By Dan Steinbock
In the pre-1914 era and during the protectionist interwar period, global economic integration declined drastically. As major corporations competed largely in home markets, their value activities were mainly domestic. Following World War II, the United States-led Bretton Woods system ensured a greater degree of internationalization – including systemic US trade deficits since 1971, decades before deficits with China.
Thereafter in the 1980s, US multinationals began to cut costs through offshoring as large chunks of productive capacity were transferred to emerging markets, especially in Asia. As a result, the current “eco-systems” of US multinationals are increasingly global.
Hence, President Donald Trump’s dilemma, in a nutshell, can be that while tariffs and tariff wars were typical to the era of domestic competition a century ago, they do not work in a more global era. Even “made in China” products feature diverse value-added inputs by multinational companies producing in, exporting from and selling in China.
Apple prices may increase because of the massive Tariffs we may be imposing on China – but there is an easy solution where there would be ZERO tax, and indeed a tax incentive. Make your products in the United States instead of China. Start building new plants now. Exciting! #MAGA
— Donald J. Trump (@realDonaldTrump) September 8, 2018
In a recent tweet, Trump urged Apple to manufacture in the US, not China. However, this is plain bad advice, as s prices would soar, Apple’s profitability would plunge since it makes 60%-70% of its revenues abroad. If the company would comply, its manufacturing price would soar because of higher labor costs, and loss of advanced manufacturing, logistics and infrastructure in China. The iPhone is not a marginal example as it alone accounts for an estimated $16 billion of the U.S. trade deficit with China.
“Made in China” does not capture value-added
Since the iPhone alone accounts for around $16 billion of the US trade deficit with China, let us use it as an example. According to data, the initial sale price of Apple’s iPhone X (64BG) was $999. The Trump administration’s tariffs are based on the idea that since this smart phone is made in China, all value-added is captured in China and by China and thus it must be penalized by heavy tariffs.
The breakdown of the iPhone X costs comprises both manufacturing costs ($378) and value shared between distributors and Apple ($621), which accounts for almost two-thirds of total costs. Another fourth of the total consists of various components made in South Korea, Japan, the US, UK, Switzerland, and Singapore.
China’s key contribution is in the basic manufacturing costs ($8) plus battery packs ($6), which is less than 4% of the manufacturing cost and 1.4% of the total cost of iPhone X as shown below.
Is the iPhoneX an exception? Certainly not, before the fall of Nokia, Europe captured 51% of the value-added of the Nokia N95 smartphone, even when it was “Made in China,” because the final assembly involved 2% of the overall value-added.
Certainly, the share of Chinese value-added differs by industries and companies, yet it tends to be very low in the case of multinational companies operating in China, particularly in advanced technology. The same goes for such companies operating in India or other emerging markets. “Made in China” value-added does not go to China.
That is precisely why Beijing seeks China’s rapid transition from exports and investment toward innovation and consumption. After all, like Apple and Nokia, Chinese industry giants – from Huawei and Xiaomi to Oppo and Vivo – capture far more of the value-added. As Vice Premier Liu He has urged, China must innovate if it wants to be a world leader in science and technology.
US taxation fails Americans, not China
However, there is one critical difference. Through taxation, Nokia’s success benefited Finnish taxpayers and its European investors. Most EU multinationals are constrained by similar taxation rules. In contrast, Apple’s success does not necessarily accrue to American taxpayers because many US multinationals, unlike their European counterparts rely on creative tax accounting or tax havens.
Theoretically, Apple should be the largest taxpayer in the world and pay $38 billion in taxes brought home from overseas and “create” 20,000 new jobs. However, as reported by Fortune that is all spin and instead, Apple plans to collect a huge windfall from the Republicans’ corporate tax handout. Currently, it holds about $252 billion – more than 90% of its cash – in profits offshore, where it can avoid paying US taxes.
Indeed, before Trump’s tax code overhaul, Apple would have paid $79 billion in taxes if it had brought the money home, but it didn’t. Instead, it let the cash sit offshore for years so that these offshore profits will be taxed at a one-time at a 15.5% repatriation rate. All other corporate profits will be taxed at 21% (down from the pre-Trump rate of 35%).
In the postwar era, the old adage was “What’s good for General Motors is good for America.” What Apple and many other US multinationals are doing today may not be illegal, but it is part of a broader problem associated with America’s decline.
Here’s the bottom line: Chinese share of 2%+ of the value-added pie is not the problem. Trump’s tariffs are a misguided solution to a wrong problem. The real question is why US companies’ lucrative profits yield so few benefits to ordinary Americans but such great benefits to few and wealthy corporate insiders.
Dan Steinbock is the founder of Difference Group and has served as research director of international business at the India, China and America Institute (US) and a visiting fellow at the Shanghai Institute for International Studies (China) and the EU Center (Singapore).
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