    Offshoring: U.S. Semiconductor and Software Industries
    Increasingly Produce in China and India (07-SEP-06, GAO-06-423).

    Much attention has focused on offshoring of information
    technology (IT) services overseas. "Offshoring" of services
    generally refers to an organization's purchase from other
    countries of services such as software programming that it
    previously produced or purchased domestically. IT manufacturing,
    notably semiconductor manufacturing, has a longer history of
    offshoring of manufacturing operations. Under the Comptroller
    General's authority to conduct evaluations on his own initiative,
    GAO addressed the following questions: (1) How has offshoring in
    semiconductor manufacturing and software services developed over
    time? (2)What factors enabled the expansion of offshoring in
    these industries? (3) As these industries have become more
    global, what have been the trends in their U.S.-based activities?
    -------------------------Indexing Terms-------------------------
    REPORTNUM:   GAO-06-423
        ACCNO:   A60410
      TITLE:     Offshoring: U.S. Semiconductor and Software Industries
    Increasingly Produce in China and India
         DATE:   09/07/2006
      SUBJECT:   Computer hardware industry
    	     Exporting
    	     Foreign governments
    	     Information technology
    	     International trade
    	     IT human capital
    	     Labor costs
    	     Manufacturing industry
    	     Research and development
    	     Skilled labor
    	     Software
    	     Software engineering
    	     Offshoring
    	     China
    	     India
    	     Malaysia
    	     South Korea
    	     Taiwan

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    GAO-06-423

         * Report to Congressional Committees
              * September 2006
         * OFFSHORING
              * U.S. Semiconductor and Software Industries Increasingly Produce
                in China and India
         * Contents
              * Results in Brief
              * Background
              * U.S. Firms Continue to Offshore Increasingly Complex
                Semiconductor Manufacturing Activities and Software Services
                   * Semiconductor Manufacturing Moved Offshore as Competition
                     from Other Countries Developed; Firms Offshored More Complex
                     Production Over Time
                   * U.S. Firms Offshored Software Services in the Mid-1990s and
                     Increasingly Offshore More Complex Activities
              * Technological Advances, Availability of Talented Human Capital,
                and Foreign Government Policies Contributed to Increased
                Offshoring of Semiconductor Manufacturing and Software Services
                   * Technology Launched Important Changes in Semiconductors
                     Manufacturing and Software Services
                        * Technology Improvements Allowed Semiconductor Firms to
                          Develop More Efficient Global Supply Chains
                        * The Software Services Industry Changed Its Global
                          Business Model
                   * The Availability of Human Capital Was Key to the Expansion
                     of Offshoring in Both Semiconductor Manufacturing and
                     Software Services
                        * Some Semiconductor Firms Turned to Low-Level Skilled
                          Foreign Workers Initially but Gradually Offshored More
                          Complex Work to Higher-Skilled Labor Forces Overseas
                        * Software Services Firms Find a Large Supply of Human
                          Capital Overseas with Top Quality Skills
                   * Foreign Government Policies Have Made Foreign Investment
                     Attractive for Semiconductor Firms and Left the Software
                     Services Industry Relatively Unregulated
                        * Government Policies in Taiwan and China Have Assisted
                          Their Respective Semiconductor Industries
                        * India's Software Industry Was Not Subject to Many of
                          India's Restrictive Policies
                        * Other Factors Constrain U.S. Firms' Offshoring
                          Decisions
              * The United States Continues to Be a Global Leader in the
                Development of Semiconductors and Software at the Most Advanced
                Levels
                   * The U.S. Semiconductor Industry, Rebounding from a Recent
                     Recession, Continues to Be a Global Leader
                        * The United States Is a Global Leader in Semiconductor
                          Design and Fabrication
                        * U.S. Semiconductor Production Rebounding from 2001
                          Recession, but Employment Has Remained Flat
                        * The United States Is a Net Exporter of Semiconductors,
                          Particularly High Value-Added Wafers and Chips
                        * U.S. Exports to Asia Growing as Demand for Finished
                          Semiconductors Expands in China
                   * The United States Is the Largest Global Supplier, Employer,
                     and Market for Software Services
                        * The United States Is a Leading Software Developer and
                          the Largest Supplier in the World
                        * U.S. Software Production Has Rebounded from the 2001
                          Recession
                        * U.S. Employment in Computer Specialist Occupations Has
                          Grown Overall Since the 2001 Recession
                        * The United States Maintains a Trade Surplus in Software
                          Services Trade, but Imports Are Growing
                   * The U.S. Semiconductor and Software Industries Benefit from
                     the Large, Innovative U.S. Economy
                        * University and Research Centers, Talented Labor, and
                          R&D Investment Have Helped Foster Innovation
                        * Business Environment, Legal System, and Domestic Market
                          Affect Commercialization of Innovation
              * Concluding Observations
              * Agency Comments and Our Evaluation
         * Scope and Methodology
         * U.S. Multinational Companies' Investment and Operations in the
           Semiconductor and Software Industries
              * In recent years, U.S. Investment Offshore Has Been Relatively
                Stable and Has Been Larger in Singapore and Malaysia, Than in
                Taiwan and China
              * Global Semiconductor Employment by U.S. Companies Is Roughly
                Split between Their U.S. Operations and Offshore Locations
              * U.S. Companies Investments in Overseas Affiliates to Supply
                Software Services Still Relatively Low
              * MNC's Research and Development Relatively Concentrated in U.S.
                Operations
         * Larger Imports of Information and Communication Goods Drive the U.S.
           Advanced Technology Product Deficit
         * Comments from the Department of Commerce
         * GAO Contact and Staff Acknowledgments
         * Related GAO Products
              * Offshoring
              * China
              * Semiconductors
         * appendixIIglo.pdf
              * U.S. Multinational Companies' Investment and Operations in the
                Semiconductor and Software Industries
                   * In recent years, U.S. Investment Offshore Has Been
                     Relatively Stable and Has Been Larger in Singapore and
                     Malaysia, Than in Taiwan and China
                   * Global Semiconductor Employment by U.S. Companies Is Roughly
                     Split between Their U.S. Operations and Offshore Locations
                   * U.S. Companies Investments in Overseas Affiliates to Supply
                     Software Services Still Relatively Low
                   * MNC's Research and Development Relatively Concentrated in
                     U.S. Operations

                     United States Government Accountability Office

    Report to Congressional Committees

    GAO

    September 2006

    OFFSHORING

      U.S. Semiconductor and Software Industries Increasingly Produce in China and
                                         India

                                           a

    GAO-06-423

    OFFSHORING

    U.S. Semiconductor and Software Industries Increasingly Produce in China
    and India

      What GAO Found

    The U.S. semiconductor industry began offshoring labor-intensive
    manufacturing operations in the 1960s, followed in the 1970s and 1980s by
    increasingly complex operations, including wafer fabrication and some
    research and development (R&D) and design work. Semiconductor assembly and
    testing was the first to move to Asia, followed by fabrication and, more
    recently, by some design operations. Software services offshoring began in
    the 1990s after Internet communications made it possible to trade services
    such as software programming and software design. The year 2000 changeover
    hastened this offshoring trend related to software services because
    programmers knowledgeable in the appropriate programming languages were
    available, primarily in India. In the 2000s, firms further expanded their
    offshoring operations, based on the low-cost and high-quality work from
    the offshored services undertaken in the late 1990s.

    Although a lower labor cost was initially a key factor that attracted
    firms to offshore locations, other factors such as technological advances,
    available skilled workers, and foreign government policy, also played
    roles. Technological advances helped firms in the semiconductor industry
    improve their management of global supply chains and logistics. Regarding
    software services, technological advances opened the way to trade in
    programming and other software services. Foreign government policies in
    Taiwan and China created favorable investment conditions for U.S.
    semiconductor firms. India changed its emphasis from state-owned
    enterprises in the 1970s to an environment more amenable to private
    enterprise by the mid-1980s. Although its restrictions on foreign
    investment constrained the software services industry's overall
    development, India established software technology parks in 1990 to give
    domestic firms preferential access to the infrastructure essential for
    offshored operations.

    Although offshoring continues to grow in both the semiconductor
    manufacturing and software services industries, the United States remains
    one of the largest and most advanced producers of semiconductors and
    software services. U.S. production data show that both industries have
    largely rebounded from the 2001 recession. Employment data show a mixed
    picture, with semiconductor employment remaining flat and software
    employment mostly recovering. The United States has global trade surpluses
    in the semiconductors and software services sectors, although production
    is increasingly shifting to Asia. Both U.S. industries have become global,
    sourcing components from many locations overseas. U.S. firms have
    offshored increasingly complex products, essentially moving up the value
    chain. The ability of the United States to compete depends on research and
    development investment, innovative academic environments attracting
    topquality students, and a competitive business environment. It will be
    important for U.S. businesses and policymakers to keep alert to
    technological changes and competitor countries' strategies while enhancing
    the elements of the innovation environment in the United States.

                     United States Government Accountability Office

                                        Contents

    Letter                                                                   1
               Results in Brief                                                 2
               Background                                                       4
                    U.S. Firms Continue to Offshore Increasingly Complex
                  Semiconductor Manufacturing Activities and Software Services  8
               Technological Advances, Availability of Talented Human Capital,
                      and Foreign Government Policies Contributed to Increased
                        Offshoring of Semiconductor Manufacturing and Software
               Services                                                        13
                  The United States Continues to Be a Global Leader in the
                        Development of Semiconductors and Software at the Most
               Advanced Levels                                                 22
               Concluding Observations                                         43
               Agency Comments and Our Evaluation                              45

    Appendixes
                    Appendix I: Scope and Methodology                          47
                   Appendix II: U.S. Multinational Companies' Investment and
                                Operations in the Semiconductor and Software
                                Industries                                     49
                  Appendix III: Larger Imports of Information and
                                Communication Goods Drive the U.S. Advanced
                                Technology Product Deficit                     58
                  Appendix IV:  Comments from the Department of Commerce       61
                    Appendix V: GAO Contact and Staff Acknowledgments          62

      Related GAO Products

    Tables Table 1: Many Factors Contributed to a Favorable Environment for
                       Offshoring in Semiconductors and Software Services      13
              Table 2: Changes in Hourly Wage and Employment for U.S.
                       Computer Specialist Occupations                         34
              Table 3: Share of U.S. Foreign Affiliates' Employment in Total
                       U.S.
                       MNC Employment Worldwide-ICT Sector Industries,
                       1999-2003                                               54
              Table 4: U.S. Companies' Foreign Affiliates' Share of Total R&D
                       Expenditures                                            55
              Table 5: Share of Selected Industries in Total MOFA R&D
                       Expenditures                                            56

    Contents

    Figures

    Table 6: Share of U.S. Companies' Foreign Affiliates' R&D Expenditures, by
    Industry for Selected Asia-Pacific Economies, 2003

    Figure 1: Annual Growth in Real Value-Added by Industry Group,

    2002-2004 7 Figure 2: Semiconductor Manufacturing Trends, 1960-2005 10
    Figure 3: Value-added Trend for U.S. Semiconductor and Related

    Device Manufacturing, 1987-2004 25 Figure 4: Employment Trend for
    Semiconductors and Related

    Devices Industry, 1972-2005 26 Figure 5: Labor Productivity, Employment
    and Compensation

    Trends in Semiconductors and Electronic Components

    Manufacturing, 1988-2004 27 Figure 6: U.S. Imports and Exports of
    Semiconductors with All

    Countries, 1985-2005 28 Figure 7: Chinese Imports of Semiconductors by
    Country, 1995-

    2005 30 Figure 8: U.S. Software Industry Revenues, 1990-2004 32 Figure 9:
    Projected Rate of Job Growth for Computer Specialist

    Occupations, 2004-2014 35 Figure 10: U.S. Unaffiliated Exports and Imports
    in Computer and

    Data Processing Services, 1986-2004 37 Figure 11: U.S. Exports of
    Software, 1998-2004 38 Figure 12: Gross Domestic Expenditures on Research
    and

    Development by Country, 1990-2004 41 Figure 13: U.S. Direct Investment
    Abroad in the Computers and

    Electronic Products Industry, Selected Asian Countries,

    1999-2004 51 Figure 14: Value-added in Semiconductors-U.S. Parents and

    MOFAs (including Asia-Pacific, excluding Japan and

    Australia) 52 Figure 15: U.S. ATP Information and Communications Trade
    with

    China 59 Figure 16: U.S. ATP Electronics Trade with China 60

    Contents

                                     Abbreviations

    ACM         Association of Computing Machinery
    ATP         Advanced Technology Products
    BEA         Bureau of Economic Analysis
    BLS         Bureau of Labor Statistics
    CMM         Capability Maturity Model
    CMMI        Capability Maturity Model-Integration
    EU-25       European Union
    FDI         foreign direct investment
    ICT         Information and Communications Technology
    IDM         Integrated Device Manufacturer
    IT          information technology
    MOFA        majority-owned foreign affiliates
    MNC         multinational company
    NAICS       North American Industry Classification System
    PPP         purchasing power parity
    R&D         research and development
    SIA         Semiconductor Industry Association
    SIC         Standard Industrial Classification

    This is a work of the U.S. government and is not subject to copyright
    protection in the United States. It may be reproduced and distributed in
    its entirety without further permission from GAO. However, because this
    work may contain copyrighted images or other material, permission from the
    copyright holder may be necessary if you wish to reproduce this material
    separately.

    A

    United States Government Accountability Office Washington, D.C. 20548

    September 7, 2006

    Congressional Committees

    Foreign competition over the last several decades has contributed to a
    decline in U.S. manufacturing employment, while U.S. firms have also moved
    some production activities to foreign locations in order to reduce costs
    or gain access to foreign markets. Concerns about U.S. manufacturing job
    losses have been allayed somewhat by the prospect of large numbers of high
    paying jobs developing in U.S. knowledge-based services industries, such
    as in the information technology (IT) sector. However, some types of
    knowledge-based services have become more easily tradable within the past
    10 years due to the spread of the Internet, and concerns have now also
    arisen about what the offshoring of these types of activities may mean for
    the United States.

    In response to widespread congressional interest, we have undertaken a
    body of work related to offshoring under the Comptroller General's
    authority to conduct evaluations on his own initiative. In this report,
    one in a series of reports on services offshoring,1 we address offshoring
    trends in two important U.S. information technology
    industries-semiconductor manufacturing and software services. To analyze
    the U.S. semiconductor and U.S. software industries' experiences with
    offshoring, we addressed the following questions:

         o How has offshoring in semiconductor manufacturing and software
           services developed over time?
         o What factors enabled the expansion of offshoring in these industries?
         o As these industries have become more global, what have been the trends
           in their U.S.-based activities?

