The distractions of development and public policy

Interestingly, the discourse of development is often marred by distractions. It may not be entirely incorrect to say that a very significant part of the development discourse is avoidable and distracting noise. I blogged here about the distractions caused by the predominance of programs and schemes. 

Bloomberg has a good op-ed that draws attention to the near-universal problem of deficient student learning outcomes and argues that the debate on school choice in the US may be a big distraction.

Cultivating more school options is not the end-all-be-all. As of 2019, 25 states had voucher programs of some type in place, but only 2% of K-12 students are in private school with public vouchers. Only 7% of public school students are in charter schools. The reality is that most kids end up staying in the public schools they are zoned for a variety of reasons: some private schools don’t take vouchers and some charters are oversubscribed or on the other side of town. School choice is particularly ineffective in rural environments... Worse, school choice can become an excuse for policymakers to skirt hard and immediately needed conversations about an ineffective public-school curriculum, classrooms that have morphed into screen zombies, or unaccountable teacher and student performance...

Indeed, the most meteoric change in student achievement this last decade wasn’t from vouchers. It was from a statewide investment in the basics. Since 2013, Mississippi has gone from one of the worst elementary school literacy rates in the country to above average from investing in third grade reading. That included better training for teachers, using a phonics-based curriculum and hiring reading coaches. These investments have been paired with steep accountability: if kids are not literate, they repeat third grade. Instead of falling behind, those kids were further ahead academically by 6th grade for having gotten the basics right. We need more of this, shoring up the foundation.

This echoes across development sectors and public policy areas, and countries, developed and developing. 

The description of school education in the US could be applied to school education systems in India and elsewhere. Smart classrooms and digital technologies, Edtech in general, may have become big distractions from doing the basics right. 

On the same lines, the neglect of public health and primary care is sought to be made up for by focusing on universal health insurance. Consultants and dashboards are the response to basic governance failures in monitoring and supervision of programs, schemes, and policies. The unwillingness (and inability) of basic energy audits and their enforcement is sought to be made up for by installing smart electricity meters to address the persistence of high electricity distribution losses. Instead of focusing on basic governance and improving their property tax base and collection efficiency, cities chase technology solutions like GIS mapping and municipal bonds. 

There’s a false comfort from believing that infrastructure financing gaps can be leapfrogged by replacing public financewith Public Private Partnerships, private capital, and foreign direct investment. Instead of derisking bank finance for infrastructure, public policy prioritises capital market deepening. Instead of managing the governance of processes and ensuring compliance, tax authorities tend to use targets and coercive practices to boost revenues. Instead of improving governance, the reflex reaction to an adverse news item about abuse of regulation is to double down with more layers of regulation.

All this, more generally, is in line with the pervasive belief that the way to fix struggling public systems is through innovation and doing new things instead of doing the basics right and doing them much better. 

The point here is not to reject these innovative approaches and technologies, but to put them in perspective, as (perhaps even distant) supplementary to the primary activities that get marginalised in the hype. This is especially so in systems entrapped in low baseline of achievement.

Internal trade barriers and deregulation

In the context of the debate on deregulation, internal trade barriers are a significant but less discussed cost. 

This blog post by Luis Garciano (HT: Marginal Revolution) points to an IMF report that looked at internal barriers to trade within the European Union (EU) and found them to be equivalent to tariffs at 45% for goods and 110% for services.

The IMF report finds that while trade costs for goods dropped 16% for EU imports, they fell only 11% for internal EU trade. It finds that internal trade among EU countries is less than half that between US states. 

It also highlights the various types of non-tariff and other barriers affecting different goods and services sectors. The graphic below is the total tariff equivalent for various service sector segments.

Garciano points to the lack of harmonisation among EU member countries’ rules across sectors and the failure to adopt mutual recognition as a means to such harmonisation. 

Tej Parikh has a good graphical summary of the importance of internal barriers as an economic friction.

He points to a graphic from QuantGov that highlights the wide variations in regulatory restrictions across US states, arising especially in occupational licensing, tax disparities, and zoning laws. 

Since the volume of internal freight flows in the US is about $20 trillion annually, even small improvements can have significant effects. 

A striking reflection of internal barriers is that Canada trades more with the US than among its provinces!

Such barriers contribute significantly to regional disparities, as in India. 

