iPencil and iPhone
View(s):Leonard Read; I am not sure whether he was a poet or an economist, probably a “poetic economist”. He has published a lot. Among them, a famous short story titled “I, Pencil” which he published in 1958 in the magazine The Freeman, explaining the power of “invisible hand” or market mechanism. As this character in the story – the Pencil -, tells us, don’t lose market freedom that you enjoy: “If you can become aware of the miraculousness which I symbolise, (the Pencil talks), you can help save the freedom mankind is so unhappily losing.”
I thought of taking a bit from this story to distinguish between old production and trade patterns and their modern emerging patterns. In doing so my purpose is to stress the importance of getting to know the global economic dynamics; otherwise when we realised that we have been left out from global dynamics, it might be too late for us.
I do not intend to talk about market mechanism or economic freedom, as the Pencil does, but the underlying truth of my story is also the same.
In the good old days…
A lead pencil in Leonard Read’s story explains its genealogy: “Pick me up and look me over. What do you see? Not much meets the eye—there’s some wood, lacquer, the printed labelling, graphite lead, a bit of metal, and an eraser.” At that time – mid-20th Century, there were about one-half billion wooden lead pencils of this kind which were produced each year in the US.
The wooden part of the pencil is made of a cedar of straight grain that grows in Northern California and Oregon. The cedar logs are shipped to a mill in San Leandro, California to cut into tiny and shiny dried pieces. The graphite lead comes from Ceylon (Sri Lanka) by ships. Graphite is mixed and blend with other chemicals such as clay from Mississippi and, wax from Mexico. Substance for its eraser is a rubber-like product made by reacting rapeseed oil from Indonesia. The pumice comes from Italy, and so on.
As in this story, the pencil, seemingly simple, is made by millions of people working in different parts of the world who actually respond to nothing but the invisible hand or the market mechanism. All their responses were guided solely by an “invisible hand” resulting in a simple manufactured product – pencil.
International trade at that time
My point here is about the world’s international trade in the old days: The pencil is manufactured in one location. For its manufacturing process, “raw materials” are supplied and shipped from many other locations around the world. After the manufacturing process, the pencils are shipped back to many different parts of the world, including to those countries which supplied its raw materials.
This is a main feature of the world trade pattern that dominated until the 1980s. The raw material suppliers were known as the countries in the South or “underdeveloped” countries. The producers of manufactured goods were known as the countries in the North or “industrialised” countries. Underdeveloped countries exported their agricultural produce and mineral resources as raw materials of manufactured goods to the industrialised countries. Manufactured goods were produced by industrialised countries and exported underdeveloped countries.
It was the North-South trade pattern or trade between industrialised countries and developing countries. It was an exchange between raw materials and manufactured goods.
Modern trade patterns
Garment factories like this are examples of how raw materials are sourced from others.
A main feature of the emerging modern trade patterns in the world is dominated by global value chains: most of the manufactured commodities are no more produced by a single company in a single country. Therefore, today it is difficult for us to find our favourite “authentic brands” produced in one country.
Let me take a little-sophisticated manufactured good for an example – iPhone. Probably, iPhone is the most studied case and, the most quoted case study in respect of “globalised supply chains”. This is because Apple in the US is one of the companies that has used the globalized supply chain for the cost advantage of its iPhone without compromising on the quality.
If Apple’s i-products such as iPhones, iPads and, iPods are made in the US, not only the cost would have been higher (causing higher price of the devices), but also the tax spending would have been higher (causing lower profit margins).
Global outsourcing
Apple’s iPhones are produced in and exported by China, according to international trade statistics. But in reality, they are produced in “parts and components” by many different companies located in many different countries, and finally assembled in China.
Software development and product design takes place in the US. Then, different parts and components are produced and supplied by Japan, Germany, Taiwan and, South Korea. Companies in these countries are also said to have outsourced the fabrication of parts and components to some other companies located in the countries such as Singapore, Malaysia, Thailand and, Philippines.
Apple’s i-products as well as many other electronic and electrical goods of different brands are now assembled in and exported by China. According to a study of the Asian Development Bank Institute in 2012 by Yuqing Xing, in 2009 China exported over 25 million iPhone units; each one was priced at US$ 179 out of which China had added $6.5 only. Similarly, in the same year China exported over 108 million units of laptops; each one was priced at $484 out of which China had added $14.5 only.
What made it possible?
Global outsourcing is the growing trade pattern today. In old trade patterns, as in the case of “I Pencil”, there is one manufacturer located in one country (most in an industrialised country), while other countries (particularly developing countries) are connected to it by supplying raw materials.
In modern trade pattern that is still growing, countries are manufacturers producing “parts and components”, each one undertaking a task that it can perform at best:
hence, the product is “Made in the world”. Even in our familiar manufacturing products such as apparel, footwear, sports goods, and rubber products, there is the presence of global supply chains.
Apparently, global supply chains have multiplied the world’s capital flows, trade flows, transport, communication, and technology transfers. The cost of these activities of global connectivity should be small enough to make the global outsourcing more advantageous. In fact, with technological progress in these areas of connectivity and liberalisation policy reforms in developing countries it has been so and global outsourcing in production has been progressing.
Policy implications
Globalised supply chains allow countries to grow as groups rather than individuals. When China was growing there were many other countries that were growing together with China. Even a tiny increase in import duties or taxes can completely wipe out the possibilities of connecting to global supply chains. Therefore, trade liberalisation is an important condition that enabled developing countries to integrate with global supply chains.
The development of global supply chains has made the old argument for “value added production” a redundant one. This might make some of us even angry about it. But what is important now is not the unit value addition, but the volume that is produced and exported.
Sri Lanka
South Asia has not performed well enough with respect to the development of globalised supply chains. According to the estimates by Prof. Premachandra Athukorala (2016), more than half of manufacturing exports from ASEAN countries comprised “parts and components” to global supply chains, while in South Asia it remains just a little more than one-tenth.
The role of India in the South Asia region is also different from the role that was played by China in the East Asian region. India’s development is more of its own traditional lines; other countries in the region have not integrated with Indian supply chains.
Even though it is not much, Sri Lanka has exhibited signs of integrating into global supply chains more than many other countries in the region. But
Sri Lanka’s potential in this particular area production and trade is huge and not exploited yet. It requires policy reforms for global integration by recognising the global dynamics in production and trade.
(The columnist is professor of economics at the University of Colombo. He can be reached at sirimal@econ.cmb.ac.lk).