    To answer these questions, we analyzed data and other research to develop
    a broad understanding of these industries. We conducted research on how

    1GAO, International Trade: Current Government Data Provide Limited Insight
    into Offshoring of Services, GAO-04-932 (Washington, D.C.: Sept. 22,
    2004); GAO, International Trade: U.S. and India Data on Offshoring Show
    Significant Differences, GAO-06-116 (Washington, D.C.: Oct. 27, 2005); and
    GAO, Offshoring of Services: An Overview of the Issues, GAO-06-5
    (Washington, D.C.: Nov. 28, 2005). See also Related GAO Products at the
    end of this report.

    these industries developed offshoring relationships in specific countries-
    Taiwan and China for semiconductor manufacturing and India for software
    services. We examined the available literature on both industries;
    analyzed

    U.S. government data on foreign investment and trade in these industries;
    and interviewed representatives from firms and private sector
    associations, as well as industry analysts in the United States, Taiwan,
    China, and India. We conducted our analysis in accordance with generally
    accepted government auditing standards from October 2005 through August
    2006. A detailed description of our methodology appears in appendix I.

      Results in Brief

    Over the past 40 years, the extent and complexity of semiconductor
    manufacturing and software services offshoring have grown as U.S. firms
    sought low-cost, high-quality workers in response to commercial
    competition. In the 1960s, U.S. firms offshored the labor-intensive stages
    of semiconductor manufacturing to make use of low-cost, unskilled foreign
    labor and to gain access to foreign markets. They maintained
    capitalintensive, highly-skilled wafer fabrication and design in the
    United States and offshored assembly operations for products generally
    destined for the

    U.S. market. In the 1980s, semiconductor firms moved some wafer
    fabrication activities to Asian contract manufacturers to reduce financial
    risk. Taiwan was a key offshore location for U.S. semiconductor
    manufacturers, initially for assembly and testing and later for
    fabrication. As China opens its market, Taiwan manufacturers are
    transferring some operations there, furthering China's role as a rising
    player in the industry. More recently, U.S. firms have offshored more
    complex research and design activities; they have also sought to take
    advantage of Asian engineering talent and to target rapidly growing Asian
    markets. In the area of software services, firms began to offshore
    operations in the mid-1990s due to the need for skilled labor and cost
    reduction. Offshoring of software programming work, in particular,
    expanded in the late 1990s with the need for additional programmers to
    prepare for the year 2000 changeover. As telecommunications infrastructure
    expanded overseas and foreign countries liberalized their economies in the
    1990s, firms turned to software programmers in other countries, such as
    India and Ireland. As firms experienced cost savings and observed
    high-quality work in these offshore locations, they expanded offshore
    operations to include more advanced operations, such as software design
    and systems integration.

    Although a lower labor cost was initially a key factor that attracted U.S.
    companies to many offshore locations, other factors such as technological
    advances, available human capital, and foreign government incentives were
    also important to the expansion of offshoring. For firms in the
    semiconductor industry, technological advances enabled improved management
    of their global supply chains. For example, sophisticated communication
    and product tracking technologies made possible efficient international
    product delivery systems. The development of telecommunications technology
    initially enabled software services firms to offshore basic software
    programming services. Such technology changes led firms in each industry
    to extend their basic business model to include global teams spread across
    multiple regions of the world and comprising foreign workers with
    high-quality skills. U.S. firms' offshoring decisions also have been
    affected by a variety of foreign government policies. Semiconductor firms
    responded to the Taiwan government's incentives and to China's policies
    aimed at attracting semiconductor industry investments. Software services
    firms benefited from the lifting of certain Indian government restrictions
    and from incentives offered by India. Nevertheless, firms also encounter
    risk factors in offshoring; among these are geopolitical risks, the
    quality of infrastructure, and the absence of legal protection for
    intellectual property rights.

    Despite the growing scope and sophistication of offshore activities, the
    United States continues to be one of the largest and most advanced
    producers of both semiconductors and software. U.S. companies are leaders
    in both industries, while foreign companies have established their own
    operations in the United States to access U.S. technology, skilled labor,
    and market. Although both semiconductor and software industries faced a
    downturn during the 2001 recession, U.S. production data show that they
    have generally rebounded and are growing. Employment data show a mixed
    story, with semiconductor employment remaining relatively flat and
    software employment rebounding. Trade data indicate that the United States
    has global surpluses in both semiconductors and software, although
    production is increasingly shifting to Asia. More broadly, the United
    States maintains several strengths that help foster and commercialize
    innovations in high technology sectors such as semiconductors and
    software. These include its higher education system, spending on research
    and development, and a competitive business environment.

    In this report, we make some observations comparing the offshoring
    experiences in semiconductor manufacturing and software services. We note
    the importance both of understanding the implications of rising foreign
    competition and technology change and of enhancing traditional

    U.S. strengths in areas supporting innovation and new commercial
    applications.

    We received written comments on a draft of our report from the Department
    of Commerce, which generally agreed with our finding. (See app. IV.)

                                       Background

    "Offshoring" generally refers to an organization's replacement of goods
    and services produced domestically with imports from foreign sources.2 For
    example, if a U.S.-based company decides to move its computer programming
    activities to an overseas supplier, this would be considered offshoring.
    The overseas supplier may be an affiliate of the company, in which case
    the company has also invested overseas. In contrast, the supplier may be
    unrelated to the domestic company, in which case the company has
    outsourced its computer programming activities, as well as offshored them.

    Semiconductors are devices that enable computers and other products such
    as telecommunication systems to store and process information.
    Semiconductor device fabrication is the process used to create "chips,"
    the integrated circuits that are present in everyday electrical and
    electronic products. It is a multiple-step sequence of photographic and
    chemical processing steps during which electronic circuits are gradually
    created on a wafer made of pure semiconducting material, most commonly
    silicon. Improvement in the performance of increasingly sophisticated
    electronics products depends on more powerful semiconductors that can
    store more information and process it faster. Demand for semiconductors is
    driven by the demand for computers and communications products that use
    them.

    The semiconductor manufacturing process can be divided into three distinct
    stages: (1) design of the semiconductor integrated circuit, (2)
    fabrication of the semiconductor wafer, and (3) assembly and testing of
    the finished integrated circuit. The design and fabrication processes are
    the most capital-intensive, while the assembly and testing process tends
    to be more labor-intensive, although still relatively technologically
    sophisticated. For example, semiconductors are designed by computer
    engineers with the

    2For a discussion of definitions of offshoring and outsourcing, see GAO,
    International Trade: Current Government Data Provide Limited Insight into
    Offshoring of Services,

    GAO-04-932 (Washington, D.C.: Sept. 22, 2004), p. 55.

    Page 4 GAO-06-423 International Trade

    assistance of advanced software. They are then fabricated using chemicals,
    gases, and materials combined in an intricate series of operations using
    complex manufacturing equipment to produce wafers containing a large
    number of chips. During assembly, the chips are assembled into the
    finished semiconductor components and tested for defects. The finished
    semiconductor consists of millions of transistors and other microscopic
    components.

    The technological complexity of semiconductors is indicated by the
    diameter of the wafer and the density of the etched lines (feature size)
    on the wafer. The size of the wafer is an important element because the
    number of chips per wafer increases dramatically as the wafer size
    increases. The current leading-edge manufacturers produce 12-inch (300
    millimeters) wafers.3 Smaller feature size measured in microns allows for
    more components to be integrated on a single semiconductor, thus creating
    more powerful semiconductors. Each reduction in feature size-from 0.35
    micron to 0.25 micron, for example-is considered a move to greater
    technological sophistication.

    The software services industry also includes several types of services and
    levels of technological sophistication. Software services include writing
    individual software programs or combined "modules;" supporting these
    programs and modules once they are installed on computers; designing
    software networks, which might include various software programs, as well
    as systems of networks; integrating and maintaining these networks and
    systems as they are applied to clients' tasks; and managing and operating
    clients' overall computer systems.

    Software services are now broadly diffused throughout the U.S. economy.
    Firms across most industries now use some form of software services-
    whether it is basic accounting software, inventory control software, or a
    much more complex software product applied to manufacturing operations.
    Automobile companies, for example, use advanced computer software in the
    design of new car models, on production lines that manufacture these cars,
    and in the cars themselves that now contain electronic components.

    3Moving from an 8-inch (or 200 millimeter) wafer to a 12-inch (or 300
    millimeter) wafer increases the number of semiconductor chips by 2.25
    times.

        Page 5 GAO-06-423 International Trade

    Software services generally range in complexity from routine software
    programming and testing to complex software programming, software project
    management, and higher-end software systems integration, architecture, and
    research. In general, software programs and modules can be produced in
    various locations; integrating these requires some focal points capable of
    working closely with the various locations.

    Both semiconductor manufacturing and software services are key industries
    within the broader information and communications technology (ICT) sector;
    they have contributed significantly to overall U.S. growth and
    productivity. For example, semiconductor and related device manufacturing
    in the United States represents about 24 percent of the total value of the
    ICT sector's computer and electronic products manufacturing. Software
    services comprise about 48 percent of the total production of the
    categories of services industries included in the broader ICT sector-
    publishing industries (includes software), information and data processing
    services, and computer systems design and related services (averaged over
    1990 to 2004).

    Although the ICT sector represents a small share of the overall U.S.
    economy (about 4 percent), it has contributed significantly to U.S.
    economic expansion. According to the Department of Commerce's Bureau of
    Economic Analysis (BEA), the ICT sector accounted for about 11 percent of
    total economywide value-added growth in 2004. Examining value-added growth
    is a useful way to compare growth rates across industries because it
    measures only the increase in output due to that industry, excluding any
    inputs or materials from other industries. Therefore, value-added growth
    measures the changes in output due to increases in factors such as labor
    and capital and to improvements in the productivity of those factors.
    Figure 1 shows that, from 2002 to 2004, the ICT sector's growth in real
    value added accelerated more than any other industry group. Although the
    ICT sector's growth slowed in 2001 during the recession, annual real
    growth has recently accelerated from 2.0 percent in 2002, to 6.7 percent
    in 2003, and to 12.9 percent in 2004.

    Figure 1: Annual Growth in Real Value-Added by Industry Group, 2002-2004
    Percentage change

    15

    12.9

    12

    9

                                          6.7

    6

    4.9

    3.9

    3.2

    3

    2.0

    1.3 1.5

    1.2

    0

    2002 2003 2004

    Year

    Private goods-producing industries

    Private services-producing industries

    ICT-producing industriesSource: BEA.

    The ICT sector also contributes to productivity in the rest of the
    economy. For example, other manufacturing and services sectors, such as
    automobiles and banking, have become more productive as they have used the
    latest products and advances from the ICT sector. Economic research has
    generally found that the investments made in ICT sector products by other
    industries contributed to a rapid economywide increase in productivity
    during the 1990s.4 In addition, the technological advances and competition
    within the sector have resulted in declining prices and rising performance
    in ICT products. This, in turn, has contributed to lower rates

    4For example, see Dale Jorgenson "Information Technology and the U.S.
    Economy" American Economic Review, March 2001, 91(1), pp.1-32, and Kevin
    Stiroh "Information Technology and the U.S. Productivity Revival: What Do
    the Industry Data Say?" American Economic Review, December 2002, 92(5),
    pp.1,559-1,576.

    Page 7 GAO-06-423 International Trade

    of inflation throughout the economy as other sectors benefit from these
    improvements.

    We present information on multinational companies' global operations in
    semiconductor and software services in appendix II.

      U.S. Firms Continue to Offshore Increasingly Complex Semiconductor
      Manufacturing Activities and Software Services

    The U.S. semiconductor industry has foreign operations in several
    locations, notably in Taiwan and China. The U.S. software services
    industry has turned to India for a significant share of its offshoring
    operations. The types of semiconductor manufacturing and software services
    that U.S. firms have offshored to Taiwan, China, and India have become
    more complex over time. U.S. semiconductor firms first offshored
    laborintensive assembly operations in the 1960s, then wafer fabrication,
    and more recently, higher value-added activities, such as advanced
    fabrication and design. The offshoring of software services largely began
    in the 1990s in preparation for the year 2000 transition. Much like
    semiconductor products, the types of software services that firms have
    offshored have become progressively more complex as firms expanded their
    offshore operations to customized applications requiring highly skilled
    workers.

    Semiconductor Manufacturing Moved Offshore as Competition from Other
    Countries Developed; Firms Offshored More Complex Production Over Time

    Offshoring in semiconductor manufacturing began in the 1960s with
    laborintensive manufacturing activities, such as assembly. U.S. firms
    invested in overseas manufacturing facilities to perform the
    labor-intensive assembly of semiconductors for export to the United
    States. Firms domestically sourced the design and fabrication of
    higher-skilled, more capital-intensive semiconductor manufacturing
    activities and then shipped the semiconductors to Asia for assembly. The
    finished semiconductors were returned to the United States for final
    testing and shipment to the customer. According to some industry experts,
    offshoring of assembly work kept the U.S. semiconductor industry
    cost-competitive as new foreign rivals emerged in countries such as Japan.

    The overall U.S. business models for semiconductor manufacturing changed
    in the 1980s. Two types of company models developed for semiconductor
    production. Some companies, known as Integrated Device Manufacturers
    (IDMs), conduct their own research, produce their own designs, and operate
    their own fabrication plants to produce semiconductor wafers.5 Other
    companies, known as fabless design firms, develop their own designs and
    contract with independent fabrication plants, known as foundries, to
    produce their wafers. Foundries emerged during the 1980s as firms in Asia,
    particularly Taiwan, began to specialize in wafer fabrication. With the
    emergence of overseas foundries, U.S. firms developed global supply chains
    for sourcing different parts of the semiconductor production process over
    multiple global locations. They continued to design in the United States
    and other developed countries, while contracting with foundries in Taiwan
    to perform capital-intensive wafer fabrication. They also continued
    domestic fabrication, but Asian countries increased their share of overall
    production-with Taiwan expanding as a major supplier of fabrication
    services and China emerging as a new source of fabrication services in the
    late 1990s.

    In recent years, some U.S. firms have offshored increasingly complex
    semiconductor fabrication and design activities-essentially going up the
    value chain (see fig. 2). As firms in other countries, notably Taiwan,
    became more adept at producing more complex semiconductors, U.S. firms
    increasingly turned to offshore manufacturers to produce these
    semiconductors. The most complex semiconductors now manufactured in
    fabrication plants (commonly called fabs) are 12-inch (300 millimeter)
    wafers with submicron feature size. U.S. firms were leaders in developing
    12-inch wafers. According to industry experts, firms have offshored design
    services to Taiwan due, in part, to maintain close contact with Asian
    customers to meet their specific requirements. Also, as semiconductor
    manufacturing becomes more complex, some experts have noted, it becomes
    all the more important to develop close relationships among design and
    manufacturing activities, so as to enable feedback discussions.

