If the trend toward outsourcing of critical technologies was a response to quarterly earnings pressure from Wall Street, it would stand to reason that U.S. technology companies’ R&D budgets should fall with rising dependence on outsourced components and processes.

But the opposite is true, which demonstrates that outsourcing is being employed not simply to cut costs, but as a means to direct capital to its most productive long-term uses — the very essence of free-market capitalism. So if all we care about is innovation — as opposed to the direct creation of manufacturing jobs in the U.S. — the market is working fine.

Here’s a case in point: In the U.S. semiconductor industry, R&D spending has increased from roughly 8% of sales prior to 1988 to 17% of sales last year, while outsourcing of basic process technology has risen from essentially zero to more than 30% industry-wide. Moreover, R&D spending as a percent of sales among purely fabless semiconductor companies as a group exceeds spending by vertically integrated producers by nearly 5 percentage points.
If companies were outsourcing merely to cut costs, one would expect the fabless group to spend less on future innovations and instead simply pocket the greater short-term profits made possible by riding outside suppliers’ investments in basic processes. Instead, these companies are able to spend the money they otherwise would have had to invest in plants and equipment on more productive long-term uses without sacrificing short-term profit. Their ability to increase market share vs. vertically integrated competitors while also exhibiting greater returns on invested capital is proof that they are able to both innovate and respond to financial-market forces.

Of course, there is a downside to emphasizing long-run returns on invested capital over all else — including the loss of certain jobs in the United States. Employment per inflation-adjusted revenue dollar has fallen by 60% in the U.S. semiconductor industry since the late 1980s.

But in preferring greater long-term returns on capital to other possible objectives and metrics, corporate leaders are responding less to short-term pressure from financial markets than to the inherent purpose of these markets: to allow investors to vie for greatest returns over time.

It is true that corporate profits have become a decreasingly accurate measure of national economic health as the falling costs of automation and transportation have weakened what once was a natural connection between domestic profits and domestic jobs. But if we want corporations to do more than maximize return on invested capital and, say, focus more on creating jobs of a certain type or investing in domestic manufacturing, we need to either change the metrics that govern how financial markets operate or enact tax and other regulations that make corporate profits a function of succeeding at these other goals.

But if we are intent on feeding, not killing, the U.S. innovation machine, we need to be very careful about what other incentives we create.

Like everyone, I worry about the implications of falling median wages in the U.S. as manufacturing jobs flow overseas. But I don’t believe that propping up domestic production in industries where manufacturing doesn’t matter is the answer. Instead of taxing corporate profits — directly or indirectly — to create manufacturing jobs in industries where we have or gain no global competitive advantage by building production capacity around already-maturing processes, we should look to invest our current innovation premium in research, education, and infrastructure to prepare for prosperity in emerging industries. Thus, we should look to policies that would return corporate profits to the U.S. workforce through creation of jobs in areas where there are yet no dominant global industrial commons.

I certainly don’t believe that corporations can or will do this on their own. So some government interference with otherwise free markets is essential. But we should eschew the short-term tactical job creation advocated by some in this debate and instead make the kinds of strategic long-term national investments that have been lacking for at least a generation.

And here is where I do have a beef with Wall Street: While global competition is increasing our need to invest in new industries and technologies, the strategies of financial institutions is to risk increasing amounts of capital on derivative instruments that have no clear industrial benefit or economic value. This is crowding out our collective ability to take risks on enterprises that could have clear impact on our national competitiveness and standard of living in the future.

Source:http://blogs.harvardbusiness.org/hbr/restoring-american-competitiveness/2009/10/the-culprit-is-capitalism-not.html