MEASURING AND SUSTAINING THE NEW ECONOMY

ENHANCING PRODUCTIVITY GROWTH IN THE INFORMATION AGE

Committee on Measuring and Sustaining the New Economy

Board on Science, Technology, and Economic Policy

Policy and Global Affairs

Dale W. Jorgenson and Charles W. Wessner, Editors

NATIONAL RESEARCH COUNCIL OF THE NATIONAL ACADEMIES

THE NATIONAL ACADEMIES PRESS

Washington, D.C.
www.nap.edu



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Measuring and Sustaining the New Economy: Enhancing Productivity Growth in the Information Age MEASURING AND SUSTAINING THE NEW ECONOMY ENHANCING PRODUCTIVITY GROWTH IN THE INFORMATION AGE Committee on Measuring and Sustaining the New Economy Board on Science, Technology, and Economic Policy Policy and Global Affairs Dale W. Jorgenson and Charles W. Wessner, Editors NATIONAL RESEARCH COUNCIL OF THE NATIONAL ACADEMIES THE NATIONAL ACADEMIES PRESS Washington, D.C. www.nap.edu

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Measuring and Sustaining the New Economy: Enhancing Productivity Growth in the Information Age THE NATIONAL ACADEMIES PRESS 500 Fifth Street, N.W. Washington, DC 20001 NOTICE: The project that is the subject of this report was approved by the Governing Board of the National Research Council, whose members are drawn from the councils of the National Academy of Sciences, the National Academy of Engineering, and the Institute of Medicine. The members of the committee responsible for the report were chosen for their special competences and with regard for appropriate balance. This study was supported by: Contract/Grant No. CMRC-50SBNB9C1080 between the National Academy of Sciences and the U.S. Department of Commerce; Contract/ Grant No. NASW-99037, Task Order 103, between the National Academy of Sciences and the National Aeronautics and Space Administration; Contract/Grant No. CMRC-SB134105C0038 between the National Academy of Sciences and the U.S. Department of Commerce; Contract/Grant No. OFED-13416 between the National Academy of Sciences and Sandia National Laboratories; Contract/Grant No. N00014-00-G-0230, DO #23, between the National Academy of Sciences and the Department of the Navy; Contract/ Grant No. NSF-EIA-0119063 between the National Academy of Sciences and the National Science Foundation; and Contract/Grant No. DOE-DE-FG02-01ER30315 between the National Academy of Sciences and the U.S. Department of Energy. Additional support was provided by Intel Corporation. Any opinions, findings, conclusions, or recommendations expressed in this publication are those of the author(s) and do not necessarily reflect the views of the organizations or agencies that provided support for the project. International Standard Book Number-10: 0-309-10220-0 International Standard Book Number-13: 978-0-309-10220-9 Limited copies are available from Board on Science, Technology, and Economic Policy, National Research Council, 500 Fifth Street, N.W., W547, Washington, DC 20001; 202-334-2200. Additional copies of this report are available from the National Academies Press, 500 Fifth Street, N.W., Lockbox 285, Washington, DC 20055; (800) 624-6242 or (202) 334-3313 (in the Washington metropolitan area); Internet, http://www.nap.edu Copyright 2007 by the National Academy of Sciences. All rights reserved. Printed in the United States of America

