What the Trump Administration Gets Wrong on Trade

The following essay was written by Jason Dedrick, a professor with Syracuse University’s School of Information Studies, Kenneth L. Kraemer with the University of California, Irvine and Greg Linden with the University of California, Berkeley.

The Trump administration’s tariffs on China have so far targeted mostly industrial goods. But the administration has also threatened a massive expansion of tariffs to $200 billion of other goods if the dispute continues. No list has been released, but these amounts would have to include consumer goods, such as smartphones, which are the largest single category in China’s exports to the U.S.

One well-known product that might be affected is Apple’s iPhone, which is assembled in China.  When an iPhone arrives in the US, it is recorded as an import at its factory cost of about $240 and added to the massive U.S.-China bilateral trade deficit.  iPhone imports look like a big loss to the U.S., at least to the President, who argues that “China has been taking out $500 billion a year out of our country and rebuilding China”. Yet this focus on the headline bilateral trade deficit shows a poor understanding about how trade is really done in the modern global economy.

Let’s examine this iPhone a little more closely and see how much value China is really getting.  Start with the major components that make up an iPhone—the touch screen display, memory chips, microprocessors, and so on.  These components, which carry high profit margins for their manufacturers, come from a mix of U.S., Japanese, Korean and Taiwanese companies, such as Qualcomm, Intel, Sony and Samsung.  None of them are manufactured in China. Apple buys the components, has them shipped to China, then they leave China inside an iPhone.

So what about all of those famous factories in China with millions of workers making iPhones? The companies that own those factories, including Foxconn, are based in Taiwan. Of the $240 factory cost, all that ends up in China is about $8.50, or 3.6% of the total. That includes a battery supplied by a Chinese company and labor used for assembly.    So China gets a lot of (low-paid) jobs, while the profits go elsewhere. This figure shows the share of the factory cost divided by country in an iPhone 7.

A better way of thinking about the U.S.-China trade deficit associated with one iPhone would be to count the value added in China, about $10, rather than $240. Some of the value goes to South Korea, some to Japan, some to Taiwan, and over a quarter comes back to the U.S.  The Chinese share is less than 5% of the total.

This arrangement has been good for the U.S. economy. By taking advantage of a vast, highly-efficient global value chain, Apple can bring new products to market at prices comparable to its competitors, most notably the Korean giant Samsung.  Consumers get the benefits, as do the thousands of companies and individuals creating apps to sell on the App Store.  Apple uses its profits to pay its armies of hardware and software engineers, marketers, executives, lawyers, and Apple Store employees. And most of these jobs are in the U.S.

Make the iPhone more expensive with tariffs and demand will fall. Meanwhile Samsung, which makes most of its phones in Korea and Vietnam, with a lower share of U.S. parts, will not be affected by a tariff on goods from China and will be able to gain market share from Apple, shifting profits and jobs from the U.S. to South Korea.

To put it another way, globalization hurt some Americans while it made life better for many more. Putting globalization in reverse with tariffs will also create a few winners and many losers.

As part of this discussion, people usually ask us “Why not just make iPhones in the U.S.?”  The main problem is that the manufacturing side of the global electronics industry was moved to Asia in the 1980s and 1990s.  Companies like Apple have to deal with this reality.  As the numbers above make clear, there’s not much value to be gained for the U.S. economy or its workers from simply assembling iPhones here from parts made in Asia. Building factories here for the parts manufacturing that now happens in Asia might be possible, but it would take at least a few years, would cost more per unit than production in Asia, and would require a lot of carrots and sticks from policymakers to get the many companies involved to do so, such as the $3 billion in subsidies Wisconsin gave to Foxconn to build an LCD factory there.

To be fair, there is plenty for the U.S. to complain about when it comes to China’s high-tech industry and policies, whether it is the lack of intellectual property protection, or non-tariff barriers that keep major tech companies such as Google and Facebook out of the huge Chinese market.  There is room for much tougher and more sophisticated bargaining to address these issues.

But where trade is concerned, policymakers need a clear understanding of how value created by global production networks is actually distributed among firms and countries. The World Trade Organization has been working on an alternate set of numbers that will be more informative than the current trade data, but it’s not yet in wide use, at least in the administration.

Trump’s trade war is based on a simplistic understanding of the trade balance. Expanding tariffs to more and more goods will weigh on U.S. consumers, workers, and firms. And there’s no guarantee that the final outcome will be good when the dispute ends. This is a war that should never have been started.