Category: Ch22: Aggregate Expenditure and Output in the Short Run

Supports:  Chapter 2, Trade-offs, Comparative Advantage, and the Market System [Econ, Micro, Macro, and Essentials]; Chapter 9, Comparative Advantage and the Gains from International Trade     [Econ and Micro; Macro Chapter 7; and Essentials Chapter 19]; Chapter 22, Aggregate Expenditure and Output in the Short Run   [Macro Chapter 12].

WILL APPLE START MAKING IPHONES IN THE UNITED STATES?

Apple, like many U.S. firms, relies on a global supply chain (sometimes also called a global value chain) comprised of firms in dozens of countries to make the components used in Apple’s products. (See Hubbard/O’Brien Chapter 2, Section 2.3 of Hubbard and O’Brien Economics and Microeconomics).  This strategy has allowed Apple to take advantage of both lower production costs and the engineering and manufacturing skills of firms in other countries to produce iPhones, iPads, iWatches, and MacBooks. But during the coronavirus pandemic, Apple found its supply chain disrupted because many of its suppliers located in China were forced to close for several months.

            Because of the coronavirus pandemic and the trade war between the United States  and China, many U.S. firms, including Apple, were considering moving some of their operations out of China. (The trade war is discussed in Chapter 9, section 9.5 of Hubbard and O’Brien Economics and Microeconomics, Chapter 7, Section 7.5 of Macroeconomics.)  As an article on bloomberg.com put it, these firms were “actively seeking ways to diversify their supply chains and reduce their dependence on any single country, no matter how attractive.” For example, two Taiwanese firms, Wistron and Pegatron, which had used factories in China to assemble iPhones were moving some factories to India, Vietnam, and Taiwan.

            It seemed unlikely, though, that production of iPhones would move back to the United States. Why not?  First, manufacturing employment has been in decline in the United States since long before U.S. firms began using suppliers based in China. In 1947, shortly after the end of World War II, 33 percent of U.S. workers were employed in manufacturing. By 2001, when China became a member of the World Trade Organization, that percentage had already declined to 12 percent. In 2019, it was 9 percent.

Manufacturing production in the United States has held up better than manufacturing employment. The Federal Reserve’s index of manufacturing production increased more than 250 percent between the beginning of 1972 and the beginning of 2020. U.S. manufacturing has been able to increase output while employment has declined because of increases in productivity. The increases in productivity have relied, in part, on increased use of robotics, particularly in assembly line work, such as the production of automobiles.  The United States has a comparative advantage in producing goods and services that require skilled labor and involve artificial intelligence, machine learning, and the use of other sophisticated computer programing. Manufacturing that relies on lower-skilled labor, such as textile and shoe production, has been mostly moved overseas. 

            The Taiwanese firms Foxconn, Wistron, and Pegatron assemble iPhones, primarily in factories in China and elsewhere in Asia where large quantities of unskilled labor are available.  Some components of the iPhone that require skilled labor and sophisticated engineering, including the screens, the touchscreen controller, and the Wi-Fi chip, are produced by U.S. firms and shipped to China for final assembly. In fact, surprisingly, the value of the U.S.-made components exceeds the value of assembling the iPhone in Chinese factories. (See Hubbard and O’Brien Economics, Chapter 22, Section 22.3 and Macroeconomics, Chapter 12, Section 12.3).

            Factory assembly lines, like those in China making iPhones, need to be flexible to respond quickly to Apple introducing new models. So, in addition, to hundreds of thousands of unskilled workers in its assembly plants, Foxconn and other firms operating in China hire thousands of engineers. Typically, these engineers do not have college degrees, but they have sufficient training to rapidly redesign and reconfigure assembly lines to produce new models. In 2010, when President Barack Obama pressed Steve Jobs, the late Apple CEO, to produce iPhones in the United States, Jobs pointed to lack of sufficient workers with engineering skills to make such production possible. Jobs stated that he would need 30,000 such engineers if Apple were to make iPhones in the United States, but “You can’t find that many in America to hire.”

            The situation hasn’t changed much in the past 10 years. As an article in the Wall Street Journal observed in March 2020, in addition to a large number of unskilled workers, Foxconn employs in China, “Tens of thousands of experienced manufacturing engineers [to] oversee the [production] process. Finding a comparable amount of unskilled and skilled labor [elsewhere] is impossible.”

            Although some firms were attempting to reduce their reliance on Chinese factories in response to the coronavirus pandemic, because the United States lacks a comparative advantage in the assembly of consumer electronics, it seemed unlikely that those factories would be relocated here.  But the coronavirus pandemic may lead some U.S. firms to change their supply chains in other ways.  For instance, firms may now put greater value on redundancy. Apple might underwrite the cost to its suppliers of building facilities in several Asian countries to assemble iPhones. In the event of problems occurring in one country, this redundant capacity would allow production to switch from factories in one country to factories in other countries.

            Similarly, some firms may rethink their inventory management. Before the 1970s, most manufacturing firms kept substantial inventories of parts and components. Retail firms often kept substantial inventories of goods in warehouses. This approach began to change during the 1970s, as Toyota pioneered just-in-time inventory systems in which firms accept shipments from suppliers as close as possible to the time they will be needed. Most manufacturers in the United States and elsewhere adopted these systems, as did many retailers.

            For example, at Walmart, as goods are sold in the stores, this point-of-sale information is sent electronically to the firm’s distribution centers to help managers determine what products to ship to each store. This distribution system allows Walmart to minimize its inventory holdings.  Because Walmart sells 15 to 25 percent of all the toothpaste, disposable diapers, dog food, and other products sold in the United States, it has involved many manufacturers in its supply chain. For example, a company such as Procter & Gamble, one of the world’s largest manufacturers of toothpaste, laundry detergent, and toilet paper, receives Wal-Mart’s point-of-sale and inventory information electronically. Procter & Gamble uses that information to determine its production schedules and the quantities and timing of its shipments to Walmart’s distribution centers.

            But as the pandemic disrupted supply chains, many manufacturers had to suspend production because they did not receive timely shipments of parts. Similarly, Walmart and other retailers experienced stockouts—sales lost because the goods consumer want to buy aren’t on the shelves.

            In 2020, firms were reconsidering their supply chains as they evaluated whether to underwrite the building of redundant capacity among their suppliers and whether to reduce the extent to which they relied on just-in-time inventory systems.

Question:  Suppose that you’re a manager at Apple. Given the coronavirus pandemic, Apple is considering whether to underwrite the cost to its suppliers, such as Foxconn, of building redundant factories in countries outside of China.. The goal is to reduce the production problems that occur when factories are concentrated in a single country during a pandemic or other disaster. Your manager asks you to prepare a brief evaluation of this idea.  What factors should you take into account in your evaluation?