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J Foreign Participation in Privately Funded U.S. R&D Foreign participation in privately funded U.S. R&Di has grown rapidly since the early 1980s. This growth is primarily the result of a surge in direct investment by foreign entities in existing or newly established manufacturing facilities based in the United States. During the 1980s, foreign investors nearly tripled their ownership share from 7.2 to 19.2 percentof U.S. manufacturing assets (Graham and Krugman, 19951. Also during this period, U.S.-based affiliates of foreign-owned firms increased their share of total private U.S. R&D spending from 6.4 percent (in 1980) to 14.5 percent (in 1992~.2 A second major source of growing foreign involvement in privately funded U.S. R&D has been the proliferation of international alliances. Be- tween 1980 and 1989, U.S. companies entered into over 1,500 technical alli- ances with European and Japanese firms in it&D-intensive industries, such as microelectronics, telecommunications, aerospace, and pharmaceuticals (Hagedoorn and Schakenraad, 19931. The rapid growth of foreign participation in privately funded U.S. R&D has generated four major concerns related to the economic welfare and military secu- rity of U.S. citizens. First, foreign-owned companies and their stakeholders abroad may be ex- tracting more intellectual property and associated economic value from the United States than they contribute to it. Second, U.S.-owned companies may not enjoy reciprocal access to privately funded R&D activities and assets abroad. These asymmetries of access may put U.S.-owned companies at a competitive disadvantage, thereby penalizing their U.S. stakeholders. 39

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40 FOREIGN PARTICIPATION IN U.S. RESEARCH AND DEVELOPMENT Third, the rapid increase in foreign direct investment in U.S.-based high- technology companies may leave the nation hostage to a small number of for- eign-controlled suppliers for technically advanced components and subsystems critical to U.S. military security. Furthermore, growing foreign direct investment and international corporate alliances may make it increasingly difficult for the United States to prevent the transfer of militarily sensitive technology to potential enemies. Fourth, it is possible that increased foreign direct investment and trans- national alliances in high-technology industries will foster monopolies. Such monopolies might injure U.S. consumers and compromise U.S.-based compa- nies' access to key components and subsystems they require to make their prod- ucts competitive with those produced abroad. In an effort to assess the validity and significance of these and related issues, the following discussion explores the causes, scope, and nature of growing for- eign participation in privately funded U.S. R&D. THE CAUSES OF GROWING FOREIGN PARTICIPATION Three related trends have fostered the recent surge of foreign participation in privately funded U.S. R&D:3 The increase in foreign industrial, financial, and technological strength compared to that of the United States; The internationalization and changing nature of competition and innova- tion in most manufacturing and service industries; and Recent U.S. trade and technology policies that have raised barriers to for- eign imports of it&D-intensive products and restricted foreign access to U.S. research in certain critical-technology areas. Collectively, these developments have provided powerful economic, techno- logical, and political incentives for foreign-owned firms to access U.S. markets and technological capabilities. The rapid expansion in the number of foreign firms with the requisite techni- cal and financial resources to exploit as well as contribute to U.S.-based R&D activities has been a key aspect of the trend. The growing presence of foreign multinationals in the U.S. economy reflects a general narrowing of the gap in scientific and technological capabilities between the United States and other in- dustrialized countries. Since the mid-1970s, many foreign companies have suc- cessfully entered the U.S. market by utilizing both their unique organizational and technological strengths as well as their newfound financial clout. (See Chap- ter 1, Table 1.1.) Reflecting the growing commercial importance of technology, industrial de-

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PRIVATELY FUNDED R&D 41 mend for scientists and engineers has outstripped the supply of these profession- als in some countries, most notably Japan. This, in turn, has provided another impetus for foreign-owned multinational companies to locate advanced techno- logical activities in the United States, where there is an abundance of scientific and engineering talent (Hakanson and Zander, 1988; Serapio, 1994~. Intense global competition, shortening product life cycles, the growing com- plexity of technologies, and spiralling R&D costs have also fostered the interna- tionalization of industrial R&D. Today, firms in most it&D-intensive industries must compete in all major international markets as well as exploit worldwide economies of scale and sources of innovation. In this evolving global competi- tion, firms need the ability to respond quickly to and anticipate customer needs and wants across highly diverse national markets. To achieve this objective, more and more it&D-intensive companies are locating production facilities and a range of advanced technological capabilities, including R&D and design, in the foreign markets they wish to serve.4 The increasingly rapid, interdisciplinary, and costly nature of technological advance in many industries demands that firms seek out and acquire technology developed elsewhere. Yet, the very pace and complexity of technological ad- vance in many industries has made it difficult for firms based in one country to effectively assess and acquire technology developed in another without establish- ing an R&D capability within the nation of interest. The United States has be- come a prime target of foreign multinational activity because of the sheer size, wealth, and sophistication of its domestic market, the strength of its basic re- search enterprise, and its unrivaled capacity for incubating new industries and products (National Academy of Engineering, 1993~. In addition to these economic and technological factors, U.S. trade and tech- nology policies have also provided incentives for foreign firms to expand their manufacturing and R&D presence in the United States. Many analysts believe that existing or threatened nontariff barriers to trade, such as voluntary export restraints, buy-American procurement laws, and domestic-content requirements, have fostered the growth of foreign direct investment in production facilities and subsequently in R&D in some U.S. industries, including steel, automobiles, elec- tronics, and telecommunications equipment. Efforts by the federal government to prevent or regulate foreign access to certain areas of commercially promising U.S. R&D, particularly government-funded R&D, also appear to have encour- aged foreign firms to establish or acquire U.S.-based R&D facilities and enter into marketing and technical alliances with U.S.-owned companies (Chesnais, 1988; Mowery, 1991; Serapio and Dalton, 19941.5 Responding to many of the same factors that have pushed their foreign coun- terparts into U.S. markets, U.S.-owned companies are looking increasingly to foreign firms and markets both as potential customers and as sources of comple- mentary capital, manufacturing capability, and technology.6

