Offshoring: U.S. Semiconductor and Software Industries Increasingly Produce in China and India
Published: 2006-09-07T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Much attention has focused on offshoring of information technology (IT) services overseas. "Offshoring" of services generally refers to an organization's purchase from other countries of services such as software programming that it previously produced or purchased domestically. IT manufacturing, notably semiconductor manufacturing, has a longer history of offshoring of manufacturing operations. Under the Comptroller General's authority to conduct evaluations on his own initiative, GAO addressed the following questions: (1) How has offshoring in semiconductor manufacturing and software services developed over time? (2)What factors enabled the expansion of offshoring in these industries? (3) As these industries have become more global, what have been the trends in their U.S.-based activities?
section_title: What GAO Found
paragraphs: The U.S. semiconductor industry began offshoring labor-intensive manufacturing operations in the 1960s, followed in the 1970s and 1980s by increasingly complex operations, including wafer fabrication and some research and development (R&D) and design work. Semiconductor assembly and testing was the first to move to Asia, followed by fabrication and, more recently, by some design operations. Software services offshoring began in the 1990s after Internet communications made it possible to trade services such as software programming and software design. The year 2000 changeover hastened this offshoring trend related to software services because programmers knowledgeable in the appropriate programming languages were available, primarily in India. In the 2000s, firms further expanded their offshoring operations, based on the low-cost and high-quality work from the offshored services undertaken in the late 1990s. Although a lower labor cost was initially a key factor that attracted firms to offshore locations, other factors such as technological advances, available skilled workers, and foreign government policy, also played roles. Technological advances helped firms in the semiconductor industry improve their management of global supply chains and logistics. Regarding software services, technological advances opened the way to trade in programming and other software services. Foreign government policies in Taiwan and China created favorable investment conditions for U.S. semiconductor firms. India changed its emphasis from state-owned enterprises in the 1970s to an environment more amenable to private enterprise by the mid-1980s. Although its restrictions on foreign investment constrained the software services industry's overall development, India established software technology parks in 1990 to give domestic firms preferential access to the infrastructure essential for offshored operations. Although offshoring continues to grow in both the semiconductor manufacturing and software services industries, the United States remains one of the largest and most advanced producers of semiconductors and software services. U.S. production data show that both industries have largely rebounded from the 2001 recession. Employment data show a mixed picture, with semiconductor employment remaining flat and software employment mostly recovering. The United States has global trade surpluses in the semiconductors and software services sectors, although production is increasingly shifting to Asia. Both U.S. industries have become global, sourcing components from many locations overseas. U.S. firms have offshored increasingly complex products, essentially moving up the value chain. The ability of the United States to compete depends on research and development investment, innovative academic environments attracting top-quality students, and a competitive business environment. It will be important for U.S. businesses and policymakers to keep alert to technological changes and competitor countries' strategies while enhancing the elements of the innovation environment in the United States.

section_title: Letter
paragraphs: Foreign competition over the last several decades has contributed to a  decline in U.S. manufacturing employment, while U.S. firms have also  moved some production activities to foreign locations in order to reduce  costs or gain access to foreign markets. Concerns about U.S.  manufacturing job losses have been allayed somewhat by the prospect of  large numbers of high paying jobs developing in U.S. knowledge-based  services industries, such as in the information technology (IT) sector.  However, some types of knowledge-based services have become more  easily tradable within the past 10 years due to the spread of the Internet,  and concerns have now also arisen about what the offshoring of these  types of activities may mean for the United States.
In response to widespread congressional interest, we have undertaken a  body of work related to offshoring under the Comptroller General’s  authority to conduct evaluations on his own initiative. In this report, one in  a series of reports on services offshoring, we address offshoring trends in  two important U.S. information technology industries—semiconductor  manufacturing and software services. To analyze the U.S. semiconductor  and U.S. software industries’ experiences with offshoring, we addressed  the following questions:  How has offshoring in semiconductor manufacturing and software  services developed over time?
What factors enabled the expansion of offshoring in these industries?
As these industries have become more global, what have been the trends  in their U.S.–based activities?
To answer these questions, we analyzed data and other research to develop  a broad understanding of these industries. We conducted research on how  these industries developed offshoring relationships in specific countries— Taiwan and China for semiconductor manufacturing and India for software  services. We examined the available literature on both industries; analyzed  U.S. government data on foreign investment and trade in these industries;  and interviewed representatives from firms and private sector associations,  as well as industry analysts in the United States, Taiwan, China, and India.  We conducted our analysis in accordance with generally accepted  government auditing standards from October 2005 through August 2006. A  detailed description of our methodology appears in appendix I.
subsections: section_title: Background
paragraphs: “Offshoring” generally refers to an organization’s replacement of goods and  services produced domestically with imports from foreign sources. For  example, if a U.S.-based company decides to move its computer  programming activities to an overseas supplier, this would be considered  offshoring. The overseas supplier may be an affiliate of the company, in  which case the company has also invested overseas. In contrast, the  supplier may be unrelated to the domestic company, in which case the  company has outsourced its computer programming activities, as well as  offshored them.
Semiconductors are devices that enable computers and other products  such as telecommunication systems to store and process information.  Semiconductor device fabrication is the process used to create “chips,” the  integrated circuits that are present in everyday electrical and electronic  products. It is a multiple-step sequence of photographic and chemical  processing steps during which electronic circuits are gradually created on a  wafer made of pure semiconducting material, most commonly silicon.  Improvement in the performance of increasingly sophisticated electronics  products depends on more powerful semiconductors that can store more  information and process it faster. Demand for semiconductors is driven by  the demand for computers and communications products that use them.
The semiconductor manufacturing process can be divided into three  distinct stages: (1) design of the semiconductor integrated circuit, (2)  fabrication of the semiconductor wafer, and (3) assembly and testing of the  finished integrated circuit. The design and fabrication processes are the  most capital-intensive, while the assembly and testing process tends to be  more labor-intensive, although still relatively technologically sophisticated.  For example, semiconductors are designed by computer engineers with the  assistance of advanced software. They are then fabricated using chemicals,  gases, and materials combined in an intricate series of operations using  complex manufacturing equipment to produce wafers containing a large  number of chips. During assembly, the chips are assembled into the  finished semiconductor components and tested for defects. The finished  semiconductor consists of millions of transistors and other microscopic  components.
The technological complexity of semiconductors is indicated by the  diameter of the wafer and the density of the etched lines (feature size) on  the wafer. The size of the wafer is an important element because the  number of chips per wafer increases dramatically as the wafer size  increases. The current leading-edge manufacturers produce 12-inch (300  millimeters) wafers. Smaller feature size measured in microns allows for  more components to be integrated on a single semiconductor, thus creating  more powerful semiconductors. Each reduction in feature size—from 0.35  micron to 0.25 micron, for example—is considered a move to greater  technological sophistication.
The software services industry also includes several types of services and  levels of technological sophistication. Software services include writing  individual software programs or combined “modules;” supporting these  programs and modules once they are installed on computers; designing  software networks, which might include various software programs, as  well as systems of networks;  integrating and maintaining these networks  and systems as they are applied to clients’ tasks; and managing and  operating clients’ overall computer systems.
Software services are now broadly diffused throughout the U.S. economy.  Firms across most industries now use some form of software services— whether it is basic accounting software, inventory control software, or a  much more complex software product applied to manufacturing  operations. Automobile companies, for example, use advanced computer  software in the design of new car models, on production lines that  manufacture these cars, and in the cars themselves that now contain  electronic components.
Software services generally range in complexity from routine software  programming and testing to complex software programming, software  project management, and higher-end software systems integration,  architecture, and research. In general, software programs and modules can  be produced in various locations; integrating these requires some focal  points capable of working closely with the various locations.
Both semiconductor manufacturing and software services are key  industries within the broader information and communications technology  (ICT) sector; they have contributed significantly to overall U.S. growth and  productivity. For example, semiconductor and related device  manufacturing in the United States represents about 24 percent of the total  value of the ICT sector’s computer and electronic products manufacturing.  Software services comprise about 48 percent of the total production of the  categories of services industries included in the broader ICT sector— publishing industries (includes software), information and data processing  services, and computer systems design and related services (averaged over  1990 to 2004).
Although the ICT sector represents a small share of the overall U.S.  economy (about 4 percent), it has contributed significantly to U.S.  economic expansion. According to the Department of Commerce’s Bureau  of Economic Analysis (BEA), the ICT sector accounted for about 11  percent of total economywide value-added growth in 2004. Examining  value-added growth is a useful way to compare growth rates across  industries because it measures only the increase in output due to that  industry, excluding any inputs or materials from other industries.  Therefore, value-added growth measures the changes in output due to  increases in factors such as labor and capital and to improvements in the  productivity of those factors. Figure 1 shows that, from 2002 to 2004, the  ICT sector’s growth in real value added accelerated more than any other  industry group. Although the ICT sector’s growth slowed in 2001 during the  recession, annual real growth has recently accelerated from 2.0 percent in  2002, to 6.7 percent in 2003, and to 12.9 percent in 2004.
