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iPhone Production and the Appreciation of the Yuan and Other Asian Currencies
The yuan's appreciation has been called for by many observers as a means to solve global imbalances, and the Sino-US trade imbalance in particular. The appreciation proponents ignore the fact that the appreciation can only affect a small portion of the cost of "made/assembled-in-China" products. In this section we use iPhone trade to examine the impact of a yuan appreciation on the high-technology contribution to the trade deficit. The calls for appreciation of the yuan vary from a needed 10% to 40% increase against the US dollar. We will assume here that it appreciates 20% from its current level. We also assume that there is no productivity growth at the PRC assembling factory.
An appreciation of 20% will raise the iPhone assembly cost to US$7.8 per unit, from US$6.5, and add US$1.3 to the total manufacturing costs. This would be equivalent to a 0.73% increase in total manufacturing costs. It is doubtful that Apple will pass this US$1.3 to US consumers as the increase is negligible and Apple would have little to gain by passing a tiny price increase to iPhone users. Even a 50% appreciation of yuan against the dollar would not bring a significant change in total manufacturing costs, as the assembling cost-contribution of PRC workers to a ready to use iPhone is very little—only 3.6%. Therefore, the expected pass-through effect of the yuan's appreciation on the price of the iPhone would be zero and US consumers' demand for the iPhone would not be affected. It is unlikely that a yuan appreciation would lower many components of the trade deficit, in this case the portion due to iPhone trade.
Realizing the limit of yuan appreciation on the PRC's trade surplus, because of the role played by processing exports, Thorbecke (2010) proposed a joint appreciation of East Asian currencies against the dollar to mitigate the imbalance between the PRC and the US. Below we analyze how the joint appreciation of the currencies of the economies involved in producing iPhone affect iPhone trade. Similarly, we assume that all these currencies—yuan, Korean won, Japanese yen and NT dollar—appreciated against the US dollar by 20%. Excluding parts supplied by Broadcom, Numonyx and Cirrus Logic, which together costs US$10.75 per unit, we assume the rest of parts are produced in these Asian economies4 and there is no technological progress or productivity gains in any factories making these components. Based on these assumptions, the joint appreciation would be expected to raise the unit cost of iPhones by US$33.64, to US$212.60. Under the scenario of a 20% joint appreciation, the manufacturing cost could rise by 19%, a much stronger increase than in the case of unilateral appreciation of the yuan.
Apple would be able to cope with the rising cost trigged by the join-appreciation through adoption of one of three strategies: (1) passing the increased cost to consumers by raising the price of iPhone to US$534 per unit, a 6.8% increase in the retail price; (2) expecting productivity growth cross the production network of iPhones to offset the impact of the join appreciation; and (3) absorbing the rising cost with profit margin adjustment.
Under strategy (1), a 20% joint appreciation would reduce iPhone imports by 6.8% at most since price elasticities of import demand are generally lower than one. In other words, despite of the assumed complete exchange rate pass-through, the impact of the proposed 20% joint appreciation on PRC's iPhone exports to the US would be relatively small.
On the other hand, under either strategy (2) or (3), the proposed joint appreciation would not affect the demand for iPhones at all, thus the bilateral trade imbalance would not change. It is highly possible that the productivity growth associated with rising global sale volume would mitigate the negative impact of the joint currency appreciation. Economies of scales play a critical role in leading productivity growth in the production of iPhones in the short run. Rising volumes of iPhone shipments continuously lowers the unit cost of the iPhone. It cost US$265 to produce an iPhone when it was introduced in 2007. Within one year, the unit cost of the iPhone dropped to US$178 and the functions and memory of newly produced models are much more powerful than of the older models (Hesseldahl 2008).
As mentioned above, global sales of iPhones reached 25.7 million in 2009, six times higher than after its inception in 2007. It is projected that the sales of iPhones will continue to rise globally, reaching an estimated 45 million in 2011 (Hughes 2010). The economies of scales created by the surging sales volume should further reduce the production costs. Hence, the productivity growth along the production chains of iPhones will likely offset at least part of the cost increase due to the proposed joint appreciation.
Moreover, Apple lowered the price of the iPhone from US$600 to US$500 in 2009. Despite a US$100 reduction in the price, the gross profit margin of the iPhone actually rose to 64% from 62%, thanks to the significant reduction in the production costs (Table 3 [ PDF 26KB | 1 page ]). The more than 50% profit margin leaves Apple with the flexibility to absorb increased manufacturing costs related to the joint appreciation. With demand for iPhones continuing to climb, both in the US and globally, and potential increases in manufacturing costs likely to be absorbed through productivity increases or through slight reductions in Apple's profit margins, neither a unilateral currency appreciation nor a joint currency appreciation will significantly affect or mitigate the US-PRC trade deficit related to iPhone trade. On the contrary, as more and more iPhones are being shipped to the US from the PRC, the US trade deficits with the PRC continue to grow.
Another possible impact of the yuan appreciation against the US dollar is increasing the purchasing power of PRC consumers for US goods such as iPhones. When PRC consumers purchase iPhones, exports of the US to the PRC increase, thus narrowing the US trade deficit in iPhone trade. Since its official introduction into the PRC market from October 2009 to January 2010, only an estimated 200,000 iPhones had been sold. As a proportion of the mobile and smart phone markets, the iPhone does not command the same market share as it does in the US or Europe, because of the high price. The price of an iPhone at the end of 2009 in mainland PRC was US$1,000 per unit, double the US unit price. Compared with US$10,000 GDP per capita in Beijing and Shanghai, the most developed metropolitan cities in the PRC, the iPhone remains relative more expensive. The iPhone market in the PRC would be limited and much smaller than its counter parts in the US and EU. Chao, Luk, and Back (2009) estimate that iPhone sales in the PRC will increase to 2.9 million by the end of 2011. Compared with more than 20 million iPhone users in the US, it is highly unlikely that the number of iPhone users in the PRC could match that in the US in the foreseeable future. Hence, trade in iPhones will continue to widen the US trade deficit with the PRC, as iPhones become a mainstream mobile phone in the US.
Download this Paper [ PDF 110KB| 12 pages ].
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