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42 FOREIGN PARTICIPATION IN U.S. RESEARCH ED DEVELOPMENT FOREIGN DIRECT INVESTMENT Foreign direct investment has been the principal way foreign firms and indi- viduals have become involved in privately funded U.S. R&D.7 Between 1982 and 1992, the cumulative stock of foreign direct investment in the United States grew from $124.7 billion to $430.2 billion. As a share of the total net worth of U.S. nonfinancial corporations, this type of investment increased more than three- fold during the decade, from 3.5 percent to 11.6 percent (Graham and Krugman, 19951. Roughly 80 percent of foreign direct investment in the United States during this period was used to acquire existing U.S.-based businesses; the re- maining 20 percent went to establish new businesses.8 In U.S. manufacturing industries, which account for nearly 90 percent of total U.S. industrial R&D expenditures, the growing importance of foreign direct investment has been even more pronounced. In 1982, U.S. affiliates of foreign- owned companies accounted for 9.8 percent of U.S. manufacturing assets, 6.6 percent of manufacturing employment, and 7.3 percent of manufacturing value- added. By 1991, affiliates claimed 19.2 percent of manufacturing assets, and by 1992, they accounted for 11.6 percent of employment and 15 percent of value- added in U.S. manufacturing industries (Graham and Krugman, 1995; U.S. De- partment of Commerce, 1994b). As foreign direct investment in U.S. industries has increased, so too has the share of industrial R&D funded by U.S. affiliates of foreign-owned firms. From 1982 to 1992, affiliates' share of spending on private-sector U.S. R&D increased from 9.3 percent to 14.5 percent (Figure 3.1~. Over this period, R&D spending by affiliates grew nearly twice as fast as did the domestic R&D expenditures of all U.S.-based companies.9 In 1992, U.S. affiliates of foreign-owned firms per- formed $13.7 billion worth of R&D, employed 104,500 people in U.S.-based R&D activity, and accounted for 12 percent of U.S. jobs in high-technology manu- facturing industries (Florida, 1994; U.S. Department of Commerce, 1993a, l995a).~ As of 1993, foreign nationals owned 1,482, or 6.5 percent, of the nearly 23,000 U.S.-based companies active in high-technology fields (Table 3.1~. Affiliate R&D Expenditures In 1992, U.S. affiliates of European-owned manufacturers accounted for roughly two-thirds of all affiliate expenditures on U.S. R&D. British-owned af- filiates accounted for 15.9 percent of such spending, followed by the Swiss at 15.8 percent, the Germans at 14.4 percent, and the French at 9.3 percent. U.S. affiliates of Canadian companies accounted for 15.7 percent of R&D expendi- tures, and spending by Japanese-owned affiliates represented 12.1 percent of the total. Spending by Japanese-owned affiliates on U.S. R&D has increased much more rapidly than that of other major investing countries since the early 1980s (Table 3.2~.

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PRIVATELY FUNDED R&D TABLE 3.2 R&D Spending by U.S. Affiliates of Foreign-Owned Companies, Volume and Percent of Total by Country, 1980, 1985, and 1992 45 1980 Percent $ Millionsa of Total $ Millionsa 1985 Percent 1992 Percent of Total $ Millionsa of Total United Kingdom 312 16.0 748 14.3 2,178 15.9 Gerrnanyb 380 19.5 671 12.8 1,968 14.4 Switzerland 338 17.4 625 11.9 2,159 15.8 France 146 5.4 166 3.2 1,272 9.3 All Europe 1,544 79.3 2,918 55.7 8,956 65.4 Canada 135 6.9 1,550c 29.6 2,151 c 15.7 Japan 88 4.5 267 5.1 1,656 12.1 aCurrent dollars. bGerman data are for the former West Germany only. CData include roughly $1 billion of R&D spending by Du Pont, a U.S. majority-owned company in which the Canadian company Seagrams held roughly 20 percent equity. Seagrams sold its holdings in Du Pont in 1995. SOURCE: National Science Board (1993); U.S. Department of Commerce (1995a). Audio, video, and communications 8.4 Electronic components 2.0 Instruments and - related products 4.4 Wholesale and retail trade 6.7 Services ~ 4.6 / Petroleum 4 ~ Primary and fabricated metals Computer and 2 5 office equipment , I 5.5 k~.~...~..~-~.-.~--~-~ ~~..~ If.-.. . ~ . ~ S?SiS-: S.~:SiS ~ S., ,:. ~ , ~ i, ,~ I, i, i, S ~ ~ So _ :~:22~, ~ ~ -it ~ /' All other non manufacturing 1.1 All other manufacturing 17.0 Pharmaceuticals / 24.8 ,~ ~ Industrial chemicals 17.0 \ \ Food and kindred products 1.8 FIGURE 3.2 U.S. affiliates of foreign-owned firms, percent of total, by industry, 1992. SOURCE: U.S. Department of Commerce (199Sa).

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PRIVATELY FUNDED R&D Industrial chemicals Pharmaceuticals Computers and office equipment Audio, video, and communications equipment Electronic components Instruments and related products Other transportation equipment Total high technology 47 0 10 20 30 1 987 3 1992 ,,,, 1, 1 1 1 1, 1 40 50 60 FIGURE 3.3 R&D spending by U.S. affiliates of foreign-owned firms in U.S. high- technology industries as a percentage of all privately funded U.S. R&D, 1987, and 1992. SOURCE: National Science Board (1993), National Science Foundation (1996~; U.S. Department of Commerce (199Sa). industries, Japanese-owned affiliates claimed the largest shares of R&D spending and sales. For the most part, data on foreign direct investment and on R&D spending by U.S. affiliates indicate that foreign parent companies have invested in areas in which they have a demonstrated competitive advantage (U.S. Depart- ment of Commerce, 1993a. Sector-by-sector comparisons of R&D spending by affiliates as a share of all privately funded U.S. R&D show considerable variations among industries (Fig- ure 3.3~. Overall in 1992, affiliate spending accounted for 19.3 percent of the total invested by U.S. high-technology companies in R&D. U.S. affiliates of foreign companies accounted for the largest share of total U.S. R&D expendi- tures in industrial chemicals (47.5 percent) and pharmaceuticals (42.7 percent). Affiliate spending on audio, video, and communications equipment R&D (33 percent of the total) also represented a significant share of U.S. R&D expendi- tures in that industry. Affiliates' shares of private-sector R&D spending in elec- tronic components, instrumentation, and in computers and office equipment were 8.1, 8.2 and 7.2 percent, respectively. U.S. affiliates of foreign-owned companies also accounted for a significant proportion of U.S. privately-funded R&D in several other sectors, including the

