Living on the Edge: Can We Thrive Independently? Conversation with Patrick McGee

Heat.

Well, the book was written a lot more quickly than that. I like to joke that the book came out of the failure of being an Apple reporter at the Financial Times rather than the success of it. And what I mean by that is it wasn't a bunch of ideas that I had already written and then sort of padded them out to make a book. It was a realization. I think this is the summer of 2022 or 2023 where I realized I really didn't know how Apple made its products. I mean, the back of the phones don't anymore, but they used to say designed in California, made in China. So everyone knew that part, but who were they working with, what sort of investments were taking place, and how did Apple react when Xi Jinping came to power and took China in a very different direction? These were answers that I really didn't know. And then what I came to understand by talking to operators and manufacturing design engineers of the company, I think I just found them absolutely staggering. So the two numbers that will forever be associated with the book are that Apple since 2008 has trained 30 million people in the supply chain. So bigger than the labor force of Canada, bigger than the labor force of California. And when Apple sort of comes under pressure in 2015 in China, where they worry they're going to be the next Facebook, the next Google that is, blacklisted in the country, they do their own supply chain study and realize that they're investing $55 billion a year into China.

Yeah, training, machinery, and some of the construction.

Well, that was just one year. And then they realized in a sense the political capital benefits of what it meant to report that sort of internally through private meetings to Beijing. So, you know, Xi Jinping comes to power in March 2013, and within 36 hours of him coming to power, Apple gets attacked by CCTV, the state-sponsored CNN, if you will, of China. And Apple is sort of flailing in its response. It doesn't really understand why it's under pressure. And it's really because they had these gargantuan operations, but there was no factory that said Apple or had a bitten fruit outside, right? And so they were operating under the radar. And the thing that people didn't know, and in fact, I didn't know when I was an Apple reporter, is that Apple doesn't just sort of come up with designs in California and then send them to factories in China already capable of performing what Apple needs them to do and then sort of sends them back. Apple sends engineers literally by the plane load over to hundreds of factories across China to sort of get everybody up to speed and if necessary purchase the machinery in the billions of dollars in the aggregate to actually get that all done. So again, the numbers can just be staggering. So, there were two times, one in 2014, one in 2016, where Apple convinced United Airlines to begin flying non-stop from San Francisco to two different Chinese cities that they'd never operated in. And basically said, "We need you flying there three times a week non-stop, and even if the rest of the plane is empty, it won't matter. We will buy so many first class seats that it'll be profitable for you."

No, nothing like it. I mean, when I would talk to someone that worked at say Motorola in 2010 or on the Pixel team for Google, they would say, you know, every once in a blue moon they would go to China and everybody else in first class would work for Apple. So there's that. The other staggering statistic is I stole this from Shannon O'Neal, who I think spoke here once, from CFR, and she says that between the signing of NAFTA in 1994 to 2020, American and Canadian businesses invested some $250 billion into Mexico.

Apple pledged to invest $275 billion just between 2016 and 2021 solely in China.

Yes. So, if it sounds like I'm maybe attacking Apple or I'm too anti-Apple, this is where I score the points that say I'm actually very pro Apple in certain respects. Apple is nearly bankrupt in 1996, in 1987, and again in 2000. They are not the company we know today in the period when they begin to outsource and offshore. In fact, Apple is the last holdout. In the late '90s, they are the only American company trying to build everything in America. That's how the company was founded. Two guys named Steve in a garage in 1976. And they're basically outcompeted not in terms of the capability of the individual computer, not in terms of the graphical user interface, but in terms of how to manufacture at scale and run global distribution and logistics. IBM, Compaq, Dell, Gateway, all these computer companies just did better than Apple, and Apple struggled to compete and was nearly bankrupt again three different times. So when Apple goes to China, they are late. But in the same way that they are late to MP3 players, but they create the iPod, they are late to smartphones, but they create the iPhone. They are late to China, but they discover what's possible in China. They sort of it's a success of imagination. They're able to understand that we don't just have low cost and abundant labor here. We have an ability to recreate how products are going to be built. So they're like anti-automation in a certain sense. They're building things in a way that's automation unfriendly because they recognize the capacity of what China can build, and they end up orchestrating just huge industrial clusters that require hundreds of thousands of people operating on Apple items frankly only sometimes for 8 to 12 to 16 weeks at a time. And it's all off balance sheet, and so it works wonders for Apple. But my point here is that Apple, like everyone else, was actually sort of encouraged by Washington at the time to create these links. And I don't hold that position in bad faith or I don't hold anyone to account for that per se. I mean, one could, but my point is that America had sort of played a starring role turning West Germany, Japan, Taiwan, Korea from authoritarian countries in various ways to middle classes with thriving democracies. America thought we could do the same thing with China. So there were solid reasons for that.

