Can the Future Be Built in America?

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 TAXESMuch 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. 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. It's not too late for the U.S. to jump back into the game. Even though global demand for solar systems in homes is slow now, it is expected to triple in four years. Moreover, the technology is shifting to an American bastion of strength: cells made from thin coatings of elements on flexible materials, such as foil and polymers, that are far cheaper and easier to make than silicon wafers. "There is plenty of opportunity for the U.S. to take the lead here," says Michael J. Ahearn, CEO of First Solar (FSLR), in Tempe, Ariz., the world's thin-film leader.

Still, most of the capacity of the U.S.-based companies is offshore. First Solar invested $1 billion to double capacity this year, creating 4,000 jobs, and it aims to open a new plant every three months. But 86% of its output is in Germany and Malaysia, and a major plant is coming in France.

A big reason is that European and Asian nations have done more to stimulate domestic demand with something called feed-in tariffs. These require utilities to buy solar-generated electricity at rates far higher than they pay for power from fossil fuels, thus guaranteeing reliable profits for solar plant developers and operators. Only a few U.S. states require utilities to pay extra for solar power, and the scale of U.S. solar farms is much smaller. "The current demand will not create an industry in the U.S.," says Subhendu Gahu, CEO of United Solar Ovonic, a Rochester Hills (Mich.) manufacturer.

Even if U.S. tax credits greatly boost demand for solar panels, Deutsche Bank (DB) analyst Stephen O'Rourke reckons the U.S. will account for less than 15% of solar cells sold globally by 2011, compared with 60% or more for Asia. Although it varies by company, a plant in Asia can be as much as 30% more profitable to operate over many years, even factoring in shipping costs, than one in the U.S. The main reason: attractive tax structures and subsidies. Absent other incentives, "you would need a negative tax rate" to level the playing field, he says.

These are real considerations for a startup such as MiaSolé. Like many U.S. solar makers, MiaSolé's technology was aided by years of research at the U.S. National Renewable Energy Laboratory in Golden, Colo. In July the company began shipping key solar components from its small Santa Clara headquarters. MiaSolé's advantage, says CEO Laia, is proprietary production processes. Its $190 million prototype plant looks like a jumble of vacuum chambers, pumps, generators, and cooling pipes. But in half an hour, the plant can take 2.5 miles of rolled steel half the thickness of a human hair and apply superthin coatings of copper, indium, gallium, and selenium. Out come cells that, MiaSolé claims, can generate electricity twice as efficiently as other thin-film cells on the market.

It won't be long before Asian rivals appear, so MiaSolé wants to ramp up now. By mid-September it aims to decide where to build a plant for high-volume production. Laia, a scientist at New Mexico's Los Alamos National Laboratory for 11 years who ran two chip equipment makers, prefers the U.S., but "10-year tax holidays in Asia are really hard for a board to get around," he says.

Solid-state lighting also illustrates America's "invented here, industrialized elsewhere" syndrome. U.S. labs have been among the leaders in light-emitting diodes, the superefficient devices on track to replace incandescent and fluorescent bulbs. Bridgelux is among the few U.S. producers of commercial LED units. It makes a chip the size of a dime packed with LEDs yielding bright white light that can be used in homes and offices. Current LED-powered devices are pricey: The equivalent of a 40-watt bulb costs $70 and up. Within two years, Bridgelux thinks it will be able to make the equivalent of a 60-watt bulb now used in most homes for less than $10.

But Bridgelux is up against a big initiative in China. The city of Dalian alone is fostering more than 40 LED companies and is helping ensure a big local market by converting 200,000 street lamps to LED. In the U.S., Bridgelux's sales are on pace to double this year, to $24 million, and the global LED market is expected to reach $12 billion in three years. "The challenge we face now is trying to get a factory in place in time to service this exploding market," says CEO Swoboda. The company wants to start with a small U.S. plant and has been scouring California for old chip facilities it could convert—but the cleanrooms are in such a state of disrepair that even this goal may not be reachable without heavy investment. "We were shocked that we found nothing," Swoboda says. "All of the cleanroom space was torn out and property owners converted these fabs to offices."

