Zatlin: When Will Apple Stop Screwing The U.S. Economy?

This article was originally published on Moneyball Economics, home of the world's most unique economic commentary.

Ty Cobb was a famous baseball player. Infamous, really. He set 90 Major League baseball records, some of which continue today. He was skillful but also mean; he had a reputation for playing dirty. Cobb was known for spiking other players: sharpening his cleats and sliding into them. Nobody much liked playing against him.

Apple Inc. AAPL is the Ty Cobb of corporate America. Like Cobb, Apple has set some impressive records. Nine years, a trillion dollars in sales, and almost no taxes paid. Apple risks having a legacy of tainted success and isolation.

The Apple Way

There’s a story I heard about electronics company Sharp. The company was about to go bankrupt and default on some major debt. This put Apple at risk, since Sharp was a major source of Apple’s LCD screens. The story goes that rather than come to Sharp’s aid, Apple instead approached the bankers and offered to buy the factory assets after bankruptcy – for pennies on the dollar of course. Talk about kicking someone when they’re down! True or not, when I share that story with others who have dealt with Apple, they shrug their shoulders and say that they aren’t surprised. That’s the Apple way.

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Business is not a popularity contest, but when the winner-take-all, cripple-the-other-guy approach goes too far and begins to damage the economy, it’s time to rein things in.

The issue at hand is the way Apple’s relentless greed has undermined the US economy and damaged its future industrial competitiveness. All so Apple can make $5 more per phone.

After oil and cars, smartphones are the US’ biggest import. Almost $100 billion of phones was imported in 2014 (per the Census Bureau). Half of them were Apple iPhones.

The trade in smartphones cuts two ways:

• It is singlehandedly keeping afloat the economies of China, Taiwan, Korea and Vietnam.
• The flip side is that it is steadily hurting the US economy, as I’ll show in a moment.

The Winners’ Circle

Korea: Roughly half of Korea’s IT exports are cell phone handsets or semiconductors. Thus Korea’s total exports are growing only as long as IT exports do. For Korea, with a slowing economy, the smartphone is the only thing standing between them and a big recession.

Taiwan: It’s the same story but even more so because Taiwan’s portfolio of exports is more tied to high-tech (unlike Korea which also sells ships and cars). Taiwan’s economy depends on exports which in turn depend on smartphone sales.

China: While China has a much larger and more varied economy than Korea or Taiwan, its growth is also now driven by smartphone exports to the US. China’s total exports to the US now rise and fall on the US consumers’ appetites for the next phone.

The US’ Loss is Everyone Else’s Gain

It’s like an unintended Marshall Plan for the 21st Century. The US is transferring $100 billion a year to three Asian economies, creating over a million jobs and helping them accelerate up the high-tech manufacturing ladder so that US jobs are now in jeopardy. In other words, the standard complaints about corporate America off-shoring production. But there’s a twist: the high-tech competitive advantage that we are losing has bigger, costlier consequences.

“Hold on a minute!” you might say. Assume that handing a $100 billion+ high-tech industry to Asia can’t possibly be in the US’s long-term economic interest. Why blame Apple? For starters, because Apple started the hollowing out of American semiconductor dominance and made certain that the critical jobs and manufacturing went offshore. Secondly, with 50 percent of the US smartphone market, Apple is the only company which can make an impact, but it won’t because that means losing $5 per phone.

Apple Undermining US Manufacturing

Nine years, a trillion dollars in sales, and almost no taxes paid. That’s just the starting point for wondering about Apple’s actual contribution to the US economy.

Apple’s success drags down the US GDP. The behemoth that is Apple sold almost 200 million phones last year, none of which were made in the US or used components made here. Instead of exporting $100 billion in iPhones, the US imported $50 billion. That $150 billion swing matters in terms of balance of trade, GDP and jobs. If you wanted to improve the US economy, there’s no better place to start than with Apple and smartphones.

Apple undermines the US manufacturing base. Assembly matters and manufacturing matters more. There was a time when Apple could have assembled phones and tablets in the US, but that would mean spending an extra $5 per phone since that’s approximately the extra labor cost to build that $700 phone here instead of in Vietnam or China. Assembly may not be a competitive, value-add step but it does employ a lot of people.

Unfortunately, it would also cut Apple’s profits by $1 billion, shrinking the company’s annual net income from $45 billion to $44 billion. Apple wouldn’t notice a drop in profits of $1 billion because it’s not putting its cash to use: Apple has $200 billion in cash conveniently parked outside of the US, not doing anything. On the other hand, assembling in the US would employ tens of thousands of people. A bit more productive use of capital, I believe.

Semiconductor manufacturing is more important in the grand scheme of things. It’s a fact that higher-skilled high-tech jobs create more wealth for an economy because they lead to innovation and new product development. Again, Apple could have its chips made in the US, by Intel Corporation INTC for example. Instead, Apple turned to Samsung (Korea) and TSMC (Taiwan), going offshore to save another few dollars.

With a healthy dose of Schadenfreude, one notes Apple’s struggles to compete with Samsung, its past and present chip manufacturer. When Apple turned to Samsung to manufacture chips, the company also transferred vital intellectual property. Samsung learned everything it needed to know to design its own chips and phones. Apple saved ~$2 billion per year. In return, Samsung gained $100 billion a year in smartphone market share.

