Watch out, Silicon Valley: China and India aren’t just graduating bad engineers and stealing intellectual property anymore. They’re fostering innovations that will shake the world.

BY VIVEK WADHWA | DECEMBER 28, 2010

Earlier this month, Americans woke up to the bad news that their education system was just “average” in the developed world. Worse news, however, was that Shanghai, China took the top spot. For a country already in a declinist mood, this was a blow. Perhaps not even U.S. President Barack Obama thought the future would arrive so quickly: As he told a group of educators at the White House earlier this year, the “nation that out-educates us today is going to out-compete us tomorrow.”

America is rightfully worried about its sinking competitiveness, and does indeed need to improve its education system. But it could win the battle and lose the war, because India’s and China’s successes aren’t due to their education systems, but despite them. You’ve probably heard of Indian outsourcing hotspots like Bangalore and Chennai, but it’s not just call centers and software sweatshops Americans now need to worry about: Technology entrepreneurship is booming all over in China and India, and is beginning to innovate; these startups will soon start competing with Silicon Valley. The next Google could well be cooked up in a garage in Guangzhou or Ahmedabad.

Indian and Chinese children are very much like their counterparts in the United States — intelligent, open-minded, and motivated to change the world. They receive poor education on average, but many are able to rise above that. And the United States is giving an unintended boost to these countries by sending away highly educated skilled foreign workers.

India and China now graduate three to six times more engineers than does the United States. The quality of these engineers is, however, so poor that most are not fit to join the workforce; their system of rote learning handicaps those who do get jobs, so that it takes two to three years for them to achieve the same productivity as American graduates. As a result, significant proportions of China’s engineering graduates end up working on factory floors; Indian industry has to spend large sums of money on retraining its employees, as my research team at Duke and Harvard learned.

Despite this, India has built a $73 billion-per-year information technology service business and has been offering IT services of steadily increasing sophistication. Its engineering R&D industry is now a $10 billion business — a three-fold increase in four years. It develops sophisticated products for Western firms in the aerospace and automotive industries, and in telecommunications, semiconductors, consumer electronics, and medical devices. And most significantly, there are thousands of new startups that are building web technologies, clean-tech products like low-power lighting, and mobile applications.

China has built world-class universities and state-of-the-art research facilities. The numbers of papers its faculty members publish and patents its researchers file are increasing dramatically. But these numbers are deceptive, as the patents and papers are largely plagiarized or irrelevant. There is also practically no innovation coming from the state enterprises that dominate industry. The big change that has occurred in China, however, is the emergence of technology startups: thousands of them, just as in India.

The first generations of Indian startups focused on selling IT services, and the Chinese developed copycat web technologies such as Baidu, China’s Google rival, and Sina, its Twitter clone. But they are going beyond that now. They are gaining the knowledge — and developing the confidence — to create innovative products, not only for domestic markets, but also for global ones.

How are India and China overcoming the problems in their education system?

In India, top private companies started learning from the best practices of the Western companies that outsourced their computer systems and call centers there. Their initial focus was on training new recruits and meeting shortages of entry-level skills. Then, Indian industry started investing in constantly improving the skills and the management abilities of its workers. It has effectively built its own surrogate education system, one that can take the workers coming from a weak education system and turn them into R&D specialists. One major Indian company, Infosys, has facilities to train 30,000 people at a time at its Mysore campus.

Now, many of these workers are leaving their high-paying tech-services jobs to start their own ventures. It’s the same dynamic as in the United States, where entrepreneurs start their companies when they are, on average, 39 years old. They have 10 to 15 years of work experience and ideas for products that solve real customer problems; they have gotten tired of working for others; and they want to build wealth before they retire. And so it is in India. There are no hard estimates available on the number of Indian entrepreneurs starting companies, but at one recent conference devoted to start-up companies, there were 1,200 attendees — up from less than 100 attendees at such events just 4 years ago. There are now start-up events in every major Indian city, with hundreds of people in attendance — mostly from new companies.

China is getting a major boost from the return home of Western-educated, skilled workers. They are returning because of frustrations with U.S. visa policies that make it extremely difficult for skilled workers from high-population countries to obtain permanent-resident visas; because of opportunities back home; and because the Chinese government is offering huge incentives to engineers and scientists. These returnees are teaching locals how to build world-class companies and how to innovate. In almost every high-growth tech company in China, you find returnees in senior management positions. In scientific research, top research labs have returnees in lead positions. And these scientists are beginning to make breakthroughs.

What has held would-be Indian and Chinese entrepreneurs back has been the taboo associated with failure, and the low social esteem granted to startups. This is changing. Given the success of the first generation of technology startups, the youth have role models, and parents are becoming more accepting. Chinese and Indian youth are also much more ambitious and confident than their parents were. In addition, they are also connected to each other and to their counterparts in other parts of the world through social networks.

American children should prepare to face a lot of competition from their peers in Asia. They will need not only to improve their mathematics and science skills, but also to learn about global markets and cultures. They need to be ready for a much more competitive world; otherwise the Indians and Chinese are going to eat their lunch.