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Measuring and Sustaining the New Economy: Enhancing Productivity Growth in the Information Age THE NATIONAL ACADEMIES Advisers to the Nation on Science, Engineering, and Medicine The National Academy of Sciences is a private, nonprofit, self-perpetuating society of distinguished scholars engaged in scientific and engineering research, dedicated to the furtherance of science and technology and to their use for the general welfare. Upon the authority of the charter granted to it by the Congress in 1863, the Academy has a mandate that requires it to advise the federal government on scientific and technical matters. Dr. Ralph J. Cicerone is president of the National Academy of Sciences. The National Academy of Engineering was established in 1964, under the charter of the National Academy of Sciences, as a parallel organization of outstanding engineers. It is autonomous in its administration and in the selection of its members, sharing with the National Academy of Sciences the responsibility for advising the federal government. The National Academy of Engineering also sponsors engineering programs aimed at meeting national needs, encourages education and research, and recognizes the superior achievements of engineers. Dr. Wm. A. Wulf is president of the National Academy of Engineering. The Institute of Medicine was established in 1970 by the National Academy of Sciences to secure the services of eminent members of appropriate professions in the examination of policy matters pertaining to the health of the public. The Institute acts under the responsibility given to the National Academy of Sciences by its congressional charter to be an adviser to the federal government and, upon its own initiative, to identify issues of medical care, research, and education. Dr. Harvey V. Fineberg is president of the Institute of Medicine. The National Research Council was organized by the National Academy of Sciences in 1916 to associate the broad community of science and technology with the Academy’s purposes of furthering knowledge and advising the federal government. Functioning in accordance with general policies determined by the Academy, the Council has become the principal operating agency of both the National Academy of Sciences and the National Academy of Engineering in providing services to the government, the public, and the scientific and engineering communities. The Council is administered jointly by both Academies and the Institute of Medicine. Dr. Ralph J. Cicerone and Dr. Wm. A. Wulf are chair and vice chair, respectively, of the National Research Council. www.national-academies.org

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Measuring and Sustaining the New Economy: Enhancing Productivity Growth in the Information Age Committee on Measuring and Sustaining the New Economy* Dale Jorgenson, Chair Samuel W. Morris University Professor Harvard University M. Kathy Behrens Managing Director of Medical Technology Robertson Stephens Investment Management Kenneth Flamm Dean Rusk Chair in International Affairs Lyndon B. Johnson School of Public Affairs University of Texas at Austin Bronwyn Hall Professor of Economics University of California at Berkeley James Heckman Henry Schultz Distinguished Service Professor of Economics University of Chicago Richard Levin President Yale University David T. Morgenthaler Founding Partner Morgenthaler Ventures William J. Spencer, Vice Chair Chairman Emeritus, retired SEMATECH Mark B. Myers Visiting Executive Professor of Management The Wharton School University of Pennsylvania Roger Noll Morris M. Doyle Centennial Professor of Economics Director, Public Policy Program Stanford University Edward E. Penhoet President Gordon and Betty Moore Foundation William Raduchel Chairman and CEO The Ruckus Network Alan Wm. Wolff Managing Partner Dewey Ballantine * As of June 2006.

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Measuring and Sustaining the New Economy: Enhancing Productivity Growth in the Information Age Project Staff* Charles W. Wessner Study Director McAlister T. Clabaugh Program Associate David E. Dierksheide Program Officer Paul J. Fowler Senior Research Associate Jeffrey McCullough Program Associate Sujai J. Shivakumar Program Officer * As of June 2006.

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Measuring and Sustaining the New Economy: Enhancing Productivity Growth in the Information Age For the National Research Council (NRC), this project was overseen by the Board on Science, Technology, and Economic Policy (STEP), a standing board of the NRC established by the National Academies of Sciences and Engineering and the Institute of Medicine in 1991. The mandate of the STEP Board is to integrate understanding of scientific, technological, and economic elements in the formulation of national policies to promote the economic well-being of the United States. A distinctive characteristic of STEP’s approach is its frequent interactions with public- and private-sector decision makers. STEP bridges the disciplines of business management, engineering, economics, and the social sciences to bring diverse expertise to bear on pressing public policy questions. The members of the STEP Board* and the NRC staff are listed below: Dale Jorgenson, Chair Samuel W. Morris University Professor Harvard University Timothy Bresnahan Landau Professor in Technology and the Economy Stanford University Lewis Coleman President DreamWorks Animation Kenneth Flamm Dean Rusk Chair in International Affairs Lyndon B. Johnson School of Public Affairs University of Texas at Austin Mary L. Good Donaghey University Professor Dean, Donaghey College of Information Science and Systems Engineering University of Arkansas at Little Rock Amo Houghton Member of Congress (ret.) David T. Morgenthaler Founding Partner Morgenthaler Ventures Joseph Newhouse John D. MacArthur Professor of Health Policy and Management Harvard University Edward E. Penhoet President Gordon and Betty Moore Foundation Arati Prabhakar General Partner U.S. Venture Partners William J. Raduchel Chairman and CEO The Ruckus Network Jack Schuler Chairman Ventana Medical Systems Suzanne Scotchmer Professor of Economics and Public Policy University of California at Berkeley * As of June 2006.