The ICT sector also contributes to productivity in the rest of the economy.  For example, other manufacturing and services sectors, such as  automobiles and banking, have become more productive as they have used  the latest products and advances from the ICT sector. Economic research  has generally found that the investments made in ICT sector products by  other industries contributed to a rapid economywide increase in  productivity during the 1990s. In addition, the technological advances and  competition within the sector have resulted in declining prices and rising  performance in ICT products. This, in turn, has contributed to lower rates  of inflation throughout the economy as other sectors benefit from these  improvements.
We present information on multinational companies’ global operations in  semiconductor and software services in appendix II.
section_title: U.S. Firms Continue to Offshore Increasingly Complex Semiconductor Manufacturing Activities and Software Services
paragraphs: The U.S. semiconductor industry has foreign operations in several  locations, notably in Taiwan and China. The U.S. software services industry  has turned to India for a significant share of its offshoring operations. The  types of semiconductor manufacturing and software services that U.S.  firms have offshored to Taiwan, China, and India have become more  complex over time. U.S. semiconductor firms first offshored labor- intensive assembly operations in the 1960s, then wafer fabrication, and  more recently, higher value-added activities, such as advanced fabrication  and design. The offshoring of software services largely began in the 1990s  in preparation for the year 2000 transition. Much like semiconductor  products, the types of software services that firms have offshored have  become progressively more complex as firms expanded their offshore  operations to customized applications requiring highly skilled workers.
subsections: section_title: Semiconductor Manufacturing Moved Offshore as Competition from Other Countries Developed; Firms Offshored More Complex Production Over Time
paragraphs: Offshoring in semiconductor manufacturing began in the 1960s with labor- intensive manufacturing activities, such as assembly. U.S. firms invested in  overseas manufacturing facilities to perform the labor-intensive assembly  of semiconductors for export to the United States. Firms domestically  sourced the design and fabrication of higher-skilled, more capital-intensive  semiconductor manufacturing activities and then shipped the  semiconductors to Asia for assembly. The finished semiconductors were  returned to the United States for final testing and shipment to the  customer. According to some industry experts, offshoring of assembly  work kept the U.S. semiconductor industry cost-competitive as new foreign  rivals emerged in countries such as Japan.
The overall U.S. business models for semiconductor manufacturing  changed in the 1980s. Two types of company models developed for  semiconductor production. Some companies, known as Integrated Device  Manufacturers (IDMs), conduct their own research, produce their own  designs, and operate their own fabrication plants to produce semiconductor wafers. Other companies, known as fabless design firms,  develop their own designs and contract with independent fabrication  plants, known as foundries, to produce their wafers. Foundries emerged  during the 1980s as firms in Asia, particularly Taiwan, began to specialize in  wafer fabrication. With the emergence of overseas foundries, U.S. firms  developed global supply chains for sourcing different parts of the  semiconductor production process over multiple global locations. They  continued to design in the United States and other developed countries,  while contracting with foundries in Taiwan to perform capital-intensive  wafer fabrication. They also continued domestic fabrication, but Asian  countries increased their share of overall production—with Taiwan  expanding as a major supplier of fabrication services and China emerging  as a new source of fabrication services in the late 1990s.
In recent years, some U.S. firms have offshored increasingly complex  semiconductor fabrication and design activities—essentially going up the  value chain (see fig. 2). As firms in other countries, notably Taiwan, became  more adept at producing more complex semiconductors, U.S. firms  increasingly turned to offshore manufacturers to produce these  semiconductors. The most complex semiconductors now manufactured in  fabrication plants (commonly called fabs) are 12-inch (300 millimeter)  wafers with submicron feature size. U.S. firms were leaders in developing  12-inch wafers. According to industry experts, firms have offshored design  services to Taiwan due, in part, to maintain close contact with Asian  customers to meet their specific requirements. Also, as semiconductor  manufacturing becomes more complex, some experts have noted, it  becomes all the more important to develop close relationships among  design and manufacturing activities, so as to enable feedback discussions.
The gap in semiconductor manufacturing capabilities has narrowed  between the United States and Taiwan and China. Currently, Taiwanese and  Chinese foundries are capable of producing technologically sophisticated  semiconductors. For example, Taiwanese foundries are now capable of  producing integrated circuits as small as 0.09 microns, and some Taiwanese  firms provide design services to support this level of semiconductor  technology. In addition, according to industry experts, the newest  semiconductor manufacturing facilities in China are capable of producing  integrated circuits up to 0.13 microns in size, with one Chinese foundry  known to be producing circuits at the 0.09 micron size. Thus, currently the  most advanced manufacturing facilities in Taiwan and China manufacture  integrated circuits that are only one generation or less behind state of the  art.
section_title: U.S. Firms Offshored Software Services in the Mid-1990s and Increasingly Offshore More Complex Activities
paragraphs: The software services industry was one of the first services industries to  offshore significant activities as U.S. firms recruited foreign software  programmers, particularly in India. Before the widespread use of the  Internet, it was not economical to export software. U.S. firms either  invested in overseas affiliates in India to directly provide software services  for the firm or hired Indian programmers to work temporarily on-site at  firms’ U.S. locations. Beginning in the 1990s, Internet communications  combined with the availability of satellite connections and reduced  telecommunication costs made it possible for foreign software  programmers to remain abroad while working for U.S. clients. Many types  of U.S. firms began re-engineering their business processes to concentrate  on core competencies and outsource or offshore other activities, such as  writing software programs. The offshored activities were those that could  be reduced to step-by-step instructions, digitized, and performed at a  distance.
In the late 1990s, preparations for the year 2000 changeover contributed to  U.S. firms’ further use of foreign software programmers who were  knowledgeable in certain programming languages. U.S. firms turned not  only to foreign software programmers who were temporarily employed in  the United States but also to programmers overseas, particularly in India,  who provided work directly to U.S. clients. In recent years, U.S. firms have  offshored increasingly complex software services, going up the value chain  as occurred in the semiconductor industry. Examples of less sophisticated  software services are operations involving basic computer language coding  or programming and managing computer databases. More complex  offshored services include advanced software design and development  activities and researching, designing, developing, and testing new software  technology.
U.S. firms experienced high-quality work in offshore locations; for  example, they discovered that firms in India have the capabilities to  produce high-end software services, such as software design at a low cost.  In addition, firms often combine highly skilled labor available in India with  skilled labor in other countries to create global teams with specific skill  sets. For example, one firm in India stated that a firm might begin a high- end software development project in India and then transfer the work to a  team in Ireland for further development before delivery to a U.S. client.  Firms also use global teams to better serve local markets worldwide by  providing customized programming services to local clients.
Currently, the types of offshored software services activities now include  advanced software engineering and research and development. For  example, in recent years Indian and multinational firms, including U.S.  affiliates, have established high-technology research and design facilities in  India to perform such high-end software services as software engineering  and software product development. According to software services  industry experts in India, many of these facilities employ hundreds of  software engineers to develop and test a wide range of new high-end  software designs and products for export to global customers. Some firms  in India stated that the quality of high-end software design and  development activities in India, combined with firms' need to introduce  new products and new technologies, have attracted increasing interest in  offshoring software development to India. Nevertheless, the bulk of  offshored software services in India can be characterized as lower-level  work, mostly in the applications development segment of the industry.  Applications development primarily requires programming skills and has  limited face-to-face interaction. Moreover, applications development can  easily be segmented and standardized, features that characterize offshoring  software services.
section_title: Technological Advances, Availability of Talented Human Capital, and Foreign Government Policies Contributed to Increased Offshoring of Semiconductor Manufacturing and Software Services
paragraphs: The combination of technological advances, available human capital, and  foreign government policies has created a favorable environment for  offshoring. Many firms in semiconductor manufacturing and software  services use offshoring in their business models to increase their global  competitiveness by lowering costs and gaining access to foreign markets.  Advances in telecommunications enabled semiconductor firms to improve  their logistics and inventory controls; they also were particularly important  to the offshoring of software services. Firms in both sectors initially sought  low-cost labor, but they expanded the scope of their offshoring activities as  they discovered and helped develop highly educated workforces in Taiwan,  China, and India. Foreign government policies played different roles in the  countries we visited. In Taiwan and China, the national governments  pursued various industrial policies to promote semiconductor  manufacturing and, in India, the loosening of regulations and the  availability of government-supported software technology parks afforded  the software industry opportunities to grow relatively unregulated.  Although offshoring conveys benefits to firms that choose to locate  operations overseas, it also encompasses business risks that challenge  management skill. See table 1 for an overview of the factors that have  contributed to increased offshoring.
subsections: section_title: Technology Launched Important Changes in Semiconductors Manufacturing and Software Services
paragraphs: Improvements in telecommunication technology helped to expand the  degree of offshoring in both semiconductor manufacturing and software  services. With improved communications, U.S. semiconductor firms were  able to create tighter linkages with overseas suppliers, and software  services firms developed global teams that could transfer digitized  information over the Internet.
subsections: section_title: Technology Improvements Allowed Semiconductor Firms to Develop More Efficient Global Supply Chains
paragraphs: Semiconductor manufacturing firms improved their management of supply  chains through better telecommunications, logistics management, and  modern transportation. Telecommunications has allowed better monitoring  of the movement of products. For example, foundries in Taiwan use  Internet-enabled software that allows real-time communication between  engineering teams in different locations. Some U.S. companies use radio- frequency identification tags in Taiwan and China to track products  shipped from these manufacturing locations to distribution centers in other  countries. According to a representative of one U.S. firm, this technology  has reduced the need for inventory sourcing redundancy, thus reducing  inventory cost and the associated employment costs.