Yeah, absolutely. I mean, you think of something like Teach for America, you know, this organization founded by Wendy Kopp, I want to say about 20 years ago. It really rekindled a sort of sexiness into going into teaching, right? People coming out of Harvard or MIT or Princeton would want to go spend two years teaching. We need something like that for manufacturing. I mean, it's looked down upon in America like it's not a job with an abundant future, and yet it absolutely could be. I used to live in Germany where it actually does have that appeal, right? Going off to work at BMW has a real appeal. I would love to see more of that in America, and actually if there's one thing that I think the Trump administration should be asking of Apple, it's to invest in massive education programs. I think Apple frankly owes it to us. They've made the commitments anyway. They're kind of nonsensical commitments, but this would be a tangible thing that they could actually do. And if someone in the audience is familiar, I mean, Apple actually has done this in Detroit, but the scale is phenomenally small once you consider that they have done vocational training for 8 million people in China. That's in addition or separate from the earlier figure I cited about how many people they've trained in manufacturing.

Yeah. Wendy Kopp has been here many, many times. Anyway, Patrick, you mentioned to me before that Apple is squeeze. You call it like a squeeze model with the suppliers in China. Can you explain a little bit about that?

Yeah. So, there's this stunning statistic. I would say this is the most stunning statistic about Apple. They have never had more than 20% of the global market share of the smartphone, right? That's the most iconic device of the 21st century. Routinely, they take 80% of the global profits. I mean, how is that possible? Find me another industry where a minority player commands absolute dominance. And the answer isn't just that the iPhone's an expensive product. I mean, frankly, the most expensive smartphone I'm familiar with is from Huawei and it unfolds twice. It's like an iPhone and an iPad in one if it were an Apple product. The reason why is that hundreds of their suppliers work for either zero margin or in fact even lose money at times, or they just work for 1% or 2% margins. And the reason they're willing to do that isn't just the incredible volumes that Apple creates at. It's that they are doing the Ivy League equivalent of training, of engineering training, for the factory workers to all sort of come to grips with what it is that Apple expects. So if you have that Hollywood image of Steve Jobs who can be maniacal and obsessive, but if you can bear it, he sort of raises up the capabilities of everybody around him. The story of Apple in China is that but through hundreds of factories across China. And I want to give great credit to the people in China, the industrial policy of China, etc. This is not an anti-China book. They got to where they were because they were offering things that nobody else was offering. And it really only would have happened because of those skill sets and that hardworkingness. So often it wasn't so much that Apple already knew how to build something and then they taught the Chinese. It's that the engineers would co-create something with these suppliers, and that's an important point, but then Apple would hold the intellectual property and sort of lord it over this poor supplier, if you will.

I like to play to the audience, right? Mexico is the [laughter]

I'd love to see it if we could.

