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

Can the Future Be Built in America?

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By comparison, the U.S. has been indifferent to manufacturing. Even when tax breaks are factored in, American corporate taxes are among the highest in the industrialized world, according to a World Bank study. Nor does the U.S. simply exempt certain industrial investments from taxes, as does much of Asia. Most U.S. states do offer tax breaks and financial aid to lure big plants, hoping to recoup the cost with income taxes generated by new jobs. But state taxes pale beside federal levies, and state budgets for subsidies are limited. "The states are playing with peanuts, while other countries play with real money," says Clyde V. Prestowitz Jr., president of the Economic Strategy Institute, a Washington think tank. Also, it can take two years to obtain all the environmental, health, and safety permits for a modern electronics plant—a lifetime in the tech world. "The political guys in Washington don't have their minds around the fact that the climate for manufacturing here is really hostile," says Joseph R. Laia Jr., CEO of Santa Clara (Calif.) solar cell startup MiaSolé, which is trying to decide whether to build its first major plant in the U.S., Europe, or Asia.

Bill Watkins, former CEO of disk-drive maker Seagate Technology (STX), compares America's predicament with an old corporation that can't adjust to a new business model. In his years at Conner Peripherals and then Seagate, Watkins set up plants in such countries as Ireland, Malaysia, and China. Last year he moved Seagate's 1,500-worker plant in Milpitas, Calif., which made various storage devices for video and photos, to Singapore. "Other countries actually pay you to create jobs," says Watkins. "The rest of the world is chewing us up alive."

The U.S. can still stem this decline with smart and bold policies. Washington has launched a number of industrial initiatives. The U.S. gives homeowners tax credits to cover 30% of the cost of installing solar panels, for example, and has set aside $25 billion in loan guarantees to help automakers build fuel-efficient vehicles. Obama's team is doling out billions in tax credits and loans to help companies build factories to make solar cells and lithium-ion car batteries. Washington is boosting spending on research and development centers for advanced manufacturing technologies, incubators for small businesses, and workforce training. And Obama has appointed Ron Bloom, head of the government's auto task force, to the new post of manufacturing policy czar. "We recognize manufacturing is and will be a critical part of the national economy and have a very robust approach to supporting it," says National Economic Council Deputy Director Diana Farrell.

But policies unveiled so far are stopgap measures justified by the financial crisis. And handing out aid on a case-by-case basis raises suspicions of political favoritism and puts public servants in the risky role of picking winners. Federal investment tax credits, meanwhile, aren't enough to offset the financial incentives offered by Asia and Europe. "They are a helpful step, but what's really needed is a systemic overhaul of the corporate tax code to spur capital investment," says Robert D. Atkinson, president of Information Technology & Innovation Foundation (ITIF), a Washington think tank.

Now many U.S. executives are calling for the kind of comprehensive game plans for nurturing industries found in Europe and Asia. Some 60% of North American manufacturing execs surveyed by Deloitte Research and the Manufacturing Institute said they believe U.S. competitiveness will decline further by 2012, and 77% said the U.S. needs a strategic approach to developing a manufacturing base.

At a National Business Summit panel in Detroit in mid-June, Dow Chemical (DOW) CEO Andrew N. Liveris and Ford Motor (F) Executive Chairman William Clay Ford Jr. both openly called for "industrial policy," a term not heard much since the U.S. was under siege from Japanese cars, chips, and steel in the early 1980s. General Electric (GE) CEO Jeffrey R. Immelt declared that GE had probably gone too far in outsourcing manufacturing, engineering, and back-office service work and lambasted as "flat wrong" the notion that the U.S. could remain an economic superpower by relying on services and consumer buying.

The Obama Administration is certainly wading into industrial policy with its bailout of Detroit and aid for green-tech factories. Still, there is little talk about Washington mapping long-term strategies for industries. To do so would go against the philosophy that has guided U.S. policymakers for much of the postwar era, which is to focus federal spending on R&D while letting the market figure out how to commercialize technology. Rewriting corporate tax codes to favor manufacturing, meanwhile, would run into big political obstacles. Liberals tend to view tax cuts as corporate welfare, while many conservatives argue tax cuts should apply to all corporations and not favor specific sectors. Either way, says Deborah L. Wince-Smith, president of Washington's Council on Competitiveness, the U.S. suffers from "a total divorce between our tremendous investments in R&D and manufacturing."

Few industries better illustrate the disconnect than solar cells. Since the 1970s federally funded labs have produced many of the breakthroughs in cells that turn the sun's rays into electricity. Yet Japan commercialized panels for homes and businesses. Now China dominates the $30 billion global solar industry, making 35% of the world's cells and 49% of its polysilicon wafers, the main material used for solar cells. The U.S. makes just 5% of cells. A growing portion of solar equipment bought with U.S. tax credits is imported from China, where a capacity glut has sent prices crashing.