added trade balance final 7 12[1]

7/30/2019 Added Trade Balance Final 7 12[1]

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Web Version:

July 2012

Author:

John B. Benedetto1

1 Tis article represents solely the views o the author and not the views o the UnitedStates International rade Commission or any o its individual Commissioners. Tis paper

should be cited as the work o the author only, and not as an ocial Commission document.Te author thanks William Powers or his comments. All errors are the authors. Please direct allcorrespondence to John Benedetto, Oce o Economics, U.S. International rade Commission, 500E Street, SW, Washington, DC 20436, email: [email protected].

Abstract

Recent academic work has suggested that Chinas exports to the UnitedStates contain a large portion o non-Chinese value added. Tis paperlooks at what the ndings o this work could suggest or U.S. and Chinesetrade balances, provides some theoretical cautions in interpreting value-added trade ndings, and applies those cautions to U.S. and Chinese tradebalances.

Te paper begins by showing that a countrys reported trade balance withthe world is always the same as its value-added trade balance with the

world. Tus, to the extent that Chinas net exports to the United Statesare lower on a value-added than on a reported basis, Chinas net exportsto some other countries must be correspondingly higher on a value-addedbasis than on a reported basis. China must also have a substantially smallermarket or imported nal goods than reported import data suggest. Ad-ditionally, the paper discusses data and theoretical issues in comparingChinese value added to value added in other countries.

Implications andInterpretations of

Value-Addedrade Balances


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Implications and Interpretations of

Value-Added rade BalancesRecent academic work has suggested that Chinas exports to the United States containa large portion o non-Chinese value added. Tis paper shows that these ndings aresubject to some arithmetic constraints that rame trade balance considerations withinthe context o Chinas changing trade relationship with the world. Additionally, thispaper suggests several interpretive questions that merit urther consideration.

I. Background

In GDP accounts, value added is gross output less intermediate inputs. From atrade standpoint, national value added is the value o national work perormed (i.e.,the contribution o all national actors o production) in a countrys exports, thusexcluding the contribution made by component production in other countries. Forexample, i a Chinese company imports $4 o inputs rom Japan, assembles thoseparts in China, and exports the nal product to the United States or $5, then Chineseoutput and reported exports are $5, but Chinese value-added exports are only $1.Tus, a countrys value-added exports can be less than its total exports, as it may haveimported some inputs, done some additional work, and then included those importedinputs in its own exports. Tere has always been the potential to misinterpret onecountrys exports as entirely the product o that country; recent economic work has

suggested that because supply chains are more globalized than ever beore, reportedexports are a less useul proxy or value added perormed in a country than ever beore.1

As Charles McMillion points out,2 some o these recent results have been used inpopular media to make it sound as i China is not really perorming much value

1 See, or example, Hammer, Koopman, and Martinez, Overview o U.S.-China rade in

Advanced echnology Products, May 2011, on the issue o Chinese value added in Chinese exportso advanced technology products to the United States.

2 McMillion, China rade Apologists Know a Reality Tat is NO rue, October 21,2011.


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added, and thereore the U.S. trade decit with China may not be a large concern. 3

For example, the Wall Street Journal reported that some researchers claimed thattraditional trade balance measures exaggerate trade imbalances.4 Tis paper discussesrade balances in the context o the new work being perormed on value-added trade,and asks what conclusions about trade balances can be drawn rom the recent workon value-added in trade.

II. Te Constraint: rade Balances With the WorldMust be the Same on Both the Reported and the

Value-Added Basis

o understand the eect o using value-added trade balances rather than reportedtrade balances, one must recognize that at the level o trade with the entire world,any countrys reported and value-added trade balances must be the same. For thisdiscussion, a reported trade balance will reer to the common measures o a countrystrade balance as currently used, i.e., reported exports5 minus reported imports. Avalue-added trade balance will reer to the usually unmeasured trade balances o acountry as the domestic value added in its own exports that stays in oreign marketsminus the oreign value added in its imports that stays in the country.

As an example o the dierences in these denitions, consider the ollowinghypothetical transaction. China imports components rom Japan and assembles them

into a cellular phone that it exports to the United States. On a reported basis, China

3 McMillion also critiques the ndings o Linden et al on the Apple iPod. Tose ndingsalleged that roughly 4 percent o the value o an iPod is perormed in China. Te author o thispaper notes that Linden et al attribute the Broadcom processor in an Apple iPod either to the UnitedStates or to Singapore and aiwan, but that Broadcoms own website notes that it may produceprocessors in China as well. See Linden, Kraemer, and Dedrick, Who Captures Value in a GlobalInnovation System? 2007, and Broadcom, Factsheet, 2011. Later work by Linden et al. acknowl-edges that the majority o the production jobs in the iPod production chain are in China (Linden,Kraemer, and Dedrick, Innovation and Job Creation in a Global Economy, 2009).

