The role of i-phone in US-China current account balances

Yuqing Xing and Neal Detert write this paper on the topic. The paper is a fascinating read as it links so many ideas/theories. WSJ also has a write-up on the same

Apple Inc, a US based company sells i-phones all around the world. So one would expect that i-phone should be leading to current account surplus (exports – imports>0). However, the authors show that it actually is worsening the US current account deficit. With China alone i-phone contributes about USD 1.8 bn of current account deficit of US:

In this paper, the authors use the iPhone as a case to show that even high-tech products invented by United States (US) companies will not increase US exports, but on the contrary exacerbate the US trade deficit. The iPhone contributed US$1.8 billion to the US trade deficit with the People’s Republic of China (PRC). Unprecedented globalization, well organized global production networks, repaid development of cross-country production fragmentation, and low transportation costs all contributed to rational firms such as Apple making business decisions that contributed directly to the US trade deficit reduction. Global production networks and highly specialized production processes apparently reverse trade patterns: developing countries such as the PRC export high-tech goods—like the iPhone—while industrialized countries such as the US import the high-tech goods they themselves invented. In addition, conventional trade statistics greatly inflate bilateral trade deficits between a country used as export-platform by multinational firms and its destination countries.

The authors point how i-phone is manufactured around the world:

iPhones are designed and marketed by Apple, one of the most innovative US companies. Apart from its software and product design, the production of iPhones primarily takes place outside the US. Manufacturing iPhones involves nine companies, which are located in the PRC, the Republic of Korea (hereafter Korea), Japan, Taipei,China, Germany, and the US. The major producers and suppliers of iPhone parts and components include Toshiba, Samsung, Infineon, Broadcom, Numunyx, Murata, Dialog Semiconductor, Cirrius Logic, etc. All iPhone components produced by these companies are shipped to Foxconn, a company from Taipei,China located in Shenzhen, PRC, for assembly into final products and then exported to the US and the rest of the world. Table 1 lists major suppliers and costs of iPhone components and parts.

Going by plain theory of comparative advantage, US has comparative advantage in hi-tech items like i-phone. But as Krugman showed in his path breaking work that what also matters is increasing returns in international trade. Hence, if certain countries can take advantage of economies of scale and produce goods cheaper than others, they can export despite not having comparative advantage in the good/service.

China is doing the same in many goods and i-phone is one of them. It assembles the i-phone components in China and exports it back to US. As sales of i-phones in China did not pick up till end-2009, China exported most of the i-phone manufactured in China to US. This results in high current account deficit in US instead. Though, when we look at value added figures it is actually a surplus:

Being solely an iPhone assembly center, the PRC first imports all components and then re-exports them as the final assembled product to the US. The imported components from other countries greatly inflate the export value. If iPhone exports from the PRC to the US were calculated based on the value-added contributed by PRC workers, i.e., the assembling cost, the value of the PRC’s iPhone exports to the US would be much smaller, at only US$73.5 million. Accordingly, the trade deficit associated with iPhone trade would also drop substantially.

As mentioned above, the PRC imported US$121.5 million worth of components from the US companies Broadcom and Numonyx for assembling iPhones. Based on the value added approach, the US would have no deficits but a US$48 million trade surplus with the PRC in iPhones related trade.

The sharp contrast between the two different trade deficit measurements indicates that conventional trade statistics are not consistent with the trade where global production networks and production fragmentations determine cross-country flows of parts, components, and final products. Bilateral trade imbalances between a country used as a final assembler and its destination markets are greatly inflated by trade in intermediate products. These statistics provide a distorted picture about bilateral trade imbalances.

This value added focus has also been suggested by WTO chief Pascal Lamy.

The authors then look at whether renminbi appreciation will help. Not much:

An appreciation of 20% will raise the iPhone assembly cost to US$7.8 per unit, from US$6.5, and add US$1.3 to the total manufacturing costs. This would be equivalent to a 0.73% increase in total manufacturing costs. It is doubtful that Apple will pass this US$1.3 to US consumers as the increase is negligible and Apple would have little to gain by passing a tiny price increase to iPhone users. Even a 50% appreciation of yuan against the dollar would not bring a significant change in total manufacturing costs, as the assembling cost-contribution of PRC workers to a ready to use iPhone is very little—only 3.6%. Therefore, it is unlikely that a yuan appreciation would lower many components of the trade deficit, in this case the portion due to iPhone trade. 

Even a joint appreciation of Asian currencies against USD will not help much as Apple can pass off the rises to consumers or can absorb the costs with a rise in productivity.

The other strategy is Apple assembles all i-phones in US alone. Here, there could be some benefits as it lowers current account deficit and also increases employment situation in US:

An interesting hypothetical scenario is one where Apple had all iPhones assembled in the US. Assuming that the wages of US workers are ten times as high as those of their PRC counterparts and their productivity would be equal in 2009, if iPhones were assembled in the US the total assembly cost would rise to US$68 and total manufacturing cost would be pushed to approximately US$240. Selling iPhones assembled by US workers at US$500 per unit would still leave a 50% profit margin for Apple. As iPhone sales increase globally, that profit margin would also increase. In this hypothetical scenario, iPhones, the high-tech product invented by the US company, would contribute to US exports and the reduction of the US trade deficit, not only with the PRC, but also with the rest of world. More importantly, Apple created jobs for US low skilled workers; those who could not be the software engineers needed by Apple. Giving up a small portion of profits and sharing them with low skilled US workers by Apple would be a more effective way to reduce the US trade deficit and create jobs in the US.

In a market economy, there is nothing wrong with a firm pursuing profit maximization. Governments should not restrict such behavior in any way. However, corporate social responsibility (CSR) has been adopted as a part of corporate values by many multinational companies, including Apple. It may be an effective policy option to practice CSR by creating jobs for low skilled workers, such as using US workers to assemble iPhones.

Hence, a better way to reduce trade deficit with US is not currency appreciation. But if some of the US hi-tech firms opt to base majority of their operations in US, it could lead to more benefits.

One Response to “The role of i-phone in US-China current account balances”

  1. PRABHAT Says:

    NICE ARTICLE..

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