And they come in the way of integrating markets and realising scale, the major attractor for foreign investors. 

Fortunately, there are several examples from across the world on the impact of reforms to ease internal barriers. Australia’s Mutual Recognition Act in 1992 enabled goods sold in one state or territory to be sold in another without needing to meet further requirements, and also established equivalence in occupations. This contributed to increased domestic freight movement and productivity growth.

India’s GST led to the dismantling of border checkposts and dramatic reductions in border-crossing times across state borders. 

It also translated into increased household expenditures in districts more exposed to the faster border crossings. In fact, faster border crossings increased household expenditures by 2% to 23% across districts. 

A Canadian study found that varying regulations faced by the truck transportation sector in the country added approximately 8.3% to freight rates. 

Finally, in the context of removing internal barriers, Luis Garciano echoes the critical point that I blogged here, that deregulation in general should not be seen as a stroke-of-pen reform but as one that requires sustained engagement. He points to examples of how the implementation of deregulation often seriously detracts from achieving its objectives. 

There are two problems: first, rather than replacing national regulations, EU rules pile on top of them. Second, member states often engage in ‘gold plating’ – adding extra national requirements when implementing EU directives. The result is that even when the EU does create common rules (directives or regulations aiming to harmonize), the outcome is often not a truly single market. New EU rules often don't replace old national ones. Instead, they create additional layers of regulation. A toy manufacturer might need to obey an EU toy safety directive while simultaneously navigating older national rules about specific materials… In a paper on capital market regulations in a top finance journal, Christiansen, Hail and Leuz (2016) find that, in fact, countries' rules diverge more (!) after harmonizing regulations… 

In other words, the new rules often only serve to add new layers of legislation. For instance, the Single Supervisory Mechanism supervises the banks, but so do the national central banks who impose their own requirements of capital or liquidity on all banks operating in their territory. If a French bank operates in Belgium, it has to satisfy French, Belgian and European regulators. This reduces the synergies of operating across borders, and is the main reason our banking systems are, even today, mostly national. Or consider General Data Protection Regulation, which (in spite of being a regulation) still means we have regulators at EU, national and regional level…A publisher that trades across the EU must now keep separate analytics setups for Austria, France, and Italy, while the same tool remains legal elsewhere. The Draghi report notes that there are around 90 tech-focused laws and more than 270 regulators active in digital networks across all EU countries…

Despite EU directives aimed at facilitating the free movement of professionals, a specialized engineering company based in, say, Portugal, that wins a contract for a major infrastructure project in Germany might find that German authorities require their engineers to undergo a lengthy ‘equivalence check’ despite holding qualifications recognized under EU frameworks. For smaller firms or individual professionals, these hurdles can be prohibitive. 

These problems echo across countries.

China made iPhone, iPhone made China?

Patrick McGee has written the definitive book on Apple’s relationship with China.

The short story goes something like this. 

Apple has always sought to build a deep moat around its products. It pursued a manufacturing strategy in China that followed this principle. Its design focus meant that many of its components were bespoke. 

Therefore, unlike its smartphone rivals, who used generic components off the shelf and could therefore hand over the design and outsource the entire manufacturing to contract manufacturers, Apple had to work very closely with its suppliers and contract manufacturers. Its obsessive focus on quality also made this an imperative. Accordingly, it sent its product designers and manufacturing design engineers from Cupertino to embed themselves with its contract manufacturers and suppliers, and transfer knowledge, skills, work practices, and work ethics. 

It set a very high standard for the deliverables from suppliers, who in turn acquired a reputation for being the best in class. This also meant that the employees in Apple’s supply chain had to undergo training and acquire a higher level of skills than was the case for others. 

Given the high employee turnover in the industry, Apple’s supply chain became a training ground for millions of manufacturing workers at all levels. McGee points to Apple’s own estimate that since 2008, a staggering 28 million workers have gone through Apple’s rigorous training, a number greater than the entire labour force of California! It may well be the single biggest skilling program that the world has ever seen, one that involved an American company imparting knowledge, skills, and practices to the entire Chinese electronics industry. 