Logistics management is an important part of global business. Taiwan’s  competitive logistics industry has offered advanced computerized systems  that assist in the management of purchasing, storage, delivery, and  distribution of products. According to a Taiwan government official,  Taiwanese companies can provide production orders to their clients in 2  days. According to an industry researcher, the automation of the  semiconductor assembly process also has improved efficiency in the  overall semiconductor infrastructure, such as packaging facilities.
Modern transportation options using more powerful computer systems,  advanced software, and telecommunications make faster delivery possible.  Countries are upgrading all elements of their transportation  infrastructure—airports, seaports, modern roads, and trucking. Because a  product may travel around the world more than once during the production  process, efficient transportation systems are essential. For example, China  has made numerous improvements to its transportation infrastructure to  permit more efficient distribution. According to one Internet firm operating  in China, the transportation infrastructure within China for delivering the  physical products to customers—an essential component for online  auction sites—did not exist before the year 2000. China reportedly invested  $30 billion in 2004 alone to improve its network of roadways.
section_title: The Software Services Industry Changed Its Global Business Model
paragraphs: In the software services sector, telecommunications improvements have  changed the types of software services traded, the way the work is done,  and the telecommunications investments made.
First, the essential advance in IT—the introduction of Internet  communications—made it possible to trade some services that were  previously not tradable. For example, software programs written in  standardized programming languages could be digitized and transferred  worldwide over the Internet.
Second, global teams have become common elements of firms’ business  strategies. The ability to transmit data electronically made it possible to  specify an application in one firm and develop it in another. Because of the  availability of the Internet, teams can work 7 days a week, 24 hours per day  to meet customer needs worldwide. These teams’ operations could be set  up relatively quickly with office space, utilities, and communication tools,  such as personal computers with broadband access. The ease of  undertaking this type of offshoring has led to an escalating use of offshored  IT services, including but not limited to software programming. According  to one research firm, the value of IT offshoring and business process  offshoring totaled $34 billion in 2005 and could double by 2007.
Finally, the services offshoring model has required investments in global  telecommunications infrastructure, such as wired landline and satellite  communication services. India has made the investments to facilitate the  telecommunications industry. According to the government of India, in  2005, 47 million landline connections and 65 million satellite connections  existed in India. Moreover, in 2004, after the telecommunication sectors  declined due to overcapacity, one major Indian telecommunications  services firm, partly owned by the government of India, purchased a large,  privately owned U.S. undersea fiber-optic network linking Asia, Europe,  and North America after receiving national security approval from the U.S.  government. This acquisition strengthened India’s control of low-cost  telecommunications infrastructure. According to an Indian government  official and several U.S. companies operating in India, the growth in  telecommunications infrastructure has also enabled firms to move from  India’s major cities to smaller, lower-cost surrounding cities.
section_title: The Availability of Human Capital Was Key to the Expansion of Offshoring in Both Semiconductor Manufacturing and Software Services
paragraphs: The availability of high-quality workers overseas has been an essential  component of the increased use of offshoring for firms in the  semiconductor manufacturing and software services sectors. Through  experience and training, the talent pool in several countries demonstrated  their value to firms seeking skilled workers to perform tasks with various  degrees of complexity.
subsections: section_title: Some Semiconductor Firms Turned to Low-Level Skilled Foreign Workers Initially but Gradually Offshored More Complex Work to Higher-Skilled Labor Forces Overseas
paragraphs: Access to human capital played an important role in the relocation of  semiconductor manufacturing firms to Taiwan and China, especially as the  need for skilled labor arose, and a quality workforce emerged in these  countries. During the earlier phase of semiconductor offshoring in Taiwan,  workers did not need advanced training. Taiwan emphasized vocational  training during this period. Industry experts stated that, although lower- cost labor was initially attractive for assembly, the labor costs component  in semiconductor manufacturing is not a decisive factor for companies’  location decisions overseas. New technology has computerized the entire  production process, leading to a reduced need for labor and an increased  need for skilled workers and managers. According to the representative of  one research firm, the quality of the Chinese and Taiwanese workforce  makes it easy to train and retain workers in semiconductor assembly and  manufacturing.
Taiwan, China, and India are each able to provide a quality workforce, with  a plentiful supply of engineers including emigrants who have returned to  work in their home countries. Highly trained professionals with experience  in U.S. firms assisted the development in each of these three countries of  their semiconductor and software industries. According to one research  firm, more than 5,000 overseas students and professionals return to China  each year, bringing with them Western knowledge and skills. For example,  several firms operating in China told us that Chinese returnees who have  studied or worked abroad are an important part of their staffs. India,  Taiwan, and China are each graduating IT and other engineers in large  numbers. For example, China’s potential supply of engineers is large;  according to one U.S. study, the number of Chinese engineering graduates  with bachelor’s degrees in 2004 numbered 351,537, as compared with  137,437 in the United States. Moreover, engineers in Taiwan, China, and  India typically earn less than their counterparts in the United States. For  example, Taiwan’s domestic supply of engineers can be hired at  approximately half the cost of engineers in the United States.
section_title: Software Services Firms Find a Large Supply of Human Capital Overseas with Top Quality Skills
paragraphs: We reported in 2004 that access to human capital, particularly lower-wage  skilled labor, an educated workforce, and quality local vendors facilitated  software services offshoring. India is the leading example of this trend. For  example, Indian wages represent a fraction of the cost of hiring U.S.  counterparts, with the salaries for Indian IT engineers starting at $5,000.  According to industry experts, the increasing demand for these workers is  causing salary rates to increase somewhat. Yet lower wages does not tell  the entire story because India also provides a skilled workforce. India’s  leading software services association reports that 44 percent of India’s  services professionals possess at least 3 years of work experience.  Moreover, many Indian nationals who studied computer technology in the  United States and gained experience with U.S. IT firms have begun to  return to India to pursue career opportunities in their native country. Some  of these individuals have gone on to create or lead successful firms in India.
India has a strong national emphasis on advanced technical education, and  its scientific and educational institutions produce well-trained scientists  and engineers. The highly competitive Indian Institutes of Technology  trains the upper echelon of talented students and, according to one  industry researcher, produces highly skilled engineers with capabilities  that match or exceed U.S. talent. In addition, an industry researcher in  India stated that nontechnical programs are beginning to offer computer  science and software programming courses to prepare students to meet the  market demand of the software services sector. According to India’s  software services association, of the 215,000 engineering graduates in 2003  to 2004, 141,000 specialized in IT (e.g., computer science, electronics, and  telecommunications). India’s use of the English language gives it a further  advantage, making India a prime destination for services offshoring.
Finally, the quality of the firms in India is another factor that is considered  when firms decide to offshore services. The quality of local vendors, many  with Capability Maturity Model (CMM) certifications, provides a sense of  security to firms seeking to offshore software services to India. According  to a business association in India, Indian companies work to attain these  certifications to demonstrate the high quality of their work. For example, a  business representative told us that more than 50 percent of the companies  that have CMM Level 5 certifications are located in India. With the update  of the CMM to the Capability Maturity Model-Integration (CMMI), the  Software Engineering Institute reports 93 Indian and 74 U.S. entities (41  percent and 32 percent, respectively, of the world total) with CMMI  certifications as of March 2006.
section_title: Foreign Government Policies Have Made Foreign Investment Attractive for Semiconductor Firms and Left the Software Services Industry Relatively Unregulated
paragraphs: Foreign government policies contributed to the development of dynamic  semiconductor and software services sectors with opportunities for U.S.  firms to offshore. The governments of Taiwan and China developed a broad  range of policies to promote their respective indigenous semiconductor  industries and to attract investment, technology and talent from abroad.  India, in its transition from a socialist government to a market-based  economy, has liberalized its software services market, thus permitting U.S.  firms to access India’s low-cost high-quality workforce.
subsections: section_title: Government Policies in Taiwan and China Have Assisted Their Respective Semiconductor Industries
paragraphs: Taiwan has long pursued industrial policy to encourage the domestic  development of science and technology. In 1972, it established a national  research institute and within that organization an office to develop its  semiconductor industry. Drawing upon the expertise of a U.S. advisory  group, Taiwan successfully duplicated elements of the Silicon Valley  technology cluster by establishing science-based industrial parks that  brought together major universities, research labs, and a dynamic venture  capital industry. Its universities feature programs sponsoring research  specific to semiconductors, and the government targeted financial and tax  incentives to the semiconductor industry. The government also emphasizes  vocational training to develop quality resources. As a result, the  government of Taiwan helped position its semiconductor industry as an  effective contract supplier integral to the U.S. semiconductor supply chain.  Its industrial strategy, which has been characterized as “close  followership,” integrated Taiwan’s industry operations with those of U.S.  companies. Although this strategy means that Taiwan’s industry may be a  step behind the U.S. industry, firms in Taiwan capture high-technology  industrial and research functions. As a result of its efforts, Taiwan is now a  leading semiconductor producer with top-level manufacturing expertise.
