Multinational corporations (MNCs) have increasingly located research and development (R&D) in developing countries such as China and India since the 1990s. On the one hand, governments in developing countries are eager to attract R&D to their local economies; on the other hand, developed countries are concerned about losing their competitive advantage due to R&D offshoring. At the same time, intellectual property protection is a growing concern.

What are the MNC R&D labs actually doing in China? Quan noted that her 2004 survey of MNC R&D labs in information technology industries in Beijing found that these MNC R&D labs are not just providing technical support, product localization, or product development for the local market; rather, they are developing products for the global market. Her study documents an emerging spatial division of labor in R&D based on the increasing specialization of R&D activities.

Ensuring returns appropriation

Appropriating returns is essential to continuous R&D investment. However, returns appropriation is not necessarily realized through formal IP protection institutions such as the patent system. As the growing trend of globalization of R&D has evolved to this new stage characterized by MNCs locating R&D labs in developing countries, it provides a good test bed to further explore more theoretical mechanisms of IP protection. Considering the weak intellectual property rights regimes these developing countries typically have, it is crucial for MNCs to find an effective way to protect their valuable technologies thus facilitating returns appropriation from their R&D activities in host developing regions. It is in fact the effective means of IP protection that can greatly assist MNCs' location of R&D offshore, in addition to other well-known incentives such as low cost R&D labor and market attraction.

R&D specialization essential

Using evidence from MNC R&D labs in Beijing and Shanghai, Quan's study proposes that R&D is further specialized within MNCs' global R&D network. Furthermore, IP protection and returns appropriation can be realized through such R&D specialization. The key proposition is formulated as below: 'Hierarchical modular R&D structure can be an effective way for MNC R&D labs to protect their intellectual property and thus facilitate returns appropriation in weak IPR regime developing countries'. This 'hierarchy' includes 'core R&D' and 'peripheral R&D', based on two dimensions--technology value-added, desire and ease of IP protection. While 'core R&D' is mostly done in developed countries, 'peripheral R&D' is conducted in developing countries. Dr. Quan's study suggests that this hierarchical modular R&D structure facilitates the global configuration of MNC R&D labs.

Slides from this presentation can be found at the event link below.

SELECT: What is the current size of the outsourcing market? What percent of U.S. software development, call centers, etc., have already moved to developing nations? Is the amount of outsourcing still increasing?

Dossani: To provide some perspective, although the off-shoring of services has been going on for mans Nears, technology led by the widespread use of the Internet has changed things. The resulting new twist in the provision of services is that the required interaction between the seller and the consumer has been substantially limited. The advances in information technology made possible the parsing of the provision of certain services into components requiring different levels of skill and interactivity As a result, certain portions of the serviced activity that might or might not be skill-intensive, but required low levels of face-to-face interaction could be relocated offshore. The sequence of events that enabled this process is the following:

First, the digital age allowed (or, at least, revolutionized) the conversion of service flows into stocks of information, making it possible to store a service. For example, a legal opinion that earlier had to be delivered to the client in person could now be prepared as a computer document and transmitted to the client via e-mail or, better yet, encoded into software. Easy storage and transmission allowed for the physical separation of the client and vendor as well as their separation in time. It also induced the separation of services into components that were standardized and could be prepared in advance (such as a template for a legal opinion) and other components that were customized for the client (such as the opinion itself) or remained non-storable. Taking advantage of the possibility of subdividing tasks and the economies that come with the division of labor, this reduced costs by offering the possibility of preparing the standardized components with lower-cost

labor and, possibly at another location.

The second fundamental impact of digitization was the conversion of non-information service flows into information service flows. For example, the sampling of tangible goods by a buyer through visiting a showroom is increasingly being replaced by virtual samples delivered over the Internet. Once converted to an information flow, the service may also he converted into a stock of information and subjected to the above mentioned forces of cost reduction through standardization of components and remote production.

Third, the low-cost transmission of the digitized material accelerated the off-shoring of services. Services such as writing software programs which were off-shored to India in the early 1970s were enabled by digitized storage and, in the 1980s, by the standardization of programming languages. Still later, as digital transmission costs fell in

the 1990s (just as digital storage costs had fallen earlier), even nonstorable

services, such as customer care, could he handled offshore.

The offshore services outsourcing market (excluding software development) is still small and will probably be approximately $10 billion for 2005. It employs about 500,000 people, two thirds of whom are located in India. The rest are widely distributed, with developing Asia and Ireland accounting for most of the remaining employment. About 60% of the employment is in call centers. The U.S. and U.K. call-center industry together employ about five million people, so the percentage of offshore jobs is still small. It is even smaller for other services.

Offshore software development employs approximately another 500,000 people. This compares with U.S. employment of about two million. This is a larger percentage of the total software development labor market. although most of the outsourced work is programming, while work such as systems integration and design continue to be done in the U.S.