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48 FOREIGN PARTICIPATION IN U.S. RESEARCH AND DEVELOPMENT primary metal industry (37.2 percent), the fabricated metal products industry (20.2 percent), the petroleum industry (25.4 percent), the nonelectrical machinery in- dustry (10.1 percent), and the food and kindred products industry (17.8 percent). In the automotive industry, affiliates accounted for less than 4 percent of total privately funded U.S. R&D (National Science Foundation, l995b; U.S. Depart- ment of Commerce, 1995a).l2 Organization and Character of Affiliate R&D Activity The R&D activities of U.S. affiliates of foreign-owned companies generally are of three types. First, there is R&D performed by freestanding facilities. Their activities range from basic research and product development to general technical support. These facilities are engaged primarily in R&D, operate under their own budgets, are overseen by their own group of officers, and are located separately from other U.S. facilities of the parent company (Dalton and Serapio, 1993, 1995~. Second, there is R&D predominantly development engineering performed within the business units of U.S.-based manufacturing affiliates. Generally, this R&D is managed by the manufacturing facility or business unit to provide gen- eral technical and organizational support to production. Third, there is R&D performed by third-party contractors to foreign-owned companies. Such contrac- tors may include universities and public- and private-sector laboratories. Few data have been collected on the scope and nature of R&D that supports the U.S. manufacturing affiliates of foreign-owned firms or on the amount of R&D that affiliates contract out to unaffiliated U.S.-based companies.~3 Con- tracting between affiliates and U.S. universities and federal laboratories is exam- ined in detail in Chapter 4. The following discussion focuses on the first type of affiliate R&D, that which is performed in freestanding laboratories. These facili- ties account for the majority of all affiliate expenditures on R&D and have been more extensively inventoried and evaluated (Dalton and Serapio, 1993, 1995; Directory of American Research and Technology, 1994; Florida and Kenney, 19931.14 Freestanding Industrial R&D Facilities Research by Dalton and Serapio (1995) documents that as of 1994, nearly 301 foreign companies had established 645 freestanding R&D facilities in the United States. Of these, 375 were owned by European companies, 225 by Japa- nese companies, 27 by Korean companies, and 8 by Canadian companies (Figure 3.4~. Two industries pharmaceuticals and biotechnology, with 115 facilities, and chemical, rubber and materials, with 110 facilities accounted for more than one-third of all freestanding R&D operations. Another third of all such facilities (238 in total) was in industries in the electronics and information technology fields. The remaining third was dominated by three industry groups automo-

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PRIVATELY FUNDED R&D 4 200 49 Europe Japan Korea Canada Other FIGURE 3.4 Number of freestanding R&D facilities in the United States owned by foreign parent companies, 1992. SOURCE: Dalton and Serapio (1995~. tive (53 facilities), instrumentation (43 facilities), and foods, consumer goods, and miscellaneous (55 facilities) (Figure 3.5~. Japanese firms owned 50 percent or more of all freestanding R&D facilities in 6 of the 13 major industrial group- ings defined by Dalton and Serapio. European firms owned the vast majority of facilities in six industry areas (Table 3.4~. In terms of the size of their professional staff, the largest foreign R&D facili- ties are in pharmaceuticals and biotechnology (Table 3.5~. On average, Japanese R&D facilities in the United States are much smaller than those of their European counterparts. Limited 1993 data on freestanding R&D centers (excluding those in the automotive industry) show an average staff size of 160 at European facili-

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PRIVATELY FUNDED R&D 79 ductor, semiconductor manufacturing equipment, and computer industries (U.S. General Accounting Office, l991b). Without timely access to these technolo- gies, most U.S. companies in these industry sectors could not sewe as effectively as they might the needs of their worldwide customers. The effect on the Japanese firms involved is less clear. Their growing involvement in U.S.-based R&D ac- tivity in these industries, through direct investment or joint ventures, may have either enhanced or weakened their ability to manipulate the market to gain com- mercial advantage (National Research Council, 1992c). Furthermore, broader concerns have been raised about the long-term effects of foreign acquisitions of U.S. niche technology companies or high-technology start-ups on the ability of U.S.-owned companies to access emerging critical ci- vilian technologies. Much more than any other industrialized country, the United States has relied since World War II on technology niche companies for a dispro- portionate share of major product and process innovation (Mowery and Rosenberg, 1993~. Since the mid-1980s, foreign acquisitions of these firms ap- pear to have increased significantly. Data gathered by Spencer (1991) and the U.S. Department of Commerce (1993a) underline the particularly large appetite of Japanese investors for U.S. high-technology start-up companies during the late 1980s and early 1990s (Table 3.9~. These data also suggest that foreign investors have targeted U.S. companies in a select number of technology areas deemed critical or emerging by the U.S. government (Council on Competitiveness, 1991; National Critical Technologies Panel, 1993; U.S. Department of Commerce, 1990~. Still, inventories of foreign acquisitions of U.S. high-technology firms offer little if any insight into the relative importance of the technological capabilities acquired, let alone the cumulative effect of these purchases on the nation's capa- bilities in a given area of technology. For example, such data do not provide information on sales, assets, or employment for either the firms acquired or their niche industrial sector. Nor do these data shed any light on the performance of the acquired firms subsequent to their takeover. Without such information, it is impossible to assess the extent and significance of foreign control in any high- technology niche sector. Many high-technology industries are already highly concentrated at the na- tional and global levels. Hence, it is likely that at least some of the many recent mergers and acquisitions have significantly reduced competition in particular civilian industry sectors. For this reason, the committee believes that the federal government should intensify its scrutiny and regulation of all U.S.-based merg- ers and acquisitions. However, there is no evidence to suggest that foreign- owned firms are any more likely than their U.S.-owned counterparts to engage in anticompetitive activity in the United States. Indeed, in terms of the sheer number of acquisitions and mergers concluded in U.S. technology-intensive in- dustries each year, foreign acquisitions are dwarfed by those involving U.S.- owned firms.