Apple was not outsourcing as the word was commonly understood. Instead, it was sending its top product designers and manufacturing design engineers from California and embedding them into suppliers’ facilities for weeks or months at a time. There they’d whip local suppliers into shape, co-invent new production processes, and stay until the operations were up and running. “The think that really stood out was not just that it’s all in China, but that it’s the most vertically integrated manufacturing system in the world and yet they don’t theoretically own anything,” he says… Instead of selecting components off the shelf, Apple was designing custom parts, crafting the manufacturing behind them, and orchestrating their assembly into enormously complex systems at such scale and flexibility that it could respond to fluctuating customer demand with precision. Just half a decade earlier, these sorts of feats were not possible in China. The main thing that had changed, remarkably, was Apple’s presence itself. So many of its engineers were going into the factories to train workers that the suppliers were developing new forms of practical know-how.

Apple was also investing heavily in the production process to build moats around its manufacturing innovations, while rivals were just giving suppliers spec sheets and saying, “Build this.”… Apple did something totally novel. It purchased hundreds of millions of dollars of machinery, placed it in the factories of its supply partners, and ‘tagged’ it for Apple use only… The investments allowed its suppliers to operate at a level they’d otherwise be incapable of… As a former Apple manufacturing design engineer puts it: “The model we had developed was: We’re going to use your factory. We’re going to use your people. But we’re going to go in there and use them as our arms and legs. You know, ‘You do this, and you go do this,’ and ‘You set the dials here.’”… Apple’s engineers were deep in the weeds building, and even inventing those capabilities. Apple was doing this on such a scale that it created an entire organisation within Ops dedicated to the procurement, planning, and deployment of this capital-intensive machinery. 

All this also meant that Apple had complete control over its supply chain. In fact, it may not be incorrect to say that it did manufacturing, but without owning any factory!

In return for the capabilities development and tight guidance (plus, of course, the large volumes and the privilege of supplying Apple), Apple’s procurement division, headed by Tony Blevins, negotiated cut-throat deals that paid the lowest margins. Counterpoint Research has estimated that in 2016, even as Apple had a profit margin of 33%, its Chinese rivals Oppo, Vivo, and Xiaomi had 7%, 6%, and 2% margins. Foxconn’s margins fell to just 2.4% in 2011, and while its revenues more than doubled from $53 bn in 2007 to $107 bn in 2011, its profits barely rose from $2.41 bn to $2.53 bn. Apple’s suppliers realised that the skill acquisition, the massive volumes, and the reputation that comes with working for Apple compensated for the low margins. They could charge a premium for supplying to other smartphone makers.

Apple actively encouraged diversification among its suppliers by requiring that none of them should have more than half of their revenues from Apple. This was also for derisking since its models often involved radical shifts that obviated certain components that would have closed down suppliers, with all the negative press around job losses. This effectively meant that Apple’s suppliers were cross-subsidising their manufacturing for Apple by charging higher prices for their supplies to Apple’s rivals. 

McGee describes this relationship between Apple and its suppliers and contract manufacturers in terms of the Apple Squeeze

Apple’s engineering and operations teams would rigorously train local partners, in the process giving away manufacturing knowledge, in particular how to efficiently scale while maintaining the highest quality standards. In exchange, the local supplier would work for soul-crushingly low margins with the understanding that it could profit from the incredible volumes Apple demanded. It could also use these skills to win orders from other clients, charging them more for similar work.

Importantly, this condition also may have contributed to the birth of the Chinese smartphone industry. 

In 2009, the majority of smartphones sold in China were produced by Nokia, Samsung, HTC, and Blackberry. But as Apple taught the supply chain how to perfect multi-touch glass and make the thousand components within the iPhone, Apple’s suppliers took what they knew and offered it to homegrown companies led by Huawei, Xiaomi, Vivo, and Oppo. Result: the local market share of such Chinese brands grew by leaps and bounds, from 10% in 2009 to 35% by 2011, and then to 74% by 2014. It’s no exaggeration to say that the iPhone didn’t kill Nokia; Chinese imitators of the iPhone did. And the imitations were so good because Apple trained all their suppliers… Apple became the developer for China… Apple, in other words, set in motion a series of events that helped Chinese suppliers win more orders and advance their understanding of cutting-edge manufacturing. At the same time, Western manufacturing of electronics atrophied.

