Globalisation has been a big driving force behind US companies’ earnings growth in the past decade, but the proposed ban on TikTok marks another sign that the end of this era has arrived.
A National Bureau of Economic Research (NBER) paper from Northwestern University economists quantified the positive earnings impact globalisation has had on S&P 500 companies. Taking China’s admission into the World Trade Organisation in 2001 as more or less the beginning of the globalisation age, they found that the average annual profitability of US public companies between 2003 and 2019 increased 11.5 per cent compared with the pre-globalisation period (1984-2002). The interesting thing was that this growth was primarily driven by foreign profitability increasing by 47.4 per cent for companies in the S&P 500, with more intangible assets created by research and development spending.
In other words, the US technology industry has benefited massively from globalisation. This makes sense; the US is where a lot of the high-margin innovation happens. These companies have then been able to outsource the manufacturing of the technology to China. Apple (US:AAPL) was the poster child for this: the parts for the iPhone come from suppliers across 43 different countries, and it is then assembled in China by Foxconn – where for the past decade the average wage was less than one-fifth of American counterparts.
It is the same profile in the semiconductor industry. Semiconductor designers Nvidia (US:NVDA) and Qualcomm (US:QCOM) have operating margins consistently above 40 per cent and 30 per cent, respectively. They achieve this by outsourcing production to Taiwan Semiconductor Manufacturng Company (TW:2330) in Taiwan.
It is no surprise then that one of the only companies trying to manufacture semiconductors in the US is also one of the least successful. Intel (US:INTL), which is now trying to ramp up its domestic manufacturing capacity, has been languishing behind its competitors. Its operating margin has historically been below 30 per cent, and in the past two years has dropped to almost zero.
The US Chips and Science Act is trying to rebalance production by offering billions of subsidies to build semiconductor manufacturing plants in America, but this is proving a lot easier said than done. TSMC’s Arizona plant has been delayed to 2025, while last month it was reported that Intel’s plant in Ohio has been pushed back to either 2026 or 2027.
These troubles are in stark contrast to the success TSMC has had in building in Japan. Last month, it opened a new plant in the country, having begun construction around the same time as the one in Arizona. Semiconductor analyst Kevin Xu said this success was down to the fact that Japanese workers worked longer hours for a third of the pay, and were happy to accept Taiwanese engineers’ help. When TSMC tried to move 500 of their experienced Taiwanese workers to Arizona, the local unions got together to try to block their visas.
The defining features of the 21st century have been globalisation, the progression of Moore’s Law (relating to the scaling power of chip production) and the rise of internet platforms. None of these would have been possible without the others. Increased globalisation allowed the cheap production of exponentially more powerful chips, which made smartphones cheaper to construct and put the internet in everyone’s pockets.
Now, rising political tensions between the US and China are threatening to undo this process. Last week, the House of Representatives passed a bill to force the divestment or ban of TikTok in the US. The law still has to pass the Senate, which is less likely. But the move is part of a wider trend.
Fear of China has already led the US to ban the export of its most powerful AI semiconductors to China. The US government has also restricted Dutch semiconductor equipment manufacturer ASML (US:ASML), preventing it from selling its most advanced lithography machines to Chinese customers. However, China is already finding ways to adapt. At the end of last year, Huawei announced its new phone, the Mate 60, would use a powerful 7nm semiconductor. Correspondingly, iPhone sales in China dropped 24 per cent in the first six weeks of this year, according to research business Counterpoint, partly because Chinese customers decided to use the Huawei phone instead. Apple’s share price has dropped 7 per cent in the year to date
In the long run, capitalism usually finds a way to prevail. After all, Apple is already looking to outsource production to India. But globalisation’s beneficial impact on corporate America shouldn’t be underestimated. Globalisation hasn’t helped everyone, but it certainly benefited the US stock market, and unwinding it will not be a pain-free process.
