May 6, 2013

What the Trade Numbers Hide

Everything isn’t what it seems when it comes to trade imbalances. Chazen Director Shang-Jin Wei looks behind the numbers.

Shang-Jin Wei
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Both researchers and an increasing number of policy makers have realized that the way we measure trade between countries in official statistics is woefully deficient. That deficiency is growing with our increasingly segmented global production chain. More than just a numbers game, this data is often the basis of trade policies, which means that these miscalculations can drive decisions that could negatively impact a country’s economic stability. In fact, our research shows that this is already happening.

Standard measures of bilateral trade balances are based on gross trade, and that data assumes that everything exported from a country was produced completely within that country’s borders. But that’s not how the world works any more. Today, many developing countries are basically aggregators. Production facilities import pieces of each product from a variety of countries, put it together, and then export the finished product around the world.

Consider the iPhone. The bulk of its value (including its design and key components) is produced in the United States and Japan, shipped to China, and then China exports the final product around the world. When calculating the balance of trade between the United States and China, though, the full value of iPhone is credited to China’s side of the ledger. In contrast, value added data calculates these economic linkages and shows the contribution that other countries make in producing that iPhone.

Applying value added data to the reported trade surpluses that Japan and China enjoy against the United States tilt the balance. Current numbers don’t reflect the fact that much of China’s export production incorporates lots of materials imported from Japan, Korea, the United States, and elsewhere. In comparison, US production for its exports to China uses mostly domestically made inputs.

As a result, the trade deficit with China is 25 percent lower in value-added terms than in gross terms, according to the OECD-WTO report Measuring Trade in Value Added. In contrast, the Japanese surplus against the United States would increase, since Japan also exports value added indirectly by exporting intermediate goods to China and other countries that are used in these countries’ exports to the United States.

Bad Math Can Produce Bad Policy

Because high-income countries are more likely to be at the upstream end of global production chains, their imports from low-income countries are more likely to contain their own value added inputs. For example, China and Mexico are both heavy users of production inputs from the United States and other countries in their exports. Given this structure, when the United States moves to raise barriers on imports from Mexico and China that policy will also hurt the US businesses that produce the parts used in foreign production.

This is true for trade policies of most other high-income countries. A study of the Swedish National Board of Trade on the European shoe industry highlights that shoes “manufactured in Asia” incorporate between 50 percent and 80 percent of European Union value added materials. In 2006, though, the European Commission introduced anti-dumping duties on shoes imported from China and Vietnam. An analysis in value added terms would have pointed out that EU value added was in fact subject to anti-dumping duties.

Value added is also a critical consideration when trying to determine the impact of a given trade policy on employment in both Asia and Europe. Traditional thinking in gross terms would view imports of shoes manufactured in China and Vietnam by Europe as European jobs lost and transferred to these countries.

In value added terms, though, policy makers would need to consider the positive impact that these imports have on the European shoe industry. While some workers may have indeed lost their jobs in the EU at the assembly stage, there could be a higher number of jobs created in the research, development, design, and marketing activities that only exist because of trade. Another important factor that is often lost in the policy debate is the fact that this fragmented production process keeps costs low and EU companies competitive.

Expanding the Production Chain

Perhaps the greatest benefit of measuring value added trade is in understanding how developing countries are already participating in the global supply chain and how this expanding global supply chain is boosting indirect exports from these emerging markets.

We could also understand what role developing countries play in such supply chains and why. In fact, research suggests that improved property rights and better quality control may help developing countries move up the supply chain. For example, in 2002, when China joined the WTO, domestic added value in its overall manufacturing exports was about 50 percent. By 2007, it had increased to 60 percent.

Using value added data in measuring trade balances also would reflect more accurately the global impact of individual countries’ trade policies. It will show how barriers to Chinese imports could not only hurt US consumers by raising prices, but US manufacturers could end up paying more for the raw materials that go into their products, making them less competitive both domestically and abroad.

Of course, the two greatest challenges to recalculating trade numbers are a conceptual framework to decompose gross trade into value added terms and double counted terms, and comparable data from every country. Important progress has been made on the front of the conceptual framework, including the methodology developed by Robert Koopman, Zhi Wang (both of US International Trade Commission) and me. An internationally coordinated approach on data collection is another important piece, and we believe it could best be achieved with an inter-secretariat approach that brings together a number of international agencies that are able to tap into their existing institutional networks of official statistics.

The WTO and OECD joint initiative is an important first step. The work is designed to provide a means to develop these new metrics of trade on an ongoing and long-term basis. There has been a burgeoning interest in developing new measures of value added trade, and we may be on the verge of breaking new ground in developing feasible new measures that can illuminate trade policy discussions.

This article summarizes some key points of an overview chapter for a newly released book, “Trade in Value Added: Developing New Measures of Cross-border Trade,” edited by Aaditya Mattoo, Zhi Wang, and Shang-Jin Wei, and published jointly by the Centre for Economic Policy Research and the World Bank, 2013.

Robert Koopman, Zhi Wang, and Shang-Jin Wei, 2012, “Tracing Value Added and Double Counting in Gross Exports,” National Bureau of Economic Research working paper 18579, and forthcoming in the American Economic Review.

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