It also birthed a high-quality Chinese contract manufacturing industry. By shifting orders from its Taiwanese contract manufacturers, Apple has allowed Luxshare, BYD Electronic, Goertek, and Wingtech to take significant shares of Apple’s supplier network. More than half its component suppliers are Chinese firms, and many of the rest manufacture in China. The spectacular success of China’s electronics manufacturing ecosystem owes no small measure to Apple. I have blogged here about iPhone’s domestic value addition in China. 

Given its bespoke components, obsession with quality, and the massive volumes involved, Apple often invested in the equipment and machinery for its suppliers. As McGree writes,

The value of its “machinery, equipment and internal-use software” – namely the instruments placed in third-party factories for production – totalled less than $2 billion in 2009, but then soared beyond $44.5 billion by 2016 – more than four times the value of “land and buildings” owned by Apple – as the company took unprecedented control of its supplier network.

All told, Apple invested a staggering $55 billion a year for five years from 2015, for a total of $275 billion, more than double the entire post-war Marshall Plan. In addition to the investments in equipment to suppliers and construction of its retail stores, this estimate includes a sizeable part of wages that Apple paid to workers across its supply chain as training costs for teaching new skills and processes to refresh its multidimensional product portfolio. 

I’ll let McGee summarise the Apple story

By investing in and teaching local suppliers, Apple was inculcating a corpus of hands-on knowledge, both in tangible skills and abstract concepts, which applied well beyond serving its own needs. True, this was fairly unintentional; Apple hadn’t designed its supply chain to spur innovation at its suppliers. Yet that’s exactly what it had accomplished. And Apple’s investments weren’t just large, they were ruthlessly efficient and narrowly targeted in the advanced electronics sector… Thinking of Apple’s investment like a government program is instructive. Year in, year out, China didn’t have the talent or expertise to build the products that Jony Ive’s studio conceived, but the engineers Apple hired out of MIT, Caltech, and Stanford, or poached from Tesla, Dell, and Motorola, routinely got them up to speed. Apple could send a calibre of talent to China – what one Apple veteran calls “an influx of the smartest of the smart people” – that no government program ever could. And the culture was such that the Apple engineers would work up to 18 hours a day. Moreover, whereas a government program could at best train a workforce to engineer products, it wouldn’t have the ability to actually purchase the goods. But Apple could and did.

In economic terms, Apple was creating the whole market – supplying inputs in the form of worker training and machinery, then purchasing the outputs. The suppliers who won Apple contracts were given a massive order book and were taught to ramp up at a pace none had ever experienced. Better still, Apple had put so much design, brand image, and superb marketing into its products that even without commanding a dominant market share, it nevertheless attained a dominant market style. A new Apple product would set into motion the look, feel, and substance of what a laptop or smartphone should be. So the processes it often co-invented with China-based suppliers were in great demand…

What Apple had realised was that, unwittingly, its presence in China was enabling technology transfer on an extraordinary scale… Apple wasn’t just creating millions of jobs in the country; it supported entire industries by facilitating an epic transfer of “tacit knowledge” – hard-to-define but practical know-how “in the art of making things, in organising practical matters, and in the way people produce, distribute, travel, communicate, and consume,” as the China-born Federal Reserve economist Yi Wen defines it… The technology transfer that Apple facilitated made it the biggest corporate supporter of Made in China 2025, Beijing’s ambitious, anti-Western plan to sever its reliance on foreign technology.

Some thoughts: 

1. While China’s manufacturing prowess undoubtedly arose from multiple factors, it may not be incorrect to highlight the point about the central role played by Apple’s iPhone manufacturing to claim that China made the iPhone, and the iPhone made China!

2. When history is written, Apple will be considered an icon of efficiency and profit-maximising capitalism. The cost-minimising contracts with suppliers, low-margin outsourcing, the transfer of inventory to the contract manufacturer, the tight oversight of its suppliers and contract manufacturers, and the concentration of everything in China meant that Apple could harvest economies of scope and scale in an unprecedented manner, and thereby maximise its profits.

3. The other side of efficiency and profit maximisation is that Apple will also be considered a totemic example of risk concentration. It has yoked itself so deeply and intimately to China that any exit is near impossible, and it’s now virtually at the mercy of the Communist Party and President Xi Jinping. McGee compares Tim Cook to Jack Welch, who laid the foundations for GE’s demise. 

