Outsourcing and the global IP "devaluation" Ken Brown March 10, 2004 Copyright © Alexis de Tocqueville Institution Read press, commentary here In a widely quoted study, Baruch Lev of the Brookings Institution reported that in 1982, 62% of the market value of companies in the S & P 500 Index could be attributed to tangible assets, and only 38% to intangibles. By 1992, Lev noted, the ratio had essentially reversed: 32% of the assets for S & P companies were tangible, while 68% were intangible. A follow-up study by Brookings in 1998 reported that the asset ratio had shifted even more, with 85% of assets intangible, and only 15% tangible. While similar findings have been pointed to in hundreds of journals and reports, few observers have made the connection to the fact that the devaluation of U.S. intellectual property is directly linked to the widespread export of information technology jobs to foreign countries. Our haste to embrace globalization is one of the clearest culprits. In the name of globalization, the U.S. has relentlessly pursued business partnerships with countries that are home to relentless intellectual property theft. It almost seems as though the more evidence there is of piracy in a country, the more information technology business and investment we bring in. The relationship is simple: unpunished theft of intellectual property, coupled with IT and IP globalization, has exponentially increased the overall amount of IP theft. Simply put, the more there is to steal, the more will be stolen. While many would argue that intellectual property theft abroad does not have a significant impact on our economy, the math provides the grim truth. If 85% of the assets of the Standard Poor 500 shrinks by even 1% percentage point, it devalues U.S. corporations by billions of dollars. Second, while worldwide IP enforcement needs drastic improvement, the attitudes and activities of many U.S. corporations are equally as problematic. While most information technology firms insist that outsourcing exists solely because of reduced production costs abroad, we are not asking a very obvious question. Why are workers abroad able to produce our technology at all? The reason is because they know how to -- because they have our intellectual property. Generally speaking, when you talk to technology firms about IP and outsourcing, their response is either a) we know that they are stealing our intellectual property, but we have no choice but to do business there---and “hope” with our presence, piracy slows down b) we know that they are stealing our intellectual property, but it is not significantly affecting our bottom line or c) just because we show foreign companies and workers how to build our technology, it is not affecting our bottom line, because the intellectual property stays in the U.S. While the hubris of the first and second responses is predictable, the third response is more problematic than the first two. Today, intellectual property is not just patents, copyrights and trademarks, it is processes, techniques, methodology and talent; described by many experts as intellectual capital. Our “knowledge economy” and IP economy are very closely related, if not the same. Knowledge in the technology industry has a particularly significant value, especially when it is the result of billions of dollars in research and development. Furthermore, without intellectual property protection abroad, it is irrelevant whether the physical rights to intellectual property stay in the U.S. or not. It is patently false to state that when we outsource IT jobs overseas, we are not devaluing U.S. IP. When corporations transfer business secrets and processes overseas, foreign countries reap the reward of gaining highly profitable intellectual capital at a very low cost. Only five years ago, Congress was being aggressively lobbied by technology firms to allow more talent from overseas to emigrate to the U.S. to fill new tech jobs. In a weird reversal of fortune, American IT workers may end up having to leave the U.S. to pursue information technology careers, while foreign companies (using American ingenuity) may become their new employers. Many U.S. firms are not only devaluing intellectual property via outsourcing, but are also embracing business strategies to devalue (and if necessary, eradicate) their competitor’s intellectual property. Open source software, also described as free software, is the neutron bomb of IP. The strategy basically is this: businesses that make money selling hardware, selling programming services, selling hardware integration, etc. do not like being beholden to the software companies. In addition, they can increase products sales if accompanying or required software is free. So, major U.S. corporations are heavily investing in developing a widely available “free software inventory” that is open to anyone to use or customize at will. If customers only want to use free software, they will buy more hardware and services because there is no additional cost for software. Moreover, with no software costs, even hardware development, etc. becomes even cheaper. Active international campaigns (many sponsored by U.S. companies) have skyrocketed free software adoption around the world. However, the open source strategy is a triple-edge sword. First, most free software such as Linux, (the most popular because of its operating system capability), comes with a license that dictates that any all development of the product (which would have been valuable intellectual property) becomes community property and must subsequently become free as well. Second, Linux initiatives have enabled foreign-based information technology firms with zero IP costs and cheap labor to easily compete with U.S. software companies. While some may argue that Linux only impact the business software sector, BSA reports that the business market for software is over $160 billion. Third, and even more serious, these initiatives are continually pushing U.S. intellectual property asset values downward. The irony is that U.S. corporations with Linux initiatives believe that the IT industry can survive without intellectual property. Open Source activists that want to see Linux succeed argue that eventually, they want all intellectual property protection to end, including patents and trademarks. The bottom line is this: a non-IP future means that all companies in the Baruch Lev study go to from 85% to 0% in intangible asset value. In conclusion, while it is debatable whether outsourcing can be described as just another business solution or the hemorrhaging of the IT industry, downward pressure on intellectual property is having a serious impact upon the information technology sector and the entire U.S. economy. Instead of asking how much harm is this having on our economy, we should really be asking how much longer can we continually export the U.S. IP economy to every (and any) global competitor at no cost? Unless intellectual property assets are better protected, we will soon see information technology firms resorting to draconian measures even worse than outsourcing. Ken Brown is president of the Alexis de Tocqueville Institution and director of its technology programs. He is the author of numerous studies on intellectual property rights, telecommunications, and trade. View a version of this article at: www.darwinmag.com