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Innovation in Global Industries: U.S. Firms Competing in a New World - Collected Studies 2 Software ASHISH ARORA Carnegie Mellon University CHRIS FORMAN Georgia Institute of Technology JIWOONG YOON Kyung Hee University, Seoul, South Korea INTRODUCTION The global movement of software services activities (defined to include software engineering services and research and development [R&D] as well as the development of software products) to locations outside of the United States is an important and growing phenomenon that has recently attracted widespread attention. Over the period 1995-2002, exports of business services and computer and information services grew at an average annual rate of over 40 percent in India and at a rate of 20 percent in Ireland. These changes have received widespread attention within the United States and have led to concerns of a “hollowing out” of the American information technology (IT) sector and about the potential loss of American technological leadership. However, despite these changes in the location of production of IT services, there is relatively little evidence of global changes in the location of new software product development. U.S. companies have historically been and continue to be the leading exporters of software products. Moreover, evidence from software patents suggests that inventive activity in software continues to be concentrated in the United States. In the short run, the United States will continue to enjoy a significant lead over other countries in the stock of highly skilled programmers and software designers that provide it with an advantage in the production of new software products. Moreover, proximity to the largest source of IT demand and potential agglomeration economies arising from proximity to competitors and complementors provide software product companies located in the United States with a significant advantage.
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Innovation in Global Industries: U.S. Firms Competing in a New World - Collected Studies DISPERSION OF INVENTIVE ACTIVITY IN SOFTWARE In this chapter we provide evidence on the geographic distribution of inventive activity in software. Economists have long made a distinction between innovation and invention in the study of technological change. Schumpeter (1934) defined innovations as new, creative combinations that upset the equilibrium state of the economy. Mokyr (2002) defines invention as an increment in the set of technological knowledge in a society. Schumpeter pointed out that invention does not imply innovation, and that it is innovation that provides capitalism with its dynamic elements. Because it is more easily measured, in this chapter we will focus on the geographic dispersion of inventive activity. However, we adopt the position of Mokyr (2002), who argues that in the long run invention is a necessary precursor to innovation. Unlike some of the other industries studied in this volume, one feature of software development is that it is frequently performed both by suppliers of software packages and services and by users. As a result, software development occurs throughout all industries in the economy, and so to understand the location of inventive activity in software it is insufficient to examine where one or two industries are located. To understand this point further, it is helpful to gain a better understanding of the types of software development activity. The design, installation, implementation, and use of software consist of several phases. Messerschmitt and Szyperski (2002) identify two distinct value chains in software development. First, there is a supply value chain in which software creators develop software artifacts that provide value for the end user. This part of the software value chain consists primarily of design and development activities that can be thought of as software “production.” In the past this role had been played primarily by independent users, third-party programmers, or independent software vendors creating custom software, but over the past 20 years this role has passed increasingly to independent software vendors creating software products. The output of this value chain contains all of what we would traditionally define as software products, such as word processors, operating systems, enterprise software such as enterprise resource planning (ERP) and business intelligence software, as well as middleware software, such as some transaction processing middleware and enterprise application integration. The total value of production in the software product industry was $61,376.9 million in 1997,1 and 195,200 persons were employed in this industry in the same year.2 Firms that operate in 1 Data from the U.S. Bureau of Economic Analysis input-output tables. This figure includes the total value of products made in NIPA industry 511200 (Software Publishers); 1997 is the latest benchmark year for the input-output tables. More recent years do not separate software producers from other information publishers. 2 Data from the Bureau of Labor Statistics (BLS) on the number of employees in the software publishing industry (NAICS 5112), available at http://www.bls.gov/ces/home.htm.
