I have two interesting stories on Apple and the iPad to reflect on today.
First, ABC’s Nightline recently became the first Western journalists actually welcomed into an Apple assembly plant in China. The show recently aired a 15 minute feature on working conditions inside Apple’s Foxconn factory in Shenzhen, China last week. Watch the video and then scroll down for what may be some additional surprising news about Apple’s operations in China.
Next, the story that has gone unreported lately is a University of California study titled “Capturing Value in Global Networks: Apple’s iPad and iPhone”. The study’s most interesting finding, in my opinion, is the tiny percentage of the total value of Apple’s iPhone and iPad that actually goes to the Chinese manufacturers of the products. The charts below, from the study, show how the value is divided among the various groups involved it their production and sales:
The chart shows a geographical breakdown of the retail price of an iPad. The main rewards go to American shareholders and workers. Apple’s profit amounts to about 30% of the sales price. Product design, software development and marketing are based in America. Add in the profits and wages of American suppliers, and distribution and retail costs, and America retains about half the total value of an iPad sold there. The next biggest gainers are South Korean firms like Samsung and LG, which provide the display and memory chips, whose profits account for 7% of an iPad’s value. The main financial benefit to China is wages paid to workers for assembling the product and for manufacturing some inputs—equivalent to only 2% of the retail price.
A student today asked why Apple doesn’t produce its products in the United States, where an economic downturn has left 14 million American out of work for the last three or four years. If iPads and iPhones were just made in America, jobs could be created, households would have more income to spend on Apples products, and both the country and the economy would benefit.
The data in the UC study indicates that in fact, more than half the value of an iPad or iPhone does end up in the hands of Americans. But Apple could never achieve the low costs and high profits that it does by assembling its products in the US. After watching the Nightline video above, it should be clear that the type of production involved in Apple factories’ is very low-skilled and labor-intensive. Using American labor, with its unions, minimum wages and 40 hour work weeks, would require Apple to employ such large numbers of workers and raise the company’s variable cost to such a level that the firm’s profits would be reduced significantly and its sales would fall dramatically. Apple would lose out to foreign producers of smart phones and tablet computers, such as LG, Samsung, Sony and others, which would continue assembling their goods with Chinese labor.
Ultimately, any gain to the low-skilled American workers (presuming Apple could even find enough to do the work of the 400,000 Chinese employed in the production of Apple products in China), would be offset by a loss of profits enjoyed by the millions of Americans who hold shares in Apple Computer and the thousands of American who are employed engineering and designing its products, as the firm’s sales would slip in the face of lower-cost competitors.
So this student’s question identifies an interesting paradox: America, with its large pool of unemployed workers, will never be attractive as a place to produce labor-intensive products such as phones and tablet computers, due to the vast wage differential between the US and China. And even if one firm did decide to produce its products in America, the gains to low-skilled workers who may find minimum wage work in the new assembly plants would be off-set by losses to the firms’ shareholders and the high-skilled workers whose jobs would be lost as sales decline due to the lower prices offered by lower-cost competitors.
The lesson here is two-fold: First, Apple and other American technology companies should continue using Chinese labor to assemble their products, and second, America is better off for it: lower costs mean cheaper products and higher sales, thus greater employment in the high-skilled sectors of the US economy, and more profits and returns on the investments of shareholders in American corporations. Americans are richer and enjoy a higher standard of living thanks to the millions of Chinese working in factories assembling the goods we consume.
Keep in mind, this analysis did not even consider the effect on the Chinese economy and the millions of Chinese workers (whose lives are much harder than the typical American) should companies like Apple shut down their Chinese manufacturing plants. That’s a whole other blog post!
American consumers are a curious bunch. Up until 2007, the average savings rate in the United States fell as low as 1%, and during brief period was actually negative. What does negative savings actually mean? It means that Americans consume more than they actually produce.On the micro level, the only way to consume beyond ones income is to borrow from someone else to pay for the additional consumption. In other words, savings must be negative for one to consume beyond his or her income. The US is a nation of borrowers, but from whom do we borrow? China, for one…
China is a nation of “savers”, where national savings averages 50% of income. What exactly does this mean? Well, just the opposite what negative savings means; rather than consuming more than it produces, the Chinese consume only about half of what it produces. Here’s how James Fallows, a Shanghai-based journalist, explains the China/US dilemma:
Any economist will say that Americans have been living better than they should—which is by definition the case when a nation’s total consumption is greater than its total production, as America’s now is. Economists will also point out that, despite the glitter of China’s big cities and the rise of its billionaire class, China’s people have been living far worse than they could. That’s what it means when a nation consumes only half of what it produces, as China does.