Taiwan’s support of a strong semiconductor sector continues to evolve  with a project that focuses on integrated circuits manufacturing  infrastructure. The government is providing partial financial support to this  project, which includes the expansion of university-based training,  investments in new technologies, and a design park to focus on system-on- a-chip design. With added pressure from the opening of China’s market  and the competition from Chinese firms, Taiwan is revisiting its restrictions  on the level of technology that firms may transfer to mainland China. In  April 2006, Taiwan announced it was removing restriction of the export of  low-end semiconductor packaging and testing technology to China.
China’s current policies have helped its semiconductor sector to grow  dramatically since 2000, but its wafer production represents a relatively  small percentage of worldwide production. Nevertheless, China is  considered a rising player in the field of advanced technology. Prior to  2004, China’s differential value-added tax, since normalized, was a notable  policy that led to an influx of semiconductor firms into China —notably  from Taiwan—that sought to avoid the impact of the tax. Following  Taiwan’s strategy, China is creating a modern infrastructure to support  semiconductor operations. For example, the government provides tax  incentives, preferential loans, and opportunities to locate in special  economic zones and science parks. China announced, in 2006, the adoption  of a 15-year national technology strategy to develop, among other things, a  world-class information sector and to focus on developing independent  innovation. The result of China’s policies is an expanding semiconductor  sector that relies heavily on the expertise of Taiwan’s managers and other  expatriates whom China is actively recruiting to return to the mainland.
section_title: India’s Software Industry Was Not Subject to Many of India’s Restrictive Policies
paragraphs: India’s policy for software services differed from the deliberate industrial  policy undertaken by Taiwan and China. India’s government policy shifted  from protection of domestic industries to a gradual liberalization of some  regulations. Although India maintains significant controls on some  industries, the software services sector was not affected by some of the  most restrictive policies, given the small size of its enterprises.  Entrepreneurs in the software services sector were able to build the  industry based on the special attributes of India —its English-speaking  population, its supply of IT professionals, and its favorable  telecommunication infrastructure.
Between the 1950s and 1980s, India generally protected domestic firms  from foreign competition and undertook a policy of import substitution.  India pursued policies that sought to support state-owned enterprises.  Where private firms were permitted to operate, a cumbersome licensing  bureaucracy controlled their operations. Initially prevented from  expanding into higher value-added segments of the industry in the 1980s,  software services firms nevertheless found areas of specialization that the  government did not restrict. In 1991, India experienced a shortage of  foreign exchange, which required liberalization of its economy as a  condition to gain support of the International Monetary Fund. This led to  further deregulation, which enabled software services to expand.  Moreover, in the 1990s, India introduced software technology parks, which  are similar to export processing zones. Firms in these parks were given tax  exemptions, access to high-speed satellite links, and reliable electric  power. India’s technical universities trained large numbers of engineers and  specialists in their highly selective IT programs. Later reforms of foreign  ownership rules, intellectual property protections, and venture capital  policy further opened the way for trade in services.
section_title: Other Factors Constrain U.S. Firms’ Offshoring Decisions
paragraphs: Firms seeking to offshore also encounter risks, including unforeseen costs,  geopolitical concerns, cultural differences, infrastructure adequacy, and  foreign government requirements. The destination country’s legal system  and contract enforcement affect firms’ decisions to offshore. Both the  semiconductor and software services industries have specific concerns  about countries’ intellectual property protection for their products and  make location decisions accordingly. It should also be noted that offshoring  places higher demands on firms’ internal management skills. Managers  must be able to lead teams with cultural differences, establish metrics to  assess contract performance, and manage teams located around the world,  using telecommunications as a primary tool. Although firms have found  some cost savings in labor, nevertheless, they have also found other  management challenges that tend to moderate the overall cost savings. One  recurrent concern of U.S. firms operating in China is the lack of middle  managers with the combination of business training, business acumen,  management skill, and creative thinking.
section_title: The United States Continues to Be a Global Leader in the Development of Semiconductors and Software at the Most Advanced Levels
paragraphs: While offshore suppliers are playing a larger and more sophisticated role as  the industries globalize, the U.S. semiconductor and software industries  have remained technological leaders in the most advanced research and  development (R&D) and design work, and the United States remains one of  the largest producers globally of products in both industries. Available  indicators on production, employment, and trade show that both of these  industries have generally rebounded since the 2001 recession and continue  to grow. Traditionally, the U.S. economy has had several advantages that  fostered strong semiconductor and software industries, including its highly  competitive university system, talented labor pool, large domestic market  for products, high levels of spending on R&D, and competitive business  environment.
subsections: section_title: The U.S. Semiconductor Industry, Rebounding from a Recent Recession, Continues to Be a Global Leader
paragraphs: Despite having offshored some semiconductor operations, the U.S.  semiconductor industry remains a global leader in cutting-edge  semiconductor chip design and fabrication. U.S. semiconductor production  has begun to rise again after a sharp decline during the 2001 recession.  However, U.S. semiconductor employment, which also fell during this  period, has remained relatively flat since 2003. U.S. exports have also  remained flat, but imports declined more sharply creating a U.S. trade  surplus in semiconductors. The United States generally exports high-value  fabricated chips and wafers to lower-cost locations for assembly and  testing. It imports integrated circuits (semiconductor wafers that have  been assembled and tested) for use in a variety of industries. However,  global demand for finished semiconductors has increasingly shifted to Asia  where final assembly of electronic consumer products takes place.
subsections: section_title: The United States Is a Global Leader in Semiconductor Design and Fabrication
paragraphs: Semiconductor fabrication and design capabilities are spread among  traditional producers such as the United States, Japan, the European  Union, and newer producers such as South Korea, Taiwan, and China.  According to industry experts and data, however, the United States remains  one of the largest producers of semiconductors and, in particular,  maintains cutting-edge development of both design and fabrication of new  semiconductors. Industry estimates of semiconductor capacity vary, but  the United States and Japan remain the largest two producers of  semiconductors. Although a significant share of new high-end fabrication  facilities are being built outside the United States for mass production, the  United States is a key location for the fabrication facilities used for  development of new semiconductor chips.
As a global industry, U.S. production includes both U.S. companies and  affiliates of foreign companies operating in the United States. Foreign  companies have established operations in the United States to take  advantage of U.S. technology, skilled labor, and the large domestic market,  according to industry experts. One estimate suggests that about one-fifth of  U.S.-based fabrication capacity was owned by foreign companies in 2001.  In addition, foreign companies also take advantage of experienced design  teams in the United States. Companies can potentially benefit from having  operations in key areas around the globe where innovation is occurring.  These operations are able to access the experienced labor pool and new  innovations occurring in a particular region and transfer those  developments to their global operations. Silicon Valley, California, for  instance, is widely known as a key center of innovation in the  semiconductor industry.
Similarly, U.S. firms have invested in production capacity in Europe and  Asia. However, according to industry experts, U.S. firms have generally not  moved their R&D operations offshore. Data on patents and expenditures  on R&D also indicate that U.S. semiconductor companies continue to  locate their R&D work in the United States. Some industry analysts,  though, are concerned that as production increasingly moves offshore to  Taiwan and China, it will begin to draw more and more research activities  with it.
Industry experts also believe that most U.S. company design work is still  conducted in the United States rather than offshore. According to these  experts, U.S. companies are significant technology leaders in both the IDM  and fabless design models. Although U.S. IDMs and fabless design  companies operate globally, a larger share of their R&D and design work is  conducted in the United States. Most of the fabless design firms are based  in the United States, and many of the largest IDM’s are also U.S.-based.  Also, the development of foundries, particularly in Taiwan, likely allowed a  wider range of fabless companies to develop in the United States than may  have been possible without the existence of foundries. This is because the  high cost of fabrication plants acts as an entry barrier to smaller firms. At  the same time, there are a growing number of fabless design firms in  Canada, Israel, and Taiwan, and U.S. companies are also operating design  offices in these countries. Thus, the global share of design work by fabless  companies is becoming less concentrated in the United States.
section_title: U.S. Semiconductor Production Rebounding from 2001 Recession, but Employment Has Remained Flat
paragraphs: U.S. production statistics show that the value of semiconductor production  in the United States grew steadily during the 1990s even while offshoring  expanded. U.S. production of semiconductors and related devices  (measured by value-added) peaked in 1999 at about $68 billion, then  declined steeply during the 2001 recession. It has since rebounded  somewhat to $56 billion in 2004 (see fig. 3).
U.S. employment in the semiconductor industry did not rebound after the  2001 recession as production did. After a long decline from the mid-1980s  through the early 1990s, U.S. semiconductor employment grew strongly  through 2001 (see fig. 4). However, employment dropped sharply from a  peak of about 292,000 in 2001 to around 226,000 employees in 2003. After  hitting a trough in 2003, employment in the semiconductor industry has  been stagnant, although overall U.S. employment across all industries  resumed growth in 2004.