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Innovation in Global Industries: U.S. Firms Competing in a New World - Collected Studies this value chain include all of the well-recognized names that are traditionally regarded as “software” firms, including Microsoft, Adobe, Oracle, and the SAS Institute, as well as smaller firms such as Oblix and Primatech. This value chain also includes the activity of third-party firms involved in custom programming and software analysis and design. Such firms create custom software products for their customers and include firms like CIBER, Inc., Intergraph Corp., and xwave Solutions. The total value created in custom programming and design services was $115,834.6 million in 1997 while total employment was 675,000 in 1997, indicating that both revenue and employment in this sector are greater than that in the packaged software industry.3 Moreover, custom programming and design services are also growing faster than is the software publishing industry. Though 1997 is the last year for which we have data on revenues by industry, we can compare employment growth across these two industries. Employment in custom programming and design services has grown from 675,000 in 1997 to 1,025,300 in 2005, for an average annual growth rate of 5.8 percent. In contrast, employment in software publishing has grown from 195,200 in 1997 to 238,700 in 2005, for an average annual growth rate of 2.5 percent. Second, there is a software requirements value chain in which users add functionality to software to meet their own needs. Users engage in co-inventive activity (Bresnahan and Greenstein, 1996) to translate general-purpose software into a specific application. Such co-inventive activity may include modifications to packaged software applications or development of new applications. However, in business software it also involves changes to business processes or organization design. Activity in this value chain includes both programming by professional programmers and software designers employed by IT-using firms and programming activities performed by users themselves. The activity of both groups is difficult to measure but represents a major share of value created. Scaffidi, Shaw, and Myers (2005) estimate that there were approximately 80 million end-user programmers in 2005,4 compared to 3 million professional programmers. Moreover, occupation data from the United States indicate that over two-thirds of software professionals do not work for IT firms but rather work for IT-using industries.5 Neither this software development activity performed by users nor the work performed by software professionals working for IT users is measured in any systematic statistics. 3 These calculations are based on total sales in custom computer programming services (NAICS 541511) and computer systems design services (NAICS 541512). This latter category may include activities outside of programming, such as IT systems design and integration. A conservative estimate of the value and employment of third-party custom programming services uses only NAICS 541511 and yields estimates of $86,326.8 million and 522,300, respectively. 4 This estimate includes those who create user-developed software that is not sold in markets. 5 Data from BLS Occupational Employment Statistics.
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Innovation in Global Industries: U.S. Firms Competing in a New World - Collected Studies Though systematic evidence is rare, what we do know suggests that economic activity in this value chain is likely to be far greater than that in the supply value chain. According to Gormely et al. (1998), though the typical cost of implementing an ERP application suite is $20.5 million, only $4 million of this cost is related to hardware and software; the rest is due to the costs of implementing and deploying the software within the business. Using data on sales of software products and services in several Western European countries, Steinmueller (2004) estimates that for every €1 spent on software there is an additional €2.36 spent on IT-related business services. However, this estimate is likely a lower bound, because it includes only software services conducted through market transactions and excludes software development activities within IT-using firms themselves. The importance of the software requirements value chain has two implications for the measurement of where inventive activity in software takes place. First, a large part of value creation in software takes place outside of firms that reside in what is considered the software product industry. The value of this activity goes largely unmeasured in traditional government statistics, as it often occurs as a labor expense within firms developing or implementing packaged software. Second, it is very difficult to place a precise definition of what exactly constitutes inventive activity in software. Creation and modification of source code is of course one major component, but so are user modification and business process change. Should these latter activities be included as well?6 Moreover, how should we treat changes to software code that are embedded in IT hardware? Are these hardware or software inventions? As we will discuss next, given available data, a precise estimate of inventive activity in software is probably not feasible. Instead, we provide a variety of metrics that enable us to estimate broad trends and orders of magnitude in economic and inventive activity in software. In the section “Trends in the Location of Value Creation” we provide evidence of recent trends in globalization of software services. These data provide evidence on globalization of activity in the software requirements value chain and some inventive activity conducted by services firms in the supply value chain, though they will largely miss changes in cross-country software service activities that are undertaken by firms outside of the software services industry. In the section “Empirical Evidence on the Location of Inventive Activity” we use U.S. software patent data to examine changes in the global dispersion of inventive activity in software product development. TRENDS IN THE LOCATION OF VALUE CREATION In this section we investigate broad trends in the location of value creation activities in software. We begin with some statistics describing global variation in 6 It is interesting to note that the U.S. Patent Office has struggled with similar definitional issues, within the context of so-called business method patents (Allison and Tiller, 2003).