The harder task is figuring out where to build the large-scale facilities. To be near Bridgelux's scientists and protect intellectual property, Swoboda wants to stay in the U.S., but investors are balking at the high costs. The company is now applying for an Energy Dept. loan, but it's also getting great offers from Singapore, China, and Malaysia. Examples like this worry Robert Street, a senior research fellow at Palo Alto Research Center (PARC) who specializes in a related field known as flexible electronics. "We could just be a big funnel of R&D to Asia," he says.

One area where the U.S. is backing up R&D with manufacturing aid is rechargeable lithium-ion batteries for cars. With the auto world moving toward electric vehicles, having domestic battery producers is seen as vital to retaining a U.S.-based car industry. In August the Energy Dept. lent $2.4 billion to A123 Systems, EnerDel (HEV), Johnson Controls, and other companies to build factories in the Midwest.

Yet already, General Motors has awarded its contract to supply batteries for the Volt, due on the roads in 2010, to South Korea's LG Chemical, which will assemble battery packs in Detroit from cells made in its home country. U.S. upstarts also will compete with better-funded Asian giants such as Panasonic (PC) and China's BYD Auto, which dominate mass production of lithium-ion batteries for consumer electronics. The biggest markets, moreover, are likely to be in Asia, where carmakers are ahead in developing electric vehicles and governments keep gasoline prices high. "This industry will not be inside the U.S.," predicts VantagePoint's Salzman.

What can Washington do to boost manufacturing competitiveness? It could bridge the disconnect between R&D and commercialization, as it has done in biotech. If the U.S. believes flexible displays, fuel cells, or solid-state lighting warrant billions in R&D, it should follow through with enough aid for product development and manufacturing.

To critics of government intervention, such measures smack of picking winners, but it's not as if that's something new to Washington. Agriculture and oil drilling remain heavily subsidized. The federal government was crucial to launching the aerospace, telecom, and Internet industries. Now it owns General Motors. "We do have an industrial policy," says Craig A. Giffi, vice-chairman of Deloitte Consulting. "What we don't have is a coherent industrial policy. We don't know what industries we want and where we are going."

Even short of an overarching strategy, there is a lot the U.S. can consider. Perhaps it's politically impossible to grant corporations 10-year tax holidays for building a factory, says ITII's Atkinson. But Washington could allow companies investing $100 million, say, in a new high-tech plant to write the entire sum off in the first year, rather than depreciate it over time. To create enough demand for large-scale domestic production of renewable energy equipment, the U.S. could impose European-style feed-in tariffs on all utilities.

And rather than dispense limited funds to a chosen few, Washington could offer low-cost loans for all new U.S. factories that can show they have a market and meet certain criteria. Or it could create an institution similar to the U.S. Export-Import Bank, which lends to companies so they can fill export orders.

The U.S. could even explore strategies used in certain emerging markets. Hau L. Lee, a professor at Stanford Graduate School of Business, thinks America needs large industrial zones devoted to specific industries—similar to zones in Taiwan, Singapore, Malaysia, and much of China. Such areas offer tax breaks, cheap or free land, workforce training, plenty of water and power, and agencies that serve as one-stop shops for all of the necessary permits and regulatory approvals. The idea isn't too far-fetched. The Interior Dept. hopes to set aside thousands of acres of federal land in the West for 13 solar power generation zones, with a special office in Nevada to approve projects quickly. Such zones also could include solar manufacturing plants.

Thinking like a developing nation may be a comedown for the world's greatest economic superpower. But that is the level to which America's manufacturing might has eroded. Unless it changes course, the U.S. not only won't be able to recapture industries it has lost—it may not be able to launch the new industries it invents.

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