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PRIVATELY FUNDED R&D 8 SUMMARY During the past decade, foreign participation in privately funded U.S. R&D has grown significantly, both through direct investment and intercorporate tech- nical alliances. In 1990, U.S. affiliates of foreign-owned firms accounted for a sizeable fraction (20 percent or more) of U.S.-based R&D activity in several large manufacturing industries. These included industrial chemicals, pharmaceu- ticals, audio, video, and communications equipment, and primary and fabricated metals. Roughly two-thirds of total affiliate R&D spending in the United States is accounted for by companies based in Canada, the United Kingdom, Germany, Switzerland, and Japan. Since 1980, Japanese-owned affiliates have increased their share of total affiliate R&D activity faster than has any other major investing coun- try. For the most part, foreign parent companies have invested in areas in which they have a strong export position or demonstrated competitive advantage. Comparative surveys of U.S.- and foreign-owned multinational companies across a range of industries suggest that the motives for engaging in R&D in a foreign market, as well as the type of R&D activity, vary in importance primarily according to the industry sector, not the company's nationality. Overall, the two most frequently cited motives are to help the local manufacturing affiliate and the parent company meet the demands of U.S. customers, and to improve access to U.S. scientific and technical talent. Most major foreign-owned R&D facilities are clustered near major U.S. cen- ters of R&D activity, and most affiliate R&D performed in the United States appears oriented toward meeting the more immediate technical needs of the af- filiates' U.S.-based production facilities. Thus, affiliates concentrate largely on design work, incremental process-oriented applied R&D, and applied R&D re- lated to U.S. technical standards or domestic regulation. Growing foreign involvement in the nation's industrial R&D base brings with it costs and risks as well as benefits and opportunities. One key question, however, cannot be answered definitively: Do foreign nationals take away more technology and associated economic value than they return to the United States through their participation in U.S. industrial R&D? The evidence suggests that in general, the technological contributions of foreign-owned firms through affiliates or technical alliances vary from industry to industry. Thus, in some industries, foreign firms are net exporters of technology; in others, they are net importers. The few quantitative measures that exist confirm that overall, U.S.-based affili- ates of foreign-owned firms import significantly more codified technology from their parent companies than they export to them or to unaffiliated firms abroad. Case studies show that foreign-owned companies, and Japanese companies in particular, have imported significant amounts of advanced production technology and methodologies into the United States in several industries. Foreign involvement in U.S.-based industrial R&D has in some cases re- sulted in lost opportunities for U.S.-owned firms, as well as in foregone wealth

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82 FOREIGN PARTICIPATION IN U.S. RESEARCH AND DEVELOPMENT for their U.S.-based stakeholders. In other cases, however, foreign firms have created opportunities and wealth for U.S.-owned firms and Americans generally as they transfer technology, know-how, capital, and other complementary assets to the United States. On balance, the committee considers the growth of foreign direct investment in the United States and the proliferation of transnational corporate alliances to be generally positive trends that enhance the productivity and wealth of the United States and its trading and investing partners overseas. Furthermore, the commit- tee believes that for the purpose of assessing its consequences for the U.S. economy, foreign participation in privately funded U.S. R&D cannot be sepa- rated meaningfully from the larger trends that carry it. Asymmetries of access to the economies and innovation systems of the United States and other industrialized nations have affected profoundly public perceptions and federal policies on foreign involvement in U.S.-based R&D. During the past decade, America's trading partners have liberalized their policies on foreign direct investment- the most important avenue of access to privately funded R&D activities abroadmaking them more similar to those of the United States. Nevertheless, significant impediments to open access the product of structural barriers, public policies, or collusive or discriminatory corporate prac- tices remain in some major economies. These impediments have led some to call for aggressive unilateral action by the U.S. government. The committee, however, considers many such proposals ill advised and, in their stead, urges the government to use existing policies to hold itself and its trading partners account- able to international agreements. The government should also redouble its efforts to negotiate solutions to these asymmetries of access in bilateral and multilateral forums. The public debate about national security has focused almost exclusively on the difficult-to-assess risks that accompany growing foreign involvement in par- ticular it&D-intensive industries. Current national security regulations and pro- cedures appear to minimize the risk that militarily sensitive U.S. technology will be transferred to foreign-owned companies. However, the utility of these rules and procedures is of questionable value for addressing the medium- to long-term risks of delayed or denied access to militarily critical technological capabilities posed by foreign direct investment or mergers and acquisitions. Two sets of issues inform the debate on whether existing measures intended to protect national security are sufficient. On the one hand, current monitoring efforts and methodologies associated with the enforcement of U.S. antitrust laws may be neither extensive nor strong enough to address the monopoly risks that mergers, acquisitions, and corporate alliances pose in niche defense markets, whether instigated by foreign- or U.S.-owned companies. Moreover, the task of identifying vulnerable niche sectors is made difficult by the federal government's lack of clearly defined, agreed-upon criteria or procedures to determine whether a particular company's technological capabilities are critical to the military.

