Senator Lieberman, White Paper: Offshore Outsourcing and America’s Competitive Edge: Losing Out in the High Technology R&D and Services Sectors, May 11, 2004; Office of Senator Lieberman, White Paper: National Security Aspects of the Global Migration of the U.S. Semiconductor Industry, June 2003, pp. 1-10 (competitive pressure from China on a U.S. advanced manufacturing sector, semiconductors); Office of Senator Lieberman, Data Dearth in Offshore Outsourcing: Policymaking Requires Facts, December 2004 (data presented in his presentation was developed in part by his office for these three reports, which are carried on the Senator’s Web site).

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Measuring and Sustaining the New Economy: Software, Growth, and the Future of the U.S. Economy - Report of a Symposium FIGURE 41 Mankiw vs. Grove. Grove’s statement, which had been circulated widely in the nation’s capital around the same time, reflected the other side of the coin. The two together provided a backdrop for the discussion. Forrester had projected that 3.3 million U.S. IT service jobs and $136 billion in wages would go offshore over the following 15 years, while McKinsey had predicted a 30-40 percent annual acceleration over 5 years in the number of such jobs lost to outsourcing. Mr. Bonvillian said he had seen an even more extreme prediction: that a total of 14 million IT service jobs would disappear from the United States in that manner within a decade. He was skeptical of these projections because the relevant government agencies were not collecting the foundation job data. Nonetheless, while very significant declines in IT employment might be led by IT manufacturing, IT services would be right behind. Although the lack of data made it impossible to track the activity of the many companies engaging in overseas outsourcing, it was clear that the phenomenon was not restricted to any one sector. From low-end services—like call centers, help desks, data entry, accounting, telemarketing, and processing work on insurance claims, credit cards, and home loans—it was moving increasingly toward such higher-tech, higher-end services as software, chip design, consulting, engineering,

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Measuring and Sustaining the New Economy: Software, Growth, and the Future of the U.S. Economy - Report of a Symposium architecture, statistical analysis, radiology, and health care centers. And those were only some of the leaders. R&D Following Manufacturing Overseas Another, parallel phenomenon, mentioned earlier by Dr. Hira, needed to be kept in mind: the growing trend of moving R&D offshore so that it would be closer to manufacturing (See Figure 42). The country had already lost 2.6 million manufacturing jobs, many of them in the tech sector during the 2001 recession and post-recession, and R&D had started to follow. A significant part of the R&D going abroad had been very high-end, very capable; in semiconductors, to pick one example, it was very important to have R&D and design close to the manufacturing stage. R&D spending abroad by U.S. corporations had quadrupled since 1968 to about $17 billion, and, since 1985, the ratio of foreign to domestic corporate R&D spending by U.S. firms had risen 50 percent. “These are big numbers,” Mr. Bonvillian observed, which U.S. policymakers had to “begin to understand.” He then posted a pair of lists—of factors behind the exportation of U.S. jobs in services and R&D (See Figure 43), and of risks involved in transferring business functions abroad (See Figure 44)—without commenting on them other than to say that moving offshore is “not necessarily a simple equation [but] a complicated business transaction.” Another graphic, this one illustrating the differences in salary levels for computer programmers from country to country (See Figure 45), FIGURE 42 R&D trends.

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Measuring and Sustaining the New Economy: Software, Growth, and the Future of the U.S. Economy - Report of a Symposium FIGURE 43 WHY is the U.S. losing service and R&D jobs to overseas? FIGURE 44 Risks associated with moving offshore. was offered in explanation of the offshoring trend. Both it and a chart representing differences in the ratio of engineering degrees to total bachelor of science degrees in the United States and China, among other countries (See Figure 46), depicted what he judged “startling historical developments.”

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Measuring and Sustaining the New Economy: Software, Growth, and the Future of the U.S. Economy - Report of a Symposium FIGURE 45 Annual salaries for a programmer in various countries. SOURCE: Computerworld, April 28, 2003. FIGURE 46 Ratio of engineering to total B.S. degrees awarded in various countries. SOURCE: National Science Foundation, Science and Engineering Indicators. While offshoring’s impact on the U.S. economy was hard to ascertain using the limited data available, a debate had begun between optimists adhering to classical economics and some who had been voicing a more general but growing concern about the country’s economic future. The former argued that offshoring would yield such benefits as lower product and service costs, new markets abroad fueled by improved local living standards, and more latitude for U.S. corpora-