The growth rate is still high and there are concerns about whether or not this rapid growth rate will hurt the quality of work done. However. this rate will still likely he in excess of 30% in 2005 and 2006. The reason for this is the massive wage differential.

Clearly there have been massive failures as well as outstanding successes in outsourcing. What are the critical success factors for making outsourcing work?

The infrastructure (telecom. finance, power) has all been standardized, although the solutions might not he the same as in developed countries. The critical success factors are two: the quality of labor and supervision; and managing growth. Unbelievable there is a growing shortage of labor. The result is that the quality of work is declining. Project supervisory skills are also in short supply. Managing growth, especially keeping attrition

under control, training, developing new vertical skills, moving into back-office work, and offering the client turnkey packages are some of the critical managerial factors for success.

Short of being willing to work for $15,000/year, what can western IT professionals do to provide sufficient value to prevent their functions from being outsourced?

The U.S. educational system still turns out a good product. It is sufficiently ahead of the comparable Indian product so that a recent computer science/computer engineering graduate from the average U.S. university can earn a premium of at least 100% over his Indian counterpart from a good university such as the IlTs, with substantially higher premiums for graduates from schools such as MIT and Stanford. The problem occurs more with mid-career professionals. Those with older skills are unable to compete with freshly trained graduates from India. Therefore, they need to update those skills regularly and take advantage of opportunities to globalize and convert them into managerial skills. This may have to he mandated at some point, as has happened in the financial sector, where stockbrokers need to regularly sit for exams to renew their licenses.

That said, most of the offshore jobs are relatively low-skilled. For example, the single largest category of offshore services is outbound calling for the financial services industry for selling mortgages or collecting overdue receivables. The work is routine, based on scripts that pop-up on the computer screen in response to prompts.

Do these findings suggest that developed countries are likely to be only marginally threatened by the globalization of services? Even if high-end work is stays within developed countries, as has happened in the software industry, the problem is that not everyone in developed countries can readily shift to high-end work. Since the 1960s, the shift in the economies of developed nations towards service-based economies certainly increased the number of highly-skilled service workers, but there was an even greater swelling in the number of other less-skilled service workers. This is partly a consequence of the nature of many services as linked, inseparable sets of activities with different

skill levels, combined with a pyramid of labor requirements, i.e., there is more demand for lower-level work than for high-end work. In manufacturing. the unemployment created by the reduction in demand for blue collar labor in developed countries was offset by the absorption of much of the surplus labor into service industries, often with minimal training. But the shift of low-end service workers to high-end workers will require a longer period of re-education and may have significant interim consequences on unemployment rates.

The threat to developed countries is increased by the fact that, apart from software, the largest growth in off-shoring is happening in business services. These are also the sectors with the largest growth in U.S. employment.

Further, there is evidence that even higher skilled functions can be moved offshore or might evolve on their own. For example, interviews with people at a firm earlier this year revealed that they had initially been contracted by an American firm to call its clients with overdue credit card payments. The offshore company eventually purchased the receivables from its client and assumed the collection risk itself. Another firm, Wipro Spectramind, managed the radiology services of Massachusetts General Hospital for its second and third shifts. Thus, American radiologists, who earn an average of $315,000 a year were replaced by Indian radiologists, who earn $20,000 a year on average.

I understand that there is a whole subculture in Pakistan and India of people who go to work in the late afternoon or evening and then work a full day on U.S. time. What effect has outsourcing had on the cultures of the countries that are recipients of much of the outsourced work? Have labor rates dramatically increased? Is it difficult for local companies in India and Pakistan to get quality IT talent?

Indeed such a subculture now exists. It is viewed as very stressful work and not suitable for a long-term career. Companies that do such work try to ameliorate the stress by hiring psychiatric counselors to provide free counseling to stressed-out employees. They also provide free meals and transportation, sports facilities, etc.

However, labor rates have increased only, a little. This is more than offset by

the rise in productivity of this labor over time.

Outsourcing is clearly a temporary solution. As labor rates equalize, the benefit of outsourcing decreases. In Pakistan and China, there are still huge differences in labor costs, but in Turkey, rates are closer to what they are in the 11.5. and other Western states. Realistically, how long can we gain a significant benefit form outsourcing?

India and China, and to some extent, Pakistan, have large labor pools. That is why, in manufacturing, Chinese wage rates have not changed despite massive employment growth over the past three decades. I think that wage rates in India will actually fall because of increasing supply, which is being drawn into outsourcing. This would mean several more decades of benefit from outsourcing.

One way in which developed countries may retain value is if their firms control the work done, either through providing the risk capital or through subsidiaries. While it is difficult to predict which organizational types will dominate, a number of firm-specific factors that influence the liability of off-shoring and organization structure are summarized here:

The knowledge component of the activity. A higher knowledge component makes the firm more concerned about whether the quality of the service will change due to a location change or the transfer process.

