Is U.S. Innovation Headed Offshore?

Apparently not, even though more research and development is joining manufacturing in the shift toward low-cost nations

To those worried about America's ability to compete in the 21st century, the trend is alarming: Just as key manufacturing industries fled offshore in the 1970s and '80s, U.S. companies are now shifting more engineering and design work to low-cost nations such as China, India, and Russia. Surely, innovation itself must follow.

Apparently not, according to a new study published by the National Academies, the Washington organization that advises the U.S. government on science and technology policy. The 371-page report titled Innovation in Global Industries argues that, in sectors from software and semiconductors to biotech and logistics, America's lead in creating new products and services has remained remarkably resilient over the past decade—even as more research and development by U.S. companies is done offshore.

"This is a good sign," says Georgetown University Associate Strategy Professor Jeffrey T. Macher, who co-edited the study with David C. Mowery of the University of California at Berkeley. "It means most of the value added is going to U.S. firms, and they are able to reinvest those profits in innovation."

The report, a collection of papers by leading academics assessing the impact of globalization on inventive activity in 10 industries, won't reassure all skeptics that the globalization of production and R&D is good for the U.S. One drawback is that most of the conclusions are based on old data: In some cases the most recent numbers are from 2002.

Exporting the Benefits?

And while the authors of the report make compelling cases that U.S. companies are doing just fine, thank you, none of the writers addresses today's burning question: Is American tech supremacy thanks to heavy investments in R&D also benefiting U.S. workers? Or are U.S. inventions mainly creating jobs overseas? A few years ago, most people took it for granted that what was good for companies was good for the greater economy. But the flat growth in living standards for most Americans during the last boom has raised doubts over the benefits of globalization.

"Innovation shouldn't be an end in itself for U.S. policy," says trade theorist Ralph E. Gomory, a research professor at New York University's Stern School of Business. "I think we have to address whether a country can run on innovation. If you just do R&D to enhance economic activity in other countries, you are getting very little out of it." Gomory, a former top IBM (IBM) executive, retired in 2007 as president of the Alfred P. Sloan Foundation, which funded the National Academies study.

Still, given all the debate over offshoring, the report's central findings are interesting. The authors marshal a wealth of evidence to show that, thanks to innovation, globalization hasn't eroded U.S. leadership even in some industries where there has been a substantial offshore shift in engineering and design.

Despite an explosion of outsourcing to India and Ireland, for example, America's software industry still trumps the rest of the world in exports of packaged software and services, patent activity, and venture capital investment. The U.S. also accounts for 90% of chip-design patents—the same level as 1991—although Asian companies now do most of manufacturing. And when it comes to biotechnology, the U.S. is way ahead, luring more venture capital than all other countries combined.

America First

The U.S. even remains a heavyweight in personal computers, the study says, though China and Taiwan manufacture most of the hardware. That's because the real innovation and profits still belong to companies like Microsoft (MSFT) and Intel (INTC), makers of the operating system and central processors, while U.S. brands command 40% of the global market and still define breakthrough design.

There are cases where the U.S. can lose a commanding lead when domestic manufacturing disappears—namely in flat-panel displays and lighting. Macher also concedes "there are problems on the horizon" regarding America's future competitiveness. Other nations are starting to mimic many of the strategies that give the U.S. an innovation edge, for example. And as Asians grow richer "they are becoming more sophisticated and demanding than Americans as users of many tech products."

But for now, "all evidence is that our position in many of these industries will continue," says Macher. Why is the U.S. so entrenched? One reason, he says, is simply that U.S. corporations are proving very adept at managing global R&D networks while keeping core innovation at home. While innovative activity in chips and software is growing fast elsewhere, it has not yet been enough to close the gap with the U.S.

The fact that the U.S. remains by far the world's most lucrative market for pharmaceuticals and business software helps explain its continued strength in those industries. What's more, industry clusters involving companies, universities, and venture capital are so well-established—such as San Diego and Cambridge, Mass., in biotech—that it will take many years for other nations to replicate them.

Persistent Worries

Despite the impressive volume of data, however, the National Academies study is unlikely to allay completely fears that U.S. supremacy in innovation is under threat. The old data, for example, are fine in the academic world, which prizes the reliability and consistency of data over timeliness and where research papers take eons to wend through the peer-review process.

But the real boom in offshore R&D in Asia and Eastern Europe has occurred in the past six years, when multinationals began hiring engineers and designers by the thousands and signing major outsourcing deals with foreign engineering houses. Visit the huge Indian labs of companies like General Electric (GE), Texas Instruments (TXN), IBM, Cisco (CSCO), and Motorola (MOT), for example, and you'll find many examples of Indian engineers developing important next-generation products for global markets. In the pharmaceutical industry, Merck (MRK), Eli Lilly (LLY), Forest Laboratories (FRX), Wyeth (WYE), Bristol-Myers Squibb (BMY) and others have struck alliances to collaborate with Indian companies on major drug-discovery programs since 2005.

Most authors of the papers in the study acknowledge their data aren't perfect. But they contend that even the growth in offshore R&D in the past few years probably isn't enough to change the big picture about where important innovation is taking place—and who profits from it.

It is probably true that American companies are the biggest winners from the globalization of R&D. But if the aim is to rally national support for dramatic increases in federal spending for science and technology in the name of boosting American competitiveness, the next studies on the topic may need to go further. The deeper question is whether U.S. leadership in innovation still creates wealth for average Americans, not just corporate shareholders and top executives.

Click to view a slide show looking at the state of U.S. innovation within specific sectors.

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