Prestowitz

It’s not just the iPhone that America doesn’t make

It’s not just the iPhone that America doesn’t make


Okay, so yesterday I explained not only that John McCain was wrong to say the iPhone is made in America (as you already knew), but also that most of you were wrong to think it is made in China. I went on to show that the phone is only assembled in China from high-tech parts that are mostly made in Japan, South Korea, and Taiwan. I further explained that production of these parts is not labor intensive, but capital and technology intensive.

In other words, these parts are just the kinds of products American economists, Silicon Valley venture capitalists and entrepreneurs, and Washington political leaders always say America is the best in the world at making. (That’s probably why McCain just automatically said without thinking that the iPhone is made in America — he couldn’t imagine it being made anywhere else). Then I left you with the question of why, if America is so good at making this stuff, it doesn’t.

All right, I know you’ve had a sleepless night over this, so I’ll relieve the suspense.

Here’s the answer — or perhaps I should say, answers:

The first is economies of scale. Take two economies, say the United States and the E.U. Take a product, say airplanes and especially commercial airliners. During World War II, the Germans, Japanese, British, and Americans all made very good airplanes. Europe was competitive with the United States in its ability to make airplanes. After the war, both the Europeans and the Americans had all the technology, resources, and skills requisite for aircraft production. And, indeed, it was Britain that actually produced the first commercial jetliner. Yet, it was the American companies — Boeing, Lockheed, and Douglas — that emerged in the post war period as the globally dominant aircraft makers, especially of commercial jetliners. This was because, as part of the post-war occupation policies, Germany and Japan were forbidden to produce aircraft. While the French and British faced no such prohibition, their national markets for jetliners were relatively small compared to the U.S. market. Aircraft production is an industry with enormous economies of scale.

If you build only one plane, the cost for that one plane is prohibitive. But if you build a thousand of the same model, the cost per plane falls dramatically because high fixed costs can be amortized over a large number of planes produced. With a big home-market advantage, U.S. producers were able quickly to reduce their costs far below the level of the British and French. Once that happened, the British and French producers could not sell at a profit to anyone and could not survive without major subsidies from their governments.

Of course, the E.U. governments decided to engage in what economists call "picking winners and losers" by heavily subsidizing Airbus to make it a viable competitor with the U.S. producers. Their policy eventually paid off and today, Airbus is the world’s leading commercial aircraft maker. But it took great policy determination over a long time and hundreds of billions of dollars of subsidies to achieve.

The second answer is U.S. geopolitical and international economic policy doctrine. Since the end of World War II, America’s highest priorities have been to assure access to military bases around the globe, to conclude and maintain alliances, and to engage in military intervention to assure a global balance of power deemed favorable to U.S. interests. To this end, Washington has continually been prepared to make economic concessions in order to obtain geo-political objectives. Thus, for example, Washington effectively responded to the Airbus subsidies for fear that doing so might upset NATO arrangements.

This geopolitical priority has long been rationalized and justified by an international economic policy that held free trade to be always and everywhere a win-win proposition. Indeed, it was believed that unilateral free trade (keeping one’s markets open, even in the face of protectionism by one’s trading partners) was a winning proposition. Thus, there was no need to be concerned about things like subsidization of key foreign industries or loss of capability in these fields, and hence no need for trade measures that might upset delicate geopolitical relationships.

This economic doctrine has been based upon the assumption of Anglo/American economics that economies of scale either don’t exist in most traded products and industries or are relatively unimportant. That this assumption is dramatically and demonstrably wrong and not accepted by most of the non-Anglo world has not deterred its application to the making of much American and global trade policy.

A corollary of the free-trade doctrine was also the doctrine that governments cannot and should not "pick winners and losers" by favoring some industries with protection and subsidization.

The third answer is that the rise to dominance of the theory of Shareholder Value (the sole duty of the CEO is to increase relatively short-term returns to shareholders) in U.S. business schools. Beginning in the 1970s, business leaders promoted the off-shoring of production by American CEOs who aimed to increase returns by arbitraging labor costs between Asia and America.

In the 1960s and early 1970s, the U.S. consumer electronics industry was the world leader in virtually every dimension. But first Japan, and then the Asian Tigers, and then China were determined to catch up. Far from believing that  governments should not "pick winners" by subsidizing and protecting them, they saw that most of the major industries like steel, shipbuilding, aircraft, and electronics were characterized by economies of scale and that they had no chance of being in these industries except by dint of subsidies and protection. Governments, they believed, had an absolute duty to achieve rapid economic growth precisely by picking these kinds of industries to be winners.

Thus, Japan kept its yen undervalued (just as China is today keeping its yuan undervalued), provided preferential financing to consumer electronics producers, subsidized their exports, encouraged them to dump (sell abroad at prices below cost and/or below the prices at home) fiercely protected its domestic markets, and forced foreign producers to transfer technology to Japan as a condition of obtaining market access. The objective was to achieve high rates of production in order to obtain the economies of scale necessary to match the costs of American producers.

At the same time, the U.S. government, not wishing to upset the U.S.-Japan alliance with nasty trade issues and seeing no need to do so because it believed that trade is always win-win, took no action to counter the dumping, currency undervaluation, intellectual property theft, and subsidization of "winner" industries by Japan.

Also at the same time, U.S. CEOs at companies like RCA, Motorla, Zenith, and Ampex began to outsource the production of their television, radio, and VCR components to Japan while they kept the design, marketing, and distribution functions at home. By the mid-1980s there were virtually no U.S. consumer electronics producers left. The display technology for televisions, electronic watches, and video tape recorders had been taken over by Japan as had also much of the semiconductor production along with production of timers, lenses, and other key components.

In the past 25 years, the governments of Korea, Taiwan, Singapore, and other Asian countries have sought to wrest dominance in these and other key industries away from Japan by imitating its mercantilist, strategic export led growth strategies and its "picking of winners." Thus Korea heavily subsidized and protected companies like Samsung, Hynix, and LG while Taiwan actually founded Taiwan Semiconductor Manufacturing Company, now the second or third largest semiconductor producer in the world.

All of these players managed to achieve large scale production such that, even if a U.S. company like Apple had the requisite technology and resources, it could not hope to compete economically with the giant industry leaders. To do so would require that the U.S. government heavily subsidize and protect U.S. based production, a step that would require a revolution in American policy thinking and that may well no longer be affordable even if it were feasible.

That’s why America doesn’t produce iPhones or much of the other stuff it keeps saying it’s good at. Maybe it could be good and maybe it should be good. But you know how that "coulda, shoulda, woulda thing goes.