The interactive components of the process.

The ability to modularize the process

Savings from concentrating an activity in one location, leading to

benefits of scale and scope.

Reengineering as part of the transfer process. To transfer a business process, it is necessary to study it intensively and script the transfer. In the process of study, often there will he aspects of the current methodology for discharging the process that do not add value. Very often these aspects are legacies of earlier methodologies that were not eliminated as the production process evolved. During the act of transfer these are easier to abandon than at an existing facility' where they have become a "natural' part of the daily routine. Our interviews identified other unexpected benefits that go beyond the efficiency effects. Simply examining the business processes may reveal previously undetected inefficiencies. During the transfer process, these inefficiencies can be addressed without disrupting work patterns. Workers in the new location then use the reengineered process which is usually more efficient.

The time-sensitive nature of the work.

On the surface, President Bush's week-long swing through Northeast Asia has been a strong contrast with his recent stormy (and, some say, stumbling) excursion into Latin America.

There was little sign of overt anti-Americanism. And no Asian leader will openly oppose American leadership in the flamboyant manner of Venezuela's Hugo Chavez. Even prickly China swallowed President Bush's barbs about lack of democratic freedom in China, quietly acknowledging the two powers' differences. In contrast to the meeting of leaders from the Americas, the annual summit of the Asia Pacific Economic Cooperation (APEC) forum in Korea will embrace the principles of free trade.

Beneath the polite appearance, however, there is no less a challenge to American leadership in Asia. While Washington fiddled, a powerful momentum has been building up in Asia toward the formation of an East Asian Free Trade Area or, more ambitiously, an East Asian Community, modeled on the European community. Led by China, the East Asian grouping pointedly excludes the United States.

The APEC agenda focuses on an initiative to counter the spread of avian flu and to offer a common push at the WTO meeting in Hong Kong next month to revive the Doha Round of global trade talks. The Bush administration has its own agenda for the APEC meeting: to reposition itself as a leader of economic growth and integration in the region. For this, APEC has the virtue of being a more open organization than those behind the disappointment at the American summit. Its 21 members span the Pacific Rim, bringing together nations from Chile and Mexico to Russia, China and Southeast Asia. But this attention to APEC may be a case of too little, too late. The momentum to give the amorphous APEC an ongoing institutional role, beyond its annual summit meetings, has slowed in recent years. Its pledges for mutual tariff reduction exist almost entirely on paper.

Until this year, the Bush administration barely addressed regional economic issues at APEC. It preferred to use the meetings to promote a post-9/11 security agenda of anti-terrorism. U.S. trade policy has focused more on reaching free trade agreements with a few selected "friends" in that war, such as Singapore and Australia.

Meanwhile a Chinese-sponsored move to hold an East Asian summit offers the most visible expression of a trend of declining American influence in Asia. That meeting will take place in Malaysia in mid-December. The gathering groups the 10-member Association of Southeast Asian Nations, Japan, China, South Korea, India, Australia and New Zealand. Pointedly not invited is the United States.

This meeting is an outgrowth of the ASEAN Plus Three (APT) process - an annual dialogue of ASEAN with China, South Korea and Japan that began in December 1997 in the midst of the Asian financial crisis. The APT has grown into an elaborate mechanism for cooperation in a range of areas from finance and agriculture to information technology. This reflects an underlying economic reality - the growth of regional and bilateral trade agreements and the rapid rise of intra-Asian trade.

Until fairly recently, foreign trade in East Asia was dominated by trans-Pacific trade with the United States. But the share of Asian exports headed to the U.S. has dropped dramatically, while those destined for other Asian nations has risen. In the two decades from 1981 to 2001, according to economist Edward Lincoln, the share of intra-regional exports has risen from 32 percent to 40 percent, and intra-regional imports from 32 percent to 50 percent.

Much of the growth of regional integration is being driven by China, which is generating enormous demand for imports of raw materials as well as for semi-finished goods that are assembled for export. China has not been hesitant to use this role to expand its influence in the region. It has embraced the APT as a road towards creation of an East Asian community. At the ASEAN summit last year, Chinese Premier Wen Jiabao declared that such a community was a "long-term strategic choice in the interests of China's development." China has also outmatched the U.S. in negotiating free trade agreements, both bilateral and regional. The most impressive is an FTA deal between China and ASEAN set to take effect in 2010. Beijing even dreams of an Asian currency, based on the Chinese yuan, to rival the dollar and the euro.