What happens to the rest of China’s output? Naturally, it’s shipped overseas for Americans and others in the West to consume. The irony is that the consumption of China’s products has been kept affordable and cheap thanks to the actions the Chinese government has taken to suppress the value of the RMB, thus keeping its products cheap and attractive to American consumers.
When the dollar is strong, the following (good) things happen: the price of food, fuel, imports, manufactured goods, and just about everything else (vacations in Europe!) goes down. The value of the stock market, real estate, and just about all other American assets goes up. Interest rates go down—for mortgage loans, credit-card debt, and commercial borrowing. Tax rates can be lower, since foreign lenders hold down the cost of financing the national debt. The only problem is that American-made goods become more expensive for foreigners, so the country’s exports are hurt.
When the dollar is weak, the following (bad) things happen: the price of food, fuel, imports, and so on (no more vacations in Europe) goes up. The value of the stock market, real estate, and just about all other American assets goes down. Interest rates are higher. Tax rates can be higher, to cover the increased cost of financing the national debt. The only benefit is that American-made goods become cheaper for foreigners, which helps create new jobs and can raise the value of export-oriented American firms (winemakers in California, producers of medical devices in New England).
Clearly, a strong dollar is good for America in many ways. The dollar’s strength in the last decade can be credited partially to the Chinese, who have been buying dollar denominated assets in record numbers over the last seven years.
By 1996, China amassed its first $100 billion in foreign assets, mainly held in U.S. dollars. (China considers these holdings a state secret, so all numbers come from analyses by outside experts.) By 2001, that sum doubled to about $200 billion… Since then, it has increased more than sixfold, by well over a trillion dollars, and China’s foreign reserves are now the largest in the world.
China’s purchase of American assets keeps demand for dollars on foreign exchange markets strong, thus the value of the dollar high relative to other currencies, allowing American firms and consumers the benefits of a strong dollars described above.
A nation’s balance of payments consists of the current account, which measures the difference between a country’s expenditures on imports and its income from exports (In 2008 China had a $232 billion current account surplus with the US, meaning the US bought more Chinese goods than China bought of American goods), and the capital account, which measures the difference between the inflows of foreign money for the purchase of real and financial assets at home and the outflows of currency for the purchase of foreign assets abroad. In the financial account, China maintains a deficit (meaning China holds more American financial and real assets than America does of China’s), to off-set its current account surplus.The two accounts together, by definition, balance out… usually. Any deficit in the China’s capital account that does not cover the surplus in its current account can be held as foreign exchange reserves by the People’s Bank of China. The PBOC, however, prefers not to hold excess dollars in reserve, as the dollar’s value is continually eroded by inflation and depreciation; therefore it invests the hundreds of billions of excess dollars it receives from Americans’ purchase of Chinese goods back into the American economy, buying up American assets, with the aim of earning interest on these assets that exceed the inflation rates.
The “assets” the Chinese are using their large influx of dollars to buy are primarily US government bonds. The government issues these bonds to finance its budget deficits, and the Chinese are happy to buy these bonds for a couple of reasons: They are secure investments, meaning that unless the US government collapses, the interest on US bonds is guaranteed income for China. That’s one reason; but the primary reason is that the purchase of these bonds puts US dollars that were originally spent by American consumers on Chinese imports right back into the hands of American consumers (via government spending or tax rebates), so they can continue buying more Chinese imports.
The Chinese demand for dollar denominated financial assets, including government bonds, corporate stocks and bonds, and real assets like real estate, factories, buildings and so on, has resulted in a long period of a strong dollar. If the Chinese ever decided to stem the flow of dollars into American assets, the dollar’s value would plummet to record lows, leading to high inflation and eventually a balancing of America’s enormous current account deficit with China and the rest of the world.
However, a falling dollar is the last thing China wants to see happen, for two reasons: One, it would make Chinese imports more expensive thus less attractive to American households, thus harming Chinese manufacturers and slowing growth in China. Two, US dollars are an asset to China. Its $1.4 billion of US debt would evaporate if the dollar took a major plunge. To China, this would represent a loss of national wealth; in effect all that “savings” that makes China so unique would disappear as the dollar dived relative to the RMB. For these reasons, it seems likely that China will continue to be a willing buyer of America’s debt, thus the financier of Americans’ insanely high consumptive lifestyle.
Many people in America are terrified that the Chinese might dump their dollar holdings. What would happen to the value of the US dollar if China decided to change its foreign reserves to another currency?
Why is it very unlikely that China will do this? In other words, how does the status quo benefit China as well as the US?