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Measuring and Sustaining the New Economy: Software, Growth, and the Future of the U.S. Economy - Report of a Symposium tions to focus on core competencies at home. The other side, goaded by what Mr. Bonvillian dubbed the “Uh-oh Factor,” and seeing growing world competition over innovation capability, cited downward pressure on wages for high-skill jobs, as well as diminishing talent, tax, and investment bases at home. Such concern, having become “in many ways a storm,” was starting to buffet Capitol Hill. Will Offshoring Erode Technological Comparative Advantage? He then accorded special consideration to the argument that offshoring’s movement up the value chain is accompanied by potential loss of technological competitive advantage. This could be seen as an emerging bone of contention between classical economics and the growth economics school. A representative of the latter, Clayton Christiansen of Harvard, had written that low-end entry and capability fuel the capacity to move into higher-end markets.37 This familiar pattern of economic expansion, typified by the progression from the Corolla to the Lexus over time, had been replicated in any number of industries. “We have to understand that low-end competition now is not necessarily going to end at those low-end levels,” Mr. Bonvillian warned. Similarly, Michael Porter had contended that if high-productivity jobs are lost abroad, then long-term economic prosperity is compromised.38 Some growth economists, echoing real estate agents, had placed the emphasis on “location, location, location.” Porter himself had done a great deal of work on “clustering,” the notion that it is possible to create a competitive force that is regionally based and collaborative across different sectors and institutions. The cluster spurs upgrading because it stimulates diversity in R&D approaches and provides a network mechanism for introducing new strategies and skills. Location is a key element: Since there is a tremendous skill set involved in the different work functions at an advanced-technology factory, losing a significant part of that manufacturing will affect the cluster’s ability to thrive in its region. And when such loss is taking place on the service and R&D sides as well, another set of issues arises on top of that. According to John Zysman, who has maintained that manufacturing matters even in the Information Age, the advanced mechanisms for production and the accompanying jobs are a strategic asset, and their location makes the difference as to whether or not a country is “an attractive place … to create strategic [economic] advantage.”39 37   See Clayton Christianson, The Innovator’s Dilemma, New York: Harper Business, 2003. 38   Michael Porter has argued that business leaders should look for locations that gather industry-specific resources together in one “cluster” that can lead to competitive advantage. See Michael Porter, “Building the Microeconomic Foundations of Prosperity: Findings from the Business Competitiveness Index,” The Global Competitiveness Report 2003-2004, X Sala-i-Martin, ed., New York: Oxford University Press, 2004. 39   See Stephen S. Cohen and John Zysman, Manufacturing Matters: The Myth of the Post-Industrial Economy, New York: Basic Books, 1988.

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Measuring and Sustaining the New Economy: Software, Growth, and the Future of the U.S. Economy - Report of a Symposium “A Different Kind of Competitiveness Story” What all this added up to, Mr. Bonvillian said, was “a different kind of competitiveness story.” Although the debate outlined above might seem familiar from the 1980s, a new set of competitors had emerged and the competitive situation had grown far more complicated: In its competition against Japan during the 1970s and 1980s, the United States was facing a high-value, high-wage advanced-technology country very similar to itself, whereas competing against China meant competing against a low-wage, low-value increasingly advanced-technology country. The United States, one could argue, had been able to use its entrepreneurial advantage to offset Japan’s advantage in industrial policy. China, in contrast, was not only a very entrepreneurial country, it was making intense use of industrial policy in pursuing such aims as capturing the semiconductor sector. The rule of law, which was a common assumption in competition with Japan, is still an emerging idea in the competition with China. By a similar token, Japan protected intellectual property, while an “intellectual property theft model” unfortunately structured much of the Chinese competitive environment; according to one source, the FBI estimated at around $250 billion per year the intellectual property theft in China of U.S.-bred products and ideas Japan was a national-security ally, China a potential peer-competitor. One constant had been that both Japan and China had undervalued their currency and bought U.S. debt, in consequence of which the United States was not in a position to push its trade arguments vigorously. China would maintain as long as it could the low value of its currency while continuing to buy U.S. debt at massive levels, he predicted, so it can retain leverage over U.S. economic policy. With data scarce and concern “enormous,” a multitude of bills had been introduced in Congress, which, according to Mr. Bonvillian, sometimes reflected a move toward a protectionist outlook. Under a bill offered by Sens. Edward Kennedy and Tom Daschle, companies that sent jobs abroad would have to report how many, where, and why, giving 90 days’ notice to employees, state social-service agencies, and the U.S. Labor Department. Senator John Kerry had introduced legislation requiring call-center workers to identify the country they were phoning from. Other bills would require government contractors to have 50 percent of their employees in the United States, prohibit work under federal contracts from being performed outside the country, or bar companies that outsourced jobs from contracting with the federal government. Legislation that had failed three years before, but was being revived would extend Trade Adjustment Assistance (TAA), up to then available only in the case of manufacturing jobs that had been offshored, to service-sector jobs as well—a proposition bringing with it a complex