China is not the first nation to try for such East Asian economic unity. Back in the days when Japan was riding high as an economic superpower, it too talked of leading an East Asian bloc, based on a yen currency zone. As late as 1997, in response to the Asian financial crisis, Japan proposed the creation of an Asian Monetary Fund, a kind of alternate regional financial system. More recently, both South Korea and Japan offered their own visions of an East Asian community in 2001. And both countries tried to match China in the APT by offering to form free trade agreements with ASEAN.

Japan, however, was never as successful as China is likely to be. "It would seem that Japan is a natural counterweight to China, but Tokyo is generally perceived as reactive and incapable of outflanking Beijing," Brad Glosserman, director of research at the Pacific Forum of CSIS, wrote recently. "Its economic dynamism is no match for that of China."

The United States has never been friendly toward efforts to create an East Asian economic bloc, viewing them as chipping away at the global trading system and rivaling American leadership. But Asia is arguably only following in American footsteps -- witness the NAFTA deal with Canada and Mexico and the more recent trade pact with Central America.

Many American policymakers believe these developments are partly a product of the failure of the Bush administration to articulate - much less pursue - a strategy to engage East Asia.

"The United States has greater strategic interests in Asia now than it did in Europe before World War I or World War II,'' argued a recent report of the Grand Strategic Choices Working Group, co-chaired by John Hopkin's University's Francis Fukuyama and Princeton's G. John Ikenberry. "Thus," the report continued, "it is unfortunate that part of the problem, in East Asia in particular, is that America's relative lack of interest in tending to the region has caused some allies of the U.S. to doubt our resolve and question the value of resisting unfavorable developments alone."

The report echoes other policymakers in suggesting the U.S. form its own East Asian economic zone with Japan, South Korea and Australia."That's a non-starter,'' says Professor Vinod Aggarwal, director of Berkeley's APEC study center. "Nobody wants to be cut out of the China market."

Privately, Bush administration officials downplay the importance of the East Asian summit in December, pointing to the lack of any concrete agenda. The addition of India, Australia and New Zealand to the invitation list, along with Japan, should effectively counter any Chinese initiative, they believe.

But those countries also fear being left out of whatever may emerge from this process. They cannot afford to be left on the outside, looking in.

Ultimately, neither can the United States. The President's trip is a belated recognition of that fact. But to be more than a momentary gesture, the United States must give East Asia the consistent attention it deserves.

Over the last several decades, there has been a strenuous debate about policies for economic development between the Washington Consensus promoted by the major international financial institutions and the revisionist political economists . Followers of the former view advocate free and unfettered markets buttressed by institutions to protect property rights. The revisionists argue that development involves social and political processes not adequately captured by the narrow prescriptive focus of the Washington Consensus.

In confronting globalization, there is also a new split among the revisionists themselves. Whereas the Washington Consensus welcomes globalization as a boon to developing countries through expanding the scope of market forces, the revisionists divide over the prospects for developing countries under globalization. The optimists, such as Ernst and Saxenian, see transnational networks as providing opportunities for developing countries to continue to learn the skills and competencies necessary to further their progress. The pessimists of the revisionist camp, such as Stiglitz and Strange, see globalization eroding the capabilities of the state or state-societal alliances necessary for development.

Using the case of technological upgrading (one aspect of economic development) in China's information technology (IT) industry, I demonstrate that opportunities for development exist under globalization. These paths to development are not simply the result of picking the right international networks to join nor are they due to the continued efficacy of state action. They also do not arise from well-developed market institutions within China. China's development success in spite of low levels of state industrial policymaking capacity and very incomplete market institutions tells us that other developing countries similarly unequipped can develop even in this globalized world.

In China's IT industry, two local institutional variables, firm operational strategies and state-firm relations, have interacted with the technology flows present in global networks to create opportunities for certain types of firms to upgrade. A firm's operational strategy (OS) determines its motivation to upgrade in China as opposed to doing so elsewhere. The relationship of firms to the state determines their sources of finance i.e. whether or not they can access functioning financial institutions.

The relationship of firms to the state determines their sources of finance and these sources of finance in turn impact their ability to upgrade. Sources of finance that provide credit with hard budget constraints give firms incentives to upgrade. Firms have hard budget constraints when they do not receive free help in covering their own financial obligations. With hard budget constraints forcing firms to meet their financial obligations, firms have to remain competitive to survive. For technology firms, a critical part of their competitiveness is their technology so they have every incentive to improve their technologies to keep pace with competitors. Finance that provides credit with soft budget constraints deprives firms of the incentives and even the capabilities to upgrade. Firms have soft budget constraints when they do not have to pay for some or all of their financial obligations themselves. These firms can rationally expect to survive even if not competitive because others are willing to bail them out. A third possibility is no source of finance. Firms without financing will not be able to invest in technological development.

