Correct Allocation of Manufacturing & Production Costs Could Alter Global Trade Stats

Sometimes it's fun to confabulate a micro scenario to elucidate a problem. Let's assume that your kids decide to make some extra money this holiday season by baking and selling cookies (for the sake of convenience we'll ignore local health and tax laws;-). They also have a knack for business and quickly decide to engage some school friends in the production process. After experimenting and settling upon a few recipes, you front the money for raw materials and your offspring -- we'll call them the A-team -- distribute the butter, flour, sugar, baking powder, nuts and raisins to various friends to mix and bake at their respective homes. A-team then collects the cookies in bulk, has another friend do the packaging and then sets out to sell them to neighbors.

Ingredients cost $.03/cookie, the bakers are paid $.10/cookie, packager $.03/cookie, and A-team adds $.15/cookie for administrative costs for a wholesale cost of $.31/cookie – they're big cookies. Now, would it be correct to allocate the total cost-of-goods to be sold of 31 cents to the packager? Incredibly, that appears to be how globally outsourced production is allocated when calculating trade balances.

Today's WSJ reports that "Yuqing Xing and Neal Detert, two researchers at the Asian Development Bank Institute, a think tank in Tokyo ... say traditional ways of measuring global trade produce the number but fail to reflect the complexities of global commerce where the design, manufacturing and assembly of products often involve several countries." To wit, they "estimate that Apple Inc.'s iPhone -- one of the best-selling U.S. technology products -- actually added $1.9 billion to the U.S. trade deficit with China last year." But while "the entire $178.96 estimated wholesale cost of the shipped phone is credited to China, ... the value of the work performed by the Chinese workers at Hon Hai Precision Industry Co.[assembling and shipping the phones] accounts for just 3.6%, or $6.50, of the total." So "even though [the iPhone] is entirely designed and owned by a U.S. company, and is made largely of parts produced in several Asian and European countries statistics in both countries consider the iPhone a Chinese export to the U.S. ..."

The Journal quotes Pascal Lamy, director-general of the World Trade Organization, from a speech in October saying "The concept of country of origin for manufactured goods has gradually become obsolete ... What we call 'Made in China' is indeed assembled in China, but what makes up the commercial value of the product comes from the numerous countries.." The potential impact upon currency valuation and accusations of unfair trading practices is staggering if this research can be validated and expanded. Mr Lamy claims that "if trade statistics were adjusted to reflect the actual value contributed to a product by different countries, the size of the U.S. trade deficit with China -- $226.88 billion, according to U.S. figures -- would be cut in half."

Spring can't come too soon. I wish this coverage was an April Fool's story.

William Busch

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