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Measuring and Sustaining the New Economy: Enhancing Productivity Growth in the Information Age STEP Staff* Stephen A. Merrill Executive Director McAlister T. Clabaugh Program Associate David E. Dierksheide Program Officer Paul Fowler Senior Research Associate Charles W. Wessner Program Director Jeffrey McCullough Program Associate Ben Roberts Christine Mirzayan Science and Technology Policy Fellow Sujai J. Shivakumar Program Officer * As of June 2006.

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Measuring and Sustaining the New Economy: Enhancing Productivity Growth in the Information Age Contents PREFACE   xi LIST OF ACRONYMS   xvii     OVERVIEW OF THE FINDINGS AND RECOMMENDATIONS   1 I. INTRODUCTION   11 II. FINDINGS AND RECOMMENDATIONS   17 III. SUMMARY OF THE NRC CONFERENCES ON THE NEW ECONOMY   61      Moore’s Law and the New Economy,   64      Raising the Speed Limit,   64      The Role of Moore’s Law,   65      Measuring the New Economy,   68      The Challenge of Measurement,   69      Modeling the Productivity and Cyclicality of the Semiconductor Industry,   71       Semiconductors and the New Economy,   72       Explaining Productivity and Cyclicality in the Semiconductor Industry,   73       A Possible Model of the Semiconductor Industry,   75

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Measuring and Sustaining the New Economy: Enhancing Productivity Growth in the Information Age                  Deconstructing the Computer: Measuring Computer Hardware Performance,   76       Developing Hedonic Price Indexes,   77       Methodological Challenges and Opportunities for Hedonic Pricing,   78      Measuring Software Performance,   81       Measurement Challenges: The Complexity of Software,   82       Tracking Software in National Accounts,   83       Gauging Private Fixed Software Investment,   84       Tracking Software Price Changes,   87      Measuring Telecom Prices,   87       Towards Improved Measures of the New Economy,   90      Sustaining the New Economy,   90      Challenges to Sustaining Moore’s Law,   90       Overcoming Technological Brick Walls,   91       Resource Challenges to Sustaining Moore’s Law,   92      Strategies to Sustain Moore’s Law,   94       Cooperative Ventures in Semiconductor Research,   94       Expanding the Use of Technology Roadmaps,   95      Software and the New Economy,   98       Making Software More Robust Against Errors and Attacks,   100       Enhancing Software Reliability,   101       The Software Labor Market and the Offshoring Impetus,   102       Potential Impacts of Offshoring on Future U.S. Innovative Capacities,   105      The Telecommunications Challenge,   109       Communications Technology: A Vision of the Future,   109       Sustaining the New Economy: The Broadband Challenge,   113       The End of Stovepiping,   122       Intellectual Property in the Era of Digital Distribution,   124       The Challenge for Regulation,   126       Towards a New Agenda of Research,   126      The Future of the New Economy,   127 IV. BIBLIOGRAPHY   131

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Measuring and Sustaining the New Economy: Enhancing Productivity Growth in the Information Age Preface The New Economy refers to technological and structural changes in the U.S. economy as individuals capitalize on new technologies, new opportunities, and national investments in computing, information, and communications technologies. Ongoing rapid declines in the prices of computers and semiconductors as well as apparent similar declines in the prices of software and communications equipment have led to diverse new information technology (IT)-enabled capabilities and the widespread adoption of information technologies. These investments have significantly improved the nation’s productivity, raising the trajectory of economic growth since the mid-1990s.1 This gain appears to be robust, having survived the dot-com crash, the short recession of 2001, and the tragedy of 9/11. Since the end of the previous recession of 2001, productivity growth had been running at about two-tenths of a percentage point higher than in any recovery of the post-World War II period.2 A structural change most associated with the New Economy today is the transformation of the Internet from a communication media to a platform for service delivery.3 This has led to the remarkable growth of the U.S. service 1 Dale W. Jorgenson and Kevin J. Stiroh, “Raising the Speed Limit: Economic Growth in the Information Age,” in National Research Council, Measuring and Sustaining the New Economy, Dale W. Jorgenson and Charles W. Wessner, eds., Washington, D.C.: The National Academies Press, 2002, Appendix A. 2 Dale W. Jorgenson, Mun S. Ho, and Kevin J. Stiroh, “Will the U.S. Productivity Resurgence Continue?” Federal Reserve Bank of New York Current Issues in Economics and Finance, 10(13), 2004. 3 This transformation is sometimes referred to as “Web 2.0.” For a description of this new version of the Web, see Tim O’Reilly, “What Is Web 2.0—Design Patterns and Business Models

