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The "Made in China" Fallacy

Every month, we are greeted with trade figures released by the Census Bureau. Over the past decade in particular, those figures have taken on added weight, largely because of the reported trade deficit with China. Month after month, that figure has grown, with barely a pause. In January, the reported deficit with China was a bit under $28 billion.

The idea that China continues to undermine American industry and domestic wages is deeply entrenched in the United States. In the most recent Gallup poll, a majority of Americans view China as one of the primary economic and military threats facing the U.S. today. The trade balance between the two countries has not changed much in the past two years: The total goods deficit was at $315 billion in 2012 and $318 billion in 2013. It hasn’t been getting dramatically worse, but nor has the gap closed.

That reported trade deficit helps fuel the belief that so much that was once made in the U.S. is now made in China. But what if the numbers we’ve been working with are wrong?

Nations have been trying to track trade longer than almost any economic activity other than farming. Before the income taxes of the 20th century, the primary source of government revenue was tariffs on trade. The evolution of modern trade figures assumes a country that makes a certain amount of manufactured goods and either consumes them all domestically or exports them. If its domestic production is insufficient to meet domestic demand or if domestic goods are too costly, then it imports goods.

Traditional macroeconomics also evolved in the early 20th century, and one of its core ideas is that each country is a closed economic system, one that should be in some sort of balance with other closed economic systems. Otherwise, the tenuous equilibrium between nations would be upset, leading to some form of crisis or realignment of power and prosperity.

In those 20th-century terms, the trade balance between China and the U.S. is easily interpreted as an American weakness in the face of rising Chinese strength, just as American manufacturing and exports in the 1950s were seen as a foundation of American power. But that framework is out of date.

The big problem with these numbers: They assume that each finished product is made in a single country. According to the “rules of origin” established by the World Trade Organization, a finished good is ascribed to the country where it underwent its last “substantial transformation.” Generations, ago, an American car was made in greater Detroit with parts from nearby factories in Ohio and steel from Pennsylvania. Today, however, almost nothing—not T-shirts nor Boeing Dreamliners nor Nike shoes nor iPhones—is made in one place.

Take the iPhone or the iPad. They are, for the most part, assembled in factories owned by a Taiwanese company called Foxconn in southern China. They are then shipped to the Port of Long Beach, Calif., where they enter the U.S. as imports. Every iPhone that Apple sells in the U.S. adds roughly $200 to the U.S.‑Chinese trade deficit, according to the calculations of three economists who looked at the issue in 2010. By 2013, Apple’s U.S. iPhone sales alone were adding $6–$8 billion to the trade deficit with China every year.

But are iPhones really “made in China”? More than a dozen companies from at least five countries supply parts for them. Infineon Technologies, in Germany, makes the wireless chip; Toshiba, in Japan, manufactures the flash memory; Broadcom, in the U.S., makes the Bluetooth chips that let the devices connect to wireless headsets or keyboards.

The notion of a “country of origin” is an anachronism, but its effects distort our sense of what’s what. Analysts differ over how much of the final price of an iPhone or an iPad should be assigned to which country, but no one disputes that the largest slice should go not to China but to the U.S., where the design and marketing of such devices take place at Apple’s headquarters in Cupertino, Calif. The largest source of an iPhone’s value—and this goes for thousands of other high-tech products—lies not in its physical hardware but in its invention and the work of the individuals who conceived, designed, patented, packaged, and branded the device.

Taking these facts into account would leave China, the supposed country of origin, with a paltry piece of the pie. The Asian Development Bank estimates that as little as $10 of the value of every iPhone or iPad actually ends up in the Chinese economy.

Now magnify this across hundreds, even thousands of finished goods. Those Nike shoes that count as imports from China, all those flat-screen televisions, Android phones, clothing, furniture, Disney toys and figures. Almost all are the result of ideas generated in the U.S. (or Japan, or Germany, or Korea, and so on), with parts sourced globally and then assembled in China to be sold elsewhere.

Global supply chains are now powered by information technologies that allow parts to be made anywhere in the world, shipped to various assembly points, and then re-shipped to any market that wants them. The notion of a “country of origin” thus seems like one big anachronism, but its effects deeply distort our sense of what’s what.

On top of it all, our monthly bilateral trade figures (as opposed to annual ones) don’t even incorporate other data about trade in services where the U.S. runs quite a surplus—tourism is one example. But the monthly goods number, mired in 1950s thinking as it is, is the one most reported and the one that garners the most attention, casting China as a great economic threat to the U.S.

If the statistics are fundamentally misleading, then we are fundamentally misreading the present. Our sense of “the economy” is primarily a function of statistics. None of us has a personal relationship with the trade deficit. It’s a number; we can’t see it. If it’s wrong, then it isn’t China that represents the economic threat.

Instead, the threat - and the opportunity - is technology. It is robotics that make so many manufacturing jobs unnecessary. It is consumer demand in the developed world for lower-cost goods, whether those are made by low-paid labor in China (or elsewhere) and/or made at lower cost because of the efficiencies of technology. In the face of those trends, whether China is rising or falling or China is exporting less or more to the U.S. (or anywhere else) makes little to no difference. Focusing on our trade balance with China becomes a serious distraction, especially in light of how misleading those numbers are.

If we can confront how our trade numbers paint a false picture, we’d be forced to look at the real drivers of our economic flux. True trade figures would reveal that China is not the issue, nor is any other country. Without China trade to blame for our issues, we could realize that the challenge lies not with China but with ourselves, and the world that our innovations have created. Americans invented most of the disruptive technologies that both make global supply chains possible and undermine traditional labor. If we got ourselves into whatever fix we are in, we can surely get ourselves out—but only if we stop looking for old dragons to slay abroad, bolstered by statistics firmly rooted in the past.

This piece first appeared in Slate and is drawn from Zachary Karabell's most recent book, “The Leading Indicators: A Short History of the Numbers that Rule Our World”.

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Zachary Karabell
Head of Global Strategies, Envestnet, Inc., Consultant to Investment Committee*

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Author’s disclaimer: The opinions expressed herein reflect our judgment as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities, or investment advice or a recommended course of action in any given situation. Investment decisions should always be made based on the investor’s specific financial needs and objectives, goals, time horizon, and risk tolerance. Information obtained from third party resources are believed to be reliable but not guaranteed. This paper may contain ‘forward-looking’ information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this paper is at the sole discretion of the reader.

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