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Innovation in Global Industries: U.S. Firms Competing in a New World - Collected Studies the exports and imports of software products and services, followed by a qualitative description of recent trends in countries that have been known to be active producers in the market for software products and services. Statistical Trends Software Products Figure 1 shows the percentage of total 2002 software product exports and imports by selected Organisation for Economic Co-operation and Development (OECD) countries. The figure shows that among OECD countries the United States continues to be the leader by a wide margin in the export of software products, accounting for 21.7 percent of total software exports. The next closest country is Ireland, which accounts for 16 percent of software exports. However, as we will discuss in further detail, most of Ireland’s software exports arise from U.S. multinational companies that utilize Ireland as a base of operations to localize FIGURE 1 Percentage of total 2002 software product exports and imports by OECD country. SOURCE: OECD (2004, Table C.1.8; OECD trade in software goods, 1996-2002). Compiled from International Trade Statistics database.
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Innovation in Global Industries: U.S. Firms Competing in a New World - Collected Studies U.S. software products to be shipped to countries in the European Union.7 Since the bulk of software product exports from Ireland are due to U.S. multinationals in Ireland—Sands (2005) shows that over 92 percent of Irish software exports are from foreign firms—this suggests that the share of U.S. software exports in global trade flows is probably closer to one-third rather than the one-fifth that the OECD statistics indicate. Following that, the next largest exporters are Germany (due in part to software exports from ERP giant SAP) and the United Kingdom. No other country accounts for more than 10 percent of software exports. Most notably, Japan accounts for only 2.5 percent of total software exports. Figure 2 presents total packaged software product sales by region. The story here remains the same: North America represents the largest share of packaged software sales, and this percentage has been increasing over time from 47 percent in 1990 to 54 percent in 2001. We explore why other countries have not been more successful in developing software products in further detail in the next section. Software Services Figure 3 shows data from the OECD Economic Outlook (2006) and reports the global share of 1995 and 2004 exports in IT services, obtained by summing the categories “computer and information services” and “other business services” from the IMF Balance of Payments data. Though subject to a variety of caveats about measurement and coverage, Figure 3 suggests that the distribution of IT service exports is more evenly distributed across countries than is the distribution of software product exports. Many smaller countries are experiencing rapid growth in their exports of IT services, though some are starting from a very small base. To explore trends in imports, we use data from the U.S. Bureau of Economic Analysis (BEA) on International Trade in Services. Table 1 provides data on interfirm trade in exports and imports of IT services in 1998 and 2004, calculated by summing the categories “Computer and Information Services” and “Royalties and License Fees.”8 Exports of these services grew from $6,900 million to $10,862 million from 1998 to 2004, while imports grew from $1,992 to $2,591 million from 1998 to 2004. Cross-border exports to and imports from unaffiliated foreign firms of com- 7 Localization activities include activities such as manual translation or adapting software products to local markets. 8 The columns labeled “Computer and Information Services” provide data on exports and imports of private services among unaffiliated firms. The columns, “Royalties and License Fees” in the same table include computer-related services that were delivered to foreign markets through cross-border software licensing agreements. These data do not include intrafirm exports of computer services because BEA does not in general release statistics on many of the countries in Table 1. They also do not include wages of U.S. residents who provide computer services to nonresidents.
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Innovation in Global Industries: U.S. Firms Competing in a New World - Collected Studies FIGURE 2 Packaged software sales by region, 1990-2001 (U.S. dollars). SOURCE: OECD (2002) using International Data Corporation data. Reported in Thoma and Torrisi (2006). FIGURE 3 Top 30 country shares of reported exports of other business services and computer and information services, 1995 and 2004 (2004 data not yet available for all countries). For Hong Kong (China), India, and the Slovak Republic, data are for 2003. Republished with permission from OECD Economic Outlook (2006). Based on IMF Balance of Payments Database, March 2006.
