1050x300-PL-How Trade Really Adds Up

How Trade Really Adds Up

Author(s): Patrick Low

Date: Mar 7, 2014

Theme(s): Trade & Investment

Publications: Opinions & Speeches

Patrick Low says inaccurate calculations create a distorted, damaging picture of trade flows, which do not reflect the true value of exports to countries.
Forget calculus, algebra and simple arithmetic.
When it comes to calculating trade, you need a whole new understanding of value to make the mathematics work in a world where a US$425 export notionally from China is, in fact, worth only US$21 to the country.

Fail to figure out how and you end up with a badly distorted picture of trade realities.

Largely the preserve of a select network of nerds until now, the potential for increased political friction in the global trade arena means the need to spread the knowledge of how trade really adds up is becoming urgent.

It is not enough to know that trade boosts income and growth through specialization, allows producers to benefit from economies of scale and provides consumers with more choice at lower prices. Nor is it sufficient to understand that the diffusion of technology and knowledge that strengthen economic interdependency reduces the scope for conflict.

When jobs are at stake and the pall of protectionism casts its shadow, knowing where the value is created by trade – and how much is generated – is absolutely crucial.

Not least because a country taking action to curb imports could easily damage its own exports.

That is why breaking down where the value is created in a US$425 export matters.

The Fung Global Institute recently un-picked the seams of a high-end men’s branded jacket that retailed in the United States for US$425. As it was labeled ‘made in China’ it entered U.S. import statistics as a Chinese product in its entirety. That could hardly be further from the truth are often far more aggregated.

The jacket was put together in China from parts (fabric, lining, trimming, stitching, buttons, labels and so on) that came from China, Japan, Hong Kong and Korea. China also supplied the labor to create the finished garment and thereby earned the ‘made in China’ label because that was where the jacket was assembled. It was the final place of shipment to the market of sale.

But where was the value added in each part of this process?

The Asian share of the total value amounted to US$60 or 14 per cent, with the remaining US$365 accruing to the United States.

All of the U.S. value was intangible, involving services such as the design, intellectual property, branding, transport, insurance, advertising, and retailing, as well of course as profits.

Manufacturing costs (parts, labor, overheads etc.) added up to US$38 or 9 per cent of the value, and China’s individual contribution was US$21 or 5 per cent. Yet that US$21 value addition earned China a spot in U.S. trade statistics as an exporter of a jacket worth US$425.

Other researchers have undertaken similar studies on products such as an Apple iPhone, a Nokia95 and an iPad. The message is very similar, with incorrectly defined trade flows telling the same misleading story about the sources of value.

The problem arises when trade is measured as gross flows rather than in terms of value addition. Trade should be measured in the same way as we measure GDP, in value-added terms.

The distorted picture of trade we work with has far-reaching consequences for our perception of reality.

Firstly, by thinking in terms of gross trade numbers we cannot grasp the true nature of interdependency among nations through trade.

In a world where global value chains are ubiquitous, a large share of imports is contained in exports.

In countries like the Philippines, Malaysia, Singapore and Thailand, 60 per cent or more of the value of imports are contained in exports. Globally, the share of intermediate products in total imports exceeds two-thirds.

Secondly, gross trade numbers tell a false tale of the technology content of a nation’s exports.

With the traditional measure of trade it appears, for example, as if the mainland is entirely responsible for designing and making iPhones, whereas it does little more than assemble them.

Thirdly, we end up with a false picture of bilateral trade balances. Economists attach little importance to bilateral balances because it is a country’s overall trade balance that really matters, but the politics can get ugly.

If U.S.-China trade flows had been measured correctly in 2008, for example, the mainland’s trade surplus would have been 40 per cent lower than the figure at the center of the acrimonious debate about unacceptably large bilateral trade balances that triggered ill-considered threats of retaliatory action.

The data requirements for measuring trade in value-added terms are far more demanding than our traditional approach of looking only at final product value, and for technical reasons the numbers are often far more aggregated.

But if the world fails to rise to the challenge of getting this right, we invite baseless trade tension and demands for protection.

In our joined up world, acting against imports can directly damage one’s own export industries because a country’s exports may be embedded in its imports.

This ironic consequence of outdated thinking about trade may occur more frequently than we realize.

 

The views expressed in this article are the author’s own and do not necessarily reflect Fung Global Institute’s editorial policy.

This article first appeared in the South China Morning Post Business Section March 5, 2014