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November 18, 2010

A Better Formula for Economic Growth: Connecting Smart Risk Takers

By Vivek Wadhwa

Build a magnificent technology park next to a research university; provide incentives for chosen businesses to locate there; add some venture capital. That is the common recipe for harnessing higher education and industry to spur economic growth as prescribed by management consultants touting the “cluster theory” developed by Harvard Business School’s Michael E. Porter.

Hundreds of regions all over the world have spent billions on such efforts; practically all have failed. Yet others are following suit—such as Japan, with its Okinawa research-and-development cluster, and Russia, with its Skolkovo project.

All of those are well-intentioned efforts to build Silicon Valley-style technology hubs, but they are based on the same flawed assumptions: that government planners can pick industries they want to develop and, by erecting buildings and providing money to entrepreneurs and university researchers, make innovation happen.

It simply doesn’t work that way. It takes people who are knowledgeable, motivated, and willing to take risks. Those people have to be connected to one another and to universities by information-sharing social networks.

Regional planners and some academics get very defensive when asked to produce evidence of cluster theory’s success. They commonly tout Silicon Valley and North Carolina’s Research Triangle Park as examples of the success of government-supported clusters. Research Triangle Park is a 50-year-old project that achieved success decades ago but lost momentum in the Internet era. And the success of Silicon Valley was achieved without government involvement.

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The Indian Exception Proving the Rule

By Vivek Wadhwa Thursday, April 23, 2009

The Satyam scandal rocked the global business community and threatened to stifle the Indian outsourcing industry. But as the dust settles, the forces driving outsourcing are as strong as ever, with benefits for both India and the West.

On January 7, Ramalinga Raju distributed a four-and-one-half-page letter to members of the Bombay Stock Exchange and then went into hiding. In the letter, the chairman of multi-billion dollar Indian IT company Satyam told of how a small accounting discrepancy, created by a sleight of hand that artificially pumped sales numbers, turned into a gaping hole in the company’s balance sheet. After Ramalinga’s revelation, shares in Satyam plunged more than 80 percent and the Indian government sacked Ramalinga and Satyam’s entire board of directors in a desperate bid to save the company and spare its remaining shareholders. Roughly $1 billion had gone missing and Satyam had been overstating revenues for several years at least, if not more.

Almost immediately, IT executives at U.S. insurance giant State Farm decided to cut ties with Satyam, a significant black eye for the outsourcing firm. Pundits predicted a flood of other foreign companies would abandon not only Satyam but other Indian IT companies large and small.

For critics of outsourcing in the United States, the scandal seemed to confirm something they had long suspected. The Indian outsourcing story was simply too good to be true and here was the evidence. One of the four largest Indian IT companies had resorted to booking fake revenues in order to keep shareholders happy. How many other landmines lurked in the balance sheets of other Indian companies until recently deemed the darlings of Wall Street?

Today it appears that Satyam was the exception that proves the rule. Months have passed since a chastened Raju did the perp walk. Initial concerns that Satyam was only the first scandal lurking have rapidly faded. No other major Indian IT outsourcing firm has found evidence of improprieties, even after hurried deep dives into their books by finance departments and outside auditors.

Even more important, few foreign customers have pulled up stakes based on fraud fears. To the contrary, the National Association of Software and Services Companies, the powerful Indian IT trade group which counts all the outsourcing giants among its members, came out with a bold prediction on February 4 that export revenues to Indian IT companies would reach $47 billion by the end of fiscal year 2009, an increase of 16 percent to 17 percent over the previous year. This growth comes against the backdrop of the worst global recession since the Great Depression and building nationalistic sentiments against shipping white-collar jobs from the developed to the developing world.

No other major Indian IT outsourcing firm has found evidence of improprieties, even after hurried deep dives into their books by finance departments and outside auditors.

The forces pushing the growth of IT outsourcing and fueling the rise of Satyam, along with companies like Wipro and Infosys, did not disappear because Ramalinga shoved $1 billion down a rabbit hole. Rather, the very same forces are actually gathering steam. And these forces will fuel a new wave of outsourcing from U.S. companies that goes beyond India’s legacy plain vanilla data and IT administration business and into more advanced research and product development processes. Companies such as Tata ConsultancyServices and HCL Technologies are helping develop next-generation networking services, medical equipment, avionics systems, and the interiors of luxury jets for Western companies. Both HCL and Tata got their start running drab, back office data processes for foreign firms. Now they are being trusted with the crown jewels.