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Measuring and Sustaining the New Economy: Software, Growth, and the Future of the U.S. Economy - Report of a Symposium definitional issue.40 And the Genuine U.S. flag Act, one of his personal favorites, would prohibit the purchase of American flags made outside the country. Discovering That Services Are Not Invulnerable U.S. policy makers’ previous exposure to manufacturing issues had helped build their sophistication in responding to competitiveness problems in that sector. But, not having envisioned significant competitive threats to the country’s service sector, which had been regarded as “golden,” and invulnerable, they found themselves confronting what Mr. Bonvillian called a “complicated dilemma.” After taking the initial step of collecting data, lawmakers would be obliged to “think about some safety nets” in light of the fact that the voices of their constituents had grown “loud” on the subject. Among the areas of potential response in the near term were: Retraining. “A much more effective, rapid, and agile-workforce training set of programs,” with interactive IT playing a role, would be required. Compensation. Options included Trade Adjustment Assistance (TAA) for services; job-loss insurance, which had been featured in a pilot program in previous TAA legislation; and asset building compensation features. Novel thinking about incomes and assets was in order, Mr. Bonvillian said, because “in the kind of economy we’ve got now, holding assets is probably much more enduring than simply relying on straight incomes. Our upper-middle class has that capability, but it doesn’t go very far down the chain. And how do we start to turn that perspective around in governmental policy?” Trade. The large U.S. apparatus for negotiating trade deals had limited capability for looking at ongoing and shifting barriers to market entry that U.S. companies faced, and for prompt action against unfair competitive practices. Much hard work was ahead, starting with attempting to cope with “a tremendous amount of just straight industrial policy … that is likely GATT violative,” such as the VAT rebate China was providing on domestically manufactured semiconductors. Financing. Means needed to be found for bringing spending from the venture-capital system off the sidelines and back into the economy. In the longer term, if economic growth theory was right, the country would have no choice but to innovate its way out of the situation. As a consequence, far 40   Trade Adjustment Assistance for Firms (TAA), a federal program, provides financial assistance to manufacturers affected by import competition. Sponsored by the U.S. Department of Commerce, this cost sharing federal assistance program pays for half the cost of consultants or industry-specific experts for projects that improve a manufacturer’s competitiveness.

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Measuring and Sustaining the New Economy: Software, Growth, and the Future of the U.S. Economy - Report of a Symposium more serious thought had to be given to the national innovation system, raising such questions as: How might the United States increase the speed with which it brings on the “next big things”? How should it cope with talent issues surrounding math and science education? How could the number of “prospectors” in the nation’s innovation system be increased, and how could they be given the skill sets not just to make discoveries, but to grow companies? Could the country invest in R&D in such a way as to spur the development of targeted new technologies, especially in the physical sciences? If the U.S. is going to have to compete in high-end services, could it build up its negligible services R&D and accelerate services innovation? What could be done to break down barriers to entry for truly high-speed broadband which could spawn a new generation of IT applications, and how should growth of this broadband infrastructure be augmented? DISCUSSION Charles Wessner of the STEP Board pointed to a disjunction between the ability of both the economy and the policy process to adjust and the time required to take any of the long-term steps listed by Mr. Bonvillian. The lag effects of 7 years of substantial cutbacks in the federal R&D budget, which STEP had documented, were expected to hit.41 A suggestion had been made that even were the United States to pursue a trade case against China, around 18 months would be required to file it—the “equivalent of letting people rob the bank for 18 months before you pick them up”—and China would have completed planned investments on its 300 mm wafer-fabricating plants by then. “We know there’s a fire, and we’re not able to bring hoses to bear,” he contended, characterizing U.S. policy as “bankrupt.” At the same time, although Europe appeared so much less agile than the United States, European nations boasted very high standards of living and employment rates with high-wage, high-welfare jobs. Although Europe did have a structural unemployment problem, with the rate somewhat higher than that in the United States, European countries were in a position to pay their residents not to work. “Do they have any secrets?” he asked. “How do they do it?” Mr. Bonvillian responded that Europe’s safety-net structure was much more profound than that of the United States, whose government was so limited by long-term fiscal obligations that it did not have the resources to construct a new 41   National Research Council, Trends in Federal Support of Research and Graduate Education, Stephen A. Merrill, ed., Washington, D.C.: National Academies Press, 2001.