So, let me come back to Mexico in a second because I think that's an important discussion and we can probably spend lots of time talking about it. In a superficial way, the only country that can compete with China in terms of its size is clearly India. It's actually a more populous country. The wages in India are comparable to where China was 20, 25 years ago. Unfortunately, and this is maybe I should say this is Apple's plan right now, right? That they're ostensibly at least diversifying to India, expanding to India. You know, they would like to say to China that they're not retreating from China, they're expanding to India. Certainly, Apple doesn't use the language of de-risking or decoupling. They really can't do that. They've got too much at stake. But unfortunately, the superficial differences, I'm sorry, the superficial similarities are there. The differences are profound. And as much as Apple could try to copy and paste the playbook they've had over the last 25 years and do it in India, which again I think is kind of the current plan, they're going to face three major headwinds. One is that the more successful they are at expanding to India, the more China can just tighten the screws. And we've actually already seen this in the last couple months. So Foxconn has had Chinese workers recalled from India back to China. And customs, when it understands that machinery made in China is headed to a Tata production line for the iPhone, it gets blocked. So that's Beijing in action basically making sure that technology transfer is a one-way gate. It comes into China, it doesn't leave. Second is Apple has a gargantuan business within China. $70 billion a year of products sold in China. It's difficult to wrap your head around how big that is. There are only a dozen companies in the world that make more than $10 billion of revenue in China. And Apple's making $70 billion. And the risk there is that the more that Apple is seen as the poster child of Western de-risking from China, the more that $70 billion business is at risk. There's already fervent nationalist sentiment within China to buy Huawei, to buy Huawei, sorry, to buy Huawei, Vivo, OPPO, etc. You know, there have been reports that government workers aren't allowed to buy iPhones anymore at least for business use, etc. And so you know, I think that can really be ramped up. And then the third problem is just the Apple people that I speak to that are in India just aren't convinced that the country is operating at the what they used to call China speed, right, or Shenzhen speed. China is just really difficult to compete with. So even if Apple really was sending absolute plane loads of engineers to India, who's building the world-class ports? Who's building the high-speed rail? Who's building the eight-lane highways? Very difficult to do that for anyone to compete with China.

Well, I can give you the answer for when Apple started noticing. I mean, I was living in Hong Kong in 2013 to 2016, and I remember my own kind of awakening was actually just reading an article that I still recommend. It's by Evan Osnos of the New Yorker. It was called Born Red, and it was about Xi Jinping, and I thought there must have been some typos in the article because it was about how many people had been purged under his reign, and it was in the hundreds of thousands, and I mean that's just an incomprehensibly large number. It was a correct number, to be clear. So that was mind-blowing for me. But Apple had a similar kind of awakening. I mean, people might not remember when Xi Jinping comes into power, the consensus was that he was going to be a big reformer, and in fact, his father was quite famous as a reformer and played a role in Guangdong, which is the province where Shenzhen had its big reform and opening up period, sort of capitalist experimentation. And he's actually purged as a result of sort of being such a liberal, in the American sense, I should perhaps state. And so it takes some time to figure out that Xi Jinping is more like Putin than Deng Xiaoping. And so for Apple, who's really not that savvy in the early 2010s with how Chinese politics worked, like one kind of joke I make is that people often know Foxconn, the Taiwanese giant that Apple outsourced its production to. But they also outsourced their politicking to Foxconn. In fact, Foxconn wasn't just brilliant at making stuff. They were brilliant at sort of speaking the political language of, you know, getting support from the local cadres to build factories, to get state subsidies for machinery, to get the hands necessary for their lines by having migrant labor come from the country, the rural hinterlands. So Foxconn is this instrumental power not just in terms of building things but in actually sort of working the political system in Apple's favor. And they do such a good job that Apple basically remains ignorant of it. I mean, they don't have anybody living in the country that is senior. No vice presidents or anything like that. When Xi Jinping comes into power and within 36 hours of his ascent Apple gets attacked, and they really don't understand why they're attacked, and it becomes this political awakening, this moment where they sort of realize we don't understand the culture. We don't understand the people. We've somehow become the world's biggest operator in China with the world's biggest retail business in China, and yet we fundamentally don't know why they're mad at us and what we need to do. And then sort of the narrative in a sense is off to the races. So to answer your question, the Apple engineers that are flying there are living this Groundhog Day existence where they're not learning Mandarin on the side and pontificating about state affairs. They're just trying to ramp up the iPhone. And you remember this goes from 5 million units in 2007 to 230 million by 2015. There is no time to do anything else. And so it takes Apple some time to realize that Xi Jinping is really taking the country in a different direction and really putting pressure on Apple to give back. And so the policy in China ends up being called in China, for China. And if you sort of fast forward today, I think that's pretty equivalent to America First. And in fact, one reason I'm being a little bit cheeky here as to why Tim Cook is so good at placating Donald Trump, it's that he's got 12 years experience of placating Xi Jinping.

