Trade policy in the age of global supply chains

Alok Ray | Updated on October 10, 2019

The folly of trade war   -  Getty Images/iStockphoto

With internationalised production systems, gains and losses cannot be measured by simply looking at bilateral trade deficits

Global supply chains are a by-product of economic globalisation. Yet, their significance is inadequately appreciated by policymakers like President Trump.

The current trade (and tariff) policy of the US basically rests on the simplistic assumption that goods and services exported by the US are all ‘Made in America’ while those imported from China are entirely ‘Made in China’. Consequently, more exports from the US mean gains for America and more imports signify loss. The US currently runs a big trade deficit vis-à-vis China. So, if this trade deficit can be reduced, according to this logic, US would be unambiguously better off and China worse off.

The reality is far more complex. Today’s internationalised production systems are based on global supply chains running through many countries. Also, farms and factories in a country are partially or fully owned by foreign shareholders. Hence, gains and losses cannot be measured by simply looking at the size of trade deficit.

For example, when an Apple iPhone is exported by China to the US, its export price, say, $800, is recorded as Chinese exports to the US. But, in reality, the gain to Chinese GDP consists only of the value added in China which is, say, only $200. The rest, $600 accrues to many other countries, including the US, which provide the design, software, patented technologies, brands, advertising, chips, display screens and many other components which are assembled (not made) in China.

Even a large part of the value added of $200 in China may go as profits to foreign firms (like Taiwan-owned Foxconn) that are doing the assembly work in China. So, if the import of Apple phones from China is restricted by the US, the loss of income of Chinese workers and shareholders may well be less than the loss inflicted on wages and profits earned by America and its allies (like Taiwan, Japan and South Korea).

In addition, the American consumers would lose to the extent the price charged in US stores go up (as a result of higher tariffs) while the producers of ‘Made in US’ goods (the value added by American factors of production may be only a fraction of the export price) like Harley Davidson motorbikes, GM cars and soybeans suffer as US exports go down due to retaliatory tariffs by China.

Further, higher tariffs on inputs like steel, aluminium, tyres, and chemicals from China would inflate the cost of production of goods (which use those inputs) in America reducing their international price competitiveness. Hence, as some American goods become more expensive, US imports of such goods would increase or exports go down, adversely impacting American jobs, wages and profits.

Also, some producers in China may shift their factories or export locations to other countries (including Hong Kong which is considered different from China for trade statistics purposes) to evade higher US tariffs. For similar reasons, some firms producing in America would like to shift their base to other countries (including Mexico or Canada) to bypass higher Chinese tariffs, taking away American jobs.

Multilateral trade deficit

What matters for a country is its multilateral trade deficit with all countries taken together. It is a basic lesson of macroeconomics that a country’s overall trade deficit is a reflection of its overspending. Unless the US cuts down on its habit of living beyond its means (by borrowing from abroad), it may reduce its trade deficit with China but its multilateral trade deficit would remain largely unaffected.

It seems that, belatedly, Trump is realising the folly of pushing the trade and tech war with China any further, especially as re-election is approaching. He would have a hard time convincing his support bases (especially in the so-called ‘rust belt’ and agricultural states) that more jobs and incomes have been created (rather than lost) for them, as promised. Trump also knows that, despite his rhetoric of asking US companies to dismantle factories and withdraw investment from China, he cannot force them to do so against their economic self-interest.

Business interests are powerful forces determining national and international policies in all countries, including the so-called socialist or communist countries of today. Hence, the trade and technology war between US and China is unlikely to cross the threshold where it would lead to a breaking point.

India is not yet linked to any significant global manufacturing supply chain, due to a host of factors like poor infrastructure, difficulty in land acquisition and procuring necessary clearances, and uncertainty of government policies.

It is a major factor behind India’s stagnating export earnings and deprives India of the potential benefits from being a destination of parts of the global supply chains being relocated to evade tariffs in both China and the US.

[The author is a former Professor of Economics, IIM, Calcutta.

Published on October 10, 2019

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