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Measuring and Sustaining the New Economy: Enhancing Productivity Growth in the Information Age economy, as companies like Google and eBay increasingly exploit information services in new ways. THE CONTEXT OF THIS REPORT: THE COMMITTEE’S TASK In order to sustain the benefits of higher productivity and economic growth, policy makers need to improve their understanding of the operation of this new American economy. Unfortunately, the empirical record of this change is incomplete, with much remaining to be done before definitive quantitative assessments can be made about the role that these new technological assets play in the U.S. economy. To meet this need, the Board on Science, Technology, and Economic Policy (STEP) appointed a committee to convene a series of conferences designed to identify and address the policy issues associated with the measurement, development, and growth characteristic of the “New Economy.” Focusing primarily on the Information Technology sector as the major driver of productivity growth from the 1990s, the study has examined key sectors, or building blocks, that underpin this new and more productive U.S. economy. These sectors include semiconductors (one of the principal drivers of productivity growth), computers and their various components (another driver of productivity), software in its various forms (pervasive throughout the economy), and the contributions of dramatically improved capacity and lower cost of telecommunication services and data transmission. The study took up a series of issues such as: measurement issues, such as data classification and collection requirements; the building block technologies of the “new economy,” including their special characteristics and synergies across industries; and policy and regulatory issues. CONFERENCES ON THE NEW ECONOMY Following an initial conference that provided the impetus for this project, separate conferences on each of these sectors were convened over several years. Each identified major issues associated with the measurement and analysis of the current U.S. economy, the technologies underpinning its growth, and the government-industry collaborations and regulatory framework necessary to sustain its continued advance. The proceedings of each of these conferences have been captured in separate reports. These reports, together with commissioned for the Next Generation of Software” September 30, 2005. Accessed at <http://www.oreillynet.com/pub/a/oreilly/tim/news/2005/09/30/what-is-web-20.html>.

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Measuring and Sustaining the New Economy: Enhancing Productivity Growth in the Information Age papers, have been used to establish a basis for this final consensus report by the Committee. The conferences included: Measuring and Sustaining the New Economy. Held on October 6, 2000, at the National Academies, Washington, D.C., this initial exploratory conference described the nature and sources of growth in the “new” economy and set out the broad challenges faced in measuring and sustaining the growth in productivity that characterizes it. The conference provided the initial impetus for this project and, with subsequent approval and funding, led to a series of workshops dealing with the specific sectors most closely linked to emergence and sustainability of the positive trends that now distinguish the U.S. economy. An initial report captured the deliberations of this conference and attracted the interest of Washington policy makers.4 Productivity and Cyclicality in the Semiconductor Industry. Held at Harvard University on September 24, 2001, soon after the 11 September terror attacks, this conference looked at the trends, implications, and policy questions that arise from an understanding of the Moore’s Law phenomenon in semiconductors. It explored how the cyclicality found in the semiconductor industry might be modeled. It also highlighted a variety of policy initiatives needed to help sustain a vibrant semiconductor industry in the United States.5 Deconstructing the Computer. This conference, held on February 28, 2003, brought together leading figures from the different industries that develop and manufacture computer components (such as printers, memories, and monitors) to examine the extent of Moore’s Law phenomenon in their industry and to explore how best to measure computer performance and how to sustain the benefits to the economy arising from a Moore’s Law for computer components.6 Software, Growth, and the Future of the U.S. Economy. This conference, held on February 20, 2004, examined the nature of software, reviewed how software has been measured in the national accounts, and discussed the challenges of capturing the value and vulnerabilities of software, given that the nature of software is itself rapidly evolving. The meeting also highlighted the globalization of the software industry, the recent “offshoring” phenomenon, and the policy challenges that these developments pose.7 4 See National Research Council, Measuring and Sustaining the New Economy, Dale W. Jorgenson and Charles W. Wessner, eds., Washington, D.C.: National Academy Press, 2002. 5 See National Research Council, Productivity and Cyclicality in Semiconductors: Trends, Implications, and Questions, Dale W. Jorgenson and Charles W. Wessner, eds., Washington, D.C.: The National Academies Press, 2004. 6 See National Research Council, Deconstructing the Computer, Dale W. Jorgenson and Charles W. Wessner, eds., Washington, D.C.: The National Academies Press, 2005. 7 See National Research Council, Software, Growth, and the Future of the U.S. Economy, Dale W. Jorgenson and Charles W. Wessner, eds., Washington, D.C.: The National Academies Press, 2006.