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PRIVATELY FUNDED R&D 83 On the other hand, little consideration has been given to the costs and risks to national security posed by existing procurement regulations, which discourage foreign-owned firms from contracting directly with DOD or investing in existing U.S.-based defense contractors. The committee believes such concerns merit greater attention in the national security debate. This is especially true given the current relatively high level of U.S. dependence on foreign sources of component technology, the growing importance of technologies that have both civilian and military applications to the nation's military needs, and the growing strength of foreign-owned firms in many of these dual-use technologies. There is little evidence that increasing foreign involvement in U.S. indus- trial R&D through direct investment and alliances has damaged U.S. economic security. The ability of U.S.-based companies to access the technologies, compo- nents, and subsystems required to make their major products competitive with foreign producers does not appear to be impaired. Many high-technology indus- tries are already very concentrated at the national and global levels. Hence, it is likely that at least some of the many recent mergers, acquisitions, and alliances have fostered monopolies in particular civilian high-technology industries. How- ever, the actions of foreign-owned firms within the U.S. economy do not suggest that they are any more likely to engage in anticompetitive activity than their U.S.- owned counterparts. The committee anticipates that the fundamental trends that have fueled the experience of foreign involvement in privately funded U.S. R&D will continue to spur its growth into the next century. Carried by expanding international trade and foreign direct investment, global technical and economic capabilities will be distributed more evenly among an expanding population of industrialized coun- tries, and competition and innovation in most manufacturing and service indus- tries will become increasingly internationalized. NOTES 1. Privately owned U.S. companies financed 59 percent of all R&D performed in the United States in 1994 and an estimated 90 to 95 percent of all privately funded R&D (National Science Foundation, 1995b). 2. Data on R&D spending by U.S. affiliates of foreign-owned firms come from the Annual Sur- vey of Foreign Direct Investment in the United States, conducted by the Department of Commerce's Bureau of Economic Analysis. The Survey of Industrial Research and Development, conducted by the Bureau of the Census for the National Science Foundation, provides data on the total amount of privately funded U.S. R&D. Changes introduced recently in the methodology and scope of the Survey of Industrial Re- search and Development have resulted in significant upward revisions in estimates of R&D funded by U.S. companies. Beginning in 1992, survey statistics are based on annual sampling. Previously, samples were selected every 5 to 7 years. In addition, "For 1992, the sample size was increased from approximately 14,000 to approximately 23,000 firms to better account for births of new R&D-per- forming establishments in the survey universe, to survey more fully and accurately R&D activity in the service sector, and to gather more current information about potential R&D performers" (National Science Foundation, 1993b). With the upward revision in the volume of U.S. company-funded R&D,

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84 FOREIGN PARTICIPATION IN U.S. RESEARCH ED DEVELOPMENT there has been a corresponding downward revision of the share of R&D conducted by U.S. affiliates of foreign-owned firms. For instance, the proportion of R&D conducted by affiliates in 1992 fell from 17.1 percent in the old data series to 14.5 percent in the new data series (National Science Foundation, l995b, 1996; U.S. Department of Commerce, 1995a). 3. For a more extensive overview of the many factors that have contributed to the international- ization of industrial R&D, or more specifically to the decisions of many multinational firms to estab- lish R&D subsidiaries abroad, and an extensive bibliography on the subject, see the review article by Cheng and Bolon (1993). 4. Illustrating the expectations that some foreign firms have of their U.S.-based R&D facilities, Serapio and Dalton (1994) quote the following observation of an executive of a large Japanese auto- motive company: "Prior to establishing an R&D center in [the United States], our engineers in [the U.S. plant] had to work with the R&D and technical centers in Japan. We were sending faxes to each other all the time and our engineers took many trips between Japan and the United States. The process of developing and producing a car for the U.S. market or correcting an engineering problem was very time consuming. We have eliminated this lengthy process by establishing a U.S. technical center [in close proximity] to our U.S. plant, sales office and suppliers in the United States. We expect to shorten the time needed for concurrent design and development, concurrent development and engi- neering, and working on design and engineering issues for our vehicles in or near production." (p. 29) 5. Recent surveys of Japanese multinationals in a number of industries suggest that the fear of diminished access to U.S. technology has played an important role in the decision of many Japanese companies to establish an R&D presence in the United States (Ministry of International Trade and Industry, 1992; Serapio, 1994). As discussed in greater detail in Chapter 4, the U.S. Congress has placed restrictions on foreign corporate involvement in publicly funded R&D in American universi- ties, federal laboratories, and other U.S.-based institutions performing government-funded research. For example, foreign participation in the Department of Commerce Advanced Technology Program, Advanced Research Projects Agency-coordinated Technology Reinvestment Project, and cooperative research and development agreements with federal laboratories is conditioned on reciprocal access to comparable government-funded R&D initiatives abroad. Several U.S. industry-led consortia, includ- ing the Semiconductor Manufacturing Technology Research Corporation (SEMATECH), the Na- tional Center for Manufacturing Sciences, the U.S. Display Consortium all partially funded with public monies exclude foreign participants. In 1987, a U.S. government-sponsored symposium on high-temperature superconductivity (HTS) excluded foreign participants. Subsequent Reagan administration proposals for additional research funding for HTS included provisions designed to prohibit or restrict foreign access to the results of publicly funded research in this area (Mowery, 1991). 6. For documentation of the growing interest and involvement of U.S.-owned multinational com- panies in the advanced technological capabilities of foreign firms and foreign countries see, for ex- ample, Dalton and Serapio (1995), Mansfield et al. (1979), Mowery (1991), National Science Foun- dation (199Oc, 1991), and Peters (1992, 1993b). 7. The U.S. Department of Commerce defines a foreign investment as direct when a foreign investor acquires a stake of 10 percent or more in a U.S. firm. The 10-percent criterion, although arbitrary, is meant to reflect the idea that a large stockholder will generally have a strong say in the operations of a company, even if that stockholder does not have a majority stake. Data from 1988 show that on average, the foreign parent controlled 78.8 percent of its U.S. affiliate's equity. Calcu- lations by analysts at Commerce's Bureau of Economic Analysis indicate that raising the definitional cutoff for direct investment to 20 percent or even 50 percent would increase only slightly estimates of the amount of foreign direct investment in the United States (Graham and Krugman, 1991, pp. 9-11). Hence, most experts consider the potential for understating or overstating the level of foreign control with the 10 percent criterion to be small. There is one notable case of relevance to this study in which a foreign firm with a moderate equity share in a U.S. company, according to the Department of Commerce criterion, "controls" a very large R&D portfolio. Until spring of 1995, the Canadian