    5However, IDMs may also use foundries in addition to their own fabrication
         plants to handle excess demand or certain production runs that are not
                           economical for the IDM to produce.

                         Page 9 GAO-06-423 International Trade

    Figure 2: Semiconductor Manufacturing Trends, 1960-2005

                           Sources: GAO (data); MapArt (map).

    The gap in semiconductor manufacturing capabilities has narrowed between
    the United States and Taiwan and China. Currently, Taiwanese and Chinese
    foundries are capable of producing technologically sophisticated
    semiconductors. For example, Taiwanese foundries are now capable of
    producing integrated circuits as small as 0.09 microns, and some Taiwanese
    firms provide design services to support this level of semiconductor
    technology. In addition, according to industry experts, the newest
    semiconductor manufacturing facilities in China are capable of producing
    integrated circuits up to 0.13 microns in size, with one Chinese foundry
    known to be producing circuits at the 0.09 micron size. Thus, currently
    the most advanced manufacturing facilities in Taiwan and China manufacture
    integrated circuits that are only one generation or less behind state of
    the art.

    U.S. Firms Offshored Software Services in the Mid-1990s and Increasingly
    Offshore More Complex Activities

    The software services industry was one of the first services industries to
    offshore significant activities as U.S. firms recruited foreign software
    programmers, particularly in India. Before the widespread use of the
    Internet, it was not economical to export software. U.S. firms either
    invested in overseas affiliates in India to directly provide software
    services for the firm or hired Indian programmers to work temporarily
    on-site at firms' U.S. locations. Beginning in the 1990s, Internet
    communications combined with the availability of satellite connections and
    reduced telecommunication costs made it possible for foreign software
    programmers to remain abroad while working for U.S. clients. Many types of
    U.S. firms began re-engineering their business processes to concentrate on
    core competencies and outsource or offshore other activities, such as
    writing software programs. The offshored activities were those that could
    be reduced to step-by-step instructions, digitized, and performed at a
    distance.

    In the late 1990s, preparations for the year 2000 changeover contributed
    to

            U.S.
                    firms' further use of foreign software programmers who were
                    knowledgeable in certain programming languages. U.S. firms
                    turned not only to foreign software programmers who were
                    temporarily employed in the United States but also to
                    programmers overseas, particularly in India, who provided
                    work directly to U.S. clients. In recent years, U.S. firms
                    have offshored increasingly complex software services, going
                    up the value chain as occurred in the semiconductor industry.
                    Examples of less sophisticated software services are
                    operations involving basic computer language coding or
                    programming and managing computer databases. More complex
                    offshored services include advanced software design and
                    development activities and researching, designing,
                    developing, and testing new software technology.

    U.S.
               firms experienced high-quality work in offshore locations; for
               example, they discovered that firms in India have the capabilities
               to produce high-end software services, such as software design at
               a low cost. In addition, firms often combine highly skilled labor
               available in India with skilled labor in other countries to create
               global teams with specific skill sets. For example, one firm in
               India stated that a firm might begin a highend software
               development project in India and then transfer the work to a team
               in Ireland for further development before delivery to a U.S.
               client. Firms also use global teams to better serve local markets
               worldwide by providing customized programming services to local
               clients.

    Currently, the types of offshored software services activities now include
    advanced software engineering and research and development. For example,
    in recent years Indian and multinational firms, including U.S. affiliates,
    have established high-technology research and design facilities in India
    to perform such high-end software services as software engineering and
    software product development. According to software services industry
    experts in India, many of these facilities employ hundreds of software
    engineers to develop and test a wide range of new high-end software
    designs and products for export to global customers. Some firms in India
    stated that the quality of high-end software design and development
    activities in India, combined with firms' need to introduce new products
    and new technologies, have attracted increasing interest in offshoring
    software development to India. Nevertheless, the bulk of offshored
    software services in India can be characterized as lower-level work,
    mostly in the applications development segment of the industry.
    Applications development primarily requires programming skills and has
    limited face-to-face interaction. Moreover, applications development can
    easily be segmented and standardized, features that characterize
    offshoring software services.

      Technological Advances, Availability of Talented Human Capital, and Foreign
      Government Policies Contributed to Increased Offshoring of Semiconductor
      Manufacturing and Software Services

    The combination of technological advances, available human capital, and
    foreign government policies has created a favorable environment for
    offshoring. Many firms in semiconductor manufacturing and software
    services use offshoring in their business models to increase their global
    competitiveness by lowering costs and gaining access to foreign markets.
    Advances in telecommunications enabled semiconductor firms to improve
    their logistics and inventory controls; they also were particularly
    important to the offshoring of software services. Firms in both sectors
    initially sought low-cost labor, but they expanded the scope of their
    offshoring activities as they discovered and helped develop highly
    educated workforces in Taiwan, China, and India. Foreign government
    policies played different roles in the countries we visited. In Taiwan and
    China, the national governments pursued various industrial policies to
    promote semiconductor manufacturing and, in India, the loosening of
    regulations and the availability of government-supported software
    technology parks afforded the software industry opportunities to grow
    relatively unregulated. Although offshoring conveys benefits to firms that
    choose to locate operations overseas, it also encompasses business risks
    that challenge management skill. See table 1 for an overview of the
    factors that have contributed to increased offshoring.

     Table 1: Many Factors Contributed to a Favorable Environment for Offshoring in
                          Semiconductors and Software Services

                                  Semiconductors           Software
    Factors                   (Taiwan, China)           (India)
    Technology
    Computer-related Inventory control, radio           ncy tics
    infrastructure   frequeidentification of products,  Telecommunications and
                        logisimprovement                   broadband capacity
                                                           improvements

        Physical infrastructure Roads, ports, trucking improvements Fiber optics

                                     Human capital

    Workers English     Assembly workers with less    Well-educated IT workers
    language abili      education; research and       English essential
                           development and design
                           professionals with higher
                           education English not
                           required
    ty Cost of human       Wage rates lower than U.S. Wage rates lower than
    capital                               wage rates; U.S. wage
                           labor costs represent a small rates; demand is causing
                                                share of wages to
                                fabrication plants.      increase.
    Government policies

    Education/training Vocational training emphasized Government promoted
    college education as a cultural value.

    (Continued From Previous Page)
                                     Semiconductors Software
    Factors               (Taiwan, China)        (India)
    Investment incentives     Various incentives Software technology parks
                               available in science include
                                  parks; government income tax credits, duty-free
                                 shares risk; China                      entry of
                                used a preferential capital goods, and access to
                                    value-added tax high
                               incentive to attract speed telecommunications.
                                  investment in the
                             early 2000s.
    Favorable tax/ land    Offered by regional   Less prevalent generally, but
    policies                   governments                           favorable
                                                      leasing terms are available
                                                                       in science
                                                    parks.
    Private sector             Highly regulated, Software less regulated than
    regulation                licensing required some
                                                    other private industry;
                                                    private
                                                    entrepreneurship is the
                                                    prevailing
                                                    model.

                                      Source: GAO.

    Technology Launched Important Changes in Semiconductors Manufacturing and
    Software Services

    Improvements in telecommunication technology helped to expand the degree
    of offshoring in both semiconductor manufacturing and software services.
    With improved communications, U.S. semiconductor firms were able to create
    tighter linkages with overseas suppliers, and software services firms
    developed global teams that could transfer digitized information over the
    Internet.

    Technology Improvements Allowed Semiconductor Firms to Develop More
    Efficient Global Supply Chains

    Semiconductor manufacturing firms improved their management of supply
    chains through better telecommunications, logistics management, and modern
    transportation. Telecommunications has allowed better monitoring of the
    movement of products. For example, foundries in Taiwan use
    Internet-enabled software that allows real-time communication between
    engineering teams in different locations. Some U.S. companies use
    radiofrequency identification tags in Taiwan and China to track products
    shipped from these manufacturing locations to distribution centers in
    other countries. According to a representative of one U.S. firm, this
    technology has reduced the need for inventory sourcing redundancy, thus
    reducing inventory cost and the associated employment costs.

    Logistics management is an important part of global business. Taiwan's
    competitive logistics industry has offered advanced computerized systems
    that assist in the management of purchasing, storage, delivery, and
    distribution of products. According to a Taiwan government official,
    Taiwanese companies can provide production orders to their clients in 2
    days. According to an industry researcher, the automation of the
    semiconductor assembly process also has improved efficiency in the overall
    semiconductor infrastructure, such as packaging facilities.

    Modern transportation options using more powerful computer systems,
    advanced software, and telecommunications make faster delivery possible.
    Countries are upgrading all elements of their transportation
    infrastructure-airports, seaports, modern roads, and trucking. Because a
    product may travel around the world more than once during the production
    process, efficient transportation systems are essential. For example,
    China has made numerous improvements to its transportation infrastructure
    to permit more efficient distribution. According to one Internet firm
    operating in China, the transportation infrastructure within China for
    delivering the physical products to customers-an essential component for
    online auction sites-did not exist before the year 2000. China reportedly
    invested $30 billion in 2004 alone to improve its network of roadways.

    The Software Services Industry Changed Its Global Business Model

    In the software services sector, telecommunications improvements have
    changed the types of software services traded, the way the work is done,
    and the telecommunications investments made.

    First, the essential advance in IT-the introduction of Internet
    communications-made it possible to trade some services that were
    previously not tradable. For example, software programs written in
    standardized programming languages could be digitized and transferred
    worldwide over the Internet.

    Second, global teams have become common elements of firms' business
    strategies. The ability to transmit data electronically made it possible
    to specify an application in one firm and develop it in another. Because
    of the availability of the Internet, teams can work 7 days a week, 24
    hours per day to meet customer needs worldwide. These teams' operations
    could be set up relatively quickly with office space, utilities, and
    communication tools, such as personal computers with broadband access. The
    ease of undertaking this type of offshoring has led to an escalating use
    of offshored IT services, including but not limited to software
    programming. According to one research firm, the value of IT offshoring
    and business process offshoring totaled $34 billion in 2005 and could
    double by 2007.

    Finally, the services offshoring model has required investments in global
    telecommunications infrastructure, such as wired landline and satellite
    communication services. India has made the investments to facilitate the
    telecommunications industry. According to the government of India, in

    2005, 47 million landline connections and 65 million satellite connections
    existed in India. Moreover, in 2004, after the telecommunication sectors
    declined due to overcapacity, one major Indian telecommunications services
    firm, partly owned by the government of India, purchased a large,
    privately owned U.S. undersea fiber-optic network linking Asia, Europe,
    and North America after receiving national security approval from the U.S.
    government. This acquisition strengthened India's control of low-cost
    telecommunications infrastructure. According to an Indian government
    official and several U.S. companies operating in India, the growth in
    telecommunications infrastructure has also enabled firms to move from
    India's major cities to smaller, lower-cost surrounding cities.

    The Availability of Human Capital Was Key to the Expansion of Offshoring
    in Both Semiconductor Manufacturing and Software Services

    The availability of high-quality workers overseas has been an essential
    component of the increased use of offshoring for firms in the
    semiconductor manufacturing and software services sectors. Through
    experience and training, the talent pool in several countries demonstrated
    their value to firms seeking skilled workers to perform tasks with various
    degrees of complexity.

    Some Semiconductor Firms Turned to Low-Level Skilled Foreign Workers
    Initially but Gradually Offshored More Complex Work to Higher-Skilled
    Labor Forces Overseas

    Access to human capital played an important role in the relocation of
    semiconductor manufacturing firms to Taiwan and China, especially as the
    need for skilled labor arose, and a quality workforce emerged in these
    countries. During the earlier phase of semiconductor offshoring in Taiwan,
    workers did not need advanced training. Taiwan emphasized vocational
    training during this period. Industry experts stated that, although
    lowercost labor was initially attractive for assembly, the labor costs
    component in semiconductor manufacturing is not a decisive factor for
    companies' location decisions overseas.6 New technology has computerized
    the entire production process, leading to a reduced need for labor and an
    increased need for skilled workers and managers. According to the
    representative of one research firm, the quality of the Chinese and
    Taiwanese workforce makes it easy to train and retain workers in
    semiconductor assembly and manufacturing.

    6Semiconductor manufacturing plants cost about $3 billion, with labor
    costs contributing between 5 and 10 percent.

    Page 16 GAO-06-423 International Trade

    Taiwan, China, and India are each able to provide a quality workforce,
    with a plentiful supply of engineers including emigrants who have returned
    to work in their home countries. Highly trained professionals with
    experience in U.S. firms assisted the development in each of these three
    countries of their semiconductor and software industries. According to one
    research firm, more than 5,000 overseas students and professionals return
    to China each year, bringing with them Western knowledge and skills.7 For
    example, several firms operating in China told us that Chinese returnees
    who have studied or worked abroad are an important part of their staffs.
    India, Taiwan, and China are each graduating IT and other engineers in
    large numbers. For example, China's potential supply of engineers is
    large; according to one U.S. study, the number of Chinese engineering
    graduates with bachelor's degrees in 2004 numbered 351,537, as compared
    with 137,437 in the United States.8 Moreover, engineers in Taiwan, China,
    and India typically earn less than their counterparts in the United
    States. For example, Taiwan's domestic supply of engineers can be hired at
    approximately half the cost of engineers in the United States.

    Software Services Firms Find a Large Supply of Human Capital Overseas with
    Top Quality Skills

    We reported in 2004 that access to human capital, particularly lower-wage
    skilled labor, an educated workforce, and quality local vendors
    facilitated software services offshoring. India is the leading example of
    this trend. For example, Indian wages represent a fraction of the cost of
    hiring U.S. counterparts, with the salaries for Indian IT engineers
    starting at $5,000. According to industry experts, the increasing demand
    for these workers is causing salary rates to increase somewhat. Yet lower
    wages does not tell the entire story because India also provides a skilled
    workforce. India's leading software services association reports that 44
    percent of India's services professionals possess at least 3 years of work
    experience. Moreover, many Indian nationals who studied computer
    technology in the United States and gained experience with U.S. IT firms
    have begun to

    7Chung Chen, Andrew and Woetzel, Jonathan R., McKinsey & Co., "Chips Fall
    Toward Design," (South China Morning Post: Mar. 11, 2002).