Employment in the semiconductor industry highlights the broader  relationship between productivity growth and job declines in the U.S.  manufacturing sector. Figure 5 shows an increase in productivity in the  semiconductor and electronic components industry (a broader category  than used in fig. 4) over the 15-year period from 1987. The pace of  productivity growth sharply increased starting in late 1990s. Industry  output continued to grow even after employment declined due to the  increase in productivity (output per employee).
Since 2001, the United States has had a trade surplus in semiconductors,  exporting more semiconductors and semiconductor components than it  imported (see fig. 6).  Both imports and exports grew rapidly from 1985 to  1995. From 1995 to 1998, exports continued to grow while imports  remained flat. From 1998 to 2000, both imports and exports increased again  rapidly, peaking in 2000 at about $48 billion (imports) and $45 billion  (exports). From 2001 to 2005, imports declined sharply to about $26 billion,  while exports also declined, but then leveled out in 2003 to about $34  billion.
The majority of U.S. exports of semiconductors consist of chips and  wafers, which are used to produce finished integrated circuits in other  countries. The top five destinations for U.S. semiconductor exports were  all Asian locations: Malaysia (13 percent), Korea (12 percent), Philippines  (11 percent), Taiwan (9 percent), and China (8 percent). Exports of U.S.  chips and wafers are the result of the fabrication process, which involves  some of the most technologically advanced manufacturing processes.
The majority of U.S. imports of semiconductors are finished integrated  circuits (such as memory and logic integrated circuits), which are then  used in other finished electronic goods, such as computers and cell phones.  Finished integrated circuits are the result of chips and wafers being tested,  cut, and packaged by separate manufacturing plants usually located  abroad. This process, although still technologically sophisticated (and less  labor-intensive than in the past), is still significantly less advanced than the  fabrication process. In 2005, only 13 percent of imports were chips and  wafers whereas 71 percent of U.S. exports comprised chips and wafers.
section_title: U.S. Exports to Asia Growing as Demand for Finished Semiconductors Expands in China
paragraphs: The decline in U.S. semiconductor imports since 2000 reflects the  movement from the United States to Asia of manufacturing production of  electronics products that use integrated circuits. Finished integrated  circuits are moving to other countries in Asia, particularly China, for  assembly into electronics products, rather than returning to the United  States. Therefore, U.S. exports surpassed imports for the first time in 2001.  Chinese trade statistics demonstrate the other end of this movement with  Chinese imports of integrated circuits soaring over the last 10 years,  making China one of the largest markets for integrated circuits in the  world. Much of this increase has been supplied by Taiwan, Korea, Malaysia,  Japan, the Philippines, and the United States (see fig. 7). Although the  United States is sixth in terms of direct exporters to China, some portion of  U.S. exports of chips and wafers are passing through other Asian countries  for assembly and testing (including China) before use in China’s booming  electronics industry. As mentioned above, the top destinations for U.S.  wafer exports are Malaysia, Korea, Taiwan, the Philippines, and China.  Those wafers are assembled and tested before being sent to electronics  manufacturers for use in their products. These trade flows show the  complex production chains that have developed across multiple countries.
The shift in production and trade flows toward Asia has two consequences.  First, because final production increasingly takes place in Asia, the United  States imports an increasing share of electronics and telecommunications  products (that use semiconductors). Appendix III shows that this is  reflected in the growing U.S. trade deficit with Asia and China, in particular,  including in advanced technology products. Second, as electronics and  telecommunications production chains increasingly locate in Asia, there  are benefits to U.S. producers of semiconductors to locate abroad near  their customers and take advantage of the production clusters developing  there. Therefore, this trend creates an incentive for U.S. companies to  offshore some activities.
section_title: The United States Is the Largest Global Supplier, Employer, and Market for Software Services
paragraphs: Although the industry is globalizing, the United States has maintained its  leadership in the development and expansion of the software services  industry. U.S. companies are global leaders in the packaged software and  custom software services segments of the industry. Although statistics on  software services are more limited than for semiconductor manufacturing,  indicators show that the United States is a leading developer and consumer  of software globally. U.S. production and employment data show that the  industry has generally rebounded after declining during the 2001 recession.  Also, while both imports and exports have grown rapidly, the United States  maintains a trade surplus in software services.
subsections: section_title: The United States Is a Leading Software Developer and the Largest Supplier in the World
paragraphs: The U.S. software industry is the largest in the world and plays a leadership  role in the global market for software services. U.S. companies are  disproportionately ranked among the largest in the world, both in terms of  revenues and numbers of top firms. U.S. companies also benefit from the  large U.S. domestic market, which by one industry estimate accounts for  about 50 percent of global demand for packaged software and about 40  percent of global demand for custom software services.  U.S. software  companies are also widely considered leaders in the development and  delivery of leading-edge software services. According to industry experts,  much of the development of these services takes place in the United States,  although larger companies also employ teams of developers worldwide.
section_title: U.S. Software Production Has Rebounded from the 2001 Recession
paragraphs: Although the industry experienced a downturn during the 2001 recession, it  has since begun to recover. As figure 8 shows, the U.S. software industry  grew rapidly through the late 1990s, declined during the 2001 recession  and, as of 2004, had rebounded to its peak in 2000 based on industry  revenue. Packaged software appears to be leading the rebound, while  custom software revenues have remained flat since 2002.
U.S. software industry employment is the largest in the world. According to  one industry estimate, U.S. software employment makes up roughly about  half of the global workforce in packaged software and about a third of the  workforce employed in IT services industry, which includes custom software services. As a group, software occupations, or computer  specialists as designated by the Department of Labor’s Bureau of Labor  Statistics (BLS), experienced relatively large gains in both employment and  hourly wages from 2001 to May 2005 (the most recent time period for which  comparable occupation-based data are available). This period largely  coincided with an economic recovery following the 2001 recession. Table  2 compares changes in employment and hourly wages for nine computer  specialist occupations and that of all U.S. occupations. Seven of the  occupations saw employment growth ranging from 1.1 percent to 46.9  percent compared to 1.8 percent for all U.S. occupations. Employment for  two occupations (computer programmers and database administrators)  declined by 22.4 percent and 4.7 percent, respectively, from 2001 to May  2005. The wages for these occupations also increased more slowly than the  wages for all U.S. occupations. Hourly wages for five occupations  increased more slowly than the wages for all U.S. occupations, increasing  by 3.5 percent to 10.5 percent compared with 11.4 percent for all U.S.  occupations. Wages for four occupations, however, increased faster than  the wages for all U.S. occupations, rising by 12 percent to 22.2 percent.
Computer software engineers (including systems software and applications  engineers, two high-wage occupations) saw modest increases in wages but  relatively large increases in employment, growing by 22.6 and 26.1 percent,  respectively. Computer software engineers design, develop, and test the  software and computer systems, applying computer science, mathematics,  and engineering expertise. The integration of Internet technologies and the  rapid growth in e-commerce have led to a rising demand for computer  software engineers. Although hourly wages of network systems and data  communications analysts increased by a relatively low 7.7 percent, their  job growth was the largest of all computer specialist occupations at 46.9  percent. This group of computer specialists designs, tests, and evaluates  network systems and other data communications systems.
According to BLS, employment in computer specialist occupations, apart  from computer programmers, is projected to grow much faster than overall  U.S. employment. Although total U.S. employment is projected to grow 13  percent over the 2004 to 2014 period, employment of computer specialists  is projected to grow 31.4 percent (see fig. 9). BLS projects that the demand  for computer-related jobs is likely to increase as employers continue to  adopt and integrate increasingly sophisticated and complex technologies.  Growth, however, will not be as fast as the previous decade, as the  software industry matures, and as routine work is increasingly offshored.
Projected job growth for computer software engineers and network  systems and data communications analysts is especially robust. The BLS’s  Occupational Outlook Handbook suggests that demand for workers with  specialized technological skills is expected to increase sharply as  employers use and improve the efficiency of new technologies. As the race  for increasingly sophisticated technological innovations continues, the  need for more highly skilled workers to implement these innovations will  continue. More highly skilled computer specialists will be needed as  businesses and other organizations try to manage, upgrade, and customize  their increasingly complicated computer systems. Computer specialists  who have a combination of strong technical and good interpersonal and  business skills will be in demand.
Unlike other computer specialists, job growth of computer programmers is  expected to lag significantly behind the growth in overall U.S. occupations.  Programmers are projected to grow only by 2 percent from 2004 to 2014.  Because computer programming requires little localized or specialized  knowledge, computer programming can be performed anywhere in the  world and transmitted electronically. Consequently, programmers  potentially face a higher risk of having their jobs offshored than other  computer specialists such as software engineers, who are involved in more  complex information technology functions.  Another factor limiting job  growth in computer programming is progress in programming technology.  Computer software has become increasingly sophisticated, enabling users  to write basic code without programmers’ involvement for routine  programming.
section_title: The United States Maintains a Trade Surplus in Software Services Trade, but Imports Are Growing
paragraphs: The United States is a net exporter of software services and has maintained  this trade surplus for several decades. Although U.S. exports are rising  rapidly, imports are also increasing in this category. Canada is the largest  supplier of imported computer and data processing services to the U.S.  market but, as we have previously reported, India is rapidly growing as a  supplier of these services. Figure 10 shows U.S. exports and imports of  computer and data processing services, the category that includes both  custom and packaged software services (as defined by BEA) since 1986.