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PRIVATELY FUNDED R&D 85 Bronfman (Seagram) family owned a 23 percent stake in DuPont, which invests over $1 billion annu- ally in R&D worldwide. On April 7, 1995, the Bronfman family sold its stake in DuPont, thereby removing DuPont and its R&D spending from the ledger of foreign-owned affiliates. 8. See U.S. Department of Commerce, Survey of Current Business, May issue, various years, for data regarding the share of foreign direct investment accounted for by foreign acquisitions of existing U.S.-based firms and that accounted for by the establishment of new U.S.-based companies by for- eigners. 9. "Special tabulations were prepared by [the Commerce Department's Bureau of Economic Analysis] to reveal R&D expenditures in the United States of those firms in which there is majority foreign ownershipi.e., 50 percent or more. For 1990, the 10-percent foreign ownership threshold results in an estimated $11.3 billion foreign R&D investment total. R&D expenditures of majority owned U.S. affiliates of foreign companies were $8.4 billion. "Funding trends of these two groupings are quite similar. From 1980 to 1990, inflation- adjusted R&D spending of majority-owned foreign firms was up 350 percent, whereas that of firms with 10 percent or more foreign ownership (including majority-owned firms) rose slightly more, 370 percent" (National Science Board, 1993, p. 125, footnote 77). The particularly rapid growth of affiliate R&D spending between 1987 and 1990 included several multimillion dollar acquisitions by foreign firms of U.S. pharmaceutical companies with large R&D budgets, such as Glaxo, SmithKline Beecham, and Genentech (Dalton and Serapio, 1993). 10. Majority-owned affiliates of foreign companies performed approximately $10.7 billion of R&D in 1992, roughly $750 million more than was spent by U.S. companies and their foreign subsid- iaries on overseas R&D that year (National Science Foundation, 1994, Table SD-5; U.S. Department of Commerce, 1994a, Table N-1). 11. Florida and Kenney (1993) go so far as to conclude that "foreign R&D investment in the U.S. is largely the province of corporations which are global technology leaders and that it is primarily used to consolidate that position of technological advantage." (p. 30) 12. The volume of affiliate R&D spending in the U.S. motor vehicle and equipment industry is arrived at by adding affiliate R&D expenditures that are classified in the Bureau of Economic Analy- sis' survey of affiliate R&D as "manufacturing R&D" with those that are classified as "wholesale trade R&D." Department of Commerce analysts acknowledge that much of the R&D spending clas- sified as "wholesale trade R&D" by affiliates in the motor vehicles and equipment industry is, in fact, R&D performed by U.S. manufacturing establishments of foreign-owned firms. 13. In 1992, U.S. affiliates of foreign-owned firms performed $170 million of R&D for the U.S. federal government and $689 million of R&D for other unaffiliated U.S.-based organizations. Ninety- four percent of the R&D performed by affiliates in 1992 was for the affiliates themselves (U.S. De- partment of Commerce, 1995a). For one of the most extensive, though by no means comprehensive, inventory of U.S.-based organizations that perform industrial research, development, and design, see the Directory of Ameri- can Research: Organizations Active In Product Development for Business, published annually by R. R. Bowker, New Providence, New Jersey. 14. Freestanding R&D facilities appear to play the greatest role in two industries: pharmaceuti- cals and chemicals, which together account for nearly half of all affiliate R&D expenditures. Whether freestanding facilities account for a majority of affiliate R&D expenditures in discrete manufacturing industries (i.e., automobiles or consumer electronics) is more of an open question (Peters, 1992). 15. Dalton and Serapio (1995) define a foreign R&D facility in the United States "as a free- standing R&D company (i.e., a company engaged mainly in R&D) of which 50 percent or more is owned by a foreign parent company." (pp. 16-17) A 1993 Department of Commerce report (1993a) noted that data collected earlier by Dalton and Serapio (1993) "include numbers of design studios, which are not considered research facilities by the National Science Foundation, and thus, possibly represent a significant overstatement of re- search facilities in the United States as much as 80 percent above actual R&D facilities, according

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86 FOREIGN PARTICIPATION IN U.S. RESEARCH AND DEVELOPMENT to one NSF analyst." Research by Peters (1991, 1992) also suggests that data gathered by Dalton and Serapio considerably overstate the number of "true" R&D facilities owned by foreign companies in the United States. 16. The relatively small size of many Japanese-owned freestanding R&D facilities in the United States has led some observers to suggest that these facilities may serve mainly as "listening posts" rather than research units (Fusfeld, 1994; Peters, 1991). Serapio (1994), however, notes that the smaller size of Japanese R&D facilities in the United States could be explained by their more special- ized orientation and relative newness. This may be true in the case of many recently established Japanese-owned R&D facilities in the U.S. biotechnology and electronics industries, which conduct mainly basic research. For further discussion, see pp. 54-55. 17. The overall response rate to the Pearce and Singh survey was 28.9 percent. Parent companies supplied 163 of 296 usable responses; subsidiaries supplied the remaining 133 responses. The re- sponse rate from 181 U.S.-based affiliates that were sent the survey was roughly 30 percent. The authors note that response rates were poor for French-owned companies and that there were too few Japanese companies in their sample to say much about them. 18. NEC Research Institute was established in Princeton, New Jersey, in 1989. It focuses on software development, artificial intelligence, and machine learning (Noguchi, 1989). Matsushita established its Information Technology Laboratory in Princeton the following year to conduct basic research in computer graphics, document processing, and systems software. In 1991, Hitachi set up a high-definition television research laboratory in Princeton. That same year, Mitsubishi Electric set up a basic research laboratory in Cambridge, Massachusetts, that focused on next-generation parallel processing and supercomputers. Canon established the Canon Research Center in Palo Alto, Califor- nia, in 1990 to do research on data compression, optical recognition, and network architecture. Florida and Kenney (1993) note that these facilities tend to focus on areas of research "where Japanese indus- try lags the United States, such as parallel computing, software development, and artificial intelli- gence." This may explain their proximity to leading U.S. centers of R&D in these fields. Florida and Kenney also note that these laboratories "are designed to generate and harness new sources of knowl- edge, which leverages existing corporate technological capabilities and enhances long-range corpo- rate development efforts." 19. Dibner et al. (1992) note that because of their large staffs, European-owned biotechnology R&D facilities have many more interactions with U.S. university- and industry-based researchers than Japanese-owned facilities with smaller R&D staffs. R&D managers generally agree that there is a minimum efficient size for R&D laboratories that varies from industry to industry. Below this minimum, laboratories are unlikely to be successful either at performing in-house research or drawing upon extramural research. 20. From comments by NEC Research Institute Director William Gear before the NAE study committee at a November 9, 1993, workshop. See, also, Chapter 4, p. 110. 21. Of the 12 Japanese-owned electronics R&D facilities surveyed by Dalton and Serapio (1993), six focused on applied research (new applications for existing technology, design customization), two performed basic research exclusively, and four conducted both basic and applied research, although basic research was limited. Ten R&D facilities performed prototype testing, evaluation, and produc- tion, designed new products or modified existing product designs; seven did parts evaluation; five designed parts; seven conducted joint R&D with other research organizations; and seven employed university research professors as consultants. In contrast, six Japanese automotive affiliates performed vehicle testing and evaluation, emis- sions certification, scanning of regulatory trends, technology scanning, and advanced concept design; four of the six firms surveyed did parts and materials evaluation and design; two performed joint research with a U.S. partner and produced prototypes of near-production vehicles; and three compa- nies were involved in the development of local parts suppliers. 22. See, for example, Dibner et al. ( 1992) and National Research Council ( 1 992c) for a discussion of affiliate-conducted R&D in the pharmaceuticals and biotechnology industries. For affiliate R&D