    8See "Framing the Engineering Outsourcing Debate: Placing the United
    States on a Level Playing Field with China and India" (Duke University:
    December 2005). This study indicates that China reported a total of
    644,106 engineering graduates in 2004, but that data included those with
    education and training that differ from that attained in U.S. engineering
    degree programs. We report these data, which are based on a comparison of
    equivalent engineering programs. For information on U.S. higher education
    programs related to science and technology, also see GAO, Higher
    Education: Federal Science, Technology, Engineering, and Mathematics
    Programs and Related Trends, GAO-06-114 (Washington, D.C.: Oct. 12, 2005).

    return to India to pursue career opportunities in their native country.
    Some of these individuals have gone on to create or lead successful firms
    in India.

    India has a strong national emphasis on advanced technical education, and
    its scientific and educational institutions produce well-trained
    scientists and engineers. The highly competitive Indian Institutes of
    Technology trains the upper echelon of talented students and, according to
    one industry researcher, produces highly skilled engineers with
    capabilities that match or exceed U.S. talent. In addition, an industry
    researcher in India stated that nontechnical programs are beginning to
    offer computer science and software programming courses to prepare
    students to meet the market demand of the software services sector.
    According to India's software services association, of the 215,000
    engineering graduates in 2003 to 2004, 141,000 specialized in IT (e.g.,
    computer science, electronics, and telecommunications).9 India's use of
    the English language gives it a further advantage, making India a prime
    destination for services offshoring.

    Finally, the quality of the firms in India is another factor that is
    considered when firms decide to offshore services. The quality of local
    vendors, many with Capability Maturity Model (CMM) certifications,
    provides a sense of security to firms seeking to offshore software
    services to India.10 According to a business association in India, Indian
    companies work to attain these certifications to demonstrate the high
    quality of their work. For example, a business representative told us that
    more than 50 percent of the companies that have CMM Level 5 certifications
    are located in India. With the update of the CMM to the Capability
    Maturity Model-Integration (CMMI), the Software Engineering Institute
    reports 93 Indian and 74 U.S. entities (41 percent and 32 percent,
    respectively, of the world total) with CMMI certifications as of March
    2006.

    9NASSCOM, Strategic Review 2005: The IT Industry in India (New Delhi:
    2005).

    10CMM was established in 1984 through Carnegie Mellon's Software
    Engineering Institute. The CMM is a framework that describes the key
    elements of an effective software process. The model was updated to the
    CMMI in 2000. The CMMI provides companies with guidance for improving
    their processes and managing the development, acquisition, and maintenance
    of products and services.

    Page 18 GAO-06-423 International Trade

    Foreign Government Policies Have Made Foreign Investment Attractive for
    Semiconductor Firms and Left the Software Services Industry Relatively
    Unregulated

    Foreign government policies contributed to the development of dynamic
    semiconductor and software services sectors with opportunities for U.S.
    firms to offshore. The governments of Taiwan and China developed a broad
    range of policies to promote their respective indigenous semiconductor
    industries and to attract investment, technology and talent from abroad.
    India, in its transition from a socialist government to a market-based
    economy, has liberalized its software services market, thus permitting
    U.S. firms to access India's low-cost high-quality workforce.

    Government Policies in Taiwan and China Have Assisted Their Respective
    Semiconductor Industries

    Taiwan has long pursued industrial policy to encourage the domestic
    development of science and technology. In 1972, it established a national
    research institute and within that organization an office to develop its
    semiconductor industry. Drawing upon the expertise of a U.S. advisory
    group, Taiwan successfully duplicated elements of the Silicon Valley
    technology cluster by establishing science-based industrial parks that
    brought together major universities, research labs, and a dynamic venture
    capital industry. Its universities feature programs sponsoring research
    specific to semiconductors, and the government targeted financial and tax
    incentives to the semiconductor industry. The government also emphasizes
    vocational training to develop quality resources. As a result, the
    government of Taiwan helped position its semiconductor industry as an
    effective contract supplier integral to the U.S. semiconductor supply
    chain. Its industrial strategy, which has been characterized as "close
    followership,"11 integrated Taiwan's industry operations with those of
    U.S. companies. Although this strategy means that Taiwan's industry may be
    a step behind the U.S. industry, firms in Taiwan capture high-technology
    industrial and research functions. As a result of its efforts, Taiwan is
    now a leading semiconductor producer with top-level manufacturing
    expertise.

    Taiwan's support of a strong semiconductor sector continues to evolve with
    a project that focuses on integrated circuits manufacturing
    infrastructure. The government is providing partial financial support to
    this project, which includes the expansion of university-based training,
    investments in new technologies, and a design park to focus on system-on-

    11Howell, Thomas R., testimony to the Committee on Commerce, Subcommittee
    on Technology, Innovation and Competitiveness, Hearing on Manufacturing
    Competitiveness, June 8, 2005 (Washington, D.C.). "Close followership"
    refers to firms that closely align themselves with their customer,
    adopting technology soon after the customer.

    Page 19 GAO-06-423 International Trade

    a-chip design.12 With added pressure from the opening of China's market
    and the competition from Chinese firms, Taiwan is revisiting its
    restrictions on the level of technology that firms may transfer to
    mainland China.13 In April 2006, Taiwan announced it was removing
    restriction of the export of low-end semiconductor packaging and testing
    technology to China.

    China's current policies have helped its semiconductor sector to grow
    dramatically since 2000, but its wafer production represents a relatively
    small percentage of worldwide production. Nevertheless, China is
    considered a rising player in the field of advanced technology. Prior to
    2004, China's differential value-added tax, since normalized,14 was a
    notable policy that led to an influx of semiconductor firms into China
    -notably from Taiwan-that sought to avoid the impact of the tax. Following
    Taiwan's strategy, China is creating a modern infrastructure to support
    semiconductor operations. For example, the government provides tax
    incentives, preferential loans, and opportunities to locate in special
    economic zones and science parks. China announced, in 2006, the adoption
    of a 15-year national technology strategy to develop, among other things,
    a world-class information sector and to focus on developing independent
    innovation. The result of China's policies is an expanding semiconductor
    sector that relies heavily on the expertise of Taiwan's managers and other
    expatriates whom China is actively recruiting to return to the mainland.15

    12System-on-a-chip design integrates computer components on a single chip.
    It may contain digital, analog, mixed-signal and radio frequency
    functions.

    13Currently, wafer technology using at most .25 micron circuitry may be
    transferred to the mainland. In February 2006, Taiwan levied a fine of
    about $155,000 on a leading Taiwanese firm that aided in the establishment
    of a Chinese chipmaker without Taiwan's approval in violation of its
    statute governing relationships between people in Taiwan and people on the
    mainland.

    14In July 2004, China and the United States resolved the World Trade
    Organization dispute over China's differential value-added tax, which had
    disadvantaged U.S. and other foreign firms whose semiconductors were not
    designed or produced in China. According to experts, China has implemented
    this agreement.

    15Taiwan's supplier relationship with the U.S. microelectronics industry
    is under pressure from the new opportunities for U.S. (and other) firms in
    China. According to one U.S. legal analysis, Taiwan has placed legal
    restrictions on the level of technology which its own firms may transfer
    to mainland China.

    Other Factors Constrain U.S. Firms' Offshoring Decisions

    India's policy for software services differed from the deliberate
    industrial policy undertaken by Taiwan and China. India's government
    policy shifted from protection of domestic industries to a gradual
    liberalization of some regulations. Although India maintains significant
    controls on some industries, the software services sector was not affected
    by some of the most restrictive policies, given the small size of its
    enterprises. Entrepreneurs in the software services sector were able to
    build the industry based on the special attributes of India -its
    English-speaking population, its supply of IT professionals, and its
    favorable telecommunication infrastructure.

    Between the 1950s and 1980s, India generally protected domestic firms from
    foreign competition and undertook a policy of import substitution. India
    pursued policies that sought to support state-owned enterprises. Where
    private firms were permitted to operate, a cumbersome licensing
    bureaucracy controlled their operations. Initially prevented from
    expanding into higher value-added segments of the industry in the 1980s,
    software services firms nevertheless found areas of specialization that
    the government did not restrict. In 1991, India experienced a shortage of
    foreign exchange, which required liberalization of its economy as a
    condition to gain support of the International Monetary Fund. This led to
    further deregulation, which enabled software services to expand. Moreover,
    in the 1990s, India introduced software technology parks, which are
    similar to export processing zones. Firms in these parks were given tax
    exemptions, access to high-speed satellite links, and reliable electric
    power. India's technical universities trained large numbers of engineers
    and specialists in their highly selective IT programs. Later reforms of
    foreign ownership rules, intellectual property protections, and venture
    capital policy further opened the way for trade in services.

    India's Software Industry Was Not Subject to Many of India's Restrictive
    Policies

    Firms seeking to offshore also encounter risks, including unforeseen
    costs, geopolitical concerns, cultural differences, infrastructure
    adequacy, and foreign government requirements. The destination country's
    legal system and contract enforcement affect firms' decisions to offshore.
    Both the semiconductor and software services industries have specific
    concerns about countries' intellectual property protection for their
    products and make location decisions accordingly. It should also be noted
    that offshoring places higher demands on firms' internal management
    skills. Managers must be able to lead teams with cultural differences,
    establish metrics to assess contract performance, and manage teams located
    around the world, using telecommunications as a primary tool. Although
    firms have found some cost savings in labor, nevertheless, they have also
    found other
    management challenges that tend to moderate the overall cost savings. One
    recurrent concern of U.S. firms operating in China is the lack of middle
    managers with the combination of business training, business acumen,
    management skill, and creative thinking.

      The United States Continues to Be a Global Leader in the Development of
      Semiconductors and Software at the Most Advanced Levels

    While offshore suppliers are playing a larger and more sophisticated role
    as the industries globalize, the U.S. semiconductor and software
    industries have remained technological leaders in the most advanced
    research and development (R&D) and design work, and the United States
    remains one of the largest producers globally of products in both
    industries. Available indicators on production, employment, and trade show
    that both of these industries have generally rebounded since the 2001
    recession and continue to grow. Traditionally, the U.S. economy has had
    several advantages that fostered strong semiconductor and software
    industries, including its highly competitive university system, talented
    labor pool, large domestic market for products, high levels of spending on
    R&D, and competitive business environment.

    The U.S. Semiconductor Industry, Rebounding from a Recent Recession,
    Continues to Be a Global Leader

    Despite having offshored some semiconductor operations, the U.S.
    semiconductor industry remains a global leader in cutting-edge
    semiconductor chip design and fabrication. U.S. semiconductor production
    has begun to rise again after a sharp decline during the 2001 recession.
    However, U.S. semiconductor employment, which also fell during this
    period, has remained relatively flat since 2003. U.S. exports have also
    remained flat, but imports declined more sharply creating a U.S. trade
    surplus in semiconductors. The United States generally exports high-value
    fabricated chips and wafers to lower-cost locations for assembly and
    testing. It imports integrated circuits (semiconductor wafers that have
    been assembled and tested) for use in a variety of industries. However,
    global demand for finished semiconductors has increasingly shifted to Asia
    where final assembly of electronic consumer products takes place.

    The United States Is a Global Leader in Semiconductor Design and
    Fabrication

    Semiconductor fabrication and design capabilities are spread among
    traditional producers such as the United States, Japan, the European
    Union, and newer producers such as South Korea, Taiwan, and China.
    According to industry experts and data, however, the United States remains
    one of the largest producers of semiconductors and, in particular,
    maintains cutting-edge development of both design and fabrication of new
    semiconductors. Industry estimates of semiconductor capacity vary, but the
    United States and Japan remain the largest two producers of
    semiconductors. Although a significant share of new high-end fabrication
    facilities are being built outside the United States for mass production,
    the United States is a key location for the fabrication facilities used
    for development of new semiconductor chips.

    As a global industry, U.S. production includes both U.S. companies and
    affiliates of foreign companies operating in the United States. Foreign
    companies have established operations in the United States to take
    advantage of U.S. technology, skilled labor, and the large domestic
    market, according to industry experts. One estimate suggests that about
    one-fifth of U.S.-based fabrication capacity was owned by foreign
    companies in 2001.16 In addition, foreign companies also take advantage of
    experienced design teams in the United States. Companies can potentially
    benefit from having operations in key areas around the globe where
    innovation is occurring. These operations are able to access the
    experienced labor pool and new innovations occurring in a particular
    region and transfer those developments to their global operations. Silicon
    Valley, California, for instance, is widely known as a key center of
    innovation in the semiconductor industry.

    Similarly, U.S. firms have invested in production capacity in Europe and
    Asia. However, according to industry experts, U.S. firms have generally
    not moved their R&D operations offshore. Data on patents and expenditures
    on R&D also indicate that U.S. semiconductor companies continue to locate
    their R&D work in the United States. Some industry analysts, though, are
    concerned that as production increasingly moves offshore to Taiwan and
    China, it will begin to draw more and more research activities with it.

    Industry experts also believe that most U.S. company design work is still
    conducted in the United States rather than offshore.17 According to these
    experts, U.S. companies are significant technology leaders in both the IDM

    16See Clair Brown and Greg Linden, "Offshoring in the Semiconductor
    Industry: A Historical Perspective" prepared for the 2005 Brookings Trade
    Forum on Offshoring of White-Collar Work (May 2005). Estimates are based
    on work by Robert Leachman and Chien Leachman, of the University of
    California at Berkeley.

    17Systematic data on the location of design work, particular leading edge
    product innovation, is not readily available. Therefore, industry experts
    rely on the location of companies' offices, patent data, and interviews
    with company officials to ascertain where design work is being carried
    out.

    and fabless design models. Although U.S. IDMs and fabless design companies
    operate globally, a larger share of their R&D and design work is conducted
    in the United States. Most of the fabless design firms are based in the
    United States, and many of the largest IDM's are also U.S.-based. Also,
    the development of foundries, particularly in Taiwan, likely allowed a
    wider range of fabless companies to develop in the United States than may
    have been possible without the existence of foundries. This is because the
    high cost of fabrication plants acts as an entry barrier to smaller firms.
    At the same time, there are a growing number of fabless design firms in
    Canada, Israel, and Taiwan, and U.S. companies are also operating design
    offices in these countries. Thus, the global share of design work by
    fabless companies is becoming less concentrated in the United States.

    U.S. Semiconductor Production Rebounding from 2001 Recession, but
    Employment Has Remained Flat

    U.S. production statistics show that the value of semiconductor production
    in the United States grew steadily during the 1990s even while offshoring
    expanded. U.S. production of semiconductors and related devices (measured
    by value-added) peaked in 1999 at about $68 billion, then declined steeply
    during the 2001 recession. It has since rebounded somewhat to $56 billion
    in 2004 (see fig. 3).

    Figure3: Value-added Trend for U.S. Semiconductor and Related Device
    Manufacturing, 1987-2004 Dollars in billions

    10

    0

    Year

    Source: U.S. Census Bureau, Annual Survey of Manufacturers.

