IMPORTant Statistics: The Value of Value-Added Metrics

My regular readers are aware that I am deeply irritated by what I see as a sort of New Orientalism creeping into discourse regarding the rise of East Asia as the center of global economic power. But even a stopped (and paranoid) clock can be right twice a day, and Eamonn Fingleton is right that the metrics used to measure current accounts is deeply flawed. The traditional measure of current accounts, where say an iPhone is considered to be produced entirely in China, badly distorts how trade and production happens in the modern world.

Global trade means global supply chains.

Anything manufactured that’s more than a plastic widget these days has components sourced from around the world. This is particularly true of complex, high-tech goods such as phones, computers, cars and airplanes. The Boeing 787 Dreamliner has components built in the US, Canada, Australia, Japan, South Korea and the European Union.

Yet traditional trade metrics have not kept up with this change. We still measure trade relationships as if a single country produces any product sold between borders. Current accounts measurements count the full value of an object as it passes a border, resulting in a substantial problem of double-counting in the global economy, while distorting the trade picture between two countries.

The solution has been the development of a new generation of trade statistics referred to as trade in value-added. The OECD has a fantastic site which describes the idea, but in short the new metric is intended to measure the value to a product added by the economic activity in that country alone. So for example if a Boeing 787 were sold to Singapore, the US trade in value-added would be the final sale price of the 787, subtracted by the value of components and materials produced outside the US.

The Boeing 787 is a fantastic example of global supply chains in action.

Robert Johnson and Guillermo Noguera demonstrate the importance of this development in an excellent column at Vox. According to them, traditional measurements of trade balances overstate the strength of countries with final assembly plants. In their column they point out that if the US trade with China were calculated in trade in value-added terms, the bilateral trade deficit would be nearly 40% smaller. (Johnson and Noguera have done a substantial amount of work in determining the amount of trade fragmentation, and you can read a full paper where they go into detail of the longitudinal effects of this over 40 years here.)

Why is this important?

Well for many years the rhetorical basis of US trade policy has been about current accounts. Whether or not the US has a trade deficit or a trade surplus, the desirability of such a surplus or deficit and how governments policies might influence the flow of jobs that would impact the gross trade balance has been a fixture in American political discussions since the rise of Japan in the 70s and 80s. It has created an environment where trade deficits are routinely regarded as a minus, with good economic nationalists expected to find ways to reduce the trade deficit with other countries.

Witness the conversation about China and trade. The ubiquity of the “made in China” iPhone and iPad, and their phenomenal success have helped spawn a new round of discussions about the place of economic competition, the rules of international trade and the desirability of manufacturing jobs.

In the second Presidential debate Mitt Romney advocated the traditional economic nationalism with a desire to bring assembly jobs to the US, while the President stated that the jobs were of a low-skill, low-pay variety that would not return to the US.

Who had the better of the exchange depends on how you measure trade balances.

Traditional trade metrics would measure the value of each iPhone imported, then subtract the total sum of the phones from the US’s balance of trade and add it to China’s. Under this metric, the trade-imbalance caused by the iPhone alone in 2009 accounted for $1.9 billion. This would suggest that having the assembly lines of the iPhone in China is a net plus for Chinese workers, and a net minus for American ones.

A working paper by Yuqing Xing and Neal Detert from the Asian Development Bank Institute, however, casts some doubt on this conclusion.

In the paper Xing and Detert determine the manufacturing price of the iPhone ($179) then go through the wholesale values of each of its constituent components to determine how much value was added by the Chinese assembly plants. Their conclusion was rather startling. Only $6.50 out of every $179 (or 3.6%) were added by the assembly lines in China. In fact, US companies provided $11 of the value in terms of components, meaning that China had to import an additional $3.50 worth of components from the US than it made in assembling a phone. While small, this would mean that on the basis of total value-added, China would have a net deficit in terms of value in terms of iPhone production.

Using proper metrics is the first step to improving policy-making. More widespread adoption of trade in value-added, by academics and policy-researchers (nevermind the popular press) would go a long way in improving the public’s understanding about trade and how the global economy works. And that would be the first step toward a saner approach to trade policy.