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PRIVaTELY FUNDED R&D 87 in electronics, see Florida and Kenney (1993), Kummerle (1993a,b), Peters (1991, 1992), Voisey (1992), and Westney (1993). 23. According to Serapio (1994), Japanese companies are under additional pressure to internation- alize their R&D activities as a result of a growing shortage of highly skilled scientific and engineering manpower in Japan. 24. See, for example, National Research Council (1992b), U.S. Congress, Office of Technology Assessment (1993, 1994), Organization for Economic Cooperation and Development (1994). See, also, Figure 3.9. 25. Summarizing the results of a 1992 Mitsubishi Research Institute survey of Japanese compa- nies with overseas R&D facilities, Kummerle (1993b) notes the following: Out of 28 labs which the 7 leading Japanese electronics companies have established abroad during the last 5 years, l5 were built with the intention to create new knowledge in targeted areas, 7 facili- tate local adaptation of products, 3 support complex local production facilities, and 3 were built because of local political pressure. These figures mean that more than half of the new labs serve as facilitators for learning and creating new knowledge abroad. In the pharmaceutical sector, numbers are even more striking: 7 out of 9 labs abroad were established for purposes of local learning and local creation of new knowledge. Moreover, the majority of electronics and pharmaceutical compa- nies expressed an intent to establish at least one more laboratory abroad during the next 5 years.... The research focus of the new 'learning-creating laboratories' is generally on areas with strategic importance for the firm but which are still mastered insufficiently by the company. Out of 5 labora- tor~es that Canon has founded in Europe and the United States since 1988, none is concerned with research in optics: the focus is on either computer languages, image processing software, or tele- communications. This is in line with Canon's intent to shift from an 'Optical Technology Company' to a 'Total Image and Information Processing Company.' 26. Hagedoorn and Schakenraad (1993) attribute the recent growth of corporate interest in techni- cal alliances to three primary motives. First, firms view alliances as a way to strengthen their research capabilities in the face of rapid technological change and the need to monitor and exploit external sources of science and technology. Second, by leveraging the know-how of alliance partners, compa- nies can expand their ability to develop and apply new technologies. Third, alliances enhance firms' access to foreign markets and help them to seek out new business opportunities abroad. 27. Under the National Cooperative Production Amendments of 1993 [P.L. 103-42], which amended the National Cooperative Research Act of 1984 [P.L. 98-462], R&D and production joint ventures located within the United States and registered with the U.S. Department of Justice are exempted from the treble damages liability of U.S. antitrust laws. If any of the firms involved in a joint venture are foreign-owned, the home country of that firm must accord national treatment to U.S. firms with respect to antitrust treatment of similar joint ventures in the country. 28. The Department of Commerce (1991) found that the number of alliances involving biotech- nology firms in the United States increased from 30 in 1981 to 400 in 1988. In 1981, 30 percent of such alliances included a foreign partner and in 1988, 45 percent had one. Peters (1992) notes that during the 1980s, the number of international strategic alliances grew eightfold in the telecommunica- tions industry, around sevenfold in the pharmaceuticals industry, and sixfold in the biotechnology industry. 29. Peters (1993a) cites the example of NEC to show the complementary relationship between the growth of Japanese R&D facilities in the United States and the growth of technical alliances in the computer industry. In 1991, 2 years after establishing its basic research facility in Princeton, New Jersey, "NEC signed a contract with AT&T for a comprehensive package in semiconductor develop- ment for the next 5 years. NEC also entered a joint development agreement with Hewlett Packard to develop tools for microprocessors and microcomputers. Other companies having joint technology agreements with NEC include Grumman (supercomputer), American Microsystems (microprocessors), 3M (optical memory system), Summit Micro Circuit (a venture company to develop high-speed static random access memory chips), Hughes (weather satellite), Adobe Systems (desktop publishing soft- ware), General Electric (international PC network), Tektronix (gate array design software)." (pp. 6-7)