U.S. exports of software services make up about 13 percent of overall U.S.  software revenues according to the U.S. Census Bureau (Census).  However, most export revenue is derived from packaged software exports.  These Census statistics show a much larger value of exports than the BEA  trade in services statistics. As shown in figure 11, U.S. companies report  nearly $22 billion in exports of software services, primarily comprising   about $20 billion in U.S. package software exports.
Information on trade in software services is significantly more limited than  information on trade in semiconductors. Although both BEA and Census  collect statistics on software trade, as demonstrated by the previous two  figures, the data are available only for the aggregate categories shown. In  comparison, for semiconductors, over 230 individual semiconductor goods  are identified by Census as they cross international borders. In addition,  most countries in the world utilize the same goods classification system,  known as the Harmonized System, to record trade in goods. However,  efforts to create and utilize detailed and compatible classification systems across countries for services such as software are still relatively new. Part  of the challenge in collecting detailed statistics on services industries, such  as software, derives from the “intangible” nature of many services—they  are not necessarily physical products—and the fact that they don’t cross  customs borders like goods. Rather, services data is collected by surveying  companies for information on their payments or receipts for services. In  addition, services can be delivered to the customer through many different  channels, including licensing agreements, imbedded in goods such as  computers, or a commercial presence such as a foreign subsidiary.
section_title: The U.S. Semiconductor and Software Industries Benefit from the Large, Innovative U.S. Economy
paragraphs: The United States maintains substantial advantages as a large,  technologically sophisticated economy. The U.S. high-technology  industries, such as semiconductors and software, have benefited from a  U.S. economic environment that supports innovation—world-class  universities and research centers, a talented labor pool, and high levels of  spending on R&D. The industries also benefited from a competitive U.S.  business environment, an efficient legal system for contracts and  intellectual property protection, and a large domestic market.
subsections: section_title: University and Research Centers, Talented Labor, and R&D Investment Have Helped Foster Innovation
paragraphs: Although a wide range of causes and circumstances leads to new  innovations, certain enabling factors create an environment that fosters  new ideas and their development. These include (but are not limited to)  such factors as the higher education system and related research centers,  pools of talent available, and the investments in research and  development.
The U.S.’s world-class higher education system and research institutes  create communities for researchers and educators and are widely  considered a key competitive advantage. The higher education system in  the United States includes many universities that are ranked among the  best in the world in terms of research, education, and entrepreneurship.  Also, a large number of top applicants from around the world apply for  undergraduate, graduate, and postdoctoral study. More specifically, U.S.  computer science and engineering programs—of particular importance to  high-technology industries such as semiconductors and software—are  leaders in their fields. The higher education system has provided both a  strong research environment and a pool of talented labor—both native  born and foreign students who remained after education.
A second factor that fosters innovation is the quality and number of  available researchers and other skilled labor. Countries with larger and  more talented labor pools are more likely to foster and sustain innovation.  The United States has a world-class talent pool that includes both technical  and managerial talent. The United States has the largest number of  researchers worldwide, with about 1.3 million, followed closely by the  European Union (EU-25), according to data from the Organization for  Economic Cooperation and Development. China, ranked third, has rapidly  increased the number of its researchers to surpass Japan. Although the  quality of these researchers is not captured by the indicator, it does show  the growing size of the Chinese research community.
A third factor that fosters innovation is a country’s investment in research  and development. This investment may come from several sources,  including the government, academia, and business. U.S. expenditures on  R&D are the largest in the world and have continued to grow over time (see  fig. 12). Currently, the United States spends about 2.7 percent of its gross  domestic product on R&D expenditures, compared with about 3.2 percent  for Japan and 1.4 percent for China. For certain industries such as  semiconductors, early investments by the federal government—the  military, in particular—have been key in the initial development of the  industry.  However, this role may change over time. For the United States,  the increase in R&D expenditures over the past decade has been driven by  the business community, while the total amount of federal R&D has grown  much more slowly in comparison.
While the United States has generally maintained a strong advantage in  areas that foster innovation, several studies have recently raised questions  about continued dominance of the United States in cutting-edge  innovation. They cite a range factors that indicate the rise of other  competitors in traditionally U.S.-dominated areas. For instance, changes in  U.S. visa and immigration requirements have been cited as hampering the  number of foreign students, researchers, and high-tech workers who are  attracted to the United States and allowed to reside here. At the same  time, other countries’ university systems are increasingly competing with  the United States to attract the most qualified students and researchers.  According to these studies, these changes have led to a decline in the  number of university applications from foreign students. Similarly, other  countries have liberalized their economies and provided greater  opportunities for higher skilled workers. Therefore, more students and  researchers, including those from India and China, who may have once  stayed in the United States have an incentive to return to their native  countries.
section_title: Business Environment, Legal System, and Domestic Market Affect Commercialization of Innovation
paragraphs: In addition to an environment for fostering innovation, countries need to be  able to commercialize these innovations to affect the wider economy.  Several factors contribute to a U.S. competitive environment that  encourages innovation to be commercialized.  First, the business  environment includes relatively competitive product markets that  encourage businesses to take new products to market in order to gain  advantage over rivals, while also allowing new entrants to challenge  existing companies. The United States also has a relatively efficient  financial system, including venture capital markets that fund new  innovations and start-ups in high-technology industries. The U.S. legal and  regulatory environment, including its intellectual property protections  (such as patents), allows individuals and companies to be rewarded for  their investment in innovation. Finally, the large U.S. domestic market  provides an avenue for companies to sell new products to a wide range of  sophisticated customers. The U.S. economy is by far the largest in the  world, and per capita income is also one of the highest in the world. This  creates an environment for U.S. companies to develop and sell new  products profitably. In addition, companies that are close to their  customers are able to spot new trends and preferences in demand and  cater to them. This is particularly true in high-technology industries in  which the product life cycle is relatively short and profit margin for older  products declines quickly.
section_title: Concluding Observations
paragraphs: The past decade’s revolution in telecommunications and related advances  in supply chain management capabilities have deeply affected the business  models for both the semiconductor manufacturing and software services  industries. These industries’ overall business model is now a global one, in  which U.S. firms regularly consider a wide range of locations for their  operations and source different parts of their operations wherever the  advantages are most compelling. For the semiconductor industry, firms  initially offshored labor-intensive assembly activities to cut labor costs, but  more recently firms have offshored other activities for various reasons,  including proximity to other industry suppliers, closer relations with  foreign customers, benefits offered by foreign governments, and the  availability of both skilled and unskilled human capital. In the software  industry, the offshoring trend is more recent, but the motivations are  similar.
For software services, however, an important difference may be the  possible speed and scale of employment shifts. Software services  offshoring, compared with semiconductor manufacturing offshoring, does  not need the same physical infrastructure, such as ports, roads, and  factories, and thus can be set up more quickly. It is more labor intensive  than capital intensive, and thus may be more sensitive to wage differentials.  In addition, service occupations related to software programming are large  in comparison to manufacturing jobs in the semiconductor industry. In  semiconductor manufacturing, there was relatively slow movement up the  value chain as firms invested in the overseas workforce and factory  facilities. India’s software industry development has advanced more  quickly, with rapid technological changes bringing large numbers of highly  educated, but underused, English-speaking workers to the doorstep of  firms willing to operate from India. The data available to monitor the scale  of services offshoring, unfortunately, are much more limited than those  available for following trade in manufactured products. Semiconductor  products, for example, can be identified and inspected at U.S. borders,  whereas software imports and exports can be transmitted almost  instantaneously over the Internet.
Government policies also played important, but different, roles in Taiwan,  China, and India; however, all three governments have placed high  importance on education. In recent years, China has been transforming  large parts of its coastal cities through massive infrastructure investments  and has provided more targeted inducements for firms, such as support for  science and technology parks and various types of financial assistance.  India liberalized parts of its central government apparatus in the early  1990s, but its investment in physical infrastructure such as roads and ports  has been much more limited, although India has also supported its science  parks and put in place advanced telecommunications infrastructure  improvements. These incentives for software exporters appear to have  been well targeted.
The comparison of these two offshoring experiences offers some insights  for U.S. policies. Clearly, a large and well-educated population appears to  be a central element to success in both semiconductor manufacturing and  software services activities. Also, technological changes have impacts that  are not always predictable and, in a now closely-connected global business  world, such changes can have continuing dynamic effects on U.S.  industries. India may have neither fully predicted or planned its current  strengths in software services, nor foreseen how its pool of native English  speakers could be such an asset, but it now realizes the importance of  enhancing its strengths in these areas. In addition, ambitious national  goals—whether China’s semiconductor development road maps or Indian  businesses’ long-term strategies—are additional elements in the mix of  factors that will shape these countries’ futures and will pose competitive  challenges to U.S. firms.