    Note: This figure shows output of the industry measured by value-added.
    Value-added measures the dollar value of output in an industry minus the
    dollar value of intermediate products and raw materials purchased from
    other industries. For example, semiconductor value-added does not include
    the value of the raw silicon used in the production of the wafers. The
    values shown above are in current dollars (unadjusted for inflation).
    Price indices at this level of industry detail were not available.
    However, we did examine how the results would change using a higher level
    industry (computer and electronic products) price index to adjust for
    inflation (or deflation). Due to declining prices over time in the broader
    industry, the inflation-adjusted trend was accentuated, such that the rise
    was much steeper, the decline between 2000 and 2002 was much shallower,
    and the industry has rebounded. Therefore, we found that our observation
    that the industry has grown rapidly and has rebounded since the recession
    is even stronger.

    U.S. employment in the semiconductor industry did not rebound after the
    2001 recession as production did. After a long decline from the mid-1980s
    through the early 1990s, U.S. semiconductor employment grew strongly
    through 2001 (see fig. 4). However, employment dropped sharply from a peak
    of about 292,000 in 2001 to around 226,000 employees in 2003. After
    hitting a trough in 2003, employment in the semiconductor industry has
    been stagnant, although overall U.S. employment across all industries
    resumed growth in 2004.

    1988

                                          1989

                                          1990

                                          1991

                                          1992

                                          1993

                                          1994

                                          1995

                                          1996

                                          1997

                                          1998

                                          1999

                                          2000

                                          2001

                                          2002

                                          2003

    Figure 4: Employment T rend fo r Semiconductors a nd Related Dev i ces
    Industry, 1972-2005

    Number of employ e es (in thousands) 350

    300

    100 50 0

    2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990
    1989 1988 1987 1986 1985 1984 1983 1982 1981 1980 1979 1978 1977 1976 1975 1974
                                       1973 1972

    Year

    Source: Bureau of Labor Statistics.

    Employment in the semiconductor industry highlights the broader
    relationship between productivity growth and job declines in the U.S.
    manufacturing sector. Figure 5 shows an increase in productivity in the
    semiconductor and electronic components industry (a broader category than
    used in fig. 4) over the 15-year period from 1987. The pace of
    productivity growth sharply increased starting in late 1990s. Industry
    output continued to grow even after employment declined due to the
    increase in productivity (output per employee).

    Figure 5: Labor Productivity, Employment and Compensation Trends in
    Semiconductors and Electronic Components Manufacturing, 1988-2004

    Index (1997=100)

    Year

    Labor productivity index

    Compensation index

    Employment index

    Source: Bureau of Labor Statistics.

    Note: Productivity, employment, and compensation are presented here as
    indexes that represent their values at each year relative to the base year
    (1997).

    The United States Is a Net Exporter of Semiconductors, Particularly High
    Value-Added Wafers and Chips

    Since 2001, the United States has had a trade surplus in semiconductors,
    exporting more semiconductors and semiconductor components than it imported
    (see fig. 6). Both imports and exports grew rapidly from 1985 to 1995.
    From 1995 to 1998, exports continued to grow while imports
    remained flat. From 1998 to 2000, both imports and exports increased again
    rapidly, peaking in 2000 at about $48 billion (imports) and $45 billion
    (exports). From 2001 to 2005, imports declined sharply to about $26
    billion,
    while exports also declined, but then leveled out in 2003 to about $34
    billion.

    1988

                                          1989

                                          1990

                                          1991

                                          1992

                                          1993

                                          1994

                                          1995

                                          1996

                                          1997

                                          1998

                                          1999

                                          2000

                                          2001

                                          2002

                                          2003

    Figure 6: U.S. Imports and Exports of Semiconductors with All Countries,
    1985-2005

    Dollars in billions

    2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990
                                1989 1988 1987 1986 1985

    Year

    Imports

    Exports

    Trade balance Source: GAO analysis of U.S. Census Bureau trade statistics.

    Note: Trade values are presented in current dollars (unadjusted for
    inflation). Price indices for making inflation adjustments were not
    available for the entire time period. However, we did examine
    inflationadjusted constant dollar trade values for more recent years, and
    the findings in our analysis did not change.

    The majority of U.S. exports of semiconductors consist of chips and
    wafers, which are used to produce finished integrated circuits in other
    countries. The top five destinations for U.S. semiconductor exports were
    all Asian locations: Malaysia (13 percent), Korea (12 percent),
    Philippines (11 percent), Taiwan (9 percent), and China (8 percent).
    Exports of U.S. chips and wafers are the result of the fabrication
    process, which involves some of the most technologically advanced
    manufacturing processes.

    The majority of U.S. imports of semiconductors are finished integrated
    circuits (such as memory and logic integrated circuits), which are then
    used in other finished electronic goods, such as computers and cell
    phones. Finished integrated circuits are the result of chips and wafers
    being tested,
    cut, and packaged by separate manufacturing plants usually located abroad.
    This process, although still technologically sophisticated (and less
    labor-intensive than in the past), is still significantly less advanced
    than the fabrication process. In 2005, only 13 percent of imports were
    chips and wafers whereas 71 percent of U.S. exports comprised chips and
    wafers.

    U.S. Exports to Asia Growing as Demand for Finished Semiconductors Expands
    in China

    The decline in U.S. semiconductor imports since 2000 reflects the movement
    from the United States to Asia of manufacturing production of electronics
    products that use integrated circuits. Finished integrated circuits are
    moving to other countries in Asia, particularly China, for assembly into
    electronics products, rather than returning to the United States.
    Therefore, U.S. exports surpassed imports for the first time in 2001.
    Chinese trade statistics demonstrate the other end of this movement with
    Chinese imports of integrated circuits soaring over the last 10 years,
    making China one of the largest markets for integrated circuits in the
    world. Much of this increase has been supplied by Taiwan, Korea, Malaysia,
    Japan, the Philippines, and the United States (see fig. 7). Although the
    United States is sixth in terms of direct exporters to China, some portion
    of

    U.S. exports of chips and wafers are passing through other Asian countries
    for assembly and testing (including China) before use in China's booming
    electronics industry. As mentioned above, the top destinations for U.S.
    wafer exports are Malaysia, Korea, Taiwan, the Philippines, and China.
    Those wafers are assembled and tested before being sent to electronics
    manufacturers for use in their products. These trade flows show the
    complex production chains that have developed across multiple countries.

    Figure 7: Chinese Imports of Semiconductors by Country, 1995-2005

    Dollars in billions

    25

    20

    15

    10

    5

    0

    1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

    Year

    Philippines

    Malaysia

    South Korea

    United States

    Taiwan

    Japan

    Source: GAO analysis of Chinese trade statistics provided by Global Trade
    Information Services.

    Note: Trade statistics are presented in current U.S. dollars unadjusted
    for inflation since an appropriate price index for these imports is not
    available.

    The shift in production and trade flows toward Asia has two consequences.
    First, because final production increasingly takes place in Asia, the
    United States imports an increasing share of electronics and
    telecommunications products (that use semiconductors). Appendix III shows
    that this is reflected in the growing U.S. trade deficit with Asia and
    China, in particular, including in advanced technology products. Second,
    as electronics and telecommunications production chains increasingly
    locate in Asia, there are benefits to U.S. producers of semiconductors to
    locate abroad near their customers and take advantage of the production
    clusters developing there. Therefore, this trend creates an incentive for
    U.S. companies to offshore some activities.

    The United States Is the Largest Global Supplier, Employer, and Market for
    Software Services

    Although the industry is globalizing, the United States has maintained its
    leadership in the development and expansion of the software services
    industry. U.S. companies are global leaders in the packaged software and
    custom software services segments of the industry. Although statistics on
    software services are more limited than for semiconductor manufacturing,
    indicators show that the United States is a leading developer and consumer
    of software globally. U.S. production and employment data show that the
    industry has generally rebounded after declining during the 2001
    recession. Also, while both imports and exports have grown rapidly, the
    United States maintains a trade surplus in software services.

    The United States Is a Leading Software Developer and the Largest Supplier
    in the World

    The U.S. software industry is the largest in the world and plays a
    leadership role in the global market for software services. U.S. companies
    are disproportionately ranked among the largest in the world, both in
    terms of revenues and numbers of top firms.18 U.S. companies also benefit
    from the large U.S. domestic market, which by one industry estimate
    accounts for about 50 percent of global demand for packaged software and
    about 40 percent of global demand for custom software services. U.S.
    software companies are also widely considered leaders in the development
    and delivery of leading-edge software services. According to industry
    experts, much of the development of these services takes place in the
    United States, although larger companies also employ teams of developers
    worldwide.

    U.S. Software Production Has Rebounded from the 2001 Recession

    Although the industry experienced a downturn during the 2001 recession, it
    has since begun to recover. As figure 8 shows, the U.S. software industry
    grew rapidly through the late 1990s, declined during the 2001 recession
    and, as of 2004, had rebounded to its peak in 2000 based on industry
    revenue. Packaged software appears to be leading the rebound, while custom
    software revenues have remained flat since 2002.

    18According to the Association of Computing Machinery (ACM), an industry
    association,

    U.S. firms make up 11 of the top 15 software companies (both packaged and
    custom services), with the remaining 4 companies from Germany, Japan, and
    France. See ACM,

    Globalization and Offshoring of Software: A Report of the ACM Job
    Migration Task Force

    (www.acm.org, March 2006).

    Page 31 GAO-06-423 International Trade

        Figure8: U.S. Software Industry Revenues, 1990-2004

    Total revenue (dollars in billions)

    200

    180

    160

    140

    120

    100

    80

    60

    40

    20

    0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
    2004

    Year

    Packaged software

    Custom software

    Total software services

    Census industry classification change

    Source: U.S. Census Bureau, Services Annual Survey.

    Note: Census industry classification changed from the Standard Industrial
    Classification (SIC) system in 1997 to the North American Industry
    Classification System (NAICS) in 1998. Therefore, there is a break in the
    series as indicated by the shaded area and dotted trend lines. Also, data
    on value-added for software services industries are not collected by the
    Bureau of the Census. Total revenue includes exports and is reported in
    current U.S. dollars (not adjusted for inflation). Price indices at this
    level of industry detail were not available. However, we did examine how
    the results would change using a higher level industry price index to
    adjust for inflation (or deflation). The higher level industries
    (publishing, which includes packaged software, and information and data
    processing services, which include custom software) experienced some
    inflation over this period and, therefore, after adjusting for inflation
    the growth in the software industry was somewhat reduced. However, our
    observations on the both the growth of the industry and its rebound since
    the recession were still consistent with the inflation-adjusted data.

    U.S. Employment in Computer Specialist Occupations Has Grown Overall Since
    the 2001 Recession

    U.S. software industry employment is the largest in the world. According
    to one industry estimate, U.S. software employment makes up roughly about
    half of the global workforce in packaged software and about a third of the
    workforce employed in IT services industry, which includes custom software
    services.19 As a group, software occupations, or computer specialists as
    designated by the Department of Labor's Bureau of Labor Statistics (BLS),
    experienced relatively large gains in both employment and hourly wages
    from 2001 to May 2005 (the most recent time period for which comparable
    occupation-based data are available).20 This period largely coincided with
    an economic recovery following the 2001 recession.21 Table 2 compares
    changes in employment and hourly wages for nine computer specialist
    occupations and that of all U.S. occupations. Seven of the occupations saw
    employment growth ranging from 1.1 percent to 46.9 percent compared to 1.8
    percent for all U.S. occupations. Employment for two occupations (computer
    programmers and database administrators22) declined by 22.4 percent and
    4.7 percent, respectively, from 2001 to May 2005. The wages for these
    occupations also increased more slowly than the wages for all U.S.
    occupations. Hourly wages for five occupations increased more slowly than
    the wages for all U.S. occupations, increasing by 3.5 percent to 10.5
    percent compared with 11.4 percent for all U.S. occupations. Wages for
    four occupations, however, increased faster than the wages for all U.S.
    occupations, rising by 12 percent to 22.2 percent.

    19See McKinsey Global Institute, The Emerging Global Labor Market: Part
    I-The Demand for Offshore Talent in Services (www.mckinsey.com/mgi: June
    2005).

    20In November 2002, BLS's Occupational Employment Statistics Survey
    changed from an annual survey to a semiannual survey.

    21The National Bureau of Economic Research's Business Cycle Dating
    Committee determined that a trough in business activity occurred in the
    U.S. economy in November 2001 marking the end of the recession that began
    in March that year.

    22Database administrators identify user requirements and set up and
    administer computer database systems.

    Table 2: Changes in Hourly Wage and Employment for U.S. Computer
    Specialist Occupations

                                       Percentage
                                            change in                  Percentage
                                  Hourly hourly wage  Number of         change in
                               wage (May    (2001-May  jobs (May       employment
    Occupations                 2005)        2005)       2005) (2001-May 2005)
    Computer and
    information scientists,
    research                   $45.21        22.2%      25,890           1.1 %
    Computer software
    engineers, systems
    software                    40.54         13.2     320,720            22.6
    Computer software
    engineers, applications     38.24          9.9     455,980            26.1
    Computer systems
    analysts                    33.86         10.5     492,120             9.8
    Computer programmers        32.40          7.2     389,090           -22.4
    Database administrators     31.54         12.3      99,380            -4.7
    Network systems and
    data communications
    analysts                    31.23          7.7     185,190            46.9
    Network and computer
    systems administrators      30.39         12.0     270,330            18.6
    Computer support
    specialists                 20.86          3.5     499,860             1.3
    All U.S. occupations       $18.21        11.4% 130,307,850            1.8%

    Source: Occupational Employment Statistics Survey, BLS.

    Note: Occupations are ranked by hourly wage.

    Computer software engineers (including systems software and applications
    engineers, two high-wage occupations) saw modest increases in wages but
    relatively large increases in employment, growing by 22.6 and 26.1
    percent, respectively. Computer software engineers design, develop, and
    test the software and computer systems, applying computer science,
    mathematics, and engineering expertise. The integration of Internet
    technologies and the rapid growth in e-commerce have led to a rising
    demand for computer software engineers. Although hourly wages of network
    systems and data communications analysts increased by a relatively low 7.7
    percent, their job growth was the largest of all computer specialist
    occupations at 46.9 percent. This group of computer specialists designs,
    tests, and evaluates network systems and other data communications
    systems.

    According to BLS, employment in computer specialist occupations, apart
    from computer programmers, is projected to grow much faster than overall

    U.S. employment.23 Although total U.S. employment is projected to grow 13
    percent over the 2004 to 2014 period, employment of computer specialists
    is projected to grow 31.4 percent (see fig. 9). BLS projects that the
    demand for computer-related jobs is likely to increase as employers
    continue to adopt and integrate increasingly sophisticated and complex
    technologies. Growth, however, will not be as fast as the previous decade,
    as the software industry matures, and as routine work is increasingly
    offshored.

