As Manufacturing Shifts Abroad, Innovation's Reward Dwindles

Originally published at the Breakthrough Institute

President Obama's recent proposal to increase and make permanent the research and development (R&D) tax credit is unlikely to substantially accelerate economic growth without greater efforts to manufacture and commercialize innovations in the United States.

The President recently unveiled the new $100 billion measure as a way to boost the flagging economy and provide incentives for businesses to invest in new products and technologies.

Yet the decades long trend of U.S. innovations being commercialized abroad threatens to dilute the economic benefits--in terms of new industries, jobs, and revenues--of new technology investment. The United States pioneered advanced technologies like flat-panel televisions, printed circuit boards and semiconductors--ubiquitous technologies for which there are enormous global markets--but the production of these technologies and many others has long since shifted overseas, particularly to Asia.

Take the semiconductor industry. In 2009, the percentage of global semiconductor production capacity in the United States was only 14 percent, down from 25 percent in 2005, according to Manufacturing and Technology News. Nearly 75 percent of manufacturing capacity was in Asia.

Overall, the U.S. trade balance in product fields designated as "technologically advanced" is negative, and has remained so for the last eight years.

The Continuing Importance of Manufacturing

Despite what many economists preach about benefits of unfettered free trade and "comparative advantage," the hollowing out of high-tech manufacturing in the United States has deleterious impacts on both job creation in the U.S. and the capacity for innovation in next-generation technologies.

As Richard McCormack, editor of Manufacturing and Technology News, reminds us, when manufacturing moves abroad, it's not just laid-off workers that suffer:

When a factory closes, it creates a vortex that has far-reaching consequences. The Milken Institute estimates that every computer-manufacturing job in California creates 15 jobs outside the factory. Close a manufacturing plant, and a supply chain of producers disappears with it. Dozens of companies get hurt: those supplying computer-aided design and business software; automation and robotics equipment, packaging, office equipment and supplies; telecommunications services; energy and water utilities; research and development, marketing and sales support; and building and equipment maintenance and janitorial services. The burden spreads to local restaurants, cultural establishments, shopping outlets, and then to the tax base that supports police, firemen, schoolteachers, and libraries.

There are three other reasons why the manufacturing of advanced technologies is critically important for future economic prosperity. First, high tech industries produce higher rates of productivity growth and exhibit higher wages compared with other sectors of the economy, according to a 2004 analysis by the Bureau of Labor Statistics.

Second, a disproportionate share of U.S. exports and research and development (R&D) occur in the manufacturing sector. While manufacturing makes up only 12 percent of U.S. GDP, it represents nearly two-thirds of industry R&D spending and accounts for more than 80 percent of U.S. exports.

Third, and perhaps most important, the manufacturing sector is a key component of the national "innovation ecosystem," and is necessary both to encourage greater research and innovation and make those activities more productive by increasing the commercialization of new technologies.

In a quietly-released and underreported 2004 report, George W. Bush's Council of Advisors on Science and Technology (PCAST) wrote that research and manufacturing do not occur in isolation, but in a cyclical dynamic relationship characterized by multiple feedback-loops:

The research-to-manufacturing process is not sequential in a single direction, but rather results from and R&D-manufacturing "ecosystem"...where design, product development, and process evolution all benefit from proximity to manufacturing, so that new ideas can be tested and discussed with those working on the ground...locations that possess both strong R&D centers and manufacturing capabilities have a competitive edge.

Advanced manufacturing is an anchor of competitive innovation ecosystems, and as manufacturing centers move abroad, the U.S. capacity for innovation is weakened. Leading U.S. companies, including firms like Applied Materials, IBM, and GE, have increasingly moved state-of-the-art research and innovation activities overseas to be near manufacturing capabilities. Should this trend continue, new technology innovations may originate--and be produced--in other countries, to the detriment of U.S. economic growth.

In the words of PCAST:

Over time, should our own ecosystems weaken while foreign ecosystems grow in strength, the maintenance of U.S. technological preeminence is not assured.

We're Competing Against Countries, Too

It's not simply greater labor-cost advantages that are sending high-tech manufacturing, and subsequent research and innovation activities, overseas. Indeed, the high-capital intensity of leading-edge manufacturing plants makes non-labor costs much more important.

Rather, national governments are using generous public policy--like tax breaks, cash grants, free land, and access to cheap credit--to make a deliberate play for innovative new industries to drive their economies, and the United States is not in the game.

As innovation expert Robert Atkinson recently told the LA Times, "Other countries do a much better job. We're pretty much the only country with the illusion that we are not in competition with the rest of the world."

The new realities of global technology-based competition--driven by partnerships between the public and private sectors and facilitated through public policy--have made past notions of "comparative advantage" obsolete. In today's high-tech knowledge economy, competitive advantages are created, not endowed.

The rapidly growing clean energy sector is a case in point. China has emerged as a clean energy powerhouse, leading the world in the production of solar cells and wind turbines after virtually no market presence five years ago. China is set to invest more than $700 billion over the next ten years to secure its first-mover advantages in clean energy.

As with many other sectors of the economy, the United States has seen its clean energy innovations commercialized overseas. Avoiding this fate in the future will require a more integrated approach toward both clean energy R&D and manufacturing as key pillars of a new clean energy economy.

Fortunately, a number of important public officials have publicly endorsed such a "cluster" approach, recognizing the importance of public-private partnerships and a strong role for the public sector in facilitating the co-location and integration of R&D and manufacturing.

In a speech earlier this year, Commerce Secretary Gary Locke noted, "When products are designed and manufactured side by side in America, businesses can discover new efficiencies and develop second-, third- and fourth-generation upgrades that simply would never occur in a cloistered research lab." And Secretary of Energy Chu recently penned a thoughtful article, "Revitalizing American Manufacturing," writing, "We can and must make high quality products in America."

Yet with major clean energy investments set to expire with the U.S. stimulus legislation later this year, it's unclear how today's nascent clean energy progress will be sustained. Without a prolonged commitment to rebuilding America's innovation ecosystems, the future may turn into the past, and American prosperity will suffer.