A handful of key forces constitute strong winds at the back of the IT outsourcing movement and the subsequent move into outsourcing innovation. The first of these is pure, hard economics. Wages in India remain significantly below those in the West. Computer programmers on the subcontinent earn less than fourth as much as their peers in the West. For a while, it looked as if a labor shortage and demand for outsourcing would outstrip supply and push wages up sharply. But in the past year wage pressures have subsided as Indian IT companies, with impressive in-house education programs, have succeeded in training hundreds of thousands of smart young Indians to pick up the slack. At the same time, other costs affecting IT services in India have begun to rapidly abate. A real estate bubble in India had resulted in land appreciation far greater than that experienced even in tech meccas such as Silicon Valley. Now that bubble is bursting and prices are coming down hard, bringing down with them the cost of setting up a facility in India.

In 2007, the Indian rupee dramatically appreciated against the U.S. dollar. This squeezed many outsourcers locked into long-term contracts and reduced profit margins (ironically, it also induced many of them to hire heavily in the United States and the West to expand operations and hedge against currency risk). As the U.S. mortgage and financial crisis unfolded and economists theorized that the general indebtedness of the United States would result in a weak currency, it appeared that the strong rupee was a permanent reality. But when the U.S. banking crisis grew more serious in 2008, stock markets in the developing world plunged even faster than the U.S. exchanges, and fears that these economies, too, would swing into deep recessions exerted strong downward pressure on the rupee. The world fled to the safety of the U.S. dollar. Trading at roughly 39 to the dollar in the fall of 2007, the rupee has fallen sharply in early 2009 to an exchange rate of 50 to the dollar.

Since the bulk of sales growth for most U.S. multi-nationals is expected to take place in developing Asia, it makes perfect sense to put product development closer to customers.

True, the dollar may well plunge again if deficit spending runs amok. And the ongoing deep recession in the United States has alleviated some of the economics that spurred outsourcing. Real estate prices have dropped and wage growth among IT professionals has slowed. But U.S. companies have grown used to the flexibility that outsourcing allows, with the ability to easily upsize or downsize departments or headcount without worrying about paying unemployment or severance, or receiving bad publicity. And the difference in costs between comparable employees based in the United States or India remains stark.

Beyond economics, other forces are at play. Over the past decade, the very same Indian IT companies handling mundane data-centric tasks have watched with interest as U.S. companies such as General Electric, Cisco Systems, Microsoft, Adobe, Motorola, and Google have set up engineering and development centers in the Indian subcontinent. These U.S. companies have placed these advanced and high value added processes in India not only to take advantage of cheap labor but also to put product development closer to fast growing markets. Since the bulk of sales growth for most U.S. multi-nationals is expected to take place in developing Asia, it makes perfect sense to put product development closer to customers. Another key reason for locating R&D in India is to take advantage of the time zone difference and build a 24-hour product development and research cycle.

Not surprisingly, Indian IT and outsourcing companies began developing advanced R&D capabilities that would allow them to compete for this type of work (albeit on an outsourced basis) for foreign multi-nationals. After all, helping to design and plan manufacturing of actual products would surely be a more profitable service than running server farms or tending corporate computing networks.

Restrictive U.S. immigration policies have forced many of the talented top-level science and engineering researchers from India to leave.

These types of R&D outsourcing arrangements are rapidly growing in number. In addition to Boeing’s avionics contracts with HCL, the aerospace giant in January 2008 entered into agreements with the Indian Institute of Science and software firms Wipro Technologies and HCL Technologies to create and develop wireless and networking technologies. HCL also has an agreement with General Electric aerospace subsidiary Smiths to set up and operate an R&D center in India. Wipro, MindTree, and other Indian companies are now offering semiconductor chip design services, a high value added activity formerly dominated by outsourced chip design firms in the developed world and in Taiwan. Indian pharmaceutical company Ranbaxy has an agreement with Merck to perform early stage drug development in exchange for downstream royalties. The arrangements listed here are merely the tip of the iceberg. In a study conducted by California management consultancy firm Zinnov, outsourcing of R&D to India (either to regional subsidiaries of multinational corporations or to Indian IT outsourcing firms) should hit $22 billion by 2012. This is a shocking figure considering that dollar value of Indian R&D outsourcing 20 years ago was a tiny fraction of that large sum.

