How the iPhone widens the US trade deficit with China

Yuqing Xing, 10 April 2011

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At the centre of global imbalances is the bilateral trade imbalance between China and the US. Most attention to date has been focused on macro factors and China’s exchange-rate regime. Little attention, however, has been paid to the structural factors of economies and global production networks that have reversed conventional trade patterns, transformed the implications of trade statistics and weakened the effectiveness of exchange rates on trade balances.

Today’s trade is not that experienced by the British economist David Ricardo two hundred years ago (Grossman and Rossi-Hansberg 2008). It is almost impossible to define clearly where a manufactured product is made in the global market. This is why on the back of an iPhone one can read “Designed by Apple in California, Assembled in China”. In this column, I use the smartphone in your pocket to argue that current trade statistics have distorted the reality of the Sino-US trade imbalance and the appreciation of the renminbi would have little impact on the imbalance.

How iPhones are produced

The iPhone is designed and marketed by Apple. Apart from its software and product design, the production of iPhones primarily takes place outside of the US. Manufacturing iPhones involves nine companies, which are located in China, South Korea, Japan, Germany and the US (Table 1). All iPhone components produced by these companies are shipped to Foxconn, a Taiwanese company located in China, for assembly into final products and then exported to the US and the rest of the world.

By any definition, the iPhone belongs to high-tech products, where the US has an indisputable comparative advantage and China does not domestically produce any products that could compete with it. However, the iPhone trade pattern is not what is predicted by either the Ricardian comparative advantage theory or the Heckscher-Ohlin theory. The manufacturing process of the iPhone illustrates how the global production network functions, why a developing country such as China can export high-tech goods, and why the US, the country that invented the iPhone, becomes an importer.

Table 1. Apple iPhone 3G’s major components and cost drivers

Manufacturer
Component
Cost
Toshiba (Japan)
Flash Memory
$24
Display Module
$19.25
Touch Screen
$16.00
Samsung (Korea)
Application Processor
$14.46
SDRAM-Mobile DDR
$8.50
Infineon (Germany)
Baseband
$13.00
Camera Module
$9.55
RF Transceiver
$2.80
GPS Receiver
$2.25
Power IC RF Function
$1.25
Broadcom (USA)
Bluetooth/FM/WLAN
$5.95
Numonyx (USA)
Memory MCP
$3.65
Murata (Japan)
FEM
$1.35
Dialog Semiconductor (Germany)
Power IC Application Processor Function
$1.30
Cirrus Logic (USA)
Audio Codec
$1.15
Rest of Bill of Materials
$48.00
Total Bill of Materials
$172.46
Manufacturing costs
$6.50
Grand Total
$178.96

Source: Rassweiler (2009)

iPhones and the Sino-US trade imbalance

The shipment of the ready-to-use iPhones from China to the US is recorded as China’s exports to the US. Using the total manufacturing cost $178.96 as the price of the iPhone, China’s iPhone exports to the US amounted $2.0 billion in 2009. Assuming that the parts supplied by Broadcom, Numonyx and Cirrus Logic, valued at $121.5 million, were imported from the US the iPhone alone contributed $1.9 billion trade deficit to the US, about 0.8% of the US trade deficit with China (Table 2).

On the other hand, most of the export value and the deficit due to the iPhone are attributed to imported parts and components from the third countries and have nothing to do with China. Chinese workers simply put all these parts and components together and contributed only $6.50 to each iPhone, about 3.6% of the total manufacturing cost (e.g. the shipping price). The traditional way of measuring trade credits all $178.98 to China when an iPhone is shipped to the US, thus exaggerating the export volume as well as the imbalance. Decomposing the value added along the value chain of the iPhone manufacturing suggest that, of the $2.0 billion iPhone export from China, 96.4% is actually the transfer from Germany ($326 million), Japan ($670 million), Korea($259 million), the US ($108 million) and others ($ 542 million). All of these countries are involved in the iPhone production chain.