As numerous recent studies have reported, the ability of the United States  to continue to compete at the most advanced levels in high technology  industries depends on a range of reinforcing factors: high-level R&D  investment by companies and government, innovative academic  environments attracting and training the highest-skilled researchers, a  competitive business environment that fosters development and  commercial application of new technologies, and a flexible and skilled  workforce. These factors are being nourished in China, Taiwan, and India,  as these countries seek to move further up the value chain and to “leapfrog”  advanced country capabilities where possible. Indeed, these countries have  modeled their industry development strategies on various aspects of the  U.S.’s successful model.  The United States is an integral part of this  dynamic world economy—in which it will be important for U.S. businesses  and policymakers to keep alert to technological changes, to anticipate  competitor countries’ strategies, and to preserve and enhance the elements  of the innovation environment that helped make the United States a model.
section_title: Agency Comments and Our Evaluation
paragraphs: We provided a draft of this report to the Departments of State and  Commerce for their review and comment. The Department of State did not  provide comments. We received written comments from the Department of  Commerce, which agreed our findings. (See app. IV.) The Department of  Commerce also provided technical comments, which we incorporated into  the report, as appropriate.
We are sending copies of this report to interested congressional  committees and the Departments of State and Commerce. We also will  make copies available to others on request. In addition, the report will be  available at no charge on the GAO Web site at http://www.gao.gov.
If you or your staff have any questions about this report, please contact me  at (202) 512-4128 or yagerl@gao.gov. Contact points for our Offices of  Congressional Relations and Public Affairs may be found on the last page  of this report. Key contributors to this report are listed in appendix V.
section_title: Scope and Methodology
paragraphs: This report discusses (1) the development of offshoring in semiconductor  manufacturing and software services over time, (2) the factors enabling the  expansion of offshoring in these industries, and (3) the development of  these industries in the United States as they have become more global.
To obtain information about the key developments in the offshoring of  semiconductor manufacturing and software services, we reviewed  available literature; attended conferences on the subject; and interviewed  government officials, representatives of private firms, industry  associations, and research organizations in China, India, Taiwan, and the  United States. We performed a literature search and obtained information  from several research organizations, universities, and industry associations  that have published industrywide studies on offshoring and the key  developments in both the semiconductor manufacturing and software  services industries, including the Association for Computing Machinery;  Brookings Institution; Gartner, Inc.; McKinsey and Company; the  University of California, Berkeley; Stanford University; Carnegie Mellon  University; the Semiconductor Industry Association; and the Information  Technology Association of America. We attended conferences on  developments in the semiconductor and software services industries and  the general offshoring phenomenon. We interviewed researchers at private  research organizations, industry experts at the U.S. Department of  Commerce and the U.S. International Trade Commission, and government  officials from India and Taiwan. In addition, we met representatives of  private sector firms in the semiconductor and software services industries  in China, India, Taiwan, and the United States. We also interviewed  representatives and obtained data from organizations representing  semiconductor and software services firms and workers, including the  Semiconductor Industry Association, the National Association of Software  and Service Companies, and the Information Technology Association of  America. We discussed with these sources the historical changes that have  occurred broadly in the computer hardware industry, particularly with  respect to China and Taiwan, and the software services industry,  particularly with regard to India.
To determine the factors that have contributed to offshoring in  semiconductor manufacturing and software services, we conducted a  review of available literature and interviewed representatives of private  sector firms, semiconductor and software services industry associations,  business associations, and research organizations (see above). In addition,  we interviewed industry experts within the U.S. government and the  governments of India and Taiwan. We met with and reviewed relevant  literature from researchers who have published on the offshoring  phenomenon and the factors contributing to global developments in  semiconductor manufacturing and software services; including experts  from the Brookings Institution; the Institute for International Economics;  the Milken Institute; and the University of California, Berkeley. We  interviewed representatives of private sector firms in China, India, Taiwan,  and the United States that have globally sourced semiconductor  manufacturing and software services; trade and industry experts in the U.S.  Department of Commerce; and the governments of India and Taiwan. In  addition, we interviewed representatives of business and industry  associations, such as the Federation of Indian Chambers of Commerce and  Industry, the U.S.-Taiwan Business Council, and the Semiconductor  Industry Association.
To determine developments in the semiconductor and software services  industries in the United States as they have become more global, we  examined available government data, information from experts in both the  semiconductor and software services industries, and other private sector  research. We obtained U.S. international trade data from the Bureau of  Economic Analysis (BEA) and the U.S Census Bureau. We also obtained  foreign countries’ international trade data through the United Nations and a  private company, Global Trade Information Services. We obtained foreign  direct investment data from BEA and domestic production data from  Census. To assess the limitations and the reliability of various data series,  we reviewed technical notes and related documentation and met with  officials from BEA and Census, as well as individuals in the private sector  familiar with these data. In addition, we reviewed relevant research studies  and obtained data from several private sector entities. Although we do not  report these data directly, we used them to corroborate information from  other sources. To determine employment trends in the semiconductor and  software services industries, we analyzed available U.S. government  employment data from the Bureau of Labor Statistics (BLS).  We cross- checked various employment data and reviewed technical notes in BLS  publications to assess the limitations and reliability of these data. We also  discussed the limitations and reliability of BLS data with BLS officials. We  determined that the data we used in this report to show the development  and trends in the semiconductor and software industries were sufficiently  reliable for these purposes.
We conducted our review from October 2005 through August 2006 in  accordance with generally accepted government auditing standards.
section_title: U.S. Multinational Companies’ Investment and Operations in the Semiconductor and Software Industries
paragraphs: U.S. multinational companies’ worldwide investments and operations  (including production, employment, and research and development (R&D)  have played an important role in the globalization of the semiconductor  and software industries. U.S. statistics show that overall multinational  corporation (MNC) investments have still tended to be in developed  economies, rather than in developing economies such as India and China.  However, certain manufacturing sectors such as the computer and  electronic products industry (including semiconductors) have a relatively  higher share of investment, production, and employment in developing  countries. In particular, U.S. companies’ investments and production in this  industry are relatively higher in the Asia-Pacific region (particularly  Singapore) than other industries. Employment is even more concentrated  abroad—likely due to the movement of more labor-intensive production  operations overseas in order to reduce costs. Conversely, research and  development expenditures are much more concentrated in the United  States than they are in foreign affiliates.
subsections: section_title: In recent years, U.S. Investment Offshore Has Been Relatively Stable and Has Been Larger in Singapore and Malaysia, Than in Taiwan and China
paragraphs: U.S. direct investment abroad statistics show that overall U.S. investment  (across all industries) in developing country markets is still a relatively  small share of total U.S. direct investment abroad (less than 1 percent of  the total each for India, China, and other developing countries, except  Mexico and Brazil), according to statistics from the Bureau of Economic  Analysis (BEA). However, within the computer and electronic products  industry (which includes semiconductors), Singapore was the most  significant Asia-Pacific country accounting for 15 percent of U.S. global investment in that industry as of 2004. Malaysia and Japan were next with  about 5 percent; followed by Korea (4 percent); Taiwan (3 percent); and  China, Hong Kong, and the Philippines (2 percent, each). Figure 13 shows  the value of U.S. foreign direct investment (FDI) from 1999 to 2004 in this  industry for selected Asian countries. As figure 13 shows, Singapore  accounted for $8.8 billion in U.S. FDI in 2004 (down from $13.5 billion in  2001), or about 15 percent of the global total in this industry. Interestingly,  the value of U.S. FDI in China in this sector has fallen since 2001—more  significantly than for other countries, except Singapore. These data  represent the accumulated investments (stock) made by U.S companies in  the computer and electronic products industry. As discussed in this report,  U.S. companies moved labor-intensive assembly and testing operations  overseas over the past several decades. Also, U.S. exports of  semiconductor wafers were largest to Malaysia, Korea, Taiwan,  Philippines, and China. This reflects the production process in which  fabricated wafers are then sent overseas for final assembly and test by U.S.  companies’ affiliates (as well as unaffiliated contractors).
Within the semiconductor industry, the majority of U.S. companies’ global  production (as measured by value-added) remained in the United States,  although the share declined during the recent recession. As figure 14  shows, semiconductor value-added by U.S. parents (U.S. operations) took a  steep decline in 2001, remained flat in 2002, and rebounded somewhat in  2003. Value-added by U.S. companies’ affiliates abroad accounted for about  28 percent of U.S. MNC’s global production, while the Asia-Pacific region  (excluding Japan and Australia), in particular, accounted for about 9  percent of global production.
section_title: Global Semiconductor Employment by U.S. Companies Is Roughly Split between Their U.S. Operations and Offshore Locations
paragraphs: U.S. MNCs that operate affiliates offshore have overall split their  employment between their U.S. operations and their foreign affiliates.  According to data from BEA, about 53 percent of MNC’s global  semiconductor employment was located in offshore affiliates in 2003, up  from 49 percent in 1999. As previously discussed, this reflects the trend  begun in 1960s of U.S. companies’ offshoring much of their labor-intensive  assembly and testing operations to lower wage countries, particularly in  Asia. BEA statistics also show that a relatively higher share of U.S.  employment in semiconductor manufacturing is concentrated in Asia  compared with other industries. Similarly, U.S. MNCs in computer and  electronic product manufacturing industries (of which semiconductors is a  part), in general had relatively higher shares of their global employment  located abroad (about 38 percent) than other information and  communications technology industries such as computer system design  and related services (35 percent), as well as across all industries (28  percent) in 2003.
