iFlating the U.S. Trade Deficit with China

While designed and marketed in Cupertino, California, the iPhone is estimated to have contributed $1.9 billion to the U.S. trade deficit with China in 2009. This is the finding of Yuqing Xing and Neal Detert, two economists with the Asian Development Bank Institute.

“Apart from software and product design, the production of iPhones primarily takes place outside of the US,” the authors report.

Component parts come from eight different companies scattered across four countries: South Korea, Japan, Germany, and the U.S. Final assembly, however – which accounts for a mere $6.50 of the $178.96 total cost of manufacturing each iPhone – takes place in Taipai, China. By the standard methodology for tabulating trade statistics, China exports the full $178.96 with each iPhone.

The iPhone is a problem for conventional trade theory. As the authors note, both Ricardian theory and Hecksher-Ohlin theory would find the U.S. exporting iPhones to China. (The U.S. has a competitive advantage in high technology and an absolute advantage in smart phones.) “Foreign direct investment, product fragmentation, and production networks have jointly reversed the trade pattern predicted by conventional trade theories,” the paper says.

In the end, the authors hope to draw attention away from popular explanations of the ballooning trade deficit — low U.S. savings, low Chinese consumption, and the price of the Chinese yuan.

Consider China’s oft-cited exchange rate regime. Were the Chinese to allow the yuan to appreciate by 20% against the dollar, total manufacturing costs would increase a mere $1.30 per iPhone under Xing and Detert’s calculations. Since Apple would be unlikely to pass the cost onto consumers, U.S. demand for iPhones — and the product’s corresponding chunk of the U.S. trade deficit with China — would remain the same.

And if the iPhone were simply assembled in the U.S.? Assuming a U.S. wage rate ten times that of the Chinese worker and a minimum profit margin of 50% (Apple’s profit margins on iPhones in 2007 and 2009 were 62% and 64%, respectively), iPhones would sell to the U.S. consumer at a price of $500 per unit.

Tough tradeoff.