There are four types of firms in China: the favored domestic firms, the neglected domestic firms, the hybrid foreign-invested enterprises (FIEs) and the regular FIEs. Financing and motivation have varied across firm categories. Due to different state-firm relations, FIEs rely on foreign finance and domestic firms do not. Hybrid FIEs differ from regular FIEs because the hybrids have a China-based operational strategy. This operational strategy (OS) is a mix of interests and ideational factors that causes these firms to perceive China either as the vital center of their operations (the China-based OS) or as just another location among many (the non-China-based OS). Thus, variation in firm-state relations (finance) and operational strategy (motivation) determine the variation in technological upgrading.

This thesis finds that the two types of FIEs are more likely to contribute to upgrading in China than the two types of domestic firms. Among the FIEs, the hybrid FIEs are more likely to contribute than the regular FIEs though the discrepancy is not as large as it is between the FIEs and domestic firms.

The hybrids are the most successful upgraders because they have both disciplined finance (i.e. credit with relatively hard budget constraints) from foreign financial institutions and the motivation to upgrade in China due to their China-based OS. The unsuccessful domestic upgraders lack finance (neglected domestic firms) or financial discipline (the favored domestic firms) due to their particular relationships to the state. The regular FIEs have the capabilities to upgrade due to their financial discipline and access to transnational technology networks, but undertake less upgrading in China than the hybrids because they lack the China-based operational strategy.

Despite a late start, Pakistan's information technology entrepreneurs and the government are hoping to make it big in the global marketplace for outsourcing of IT-enabled services. How have other countries succeeded and where does Pakistan stand?

Naween A. Mangi spoke from New York to Ron Hira, professor of public policy at the Rochester Institute of Technology, and Rafiq Dossani, senior research scholar at the Walter H. Shorenstein Asia-Pacific Research Center at Stanford University.

Software exports, call centres and medical transcription firms have become all the rage over the last three years. Young entrepreneurs are returning after years spent working at major tech firms in the US to start up their own ventures and the government is forecasting that IT will be the next big thing in Pakistan's economy.

So far, the numbers tell a less-than-compelling story. In 2004, although the software and IT enabled services business was worth $300 million, (including hardware the figure is $600 million), exports and outsourcing made up for just $33 million of that. By comparison, India logged $12.8 billion in software and services exports in 2004.

Still, the Pakistan Software Export Board, a federal body set up to promote outsourcing, forecasts that the business will grow by at least 45 per cent annually for the next five years. A lot of that growth will come from call centres and business process outsourcing which last year made up one-fourth of total exports. In the next ten years, the PSEB aims to be at the top of the class of tier two global IT companies.

But as experts and practitioners agree, Pakistan will need more than ambitious aims to meet that goal. Prof Ron Hira, whose new book Outsourcing America assesses the impact on the US job market, says the outsourcing industry is set for rapid growth in the next few years and if done right, developing countries like Pakistan could benefit from the boom.

Hira is an expert who has testified before the US Congress on the implications of outsourcing. "Pakistan isn't on the map yet," he says. "India dominates what most people think about [when it comes to outsourcing]."

Rafiq Dossani, an expert on outsourcing and a senior research scholar at Stanford University says there are several reasons for that. First, is the poor quality of infrastructure.

"When the Internet tanked recently, that created a really bad perception that the country has not thought through even the most rudimentary aspects," Dossani says. "Deregulation in this area is too limited." He says that while voice services have benefited from the deregulation, data services are still uncompetitive.

He says there are too many stumbling blocks since bandwidth is more expensive than in other countries. "The costs are outrageous at four or five times what they should be," he says.

Dossani identifies the thin segment of English speakers as a second hurdle in the way of a flourishing outsourcing industry in Pakistan. "Of the 30 per cent of the population that lives in urban Pakistan, one tenth speak English that's good enough to work at a call centre," he says. "And of those five million or so, only about one million are available to come into this field as the rest are working elsewhere."

Then, he says poor marketing also holds the industry back. "You just don't see the trade body [in Pakistan] working like India's Nasscom to project a positive image," he says. "The Pakistani diaspora has done well and there is a great need to better use that network."

He forecasts that the outsourcing business in Pakistan can be at least $1 billion in size but says this is only possible if alliances are formed with countries like India and China.

"The Philippines has done well by understanding that it cannot reach critical mass on its own and therefore forming alliances and pitching themselves as a second location to offset country risk," he says. Dossani also says Pakistan has the advantage of a highly skilled group of entrepreneurs which "is the reason why the tiny industry does exist."

Hira adds that since Pakistan entered into the industry late, playing catch up is an inevitable need. However, the sector can take advantage of the circumstances in other countries. "India has done a lot of things right," he says. "They have been successful at not just attracting foreign investment but also building their own companies and leveraging the large Indian diaspora," Hira says.

"India is also so talked about that people are comfortable doing business there. But since wages are rising, Pakistan can use that as an entry point." He says that while countries like India have accumulated critical mass and scale, others are distinguishing themselves in different ways.