If China’s iPhone exports were calculated based on the value added, i.e., the assembling cost, the export value as well as the trade deficit in the iPhone would be much smaller, at only $73 million, just 3.6% of the $2.0 billion calculated with the prevailing method (Table 2). The sharp contrast of the two different measurements indicates that conventional trade statistics are inconsistent with trade where global production networks and production fragmentation determine cross-country flows of parts, components, and final products. The traditional method of recording trade has failed to reflect the actual value chain distribution and painted a distorted picture about the bilateral trade relations. The Sino-US bilateral trade imbalance has been greatly inflated.

Table 2. iPhone trade and the US trade deficit with China

Year
2007
2008
2009
iPhone Sales in the US* (million Units)
3.0
5.3
11.3
Shipping Price/unit**
(the US dollar)
229
174
179
China’s Export to the US in iPhone (million US dollar)
687
922.2
2,022.7
China’s Trade Surplus with the US in iPhones
N/A
N/A
1,901.2[1]
China’s iPhone exports to the US based on value added ( million US dollar)
19.5
34.35
73.45
Value added / total exports
2.8%
3.7%
3.6%
China’s trade surplus with the US in iPhones based on value added
N/A
N/A
73.45[2]

Sources: * Hughes (2010); ** Rassweiler (2009)
[1] When calculating trade deficits between PRC and the US in iPhones, we assume that all parts supplied by Broadcom and Numunyx were imported from the US.
[2] The parts provided by Broadcom and Numunyx are shipped back to the US within the ready-to-use iPhones. They are “round tripping” exports, which should not be considered as actual exports in the value-added approach.

iPhone trade and the appreciation of the renminbi

Many believe that appreciation of the renminbi would be an effective means to solve the Sino-US trade imbalance. Appreciation proponents ignore the fact that the appreciation can only affect a small portion of the cost of made/assembled-in-China products. If the renminbi appreciated against the US dollar  by 20%, the iPhone's assembly cost would rise to $7.80 per unit, from $6.50, and add merely $1.30 to the total manufacturing costs. This would be equivalent to a 0.73% increase in total manufacturing costs. It is doubtful that Apple would pass this $1.30 to American consumers. Even a 50% appreciation would not bring a significant change in the total manufacturing cost, as the appreciation would only affect the assembling cost. Therefore, the expected pass-though effect of the renminbi’s appreciation on the price of the iPhone would be zero and the American consumers’ demand on the iPhone would not be affected. The appreciation of the renminbi would have little impact on the Sino-US trade imbalance.

Could the iPhone be assembled in the US?

There is no doubt that US workers and firms are capable of assembling iPhones. If all iPhones were assembled in the US, the $1.9 billion trade deficit would not exist. There are two possible reasons for Apple to use China as an exclusive assembly centre for iPhones. One is competition, the other is profit maximisation.

The gross profit margin of the iPhone was 62% when the phone was launched in 2007, then rose to 64% in 2009 due to reductions in manufacturing costs (table 3). If the market were perfectly competitive, the expected profit margin would be much lower and close to its marginal cost. The surging sales and high profit margin suggest that the intensity of competition is fairly low and Apple maintains a relative monopoly position. Therefore, it is not the competition but profit maximisation that drives the iPhone’ s assembly to China.

Table 3. Profit margin of the iPhone

 
2007
2008
2009
Unit Price to carriers
$600
$500
$500
Unit manufacturing costs*
$229
$174.33
$178.96
Profit margin
$371
$325.67
$321.4
Profit Margin (%)
62
65
64

Sources: iSupply, and the authors’ calculations.

An interesting hypothetical scenario is one where Apple had all iPhones assembled in the US. Assuming that the wage of American workers is ten times as high as those of their Chinese counterparts, the total assembly cost would rise to $68 and total manufacturing cost would be pushed to approximately $240. Selling iPhones assembled by American workers at $500 per unit would still leave a 50% profit margin for Apple. In this hypothetical scenario, the iPhone could contribute to US exports and reduce the US trade deficit, not only with China, but also with the rest of world. More importantly, Apple would create jobs for US low-skilled workers.

