Burning Innovation (Bobby Yip/REUTERS)

I’ve always assumed that the future of the American economy relies on its continued edge in innovation. Well-designed, high-tech products from smart, creative companies, like the iPhone from Apple, would ensure that the U.S. could compete with and stay ahead of China and India. Of course, that’s still true. But a recent study by the Asian Development Bank Institute gives us a different, more sobering perspective on the role high-tech products are playing in the American economy.

The researchers, Yuqing Xing and Neal Detert, tracked the manufacturing process of the iPhone and disturbingly discovered that the iconic American invention was contributing significantly to the U.S. trade deficit with China – adding $1.9 billion to that deficit in 2009, in fact. Why is that? The reason can be found in the globalized production system, in which products are designed and manufactured in multiple countries. The result is that American-designed products, even high-tech ones, don’t end up increasing American exports. Here’s what Xing and Detert concluded:

Even high-tech products invented by United States companies will not increase US exports, but on the contrary exacerbate the US trade deficit…Global production networks and highly specialized production processes apparently reverse trade patterns: developing countries such as the PRC (China) export high-tech goods—like the iPhone—while industrialized countries such as the US import the high-tech goods they themselves invented.

So what does that mean for the U.S. economy? It all depends on how you look at the iPhone, and where its value lies.

First, let’s look at exactly how the iPhone is manufactured, and the impact of that process on U.S.-China trade. Conventional economics tells us that since the U.S. has a clear technological advantage in designing a product like the iPhone over the still-developing Chinese economy, the U.S. should be exporting iPhones to China. That’s the kind of theory you learn in Econ 101. But, as the ADBI study shows, that’s not what’s actually happening in the new world economic order – because Apple has outsourced the manufacturing of what it has designed. The ADBI study says that iPhone parts come from nine different companies spread across the world — China, South Korea, Japan, Taiwan and the U.S. — which are all brought together for final assembly to factories located in the Chinese industrial enclave of Shenzhen. From there, the iPhones are exported around the world, including back to the U.S. The end result is a country (China) exporting a product that it couldn’t possibly have the know-how to design at its level of development, and adding to the U.S. trade deficit with China.

So what do we do about it? Xing and Detert conclude that factories are important to the U.S. economy. If production was moved from China back to the U.S., they figure that Apple could still get an acceptable profit even though labor costs incurred in the manufacturing process would be significantly higher, while contributing to U.S. jobs and exports:

If iPhones were assembled in the US the total assembly cost would rise to US$68 and total manufacturing cost would be pushed to approximately US$240. Selling iPhones assembled by US workers at US$500 per unit would still leave a 50% profit margin for Apple…In this hypothetical scenario, iPhones, the high-tech product invented by the US company, would contribute to US exports and the reduction of the US trade deficit, not only with the PRC, but also with the rest of world. More importantly, Apple created jobs for US low skilled workers; those who could not be the software engineers needed by Apple. Giving up a small portion of profits and sharing them with low skilled US workers by Apple would be a more effective way to reduce the US trade deficit and create jobs in the US.

That sounds obvious, right? Well here’s where things get interesting. Xing and Detert also make the case that the way in which trade statistics are calculated greatly inflates the value of the iPhone to China and thus distorts the nature of the U.S.-China trade relationship. China gets the credit for 100% of the iPhone’s export value, even though it is only assembling the product designed elsewhere from parts that are made elsewhere. In reality, Chinese workers are adding very little to the value of the iPhone in the manufacturing process – a mere 3.6% of the total cost. Calculating U.S-China iPhone trade based on the actual value added to the product in China changes the entire picture – in America’s favor. In fact, because some parts assembled into the iPhone in China are shipped there from American factories, the U.S. ends up with a trade surplus with China on the iPhone:

Most of the bilateral deficit associated with iPhone trade did not originate in the PRC as PRC workers contributed a very small portion of the value-added to an iPhone sold in markets…It costs only US$6.50 per unit to assemble all parts and components into a ready to use iPhone. The assembly cost accounts for merely 3.6% of the total manufacturing cost… If iPhone exports from the PRC to the US were calculated based on the value-added contributed by PRC workers, i.e., the assembling cost, the value of the PRC’s iPhone exports to the US would be much smaller, at only US$73.5 million. Accordingly, the trade deficit associated with iPhone trade would also drop substantially…The PRC imported US$121.5 million worth of components from the US companies Broadcom and Numonyx for assembling iPhones. Based on the value added approach, the US would have no deficits but a US$48 million trade surplus with the PRC in iPhones related trade.

Slicing the iPhone in this way, we can see that the real value of the iPhone isn’t in the manufacturing process at all, but lies in its design and the development of its components. And by owning the technology and design, the U.S. also gains in global trade, even though the iPhone isn’t manufactured in America. What the study fails to point out as well is that by manufacturing in China, Apple can gain higher profits on the iPhone, profits that then can be reinvested to develop new cutting-edge products the world wants to buy, helping the U.S. keep its technological edge over China. So from this perspective, the globalized manufacturing system is working. That’s how The Wall Street Journal read the study. The U.S. shouldn’t start a trade war with China over flawed and misleading statistics, the WSJ says, but find ways to help the U.S. business better capitalize on globalization:

Trade has always benefited the U.S. economy. So rather than launching a trade war with China over $6.50, here’s a better agenda for the 112th Congress: Focus on policies that will help Americans and U.S. companies better capitalize on a global economy. That includes tax policies to reward investment and entrepreneurship; environmental regulation that doesn’t discourage manufacturing in America;…and free trade to let Americans import goods like iPhones that will spur new growth.

We may never be able to fully determine who really wins and loses from a product like the iPhone. The global manufacturing system has just become too complex. But if anything, this fascinating ADBI study tells us that the real world of trade today differs greatly from what we see in statistical charts, and the benefits and costs of that trade aren’t always what they appear to be.