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In Depth September 10, 2009, 5:00PM EST

Can the Future Be Built in America?

The manufacturing exodus from the U.S. is accelerating, but smarter tax policies, low-cost loans, and industrial zones may help keep factories at home

By Pete Engardio

From its headquarters in a modest office park outside Sunnyvale, Calif., Bridgelux is hoping to spark a revolution in light fixtures for homes and offices across the U.S. It's ready to ramp up production of tiny light-emitting chips that blaze as bright as some incandescent bulbs but consume a fraction of the energy. To meet surging orders for its chips, it's prepared to spend $250 million over three years on gleaming cleanrooms. The question is, where should it put its plants?

For a host of strategic reasons, Bridgelux would like to keep manufacturing in the U.S., but financial realities point to Asia. Not only are taxes far lower and government incentives more generous in such nations as Malaysia, China, and Singapore, but it's easier to raise cheap funding offshore than in the U.S., where private investors frown on manufacturing and bank lending is nearly frozen. CEO Mark Swoboda calls the decision "the toughest challenge facing our company."

Not that long ago it didn't seem to matter where such companies made their stuff. After all, America has been inventing industries and losing them to Asia for decades, from color TVs to memory chips, personal computers, and liquid-crystal displays. While the Japanese, Koreans, Taiwanese, and Chinese plowed billions into megaplants to churn out commodity products, America steamed ahead in more lucrative pursuits, such as software, life sciences, and financial services. As for companies such as Dell (DELL) and Apple (AAPL), they could still reap high profits by focusing on marketing and design while letting offshore contractors handle the grunge work.

That situation has changed in dramatic ways. At a time when the U.S. is desperate for new sources of growth, Bridgelux and hundreds of other startups that represent the best hope for a manufacturing renaissance find it almost impossible to achieve scale in the U.S. It's troublesome because these companies are launching a blizzard of innovative products that promise to disrupt entire industries, including tiny diodes that could reshape the $100 billion global lighting business, fuel cells to power electric cars, and thin, flexible TV screens and solar panels. "When large transformations like this occur, everything gets reset with new winners and losers," says CEO Alan E. Salzman of San Bruno (Calif.) venture capital firm VantagePoint Venture Partners, which has stakes in Bridgelux and 21 other clean-energy startups. "If you aren't in the game from the beginning, you don't get a second chance."

The good news is that the U.S. is at or near the cutting edge in most of the emerging product areas. Indeed, the new wave of high-tech devices hitting the market is the payoff from billions of dollars in taxpayer-funded research at federal and university science labs stretching back to the 1960s, when the applications were but glimmers in the eyes of futurists.

Now the bad news: Unless the U.S. can magically resurrect its manufacturing base, the good-paying jobs from these breakthroughs will be offshore. Cheap Asian labor has little to do with it. Unlike other industries that fled to low-cost offshore havens, these emerging tech goods are made on highly automated production lines. The problem is, the U.S. is losing its lead in large-scale high-tech manufacturing.

You can see this in the balance of trade. In 2000 the U.S. exported $29 billion more high-tech products than it imported, notes Harvard Business School professor Willy C. Shih. Owing to a legacy of underinvestment in manufacturing, by 2007 that had turned into a $54 billion trade deficit.

The causes of this manufacturing decline "are numerous, complex, and a long time in the making," says Shih, a 14-year IBM (IBM) veteran and former president of Eastman Kodak's (EK) digital consumer products unit. Two decades of unconstrained outsourcing to Asia have hollowed out much of America's base of suppliers, factory managers, and skilled technicians. U.S. private capital markets, meanwhile, are loath to tie up their billions in factories and machinery. In the boom years from 1994 to 1999, when the economy surged 26%, U.S. manufacturing capacity swelled by 44%, according to a BusinessWeek analysis of Federal Reserve Bank data. From 2002 through 2007, when the U.S. expanded by 17%, capacity rose a paltry 5%. Over that time, Chinese investment exploded.

HIGH CORPORATE TAXES

Much of the blame lies with U.S. government policy. Nations in Asia and Europe aggressively court strategic high-tech industries with generous tax breaks, cash grants, cheap credit, low-cost utilities, and speedy regulatory approval. Governments prize such plants because they serve as broad economic catalysts. Besides skilled jobs, they spur parts suppliers, construction work, services, and the creation of big engineering forces that are the pillars of new industries and companies.

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