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Profiting from trade in value added

The world economy has become more complex, with global value chains and myriad interconnections among producers across continents. This has an impact on trade and investment policy, as well as on development, and exposes the shortcomings of the usual way of measuring trade.

David Hume, the 18th century Scottish philosopher and historian, observed that in Ancient Greece, it was a crime to export figs on the grounds that figs were too exquisite a fruit for barbarian palates. “It is easy to observe,” Hume wrote, “that all calculations concerning the balance of trade are founded on very uncertain facts and suppositions.”

Such a policy would probably not gain much traction today, but wrongheaded notions do persist about trade. Take the iPhone. Most people probably take it for granted that Apple’s creation is manufactured in China, and that China earns a considerable profit from exporting it. In 2010, an iPhone cost just over US$187 at the factory gate. Within that amount, however, Korea contributed $80.05 worth of components, Chinese Taipei $20.75, the United States $22.88 and Germany $16.08. China was among a host of contributors at the bottom of the list; by simply putting all the parts and components together, Chinese workers contributed just US$6.50 to each iPhone.

So who really produces the iPhone? A study by the Asian Development Bank estimated that the iPhone deepened the US trade deficit with China by $1.9 billion–that is, until the real “value-added” is measured, in which case the deficit evaporated to $73.5 million.

This statistical bias of attributing the origin of product to its last port of call not only distorts economic reality, but gives a credible arm to trade protectionists.

Current trade statistics reveal little about the value added to a product at each stage of the process. There is also the tendency to think of value-added as pertaining only to components: the memory function, touch screen and applications processor in an iPhone, rather than the logistics, R&D, marketing and branding.

In fact, all are part of a global value chain (GVC) with unsuspected links to other chains. OECD data show that the added value of these “intermediate inputs” accounts for more than 50% of the value trade in goods and 70% in services. If such is the case, it might reasonably be asked whether the old way of measuring trade is of much use.

Assessing the true costs of production means tracking each of these inputs to the source, which for the moment is not the case. If it were, the world would look quite different. The problem starts with an arithmetical blunder. Nominal duties on gross exports reveal little about the harm caused by tariffs and other protectionist measures which boost production costs. Spared the agony of jumping one high barrier, exporters grow weary at having to jump a lot of little ones. The tariff a country pays to export its cars to another may be low, but if the manufacturer depends heavily on foreign intermediate inputs, any tariff on those intermediate inputs carries over into the production cost. In short, keeping intermediate tariffs low is as important as keeping them low on final goods.

Consider the production chain. A country (having paid its tariff) exports a computer chip to a second country for installation in a circuit board. The second country, having installed the chip (and paid its tariff), ships the circuit board off to a third country, where the chip (now counted as a “circuit board”) is assembled as part of a car computer. Next, the chip (now in its final metamorphosis as a “car”) is exported to a fourth country where it is marketed and sold. Instead of being counted once, the chip is counted three times, each time as part of a larger component.

The cumulative effect obscures the real cost of a product and distorts policy decisions. Protectionist measures against intermediate inputs, for instance, become self-defeating in this light since higher costs on these imports would obviously hurt a country’s exports too. Government efforts to lighten the burden on producers through currency interventions bring no relief. Any competitive advantage gained through a cheaper currency is lost because intermediate inputs purchased from abroad end up being more expensive.

To help clear up this confusion and build a sharper picture of trade based on the complexity of measuring the value-added of inputs, the OECD and WTO released the TiVA (Trade in Value-added) database in January 2013. The database, which was updated in May, covers 18 industries in 57 countries. The OECD has also released a set of trade facilitation indicators for 133 countries. These reveal the unexpected costs engendered by tariffs and protectionist measures and lay the groundwork for advancing multilateral trade negotiations.

It is a valuable database, because in a world of GVCs, policymakers are apt to lose sight of the fact that success in global markets depends as much on a country’s capacity to import high-quality inputs as to export them. It helps no one if some countries pay tariffs on their value-added exports five times higher than the nominal tariff rate. Manufacturers of components are not the only losers. Tariffs on agricultural goods, for example, are on average three times higher than those on manufactured products. Along with lowering or eliminating tariffs, policymakers must also address debilitating non-tariff measures (NTMs), and take a long, hard look at services.

The service sector is the fastest growing sector in the world due mostly to the boom in information technology. Aside from the components in a PC or smartphone, much of the trade in this sector is intangible. Software development, patent acquisition and data transfer do not require the container ship but liberalised telecommunications and clear regulations concerning intellectual property rights. Even the idea of “logistics” is evolving. In Sweden, digital distribution of music, video games, etc., is outstripping traditional distribution through retailers. Firms, especially small ones, say that digital distribution makes it easier to reach larger markets, refine marketing strategies and attract financing through novel methods like crowdsourcing and crowdfunding–common in the video games industry. But one of the most striking aspects of GVCs in services is that the highest value-added occurs at the extreme ends of the chain: in the early innovation and later branding and marketing, for instance.

Most countries will rightly want to move up the value chain. To help them, policies to nurture talent and develop new skills will therefore be essential. Talent and skill are themselves value-adding intermediate inputs. Visas and overly tight work permits, as well as restrictions on intellectual property rights (IPR) and patent acquisition can in contrast stifle innovation. Government must also help ensure that workers in outmoded sectors can be retrained for new jobs.

Changing policy is easier than overcoming biases, but if the map were redrawn to show countries where they truly stood in terms of value-added trade, it could ease geopolitical tensions over trade surpluses and deficits. And given the interconnected nature of our economies, it would not only heighten competition, but strengthen trust and co-operation as well, surely the most valuable assets in a global economy.

Lyndon Thompson

For more detail on trade in value-added, contact Sébastien Miroudot at the OECD

References

Lord Green (2013), “Made in the world: How value affects trade policy”, OECD Observer, No 294, Q1 2013

OECD (2013), “Interconnected Economies Benefitting from Global Value Chains”, OECD Publishing

OECD (2013), “Measuring Trade in Value-Added” and OECD-WTO Joint Initiative, OECD Publishing

OECD (2012), “Trade in Value-Added: Concepts, Methodologies and Challenges” (Joint OECD-WTO Note), OECD Publishing 

OECD (2013), “Trade Policy Implications of Global Value Chains”, OECD Publishing 

Swedish National Board of Trade (2013), “Minecraft Brick by Brick: A Case Study of a Global Services Value Chain”, Swedish National Board of Trade Kommerskollegium

 © OECD Observer No 295 Q2 2013