4 Batson, Not Really Made in China, December 15, 2010. Other examples are citedby McMillion. Oen articles on the subject may not overtly state that the recent value-added workshows that the China is not running a large trade surplus with the world. However, the articles willplace the work in the context o critiquing those who have raised concerns about Chinas currency

policies or trade surpluses. See, or example, Gang, Behind Chinas rade Decit, April 30, 2010.5 Tis denition is equivalent to the gross exports term used in Koopman et al., Give

Credit Where Credit is Due, 2010. Tis author preers the term reported as reported makesclear that the reerence is to the actual data as reported by countries governments.


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now runs a trade decit with Japan (the value o the imported components) and atrade surplus with the United States (the value o the entire exported cellular phone,with both Chinese and Japanese content). However, on a value-added basis, Chinaruns no trade decit with Japan (Chinese imports do not stay in China but are insteadexported to the United States), and a smaller trade surplus with the United States(only the value o the assembly work perormed in China).

o understand how value-added analysis will aect trade balances, one must recognizea crucial constraint: a countrys reported trade balance with the world must be the sameas its value-added trade balance with the world. Te ollowing analysis will demonstratethis point.

A countrys reported trade balance includes the trade in intermediate products thatwill go into nal products that are in turn re-exported or re-imported, whereas itsvalue-added trade balance does not.

Tus, a countrys reported exports include three types o value added: domestic valueadded that stays overseas, domestic value added that will return home embeddedin imports, and oreign value added embedded in the countrys reported exports.Similarly, a countrys reported imports include three types o value added: oreignvalue added that will stay in the country or consumption, domestic value added thatwas previously exported, and oreign value added that will be re-exported (and countedwithin reported exports).6 Te reported trade balance is the dierence between thesereported exports and reported imports.

On the other hand, a countrys value-added trade balance with the world is thedierence o only two items rom above: its exports o domestic value added that stayoverseas less imports o oreign value added that stay in the country.

Importantly, as shown in table 1, with regard to a countrys trade balance with theentire world, the additional terms in the reported trade balance will always cancel outexactly, i.e., have no net eect. In the table, the terms marked (1) are equivalent andwill net each other out, as will the terms marked (2). Te (1) and (2) terms representvalue added that must travel both as an import and as an export, and so will alwayscancel out exactly. Tus, at the level o trade with the entire world, a countrys reportedtrade balance with the world must be the same as its value-added trade balance withthe world.

6 Tis paragraph reects the analytical ramework in Koopman et al., Give Credit WhereCredit is Due, 2010.


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As an example o (1), assume China exports steel to Korea. Korea takes the Chinesesteel and makes auto parts that it exports to the United States. Te United Statestakes those parts (containing Chinese-made steel) and uses them to make autos, whichChina then imports. Te Chinese value-added in its steel is counted both as a Chineseexport o value-added to Korea and as a Chinese import o value added rom theUnited States (embedded in Chinas auto imports). Tus, rom the standpoint oChinas trade balance with the world, the exports and imports o steel will cancel eachother out exactly.

TABLE 1 The equivalence of reported and value-added trade balances at the level of

trade with the entire worldItem Exports Imports Net

Reported trade

balance with the

world

Domestic value

added that stays

overseas

+

(1) Domestic value

added that will return

home in imports

+

(2) Foreign value

added that is

embedded in exports

Foreign value

added that stays

home

+

(1) Domestic

value added that

is embedded in

imports

+

(2) Foreign value

added that will

be embedded in

exports

Domestic value

added that stays

overseas minus

foreign value-

added that stays

home

Value-added

trade balance

with the world

Domestic value

added that stays

overseas

Foreign value

added that stays

home

Domestic value

added that stays

overseas minus

foreign value

added that stays

home

Source: Author, 2012.


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Similarly, as an example o (2), assume China imports components rom Japan and

uses those components to make cellular phones, which it then exports to the UnitedStates. Considering Chinas trade balance with the world, the Japanese value addedin the components will count both as a Chinese import rom Japan and as a Chineseexport to the United States (embedded in Chinas exports o the cellular phones), andthereby cancel out.