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Measuring and Sustaining the New Economy: Enhancing Productivity Growth in the Information Age The Telecommunications Challenge: Changing Technologies and Evolving Policies. Taking stock of the rapid convergence between telecommunications and information technologies, participants at this final conference in the series, held on November 15, 2004, examined the need to expand the reach of the nation’s high-bandwidth broadband network. Discussed in this context was the need for an adaptive policy framework that encourages innovation in telecommunications, and the development of new business models for telephony as well as voice and video entertainment.8 The proceedings of each of these conferences have been published in separate volumes by The National Academies Press. Although the technologies of the industries considered at these conferences continue to evolve rapidly, the reports nonetheless capture conceptual issues of continued policy relevance to the industry leaders, academics, policy analysts, and others who participated in these workshops. Part III of this report summarizes key issues taken up at these five conferences. The knowledge and insights reflected in the remarks of industry and policy representatives capture tacit knowledge that is not always available through formal academic analysis. These insights, buttressed by the commissioned papers, provide a valuable review and, in some cases, analysis of selected themes. Both the workshop summaries and the papers contributed to this consensus report. While this report reflects the wide scope of the Committee’s deliberations, it does not attempt (nor could it hope) to address all aspects of the causes and effects of the modern information economy. For instance, this volume does not provide a comprehensive study of the developments within industries that use information technologies, such as the retailing or transportation industries. Nor does it provide a detailed discussion of the experience of information technology-supplying industries that are related to but outside the Internet, such as the supercomputing or cellular industries. Other areas not covered include the potential role of standards committees in fostering technical advance, possible changes to the Generally Accepted Accounting Principles to improve how R&D is captured, the role nanotechnologies could play in advancing information technology, and changes in spectrum policy to move the spectrum from low value to higher value uses. ACKNOWLEDGMENTS There is considerable interest in the policy community in developing a better understanding of the technological drivers and appropriate regulatory framework 8 See National Research Council, The Telecommunications Challenge: Changing Technologies and Evolving Policies, Charles W. Wessner, ed., Washington, D.C.: The National Academies Press, 2006.

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Measuring and Sustaining the New Economy: Enhancing Productivity Growth in the Information Age for the New Economy, as well as a better grasp of its operation. This interest is reflected in the support on the part of agencies that have played a role in the creation and development of the technologies and regulatory frameworks that underpin the New Economy. We are grateful for the participation and the contributions of the National Science Foundation, the National Institute of Standards and Technology, the Department of Energy, the National Aeronautics and Space Administration, the Office of Naval Research, and Sandia National Laboratories. Among STEP staff, we especially wish to thank Dr. Sujai Shivakumar for his instrumental role in the creation of this report. His ability to synthesize the diverse perspectives into a coherent whole while capturing key themes was essential. We are also indebted to David Dierksheide for his role in preparing this report for publication. NRC REVIEW This report has been reviewed in draft form by individuals chosen for their diverse perspectives and technical expertise, in accordance with procedures approved by the National Academies’ Report Review Committee. The purpose of this independent review is to provide candid and critical comments that will assist the institution in making its published report as sound as possible and to ensure that the report meets institutional standards for objectivity, evidence, and responsiveness to the study charge. The review comments and draft manuscript remain confidential to protect the integrity of the process. We wish to thank the following individuals for their review of this report: Ana Aizcorbe, Bureau of Economic Analysis; Bruce Grimm, Bureau of Economic Analysis; Paul Horn, IBM Thomas Watson Research Center; Way Kuo, University of Tennessee; William Scherlis, Carnegie Mellon University; Kevin Stiroh, Federal Reserve Bank of New York; William Taylor, NERA Economic Consulting; and Larry Thompson, Ultratech Stepper, Inc. Although the reviewers listed above have provided many constructive comments and suggestions, they were not asked to endorse the conclusions or recommendations, nor did they see the final draft of the report before its release. The review of this report was overseen by Charles Phelps, University of Rochester. Appointed by the National Academies, he was responsible for making certain that an independent examination of this report was carried out in accordance with institutional procedures and that all review comments were carefully considered. Responsibility for the final content of this report rests entirely with the authoring committee and the institution. STRUCTURE Part I of this report is an introduction to the features and challenges of the New Economy by Dale Jorgenson. Part II of this report provides a summary of