4. As McGee writes, unlike Japan, Taiwan, Korea, and China, which first made components before getting into SMT, assembly, testing, marking, packaging, and higher value-added activities, India has jumped straight into SMT and ATMP. Manufacturing of components is hard and requires the development of several critical capabilities, besides a workforce with high productivity that can also produce with high quality. These tasks are not amenable to the kind of learning by doing skill and knowledge spillovers like actual manufacturing, even if of components. 

5. Finally, the book is a story about how conventional theories of institutions and the rule of law to attract foreign investors break down completely in the context of China. If anything, as McGee highlights with several examples, China followed the opposite model of Rule by Law, where everything was subordinate to national interest as defined by the Party. Western multinational corporations invested and remained in China despite these problems.

Weekend reading links

1. India's airline industry

No-frills airlines, of which Indigo is one of the world’s best examples, accounted for half the total seat capacity in 2014. A decade later, their share had shot up to over two-thirds, helped in no small measure by full-service carrier Jet Airways’ collapse in 2019... China has seen a bigger decline in airfares since 2011—45%—than India. That’s partly a function of how competitive the market is. China has 146 operating airlines, including global ones, compared with 91 in India. The latter had over 100 pre-Covid. Go First, formerly Goair, was the last prominent airline to bite the dust when it declared bankruptcy in 2023. Over 15 Indian airlines have failed in the past two decades, according to IATA.

2. The Ken has a story on Indian automaker's rare earths dependence.

India imported about 2,270 tonnes of rare earth minerals in FY24, up 15% from the previous year. According to Volza, a platform that tracks import data, there were 42 Indian buyers in 2024, sourcing from 43 suppliers around the world.

Rare earths have a critical role in EV manufacturing

Rare earth elements (REEs) include 17 elements, mostly placed on one side of the periodic table. These are what make permanent magnet synchronous motors (or PMSMs) go. PMSMs are the de facto standard for EVs, especially in two- and three-wheelers. Other REEs like Yttrium and Lanthanum quietly show up in your battery cathodes and electrodes... Electric vehicles are powered by lithium batteries. But to actually move, they need magnets. Not just any magnets—rare-earth permanent magnets made from things like neodymium and praseodymium. They sit inside motors and quietly make everything spin... the rare-earth permanent magnet is the invisible hero of modern mobility—sitting inside motors, power steering systems, infotainment units, even automatic window mechanisms. Basically anything that makes EVs feel like tomorrow’s tech instead of just today’s transport.

3. Consulting firms have become the major sources of CEO recruitment in the US.

General Electric. Procter & Gamble. IBM. For years, those companies and a handful of others were held aloft as “CEO Factories,” admired for their ability to recruit and mold corporate chiefs. Over a 20-year span, just three dozen companies produced one-fifth of the chief executives in the entire S&P 1500 index... the dominance of the traditional CEO factories is fast becoming a thing of the past. The companies most notably taking their place: consulting firms. Alumni of Accenture, Deloitte, PwC, EY and even little-known Swiss staffing firm The Adecco Group have all grabbed a bigger share of global CEO roles over the past 15 years, according to an exclusive analysis of the career paths of the CEOs at more than 4,300 global public companies. Meanwhile, the influence of storied CEO factories like GE and IBM has diminished, according to the analysis by Live Data Technologies.

4. Oil prices and the Indian economy

According to the Reserve Bank of India’s (RBI’s) projections, a 10 per cent increase in oil prices from the baseline assumption can push up the inflation rate by 30 basis points and reduce the growth rate by 15 basis points. A substantially higher increase in oil prices would inevitably have a bigger impact. The RBI’s Monetary Policy Report in April had a baseline assumption for crude oil (Indian basket) at $70 per barrel for 2025-26.

5. India's use of anti-dumping duties (ADD) to combat "material injury" to domestic industries arising from dumping.

From 1995 to 2023, India initiated over 1,100 investigations — more than the US or European Union — targeting not only China but also the EU, Switzerland, South Korea, Japan, and others. In 2024 alone, India launched 47 trade remedy investigations — 37 aimed at Chinese products like aluminium foil, vacuum flasks, and steel... In the past five years, India has imposed 133 anti-dumping measures on 418 products, many in the chemicals sector. Firms that rely on these chemicals as inputs face a constant threat of sudden duties, resulting in price volatility and supply disruptions.