    Figure 9: Projected Rate of Job Growth for Computer Specialist
    Occupations, 2004-2014 All occupationsTotal computer specialistsNetwork
    systems and data communications analystsNetwork and computer systems
    administratorsDatabase administratorsComputer systems analystsComputer
    supportspecialistsComputer software engineers, systemssoftware Computer
    software engineers, applicationsComputer programmersComputer and
    information scientists, research

    0 1020304050 Percentage

    Source: BEA.

    23Daniel Hecker, "Occupational Employment Projection to 2014," Monthly
    Labor Review, November 2005, Bureau of Labor Statistics.

    Page 35 GAO-06-423 International Trade

    Projected job growth for computer software engineers and network systems
    and data communications analysts is especially robust. The BLS's
    Occupational Outlook Handbook suggests that demand for workers with
    specialized technological skills is expected to increase sharply as
    employers use and improve the efficiency of new technologies. As the race
    for increasingly sophisticated technological innovations continues, the
    need for more highly skilled workers to implement these innovations will
    continue. More highly skilled computer specialists will be needed as
    businesses and other organizations try to manage, upgrade, and customize
    their increasingly complicated computer systems. Computer specialists who
    have a combination of strong technical and good interpersonal and business
    skills will be in demand.

    Unlike other computer specialists, job growth of computer programmers is
    expected to lag significantly behind the growth in overall U.S.
    occupations. Programmers are projected to grow only by 2 percent from 2004
    to 2014. Because computer programming requires little localized or
    specialized knowledge, computer programming can be performed anywhere in
    the world and transmitted electronically. Consequently, programmers
    potentially face a higher risk of having their jobs offshored than other
    computer specialists such as software engineers, who are involved in more
    complex information technology functions. Another factor limiting job
    growth in computer programming is progress in programming technology.
    Computer software has become increasingly sophisticated, enabling users to
    write basic code without programmers' involvement for routine programming.

    The United States Maintains a Trade Surplus in Software Services Trade,
    but Imports Are Growing

    The United States is a net exporter of software services and has
    maintained this trade surplus for several decades. Although U.S. exports
    are rising rapidly, imports are also increasing in this category. Canada
    is the largest supplier of imported computer and data processing services
    to the U.S. market but, as we have previously reported, India is rapidly
    growing as a supplier of these services.24 Figure 10 shows U.S. exports
    and imports of computer and data processing services, the category that
    includes both custom and packaged software services (as defined by BEA)
    since 1986.

    24See GAO-06-116 . This report also highlights limitations in the data of
    services trade and the significantly larger exports statistics reported by
    India.

    Page 36 GAO-06-423 International Trade

    Figure 10: U.S. Unaffiliated Exports and Imports in Computer and Data
    Processing Services, 1986-2004

    Dollars in billions

    4

    3

    2

    1

    0

    Year

    U.S.
               imports

    U.S.
               exports

    Source: BEA.

    Note: The values are for unaffiliated transactions-sales between companies
    located in the United States and unrelated third party providers or
    purchasers located abroad. Statistics on both affiliated and unaffiliated
    transactions in this product category are only available since 2001.
    However, these data show that United States also maintains a trade surplus
    in overall (affiliated and unaffiliated) computer and data processing
    services from 2001-2004.

    U.S. exports of software services make up about 13 percent of overall U.S.
    software revenues according to the U.S. Census Bureau (Census). However,
    most export revenue is derived from packaged software exports. These
    Census statistics show a much larger value of exports than the BEA trade
    in services statistics.25 As shown in figure 11, U.S. companies report

    1987

                                          1988

                                          1989

                                          1990

                                          1991

                                          1992

                                          1993

                                          1994

                                          1995

                                          1996

                                          1997

                                          1998

                                          1999

                                          2000

                                          2001

                                          2002

                                          2003

    25BEA reported U.S. affiliated and unaffiliated exports of computer and
    information services (which includes computer and data processing
    services) at $8.5 billion in 2004. Census reported U.S. exports by custom
    computer programming services and software publishers at $21.6 billion.
    Some of this discrepancy is accounted for by differences in the treatment
    of packaged software, classifications, and survey samples. For example,
    BEA's statistics exclude computer software that is physically shipped and
    considered a good rather than a service.

    nearly $22 billion in exports of software services, primarily comprising
    about $20 billion in U.S. package software exports.

    Figure 11: U.S. Exports of Software, 1998-2004

    Dollars in billions

    0
        1998       1999        2000        2001        2002       2003       2004
        Year
               Custom software exports
               Package software exports
               Total software exports

    Source: Census.

    Information on trade in software services is significantly more limited
    than information on trade in semiconductors. Although both BEA and Census
    collect statistics on software trade, as demonstrated by the previous two
    figures, the data are available only for the aggregate categories shown.
    In comparison, for semiconductors, over 230 individual semiconductor goods
    are identified by Census as they cross international borders. In addition,
    most countries in the world utilize the same goods classification system,
    known as the Harmonized System, to record trade in goods. However, efforts
    to create and utilize detailed and compatible classification systems

    U.S. Economy

    across countries for services such as software are still relatively new.26
    Part of the challenge in collecting detailed statistics on services
    industries, such as software, derives from the "intangible" nature of many
    services-they are not necessarily physical products-and the fact that they
    don't cross customs borders like goods. Rather, services data is collected
    by surveying companies for information on their payments or receipts for
    services. In addition, services can be delivered to the customer through
    many different channels, including licensing agreements, imbedded in goods
    such as computers, or a commercial presence such as a foreign subsidiary.

    The U.S. Semiconductor and Software Industries Benefit from the Large,
    Innovative

    The United States maintains substantial advantages as a large,
    technologically sophisticated economy. The U.S. high-technology
    industries, such as semiconductors and software, have benefited from a
    U.S. economic environment that supports innovation-world-class
    universities and research centers, a talented labor pool, and high levels
    of spending on R&D. The industries also benefited from a competitive U.S.
    business environment, an efficient legal system for contracts and
    intellectual property protection, and a large domestic market.27

    University and Research Centers, Talented Labor, and R&D Investment Have
    Helped Foster Innovation

    Although a wide range of causes and circumstances leads to new
    innovations, certain enabling factors create an environment that fosters
    new ideas and their development. These include (but are not limited to)
    such factors as the higher education system and related research centers,
    pools of talent available, and the investments in research and
    development.28

    26For example, see the discussion of the discrepancies between U.S. and
    Indian services trade data in GAO-06-116.

    27However, measuring the individual contribution of any one of these
    factors on the development of the semiconductor and software industries,
    as well as their future importance to these industries, is beyond the
    scope of this report.

    28Although we discuss several indicators of innovation in this section,
    there are a variety of measures available. See for example, National
    Science Board, Science and Engineering Indicators, 2006 (Washington, D.C.:
    National Science Foundation, 2006) available at www.nsf.gov. Also, it is
    important to note that each of these indicators provides only a limited
    measure of certain aspects of innovation, which is a broad and elusive
    concept. For a comparison of R&D globalization across countries, see
    Swedish Institute for Growth Policy Studies, The Internationalization of
    Corporate R&D (Stockholm, ITPS, 2006) available at www.itps.se .

    The U.S.'s world-class higher education system and research institutes
    create communities for researchers and educators and are widely considered
    a key competitive advantage. The higher education system in the United
    States includes many universities that are ranked among the best in the
    world in terms of research, education, and entrepreneurship. Also, a large
    number of top applicants from around the world apply for undergraduate,
    graduate, and postdoctoral study. More specifically, U.S. computer science
    and engineering programs-of particular importance to high-technology
    industries such as semiconductors and software-are leaders in their
    fields. The higher education system has provided both a strong research
    environment and a pool of talented labor-both native born and foreign
    students who remained after education.

    A second factor that fosters innovation is the quality and number of
    available researchers and other skilled labor. Countries with larger and
    more talented labor pools are more likely to foster and sustain
    innovation. The United States has a world-class talent pool that includes
    both technical and managerial talent. The United States has the largest
    number of researchers worldwide, with about 1.3 million, followed closely
    by the European Union (EU-25), according to data from the Organization for
    Economic Cooperation and Development. China, ranked third, has rapidly
    increased the number of its researchers to surpass Japan. Although the
    quality of these researchers is not captured by the indicator, it does
    show the growing size of the Chinese research community.

    A third factor that fosters innovation is a country's investment in
    research and development. This investment may come from several sources,
    including the government, academia, and business. U.S. expenditures on R&D
    are the largest in the world and have continued to grow over time (see
    fig. 12). Currently, the United States spends about 2.7 percent of its
    gross domestic product on R&D expenditures, compared with about 3.2
    percent for Japan and 1.4 percent for China. For certain industries such
    as semiconductors, early investments by the federal government-the
    military, in particular-have been key in the initial development of the
    industry. However, this role may change over time. For the United States,
    the increase in R&D expenditures over the past decade has been driven by
    the business community, while the total amount of federal R&D has grown
    much more slowly in comparison.

    Figure 12: Gross Domestic Expenditures on Research and Development by
    Country, 1990-2004

    Dollars in billions (2000 PPP$)

                               350 300 250 200 150 100 50

    0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
    2004

    Year

    Taiwan Korea China Japan EU25 United States

    Source: Organization for Economic Cooperation and Development, Main
    Science and Technology Indicators, 2005.

    Note: 2000 PPP$ refers to gross expenditure data converted from national
    currencies (e.g., the Yen) into inflation-adjusted year 2000 U.S. dollars
    based on purchasing power parity (PPP) conversion factors. PPP conversion
    factors take into account differences in the relative prices of goods and
    services and differ from market exchange rates. Data on EU-25 R&D
    expenditures prior to 1995 are not available.

    While the United States has generally maintained a strong advantage in
    areas that foster innovation, several studies have recently raised
    questions about continued dominance of the United States in cutting-edge
    innovation.29 They cite a range factors that indicate the rise of other
    competitors in traditionally U.S.-dominated areas. For instance, changes
    in
    U.S. visa and immigration requirements have been cited as hampering the
    number of foreign students, researchers, and high-tech workers who are
    attracted to the United States and allowed to reside here.30 At the same
    time, other countries' university systems are increasingly competing with
    the United States to attract the most qualified students and researchers.
    According to these studies, these changes have led to a decline in the
    number of university applications from foreign students. Similarly, other
    countries have liberalized their economies and provided greater
    opportunities for higher skilled workers. Therefore, more students and
    researchers, including those from India and China, who may have once
    stayed in the United States have an incentive to return to their native
    countries.

    Business Environment, Legal System, and Domestic Market Affect
    Commercialization of Innovation

    In addition to an environment for fostering innovation, countries need to
    be able to commercialize these innovations to affect the wider economy.
    Several factors contribute to a U.S. competitive environment that
    encourages innovation to be commercialized. First, the business
    environment includes relatively competitive product markets that encourage
    businesses to take new products to market in order to gain advantage over
    rivals, while also allowing new entrants to challenge existing companies.
    The United States also has a relatively efficient financial system,
    including venture capital markets that fund new innovations and start-ups
    in high-technology industries. The U.S. legal and regulatory environment,
    including its intellectual property protections

    29See, for example, Rising Above The Gathering Storm: Energizing and
    Employing America for a Brighter Economic Future (Washington, D.C.:
    National Academy Press, February 2006), America's Pressing Challenge -
    Building a Stronger Foundation: A Companion to Science and Engineering
    Indicators 2006 (Washington, D.C.: National Science Board, January 2006),
    and Sustaining the Nation's Innovation Ecosystems, Report on Information
    Technology Manufacturing and Competitiveness, (Washington, D.C.:
    President's Council of Advisors on Science and Technology, January 2004).

    30For additional information of the U.S. visa program, see GAO, Border
    Security: Streamlined Visas Mantis Program Has Lowered Burden on Foreign
    Science Students and Scholars, but Further Refinements Needed, GAO-05-198
    (Washington, D.C.: Feb. 18, 2005) and GAO, Border Security: Improvements
    Needed to Reduce Time Taken to Adjudicate Visas for Science Students and
    Scholars, GAO-04-371 (Washington D.C.: Feb. 25, 2004).

    (such as patents), allows individuals and companies to be rewarded for
    their investment in innovation. Finally, the large U.S. domestic market
    provides an avenue for companies to sell new products to a wide range of
    sophisticated customers. The U.S. economy is by far the largest in the
    world, and per capita income is also one of the highest in the world. This
    creates an environment for U.S. companies to develop and sell new products
    profitably. In addition, companies that are close to their customers are
    able to spot new trends and preferences in demand and cater to them. This
    is particularly true in high-technology industries in which the product
    life cycle is relatively short and profit margin for older products
    declines quickly.

      Concluding Observations

    The past decade's revolution in telecommunications and related advances in
    supply chain management capabilities have deeply affected the business
    models for both the semiconductor manufacturing and software services
    industries. These industries' overall business model is now a global one,
    in which U.S. firms regularly consider a wide range of locations for their
    operations and source different parts of their operations wherever the
    advantages are most compelling. For the semiconductor industry, firms
    initially offshored labor-intensive assembly activities to cut labor
    costs, but more recently firms have offshored other activities for various
    reasons, including proximity to other industry suppliers, closer relations
    with foreign customers, benefits offered by foreign governments, and the
    availability of both skilled and unskilled human capital. In the software
    industry, the offshoring trend is more recent, but the motivations are
    similar.

    For software services, however, an important difference may be the
    possible speed and scale of employment shifts. Software services
    offshoring, compared with semiconductor manufacturing offshoring, does not
    need the same physical infrastructure, such as ports, roads, and
    factories, and thus can be set up more quickly. It is more labor intensive
    than capital intensive, and thus may be more sensitive to wage
    differentials. In addition, service occupations related to software
    programming are large in comparison to manufacturing jobs in the
    semiconductor industry. In semiconductor manufacturing, there was
    relatively slow movement up the value chain as firms invested in the
    overseas workforce and factory facilities. India's software industry
    development has advanced more quickly, with rapid technological changes
    bringing large numbers of highly educated, but underused, English-speaking
    workers to the doorstep of firms willing to operate from India. The data
    available to monitor the scale of services offshoring, unfortunately, are
    much more limited than those available for following trade in manufactured
    products. Semiconductor products, for example, can be identified and
    inspected at U.S. borders, whereas software imports and exports can be
    transmitted almost instantaneously over the Internet.