Eastern European wages are slightly higher than Pakistan and companies in that region have specialized in near-shoring by targeting the European market. Russia, meantime, is aiming at the U.S. market in both services and manufacturing while the Philippines and Malaysia are targeting services.

"The question really is how you separate yourself from the pack," Hira says. "You can compete on price to a certain extent but you have to offer something more to distinguish yourself."

He says U.S. companies are now moving from pilot stage outsourcing to full deployment which indicates both the success of the pilot projects and the rapid growth that is likely to come in the outsourcing market for the next few years. "There will continue to be a backlash from U.S. workers, but by and large there has not been any real policy movement to restrict outsourcing so there is still a large opportunity," he says.

Hira admits that the extent to which a growing outsourcing industry ties into the broader economy in terms of job creation remains unclear but he says, other advantages emerge. "In India, for example, it remains unclear that they've been able to link the benefits [from outsourcing] back in, but the big benefit is that they have created world class management which can then move into other sectors."

Therefore, Hira recommends that Pakistan take a long-term vision not for the next three or five years but for the next two decades. "Right now you can try to pick up the low hanging fruit and absorb the excess demand but don't just think about attracting the individual company to come [to Pakistan]," he says. "Think about how this will fit into the larger set of skills for your country so that you can differentiate yourself much later down the road."

Chris Farrell: Remember the dot-com boom of the 1990s? It seemed as if every entrepreneur with a good idea and a PC could challenge established companies for customers. Brick-and-mortar companies jumped on the e-commerce bandwagon. The demand for digital workers soared. Long-time computer professionals hopped from job to job, pulling down more money with every employer. Newly minted college graduates juggled multiple job offers. But when the Y2K problem emerged in the latter part of the '90s business and government quickly realized there still weren't enough IT workers on hand to find and repair the computer glitch. The quick fix? Hire computer professionals overseas. And that temporary solution permanently changed the global economy.

Paul Saffo: Y2K was huge in getting the ball rolling on offshoring.

Farrell: Paul Saffo is director of the Institute for the Future, a high-tech think tank in Silicon Valley.

Saffo: But once they went overseas, they discovered it's not just a matter of cost. These programmers overseas are often better than the best you can get in the United States.

Farrell: Ireland, the Philippines, and Israel were among the more popular destinations for offshoring Y2K programming fixes. But India became the offshore capital. It had plenty of high-tech companies staffed with well-educated English speaking digital workers. Thanks to India's steep import barriers in the 1980s, no one could afford new computer systems. So Indian tech workers were the world's leading experts in the older software languages that needed upgrading. Suhas Patil is chairman emeritus of semiconductor maker Cirrus Logic.

Suhas Patil: And they were listening to their customers and what their needs were, and as the recognition came that systems had to be upgraded to not have the problem based on the Y2K issues, that's how they got their break.

Farrell: And made the most of the opportunity. AnnaLee Saxenian is Dean of the School of Information Management and Systems at the University of California, Berkeley.

AnnaLee Saxenian: I think the importance of Y2K was overwhelmingly about establishing Indian companies' reputation among US customers and helping begin a set of customer supplier relationships that have simply taken off in the last four years.

Farrell: Of course, Y2K contracts ended in 2000. Yet many Indian companies took advantage of their now sterling programming reputations to negotiate for more sophisticated work. Research. Software development. Accounting services. Long-distance medical advice. Rafiq Dossani is a senior research scholar at Stanford University.

Rafiq Dossani: India is now growing at 70-80 per cent a year in offshored services ... services which are maintaining an accounting system, maintaining an HR system, doing claims processing, that's growing easily at 70 per cent, maybe even higher.

Farrell: Offshore also came onshore during Y2K. The town of Mountain View lies at the heart of California's Silicon Valley. Housed in one of the many nondescript low-rise office buildings that crowd the region's business avenues is the Indus Entrepreneur, or TIE. It is a networking base for the Indian high-tech Diaspora.

Shankar Muniyappa: Y2K was a big opening as early as 98.

Farrell: Shankar Muniyappa is director of information systems for TIE. He came to America for Y2K-and stayed.

Muniyappa: Myself and many of us believe still believe this is the place where you need to be if you want to be middle of innovation.

Farrell: Some 30,000 Indian IT professionals now live and work in the Valley. Rafiq Dossani of Stanford University:

Dossani: At least 25 per cent of the start ups have Indian employees at fairly senior levels working for them. And ... there's a whole infrastructure therefore being built around them because it's a substantial number now, so you see shopping malls you see business services and so on catering to this particular immigrant community.