6. Indian economy facts

Private final consumption expenditure (PFCE), which makes up nearly 60 per cent of India’s GDP, fell from a growth rate of 6.8 per cent in the pre-Covid years to 4.1 per cent in 2019-20 (FY20). After a brief post-pandemic recovery, it fell again: To 5.6 per cent in FY24, according to the RBI, and an even weaker 4.4 per cent, according to the National Statistics Office... Since mid-2023, growth in personal loans has fallen off the cliff — from 22 per cent then or 10 per cent or so now — reducing consumption... merchandise exports, which fell 12.8 per cent in FY24 and are expected to grow by only 2 per cent in FY25... According to the Forward-Looking Survey of the Ministry of Statistics and Programme Implementation, actual intended private-sector capex will fall from ₹6.56 trillion in FY25 to ₹4.9 trillion in FY26, a fall of 26 per cent... According to the government data, net payroll addition under the Employee Provident Fund was -5.1 per cent in FY24 and -1.3 per cent in FY25. The Naukri Jobseek Index of white collar jobs has flattened since FY23.

7. Disturbing data on a surge in Chinese exports despite all the trade war restrictions.

This year so far, China’s trade surplus with the world is nearly $500 billion — a more than 40 percent increase from the same period last year... China has made 45 percent more electric vehicles this year, even as Chinese companies are engaged in a vicious price war at home because of flagging consumer appetite. Exports of electric vehicles have soared 64.6 percent this year, according to the Chinese Association of Automobile Manufacturers.

Domestic value addition in manufacturing - iPhone in China

As Patrick McGee has shown in a brilliant new book, the partnership between Apple and Foxconn to make the iPhone may have been a primary contributor to the emergence of China as the factory of the world. It may be no hyperbole to say that China made the iPhone, and the iPhone made China!

This post will highlight some aspects of the domestic value addition of the iPhone in China. 

The value addition chain for any product was described by the founder of Acer Stan Shih in terms of the smile curve. It says that the highest value is at the beginning and end of the value chain, while manufacturing, the middle stage, contributes less value. Yuqing Xing has a very good description of the manufacturing value addition smile curve. Outsourcing starts with the lowest-value assembly and moves to the manufacturing of non-core components, and then to more complex electronic components. The highest value-added activities like design, R&D, and branding remain with the original equipment manufacturers (OEMs). 

Yuqing Xing and Shaopeng Huang tore down and analysed the value-added by country for three mobile handsets assembled in China - Apple iPhone X, Xiaomi MIX 2, and OPPO R11s. They write

We adopt two baselines: production costs and retail prices. In terms of the production costs, it is found that the shares of domestic value-added for the three handsets are 25.4%, 15.5% and 16.7% respectively. For the iPhone X, Chinese firms collectively captured more value-added than the first generation iPhone 3G and performed relatively sophisticated tasks beyond simply assembly. For MIX 2 and OPPO R11s, the teardown analyses further reveal that no indigenous Chinese firms are involved in the manufacturing of components mounted on printed circuit board assembly. In terms of retails prices, the shares of domestic value-added for Xiaomi MIX 2 and OPPO R11s are 41.7% and 45.3% respectively, higher than the corresponding figures for production costs, suggesting that developing indigenous brands before overcoming technology deficiency is an alternative strategy to move up the value ladder along the value chains.

This graphic captures the respective domestic value addition for the three phones.

The high level of value added as a share of retail price in the case of OPPO and Xiaomi arises from branding.

However, using retail price as the benchmark, it is showed that there is strong evidence that Chinese firms have climbed up the ladder of value chains in the smile curve, more by building a strong brand name rather than developing advanced technological capabilities. More specifically, by taking advantage of (1) the size of the Chinese market; (2) their familiarity with the preferences of low- to mid-income customers; (3) the availability of modular production system and technological platforms, Chinese smartphone vendors have pursued a less conventional locus of upgrading, jumping directly to brand development before acquiring sufficient technology capacity. Such a strategy enabled them to overcome technological disadvantage and take a short-cut to catch-up with their foreign rivals.

But even for the Chinese brands, the major components are almost completely sourced from foreign firms. 