In a market economy, there is nothing wrong with a firm pursuing profit maximisation. Governments should not restrict such behaviour in any way. However, corporate social responsibility has been adopted as a part of corporate values by many multinational companies, including Apple. Employing American workers to assemble iPhones may be an effective way to practice corporate social responsibility.

Concluding remarks

Due to the limitations of the data, it is not possible to outline a more detailed distribution of the iPhone’s manufacturing value chain across all countries involved. However, adding additional countries and parts into the analysis would not change the bottom line – the value added created by Chinese workers accounts for only a small portion of a ready-to-use iPhone, so current trade statistics greatly inflate the value of China’s iPhone export to the US as well as the corresponding trade imbalance. Given this, the renminbi’s appreciation would have little impact on the global demand of the products simply assembled in China.

References

Grossman, Gene M and Esteban Rossi-Hansberg (2008), “Trading Tasks: A Simple Theory of Offshoring”, American Economic Review, 98(5):1978-1997.
Hughes, N (2010), “Piper: 15.8M US iPhone sales in 2010, even without Verizon”, Apple Insider, 6 January.
Rassweiler, A (2009), “iPhone 3G S Carries $178.96 BOM and Manufacturing Cost, iSuppli Teardown Reveals”. iSuppli, 24 June.

Topics: Exchange rates, International trade
Tags: China, exchange-rate policy, global imbalances, iPhone, US

Comments

conclusion about effect of RMB appreciation not warranted

Xing's is quite right than in a highly interconnected international economy the raw bilateral trade relationship may not capture the actual net trade flow between two countries, and that the domestic value added of the exported good is a better proxy. However, the conclusion that an appreciation of the RMB would not have much of an effect on the bilateral trade deficit between China and the USA because the Chinese component of the final cost of the iPhone is only 3.7%, is still not entirely warranted for the following reason.
 
Companies like Apple outsource labor-intensive assembly to low-wage countries like China because this increases their profit margin, even if by only a small increment. Thus Apple is very sensitive in this outsourcing decision to small cost differentials. If the RMB appreciates, Apple might decide to relocate assembly to now even lower cost countries like Vietnam or Indonesia, thus transferring the entire bilateral effect from China to that venue. This would not change the US's balance of trade with the world (and not impact all that much on China's either), but would make an enormous difference to their bilateral account. Xing's assumption that the effect of RMB appreciation must be examined holding the assembly location constant, or only considering repatriation to the US, is too restrictive.
 
And even repatriation of assembly to the US is not as unlikely as the raw wage disparity makes it seem, and in fact may even be happening, if manufacturing is more automated in the US than in China and transport costs both to consumers and from supplies are lower. Thus a recent New York Times article reports that GE is repatriating assembly of its water heaters from China to a plant in the US because, as a result of the economic crisis, it can now hire US workers for considerably lower wages than previously (if I remember correctly, $16/hour instead of $24). This would imply that an appreciation of the RMB by 33% would be sufficient to trigger repatriation of much manufacturing back to the US, even though the wage gap is much larger. And while the value-added and employment effects might not be too great, the direct effect on the bilateral trade balance would be greatly magnified for exactly the reasons Xing provides.

iPhone Economics

 This is really a fascinating paper which is politically important and  deserves much more publicity. I've featured  on my English blog "Economics Intelligence" and in Handelsblatt (German)   in February.

Apple and IPhone

I fail to understand how will Apple as a "multinational company" do better on its practice of corporate social responsibility by relocating assembly process from China to USA? Globally, we will still have the same amount of employed, only now we will increase poverty in China. CSR?

Professor of economics and the Director of Asian Economic Program at the National Graduate Institute for Policy Studies, Tokyo