But if a country loses production of a given product range, it will quickly lose the knowledge base and the set of skills needed to keep innovating, and, at an even faster rate, it will lose the incentives. Companies that exit production, especially in the low-end, low-margin range, and seek to concentrate on higher margin, high-end products are usually poor bets for long-term success. It is easier for competitors to move up from the low end into the middle and ultimately squeeze out the once high end. Think of the video recorder and the sad fate of Ampex. The company pioneered the product in 1956, only to lose the mass market 25 years later to European and Japanese manufacturers with more technical advances.

Innovation tends to depend on lead users, not just great corporate laboratories.

Now that we increasingly offshore U.S. manufacturing, these offshore production facilities will soon have to respond to the need for innovation. They will also have to act on opportunities to supersede the very American firms that extend supplier contracts to them, thus taking more jobs. They will typically begin by capturing the hard, dirty work, but will build competence determinedly and move up into richer pickings.

Toyota says it builds 1.5 million cars in North America and proudly maintains R&D facilities in California and Michigan, but consider the way the company developed a shining R&D success: the hybrid engine. From the beginning, Toyota invested heavily in it. The company kept the R&D team centralized, within a few miles of its Japan headquarters. The overwhelming reason that Toyota felt the need to keep the R&D near its main plants was that the project called for a wide range of knowledge and experience, available only at the production facilities.

Canon, another Japanese powerhouse, used a similar strategy when it set out to develop its successful ink-jet; it needed knowledge only available in its production plants in Japan. It funded laboratories in the United States and utilized them—to translate the user’s manual into English.

The China Syndrome
Manufacturing accounts for approximately 52 percent of China’s rapidly growing GDP, but China is not adding manufacturing jobs—it’s adding productivity and sophistication, while rapidly moving into higher value-added and high-end manufacturing.

The principal source of new technologies and business practices in China exists in Foreign Invested Enterprises—foreign-owned or joint-venture companies operating in China. These enterprises produce more than half of China’s exports and are responsible for 30 percent of Chinese industrial output. They boast productivity rates about nine times the national average. They start with far better technology and know-how than their Chinese-owned competitors, and they are also the major source of innovation—initially as adaptations for the Chinese market, but increasingly for export markets as well. Their share of Chinese exports will likely decline as Chinese competitors improve, often with some help from the government. Anyone who imagines China as a country not in a good position to start innovating is deeply deluded.

Innovation tends to depend on lead users, not just great corporate laboratories. China is now the world’s largest market for cell phones, and considers itself the lead market for a slew of products. If consumers continue to demand new technology, Chinese manufacturers will continue to innovate. To bolster their odds, the country invests heavily in the creation of engineers and scientists. Along with Singapore and the UK, it also tries to take advantage of the United States’ self-inflicted problems in trying to move ahead in the new, giant health science frontier of stem cells.

For any company, there is just no payoff in attempting to innovate a product or technology that it cannot produce competitively. The payoff curve for innovation has a long tail, which only competitive producers can capture. After a few rounds, the others learn their lesson—especially after the deadly barb at the tip of that tail stings them.

Stephen Cohen is a professor at the University of California, Berkeley, where he directs the Berkeley Roundtable on the International Economy, a source of innovative ideas on international economics and business.