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Innovation in Global Industries: U.S. Firms Competing in a New World - Collected Studies puter and information services are shown in Table 1. Computer and information services (NAICS 518) include the categories computer and data processing services (NAICS 5181) and database and other information services (NAICS 5182). This table was reorganized based on the tables of Business, Professional, and Technical Services with Unaffiliated Foreigners from BEA. Ireland is included in all other EU and is not identified in BEA’s tables. These export and import transactions with unaffiliated foreigners are interfirm transfers, which are traditional trades. Note that “affiliated foreigners” are locally established affiliates of multinational firms. The Asian Tigers consist of Korea, Singapore, Taiwan, and Hong Kong. There are three things to notice about this table. First, at present the numbers are small relative to total U.S. trade in services: exports and imports of software services represent 3.3 and 1.0 percent of total exports and imports of services, respectively. Second, the United States maintains a positive overall balance in trade and services; moreover, over the period 1998-2004 exports of computer services grew at a faster rate than imports (7.86 vs. 4.48 percent average annual growth rate [AAGR]). Third, although imports of computing services from India grew rapidly from 1994 to 2004, overall U.S. imports from India and the other software underdogs are small relative to other estimates. Data from other sources suggest that the U.S. data may underestimate imports of software services. An OECD estimate indicates that over 90 percent of Indian service exports to OECD countries are not accounted for in the data on service imports published by these countries (OECD, 2004). Other analyses report similar difficulties in tracking Indian software services exports to the United States. A recent General Accounting Office (GAO) report notes that, for 2002, the United States reported $240 million in unaffiliated imports of business, professional, and technical (BPT) services from India, whereas India reported about $6.5 billion in affiliated and unaffiliated exports in similar services categories (GAO, 2005).9 For 2003, the United States reported $420 million in unaffiliated imports of BPT services from India, whereas India reported approximately $8.7 billion in affiliated and unaffiliated exports of similar services to the United States. The bulk (40-50 percent) of the difference, according to the GAO, is because the United States does not count the earnings of temporary workers resident in the United States in services imports. Other sources include differences in coverage (e.g., embedded software is counted as exports of goods by the United States, or IT-enabled financial services are not classified as IT services by the United States), and because U.S. data do not indicate affiliated imports by country of origin. As noted earlier, services trade data do not capture intrafirm migration of software activity abroad. The BEA data on U.S. MNCs provide detailed information on the investment and production activities of U.S. companies abroad. 9 Affiliated trade occurs between U.S. parent firms and their foreign affiliates and between foreign-owned firms in the United States and their foreign parent. Unaffiliated trade occurs between U.S. entities and foreign entities that neither own nor are owned by the U.S. entity.
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Innovation in Global Industries: U.S. Firms Competing in a New World - Collected Studies TABLE 1 Computer and Information Services with Unaffiliated Foreigners (million dollars) Years AAGR, 1998-2004 1994 1998 2004 Computer and Information Services Computer and Information Services Royalties and License Fees Total Computer and Information Services Royalties and License Fees Total Computer and Information Services Royalties and License Fees Total Exports All countries 2,332 3,705 3,195 6,900 6,601 4,261 10,862 10.10 4.92 7.86 Canada 333 430 125 555 1,144 279 1,423 17.71 14.32 16.99 Europe 899 1,767 1,508 3,275 3,281 1,328 4,609 10.87 −2.10 5.86 Japan 177 306 724 1,030 327 1,568 1,895 1.11 13.75 10.70 Asian Tigers 117 200 … … 163 … … −16.34 … … Underdogs Brazil 48 136 ... ... 149 81 230 1.53 .... ... Israel 51 24 32 56 38 13 51 7.96 −13.94 −1.55 China 17 29 46 75 48 51 99 8.76 1.73 4.74 India 9 38 17 55 227 29 256 34.70 9.31 29.21 Imports All countries 286 1,494 498 1,992 2,002 589 2,591 5.00 2.84 4.48 Canada 34 589 9 598 1,189 12 1,201 12.42 4.91 12.32 Europe 122 259 449 708 400 562 962 7.51 3.81 5.24 Japan 20 41 26 67 15 1 16 −15.43 −41.90 −21.23 Asian Tigers 6 18 … … 31 … … 55.98 … … Underdogs Brazil 1 1 1 2 1 ... ... 0.00 ... ... Israel 0 9 2 11 7 3 10 −4.10 6.99 −1.58 China 2 6 ... ... 7 ... ... 2.60 ... ... India 7 100 ... ... 315 6 321 21.07 ... ... NOTE: Omitted cells include either transactions below $500,000 or data that were omitted to maintain confidentiality. AAGR, average annual growth rate. SOURCE: BEA Data on U.S. International Trade in Services.