Spurring this rapid rise of R&D is restrictive U.S. immigration policies that have forced many of the talented top-level science and engineering researchers to leave the United States after completing graduate educations and, sometimes, brief stints of employment on H-1B visas. Combined with India’s own efforts to build a strong talent pool in science and engineering specialties, the result has been a deep and relatively inexpensive high-tech work force that rivals that of the best U.S. technology regions such as the Bay Area of California. Aside from disliking the restrictive immigration policies, many Indians studying in the United States now feel that better opportunities lie at home than in America, all things being equal. These opportunities are both professional—with the rapidly developing R&D and science and engineering research complex—and cultural. Family, closeness to friends, and care of aging parents are often cited by Indian students as strong factors behind their decision to return home. The shift of talent to India has made it far easier for multinational corporations to make the decision to relocate research activities there.

Vivek Wadhwa is executive in residence at Duke University’s Pratt School of Engineering and a senior research associate at Harvard Law School’s Labor and Worklife Program. He earlier wrote for The American about “America’s Other Immigration Crisis.”

America’s Other Immigration Crisis

By Vivek Wadhwa From the July/August 2008 Issue

We are bringing the world’s smartest people to our shores, training them, and then making them leave.

From his early childhood, Sanjay Mavinkurve dreamed of coming to America and making it big. So his parents, who are from India, sent him to boarding school in Cleveland, Ohio when he was 14. He did so well that he gained a scholarship to Harvard, where he completed both a bachelor’s and a master’s degree in computer science. In his spare time, he helped conceive the design for Facebook and wrote its first computer code. After graduating, Sanjay joined Google and designed key parts of their mapping software for mobile devices.

Then Sanjay fell in love and had to choose between his heart and the American dream. He was in the United States on a temporary visa and was years away from obtaining permanent resident status. His fiancée had graduated from a top university in Singapore and started work as an investment banker. The only U.S. visa they could obtain for her would not allow her to work, and that would force her to abandon her ambitions. Instead, they decided to abandon America and move to Canada, which welcomed them with open arms.

The U.S. immigration system allows highly educated workers to enter the country for up to six years on a visa called the H-1B. But this visa imposes many restrictions. If these workers want to stay longer and enjoy the same rights as Americans, they need to obtain a permanent resident visa. And then after five years as a permanent resident, they can apply to become naturalized American citizens.

Over a million skilled workers and their families in the U.S. are waiting for permanent resident visas. But few visas are available and the backlog is rapidly increasing.

The problem is that there are more than a million skilled workers and their families in the United States who are waiting for these permanent resident visas, but there are hardly any visas available and the backlog is rapidly increasing. So, over the next few years, Sanjay’s story is likely to be repeated many times.

These engineers, scientists, doctors, and researchers entered the country legally to study or to work. They contributed to U.S. economic growth and global competitiveness. Now we’ve set the stage for them to return to countries such as India and China, where the economies are booming and their skills are in great demand. U.S. businesses large and small stand to lose critical talent, and workers who have gained valuable experience and knowledge of American industry will become potential competitors.

My team at Duke University has been researching the impact of globalization on U.S. competitiveness and the sources of the U.S. advantage. We had many surprises in store when we looked at the role of immigrants in the tech sector.

In 1999, AnnaLee Saxenian of the University of California at Berkeley published a groundbreaking report on the economic contributions of skilled immigrants to California’s economy. She found that Chinese and Indian engineers ran a growing share of Silicon Valley companies started during the 1980s and 1990s and that they were at the helm of 24 percent of the technology businesses started from 1980 to 1998. Saxenian concluded that foreign-born scientists and engineers were generating new jobs and wealth for the California economy.

We decided to update and expand her study and focus on engineering and technology firms started in the United States from 1995 to 2005. Over a period of two years, we surveyed thousands of companies and interviewed hundreds of company founders.

We found that the trend Saxenian documented had become a nationwide phenomenon. In over 25 percent of tech companies founded in the United States from 1995 to 2005, the chief executive or lead technologist was foreign-born. In 2005, these companies generated $52 billion in revenue and employed 450,000 workers. In some industries, such as semiconductors, the numbers were much higher—immigrants founded 35 percent of start-ups. In Silicon Valley, the percentage of immigrant-founded start-ups had increased to 52 percent.

When we looked into the backgrounds of these immigrant founders, we found that they tended to be highly educated—96 percent held bachelor’s degrees and 74 percent held a graduate or postgraduate degree. And 75 percent of these degrees were in fields related to science, technology, engineering, and mathematics.

The vast majority of these company founders didn’t come to the United States as entrepreneurs—52 percent came to study, 40 percent came to work, and 6 percent came for family reasons. Only 1.6 percent came to start companies in America. They found that the United States provided a fertile environment for entrepreneurship.