The domestic value added as a share of manufacturing cost is 15.5% for Xiaomi (total manufacturing cost of $293.18) and 16.7% for OPPO ($335.98). Even for Huawei, with its in-house chip, the domestic value added is only 38.1%, mainly due to the Kirin processor of HiSilicon, a Huawei subsidiary, and the OLED display made by BOE Technology. 

Xing traces the change in value addition as a share of manufacturing cost and retail price across iPhone 3G (2009) and iPhone X (2010). The table captures the tasks done by Chinese firms for the two models.

And the graphic below captures the respective value added in the two models. 

However, it’s interesting that while manufacturing value added in China has increased, the share of the iPhone’s total cost coming from Chinese firms has remained tiny, even for the latest models. Just 2.5% of the total cost came from Chinese firms, whereas over 80% came from US, Korean, Japanese, and Taiwanese firms. 

This graphic captures the country-wise headquarters of the suppliers of iPhone.

Though the cost-to-retail price ratio for iPhone models has been rising, it was still only 49% and 52% for the 15 Plus and 15 Pro models. This points to the dominant share of value added going to R&D and branding. 

In another paper, using the data for value-added for iPhone X, Xing shows (also this) that the standard trade statistics, which use the gross value of exports, overestimate the US trade deficit with China by attributing all gross value generated to the exporting nation. 

According to that principle, whenever China ships one iPhone X to the US, the current system of trade statistics calculates it as a $409.25 export to the US. The teardown data reveals that the total value of the parts imported from the US for assembly of the iPhone X is $76.5. Hence, importing one iPhone X from China generates a $332.75 ($409.25–$76.5) trade deficit for the US… However, Korea, Japan, and other countries are also involved in the production of the iPhone X and supply more than 45% of the parts and components. In other words, the $332.75 consists of not only value-added originating in China but also that contributed by Korea, Japan, and other non-US countries. It should be considered as a trade deficit between the US and all other countries involved in manufacturing the iPhone X, not just China. 

In terms of value-added, the US deficit with China for the import of one iPhone X is only $104, less than one-third of the figure based on gross value. For every iPhone X imported by the US, current trade statistics mistakenly add $228.75 to its trade deficit with China. In 2017, American consumers bought 42.2 million iPhone units. Using that figure as a reference, the iPhone trade alone exaggerated US trade deficit with China in 2018 by $9.65 billion, about 2.3% of its total deficit with China.

He also shows that, given the high share of foreign value added, China would need to depreciate its currency by a large percentage to offset tariffs by the US. 

The large portion of the foreign value-added embedded in the iPhone X greatly weakens the effectiveness of yuan depreciation in counterbalancing Trump’s tariffs. When the Chinese yuan depreciates against the US dollar, only the $104 Chinese value-added of the iPhone X will be affected. The rest of the iPhone X’s production cost—$305.25, the sum of all parts and components imported for assembling the iPhone X—will remain constant and not be affected whatsoever. However, if President Trump decides to levy a 25% tariff on the iPhone X, the tax base will be $409.25, i.e. the sum of both Chinese and foreign value-added. To offset the tariff burden due to the foreign value-added, the yuan should depreciate much more than 25%.

The horizontal axis denotes the percentage of foreign value-added embedded in Chinese exports.

Farok J Contractor of Rutgers Business School has updates on this analysis of the trade deficit arising purely from value-addition. His value-added numbers are much smaller than those of Xing. 

For a start, he writes that the components of the iPhone 16 may be sourced from as many as 43 countries, and Foxconn receives just $14 for the final assembly. 

He estimates the Chinese value added in the total cost of a finished and assembled iPhone 16 of $563.73 to be just $38.89. Taking the 62 million iPhone 16 imported to the US from China, the US-China trade deficit caused by iPhone comes to $33.6 bn.

The estimates show that the value being added in China is only $2.41 billion annually (for the battery, case, and assembly of each phone). The value added in the US is for the US-sourced components ($1.35 billion), plus the gross margin of Apple Inc. ($22.32 billion) and its distributors and retailers ($9.30 billion), totalling $32.97 billion.

He points to how tariffs on the finished import is deeply distortionary.

We can see in the Apple example how the value added in China amounts to only $38.89 in an iPhone 16. But the US customs department may assess a punitive tariff on the entire $563.73 FOB import value of the phone because all the components were finally assembled in China and shipped to the US from there.