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Innovation in Global Industries: U.S. Firms Competing in a New World - Collected Studies Table 2 shows that growth in employment in IT services and computer design industries has been faster for foreign affiliates of U.S. firms than for their domestic operations (AAGR 5.1 vs. 3.9 percent) due to faster growth among foreign affiliates in computer design and related services. Financing of Software Products and Services Table 3 includes data on one of the inputs to software product and service firms: financial capital. It includes data on disclosed rounds of venture capital financing by year and by destination country as reported in the Venture Economics VentureXpert database. As is well known, venture financing exhibits significant yearly variation (e.g., Gompers and Lerner, 2006) and our data may not capture all venture financing rounds. However, some broad trends are suggested. First, similar to our data on inventive outputs (described in further detail later), the United States clearly dominates in inputs of financial capital to emerging software firms. However, based on data from 2002-2005, there is some evidence that rounds of venture financing to the software underdogs declined less from their 2000 peak than did financing to U.S. firms.10 However, there was an apparent decline in venture financing to these countries in 2005. In short, more years of data are needed to discern whether there is a trend of increasing venture capital financing to the software underdogs. Regional Trends in Packaged Software and Software Services In the previous section we showed that the United States represents the majority of world sales in packaged software. However, other regions of the world have a large and increasing percentage of software services. In this section we discuss some regional trends that are partially responsible for the geographic variance in economic activity in packaged software and services. Software Producers in Europe and Japan In Western Europe, the software industry has long been dominated by custom software development and software services (Malerba and Torrisi, 1996; Steinmueller, 2004). Table 4 shows sales of software products and IT services in the EU15 during 2003-2005.11 IT professional services such as consulting, implementation, 10 The software underdogs consist of India, Ireland, Israel, Brazil, and China. 11 The EU15 comprised the following 15 countries: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Netherlands, Portugal, Spain, Sweden, and the United Kingdom.
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Innovation in Global Industries: U.S. Firms Competing in a New World - Collected Studies TABLE 2 Growth in Employment for Foreign Affiliates of U.S. Firms vs. Growth for All U.S. Establishments, Selected Industries, 1999-2002 1999 2002 AAGR Information services and data processing services Foreign affiliates of U.S. firms 104.5 132.0 8.1 All U.S. establishments 371.9 473.8 8.4 Computer system design and related services Foreign affiliates of U.S. firms 157.9 172.9 3.1 All U.S. establishments 997.0 1,061.3 2.1 Total Foreign affiliates of U.S. firms 262.4 304.9 5.1 All U.S. establishments 1,368.9 1,535.1 3.9 NOTE: AAGR, average annual growth rate. SOURCE: Data on foreign affiliates of U.S. firms from table on selected data for majority-owned nonbank foreign affiliates and nonbank U.S. parents in all industries, 2003. From BEA International Economic Accounts, U.S. Direct Investment Abroad: Financial and Operating Data for U.S. Multinational Companies. Data on all U.S. establishments from U.S. County Business Patterns data. TABLE 3 Disclosed Rounds of Venture Financing by Country, 1988-2005 (thousands of dollars) United States Other G-7 Underdogs All Other Total 1988 2,565 660 0 0 3,225 1989 15,000 2,465 0 0 17,465 1990 6,350 464 248 0 7,062 1991 1,100 0 0 0 1,100 1992 1,607 1,418 0 0 3,025 1993 15,247 582 0 0 15,829 1994 7,403 138 0 0 7,541 1995 14,340 0 0 0 14,340 1996 92,784 1,466 0 2,766 97,016 1997 242,873 0 0 7,049 249,922 1998 300,355 9,359 0 6,039 315,753 1999 1,068,310 68,011 28,666 21,102 1,186,089 2000 2,036,591 221,297 73,307 169,636 2,500,830 2001 460,911 83,944 32,256 16,629 593,740 2002 99,836 23,295 6,831 3,815 133,777 2003 173,205 14,607 15,251 167 203,230 2004 151,025 9,492 10,600 1,848 172,965 2005 138,428 2,000as 2,000 59 142,487 SOURCE: Venture Economics VentureXpert database, and author’s calculations. Software includes rounds of financing from software and e-commerce software firms. Dates are round date of financing.
