Subsidies and international trade

The primary international trade challenge facing countries in manufacturing is that they must compete with China. To achieve this, they must bridge a significant competitiveness gap. Econ 101 points to increasing productivity (through the likes of improving worker skills and using the latest technologies), investing in infrastructure, lowering the cost of capital, and easing regulations. 

This overlooks an important aspect. A critical requirement to compete with China is to maximise economies of scale. In most sectors, this, in turn, cannot be achieved without being export-focused. This, in turn, draws attention to export promotion policies, especially important to bridge the competitiveness gap arising in particular from China’s massive economy-wide indirect subsidies. 

This is especially important with component manufacturing, the next stage of value addition in India’s manufacturing strategy. The low domestic market volumes and the need to maximise economies of scale mean that Indian manufacturers must aim to Make in India for the World. 

India does not have anywhere near the fiscal resources to match China in providing economy-wide subsidies. It must rely on direct and targeted export subsidies. But, despite the near complete paralysis of WTO and egregious violation of its provisions by the major economies (read US and China), India has been surprisingly reluctant to support industrial policies that support the promotion of exports.

The WTO’s Subsidies and Countervailing Measures (SCM) Agreement categorises two kinds of “prohibited” subsidies - those “contingent on export performance” (Article 3(1)(a)), and those “contingent on the use of domestic over imported goods” (Article 3(1)(b)). It allows for subsidies that are specific to enterprises, industries, and regions. When the SCM and other WTO Agreements were being negotiated in the nineties, it was thought that only the subsidies contingent on export performance would be trade-distorting in any significant manner. It was also thought that the subsidies specific to enterprises, industries, and regions (or the economy as a whole) could not be sustained at the scale required to distort trade in particular products, much less global trade in general. 

China has proved otherwise. This necessitates a wholesale revisit of the WTO itself. 

In this context, it’s useful to place the issue of trade-related (or export promotion) subsidies in perspective.

For a start, as Lorenzo Rotunno and Michele Ruta show, there has been a sharp rise in the use of domestic subsidies in industrial policy, especially aimed at manufacturing, and by developed and emerging economies. They categorize subsidies into four groups - production subsidies, direct transfers (including state aid and grants), policies resulting in a loss of government revenues (tax breaks), and policies wherein the government assumes risk related to the beneficiaries’ actions (loans). 

They show that trade finance and export subsidies and incentives are the two main types of export promotion policies. While both have declined over time, the latter now dominates and is still employed by several countries. 

They analyse the impact of domestic subsidies on international trade flows. 

Exports of subsidized products from G20 emerging markets increase 8 percent more than exports of other products, with no evidence of selection. The gravity estimates confirm that subsidies promote international relative to domestic trade. These spillover effects are concentrated in some industries, such as electrical machinery, and are stronger when subsidies are given through tax breaks than other policy instruments. 

Reka Juhasz and co-authors have a new paper that uses supervised machine learning tools on data from policy announcements in the Global Trade Alert (GTA) database to analyse policy language (instead of policy instruments) to categorise industrial policies (IPs) across the world over the 2010-22 period. They define industrial policy as deliberate government action aimed at altering the composition of the domestic economy to achieve a public goal. Their findings:

The new data on IP suggest that i) IP is on the rise; ii) modern IP tends to use subsidies and export promotion measures as opposed to tariffs; iii) rich countries heavily dominate IP use; iv) IP tends to target sectors with an established comparative advantage, particularly in high-income countries.

The graphic below points to the eight most commonly used industrial policy instruments, which highlights that export-related measures (mainly trade financing) are the second largest category of IP interventions. In fact, export-related measures run a close second to non-export subsidies among IP interventions. 

This figure reveals that most export-related IP measures are deployed via trade-financing, and, to a lesser extent, financial assistance in foreign markets… export-related IP measures tend to operate by providing financing as opposed to directly incentivising exporting… much industrial policy seems designed to facilitate participation in export markets... Finally, this finding highlights that modern industrial policy requires fiscal resources and high administrative capacity. Specifically, states need sufficient fiscal revenue to subsidize firms and promote exports, as well as the administrative capacity to identify which firms to support.

Michael Pettis and Erica Hogan point out that focusing on direct subsidies conceals the true extent of trade-distorting subsidies. Instead, they show that indirect subsidies have become the main instruments of export promotion. The table below captures commonly used indirect trade subsidies.

For example, surplus economies typically have undervalued currencies as part of their trade strategies. Having an undervalued currency subsidizes manufacturing at the expense of households because households are all net importers—as they do not produce for the purpose of exporting—while net exporters are mostly manufacturers. An undervalued currency makes the manufacturing sector in that country more competitive, while reducing households’ consumption capacity… repression of interest rates below the neutral real interest rate has also been a powerful cause of financial transfers from household savers to manufacturers, as seen in Japan in the 1980s and China in the 2000. Further, overspending on transportation and infrastructure serves as an especially significant transfer from households to manufacturers in China today. Other transfers include centrally directed systems of credit, low penalties for environmental degradation, repressive labor laws, and restrictions on worker mobility.

