Trade agreements and the Trade Deficit have come under acute focus during Trump’s campaign. The subject matter of international trade is fairly complicated and consequently, not very well understood. There is so much to talk about and clarify here. In this short note, I will talk about China’s Merchandise Trade Deficit (includes only goods, not services) with the US, which has been one of Trump’s pet subjects on the campaign trail.
Note: US runs a surplus in its trade of services with China, which is why it's the trade in goods i.e. the Merchandise Trade Deficit with China which has been Trump's focal point of assault.
Note: US runs a surplus in its trade of services with China, which is why it's the trade in goods i.e. the Merchandise Trade Deficit with China which has been Trump's focal point of assault.
I’m not going to challenge Trump’s view of international trade in this post (I’ll do that in others). I’m simply going to explain why the Gross Trade Deficit measure of bilateral trade (especially with China) can be misleading.
Let’s use the iPhone 7 for Illustration
The unsubsidized cost for a 32GB iPhone 7 in the US is $649. IHS Markit estimates the Bill of Materials (BOM) for the iPhone 7 at ~$220/unit.
What is the “Bill of Materials” or BOM, you ask? It is the list of raw materials, components and assemblies required to manufacture a product.
This BOM for the iPhone 7 does not include labor costs. These costs are pretty hard to estimate. Based on an audit carried out by the Fair Labour Association (FLA) at a Foxconn (a top Apple supplier in China) factory in 2012, ABC news reporter Bill Weir, who was invited to tour along with the FLA representatives, estimated labor costs per iPhone at ~$12.5. IHS Markit estimates labor costs/iPhone 7 at just $5. Other experts have also estimated these at <$10/unit.
Let’s assume an average labour cost of $10. After adding factory costs etc. to the labor cost, let’s assume the production cost for the iPhone 7 is $15/unit. This implies a total cost per unit of $220 + $15 = $235.
So each time a fully assembled iPhone 7 is shipped to the US from Foxconn’s Chinese factory, USA’s Trade Deficit with China rises by $235. The problem here is that China is basically just assembling the iPhone 7. The components are sourced mainly from other countries such as Taiwan, Malaysia, South Korea, Japan and the US. This means that the Gross Export Value of $235 greatly exaggerates China’s export contribution to the US. In terms of “value added”, China is responsible for just ~6% ($15) of this Gross Export Value.
Enter “Value Added” as a Measurement of Trade
Most published trade statistics measure trade on a “Gross” basis. They record the total value of the good exported/imported. While this method is easy to follow, as we explained above, it can be misleading since it does not account for the global, multi-national supply chains that are in place for manufacturing today. Country A could be assembling a car using materials from country B and engines from country C, and exporting to country D. Assigning the entire export value of the car to country A greatly exaggerates the value added by country A, while not giving country B or country C their rightful credit in exports to country D.
The “Value Added” method breaks down the value added at each stage of the manufacturing process and helps one get realistic measures of the true contribution of each country in international trade. The “Trade in Value Added” (TIVA) database, a joint venture of the Organisation for Economic Co-operation and Development (OECD) and the World Trade Organization (WTO), provides value-added trade data for many nations.
America’s “Value Added” Merchandise Trade Deficit with China is >50% lower than the Gross measure !
China runs the largest Trade Surplus in the world. It sources components and materials domestically and internationally, assembles these into final products and exports these products to meet global demand. It truly is the “factory of the world”.
China runs its largest Trade Surplus with the US, the world’s largest consuming market. From all that we have discussed above, I’m sure that you’ve guessed that US’s Merchandise Trade Deficit with China in valued added terms is substantially smaller than the gross figure.
You’re right. Based on OCED/WTO TIVA indicators, America’s 2009 Merchandise Trade Deficit with China in Value Added terms, was lower than the gross figure by more than 50%!
US’s 2015 gross Merchandise Trade Deficit with China was $367 Billion (48% of total Merchandise Trade Deficit; or 2% of GDP). Assuming that the 2009 TIVA indicators mentioned above are still broadly representative of trade today, US’s 2015 Merchandise Trade Deficit with China in value added terms, should be less than $183 Billion (24% of total Merchandise Trade Deficit; or 1% of GDP)!
There are important implications that follow from this especially in relation to Trump's espoused approach to trade with China. I will discuss these in my next post.
There are important implications that follow from this especially in relation to Trump's espoused approach to trade with China. I will discuss these in my next post.
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