The Trade Deficit and the Fall of the House of Hardware

Investors and politicians should understand the move of computer manufacturing to China

Source: Apple

A trade war with China is daft because our most important industry is on the other side of the fence. Computer hardware left these shores a decade ago. It’s not coming back.

Hardware-makers, and then brands, abandoned the U.S. because high labor costs and environmental concerns (chip-making is very messy) meant profits would be found only where there was abundant labor and no such concerns.

China took the dirt, guaranteed low wage and regimented workforces, and U.S. CEOs went for it, knowing that the real profits were in the designs, the software and the branding.

During this century, Hewlett-Packard split in two, the “bad” hardware part becoming HP Inc. (NYSE:HPQ), Dell went private, and International Business Machines Corp. (NYSE:IBM) sold most of its manufacturing to China’s Lenovo.

Was Apple Inc. (NASDAQ:AAPL) an exception? No, it exemplifies the deal.

My Brains, Your Brawn

Apple failed in the PC market during the last century because Steve Jobs insisted on controlling its intellectual property and could not scale manufacturing against a host of Original Equipment Manufacturers (OEM) based in Taiwan, with factories in China, making cheap Windows machines.

After returning to the company and coming up with the iPod, Jobs resolved not to make the same mistake again. Chinese manufacturing by this time had scaled to capture entire markets, so that’s where the iPod was made.

The same with subsequent inventions, including the iPhone, which slipped into an existing structure where Hon Hai Precision Industry, known as Foxconn, built and ran the factories making the gear. Stock in Hon Hai, traded on the Taiwan exchange as number 2354, is up 432% this century as a result.

Apple, by comparison, is up over 4,100%!

The deal was great for both sides. China had workers who needed jobs and was willing to turn a blind eye both to how they were treated and the pollution their factories caused. Apple got the money. This is the way global development works. China, in fact, is now outsourcing low-skill work to countries like Thailand, Burma and Indonesia. Those economies are prospering.

Computer Hardware Is Software

The move of hardware manufacturing to China has obscured the most important fact of our 21st Century technology world.

Hardware is software.

The most successful chip company of our time, Nvidia Corp. (NASDAQ:NVDA), doesn’t own a chip-making factory. It designs chips and has those who own factories manufacture them. Most successful chip companies today are “fab-less,”  thanks to what I call “Moore’s Second Law,” the fact that, as chips get more complex, the capital cost of making them also goes up exponentially.

Another illustration comes from the current decade’s chief trend, the cloud. The “cloud czars” — Apple, Alphabet Inc. (NASDAQ:GOOGL)(NASDAQ:GOOG),, Inc. (NASDAQ:AMZN), Microsoft Corporation (NASDAQ:MSFT) and Facebook, Inc. (NASDAQ:FB), are all in the software business.

They work to minimize their cloud capital expenditures by assembling their own hardware from commodity parts and using open source software. The money comes back in software they then write which provides services to billions.

The Bottom Line

Intellectual capital, not financial capital, and not manufacturing expertise, is the way to success in the 21st Century. America has proven this.

China is trying to follow what America has done, to become more like us, to compete on an equal footing. But while they’re working to match what we are today, our technologists are busy inventing tomorrow, with cloud applications, space vehicles, and biological breakthroughs that can save this planet for our grandchildren.

The “trade debt,” especially in hardware, is just a cost of goods sold, a piece of the puzzle that leads to profit. American tech companies know that. American investors and political leaders need to understand that.

Dana Blankenhorn is a financial and technology journalist. He is the author of the historical mystery romance The Reluctant Detective Travels in Time, available now at the Amazon Kindle store. Write him at [email protected] or follow him on Twitter at @danablankenhorn. As of this writing he owned shares in MSFT and AMZN.


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