Why the real U.S.-China trade deficit is much smaller than it looks

China 24

According to U.S. President Donald Trump, the U.S. trade deficit with China in 2017 was “the largest deficit of any country in this history of our world.”

The U.S. census bureau puts it around $375 billion.

President Trump said it is more than a third higher than that—“Depending on the way you calculate, $504 billion.”

This was for goods only. For trade in services, the U.S. ran a $39 billion surplus with China.

How reliable are these numbers? Well, as Trump says, it depends: “…on the way you calculate.”

If you look at Chinese exports to U.S., you’ll find big U.S. brands such as Apple iPhones, Dell computers and Nike shoes. They’re American products, but their value is assessed to China. Why?

The answer is on the product labels, which say: “Made in China.” And that’s the problem.

When a product crosses a border, deficit calculations go awry. That’s because governments assign an export’s full value to the country that shipped it—even if that country’s contribution to the total value is small.

Today’s manufacturing supply chains are often global. Multinational enterprises, or MNEs, assemble products from parts produced in many countries. Economists calls these products “intermediate goods.”

Global supply chains are also “value-added chains.” That’s because parts produced by each link in the chain adds value to the product.

Failure to account for value-added components distorts the true balance of trade with any nation. This becomes especially problematic with China. China is the “factory for the world.” Chinese workers assemble products like Apple’s iPhone from many parts made in other countries, including the U.S. But when China ships fully assembled iPhones to the United States, the U.S. assigns their full value to China—the last link in the production chain.

Economists have been criticizing this method of accounting for years. Back in 2013, the Dallas Federal Reserve Bank published a letter explaining how it creates an accounting problem for nations like China. “Although its participation is mostly toward the final stages of production, its contribution to the final value of a product is often small,” says the Dallas Fed. “As a result, Chinese exports are inflated.”

In November 2017, so-called “teardown engineers” at IHS Markit concluded the cost of the components in a $999 iPhone X was $370.25.

This year, using IHS Markit data, Reuters identified the country of origins for most of the iPhone X components. To the cost of parts, Reuters added an $8.00 “Basic manufacturing cost” attributed to China. Combined with $6.00 in Chinese “Battery packs,” China’s combined valued-added contribution to the iPhone X totaled $14.00.

Yet, when Chinese firms like Foxconn ship fully assembled iPhone X’s to the United States, U.S. Customs assigns their gross value to China.

To be more accurate, the “Designed by Apple in California Made in China” label on an iPhone X should really say: “Designed by Apple in California Made in China, South Korea, Japan, USA, UK, Netherlands, Switzerland & Singapore.”

Yale University economist, Stephen Roach, says adopting this practice in calculating trade balances would slash China’s trade deficit with the U.S.

Roach, a former chairman of Morgan Stanley Asia, says: “the 47 percent share of the U.S. deficit ascribed to China would be reduced to around 28 percent.”