Contractor also draws attention to an important point about how much value is captured by non-manufacturing activities, raising the question of whether the iPhone is predominantly a product or a service. 

Is this gross margin of $359.97 the profit per iPhone? No. The gross margin totaling $22.32 billion is used to pay for Apple’s 80,000 American employees – brilliant R&D scientists, technicians, designers, IT specialists, managers, marketers, supply chain personnel, etc. – who are talented enough to earn a median $127,000 salary annually. Only after paying for its US employees, US domestic transportation, distribution costs, marketing, and other overheads can what is left over be called “profit.” True, the great majority of Apple’s value added in the US is in high-end, valuable services – such as research, design, clever management, and orchestration of international supply chains and marketing – and not manufacturing or production, which is done abroad. Hence the earlier rhetorical question: Is the iPhone a product or a service?

Kun Cai, Zhi Wang, and Shang-Jin Wei have a new paper where they examine the trajectory of domestic value addition (DVA) in Chinese exports disaggregated on several dimensions and finds that industrial policies helped with the increase in DVA. This graphic shows the evolution of DVA of processing exports (those involving the export of goods with imported intermediate inputs, of the kind involving the iPhone) of manufactured goods. 

Direct value addition is that coming from the industry itself and not from other industries. The paper shows that the share of DVA did not increase sharply even over the 13 years of peak Chinese manufacturing growth. 

But the biggest story in value addition is how it has helped in the emergence of Chinese component makers, contract manufacturers, and branded OEMs in the mobile phones industry and beyond. Kyle Chan writes,

Apple’s Chinese suppliers are moving up the value chain. YMTC is the most striking case. State-backed semiconductor firm Yangtze Memory Technologies Co. (YMTC) is China’s most advanced NAND flash memory maker. In 2022, Apple was planning to use YMTC’s NAND chips for its iPhones, which are reportedly 20% cheaper than its competitors’ chips… Sunny Optical… became China’s leading optical parts manufacturers… Apple started using Sunny Optical in recent years to make the main camera lens for its iPhones, which had previously come from Taiwanese companies like Largan Precision and GSEO. Interestingly, one of Sunny Optical’s rising competitors is another Chinese company, AAC Technologies, which already makes acoustic and haptic components for the iPhone… Then there are Chinese companies like Lens Technology that have grown up with Apple over time… The company got its big break making the cover glass for the first iPhones in 2007. Over time, Apple has shared manufacturing technology from foreign firms with Lens Technology, like a new scratch-resistant screen material, to help the Chinese company improve its products. Today, Lens Technology is the world’s largest supplier of touchscreens, not only for most Apple products but also for Samsung, Huawei, Xiaomi, Oppo, and Vivo…

Historically, Apple relied on the big three Taiwanese contract manufacturers to make its products in China: Foxconn, Pegatron, and Wistron. But the past few years have witnessed the rise of homegrown Chinese contract manufacturers, such as Luxshare and Wingtech, which have been taking on a growing share of Apple’s manufacturing… This supplier base, which Apple and Foxconn helped to develop, later empowered China’s own smartphone companies like Huawei, Xiaomi, and Oppo. Apple’s suppliers in China—like Samsung, SK hynix, Sunny Optical, and Lens Technology—supply similar components to its Chinese smartphone competitors. The kicker is that even as companies like Apple try to move away from China, China’s manufacturing ecosystem will continue to be supported and pushed forward by its own homegrown smartphone companies. And now these same Chinese suppliers are already supporting China’s expansion into other industries, like semiconductors and EVs.

This is a good presentation by Yuqing Xing on how China’s role in the Global Value Chains emerged over time and the role of processing exports (those mainly made of imported intermediate inputs) in Chinese exports. 

The short lesson for India is this. Since its launch in 2021, the Production Linked Incentive (PLI) scheme helped create a large ecosystem of surface mount technology-based assembly in India, the starting point in the manufacturing race. But all the electronic components and PCBs, and the vast majority of electromechanical, mechanical, and other components are being imported and then assembled here. The natural next stage is to focus on the domestic manufacture of the purely mechanical non-core and then the other non-electronic components. This will require a PLI 2.0 that focuses exclusively on domestic value addition by targeting a few products and following a realistic pathway as mentioned above. I blogged about it here.