Dangers to global economy's health

Economists have long analysed trade, why nations need it to prosper, and what governments do to reap the gains while managing the costs. But if the economics of trade policy are clear, the politics of trade are highly complex. Trade policy, like so many other areas of policy, has ramifications on how resources are distributed, and this inevitably creates competing interest groups within society.

The public debate that inevitably accompanies the formulation of contested trade policy challenges the notion that open trade brings overall societal benefits. At the same time, contested policy provides fertile ground for the incubation of urban legends and misconceptions with popular appeal. One such widespread fallacy is that it is unhealthy for trade to grow faster than output.

After the World War II, international trade grew much faster than world production. The ratio of international trade to world Gross Domestic Product (GDP) has risen from 5.5 per cent in 1950 to over 20 per cent today. Some argue that this development poses a danger to the health of the global economy. However, in reality it is simply a reflection of the international fragmentation of production and the rise of trade in intermediate products.

Literally global

Reductions in transport costs, the information technology revolution, and more open economic policies have made it easier to distribute production across a range of countries. The parts and components that make up a final product are manufactured in different countries around the globe.

These intermediate goods may cross national borders several times before they are assembled as a final product. Thus some of what passes for international trade is in reality intra-firm trade, exchanges of intermediate inputs and goods for processing between establishments that belong to the same company. By allowing each country in the supply chain to specialise in the part or component, the internationalisation of supply chains creates enormous economic benefits.

This growth in the trade of parts and components means that statistics on imports overstate the degree of competition that comes from one’s trading partners. In international trade theory, trade in goods is seen as a substitute for the movement of factors of production.

Thus, a country’s imports of goods from a trading partner are seen as additional supplies of the partner country’s labour and capital, which compete with the importing country’s own workers and entrepreneurs. But the share of value added by the country originating a product is considerably lower than in the past.

Take the example of an iPod assembled in China by Apple. According to a recent study, it has an export value of $150 per unit in Chinese trade statistics, yet the value added attributable to processing in China is only $4.

Consequently, the degree to which a given volume of imports implies competition between the factors of production in the country of origin and those in the importing country is overstated.

Focusing on gross values of trade or imports from a particular country also understates the degree to which the importing country’s own firms benefit from trade because part of their output is incorporated in the imported good.

Conventional trade statistics gives us a distorted picture of trade imbalances between countries. What counts is not the imbalances as measured by gross values of exports and imports, but how much value added is embedded in these flows. Let us take again the bilateral trade between China and the US.

According to data from the Institute of Developing Economies and WTO estimates, in 2008 the domestic content comprised 80 per cent of the value of the goods exported by the US. The comparable figure was 77 per cent in the case of Japan, 56 per cent for Korea, and 42 per cent for Malaysia and Chinese Taipei, meaning that about half the exported value originated from other countries.

Conventional trade statistics would overestimate the US bilateral deficit vis-a-vis China by around 30 per cent as compared to measuring in value-added content. This figure would reach more than 50 per cent when the activity of export processing zones is fully taken into account. It makes sense for us to start measuring trade in value added rather than in gross value, as is the case today. Debunking fallacies about trade is not enough. We need debate and make informed choices, because trade has an impact on our lives, whether as workers or as consumers.

(The writer is director-general of the World Trade Organisation)