They argue that such indirect subsidies constitute a transfer of wealth from households to manufacturers. They write 

Economies that heavily subsidize manufacturers at the expense of households will typically have: larger manufacturing shares of GDP than their trade partners, since manufacturers must migrate to jurisdictions where workers are paid the lowest relative to their productivity to remain globally competitive in a hyper-globalized world; lower consumption shares of GDP than their trade partners, reflecting the cost of the subsidies on consumers; and large, persistent trade surpluses, as the repressed household income used to pay for manufacturing subsidies makes it impossible for domestic household consumption to balance trade. When all three conditions hold, it is almost certain that repressed household demand is subsidizing manufacturing. And, indeed, we see this reduction of household consumption and increase in trade reflected in economic data for surplus countries (and the opposite trend for deficit countries). 

Yet another instrument used by China to distort trade is its State Owned Enterprises (SOEs), which systematically cut back on imports during trade wars. Chinese SOEs make up a fifth of Chinese imports from the US, providing the country with a valuable trade policy instrument that others don’t have. 

Felipe Benguria and Felipe Saffie examined the period from early 2018 when the first Trump administration initiated a trade war with China, and found that US exports fell relatively more during the trade war in products with a high Chinese import share by SOEs. It found that while tariffs account for an 8% reduction in trade, SOEs account for another 4% decline. They also find that the period of decline in US exports to China in sectors with a higher SOE share also saw an increase in Chinese imports from the rest of the world, pointing to further evidence in favour of the SOE effect. 

They write also about how China may have used its SOEs as a retaliatory weapon against the US tariffs. 

We have also found evidence that the SOE effect was stronger among industries located in Republican–voting US counties, suggesting a political motivation just like the literature has found for tariffs. Our work is the first to provide evidence on the use of state–owned enterprises as tools of trade policy, in any context… We have shown that while US exports facing Chi- nese tariffs were gradually rerouted toward other markets, this was not the case for exports facing the reduced demand by Chinese SOEs.

A World Bank report finds that subsidies have larger trade-distorting effects than even tariffs.

Subsidies create trade-distorting effects for both agriculture and manufacturing exports... Subsidies can be more distortive to trade flow than existing tariffs barriers. The distortionary effect of subsidies on trade, expressed in ad valorem equivalents, is estimated at 15 percent for agriculture and 8 percent for manufacturing… Trade-distorting subsidies can displace trade and production in other trading partners, with important repercussions for developing countries… A disproportionally large number of programs are implemented by major trading countries that have the economic heft to distort global markets for goods and services.

It also finds that the prevailing global trade rules are ill-equipped to deal with subsidies. As indirect subsidies have become the main distorting factors in international trade, and also given its own current dysfunctional state, it’s time to revisit the WTO’s provisions. 

In any case, since 2019, after the US refused to allow appointment of members to the Dispute Settlement Body that hears appeals from members, the WTO has become a toothless organization. This has also encouraged a revival of bilateral and multilateral associations, and countries have come together to also settle their disputes through negotiations. This trend will only be accentuated as the US under President Trump becomes more and more unilateral in its trade engagements. In fact, the reciprocal tariffs announced by the US signals a clear regime shift back to the pre-WTO era. 

Weekend reading links

1. The Swiss Central Bank has lowered interest rates to zero in its sixth consecutive rate cut, after consumer prices fell 0.1% in May from a year earlier. Switzerland has had negative rates from 2015-22, with the lowest being minus 0.75%.

2. Hybrids are making a comeback.

In the first three months of this year, hybrids — including cars that can and cannot be plugged in — made up about 14 percent of all light vehicles sold in the United States, according to the Department of Energy. That was around twice the market share of fully electric vehicles in that period. Republican legislation working its way through Congress could further lift sales of hybrids. In May, the House passed a policy bill backed by President Trump that would eliminate a $7,500 tax credit available to people who bought or leased electric vehicles. That legislation would also impose an annual tax of $250 on electric cars and $100 on hybrids to finance road projects. The Senate version of the bill introduced this week would do away with the tax credit, too, but does not include the annual tax.

A few large automakers dominate the sale of hybrids. Nearly half the cars and trucks that Toyota and its luxury brand, Lexus, sold in the first five months of the year were hybrids — and sales of those vehicles were up about 40 percent from a year earlier. Ford Motor’s hybrid sales rose 31 percent in the same period. Honda is on track this year for its highest hybrid sales ever, and the hybrid versions of its Accord sedan and CR-V sport utility vehicle now outsell the gasoline-only models. Hybrids are typically powered by a small gasoline engine that is paired with an electric motor driven by a battery that is much smaller and, thus, less expensive than the batteries in fully electric vehicles. These batteries are charged primarily by regenerative brakes and gasoline engines. Plug-in hybrids, which account for a small share of hybrids, have bigger batteries than regular hybrids and can also be charged from power outlets at home or at charging stations. Some plug-ins can go around 50 miles on battery power alone before the gas engine kicks in.