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Innovation in Global Industries: U.S. Firms Competing in a New World - Collected Studies TABLE 9 Output of Engineering Graduates (B.S. and B.E.) in India, Various Years Year Total Number of Engineering Graduates Produced 1990 42,022 1991 44,281 1992 46,762 1993 48,281 1994 52,905 1995 56,181 1996 57,193 1997 61,353 1998 67,548 1999 75,030 2000 79,343 2001 97,942 2002 107,720 2003 128,432 NOTES: These data are based on the figures for the 14 major states (except the State of Bihar) in India, which account for 80% of the gross domestic product and likely more than that number of the total production of engineering graduates. These data are based on “Annual Technical Manpower Review” (ATMR) reports published by National Technical Manpower Information System (NTMIS), India. These reports are prepared by a state-level nodal center of NTMIS and give details of sanctioned engineering college capacity and outturn for all undergraduate technical institutions in the state. See cited source for more details. SOURCE: Arora and Bagde (2006). Labor Market Trends There is some evidence that growth in the number of computer science degrees awarded over the past 25 years has not been fast enough to keep pace with demand for workers with computer science training. Figure 17 shows that the annual growth rate in the production of all mathematics and computer science degrees averaged 4.2 percent during the period 1980-2000, significantly less than the average annual growth of 9.3 percent in occupations directly associated with these fields.29 In comparison, over the same period, growth of all science and engineering graduates (including math and computer science) averaged 1.5 percent while growth in all science and engineering occupations averaged 4.2 percent (Table 10). Thus, the difference between degree growth and employment growth is larger in mathematics and computer science than it is for science and engineer- 29 Occupational data from these figures were compiled by the National Science Foundation, Division of Science Resources Statistics, from U.S. Census data.
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Innovation in Global Industries: U.S. Firms Competing in a New World - Collected Studies FIGURE 16 U.S. graduate enrollment in computer science by citizenship. SOURCE: Science and Engineering Indicators 2006. FIGURE 17 Average annual growth of degree production and occupational employment in mathematics and computer science, 1980-2000. SOURCE: Science and Engineering Indicators 2006.
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Innovation in Global Industries: U.S. Firms Competing in a New World - Collected Studies TABLE 10 Output of Engineering Graduates (B.S. and B.E.) in India, Various Years Degree Growth Employment in Occupation All science and engineering 1.5 4.2 Mathematics/computer science 4.2 9.3 NOTES: Degree growth includes undergraduate, master’s, and doctoral degrees. SOURCE: Science and Engineering Indicators 2006. ing overall. These data are now several years old and do not account for students receiving degrees from outside of computer science but moving into computer science professions. However, despite these qualifications, they do suggest that the United States may have relied in part on workers from abroad to make up for the shortfall of native workers with computer and math skills. Recent data suggest that the inflation-adjusted median salaries for master’s graduates in mathematics and computer science rose 54.8 percent between 1993 and 2003, higher than any other broad class of science and engineering graduates and higher than the average across all non-science and engineering graduates.30 Growth in salaries was similarly competitive for graduates with bachelor’s degrees (28.0 percent AAGR, second only to engineering graduates among science and engineering graduates) and those with doctoral degrees (18.6 percent AAGR, second only to graduates in engineering and physical sciences among science and engineering graduates). Furthermore, 2003 median salaries for computer science master’s graduates are higher than any other broad category of science and engineering graduates ($80,000), whereas levels for bachelor’s ($50,000) and doctoral ($67,000) degree graduates remain similarly competitive. Thus, even when one uses data that include the recent technology downturn, salaries of occupations requiring skills in mathematics and computer science have remained quite competitive when compared to other occupations in science and engineering and compared to the national average. As noted earlier, there has been a significant shortfall in the rate of computer science degrees conferred relative to the rate of employment growth, and this excess demand for workers with computer science and engineering skills has been partially offset by the immigration of skilled workers from abroad. In fiscal year 2001 there were 191,397 H-1B visa admissions to the United States from computer-related occupations, 57.8 percent of total such admissions and 30 The source for these data is the National Science Foundation, Division of Science Resource Statistics, National Survey of College Graduates.