At the level o bilateral trade, the (1) and (2) terms do not necessarily cancel and soa bilateral value-added trade balance can be dierent rom a reported bilateral tradebalance, as discussed in the background section above. Tis potential dierencebetween bilateral value added and reported trade balances is a key insight o most othe value-added literature. However, it is also important to remember the constraintthat at the level o trade balances with the world, value-added and reported trade

balances must be equal.

As a corollary to the constraint, all o a countrys bilateral value-added trade balancesmust sum to its reported trade balance with the world. Tis is so because a countrysvalue-added trade balance with the world is the sum o all o a countrys bilateralvalue-added trade balances. Since the value-added and reported trade balances withthe world are the same, then so too the sum o all o a countrys bilateral value-addedtrade balances must sum to its reported trade balance with the world.7

Tis corollary means that, while any countrys bilateral value-added trade balance withone country might be dierent than its reported bilateral trade balance with thatcountry, the dierence must be accounted or in its total trade balance with all other

countries.

Te analysis can be applied to the current value-added trade literature. For example,the USIC estimated that in 2004, the U.S. value-added trade decit with Chinawas about $75 billion rather than the reported 2004 U.S. trade decit with China oabout $125 billion.8

7 Te constraint and its corollary come rom the denition o value added. At the rmlevel, value added is the rms output less its inputs. While it may buy inputs rom some supplierrms and sell outputs to other purchasing rms, the sum o all those relationships (all its out-puts less all its inputs) is the same as its total value added. Similarly, while a country may be a netimporter rom some countries and a net exporter to others (including importing inputs rom somecountries that it assembles into exports to other countries), the sum o all o its bilateral value-added

trade balances with individual countries is the same as its reported trade balance with the world.8 Figures are authors estimates based on box 3.4 rom USIC, Economic Eects o

Signifcant Import Restraints, 2011. Using a diferent aggregation o data, the U.S. CommerceDepartment reported a 2004 U.S. trade decit with China o $162 billion.


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However, Chinas 2004 reported and value-added trade surplus with the world is stillthe same. Tus, i Chinas trade surplus with the United States is $50 billion lower ona value-added basis, then Chinas trade surplus with all other countries (i.e., the rest othe world) must be $50 billion higher on a value-added basis.

Similarly, in 2011, economists Johnson and Noguera wrote, based on 2004 data, thatthe US-China imbalance is approximately 40 percent smaller when measured on avalue-added basis.9 Tis magnitude is similar to the results reported by the USIC,and again suggests that China exported a substantial amount o value added to othercountries in 2004.

As a general point, any claim that the Chinese trade surplus with the United Statesis substantially lower on a value-added basis than on a reported basis mandates aascinating corollaryChina is running a much higher value-added trade surpluswith other countries than is currently known.

o which countries did $50 billion o 2004 Chinese net exports go? One possibleanswer is that Chinas value-added trade balance with certain countries, such asJapan, is more positive (or less negative) than its reported trade balance with thosecountries. Tat is, Chinese reported exports to Japan may have substantial Chinesevalue added, while its reported imports rom Japan could be mostly exported againto third countries, meaning that they would not count as part o Chinas value-addedtrade balance. However, no matter which countries Chinas net exports end up beingassigned to on a value-added basis, one should remember that the $50 billion cannotdisappear rom Chinas net exports.

III. China Has a Large rade Surplus With the World;Terefore It Is Not Just a Final Assembly Point

Some have used the work done on value-added trade balances to suggest that Chinais mostly a nal assembly point that adds little value to its exports. For example, in aDecember 2011 presentation, economists Kee and ang postulated that [d]omesticvalue added in Chinese exports may be ar less than actual gross export[s].10 Similarly,in 2008, ormer U.S. Labor Secretary Robert Reich stated that i one were to subtract

9 Johnson and Noguera, Te Value-added Content o rade, June 2011.10 Kee and ang, Domestic Value-added in Chinese Exports, December 2011.


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whats merely assembled in China then more than hal o Chinas trade decit [sic]11

disappears.12

Te Cato Institutes Daniel Griswold described China as the nalassembly operation in a global actory.13

Tese claims are not consistent with some o the work that has been perormed so ar.In 2011, the USIC estimated that in 2004, about 15 percent o Chinese value addedimported into the United States went through third countries, and that Chineseimports had low Chinese value added.14 In this report, the USIC did not make anyclaim that China is merely a nal assembly platorm or products produced elsewhere.Indeed, by dividing the USIC estimate o Chinas 2004 share o U.S. value-addedimports (7.7 percent) by Chinas 2004 share o U.S. reported imports (11.1 percent),one can estimate that the 2004 U.S. imports o Chinese value added were equal toabout 70 percent o the value o 2004 reported U.S. imports rom China. Tis 2004

nding is not consistent with China being mostly a nal assembly platorm, at leastor Chinas exports to the United States.