Farrell: That community is adding vitality to the American economy. Still, many American high-tech workers are threatened by the offshoring of white collar jobs. The numbers are murky, but according to Mark Zandi of Economy.com 370,000 non-manufacturing jobs moved overseas over the past fours years-with most of the information technology jobs going to India. Salaries are down too. Still, the big factor behind the loss of 1.5 million jobs lost since Y2K is improved business efficiency or productivity - not offshoring. And Y2K also played an important role in boosting business efficiency.

Economists initially looked at Y2K as a productivity killer.

Imagine a town threatened by a rising river. Every able-bodied person in town is put to work stacking sandbags. It's necessary work to save the town - but it's unproductive work. Nothing gets built. No food gets grown.

With the Y2K bug, programmers, chief information officers, project managers, and other digital workers were getting paid to do unproductive work - stacking sandbags of silicon. No innovative investments. No new productivity enhancing software.

But economists were wrong. Y2K wasn't a flood. Instead, think of it as clearing a path choked with underbrush. Once the trail is open, it is much easier to zip from point A to point B. Y2K gave companies an excuse to clean up their software and hardware underbrush - a critical factor in today's improved business productivity. Paul Saffo:

Saffo: A lot of companies said well, gosh, if we're going to have to spend all this money to fix our software let's also see what else we can do at the same time, so it was an invitation to replace a whole bunch of stuff. ... So it forced people to ask hard questions about how they were using things and in the best instances people really did become more efficient.

Farrell: The result? Companies used the new systems they installed to cut costs and work smarter - and hire fewer workers.

[Voice of Leonard Nimoy: "Do you have hard copies of all your important documents ... such as bank statements."]

That's Leonard Nimoy, Mr. Spock from Star Trek. He's narrating the Y2K Family Survival Guide video - one of thousands of products peddled by prophets of doom. Y2K did bring home how reliant we all are on computers. Many of us still don't back up critical data at home. The same isn't true for business and government. Many learned from Y2K just how vulnerable information systems are to a malicious attack or unforeseen disaster. Case in point: Y2K actually helped some businesses survive 9/11.

[News broadcast of President George W. Bush: "I've directed the full resources of intelligence and law enforcement communities to find those responsible and bring them to justice."]

The attack on the World Trade Center stopped trading on the New York Stock Exchange. Against the odds, that citadel of capitalism opened six days later.

John Koskinen: The reason the markets, securities markets, were able to open the Monday after the Tuesday of 9-11 was they still had the test scripts that had been developed in 1998 and 99.

Farrell: John Koskinen credits preparations for Y2K. He was President Clinton's Y2K czar.

Koskinen: ... they were able to in effect take all of those Y2K scripts and make sure that all the transactions with all of the major players would close. Without that they never would have been able to do it in the time frame with the confidence they had.

Farrell: A record 2.4 billion shares traded on the New York Stock Exchange the day it reopened.

Y2K was a unique economic event. Earlier jolts to the economy, like the 1973 oil price hike and the 2001 attack of 9/11, were shocks. But the Year 2000 arrived right on schedule. The surprise was how little immediate impact the much-feared transition had on the economy. Yet we're still living and working with the economic impact of Y2K five years later.

For Marketplace and American RadioWorks, I'm Chris Farrell.

San Francisco -- Offshoring is just one of many global forces impacting job creation and destruction in the Bay Area and cannot be viewed in isolation from the key trends enabling it, such as globalization, technology-driven improvements in productivity and business disintermediation. Efforts to prevent offshoring will not be successful and are likely to come at considerable economic cost, according to a new study released today.

Sponsored by Joint Venture: Silicon Valley Network, the Bay Area Economic Forum and the Stanford Project on Regions of Innovation and Entrepreneurship (SPRIE), with research and project support from global management consulting firm A.T. Kearney, the study analyzed global trends, regional capabilities and the Bay Area job market.

Findings from the study, the first regionally focused on the Bay Area, were based on 120 interviews, analysis of 9,000 job listings and other primary and secondary research.

The Bay Area already has more experience with globalization and offshoring than other parts of the U.S., the study reports. Bay Area manufacturers earn almost 60 percent of their revenues in overseas markets. Analysis done as part of the study revealed 94 percent of companies in the semiconductor and semiconductor equipment manufacturing and software clusters - two driving sectors in the Bay Area in terms of employment and payroll contribution - are already using offshore resources.

This does not mean all jobs are going offshore. The study also found one-in-four job postings for large companies in those sectors during April 2004 was for positions in the Bay Area.

"The research makes clear that global trends will force continued creation and destruction of jobs in the Bay Area. These trends can't be reversed. Policies and investment should be directed toward helping the region strengthen its core capabilities to compete effectively on a national and global basis" said Sean Randolph, President & CEO of the Bay Area Economic Forum.