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Measuring and Sustaining the New Economy: Software, Growth, and the Future of the U.S. Economy - Report of a Symposium set of safety nets. He said, however: “If you have to choose between some key investments in safety nets vs. some key investments in your innovation system, I’d put the money on the innovation system.” He acknowledged the existence of serious short-term concerns and conceded that the economic recovery then taking place was of a very different kind from any he’d seen before: Companies were recovering while jobs were not, a phenomenon that might turn out more enduring than many suspected. But if growth economics proved right, and the bulk of growth came out of technological and technologically related innovation, then the only course of action was to get the nation’s “innovation house” in order. Can the United States Innovate Its Way Out? Egils Milbergs of the Center for Accelerating Innovation observed that the issue of employment was creating political pressure for President Bush that was compounded by the statistical difficulty of making job forecasts. There had been a loss of jobs owing to offshoring, and the BLS’s job-market projections, in particular those for IT jobs, had kept coming down. Automation, much of it driven by software, was causing productivity to increase and, at the same time, shrinking the need for workers. According to a recent study by the New York Federal Reserve Board, 75 percent of layoffs were now permanent—up from around 50 percent in previous downturns—so jobs would not be restored with a cyclical upturn. In short, the job outlook was “pretty downbeat.” Referring to the prospect mentioned by Mr. Bonvillian of “innovating out of the problem,” Mr. Milbergs suggested that Wal-Mart employed more people than had the entire Internet economy, even if the latter could be credited with generating 1 million jobs. “I’m wondering how we see ourselves out of this,” he stated, asking whether the situation on the employment front could be expected to turn around in the following 18-24 months. In response, Dr. Hira noted that recent employment data demonstrated not job creation but job destruction, and he speculated that, if the reverse were true, offshoring might be less controversial. Not unlike economists, he was unable to pinpoint the causes of the trend; therefore, he was hesitant to try projecting even 18 months out. Rather, he saw the question thus: “What do you do now, and how much damage does this current situation create for future innovation?” Evidence of the climate’s chilling effect on engineers and software developers, he said, was that they tended to converse among themselves about offshoring instead of about attending technical conferences and advancing technology, and they did not feel their concerns had met with a straightforward response. “They’ve been told over and over again, ‘This is actually good for you, because it frees you up.’ Well, it frees you up to do what?” Dr. Varian had two points to contribute to this discussion: “Be wary of focusing on just one industry.” There were different trends in different sectors, he said, citing a recent report in The Economist that the

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Measuring and Sustaining the New Economy: Software, Growth, and the Future of the U.S. Economy - Report of a Symposium majority of biotech research was moving to the United States because world-high prices for pharmaceuticals made it attractive to sell here and because of the importance of locating production close to the market. “Look at the medium term.” Focusing on 7 years out, rather than on 2 years out or on 10-15 years out, would bring into view the huge labor-market upturn that would be hitting with the baby-boomers’ retirement. That would create job loss—“quote-unquote”—for voluntary rather than involuntary reasons, and the country would need skilled labor. While he recognized that those currently unemployed might find little solace in this prospect, he said that the kind of policy responses previously mentioned—encouraging education in America of engineers, loosening some restrictions on technological development—would be very important in 7, 8, or 9 years. Concluding the panel, Dr. Myers said that a speech by Alan Greenspan then posted on the Federal Reserve Web site would probably be worth keeping in mind while seeking solutions. He paraphrased the Fed chairman as saying that the nation had learned over the previous 50 years that a flexible and adaptive economy was the most robust with respect to unexpected events leading to downturn. Dr. Myers interpreted this to mean that the solutions base had to be adaptive rather than fixed in such a way that the economy could not adjust to the changes that were bound to occur. He then thanked the speakers for their presentations on what he deemed a very provocative subject.