(Business 2.0) – When it comes to U.S. manufacturing, conventional wisdom says the prognosis is bad. Just read the headlines: During the past three years, the nation has lost 2.7 million factory jobs--many of them permanently. Manufacturing now employs just 11 percent of the U.S. workforce, compared with 30 percent in the 1950s.

But LeRoy Nosbaum, chief executive at Itron Corp., a $285 million builder of utility meter readers in Spokane, Wash., sees things differently. "If you can't manufacture in the U.S. efficiently and economically, you don't know how to manufacture," he says. Yes, making stuff in the United States requires merciless, day-by-day cost cutting. But offshore manufacturing carries hidden costs of its own--in particular, the opportunities you forgo by cutting off access to the wellspring of innovation on your factory floor. "Jumping on the low-cost bandwagon is a quick fix," says Bill Hanson, co-director of MIT's Leaders for Manufacturing program. "But it can hurt you in the long run."

Job-loss statistics may overstate the fall in U.S. manufacturing competitiveness. Productivity gains account for a big chunk of the job shrinkage. Sure, there are fewer factory workers, but thanks to increased automation and a shift to higher-value work, the value of U.S. manufactured goods has grown by 50 percent since 1990.

Jim Womack of the Lean Enterprise Institute, a nonprofit training center, adds that cheaper labor doesn't necessarily give offshore manufacturers an insurmountable advantage. They can face additional costs from time-to-market delays, air freight charges, employee travel, and local corruption. Whatever cost advantages do exist can vanish quickly if competitors follow suit and set up shop nearby.

But the most compelling reason to build here isn't easily measured in dollars. Distance severs what Hanson calls the "tight linkages" between engineers and production workers that spur innovation. "The U.S. is good at innovation," he says, "and the only way to become an innovation machine is to closely couple manufacturing with engineering and design."

Nosbaum's Itron is an example: a homegrown success that enjoys a 50 percent market share in the face of stiff import competition. Itron quality and test engineers roam its factory floor in Waseca, Minn., constantly searching for ways to improve product designs and production efficiency. With input from line workers, Itron has cut labor expenses in half since 1999 to just 8 percent of overall product cost--a rate so low that the wage gap with countries like China has become irrelevant.

The Itron case aside, it does make sense for labor-intensive industries like apparel or furniture making to build in low-wage countries. That's not the case in R&D-dependent industries such as biotech, pharmaceuticals, and aerospace, however. In those fields, the potential of factory-level innovation far outweighs the benefits of lower wages. In the end, that's where American workers will find lasting opportunity. --RALPH KING