Smartphone Manufacturing and International Trade Theory

Introduction

With the rise of outsourcing and globalization, it is tempting to think that such trends can easily be understood with a quick overview of Ricardo, but that is not necessarily the case. The theory of comparative advantage provides a basic framework—the logic that nations should produce the goods in which they have a comparative advantage, thereby achieving greater total output—and certainly provides a fairly clean underlying logic for international trade (Boudreaux, 2014).

International Trade Theory

This paper will discuss the rise of outsourcing and international trade theory with respect to the smartphone industry. In just a few short years, this industry has gone through significant structural changes that provide different examples of how the theories of international trade are applied in the real world by people with real money on the line.

The interesting thing about international trade theory is that Ricardo's arguments have not undergone particularly rigorous analysis. In particular, as Learner and Levinsohn (1994) argue, there has been little empirical evidence processed. They point out that trade data is inherently quite noisy, which makes it more difficult to parse that data for evidence about trade. Technological innovation, the role of trade barriers, exchange rates—the reality is that any individual business decision is going to be made on the basis of multiple factors, so that comparative advantage is actually difficult to either prove or disprove.

The nations that develop the most advantages are expected to be the ones that flourish most in international trade. For example, Svaleryd and Vlachos (2005) highlight the role that access to capital has played in fostering trade. In the smartphone business, China was able to leverage both its manufacturing capabilities and access to capital through government-run banks and by tapping foreign capital pools in Hong Kong to quickly establish the type of manufacturing advantage that has won it a sizable share of the smartphone business. Indeed, China built its competency in assembling basic cellphones, then extended that over time to component manufacturing and finally, today, has reached the point where it is a manufacturer of high-tech intermediate goods (Amighini, 2004).

Building on basic international trade theory and comparative advantage is the concept of new trade theory. This theory holds that there are advantages other than comparative advantage. For example, economies of scale are built when a nation has comparative advantage, but even when the comparative advantage is erased, those economies still deliver advantage to justify trade (Lamy, 2010). When China was believed to be in a state of inflation that was going to wipe out its wage advantages in particular, it had already developed supplier networks and manufacturing competencies that allowed it to remain a major player in smartphone manufacturing. It is important, however, not to fall into the fallacy of thinking that just because comparative advantage need not exist means that it never exists—it is very much relevant still. Even China still has some cost advantages, particularly in assembly.

Another element of new trade theory is that multinational firms can seek advantage through differentiation, such as local market specialization, leveraging the reality that most markets are imperfectly competitive (Markusen, 1995). In smartphones, we are only now beginning to see localization in this industry, with low-price phones being launched in the developing world, while global manufacturers focus on the developed world for their most high-end products.

The Smartphone Industry

Building on new trade theory is "new new trade theory," which takes a look at international trade more through a multinational lens. The trade is not necessarily between nations, but is orchestrated by single multinational companies, leveraging the capabilities of other companies, and likely expanding the sourcing of a single product to a dozen or more countries (Kong & Song, 2011). An iPhone has at least eight major component supplier firms from a minimum of four countries, not including China where it is assembled and where many of the minor parts might be sourced (Xing, 2011).

Firm heterogeneity is at the heart of modern international trade theory. The data on firm participation in international trade shows that relatively few firms participate in international trade, and those that do tend to already have a certain amount of size and scale from which they derive some sort of advantage over their competitors (Bernard, Jensen, Redding & Schott, 2012). It is these most productive firms that are better equipped in terms of being able to enter into international trade, and thus there is an element of self-selection.

This pattern is also true of the way that the smartphone industry has developed. Initially, you basically had a niche industry catering to business clients—Blackberry and Palm. Apple entered with a consumer focus and that move transformed the industry. Where the two firms were vertically integrated specialists, very quickly these two were run out of the industry and the smartphone business was taken over by large multinational firms: Apple, Samsung, and HTC on the hardware side; Google, Apple, and Microsoft on the software side.

A smartphone is essentially a global product, especially at the higher end of the industry, as the major manufacturers sell all over the world. A smartphone is assembled from a wide range of components. Kong and Song (2011) noted that Apple is supplied by Samsung, Toshiba, Infineon, Broadcom, Cirrus and other major manufacturers. Of particular interest is the presence of Samsung on that list, given that Samsung is a major competitor for Apple. But this shows the value of comparative advantage in a firm-specific way, the perfect case study for international trade theory. Apple has at times sourced from its competitors—Google Maps was another instance where Apple was sourcing from a direct competitor. While this may seem counterintuitive, these decisions are made on the basis of that competitor being able to produce something better than what Apple could do. Apple Maps was never going to be as good as Google's long-established product.

But Apple is not seeking country-specific advantages. Samsung is a Korean company, while Google is American. Google's product is software, so we know that it is produced in the United States. This is simply a matter of Apple identifying that Samsung and Google were offering superior products. These were not cheaper, necessarily, but they performed their functions better than what Apple could do itself. When Apple was not worrying about having its own map app, that freed up Apple resources to focus on things it could do better. It was, thus, a waste of time for Apple to develop its own map app. One can understand the principle behind Apple's action, but it does not make economic sense—any more than turning away cheap oil from Venezuela or sugar from Cuba makes economic sense. The point is that where decisions are made on the basis of ideology, they might not be economically efficient.

The other thing that is highlighted here is that the firms in the industry are diverse, from a number of different countries. The components that they manufacture are not necessarily produced at those sites—they may be produced at offshore sites. So the international trade is essentially conducted at the firm level. It is not conducted between nations when we look at a modern product like the smartphone. Components come from anywhere, and the designs come from several different companies, and then the phones themselves are sold all over the world.

Firm-Level Advantages and Global Competition

The other interesting characteristic of the industry is that firms have risen to prominence by leveraging firm-specific advantages. Consider the case of HTC, which was one of the early success stories in smartphones. This company, from Taiwan, was an OEM parts supplier for early smartphones that were proprietary phones for mobile companies that wanted a phone with their own brand on it. This business surely derived from comparative advantage, but soon became a firm-specific advantage. It did not matter if HTC was Taiwanese or not—they could have produced their parts anywhere. The company had a competency in assembly and access to technology, from anywhere, that was not tied to a country but rather tied to firm capabilities.

There are other examples. In the developing world, where people want phones but cannot afford the Apple and Samsung products Western consumers prefer, smartphones are made by different producers. Xiaomi is now the largest player in the Chinese market, with Lenovo and Yulong also becoming significant players (Dou, 2014). Firms in the Chinese market have been able to leverage the competency and scale advantages, from which comparative advantage in price are derived as well as the market advantages in new trade theory, and the result is that they are starting to take over the domestic Chinese market. The next step will be moving into Western markets with these products. But part of the price advantage lies with a different business model, where the phones are almost a loss leader and Xiaomi in particular makes money back through apps on its own operating system (Dou, 2014).

Conclusion

The smartphone industry makes a good case study for both comparative advantage and new trade theory. Comparative advantage is evident when you have something "designed in California," where design quality is high, but manufactured in China from parts designed and made all over the world. There are strong country effects at work, including cost comparative advantages, that contribute to China's strength in this market.