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Innovation in Global Industries: U.S. Firms Competing in a New World - Collected Studies the largest of any such category.31 Kapur and McHale (2005a) list the top companies that petitioned for H-1B visas in October 1999 through February 2000, a list that includes some of the leading IT hardware and software firms: Motorola (618 petitions), Oracle (455 petitions), Cisco (398 petitions), Mastech (398), Intel (367), Microsoft (362), Rapidigm (357), Syntel (337), Wipro (327), and Tata Consulting (320). Changes in immigration represent one mechanism that has the potential to affect the U.S. software industry in the relatively short term, and recent changes in the environment outside the United States can potentially affect immigration flows. The rapid growth in the software industries of countries like India and Ireland has increased the attractiveness of those countries to highly skilled indigenous workers. This has been particularly evident in Ireland, where rapid growth has encouraged an increasing number of highly skilled workers to remain in Ireland or return to Ireland from the United States. Kapur and McHale (2005a) report that emigration of male Irish graduates fell from about 25 percent in 1987 to under 15 percent in 1997, with similar trends for female graduates. Of the 644,444 Irish who had spent one year outside of Ireland in a 2002 census, 42 percent reported taking up residence in Ireland between 1996 and 2002, suggesting that a large fraction are recently returning Irish (Kapur and McHale, 2005a).32 With the continuing growth of the software industries in India and Ireland, it is likely that these historically important sources of highly skilled software professionals will retain a growing fraction of their indigenous software workers. Moreover, as noted by Kapur and McHale (2005b), the international market for software professionals is increasingly competitive. Richer countries such as the United States, Canada, Australia, Germany, and the United Kingdom increasingly compete for talent from other countries. In many cases, this competition has manifested itself as a decline in the traditional barriers to short- and long-term migration (Kapur and McHale, 2005b). This competition is likely only to increase with the aging demographics of these countries as well as the increasing requirements for a skilled workforce in software and in other industries. Federal Government Spending on Software R&D U.S. federal government investment in computer hardware and software R&D is thought to be one of the contributing success factors to both industries (Flamm, 1988; Langlois and Mowery, 1996). Early government R&D investment in software provided the computer facilities for universities to conduct early software research (Langlois and Mowery, 1996) and federal agencies such as 31 Administrative data from the U.S. Department of Homeland Security, Bureau of Citizenship and Immigration Services. 32 These data include migration of Irish citizens that have returned after studying in U.S. universities, including those studying for computer science degrees.
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Innovation in Global Industries: U.S. Firms Competing in a New World - Collected Studies National Aeronautics and Space Administration (NASA) and Defense Advanced Research Projects Agency (DARPA) have been long-standing supporters of computer-related research. Federal grants remain a major source of funding for doctoral students in computer science: in 2003, 17.4 percent of full-time computer science graduate students reported that their primary source of funding was from the federal government.33 In the 1990s, though funding from the Department of Defense had largely flattened out, R&D spending grew rapidly throughout the decade through expanded funding from agencies such as the Department of Energy and NSF. However, over the period 2001-2003 (the most recent data available), government R&D spending in computer science remained largely flat. Moreover, the percent of total R&D spending on computer science (relative to other fields) declined over the period 2001-2003, from 4.5 to 4.0 percent.34 We discuss the implications of these spending patterns in the next section. CONCLUSIONS AND IMPLICATIONS Public Policy Implications The trends that we have described in this paper have several public policy implications. First, our results have provided evidence of a sizable export-driven software services sector in countries like India and Ireland, though there is less evidence of substantial inventive activity in software going on outside of the United States. These results suggest that entry- and mid-level programming jobs can be performed away from the point of final demand, though inventive activity that requires proximity with lead users is most effectively done in the United States. However, these entry- and mid-level programming jobs have traditionally provided U.S. IT workers with the skills needed to perform more complicated development activities such as creation of new software programs (Levy and Murname, 2004). In other words, training by U.S. firms has traditionally bestowed a beneficial externality upon entry-level workers by providing them with general human capital that workers appropriate later in their careers. This human capital is not easily provided by traditional publicly funded primary or secondary school education programs (Levy and Murname, 2004). As a result, a declining demand for entry-level programming jobs could hurt U.S. workers’ future ability to perform more complex software development activity (e.g., new packaged software development). If this is true, then there are two ways that U.S. workers could obtain the general human capital needed. One would be for U.S. workers 33 National Science Foundation, Division of Science Resource Statistics, Survey of Graduate Students and Postdoctorates in Science and Engineering, WebCASPAR database (Science and Engineering Indicators, 2006). 34 Science and Engineering Indicators 2006.
