On Wednesday, the president announced on Twitter that China had been asked to reduce its annual trade deficit with the U.S. by “One Billion” dollars.
On Thursday, the Wall Street Journal’s Lingling Wei reported the actual request was for a $100 billion reduction. One source put it as high as a third of the deficit, which has been above $300 billion since 2014.
We have good news for China.
The deficit is already $100 billion narrower than the headline number the administration obsesses over, probably more, based on more accurate figures that account only for the value a country adds to the products it exports.
Standard trade measurements have their place, but they're relics of a pre-globalization age. They’re inaccurate grades on a report card that doesn’t mean much anyhow.
The measurements we report on most are essentially based on an item’s total value when crossing a border. That works if a country produces every part of a product domestically, so that each export is only counted once, or if countries are distributed evenly along the supply chain, so that the double-counting balances out.
This model breaks down because China, the world’s factory, sits squarely in the middle of many global supply chains. Multinational corporations ship components there from all around the world to be assembled into finished goods and exported once more.
It appears to run deficits with the countries that supply its components and surpluses with those that buy the goods assembled there.
Designed by Apple in California | Assembled in China
Apple is the canonical example of how trade measures distort reality, partly due to the “Designed by …” origin stamp on the back of its phones, which neatly illustrates the hazards of overvaluing the “Assembled in ...” side of the equation.
Apple imports chips, antennae and sensors from Japan, South Korea, Taiwan, the United States and Europe into China where Foxconn (a Taiwanese firm) and others assemble them into iPhones.
Those phones are stamped “Assembled in China” and count as Chinese exports, but do they actually add much to China’s economy?
Apple is secretive, but available numbers show China’s assembly added around $6.50 per phone for the first iPhone (Xing and Detert) and $8 per phone for the iPhone 6, which retailed for $749 (Bank of America Merrill Lynch via Financial Times).
Each phone is a valuable little piece of hardware that crossed China’s borders and counted as an export from China, but in truth contributed only a few dollars to the well-being of China’s workers and corporations.
U.S. manufacturers of components such as the Bluetooth/WiFi antenna and the audio processor probably added more value to the first iPhone ($10.75) than China’s assembly did.
When you adjust for this globalization distortion, the U.S.-China trade deficit drops by about a third.
Value-added figures take years and an international consortium to compile, so more recent estimates aren’t available, but Mary Lovely, an economist at Syracuse University, said other more recent trade figures imply that the value-added deficit hasn’t changed.
Around 90 percent of the value of a U.S. export is created by workers and corporations within U.S. borders. Only countries that depend heavily on natural-resource exports rank higher. Meanwhile China sits near the bottom among major economies.
China adds relatively little value to exports because it often gets stuck with the middle step in the global supply chain — hands-on assembly. The U.S. and other developed countries have retained (and even added) jobs in the higher-paying design, engineering and ultra-high-tech manufacturing steps, as well as in marketing and retail.
China’s leadership has long pushed its enterprises toward higher-value manufacturing work and has seen some success in some sectors such as pharmaceutical instruments and advanced machinery, but there are few signs that such efforts have moved the needle overall.
Value that’s harder to measure
U.S. multinationals such as Apple, Nike and Gap have pioneered a model that the forefathers of trade statistics hadn’t accounted for. They focus on marketing, design and technological innovation in the U.S. and outsource the low-value goods-related steps of the process.
Even the best numbers don’t reflect the value that Apple’s U.S. headquarters adds in this process, according to Yuqing Xing of the National Graduate Institute for Policy Studies in Tokyo.
The gross profit margin on iPhones is estimated to be around 60 percent. Apple’s main product, therefore, isn’t the goods that cross borders, it’s the brand value that engineers and marketers have built around them.
In 2015, Apple sold $139.8 billion in iPhones, iMacs and their ilk outside the United States. That’s equivalent to about 9.3 percent of U.S. exports for that year, according to Xing. It’s an American company selling a product labeled “Designed by Apple in California,” yet only a sliver of its value is credited to the United States according to standard trade measures.
When Xing accounted for the additional value that Apple added to its products but wasn't being recorded, he estimated the trade deficit with China would fall a further 6.7 percent.
While it’s not quite comparable with the other figures, it implies that even value-added measures overstate the U.S.-China deficit.
Why every measurement ultimately falls short
Even if the trade balance were reported accurately, the president’s obsession with those figures would be misguided, according to Syracuse’s Lovely, who is also a senior fellow at the Peterson Institute for International Economics.
“It doesn’t reflect the true state of the relationship,” Lovely said. “It completely misses the importance of global value chains and the role multinationals play.” About half of China’s exports (46 percent in 2014) are handled by foreign companies.
Trump’s sound and fury about the U.S. trade deficit in a globalized economy where such measures are largely obsolete is, if not much ado about nothing, then at least much ado about significantly less. Like his proposed steel and aluminum tariffs, it ultimately harms U.S. corporations.
The most innovative U.S. companies have spent decades building complex webs of trade relationships, many of which rely on China for critical parts of the process. If policymakers disrupt those webs, they put U.S. employees in jeopardy.
“Apple doesn’t manufacture in the United States, but they have thousands of jobs in the United States,” Lovely said. “Those jobs matter just as much as the ones on the shop floor.”