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Measuring and Sustaining the New Economy: Enhancing Productivity Growth in the Information Age the Committee’s findings and recommendations for each of the sectors covered in the series of conferences. Finally, Part III summarizes the main themes from the proceedings of the five conferences listed above, drawing together the main policy challenges for the United States in sustaining the productivity growth and improved welfare associated with the New Economy. The overview of the findings and recommendations that follows this preface is designed to provide the harried reader an overview of the new economy story as a whole, while Part II provides interested individuals a greater focus on the individual high-technology sectors that contribute to the remarkable growth of the United States economy. Dale W. Jorgenson

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Measuring and Sustaining the New Economy: Enhancing Productivity Growth in the Information Age List of Acronyms BEA Bureau of Economic Analysis of the U.S. Department of Commerce BLS Bureau of Labor Statistics of the U.S. Department of Labor CD Compact Disc CMOS Complementary Metal-Oxide Semiconductor, a major class of integrated circuits DRAM Dynamic Random Access Memory DSL Digital Subscriber Line is a family of technologies that provide digital data transmission over the wires of a local telephone network. DVD Digital Video Disk EUV Extreme Ultraviolet Lithography technology, capable of creating nanometer-scale patterns for use in semiconductor manufacturing FASB The Financial Accounting Standards Board (FASB) develops Generally Accepted Accounting Principles in the United States. FCC Federal Communications Commission H-1B H-1B is a U.S. visa category that allows American companies and universities to employ foreign scientists, engineers, programmers, and other professionals in the United States. IEEE Institute of Electrical and Electronics Engineers IMEC The Interuniversity Microelectronics Centre is a microelectronics research facility on the outskirts of Leuven, Belgium. IPTV Internet Protocol Television describes a system where a digital television service is delivered to subscribing consumers using the Internet Protocol over a broadband connection. ITRS International Technology Roadmap for Semiconductors

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Measuring and Sustaining the New Economy: Enhancing Productivity Growth in the Information Age LCD Liquid Crystal Display LLU Local Loop Unbundling is the process of allowing telecommunications operators to use the twisted-pair telephone connections from the telephone exchange’s central office to the customer premises. NIPA National Income and Product Accounts use double entry accounting to report the monetary value and sources of output produced in a country and the distribution of incomes that production generates. OECD Organisation for Economic Co-operation and Development OLED Organic Light Emitting Diode SEC Securities and Exchange Commission TCP/IP The Transmission Control Protocol (TCP) and the Internet Protocol (IP) are sets of communications protocols that implement the protocol stack on which the Internet and most commercial networks run. VAT Value-Added Tax VOIP Voice over Internet Protocol is the routing of voice conversations over the Internet or through any other IP-based network. WDM Wavelength-division multiplexing is a technology that multiplexes multiple optical carrier signals on a single optical fiber by using different wavelengths (colors) of laser light to carry different signals. WiFi A technology for wireless local area networks. Designed to be used for mobile computing devices such as laptops, it is increasingly used for applications including Internet access, gaming, and basic connectivity of consumer electronics such as televisions and DVD players. WiMAX Worldwide Interoperability for Microwave Access. WiMAX is a standards-based wireless technology that provides high-throughput broadband connections over long distances. WiMAX can be used for a number of applications, including “last mile” broadband connections, hotspots and cellular backhaul, and high-speed enterprise connectivity for business. WTO World Trade Organization