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88 FOREIGN PARTICIPATION IN U.S. RESEARCH AND DEVELOPMENT 30. The six industrial sectors were aerospace, computers and peripherals, computer software, semi- conductors, semiconductor manufacturing equipment, and biotechnology. 31. See note 8. Graham (1992) "guesstimates" that roughly two-thirds of the increase in Japa- nese-controlled R&D activity in the United States during the late 1980s resulted from Japanese acqui- sitions of existing U.S. operations. 32. Between 1980 and 1992 the average it&D/sales ratio for manufacturing affiliates increased from 1.6 percent to 2.6 percent (U.S. Department of Commerce, 1993a, 1995a). 33. For further discussion, see Graham and Krugman (1995), Organization for Economic Coop- eration and Development (1994), Ozawa (1991), and U.S. Congress, Office of Technology Assess- ment (1994). 34. A number of factors may explain this variation between European and Japanese firms. Differ- ences in the industrial composition of European and Japanese foreign direct investment may be one determining factor. The fact that direct investment by the Japanese is more recent in most U.S. industries than is that by European firms may also play a role. (Many U.S. affiliates of European- owned companies have added R&D capabilities after having had a U.S. manufacturing presence for decades.) Westney (1993) also points out that Japanese organization and management of affiliate R&D in the electronics industry may have a negative effect on Japanese patenting activity in the United States. Specifically, Japanese electronics firms have chosen to establish large numbers of small highly specialized facilities in the United States, each with a narrow technology mandate yet networked to the parent companies to provide input into technologies developed at the parent firms' facilities in Japan. 35. It should be noted that there is nothing unfair or unethical about foreign companies establish- ing technology scanning capabilities in the United States, or U.S. companies doing the same abroad. Indeed, the rapid pace of technological innovation in many sectors and the high costs of R&D have made it imperative that companies become much more effective at scanning for and acquiring tech- nology developed beyond their institutional borders. 36. Royalties and license fees are payments for the sale and use of intangible property rights, such as patents, copyrights, franchises, trademarks, industrial processes, know-how, and other intellectual property rights. Some observers argue that multinational corporations, U.S. and foreign, frequently use these fees as a form of "transfer pricing," that is, shifting costs from subsidiaries in low-tax countries to a high-tax country in order to minimize tax obligations. (U.S. Department of Commerce, 1993a, p. 73). 37. See, for example, the Council on Competitiveness (1993) case study of the Committee on Foreign Investment in the United States (CFIUS) review of the sale of Semi-Gas System Inc. to the Japanese company, Nippon Sanso KK (pp. 137-155). Dalton and Genther's (1991) survey of foreign acquisition of U.S. electronics companies notes that most acquired companies were small, in need of a capital infusion, and were having difficulty obtaining credit or raising equity. See also the reflec- tions of Materials Research Corporation's CEO Sheldon Weinig (1990) on his company's purchase by Sony. Graham and Krugman (1995) also review several CFIUS cases. 38. The Organization for Economic Cooperation and Development (OECD) has adopted two codes directed at international investment, the Code of Liberalization of Capital Movements and the Code of Liberalization of Current Invisible Operations, which are, in principle, binding on all OECD mem- ber states. In addition to these codes, all member states currently adhere to a "National Treatment Instrument," which obligates them to grant national treatment, with some exceptions, to companies controlled by investors from other OECD countries. The OECD is presently considering a "Wider Investment Instrument" that would, among other things, bolster national treatment provisions. Both the U.S.-Canada Free Trade Agreement (FTA) and the North American Free Trade Agreement (NAFTA) commit (with some exceptions) their respective signatory states to national treatment of enterprises owned by nationals of other signatory states, limit the screening of acquisi- lions by nationals from other signatory states, call for free repatriation of capital and earrungs, restrict recourse to performance requirements on investments that affect trade between signatories, and pro-

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PRIVATELY FUNDED R&D 89 vice for dispute settlement mechanisms (the option of binding arbitration). Finally, the Uruguay Round agreement signed in mid-1994 obliges signatories, in principle, to refrain from imposing local- content requirements and export performance requirements on foreign-owned firms operating within their borders. For a detailed assessment of these and related initiatives, see Graham and Krugman (1995). 39 For a more comprehensive review of foreign barriers to international trade and investment, see Office of the U.S. Trade Representative (1995). 40. To get a feel for this debate, see Japan Economic Institute (1991), Krugman (1991), Lawrence (199la,b), and Saxonhouse (1991). 41. It is estimated that intraf~ trade (it l ) trade between the affiliates and parent multinational companies now accounts for more than 40 percent of total world trade. Between 1983 and 1992, U.S.-Europe lL l accounted for 43 percent of all U.S.-European merchandise trade, with U.S.-owned multinationals claiming 43 percent of total U.S.-Europe IFT and European-owned multinationals 57 percent. During the same period U.S.-Japan IFT accounted for 71 percent of total U.S.-Japan mer- chandise trade. However, reflecting a large asymmetry in the volume of U.S. foreign direct invest- ment in Japan compared to Japanese foreign direct investment in the United States, Japanese multina- tionals accounted for 92 percent of total U.S.-Japan lE-l (U.S. Congress, Office of Technology Assessment, 1994). 42. Many U.S. companies enter into alliances with foreign firms in order to achieve greater access to their foreign partner's home market. In some cases, policy-related or structural barriers to access provide the foreign company with additional leverage in its negotiations with its U.S. partner. On the whole, however, transnational corporate alliances appear to have eased the entry of U.S.-owned and U.S.-based companies into foreign markets and national innovation systems. 43. The recent focus within segments of the U.S. trade community on "specific" or "tit-for-tat" reciprocity (with its emphasis on reciprocity in absolute levels of protection) marks a significant departure from the pursuit of "general" reciprocity (i.e., reciprocal changes in the level of protection with a commitment to unconditional Most-Favored-Nation treatment) that has characterized the nego- tiation of multilateral trade agreements during the post-World War II era. The former focuses on outcomes, such as comparable market access, while the latter focuses on the process of liberalization, such as market opening. For further discussion, see Bayard and Elliott (1994), and Cline (1982). 44. See Defense Science Board (1990), Institute for Defense Analysis (1990), Moran (1993), National Defense University (1987), The Analytic Sciences Corporation (1990), and U.S. General Accounting Of lice (199lb, 1994b). 45. In May 1993, the only remaining U.S.-owned supplier of mainstream semiconductor lithogra- phy equipment, SVG Lithography Systems, Inc. (SVGL), announced its intention to enter into a 10- year contract with the Japanese firm Canon. The contract would have given Canon access to all of SVGL's current and future Micrascan scan-and-step technology in return for an infusion of capital and Canon's assistance with manufacturing lithographic steppers. Negotiations between the two Grins became protracted, and ultimately the deal fell through when the SEMATECH consortium members put together an alternative financing package that SVGL accepted . . . Nevertheless, many observers agree that the SEMATECH alternative would not have materialized had Canon not given SVGL its seal of approval by entering into negotiations with the small U.S. company in the first place. Ultimately, it was Canon's reputation and the prospect of Canon backing up the struggling U.S. company with its deep pockets, manufacturing technology, distribution networks, etc., that turned the tide in customer perceptions of the company's viability. See Randazzese (1994) for a well-docu- mented assessment of the SVGL-Canon deal. 46. Aside from the oft-cited sale of sensitive U.S. submarine technology to the Soviets by Toshiba Corporation in the early 1980s, there is only limited anecdotal evidence to suggest that foreign-owned films have leaked sensitive U.S. technologies to potential adversaries (Graham and Krugman, 1991). 47. See, for example, the criteria and procedures put forward in Graham and Krugman (1991, 1995), Moran (1990), and U.S. General Accounting Office (1994b).