Employment statistics from the Semiconductor Industry Association (SIA)  show a similar pattern for U.S.-based companies. According to SIA, about  54 percent of U.S. companies’ semiconductor employment was located in  North America (mainly the United States) in 2004. This is down from a peak  of about 60 percent in 1998 but still higher than in the 1980s and 1990s,  which was between 45 and 50 percent. In addition, about 28 percent of U.S.  companies’ North American workforce was engaged in R&D in 2004.  According to industry experts, a much higher share of U.S. companies’  R&D employment is based in the United States, rather than offshore.
section_title: U.S. Companies Investments in Overseas Affiliates to Supply Software Services Still Relatively Low
paragraphs: As discussed above, U.S. direct investment abroad statistics show that  overall investment (across all industries) in developing country markets is  still a relatively small share of total U.S. direct investment abroad. This is  also generally true in services industries that include software services.  For example, U.S. direct investment in India in the information sector and  the professional, scientific, and technical services sector are both less than  1 percent of global investment in those sectors. However, investment in  Ireland in the information sector accounted for 30 percent of global U.S.  direct investment abroad in that sector in 2004. Over time, Ireland has  attracted investment by a large number of U.S. companies to produce  software for the European Union market.
Similarly, U.S. multinational companies’ operations abroad (including  employment) in software services are relatively small compared with the  semiconductor industry and the broader electronics hardware industry. For  example, table 3 shows that, for semiconductors, over half of U.S. MNC’s  employment was located in their foreign affiliates (rather than their  domestically based parent company). In contrast, services industries such  as publishing (which includes packaged software) and computer systems  design and related services (which includes custom software) had between  one-fifth and one-third of their employment located in their foreign  affiliates.
section_title: MNC’s Research and Development Relatively Concentrated in U.S. Operations
paragraphs: Compared with production or employment, U.S. MNC R&D expenditures  are more concentrated in the United States. As shown in table 4, in 2003  about 14 percent of U.S. MNC R&D expenditures were made through U.S.  majority-owned foreign affiliates (MOFAs) out of total MNC R&D  expenditures (U.S. parents plus MOFAs). The share was similar for the  computer and electronic products industry (about 13 percent) and  publishing industries (about 10 percent) but less for semiconductors (8  percent), computer systems design and related services (about 5 percent),  and information services and data processing services (1 percent). In  comparison, MOFAs accounted for about 26 percent of value-added for all  industries, 24 percent for computer and electronic products, and 28 percent  for semiconductors. Likewise, MOFAs accounted for 28 percent of  employment across all industries, 38 percent for computer and electronic  products, and 53 percent of semiconductor employment.
Across industries, MNCs spent about 22 percent of MOFA R&D  expenditures in the computer and electronic products industry (5 percent  in semiconductors alone), making it the third largest industry overall in  2003. Other information and computer technology (ICT) sectors  represented very small shares (see table 5). Across major industries,  transportation equipment manufacturing accounted for 29 percent of total  MOFA R&D expenditures (26 percent of that was autos). The next largest  was chemicals with 25 percent of R&D expenditures (of which 21 percent  was pharmaceuticals).
Asia-Pacific economies account for a relatively small share of U.S. MNC’s  R&D expenditures. Except for Japan (7 percent overall and 15 percent in  information), Singapore (10 percent in computer and electronic products),  and Malaysia (5 percent in computer and electronic products), these  countries each accounted for 3 percent or less of MOFA expenditures in  ICT-related industries (see table 6). China accounts for about 3 percent of  manufacturing, but details are not available for computers and electronic  products. India accounts for less than 1 percent of R&D expenditures  across most industries (note that in the computers and electronic products  and professional, technical, and scientific industries, where amounts were  suppressed in 2003 for India, prior years also showed less than 1 percent).
section_title: Larger Imports of Information and Communication Goods Drive the U.S. Advanced Technology Product Deficit
paragraphs: Since 1989, Commerce’s Bureau of the Census (Census) has identified  products that use leading edge technologies or innovations. Commerce  classifies these goods as Advanced Technology Products (ATP). Currently,  Census identifies about 500 of some 22,000 10- digit commodity U.S.  merchandise trade classification codes as ATP codes because they meet  the following criteria:  (1) the code contains products from 1 of 10  recognized high technology fields such as electronics (which includes  semiconductors) and information and communications (which includes  notebook computers and cell phones), (2) these products represent  leading-edge technology in that field, and (3) these products constitute a  significant part of all items in the selected classification code.
Partly as a consequence of the growing movement of electronics assembly  to Asia, and China in particular, in 2005, the United States trade deficit with  China in the ATP information and communications group, $51.5 billion, is  slightly larger than the overall ATP deficit with China, $48.4 billion, and  about 25 percent of the overall goods deficit, $203.8 billion, all of which  have dramatically grown in recent years. Finished products—such as  notebook computers and cell phones—are the largest U.S. information and  communication ATP imports from China in 2005. Computer parts and  accessories are the leading U.S. exports to China in this group. U.S.  exports, imports, and the trade balance with China in this group are  depicted in figure 15. This figure shows both the rapid growth in imports of  these products from China, as well as the rising trade deficit.
In contrast, in the ATP electronics group, beginning in 2001, the United  States has a trade surplus with China, largely due to the substantial exports  of semiconductor wafers and integrated circuits to China. (See fig. 16.)  However, this surplus of about $1 billion in 2003 has been declining  somewhat in recent years. This current trade surplus is partly a result of  slower growing U.S. demand for finished integrated circuits by  downstream manufacturers of consumer electronics, as discussed  previously.
The overall ATP trade deficit with China (as well as Asia overall) is largely  due to information and communications imports. However, trade statistics  rarely separate out the value of imported components embodied in finished  products. Therefore, some part of the value of U.S. imports of information  and communications products from China is attributable to U.S. exports of  chips and wafers (and other ATP components) directly to China or  indirectly through other Asian countries. However, to be a leading-edge  product, Census must judge the product itself to use leading-edge  technology, not simply some of its components. For example, although  autos have many leading-edge components such as semiconductors and  integrated circuits, autos are not leading-edge products.
section_title: Comments from the Department of Commerce
section_title: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
section_title: Staff Acknowledgments
paragraphs: In addition to the individual named above, Virginia Hughes, Assistant  Director; Bradley Hunt; Ernie Jackson; Sona Kalapura; Judith Knepper,  Analyst-in-Charge; Lynn Cothern; Yesook Merrill; Berel Spivack; and Tim  Wedding made major contributions to this report.
section_title: Related GAO Products
subsections: section_title: Offshoring
paragraphs: Offshoring in Six Human Services Programs: Offshoring Occurs in Most  States, Primarily in Customer Service and Software Development. GAO- 06-342. Washington, D.C.:  Mar. 28, 2006.
Offshoring of Services: An Overview of the Issues. GAO-06-5. Washington,  D.C.: Nov. 28, 2005.
International Trade: U.S. and India Data on Offshoring Show  Significant Differences. GAO-06-116. Washington, D.C.: Oct. 27, 2005.
International Trade: Current Government Data Provide Limited Insight  into Offshoring of Services. GAO-04-932.Washington, D.C.: Sept. 22, 2004.
Highlights of a GAO Forum: Workforce Challenges and Opportunities For  21st Century: Changing Labor Force Dynamics and the Role of  Government Polices. GAO-04-845SP. Washington, D.C.: June 1, 2004.
section_title: China
paragraphs: China Trade: U.S. Exports, Investment, Affiliate Sales Rising, but Export  Share Falling. GAO-06-162.  Washington, D.C.: Dec. 9, 2005.
U.S.-China Trade: Opportunities to Improve U.S. Government Efforts to  Ensure Open and Fair Markets., GAO-05-554T. Washington, D.C.: Apr. 14,  2005.
U.S.-China Trade: Observations on Ensuring China’s Compliance with  World Trade Organization Commitments. GAO-05-295T. Washington,  D.C.: Feb. 4, 2005.
U.S.-China Trade: Opportunities to Improve U.S. Government Efforts to  Ensure China's Compliance with World Trade Organization  Commitments. GAO-05-53. Washington, D.C.: Oct. 6, 2004.
World Trade Organization: U.S. Companies’ Views on China’s  Implementation of Its Commitments. GAO-04-508. Washington, D.C.: Mar.  24, 2004.
Export Controls: Rapid Advances in China’s Semiconductor Industry  Underscore Need for Fundamental U.S. Policy Review. GAO-02- 620. Washington, D.C.: Apr. 19, 2002.
section_title: Semiconductors
paragraphs: Export Controls: System for Controlling Exports of High Performance  Computing Is Ineffective. GAO-01-10. Washington, D.C.: Dec. 18, 2000.
Federal Research: SEMATECH’s Technological Progress and Proposed  R&D Program. RCED-92-223BR. Washington, D.C.: July 16, 1992.
Federal Research: SEMATECH’s Efforts to Strengthen the U.S.  Semiconductor Industry. RCED-90-236. Washington, D.C.: Sept. 13, 1990.