This paper empirically shows that innovation in Information Technology (IT) has become increasingly dependent on and intertwined with innovation in software. This change in the nature of IT innovation has had differential effects on the performance of the United States and Japan, two of the largest producers of IT globally. We document this linkage between software’s contribution in IT innovation and the differential innovation performance of US and Japanese electronics, semiconductors, and hardware firms. We collect patent data from USPTO in the period 1980-2002 and use a citation function approach to formally show the trend of increasing software dependence of IT innovation. Then, using a broad unbalanced panel of the largest US and Japanese publicly listed IT firms in the period 1983-1999, we show that (a) Japanese IT innovation relies less on software advances than US IT innovation, (b) the innovation performance of Japanese IT firms is increasingly lagging behind that of their US counterparts,
particularly on IT sectors that are more software intensive, and (c) that US IT firms are increasingly outperforming their Japanese counterparts, particularly in more software intensive sectors. The findings of this paper could provide a fresh explanation for the relative decline of the Japanese IT industry in the 1990s.
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