The study calls for policymakers to maintain strong support for basic research, invest in education to ensure a competitive local workforce and to address vulnerabilities in the regional business environment including housing, transportation and business regulations that hinder local job creation. Business leaders need to support transition programs and consider investment in local employee development to meet their future job needs.

The study found the Bay Area is losing ground to other regions in the U.S. and overseas in three competitive capabilities: mass production, back-office (transactional) operations and product and process enhancement. The competitive erosion in the latter is new. It appears that the Bay Area is rapidly losing out to other regions in occupations associated with engineering focused on cost reduction, fine-tuning processes and expanding product features. These engineering jobs, along with manufacturing and administration-related occupations, are expected to decline as the skills required for those functions are sourced more cost effectively in other regions of the United States and abroad.

The study also identified five competitive capabilities that investors and business leaders believe are key strengths of the Bay Area. In addition to three capabilities traditionally linked to the region (entrepreneurship/new business creation, research in advanced technologies and bringing new concepts to market), the analysis pointed to two other competitive capabilities not always in the spotlight:

• Cross-disciplinary research - coordinating and integrating advanced learning across industries and scientific disciplines.
• Global integrated management - managing and coordinating globally distributed business functions and networks.

Jobs aligned with these five regional strengths, such as high-level research, strategic marketing and global business and headquarter management activities, are expected to experience solid growth.

"The findings confirm that the region should continue to attract talent and foster innovation, start-up activity and job creation, as technology companies are launched and commercialized," said Russell Hancock, President and CEO of Joint Venture: Silicon Valley Network.

The Bay Area's strengths make the region a leader in job creation in early stages of the business lifecycle, but its weaknesses lead to job growth outside the region in the later stages. As a result, the study says, the Bay Area will continue to incubate and develop new businesses, a process that has historically been the core growth engine for the local job market.

"Companies founded in the Bay Area will typically maintain the majority of their workforce in the region until their first products or services gain market traction and key business processes stabilize," said John Ciacchella, Vice President with A.T. Kearney. "However, as these companies expand and mature, many of the new jobs that stay local will focus on management of expanding business operations that are outsourced, offshored and distributed to other regions."

The Bay Area also is well positioned in the industries likely to spawn new technology

start-ups, according to the study's job market analysis and interviews. Beyond its leading role in information technology, the Bay Area has the highest concentration of biotechnology firms in the country and more nanotechnology firms than all countries except Germany.

"How jobs in a region are affected by global trends depends on the competitiveness of the region's capabilities," said Marguerite Gong Hancock, Associate Director of SPRIE. "Despite a rise in the capabilities of other entrepreneurial regions globally, the Bay Area continues to lead in many of the capabilities considered most necessary for innovation and new business creation"

The study findings will be presented at a public event on Thursday, July 15, at Stanford University, where a panel of business and community leaders will discuss the report's findings and implications and take questions from the audience. The panel will be moderated by Paul Laudicina, managing director of A.T. Kearney's Global Business Policy Council, and includes:

• Edward Barnholt (Chairman, President & CEO, Agilent Technologies)
• William T. Coleman (Founder, Chairman & CEO, Cassatt Corporation, and Vice Chairman, Silicon Valley Manufacturing Group)
• Anula K. Jayasuriya (Venture Partner, ATP Capital LP)
• William F. Miller (Professor Emeritus, Stanford Graduate School of Business)
• The Honorable Joe Nation, California State Assembly

BAY AREA ECONOMIC FORUM
Bay Area Economic Forum (www.bayeconfor.org) is a public-private partnership of senior business, government, university, labor and community leaders, develops and implements projects that: support the vitality and competitiveness of the regional economy, and enhance the quality of life of the regions residents. Sponsored by the Bay Area Council a business organization of more than 250 CEOs and major employers, and the Association of Bay Area Governments, representing the region's 101 cities and nine counties, the Bay Area Economic Forum provides a shared platform for leaders to act on key issues affecting the regional economy.

JOINT VENTURE: SILICON VALLEY NETWORK
Joint Venture: Silicon Valley Network (www.jointventure.org) is a nonprofit organization that provides analysis and action on issues affecting the economy and quality of life in Silicon Valley. The organization brings together new and established leaders from business, labor, government, education, non-profits, and the broader community to build a sustainable region that is poised for competition in the global economy.

STANFORD PROJECT ON REGIONS OF INNOVATION AND ENTREPRENEURSHIP
The Stanford Project on Regions of Innovation and Entrepreneurship (http://sprie.stanford.edu), or SPRIE, is dedicated to the understanding and practice of the nexus of innovation and entrepreneurship in the leading regions around the world. Current research focuses on Silicon Valley and high technology regions in 6 countries in Asia: People's Republic of China, Taiwan, Japan, Korea, Singapore and India. SPRIE fulfills its mission through interdisciplinary and international collaborative research, seminars and conferences, publications and briefings for industry and government leaders.