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 [email protected]. 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, [email protected]

  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.

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Ensure Open and Fair Markets., GAO-05-554T. Washington, D.C.: Apr. 14,
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Trade Organization Commitment s. GAO-05-295T. Washington, D.C.: Feb. 4,
2005.

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Ensure China's Compliance with World Trade Organization
Commitments.GAO-05-53. Washington, D.C.: Oct. 6, 2004.

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of Its Commitments. GAO-04-508. Washington, D.C.: Mar. 24, 2004.

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Underscore Need for Fundamental U.S. Policy Review. GAO-02- 620.
Washington, D.C.: Apr. 19, 2002.

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Performance Computing Is Ineffect ive.GAO-01-10. Washington, D.C.: Dec.
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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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