But while Apple’s greed makes it penny wise and pound foolish, it’s the US that pays the price. Shifting manufacturing of the most cutting-edge chips has permanently eroded our manufacturing base and high-tech competitive edge.

Should the US offer a $1 billion annual manufacturing subsidy to Apple? Well, it actually already does, except the amount is closer to $15 billion. As part of Apple’s ‘Zen and the Art of Freeloading,’ Apple has found arcane tax rules that funnel sales through Ireland and dodge US taxes. The Senate found that in 2011 Apple paid the IRS just $2.5 billion in taxes on $128 billion in sales. Before someone points out that Apple’s success boosts US employment by a few thousand workers, the US economy would get much more of a boost if Apple didn’t work so hard to dodge its fair share of taxes.

Intel And US Economy Struggle Together

Intel, on the other hand, is a positive contributor to the US GDP. Intel’s factories are largely US based. Its $50 billion in annual sales means more US exports and fewer imports, the exact opposite of Apple.

Sadly, Intel is struggling. Its sales have been flat for four years in a row and the company’s product line doesn’t fit consumer demand. The PC world continues to stagnate and Intel’s semiconductor offerings are not used in the tablet, smartphone and wearable device world.

A big part of Intel’s problems is that it faces competition from the very companies that Apple directly employs (Samsung, TSMC). The result is falling production and a loss of competitive edge, both of which directly reduce the US economic strength. Last year Intel canceled a new factory in Austin. That was the first tangible sign that market share loss to TSMC and Samsung was taking a toll on Intel: lower demand for Intel products meant no need to expand production. Fast forward to this month: Intel’s latest earnings announcement included a steep reduction in capital spending – a 15 percent cut.

Intel tried to spin the CAPEX cut as a harmless thing when in fact it is a big blow to the company’s future. Intel’s entire competitive edge is determined by its ability to out-produce the competition and to be the technology leader. Ultimately Intel is just a manufacturer. Its issues are the typical problems plaguing economies of scale that come with improving production yield.

In the semiconductor world, yield is a real estate game. Semiconductors are built on 300mm silicon platters (aka wafers) and the manufacturing process follows a modern form of the lost wax casting technique: light-sensitive chemicals are layered on the silicon and ‘melted off’ via light. This creates channels that get built up like a layer cake and eventually become the transistors and resistors. The smaller you make that wavelength of light, the smaller the channels and the more transistors you can pack on that wafer. I call it a real estate game because it’s the equivalent difference between building 10-story and 40-story apartment buildings: same land, more money.

Intel has always been ahead of the pack when it comes to shrinking the light wavelength. It can crank out more chips per wafer, and has more factories to do the cranking. This enabled Intel to control the pace at which the industry shifted to smaller wavelengths. For Intel, it meant profit maximization because the company effectively dictated pricing and timing.

Well, not any more. Today, Intel faces stiff competition from Samsung and TSMC, both of whom can produce at similar volumes and using similar cutting-edge technologies. That’s really what the CAPEX cut meant: Intel has lost control. It’s incredibly difficult to regain control when you have not one, but two aggressive rivals.

How The US Has Fallen Behind

The big problem here is that the US lacks an industrial policy. China, Taiwan and Korea’s governments very clearly understand the economic importance of high-tech design and production. The US government… not so much. China fully understands the importance of high-tech jobs and especially semiconductors: it has ear-marked $10 billion in direct subsidies (or investments, as they euphemistically deem them). This isn’t steel or cement. Whoever produces the semiconductor chips has an edge with high-tech devices, and that means trillions of dollars.

I’m not suggesting that the US become protectionist. In some ways this is just another industry where our trading partners subsidize and incentivize local design and development and penalize foreign imports and production, all while the US government does nothing.

Except this time it is different. The US’ ability to make more or fewer cars was an economic and jobs issue. The US’ ability to stay competitive in the semiconductor space is a national security issue. Semiconductors are the engines for high-tech products, like super computers. Having the most powerful super computers is the linchpin of the US national security platform. (This is why it’s also an area of prime focus for the Chinese government.) With high-tech determining the economic growth of every country, enabling another nation to be more competitive makes no sense.

What is the burden of having Apple be the best it can be? Nine years, a trillion dollars in sales, and almost no taxes paid. And while Apple helps Samsung and TSMC build factories in China, Intel is shuttering factories in the US.

I have no issue with corporate greed per se; more often than not there’s a balance with the public good (lower prices, better products and services). When things become imbalanced, it falls on us, as a society, to re-align things. We need to step in here.

What to Do?

First, boycott Apple products. If you buy an Android phone you can take comfort in knowing that some of that money comes back to the US via Google, which does a lot to support the US economy. Second, let’s encourage Congress to close the tax loopholes that let companies like Apple hide from taxes. Third, don’t support a one-off tax moratorium on cash brought in from offshore. These companies are dying to bring the money back anyway. They dodged taxes to get it offshore, and now they want to continue dodging them to bring it back? No way.