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Innovation in Global Industries: U.S. Firms Competing in a New World - Collected Studies to internalize the externality by accepting jobs for lower salaries. Of course, in the short run, workers may prefer instead to accept jobs in other (relatively higher-paying) fields. Alternatively, the government could attempt to subsidize entry-level employment, for example, by raising the costs of H-1B visas or by direct labor market subsidies. However, if the cost of remote software development remains lower than that in the United States, then clearly implementation of this policy may be problematic. We have provided evidence of recent declines in computer science enrollments at the graduate and undergraduate levels. In our view, it is too soon to speculate whether these changes are evidence of a new trend or instead reflect temporary student reactions to business cycle fluctuations, particularly the IT downturn that began in the early part of this decade. Still, there is evidence that for some time, U.S. software developers have been using skilled labor from abroad as inputs into their innovation production function, presumably in part to supplement the pool of skilled labor available locally. As noted earlier, there is increasing competition from other industrialized countries for these skilled workers, and there is no sign that this competition will abate in the near future. Decreasing the costs of H-1B visas or lowering the costs of permanent migration is unlikely to be feasible in the short run because of the aforementioned concerns of labor substitution between foreign and indigenous workers. As a result, ensuring an adequate supply of local workers with sufficient basic or enabling skills (Levy and Murname, 2004) in mathematics, computer science, and related fields taught in the nation’s school and university system will be important to the long-term success of software producers in the United States. Another area of public policy concern is in government funding of computer science research. As noted earlier, federal funding of computer science has flattened out in recent years. A continuation of this trend could negatively impact innovative activity in software in the United States in two ways: by decreasing an important source of financial capital for basic research as well as potentially accentuating the negative downturn in enrollments in computer science graduate programs in the United States through a decline in graduate student funding. Summary and Conclusions There are currently two very different stories in the globalization of software development. On the one hand, the IT services industries in countries such as India, Ireland, and other countries continue to grow rapidly. The production of IT services is quite dispersed globally, and this dispersion will only increase over time. In contrast, both sales and inventive activity in packaged software are localized in the United States and undertaken primarily by U.S. firms. While differences in the levels of patent activity across countries should be interpreted with some caution because of divergence between the rate of patenting and inventive activity, examination of patent growth rates is less subject to these concerns
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Innovation in Global Industries: U.S. Firms Competing in a New World - Collected Studies and they show there is no sign of these trends reversing in the short to medium term. Recent trends in computer science enrollments have attracted considerable attention in the popular press. We do find evidence of some declines in enrollments in U.S. computer science in recent years.35 However, of likely equal or greater importance in the short run may be the increasing incentives for skilled foreign workers to remain in their home countries or to depart from the United States immediately or some years after degree conferral. There is already some evidence that improving educational systems and employment opportunities in the underdog countries is causing some skilled software professionals to remain at home or to return. Nonetheless, there are powerful forces at work that are likely to keep the development of new software products and software innovation concentrated in the United States for some time to come. Despite recent trends, the United States continues to have the best postsecondary educational systems in the world for training computer scientists, and it continues to enjoy substantial albeit declining inward migration that benefits the software (and other) industries. Beyond the education and human capital issues, U.S. software innovators continue to enjoy substantial advantages due to agglomeration economies arising from the preexisting concentration of the industry, as well as a generally favorable business environment. Perhaps the most significant advantage that U.S. software product innovators enjoy is proximity to lead users. U.S. firms have been among the most innovative users of IT in the world, and these users have benefited U.S. software producers in the past and will continue to do so for some time to come. ACKNOWLEDGMENTS We thank Jeffrey Macher and David Mowery for their comments and suggestions, and Nicholas Yoder and Kristina Steffenson McElheran for outstanding research assistance. REFERENCES Allison, J., and E. Tiller. (2003). Internet business method patents. Pp. 259-257 in Patents in the Knowledge-Based Economy, W. M. Cohen and S. A. Merrill, eds. Washington, D.C.: The National Academies Press. Allison, J., A. Rai, and B. N. Sampat. (2005). University Software Ownership: Trends, Determinants, Issues. Working Paper, Columbia University. Anchordoguy, M. (2000). Japan’s software industry: A failure of institutions? Research Policy 29:391-408. 35 In graduate programs these declines appear to be concentrated primarily among immigrants. Among undergraduate degree programs current data are not available to indicate whether these declines are from U.S. nationals or immigrants.
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