    Government policies also played important, but different, roles in Taiwan,
    China, and India; however, all three governments have placed high
    importance on education. In recent years, China has been transforming
    large parts of its coastal cities through massive infrastructure
    investments and has provided more targeted inducements for firms, such as
    support for science and technology parks and various types of financial
    assistance. India liberalized parts of its central government apparatus in
    the early 1990s, but its investment in physical infrastructure such as
    roads and ports has been much more limited, although India has also
    supported its science parks and put in place advanced telecommunications
    infrastructure improvements. These incentives for software exporters
    appear to have been well targeted.

    The comparison of these two offshoring experiences offers some insights
    for U.S. policies. Clearly, a large and well-educated population appears
    to be a central element to success in both semiconductor manufacturing and
    software services activities. Also, technological changes have impacts
    that are not always predictable and, in a now closely-connected global
    business world, such changes can have continuing dynamic effects on U.S.
    industries. India may have neither fully predicted or planned its current
    strengths in software services, nor foreseen how its pool of native
    English speakers could be such an asset, but it now realizes the
    importance of enhancing its strengths in these areas. In addition,
    ambitious national goals-whether China's semiconductor development road
    maps or Indian businesses' long-term strategies-are additional elements in
    the mix of factors that will shape these countries' futures and will pose
    competitive challenges to U.S. firms.

    As numerous recent studies have reported, the ability of the United States
    to continue to compete at the most advanced levels in high technology
    industries depends on a range of reinforcing factors: high-level R&D
    investment by companies and government, innovative academic environments
    attracting and training the highest-skilled researchers, a competitive
    business environment that fosters development and commercial application
    of new technologies, and a flexible and skilled workforce. These factors
    are being nourished in China, Taiwan, and India,

    as these countries seek to move further up the value chain and to
    "leapfrog" advanced country capabilities where possible. Indeed, these
    countries have modeled their industry development strategies on various
    aspects of the U.S.'s successful model. The United States is an integral
    part of this dynamic world economy-in which it will be important for U.S.
    businesses and policymakers to keep alert to technological changes, to
    anticipate competitor countries' strategies, and to preserve and enhance
    the elements of the innovation environment that helped make the United
    States a model.

      Agency Comments and Our Evaluation

    We provided a draft of this report to the Departments of State and
    Commerce for their review and comment. The Department of State did not
    provide comments. We received written comments from the Department of
    Commerce, which agreed our findings. (See app. IV.) The Department of
    Commerce also provided technical comments, which we incorporated into the
    report, as appropriate.

    We are sending copies of this report to interested congressional
    committees and the Departments of State and Commerce. We also will make
    copies available to others on request. In addition, the report will be
    available at no charge on the GAO Web site at http://www.gao.gov.

    If you or your staff have any questions about this report, please contact
    me at (202) 512-4128 or yagerl@gao.gov. Contact points for our Offices of
    Congressional Relations and Public Affairs may be found on the last page
    of this report. Key contributors to this report are listed in appendix V.

    Loren Yager Director, International Affairs and Trade

    List of Committees

    The Honorable Max Baucus Ranking Minority Member Committee on Finance
    United States Senate

    The Honorable Henry A. Waxman Ranking Minority Member Committee on
    Government Reform House of Representatives

    The Honorable Charles Rangel Ranking Minority Member Committee on Ways and
    Means House of Representatives

    The Honorable Bart Gordon Ranking Minority Member Committee on Science
    House of Representatives

    Appendix I:  Scope and Methodology

    This report discusses (1) the development of offshoring in semiconductor
    manufacturing and software services over time, (2) the factors enabling
    the expansion of offshoring in these industries, and (3) the development
    of these industries in the United States as they have become more global.

    To obtain information about the key developments in the offshoring of
    semiconductor manufacturing and software services, we reviewed available
    literature; attended conferences on the subject; and interviewed
    government officials, representatives of private firms, industry
    associations, and research organizations in China, India, Taiwan, and the
    United States. We performed a literature search and obtained information
    from several research organizations, universities, and industry
    associations that have published industrywide studies on offshoring and
    the key developments in both the semiconductor manufacturing and software
    services industries, including the Association for Computing Machinery;
    Brookings Institution; Gartner, Inc.; McKinsey and Company; the University
    of California, Berkeley; Stanford University; Carnegie Mellon University;
    the Semiconductor Industry Association; and the Information Technology
    Association of America. We attended conferences on developments in the
    semiconductor and software services industries and the general offshoring
    phenomenon. We interviewed researchers at private research organizations,
    industry experts at the U.S. Department of Commerce and the U.S.
    International Trade Commission, and government officials from India and
    Taiwan. In addition, we met representatives of private sector firms in the
    semiconductor and software services industries in China, India, Taiwan,
    and the United States. We also interviewed representatives and obtained
    data from organizations representing semiconductor and software services
    firms and workers, including the Semiconductor Industry Association, the
    National Association of Software and Service Companies, and the
    Information Technology Association of America. We discussed with these
    sources the historical changes that have occurred broadly in the computer
    hardware industry, particularly with respect to China and Taiwan, and the
    software services industry, particularly with regard to India.

    To determine the factors that have contributed to offshoring in
    semiconductor manufacturing and software services, we conducted a review
    of available literature and interviewed representatives of private sector
    firms, semiconductor and software services industry associations, business
    associations, and research organizations (see above). In addition, we
    interviewed industry experts within the U.S. government and the
    governments of India and Taiwan. We met with and reviewed relevant

    Appendix I Scope and Methodology

    literature from researchers who have published on the offshoring
    phenomenon and the factors contributing to global developments in
    semiconductor manufacturing and software services; including experts from
    the Brookings Institution; the Institute for International Economics; the
    Milken Institute; and the University of California, Berkeley. We
    interviewed representatives of private sector firms in China, India,
    Taiwan, and the United States that have globally sourced semiconductor
    manufacturing and software services; trade and industry experts in the
    U.S. Department of Commerce; and the governments of India and Taiwan. In
    addition, we interviewed representatives of business and industry
    associations, such as the Federation of Indian Chambers of Commerce and
    Industry, the U.S.-Taiwan Business Council, and the Semiconductor Industry
    Association.

    To determine developments in the semiconductor and software services
    industries in the United States as they have become more global, we
    examined available government data, information from experts in both the
    semiconductor and software services industries, and other private sector
    research. We obtained U.S. international trade data from the Bureau of
    Economic Analysis (BEA) and the U.S Census Bureau. We also obtained
    foreign countries' international trade data through the United Nations and
    a private company, Global Trade Information Services. We obtained foreign
    direct investment data from BEA and domestic production data from Census.
    To assess the limitations and the reliability of various data series, we
    reviewed technical notes and related documentation and met with officials
    from BEA and Census, as well as individuals in the private sector familiar
    with these data. In addition, we reviewed relevant research studies and
    obtained data from several private sector entities. Although we do not
    report these data directly, we used them to corroborate information from
    other sources. To determine employment trends in the semiconductor and
    software services industries, we analyzed available U.S. government
    employment data from the Bureau of Labor Statistics (BLS). We crosschecked
    various employment data and reviewed technical notes in BLS publications
    to assess the limitations and reliability of these data. We also discussed
    the limitations and reliability of BLS data with BLS officials. We
    determined that the data we used in this report to show the development
    and trends in the semiconductor and software industries were sufficiently
    reliable for these purposes.

    We conducted our review from October 2005 through August 2006 in
    accordance with generally accepted government auditing standards.

    Appendix II:  U.S. Multinational Companies' Investment and Operations in
    the Semiconductor and Software Industries

               U.S.
               multinational companies' worldwide investments and operations
               (including production, employment, and research and development
               (R&D) have played an important role in the globalization of the
               semiconductor and software industries.1 U.S. statistics show that
               overall multinational corporation (MNC) investments have still
               tended to be in developed economies, rather than in developing
               economies such as India and China. However, certain manufacturing
               sectors such as the computer and electronic products industry
               (including semiconductors) have a relatively higher share of
               investment, production, and employment in developing countries. In
               particular, U.S. companies' investments and production in this
               industry are relatively higher in the Asia-Pacific region
               (particularly Singapore) than other industries. Employment is even
               more concentrated abroad-likely due to the movement of more
               labor-intensive production operations overseas in order to reduce
               costs. Conversely, research and development expenditures are much
               more concentrated in the United States than they are in foreign
               affiliates.

    In recent years, U.S. Investment Offshore Has Been Relatively Stable and
    Has Been Larger in Singapore and Malaysia, Than in Taiwan and China

               U.S.
               direct investment abroad statistics show that overall U.S.
               investment (across all industries) in developing country markets
               is still a relatively small share of total U.S. direct investment
               abroad (less than 1 percent of the total each for India, China,
               and other developing countries, except Mexico and Brazil),
               according to statistics from the Bureau of Economic Analysis
               (BEA).2 However, within the computer and electronic products
               industry (which includes semiconductors),3 Singapore was the most
               significant Asia-Pacific country accounting for 15 percent of U.S.
               global

    1Investment abroad-establishing a foreign located affiliate of a parent
    company-is one means of offshoring parts of the production process. The
    other main means is to contract with an independent company, which is not
    captured in investment statistics. In addition, companies may devise
    hybrids of these two approaches, such as establishing a joint venture.
    Information provided in this appendix only relates to offshoring through a
    foreign affiliate and not offshoring that may occur through an
    unaffiliated provider that replaces domestic production and employment.
    For more information on definitions of offshoring, see GAO- 04-932 ,
    appendix II.

    2Direct investment abroad statistics on an historic cost basis, as
    reported here, will exclude the value of U.S. investments in particular
    countries if that investment is made through holding companies located in
    other countries. The U.S. investment will be attributed to the country of
    the holding company.

    3Detailed direct investment abroad statistics on the semiconductor
    industry by country are not available.

      Appendix II

    U.S. Multinational Companies' Investment and Operations in the
    Semiconductor and Software Industries

    investment in that industry as of 2004.4 Malaysia and Japan were next with
    about 5 percent; followed by Korea (4 percent); Taiwan (3 percent); and
    China, Hong Kong, and the Philippines (2 percent, each). Figure 13 shows
    the value of U.S. foreign direct investment (FDI) from 1999 to 2004 in
    this industry for selected Asian countries. As figure 13 shows, Singapore
    accounted for $8.8 billion in U.S. FDI in 2004 (down from $13.5 billion in
    2001), or about 15 percent of the global total in this industry.
    Interestingly, the value of U.S. FDI in China in this sector has fallen
    since 2001-more significantly than for other countries, except Singapore.
    These data represent the accumulated investments (stock) made by U.S
    companies in the computer and electronic products industry. As discussed
    in this report,

    U.S. companies moved labor-intensive assembly and testing operations
    overseas over the past several decades. Also, U.S. exports of
    semiconductor wafers were largest to Malaysia, Korea, Taiwan, Philippines,
    and China. This reflects the production process in which fabricated wafers
    are then sent overseas for final assembly and test by U.S. companies'
    affiliates (as well as unaffiliated contractors).

    4Singapore was the largest location of U.S. direct investment abroad as of
    2004 in this industry. Ireland (12 percent), Canada (10 percent), and
    Italy (10 percent) were the next largest locations by value.

    Page 50 GAO-06-423 International Trade Appendix II

    U.S. Multinational Companies' Investment and Operations in the
    Semiconductor and Software Industries

    Figure 13: U.S. Direct Investment Abroad in the Computers and Electronic
    Products Industry, Selected Asian Countries, 1999-2004

    Dollars in billions16

    14

    0

    1999 2000 2001 2002 2003 2004

    Year

    Taiwan

    South Korea

    China

    Malaysia

    Japan

    Singapore

    Source: BEA.

    Note: U.S. direct investment abroad is the stock of U.S. investments in a
    particular country valued in a historical cost basis. The computer and
    electronic products industry includes semiconductor production. However,
    detailed investment statistics by country for the semiconductor industry
    are not available.

    Within the semiconductor industry, the majority of U.S. companies' global
    production (as measured by value-added) remained in the United States,
    although the share declined during the recent recession. As figure 14
    shows, semiconductor value-added by U.S. parents (U.S. operations) took a
    steep decline in 2001, remained flat in 2002, and rebounded somewhat in
    2003. Value-added by U.S. companies' affiliates abroad accounted for about
    28 percent of U.S. MNC's global production, while the Asia-Pacific region
    (excluding Japan and Australia), in particular, accounted for about 9
    percent of global production.

        Appendix II

    U.S. Multinational Companies' Investment and Operations in the
    Semiconductor and Software Industries

    Figure 14: Value-added in Semiconductors-U.S. Parents and MOFAs (including
    Asia-Pacific, excluding Japan and Australia)

    Dollars in billions 60 50

    40

    30

    20

                                           10

                                           0
                                                 1999  2000   2001   2002    2003
    MOFA value-added-Asia (excluding        13,419 15,920 14,123 11,919 12,091
    Japan/Australia)
    MOFA value-added-all countries          4,122  5,818  4,230  3,908   3,812
    Parents value-added                     39,053 53,057 21,788 21,172 30,625

    MOFA value-added-Asia (excluding Japan/Australia) MOFA value-added-all
    countries Parents value-added

    Source: BEA.

    Note: MOFA refers to majority-owned foreign affiliates. Data for 2003 are
    preliminary.

    Global Semiconductor Employment by U.S. Companies Is Roughly Split between
    Their U.S. Operations and Offshore Locations

    U.S. MNCs that operate affiliates offshore have overall split their
    employment between their U.S. operations and their foreign affiliates.
    According to data from BEA, about 53 percent of MNC's global semiconductor
    employment was located in offshore affiliates in 2003, up from 49 percent
    in 1999.5 As previously discussed, this reflects the trend begun in 1960s
    of U.S. companies' offshoring much of their labor-intensive assembly and
    testing operations to lower wage countries, particularly in Asia. BEA
    statistics also show that a relatively higher share of U.S.

    5BEA data include total employment in U.S. MNC's parent operations
    (located in the United States) and majority-owned foreign affiliates
    (located in foreign countries).

    Page 52 GAO-06-423 International Trade

    employment in semiconductor manufacturing is concentrated in Asia compared
    with other industries. Similarly, U.S. MNCs in computer and electronic
    product manufacturing industries (of which semiconductors is a part), in
    general had relatively higher shares of their global employment located
    abroad (about 38 percent) than other information and communications
    technology industries such as computer system design and related services
    (35 percent), as well as across all industries (28 percent) in 2003.

    Employment statistics from the Semiconductor Industry Association (SIA)
    show a similar pattern for U.S.-based companies.6 According to SIA, about
    54 percent of U.S. companies' semiconductor employment was located in
    North America (mainly the United States) in 2004. This is down from a peak
    of about 60 percent in 1998 but still higher than in the 1980s and 1990s,
    which was between 45 and 50 percent. In addition, about 28 percent of U.S.
    companies' North American workforce was engaged in R&D in 2004. According
    to industry experts, a much higher share of U.S. companies' R&D employment
    is based in the United States, rather than offshore.

