Dramatic changes have taken place in the nature of international trade over the past several decades. Production processes have increasingly involved a sequential, vertical supply chain stretching across many countries, with each country specializing in one or more stages of production. While the international fragmentation of production allows countries to specialize in producing goods in which they have a comparative advantage, it has also created data and policy challenges.
Official exports from any country are measured in gross terms, which includes the value of both final products and intermediate inputs from other countries used in the production of those final products. By definition, this methodology double-counts the intermediate goods: they are counted first as exports from their country of origin and then counted again as exports from the country where they are used as intermediate goods. As a result of this double counting, official trade statistics are becoming less reliable as a gauge of export value actually contributed by any particular country.
China’s production of one globally-recognized product, the iPhone, provides a good example of how vertical trade challenges standard measures of trade. According to estimates by Yuqing Xing and Neal Detert, two economists from the Asian Development Bank, iPhones exported from China to the United States in 2009 were composed of 96 percent foreign intermediate goods—with the largest portions coming from Japan, Germany, Korea, and the United States—and 4 percent domestic Chinese content. Although produced almost entirely with foreign content, in gross terms, 100 percent of the export value of iPhone exports from China to the United States was recorded in China’s trade surplus with the United States. In value-added terms, an alternative method which does not double-count intermediate goods, only 4 percent of the export value of the same iPhone exports would be recorded in China’s trade surplus with the United States.
With this brief example in mind, one can easily see how the value-added approach to calculating the value of traded goods could result in significantly different bilateral trade balances than the gross approach. Using data from the World Input-Output Database to calculate the shares of foreign and domestic content in China’s exports, China’s bilateral trade surplus in with the United States was about one-quarter larger in gross terms than in value-added terms in 2008 because intermediate inputs produced by other countries (as in the iPhone example) are used extensively in Chinese goods made for export to the United States (figure 1). Similarly, China’s bilateral surplus with Mexico in gross terms is about twice as much as in value-added terms. Gaps between the two measures are also observable for countries with which China has a trade deficit. China’s deficit with Japan, for instance, is about three times larger in gross terms than in value-added terms, reflecting the fact that a significant amount of Japan’s exports to China are used not for domestic Chinese consumption, but rather in the production of China’s exports to the world.
In addition to throwing into question how best to measure trade in a world with deeply vertically integrated production chains, the global dispersion of production processes creates challenges for policymaking, including how to assess export competitiveness and develop trade policy. For example, a high degree of vertical integration can dampen competitiveness changes triggered by bilateral exchange rate movements because both imported intermediate inputs and exports are re-priced. Absent integration into global supply chains over the past decade, it is possible that China’s exports and imports would have responded much more strongly to its real effective exchange rate appreciation of some 40 percent since 2005.
This post summarizes findings presented in the January 2015 edition of the World Bank’s Global Economic Prospects.
Figure: China’s bilateral trade balance in value-added and gross terms, 2008
Sources: WIOD and World Bank.
Note: China’s bilateral trade surplus with the United States is off the scale in the figure. The relevant amounts are shown in parentheses.