3. The changing nature of business lines and revenues of Reliance Industries.

Rahul Malhotra, director at Bernstein, calculates that Reliance now generates more than half its annual earnings before interest, taxes, depreciation and amortisation from consumer-facing businesses, compared with less than 10 per cent a decade ago.

4. Smartphone assembly has been the PLI's standout success.

5. Trends with India's FDI.

Manufacturing's share of FDI has continued to decline.

6. Why Chinese consumers took to EVs?

XPeng's Mona Max, which has just gone on sale in China for around $20,000. For this price you get self-driving capability, voice activation, lie-flat beds, film and music streaming. Young Chinese graduates, we're told, see all these as standard features for a first car purchase... a huge amount of government spending goes towards making EVs financially attractive, according to the CSIS study. Members of the public receive subsidies for trading in their non-electric car for an EV as well as tax exemptions and subsidised rates at public charging stations. These perks drove Mr Lu to go electric two years ago. He used to pay 200 yuan ($27.84; £20.72) to fill up his car for 400km (248 miles) of driving. It now costs him a quarter of that. People in China also normally pay thousands for their vehicle registration plate - sometimes more than the cost of the car itself - as part of government efforts to limit congestion and pollution. Mr Lu now gets his green one for free... Another proud EV owner in Shanghai... says that rather than charge her vehicle at a station, she changes her car's battery at one of the city's many automated swapping stations provided by EV maker Nio. In under three minutes, machines replace her flat battery with a fully charged one. It's state of the art technology for less than the price of a tank of fuel.

7. Some statistics on government spending on public sector units.

The government’s total receipts from disinvestment and dividend from PSUs over this period of 10 years fell from 0.45 per cent to 0.25 per cent of GDP... In contrast, the government has been increasing its capital allocations for PSUs through equity and loans in the last 10 years, from about 0.54 per cent in 2014-15 to about 1.66 per cent of GDP in 2024-25... In 2014-15, total equity and loans to PSUs were estimated at ₹67,512 crore, accounting for just about 34 per cent of the Modi government’s total capex of ₹1.96 trillion. By the end of 2024-25, that share rose to 54 per cent, as PSU equity and loans were estimated at ₹5.48 trillion, out of a total capex of ₹10.2 trillion.

8. State capability, airline industry graphic of the day.

9. Brazilian Supreme Court rules that social media platforms can be held legally responsible for users' posts, forcing them to proactively demove material like hate speech, incitement to violence, etc., even without a prior judicial takedown order. This follows rising concerns in Brazil about harmful digital content, especially on children and youth. 

10. The balance sheet of AI spending and benefits is not looking good.

On the cost side, the effects of AI mania are all too apparent. The four tech companies leading the charge — Alphabet, Amazon, Meta and Microsoft — increased their capital spending by nearly two-thirds, or $95bn, in 2024. As this year got under way, they were planning to boost capex by another $75bn... Bank of America Securities predicts that for the tech industry as a whole, spending on data centres will jump from $333bn last year to about $1tn in 2030. By the end of the period, 83 per cent of the money will go into AI-related investments. 

On the revenue side of the equation, meanwhile, some of the AI leaders are starting to notch up big percentage increases in business — but the extra revenue is counted in the tens of billions rather than the hundreds. Early this year, Microsoft said its annualised revenue rate from AI had climbed 175 per cent to reach $13bn. That is still only about 5 per cent of the total revenue it is expected to produce this year. OpenAI’s revenue run-rate from subscriptions, its main source of income, just topped $10bn, doubling from the end of last year. The rates of increase are notable, but the absolute figures still pale in comparison to the capex.

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. 

Update 1 (30.06.2025)

India has the opportunity to emulate China with Apple.

Analysts at Counterpoint Research calculated that India had succeeded in satisfying 18 percent of the global demand for iPhones by early this year, two years after Foxconn started making iPhones in India. By the end of 2025, with the Devanahalli plant fully online, Foxconn is expected to be assembling between 25 and 30 percent of iPhones in India.

While sceptics may scorn this as “screwdriver work”, whether Apple will help do to India what it did to China will depend on the next stage of actual manufacturing, in the form of components, locating to India.

The government, dangling subsidies, is persuading companies like Apple to source more of those parts locally. It is already getting casings, specialized glass and paints from Indian firms. Apple, which opened its first Indian stores two years ago, is required by the Indian government to source 30 percent of its products’ value from India by 2028… Prachir Singh, an analyst for Counterpoint, said it had taken 15 years to figure out what would work in China and five years to import this much of it to India.