    U.S. Companies Investments in Overseas Affiliates to Supply Software
    Services Still Relatively Low

    As discussed above, U.S. direct investment abroad statistics show that
    overall investment (across all industries) in developing country markets
    is still a relatively small share of total U.S. direct investment abroad.
    This is also generally true in services industries that include software
    services.7 For example, U.S. direct investment in India in the information
    sector and the professional, scientific, and technical services sector are
    both less than 1 percent of global investment in those sectors. However,
    investment in Ireland in the information sector accounted for 30 percent
    of global U.S. direct investment abroad in that sector in 2004. Over time,
    Ireland has attracted investment by a large number of U.S. companies to
    produce software for the European Union market.

    6BEA's statistics capture U.S. MNCs and their majority-owned foreign
    affiliates in the semiconductor and other electronic components sector.
    SIA's statistics capture all U.S.-based semiconductor companies (whether
    or not they have foreign affiliates) and their entire employment abroad
    (which may include less than majority ownership). The two statistics
    differ to some degree in terms of their definition of the industry and
    selection of parent companies and affiliates.

    7Software publishing that produces packaged software is included in the
    broad industry sector of Information, while custom software services is
    included in the broader industry sector of professional, scientific, and
    technical services. U.S. direct investment data by country are not
    available below the industry sector level of detail.

      Appendix II

    U.S. Multinational Companies' Investment and Operations in the
    Semiconductor and Software Industries

    Similarly, U.S. multinational companies' operations abroad (including
    employment) in software services are relatively small compared with the
    semiconductor industry and the broader electronics hardware industry. For
    example, table 3 shows that, for semiconductors, over half of U.S. MNC's
    employment was located in their foreign affiliates (rather than their
    domestically based parent company). In contrast, services industries such
    as publishing (which includes packaged software) and computer systems
    design and related services (which includes custom software) had between
    one-fifth and one-third of their employment located in their foreign
    affiliates.

    Table3: Share of U.S. Foreign Affiliates' Employment in Total U.S. MNC
    Employment Worldwide-ICT Sector Industries, 1999-2003

    Industry                    1999       2000      2001      2002       2003
    ICT-producing industries    55%        53%        51%       49%        49%
    Computers and
    electronic products          43         40        40        39          38
    Semiconductors and
    other electronic
    components                   49         52        53        53          53
    Publishing industries
    (including packaged
    software)                    14         16        17        18          18
    Information services
    and data processing
    services                     29         29        28        28          27
    Computer systems
    design and related
    services (including
    custom software              29         31        32        32          35
    All industries (total)      25%        25%        26%       27%        28%

    Source: BEA.

    Note: Shares are calculated by dividing U.S. foreign affiliates'
    employment by total U.S. MNC employment, which is the sum of U.S. foreign
    affiliates and U.S. parent company employment. Data for 2003 are
    preliminary. ICT-producing industries include computer and electronic
    products manufacturing, publishing industries (includes software),
    information and data processing services, and computer systems design and
    related services.

      Appendix II

    U.S. Multinational Companies' Investment and Operations in the
    Semiconductor and Software Industries

    MNC's Research and Development Relatively Concentrated in U.S. Operations

    Compared with production or employment, U.S. MNC R&D expenditures are more
    concentrated in the United States. As shown in table 4, in 2003 about 14
    percent of U.S. MNC R&D expenditures were made through U.S. majority-owned
    foreign affiliates (MOFAs) out of total MNC R&D expenditures (U.S. parents
    plus MOFAs). The share was similar for the computer and electronic
    products industry (about 13 percent) and publishing industries (about 10
    percent) but less for semiconductors (8 percent), computer systems design
    and related services (about 5 percent), and information services and data
    processing services (1 percent). In comparison, MOFAs accounted for about
    26 percent of value-added for all industries, 24 percent for computer and
    electronic products, and 28 percent for semiconductors. Likewise, MOFAs
    accounted for 28 percent of employment across all industries, 38 percent
    for computer and electronic products, and 53 percent of semiconductor
    employment.

      Table 4: U.S. Companies' Foreign Affiliates' Share of Total R&D Expenditures

    Industry                     1999      2000      2001      2002       2003
    Computers and electronic
    products                     11%        13%       13%       13%        13%
    Semiconductors and other
    electronic components              7         8         7         9       8
    Publishing industries        N/A             6         6         8      10
    Information services and
    data processing services     N/A             1         1         1       1
    Computer systems design
    and related services               4         4         4         5       5
    All industries (total)       13%        13%       12%       13%        14%

    Source: BEA.

    Note: Data for 2003 are preliminary. "N/A" indicates that the data have
    been suppressed by BEA to avoid disclosure of data of individual
    companies.

    Across industries, MNCs spent about 22 percent of MOFA R&D expenditures in
    the computer and electronic products industry (5 percent in semiconductors
    alone), making it the third largest industry overall in 2003. Other
    information and computer technology (ICT) sectors represented very small
    shares (see table 5). Across major industries, transportation equipment
    manufacturing accounted for 29 percent of total MOFA R&D expenditures (26
    percent of that was autos). The next largest

      Appendix II

    U.S. Multinational Companies' Investment and Operations in the
    Semiconductor and Software Industries

    was chemicals with 25 percent of R&D expenditures (of which 21 percent was
    pharmaceuticals).

          Table 5: Share of Selected Industries in Total MOFA R&D Expenditures

    Industry                     1999      2000      2001      2002       2003
    Computers and electronic
    products                     21%        27%       29%       24%        22%
    Semiconductors and other
    electronic components              4         4         4         5       5
    Publishing industries        N/A             2         2         3       3
    Information services and
    data processing services     N/A             0         0         0       0
    Computer systems design
    and related services               2         2         2         2       2
    All industries (total)       100%      100%      100%      100%       100%

    Source: BEA.

    Note: These shares represent the percent of total R&D expenditures abroad
    for each of the selected industries. Data for 2003 are preliminary. "N/A"
    indicates that the data have been suppressed by BEA to avoid disclosure of
    data of individual companies.

    Asia-Pacific economies account for a relatively small share of U.S. MNC's
    R&D expenditures. Except for Japan (7 percent overall and 15 percent in
    information), Singapore (10 percent in computer and electronic products),
    and Malaysia (5 percent in computer and electronic products), these
    countries each accounted for 3 percent or less of MOFA expenditures in
    ICT-related industries (see table 6). China accounts for about 3 percent
    of manufacturing, but details are not available for computers and
    electronic products. India accounts for less than 1 percent of R&D
    expenditures across most industries (note that in the computers and
    electronic products and professional, technical, and scientific
    industries, where amounts were suppressed in 2003 for India, prior years
    also showed less than 1 percent).

      Appendix II

    U.S. Multinational Companies' Investment and Operations in the
    Semiconductor and Software Industries

    Table 6: Share of U.S. Companies' Foreign Affiliates' R&D Expenditures, by
                   Industry for Selected Asia-Pacific Economies, 2003

                                          Computers and             Professional,
                                             electronic                technical,
    Country               All Manufacturing products Information    scientific
                      industries
    Australia              2%            2%       0%          0%           N/A
    China                   3             3      N/A         N/A             2
    Hong Kong               1             1      N/A           0             1
    India                   0             0      N/A           0           N/A
    Indonesia               0             0        0           0             0
    Japan                   7             7        6          15             2
    Korea,                  1             1        2         N/A             1
    Republic of
    Malaysia                1             1        5           0             0
    New Zealand             0             0        0           0             0
    Philippines             0             0        1           0             0
    Singapore               2             3       10           1             0
    Taiwan                  0             0        0           1             0
    Thailand               0%            0%       0%          0%            0%

    Source: BEA.

    Note: Data for 2003 are preliminary. "N/A" indicates that the data have
    been suppressed by BEA to avoid disclosure of data of individual
    companies.

    Appendix III

    Larger Imports of Information and Communication Goods Drive the U.S. Advanced
    Technology Product Deficit

    Since 1989, Commerce's Bureau of the Census (Census) has identified
    products that use leading edge technologies or innovations. Commerce
    classifies these goods as Advanced Technology Products (ATP). Currently,
    Census identifies about 500 of some 22,000 10- digit commodity U.S.
    merchandise trade classification codes as ATP codes because they meet the
    following criteria: (1) the code contains products from 1 of 10 recognized
    high technology fields such as electronics (which includes semiconductors)
    and information and communications (which includes notebook computers and
    cell phones), (2) these products represent leading-edge technology in that
    field, and (3) these products constitute a significant part of all items
    in the selected classification code.

    Partly as a consequence of the growing movement of electronics assembly to
    Asia, and China in particular, in 2005, the United States trade deficit
    with China in the ATP information and communications group, $51.5 billion,
    is slightly larger than the overall ATP deficit with China, $48.4 billion,
    and about 25 percent of the overall goods deficit, $203.8 billion, all of
    which have dramatically grown in recent years.1 Finished products-such as
    notebook computers and cell phones-are the largest U.S. information and
    communication ATP imports from China in 2005. Computer parts and
    accessories are the leading U.S. exports to China in this group. U.S.
    exports, imports, and the trade balance with China in this group are
    depicted in figure 15. This figure shows both the rapid growth in imports
    of these products from China, as well as the rising trade deficit.2

    1We present narrow definitions of ATP trade statistics-- "domestic
    exports" and "imports for consumption" because we wish to exclude flows of
    goods for which the United States is simply a transshipment point. Census
    publishes the broad definition of ATP trade statistics-"total exports" and
    "general imports." Nonetheless in recent years, both narrow and broad ATP
    trade flows with China display similar patterns.

    2For more information on the U.S.-China trade and investment relationship,
    see GAO, China Trade: U.S. Exports, Investment and Affiliate Sales Rising,
    but Export Share Falling,

    GAO-06-162 (Washington, D.C.: Dec. 9, 2005).

    Figure 15: U.S. ATP Information and Communications Trade with China

    Dollars in billions

    Year

    Imports

    Exports

    Trade balance Source: GAO analysis of Census data.

    In contrast, in the ATP electronics group, beginning in 2001, the United
    States has a trade surplus with China, largely due to the substantial
    exports of semiconductor wafers and integrated circuits to China. (See
    fig. 16.) However, this surplus of about $1 billion in 2003 has been
    declining somewhat in recent years. This current trade surplus is partly a
    result of slower growing U.S. demand for finished integrated circuits by
    downstream manufacturers of consumer electronics, as discussed previously.

    1990

                                          1991

                                          1992

                                          1993

                                          1994

                                          1995

                                          1996

                                          1997

                                          1998

                                          1999

                                          2000

                                          2001

                                          2002

                                          2003

                                          2004

      Appendix III Larger Imports of Information and Communication Goods Drive the
                        U.S. Advanced Technology Product Deficit

    Figure 16: U.S. ATP Electronics Trade with China

    Dollars in millions

    3.0

    2.5

    2.0

    1.5

    1.0

    0.5

    0.0

    Year

    1990

                                          1991

                                          1992

                                          1993

                                          1994

                                          1995

                                          1996

                                          1997

                                          1998

                                          1999

                                          2000

                                          2001

                                          2002

                                          2003

                                          2004

    Imports

    Exports

    Trade balance Source: GAO analysis of Census data.

    The overall ATP trade deficit with China (as well as Asia overall) is
    largely due to information and communications imports. However, trade
    statistics rarely separate out the value of imported components embodied
    in finished products. Therefore, some part of the value of U.S. imports of
    information and communications products from China is attributable to U.S.
    exports of chips and wafers (and other ATP components) directly to China
    or indirectly through other Asian countries. However, to be a leading-edge
    product, Census must judge the product itself to use leading-edge
    technology, not simply some of its components. For example, although autos
    have many leading-edge components such as semiconductors and integrated
    circuits, autos are not leading-edge products.

    Appendix IV

    Comments from the Department of Commerce

    Appendix V

                         GAO Contact and Staff Acknowledgments

      GAO Contact

    Loren Yager, Director, (202) 512-4128, yagerl@gao.gov

      Staff Acknowledgements

    In addition to the individual named above, Virginia Hughes, Assistant
    Director; Bradley Hunt; Ernie Jackson; Sona Kalapura; Judith Knepper,
    Analyst-in-Charge; Lynn Cothern; Yesook Merrill; Berel Spivack; and Tim
    Wedding made major contributions to this report.

    Related GAO Products

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    States, Primarily in Customer Service and Software Development. GAO-
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    Offshoring of Services: An Overview of the Issues. GAO-06-5. Washington,
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    International Trade: U.S. and India Data on Offshoring Show Significant
    Differences. GAO-06-116. Washington, D.C.: Oct. 27, 2005.

    International Trade: Current Government Data Provide Limited Insight into
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    Highlights of a GAO Forum: Workforce Challenges and Opportunities For 21st
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    GAO-04-845SP. Washington, D.C.: June 1, 2004.

    China China Trade: U.S. Exports, Investment, Affiliate Sales Rising, but
    Export Share Fallin g. GAO-06-162. Washington, D.C.: Dec. 9, 2005.

    U.S.-China Trade: Opportunities to Improve U.S. Government Efforts to
    Ensure Open and Fair Markets., GAO-05-554T. Washington, D.C.: Apr. 14,
    2005.

    U.S.-China Trade: Observations on Ensuring China's Compliance with World
    Trade Organization Commitment s. GAO-05-295T. Washington, D.C.: Feb. 4,
    2005.

    U.S.-China Trade: Opportunities to Improve U.S. Government Efforts to
    Ensure China's Compliance with World Trade Organization
    Commitments.GAO-05-53. Washington, D.C.: Oct. 6, 2004.

    World Trade Organization: U.S. Companies' Views on China's Implementation
    of Its Commitments. GAO-04-508. Washington, D.C.: Mar. 24, 2004.

    Export Controls: Rapid Advances in China's Semiconductor Industry
    Underscore Need for Fundamental U.S. Policy Review. GAO-02- 620.
    Washington, D.C.: Apr. 19, 2002.

    Semiconductors Export Controls: System for Controlling Exports of High
    Performance Computing Is Ineffect ive.GAO-01-10. Washington, D.C.: Dec.
    18, 2000.

    Federal Research: SEMATECH's Technological Progress and Proposed R&D
    Program. RCED-92-223BR . Washington, D.C.: July 16, 1992.

    Federal Research: SEMATECH's Efforts to Strengthen the U.S. Semiconductor
    Indust ry. RCED-90-236. Was hington, D.C.: Sept. 13, 1990.

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