An interesting report on the nature of the US trade deficit, How iPhone Widens the US Trade Deficits with PRC, was published by Yuquing Xing and Neal Detert. The premise is that even high tech products such as the iPhone cause an increase in the US trade deficit since most of the value is added overseas rather than in the US. However, beyond the main premise of the authors, there is a lot more that can be pulled out of the report. In particular, data in the report backs up a view of the US trade deficit with China that is different from what Americans are accustomed to hearing.
The US assigns the entire $178.96 wholesale cost (iPhone 2010) to China as a trade deficit. However, the value of the work performed by the Chinese assembly workers is more like $6.50. The rest of the value went to countries other than China. While some have pointed out that components attributed to countries other than Chine may themselves have Chinese labor content, the fact remains that China sees only a small part of the iPhone wholesale cost. Some of the issues with the paper are pointed out in a Wall Street Journal article Not Really ‘Made in China’, 15 December 2010. However, the main point of the paper is that even high tech US goods result in a trade deficit and that premise remains intact even taking the criticism into account. In the book China Airborne by James Fallows, the author takes a different look at the same data. Fallows points out that the Chinese are acutely aware that they actually see only a small part of the iPhone money. While China’s leadership would agree that there is a trade deficit with the US, they would view it as much smaller than the US numbers so widely published. Fallows shows how this is a driving factor behind China’s new five year plan.
China today is still mostly low margin, low skill assembly labor. This compares to India which has built its success on a well educated work force and has attracted a lot of higher level engineering work. Despite the success of some engineering companies, China remains heavily skewed to blue collar assembly operations. For those of us in high tech who see companies such as Huawei, it can be difficult to accept this fact. There is certainly a lot of high tech in China and it isn’t just low level assembly. The difference, however, is one of scope and percentage.
The Chinese are well aware of the disparity between low level assembly and high value added work. They view this as a problem and are pushing to move up the food chain. There is a big effort underway to strengthen the university system and in the long run build a much stronger industrial base. China wants more of that $178.96 iPhone value to remain in China. To get there they are acutely aware of the smiling curve as proposed by Stan Chin, the founder of Acer. Just as Chin has been moving Acer to more profitable areas of the curve so the leadership of China wish to move their country.
How does this relate to working with the Chinese? It means the US can’t treat the trade deficit as a simple problem. If we throw big numbers at the Chinese they will discount them. They know that little of the cost of an iPhone stays in China and will discount what we say if we don’t make it clear that we too understand where the money goes. There is still a huge trade deficit with China but we must understand their view or we risk being unable to get them to see ours. It will also help us understand the reasoning behind the 12th Five Year Plan’s focus on biotechnology, new energy, high-end equipment manufacturing, energy conservation and environmental protection, clean-energy vehicles, new materials, and next-generation IT. The generic term “high-end equipment manufacturing” covers for their big push in aviation. More on that can he found here. China is serious about changing the nature of their industry and companies who might be in their path to success need to be watchful. If you want to do more reading on the impacts of China’s current five year plane you might start here. Warning: Free registration is required.