Even though these founders didn’t come to the United States with the intent, they typically started their companies around 13 years after arriving in the country.

We uncovered some puzzling data in the World Intellectual Property Organization (WIPO) database, which is the starting point for obtaining information on global intellectual property protection. In 2006, foreign nationals residing in the United States were named as inventors or co-inventors in an astounding 26 percent of patent applications filed in the United States. This increased from 8 percent in 1998. Some U.S. corporations had foreign nationals contribute to a majority of their patent applications—such as Qualcomm at 72 percent, Merck at 65 percent, GE at 64 percent, and Cisco at 60 percent. Over 40 percent of the international patent applications filed by the U.S. government had foreign authors.

In 1998, 11 percent of these global patent applications had a Chinese inventor or co-inventor. By 2006 this percentage had increased to almost 17 percent. The contribution of Indians increased from 9 percent to 14 percent in the same period. To put these numbers into perspective, it is worth noting that Indians and Chinese both constitute less than 1 percent of the U.S. population, and census data show that 82 percent of Indian immigrants arrived in the United States after 1980.

But our concern was that these were foreign nationals and there was no certainty that they would stay and become U.S. citizens. These foreign-national inventors were also not from the same immigrant group that was founding high-tech companies—those were permanent residents or naturalized citizens. These inventors were likely to be Ph.D. researchers on student visas and employees of U.S. corporations on temporary visas like the H-1B, as Sanjay Mavinkurve was.

The question was: Why was the number of foreign-national inventors increasing so dramatically—337 percent over 8 years?

To answer this, we had to develop our own methodology to estimate the population of skilled immigrants from which such inventors may originate.

We found that at the end of 2006, there were 200,000 employment-based principals waiting for labor certification, which is the first step in the U.S. immigration process. The number of pending I-140 applications, the second step of the immigration process, stood at 50,132. This was over seven times the number in 1996. The number of employment-based principals with approved I-140 applications and unfiled or pending I-485s, or the last step in the immigration process, was 309,823, a threefold increase from a decade earlier. Overall, there were 500,040 employment-based principals (in the three main employment visa categories of EB-1, EB-2, and EB-3) waiting for legal permanent residence. And the total including family members was 1,055,084.

These numbers are particularly troubling when you consider there are only around 120,000 visas available for skilled immigrants in the EB-1, EB-2, and EB-3 categories. To make things worse, no more than 7 percent of the visas are allocated to immigrants from any one country. So immigrants from countries with large populations like India and China have the same number of visas available (8,400) as those from Iceland and Poland.

Visit a state-of-the-art lab in China and you will meet many highly skilled workers who received their education and training in top U.S. universities and corporations.

This means that immigrants like Sanjay who file for permanent resident visas today could be waiting indefinitely. H-1B visas are valid for up to six years and can be extended if the applicant has filed for a permanent resident visa. The problem is that once these workers have started the process, they can’t change employers or even be promoted to a different job in the same company without taking the risk of having to restart the application process and move to the back of the line. Their spouses aren’t allowed to work or obtain Social Security numbers, which are usually needed for things like bank accounts and driver’s licenses. And these workers can’t lay deep roots in American society because of the uncertainty about their future.

We also researched the trends in globalization and what was happening in India and China. We met dozens of executives of top companies in several industries in these countries and toured their R&D labs.

In Hyderabad, India, companies like Satyam Computer Services and Hindustan Computers are designing navigation control and in-flight entertainment systems and other key components of jetliners for American and European corporations. In New Delhi, Indian scientists are discovering drugs for GlaxoSmithKline. In Pune, Indians are helping design bodies, dashboards, and power trains for Detroit automakers. In Bangalore, Cisco Systems, IBM, and other U.S. tech giants have made the Indian city their global base for developing new telecom solutions.

China is already the world’s biggest exporter of computers, telecom equipment, and other high-tech electronics. Multinationals and government-backed companies are pouring hundreds of billions of dollars into next-generation plants to turn China into an export power in semiconductors, passenger cars, and specialty chemicals. China is lavishly subsidizing state-of-the-art labs in biochemistry, nanotech materials, computing, and aerospace.

Visit any of these labs, and you will meet dozens of workers returned from the United States—highly educated and skilled workers who received their education and training in top U.S. universities and corporations. In GE’s Jack Welch Technology Center in Bangalore, 34 percent of the R&D staff have returned from the United States. So have 50 percent of those with a Ph.D. at IBM research in Bangalore. And so are the managers of China’s top engineering, technology, and biotech companies.