Moreover, the analysis in section II above (i.e., that trade balances with the worldmust be the same on a reported and value-added basis) provides some context andimplications or these claims. Te constraint shows that, i Chinas reported tradesurplus with the world is large as a percentage o its reported imports, then it must beexporting substantial value-added somewhere. In such a situation, it cannot be mostlya nal assembly point.15

11 Reich may have intended to mean the U.S. trade decit with China, but hismisstatement is perhaps indicative o a wider problem o conusing the possibility that the U.S.value-added trade decit with China is lower than the reported U.S. trade decit with China withthe impossibility o Chinas trade surplus with the world being lower on a value-added basis than ona reported basis.

12 Reich, Dont Blame China or the rade Decit, January 2008.13 Griswold, U.S.-China rade a Collaborative Efort, April 2010.

14 USIC, Economic Eects o Signifcant Import Restraints, 2011.15 Te reverse is not necessarily true. Tat is, a small reported trade surplus is not

necessarily a sign that a country is a nal assembly point. Instead, the country could be importingand exporting completely unrelated products in roughly the same volumes.


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IV. When China has Lower Value-Added Exports Tan

Reported Exports, Ten It Must Also Have a SmallerFinal Import Market Tan the

Reported Data Show

It is also important to note that i Chinas value-added exports are lower than itsreported exports, then its nal consumption o imports is also lower than its reportedimports. In other words, i China is importing a lot o products or processing intourther exports, then Chinas imports o products or nal consumption are that muchlower than its reported imports.

Chinas imports o goods include both (1) imports that stay in China (i.e., are not

re-exported) and (2) imports o oreign value added that will be re-exported aterurther Chinese processing. Chinas market or goods that stay in China will consisto (1), but not (2). Tat is, Chinas imports o goods that stay in China and are notre-exported are equal to its reported imports minus the non-Chinese value-added inChinas exports.16

Using a simple numerical example, assume that only 60 percent o Chinas reportedexports to the world consisted o Chinese value added. (Tis assumption closelymatches the 60.6 percent estimate rom Chinas National Bureau o Statistics, andused in Koopman et al. (2010)).17 I so, then we must subtract the other 40 percento Chinas reported exports rom Chinas reported imports to understand how mucho Chinas imports are actually intended or Chinese nal consumption, and not orre-export as part o another product.

Using this assumed ratio (60 percent o Chinas reported exports are Chinas valueadded) on Chinas 2010 exports o $1.6 trillion yields an estimate that $630 billiono Chinas 2010 reported exports were actually value added rom other countries. Inturn, however, such an estimate also means that o Chinas 2010 reported imports o$1.4 trillion, only $760 billion18 was actually or Chinese nal consumption. Tus,when China is not adding much value to its exports, then it must be true that the size

16 Here, or ease o analysis, goods that stay in China and are not re-exported includeimports o Chinese value added previously exported and now embedded in imports. I such importsexist, then Chinese imports o oreign value added will be less than reported imports minus the

non-Chinese value added in Chinese exports, by the amount o imported Chinese value added.17 Koopman, et al., Give Credit Where Credit is Due, 2010.18 Tat is, Chinas reported imports o $1.4 trillion less the oreign value added in Chinas

exports o $630 billion.


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aect any work based on the older data. As can be seen rom the tables, Chinas globaltrade in these categories changes dramatically rom 2002 to 2011. In 2002, Chinastrade fows are consistent with the prole o a country that imports a large amounto parts rom other countries and assembles them or export to the United States.By 2010, that prole is no longer accurate, because China is a large net exporter omachinery and electronics to both the United States and the rest o the world.

TABLE 2 Chinas trade balance in HS 84 and HS 85, selected years between 2002 and

2011

Category

2002 2004 2007 2010 2011

Trade balance (billions of dollars)

HS 84 with the United States 6.5 22.2 41.0 58.1 66.5

HS 84 with the rest of the world -7.9 4.6 63.3 79.5 87.9

HS 85 with the United States 8.5 19.1 43.2 46.1 54.1

HS 85 with the rest of the world -16.7 -31.4 -0.4 28.4 40.8

Source: Global Trade Atlas data for China, February 2012.

Indeed, or electronics products (HS 85), even the dierence between 2007 and 2010is stark. China goes rom running a trade decit in these products with the rest o theworld to running a trade surplus, even as its trade surplus in these products with theUnited States grows steadily.