How do American households benefit from China’s financing of the government’s budget deficits? In what way to they suffer from this arrangement?
Do you think America can continue to finance its budget deficits through the continued sale of debt to foreigners forever? Why or why not?
Sometimes when I read the news, I wonder what it would be like to NOT understand basic economics, and then I realize how much of what goes on around us can be explained by two simple concepts: demand and supply. The NPR story below talks about how the construction of two proposed coal exporting facilities on America’s west coast could, indirectly, lead to a greener future for America. Listen to the story then read on for more analysis:
China, already the world’s largest coal consumer, continues to build new coal burning electricity plants at an alarming rate. Its appetite for the “black gold” has driven the world price up to $100 per ton, as it has demanded increasing quantities from its own coal producers, but also those in other coal rich areas like Australia and the United States.
However, because of America’s lack of coal transporting and shipping infrastructure, US coal producers have been unable to sell their abundant coal to the Chinese, who are willing to pay 500% the equilibrium price in the US. The US market has remained isolated from the world market, not due to any explicit, government-imposed barriers to trade, rather due to fact that they simply can’t get their coal to the Chinese energy producers who demand it most.
Graphically, this situation can be illustrated as follows:
If the export facilities on the West coast of the US are not constructed, it will remain difficult for US coal producers to sell their output to China at the high price of $100, and the domestic quantity (Q2) will continue to be produced and sold for $20 per ton. But with the new port facilities, US energy producers will now have to compete with Chinese energy producers for American coal, and the US price will be driven up to the world price, since demand now includes thousands of Chinese coal-fired power plants. As the price rises from $20 to $100, the domestic quantity demanded in the US will fall to Q1, as domestic energy producers seek alternative sources of energy, switching instead gas, solar, or wind power.
The irony is that through increasing the ease with which American coal producers can sell their product to China, the US may reduce its own consumption of coal and its emissions of greenhouse gasses. Overall coal production in the US will rise with increased trade, but overall consumption within the US will fall.
Now, this may sound great if you’re the kind of person who thinks only locally. Air pollution will be reduced in the US, health will be improved, our electricity production will be greener and more sustainable. But globally, by making its coal available to China, the US market will contribute to the continued dependence on carbon-intensive energy production, and delay any progress among Chinese energy producers towards a transisttion to greener fuel sources.
The podcast also points out the fact that if the US did undertake the construction of the new coal-exporting facilities, it could be that the current high price of coal will have led to the entrence of several other large coal prodcuing countries into the world market, reducing China’s demand for US coal, reducing the price at which American producers can sell to China and thereby off-setting any domestic environmental benefit that may have resulted from the large decrease in quantity demanded among US producers at the current price of $100 per ton.
The whole conversation about the coal industry is somewhat depressing when the environmental costs of the industry are considered. Another NPR show, Planet Money, ran a story this week about the “gross external damages” caused by the production of coal-powered electricity.
They cited a study which found that the damages caused by coal to human health and the environment outweight the benefits enjoyed by society from the generation of cheap electricity by around $10 billion in the United States alone. This means that if the US shut down every coal-powered energy plant in the country immediately, total welfare in the US would increase by $10 billion. There’s no doubt that energy prices would rise, but the gains in human and environmental health would outweight the added costs of electricity generation by $10 billion. If a similar analysis were undertakein in China, I would guess the potential welfare gain of transitioning to alternative energies would be far greater for the Chinese people.
Here’s the chart from Planet Money’s blog showing the net welfare loss of coal-generated electricity and other economic activities in the United States.
*GED = Gross external damages from pollution
Notice that although generating electricity by burning coal adds nearly $25 billion of value to America’s economy, its negative environmental externalities create nearly $35 billion in damage to the US economy. The net effect of using coal to make electricity, therefore, is around -$10 billion. America would be better off without coal-generated electricity, if we include environmental and health factors in our measure of well-being. Unfortunately, the negative environmental and health costs of coal-electricity generation are currently externalized by the industry, indicating that this industry may be experiencing a market failure.
How would the construction of two coal-exporting facilities on America’s West coast ultimately lead to a cleaner environment in the United States? Do you think this prediction is realistic?
Who stands to gain the most if the coal-exporting facilities are constructed? Who would suffer? In your opinion, should the facilities be constructed? Why or why not?
Interpret the colorful diagram above. What do the green bars represent? What do the yellow and red bars represent? According to the graphic, which type of activity is most harmful to American society? How do you know?
True, false, or uncertain. Explain your reasoning. “The burning of coal to make electricity should be completely banned in China, since China is the world’s largest greenhouse gas emitter.”