These returnees have fueled much of the innovation and growth in R&D in China and India. And the executives of these companies will tell you that the number of résumés they receive from the United States has increased tenfold over the last few years.

We need to do all we can to attract and keep skilled immigrants rather than bring them here temporarily, train them, and send them home.

Most students and skilled temporary workers who come to the United States want to stay, as is evident from the backlog for permanent resident visas. Yet we’re leaving these potential immigrants little choice but to return home. “The New Immigrant Survey,” by Guillermina Jasso of New York University and other leading academics, found that approximately one in five new legal immigrants and about one in three employment principals either plan to leave the United States or are uncertain about remaining. These surveys were done in 2003, before the backlog increased so dramatically.

Additionally, there are over 250,000 foreign students studying in our universities. In our engineering schools, 60 percent of Ph.D. candidates and 42 percent of master’s candidates are foreign nationals. These students are often the best of their home countries. But there are few visas available for U.S. companies to hire these students when they graduate. Foreign students can work temporarily when they graduate on practical training visas. But if they want to stay long term, they need to get H-1B visas and then file for permanent residence.

The yearly allocation of H-1B visas for foreign students who graduate at the master’s level and above is 20,000. But 31,200 people filed applications for these visas in the first week they became available in April of this year. Bachelor’s-level graduates had even worse odds, as they had to compete in the general pool with only 65,000 visas available, less than half the number of applications for that visa category.

The result is that employers are now reluctant to hire foreign students. Why recruit and train new hires when there is less than a 50 percent chance that they will be able to stay? These students are getting increasingly frustrated and applying for jobs back home or in other countries.

So we have set the stage for hundreds of thousands of highly educated and skilled workers to become our competitors. Indian and Chinese industry benefited in a big way from the trickle of returnees over the last few years. Now we’re looking at a flood.

Immigration has been a hot topic in the media, but the focus has been on the plight of the estimated 12 million unskilled workers who entered the United States illegally. Emotions have been running high on the issues of amnesty and border control.

At the same time, a debate rages about H-1B visas and this gets considerable press coverage. Companies such as Microsoft, Intel, and Oracle have been lobbying for visas to bring in skilled immigrants, but have focused on expanding the numbers of H-1B visas available. Why? Perhaps because workers on these visas are desirable, as they are less likely to leave their employers during the decade or more they are waiting for permanent residence.

Moreover, I know from my experience as a tech CEO that H-1Bs are cheaper than domestic hires. Technically, these workers are supposed to be paid a “prevailing wage,” but this mechanism is riddled with loopholes. In the tech world, salaries vary widely based on skill and competence. Yet the prevailing wage concept works on average salaries, so you can hire a superstar for the cost of an average worker. Add to this the inability of an H-1B employee to jump ship and you have a strong incentive to hire workers on these visas. (To be fair, the lobbying platform of these tech companies does include recommendations that the government expand the number of permanent resident visas.)

In 2006, foreign nationals residing in the U.S. were named as inventors or co-inventors in an astounding 26 percent of patent applications filed in the U.S.

Opponents of H-1B visas complain that these visas cause job losses and damage the engineering profession. To some extent, they are right. If we bring in too many workers at the lower end of the scale, we could end up causing a reduction of salaries to the point that Americans don’t consider the profession worthwhile. And there are indications that enrollments in computer science have already dropped. The fact is that if we flood the market with workers with any skill, we end up hurting individual members of the profession; if we brought in 100,000 doctors, dentists, or plumbers, we would cause salaries to drop, create unemployment, and discourage Americans from studying these professions.

So we want skilled immigrants, but we want them to come on the right visas as permanent residents. The battles being fought are about bringing in more people with H-1B visas—not about those who are already here with them and stranded in “immigration limbo.” Which means that we’re going to be compounding the hardship on workers who are already here and forcing more, like Sanjay, to abandon America.

Unlike many of the problems facing the United States, this one isn’t hard to fix. All we have to do is to increase the number of visas offered to skilled workers in the EB-1, EB-2, and EB-3 categories from 120,000 to around 300,000 per year. And we need to remove the per-country limits. Instead of requiring graduates from top universities who receive jobs from American corporations to go through the tedious H-1B visa process, we should provide a direct path to permanent residence. We are now competing with the rest of the world for the best talent. We need to do all we can to attract and keep skilled immigrants, rather than bring them here temporarily, train them, and send them home.

Vivek Wadhwa is Executive in Residence at Duke University’s Pratt School of Engineering and a Wertheim Fellow at Harvard Law School’s Labor and Worklife Program