It's a nonsense figure. I mean, I'm going to break the protocol in the North Capital Forum very soon and I'm going to allow for some questions to Patrick soon. Okay. So, be prepared if you want to make a question on this topic. And I don't know if we can prepare a couple of mics. Let's talk a little bit about ally shoring. You mentioned ally shoring. We brag about that at the US Mexico Foundation because another economist from Michigan, they started talking about ally shoring before the friendship tour of President Biden came out, and you mentioned the alignment of China with other countries. Can you talk a little bit about those differences, the alignment of China with North Korea and others, and then the US and which countries are playing the allies of the US nowadays? I mean, it looks like I don't know who is the top ally right now for the US.

On supply chains and then...

Yeah, so I'm going to riff on the first question you asked, which is just sometimes I get asked why is it a problem that we're so dependent on high-end electronics manufacturing, or why is it such a problem that Apple's dependent on China. And of course it's because the relationship could blow up at any day. I don't know that it will blow up, but you just think of the fact that there are two major wars going on. Ukraine versus Russia, Iran versus Israel. And there's the potential for a conflict always between North Korea and South Korea. China's on the other side of all three of those conflicts. To have total and utter dependence on executing anything that comes out of Apple's portfolio every year on that country, I don't care if you're China hawk or not. That's just a terrible idea. I mean, supply chain 101 would say don't put all your eggs in one basket. Doesn't help if the basket's a surveillance state.

Yeah. I mean, Elon Musk has a good line about it where he said decoupling would be like performing surgery on symbiotic twins. Like the likelihood is that both would die. And I agree with that. It's maybe more flagrant metaphor than I would use, but yeah, I mean, look, I think the number one policy goal in terms of supply chains for Washington should be replicating in a sense everything that China's capable of outside of China. And where I think the administration gets this wrong is they think America is the answer, right?

And I just think that's nonsense. You know, what America, it's tougher to say this these days, but where America really differentiates versus China is in its allies and in its ideals. And so I think the more manufacturing capacity that you have in Mexico, the more that it would actually supplement it having it in the US. When there's stuff made in Mexico, it's often the case that 40% of the parts are coming from America. When it's made in China, there's really no American contributions. Maybe there's IP from Qualcomm or something like that. So the narrative just needs to be that reshoring is not in conflict with nearshoring. And the more nearshoring you have, the more it'll actually be good for America as well. So I'm okay with tariffs on China, but it just has to be one part of the toolbox rather than the answer to everything.

I would love to be wrong about this. I mean, and there's probably people in this room that are far more sort of up-to-date as to what's going on in the White House, but no, I don't see that. I see them pursuing a fantastical position of thinking that things really can move to the US. I mean, just to sort of give it some numbers, cuz sometimes it sounds like I'm just being pessimistic for no reason. In a sense, the secret sauce of China's manufacturing capacity as it pertains to Apple is what in China is called the floating workforce. So China's census counts this type of worker. So these are people that are born in the rural areas of China and they become temp workers by going to places like Shenzhen or Suzhou. But they're temp workers by definition. There's actually, they're discriminated against as second-class citizens within their own country. They're not allowed to settle down permanently. They can't have their children there and have them go to public school. They can't retire there. They're limited in what benefits they can get. The number of people that fall into that category is 300 million people. So what's that? Twice the population of Mexico. Good luck competing, right? It's greater than...

Exactly. And so, you know, when we talk about reshoring, it's not just about the factories, it's about the entire ecosystem. And that's why I think the focus should be on building up capabilities in allied countries, not just trying to bring everything back to the US.