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Economy

Can Trade Policy Break Up the Global Value Chain?

Dec 13 , 2016
  • He Weiwen

    Vice President and Senior Fellow, Center for China and Globalization

US president-elect Donald Trump wants to see the next generation of innovation and production develop only in the US, not in the rest of the world. In his latest speech on Nov 21, on his policy plan for the first 100 days in office, he said that “I want the next generation of production and innovation to happen right here on our great homeland America creating wealth and jobs for American workers”. He promised to “withdraw from TPP” and “negotiate fair bilateral trade deals that bring jobs and industry back onto American shores.”

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Before that, president-elect Trump made intemperate, often sensational attacks on trade during his campaign. He had a special xenophobia toward China, accusing China “stealing” American jobs. The accusation was based on the US trade deficit. Hence, he wants to kill trade deficits by production only in America. Trade deals would also be based on that goal.

America Cannot Leave the Global Value Chain

The questions are: Can trade deficit be wiped out by production in America? And can production happen in America only?

The traditional country-product and border-based trade balance concept has long been outdated. In today’s world trade, the production process, from product design, raw-material procurement, financing, manufacturing, final assembly, turnkey-providing, marketing and logistics, normally stretches across many countries. Many products in international trade are known as “global products”.

A Boeing 787 plane is produced in 66 countries of the world, with the engine, deck-control system, aircraft body, vertical tail and auxiliary power supply made in the US; the front part of the aircraft body, central wing boxes and tires made in Japan; the engine, seats and ice-proof coating of wings made in UK; the passenger doors, landing gear and electric-brake system made in France; the central aircraft body, horizontal stabilizing wings and cargo cabin doors made in Italy, etc. Can Boeing bring it all back to the US? If so, America must leave the whole global value chain and rebuild the complete chain of aircraft R&D, supplies and manufacturing which is likely to take years and certainly at a higher cost. To make it possible, America must levy high tariffs on those parts supplied from UK, Japan, France and Italy. Those countries in turn, will challenge such moves at the WTO, and America is sure to lose. Then Boeing will find it difficult to survive the competition with Airbus. Don’t forget: Wilhelm Boeing, father of the founder of Boeing Company Bill Boeing, was a German who moved to America in 1868. Should America reject the world best technologies?

The Apple iPhone is another case in point. Over 2,000 employees at the Apple company in the US engage in R&D. Japan and South Korea supply the screen, touch-screen, CPD and DRAM, accounting for 60% of the total cost. Other US suppliers provide the wireless telecom, power supply management, and the core electronic mechanism, accounting for 25.4% of the total cost. The Netherlands, France and Italy supply other parts. China — and possibly Vietnam and India — takes the final assembly, accounting for 1.6-2.0% of the total cost. Assuming that, for the next generation of the Apple iPhone, all the parts, apparatus must be made in America, and the final assembly line must also be built in America. Even if only the assembly line is moved to America (a very unlikely scenario), Apple will continue to import those parts from Japan, South Korea and Europe. If high tariffs are imposed on those imports, America will again lose at WTO. Let’s assume that all is back in America, or America leaves the global value chain. There will be a considerable retail price hike, taking away money from American consumers, including the workers. In that event, the Apple iPhone might be priced out of the world market by its competitors, leading to more American job losses at home.

As early as in 1985, Professor Michael Porter of Harvard and chairman of the Industry Competition Committee of Reagan Administration, proposed a value chain concept in his book Competitive Advantage. In 2001, Gary Gereffi, professor of Duke University, put forward the concept of global commodity chains. In 2012, WTO, in collaboration with JETRO in Japan, published a report titled East Asia Trade Pattern and Global Value Chain: From Goods Trade to Task Trade. The new measurement is no longer the customs trade balance, but the added content and value in each of the countries along the supply chain, from design, material, manufacturing, assembling, marketing, all way to the end users. According to this approach, known as ownership approach, the US multinational companies are extensively knitted in the global value chain. In 2013, the foreign affiliates of American multinational enterprises (MNEs) took 28.6% of the American goods exports, and provided 36.6% of the American goods imports. Out of the global goods trade deficit of $702.6 billion that year, $385.8 billion, or 54.9% was caused by trade between parent and affiliates of American MNEs themselves. The only way to wipe out trade deficit is for American MNEs quit the global value chain, which looks unrealistic.

Production offshore vs onshore depends on profitability

How to make sure that new production will happen in America, not offshore? A look back at the American multinationals’ recent offshore business could provide food for thought. During 2009 to 2013, the American MNEs’ parent companies onshore saw their total assets increase from $ 27,630.68 billion to $ 30,597.69 billion, up 21.5%; while their offshore majority-owned affiliates’ total assets increased from $ 18,775.26 billion to $ 22,734.35 billion, up 21.1%. The two grew at the same tempo. However, total employees increased only slightly onshore, from 22.93 million to 23.33 million, up 1.7%; employees offshore increased by 14.7%, from 107.94 million to 123.81 million. The reason is simple: Offshore operations provided higher added value rate, or higher profitability.

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The table shows that, $1.63 of added value was created by every dollar of employee compensation in 2009 onshore, compared to $2.38 offshore. In 2013, it was $1.90 vs. $2.46. In other words, the same labor cost created more added value in offshore operation than onshore operation. That’s why little progress had been made although President Obama appealed strongly for manufacturing moving back to America. If President Trump really wants to make it happen, all measures must be taken to make onshore operation generating higher profitability.

Jobs taken away by technology, not China

The above elaboration helps explain the global pattern of trade and production by American companies and the relevance with job changes. Another basic factor behind job changes is technology, rather than China.

Among all Chinese exports to the US, computer and electronics is by far the largest category, accounting for 35% of the total. During 2013-2016, despite the continuous increase of imports, the American computer and electronics industry grew by 2.9%, 5.6%, 1.4% and 4.4%, respectively, with its production index hitting 114.1 in October 2016, while the total industrial production index was 104.3. However, total employment in the sector fell by 1.3% over the past 12 months. Higher production resulted in lower employment. Apparently, the reason is higher productivity. During the first nine months of 2016, the American imports of this category from China actually decreased by $ 8.51 billion.

The aerospace industry is by the largest trade surplus sector in America. During 2013-2015, its global trade surplus grew from $ 75 billion to $ 82.5 billion, or a 10% rise. Its domestic production grew by 13%. Total employment in the sector, however, fell by 1.6%. The higher trade surplus resulted in lower employment. Again, the reason is higher productivity.

Infrastructure investment and consumer goods innovation in America

There are vast opportunities to accelerate the economic growth and job creation in America. The massive investment in reconstruction or renovation of railways, highways, bridges, airports and power plants will serve as a powerful engine for economic growth. Inadequate infrastructure investment is an important reason behind the lackluster recovery over the past eight years. Considerable job opportunities could be created, by infrastructure construction directly, and by downstream industries indirectly. That will be more effective than fighting imports.

President-elect Donald Trump is right to encourage innovation, including innovation in consumer goods. In Japan and Europe, people can often enjoy new designs, new functions, new applications of day-to-day consumer goods, such as toothbrushes, rice cookers, air purifiers, and other home appliances, as well as new materials in home textiles and home furnishings. In America, there seem to be fewer changes. America adds close to 3 million to its population and over 1 million new homes each year, and is undoubtedly a growing market. Consumer goods represent a mass market. Constant innovation and creation will create new demand, and thus new production and more jobs.

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