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China is no longer a copycat

Apple: saint or sinner?

24 Juni 2019
Autor: Michael PowerStrategist

Apple engages in cost arbitrage to a great degree, providing an object lesson in America Inc’s complicity in America’s relative decline. But do they also distort the balance of trade?


The iPhone object lesson

Apple makes a useful case study of what has been happening, as the same formula Apple applies is used by most of America Inc where a global supply chain is involved. Indeed, branded goods companies do something similar, as the emerging scandal on how Mondelez has avoided paying any tax on its Cadbury’s profits for a decade illustrates.

Take the case of Apple and its world-beating iPhone. It is mostly sourced from a China-based contract manufacturer, Foxconn. Like many of America Inc’s Chinabased suppliers, Foxconn is a foreign-owned subsidiary operating in China, Foxconn being a subsidiary of Taiwan’s Honhai.

Apple buys a single iPhone X from Foxconn for about US$370. It retails in the US for US$999. For sales made in the US, some 38% of Apple’s revenue, the lion’s share of the US$629 uplift, accrues to Apple as profit. More importantly for the trade debate, this US$629 does not appear in US trade statistics.

For the 62% of Apple’s sales made outside the US – and specifically for those profits generated outside the US – these uplift numbers do appear in the broader trade statistics but not in the trade account. Mostly, they appear as profit (or ‘royalties’) earned in the income section of the current account.

For sales made outside the US, the iPhone X would typically be bought by an offshore entity, often based in Luxembourg, the Netherlands and especially Ireland for Europe-destined product (22% of global revenues) and for product intended for elsewhere (Japan 10%, rest of world 12%). For Chinese sales (18%), the routing is more direct but the profit uplift broadly the same. End prices vary widely with the lowest being US$994 in Japan. Europe is composed of higher priced markets: Hungary US$1455, Italy US$1400, Russia US$1390, Norway US$1375, Germany US$1353. Other notable markets include China US$1267 and India US$1268.

Figure 1

Source: Quartz, 2018


Profit-shifting shell game

Typically, the phone is sold into a market, firstly, to recover the ‘Foxconn cost’ – US$370 per unit – and, secondly, to cover other Apple-specific costs, most notably what is classified as intellectual property payments in the form of royalties. While these are classified as a cost to a foreign entity, say Apple Ireland Ltd, they are booked as a profit to Apple USA Inc. In other words, after the Foxconn cost is recouped, the parent company Apple takes most of the balance of the price for its own account as profit. But little profit is generated in the market in which the product is sold or indeed made.

The European Commission under Margrethe Vestager, the European competition commissioner, has grown wise to Apple’s shell game with the result that the figures and ratios that follow below will not be the same moving forward. The tax ‘shell game’ is played so aggressively by US Big Tech that the EU is considering introducing a revenue-based tax of between 2% and 6%.

What the European Commission has discovered highlights the scale of the profit shielding Apple has been undertaking. Their investigation showed that Apple paid between 1% in 2003 and 0.005% in 2014 on its European revenues. Apple is not alone. In 2016, Amazon had European sales of €21.6 billion but paid only €16.5m tax, 0.76% of revenues. In 2017, Amazon’s British subsidiary paid £1.7 million on revenues of £11.4 billion (0.01%) and even ‘profits’ of £72 million (0.6%).


Distorting the US trade picture

The point highlighted here, however, is not – at least in the first instance – to point out the methods US Big Tech deploys to shield its offshore profits from non-US tax jurisdictions, but rather to illustrate how this behaviour distorts the US trade picture, especially for a President focused on the trade account balance. Through the eyes of Donald Trump, the likes of Apple have a negative effect on the US trade figures because of its imports of iPhones and iPads from China to the US. President Trump either does not realise, or does not acknowledge that, at the current account level the trade practices of the Apples of America are, especially in key markets like Europe and Canada, much more positive for the US.

It's impossible to tell whether the offshore earnings of America Inc. plus the onshore profits arising because of the ability of America Inc. to harvest profits inside the US, as a result of profit-shifting to the US end of the supply chain, more than cancel out the trade account deficits arising from the importation of product from the likes of China, Japan and Mexico. The US runs bilateral surpluses not just on the income line of the current account, but most likely on the capital account as well.

What can be said to a high degree of certainty, however, is that because of the structures and distributions of these supply chains, more value add is created inside the US than out of it – even if some of that value-add accrues as a cash holding owned by America Inc. but actually held outside the US.

General risks: The value of investments, and any income generated from them, can fall as well as rise. Where charges are taken from capital, this may constrain future growth. Past performance is not a reliable indicator of future results. If any currency differs from the investor's home currency, returns may increase or decrease as a result of currency fluctuations. Investment objectives and performance targets are subject to change and may not necessarily be achieved, losses may be made.

Michael Power
Michael Power Strategist

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