Imagine you are visiting a futuristic, high-tech manufacturing plant. What country are you in?
Chances are the answer won’t be the United States. As manufacturing soars toward the future with innovations that would have once seemed to be the province of science fiction, America is being left behind.
When high-tech companies making products like LED lights and solar panel cells decide where to place new factories, they are increasingly looking overseas. According to an analysis by BusinessWeek based on Federal Reserve data, America’s manufacturing capacity grew a mere 5% during the boom from 2001 to 2007, when the economy as a whole grew 17%. By way of comparison, when the economy expanded 26% from 1994 to 1999, manufacturing capacity shot up 44%.
In the current economic order, goods are made elsewhere, while the U.S. provides the market for those goods. Around 90 percent of Americans work in government or private-sector service jobs, whose products are much more difficult to export than are manufactured goods. The result is an unsustainably large and chronic trade deficit. We need to find ways to keep high-growth industries on our own soil.
We have a big advantage in that many of those industries start out here. America’s high level of support for research and development means that many of the great ideas that change our world come from this country. Pete Engardio of BusinessWeek noted that “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.”
The companies that commercialize these applications want to build their bases of production in the U.S., close to their chief engineers. It makes sense to put their production facilities close to their largest customers, as well as to the research labs and campuses where future breakthroughs and skilled workers are being produced. These companies also want to protect their trade secrets and other intellectual property, something that is problematic in many foreign locales.
But most of the time, they don’t get to do this. The United States has shown itself to be a hostile climate for manufacturing. We have the highest corporate taxes in the industrialized world. Meanwhile, nations in Europe and Asia offer huge packages of tax breaks and subsidies to manufacturing companies. Many U.S. states try to offer incentives, but, with their limited budgets, they can’t compete with foreign countries. Clyde V. Prestowitz Jr., president of the Economic Strategy Institute, a Washington think tank, summed up the situation: “The states are playing with peanuts, while other countries play with real money.”
Taxes are a crucial element in deciding where to produce goods. By and large, the selling price of the final product (think of an iPod) is the same no matter where it is built. Likewise, the various materials and other inputs, aside from labor, tend to be similarly priced around the world. Labor costs vary, but high-tech manufacturing typically requires little labor input per unit of value it produces. So, while low wages may attract low-tech business like garment manufacturing to developing countries, wages are not the driving force in deciding where to locate a high-tech factory.
Instead, taxes become crucial. If it takes $600 of inputs to produce a $1,000 product, a 40 percent combined federal and state tax rate (typical in this country) is going to reduce the gross margin per unit from $400 to $240. That gross margin has to cover all the non-manufacturing costs of the business, from research to marketing to executive salaries, as well as provide a profit to the owners. If a foreign jurisdiction offers negligible taxes on this manufacturing profit, it has an overwhelming advantage in attracting the factory.
Another reason companies often jump ship when it comes time for production is the burdensome regulatory structure in this country. According to the BusinessWeek feature, it can take two years to obtain all the environmental, health and safety permits necessary to open a modern electronics plant in the States. In the tech world, that’s simply too long. Taiwan, Singapore, Malaysia, and China have all worked to simplify and speed up the process by creating large industrial zones devoted to specific industries with agencies that serve as one-stop shops for all of the necessary permits and regulatory approvals.
Unless we match our dedication to R&D with a dedication to production, “We could just be a big funnel of R&D to Asia,” as Robert Street, a senior research fellow at Palo Alto Research Center (PARC), put it.
While we may be a leader in innovation, when it comes to creating an environment supportive of manufacturing, we need to take a lesson from the rest of the world.