While trade data are available within a ew months o the events they represent,domestic value-added data are not so quickly available. Tis gap may indicate a need

or caution in applying results rom past years, even relatively recent past years, to thecurrent time period.

VI. What Do the Measurements Actually Mean?

Another cause or exercising caution in the interpretation o value-added trade lies inhow to interpret the value-added in a countrys exports, and is best illustrated with ahypothetical example. Imagine a three-country world consisting o the United States,China, and aiwan. At rst, aiwan manuactures widgets and exports them to the

United States at a cost o $100 per widget. Widget production consists o producingwidget inputs (which cost $50) and assembling them (which also costs $50 in aiwan).


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Ten, aiwan oshores the second stage, manuacturing widget inputs with a value o

$50 and exporting them to China. China assembles the inputs or only $25 per unit.Finally, China exports the $75 nished widget to the United States.

Caution is recommended in claiming now that China only adds one-third ($25) othe value added o the nished widget ($75). Using aiwan production costs as themetric, China is adding hal the value ($50). From a aiwan cost basis, $50 does notbuy as much production as $50 in China does.

Tere are two possible reasons why China is able to perorm the second step o theproduction process at lower cost than aiwan: a market reason and a policy reason.Each reason would aect the analysis o Chinas lower value-added dierently.

Te rst possibility, the market reason, is that China is able to perorm the assemblyless expensively because ree trade has allowed the use o less-expensive Chinese laborin a global market. I so, then it may be accurate to describe China as adding $25 ovalue, or one-third o the value o its export. In this case, the less-expensive widget isthe result o a gain rom trade.

Te second possibility is that Chinese Government policies have allowed Chineserms to perorm the second step at a lower cost. Tese policies (as with those oany country) could include labor regulations, currency policy, and sectoral supportpolicies. o the extent one believes Chinese Government policies are the explanationor lower value added in China, then interpreting Chinas value-added as only $25, orotherwise suggesting that this nal stage o production is economically less important

than the rst stage may not be correct.23

As a general point, i any government provides support to its industry, that industrymay appear to be adding little value i the government support is not counted in thedata on its value-added. Similarly, i two countries have very dierent labor regulationsthat refect dierent political systems or preerences, those dierent regulationscould lead to dierent labor costs and thus dierent value-added or similar work.Depending on the larger issue being examined, interpreting value-added trade fowsbetween countries may require more consideration o these kinds o potential policydierences.

23 In such a circumstance, i one measures trade ows using reported exports rather than

value added, one may actually end up with a more accurate measure o real work being perormed,albeit or the wrong reasons. However, the point here is not necessarily to advocate using reportedexports with this interpretation, but to note that value-added trade still does not account or theissues described above.


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VII. Conclusion

Tere is no question that investigation o the value added in countries reported tradefows will allow a much greater understanding o value-added trade fows betweencountries, as the work to date already has. However, it is important to remember theconstraint that any countrys value-added trade balance with the world must equalits reported trade balance with the world. Te implications o that constraint orChinas trade include that, i China has high oreign value added in its exports, (1)then its market or imported products that stay in China is also smaller. Additionally,while China runs a large trade surplus with the world, so (2) it cannot be mostly anal assembly point. Keeping the constraint in mind may also help interpretationo recent value-added work in light o some potential data issues. Finally, (3) thetheoretical question o why one country is able to produce one stage o production less

expensively than another remains important in interpreting any results.


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http://www.nber.org/papers/w16426http://www.signallake.com/innovation/AppleiPod.pdfhttp://www.signallake.com/innovation/AppleiPod.pdfhttp://www.marketplace.org/topics/commentary/dont-blame-china-trade-deficithttp://www.marketplace.org/topics/commentary/dont-blame-china-trade-deficithttp://www.usitc.gov/publications/332/pub4253.pdfhttp://news.xinhuanet.com/english/china/2011-12/31/c_131336727.htmhttp://news.xinhuanet.com/english/china/2011-12/31/c_131336727.htmhttp://news.xinhuanet.com/english/china/2011-12/31/c_131336727.htmhttp://news.xinhuanet.com/english/china/2011-12/31/c_131336727.htmhttp://www.usitc.gov/publications/332/pub4253.pdfhttp://www.marketplace.org/topics/commentary/dont-blame-china-trade-deficithttp://www.marketplace.org/topics/commentary/dont-blame-china-trade-deficithttp://www.signallake.com/innovation/AppleiPod.pdfhttp://www.signallake.com/innovation/AppleiPod.pdfhttp://www.nber.org/papers/w16426

added trade balance final 7 12[1]

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