In my previous post, Why the US Trade Deficit with China is Lower than you Think, I talked about the “Value Added” measure of the US Merchandise Trade Deficit with China and how this is more than 50% lower than the “Gross” measure published by the government. I recommend that you read this post - it’s a quick read - before sinking your teeth into this one.
In a nutshell, the reason that value-added measures of trade are more representative of reality than gross measures is the ubiquity of complex supply chains in today’s manufacturing. Today, countries assembling a final product source inputs and components from all over the world. While the country that ships the final product or exports to it to final customers gets credit for the entire value of the export, in reality the true “value added” by this country (in terms of actual production/assembling /packaging etc.) may only be a small fraction of total export value. I’ve explained this in detail in my previous post - Why the US Trade Deficit with China is Lower than you Think - using the example of the iPhone 7.
“Value added” measures of Trade Balances with China are especially relevant since China being the “factory of the world”, is in many ways the poster-child for today’s complex, multi-national, supply chain driven, manufacturing world. China assembles a lot of products especially in the consumer electronics space, where the value it adds is actually pretty small compared to the value of the final product exported to consumer markets, yet it gets full credit (100%) for the value of these exports.
Now Mr. Trump has been fixated on the large “Gross” US Merchandise Trade Deficit with China ($367 Billion for 2015 or half of America’s total Merchandise Trade Deficit with the world) and how this is evidence of all the jobs that Americans are losing to Chinese workers and the cheater that China is (Trump has accused them of currency manipulation) in the sphere of international trade. He has announced that he will tax Chinese imports at 45% if he is elected President. He believes this will help America increase it exports/output and save/add jobs.
The “Value-added” measure of US’s Merchandise Trade Deficit with China however, is less than half of the “gross” measure or less than $184 Billion (quarter of America’s total Merchandise Trade Deficit with the world)! What does this mean especially while evaluating Trump’s rhetoric and policy stance with respect to trade with China?
1. The fact that the value-added Merchandise Trade Deficit with China is really just half of the gross figure means that in reality, other nations from where China is sourcing intermediate products (materials, components etc.) should get credit for half of all US imports from China. This is indeed what happens under the value added approach. While the US Merchandise Trade Deficit with China halves under the value-added approach, Merchandise Trade Deficits with other Asian countries more than double based on OCED-WTO TIVA (Trade in Value Added) figures for 2009. We’re assuming these TIVA indictors are in the ballpark even today.
In the chart below, we compare USA’s 2015 Merchandise Trade Deficit with China, Japan and Asia (excluding China and Japan) on a “gross” and “value added” basis (remember these are just rough estimates based on TIVA indicators).
It’s clear from the chart above that if Mr. Trump has to worry about USA’s bilateral trade deficits, he needs to also consider Japan with whom the Value Added Merchandise Trade Deficit is approximately three-fourths as large as China! Even more important, is US’s Value Added Merchandise Deficit with Asian countries ex Japan and China (~30% of its total Merchandise Trade Deficit), which is larger than its deficit with China!
Bottom-line: This singular focus on China as far as the Trade Deficit is concerned, is an unwarranted exaggeration.
2. Here’s another important statistic. Around 55 cents of every dollar spent by American consumers on products “Made in China”, go to American producers, mostly service providers. This means that if Trump imposes tariffs on Chinese imports, these will end up hurting American businesses and American workers will end up losing jobs. Trump probably believes that these losses will be compensated by increased American output since domestic consumers will end up buying more American goods. But this is not guaranteed either.
3. China won’t remain passive if America imposes a 45% tariff on its exports. It will impose taxes on American imports as well. Hence, the supposed gain in output from reduced competition from Chinese imports might be counter-balanced or more than reversed by the loss of exports to China.
4. Finally, the situation isn’t as simple as it seems above. This is not just about final goods i.e. final exports or imports. There are many American products that source components from/are assembled in China, the iPhone being a popular example. In case tariffs are levied on Chinese imports, goods such as the iPhone will become much more expensive. Their sales will suffer which will ultimately harm American producers and workers.
Tariffs/protectionism seem attractive to workers who have lost their jobs to competition from cheaper imports (I understand their motivation and appreciate the hardships they suffer), but unfortunately, these don’t really help. Tariffs and protectionism lead to trade wars, which lead to lower international trade. Lower trade is harmful for everyone. It reduces output, raises costs for consumers and leads to the misallocation of national resources.
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