Transfer Pricing Associates

The Real Price of China's Value-Added

post Saturday February 4, 2012

global business


America’s trade deficit with China hit almost $300 billion last year despite the fact that U.S. exports to China were the largest they have ever been.  America’s deficit with China makes up a staggering 40% of the total U.S. trade deficit.  Although, studies show that the trade deficit with China may be exaggerated. 

The main imports into the U.S. from China are consumer electronics, clothing and machinery.  China also serves as a contract manufacturer for a lot of U.S. multinational companies since assembly work is much cheaper in China.  And even though the products assembled in China are mostly profiting American-owned companies, for U.S. trade statistic purposes, these products are still labeled as imports.  [Source: U.S. Census Bureau]

One example is American-owned company, Apple Inc., who “imports” iPads from China even though none of the component parts are made in China, only assembly is carried out there.  The value-added by the Chinese assembly process is around $10, yet each iPad sold in America adds $275 (the total production cost) to America’s trade deficit with China.  It is estimated that in 2011, iPads made up around $4 billion of America’s $300 billion trade deficit with China, but if China’s exports were measured on a purely value-added basis, their exports would only make up $150 million of the U.S.-China deficit.  In terms of overall profits from selling an iPad, most go to America, i.e. Apple’s shareholders, American suppliers, and American distributors, where product design, software development, and marketing are based.  Yet, trade deficit statistics still report only the total production cost from the last part of the supply chain (Chinese assembly) and not true domestic content, making deficit numbers look worse for America than they really are.  [Source: The Economist “iPadded”]

Even Pascal Lamy, the head of the World Trade Organization, said in his 2010 speech on measuring international trade in value-added that “case studies have shown that the innovating country earns most of the profits; but traditional statistics tend to focus on the last link of the chain, the one which ultimately earns the least”.  He also noted that if we look instead at the national origin of where the value added comes from in the final product, we would see that a significant proportion comes from re-importation costs paid by the U.S. and very little from China assembly.

This notion is further supported by a 2006 study by Peter Schott in which he uses the factor-proportions framework along with the Heckshler-Ohlin model that shows that a country’s product mix depends on its relative factor endowments.  Schott’s finding was that China’s export bundle has become more sophisticated than other countries with similar factor endowments (labor and capital) like Korea and Mexico.  Although, even though China’s products have become more sophisticated, China’s exports sell for a significant discount relative to its level of GDP and relative to similar exports from developed OECD countries.  This shows that China is not benefitting as much as developed countries for similar products exported, and so we should take trade statistics that suggest otherwise with a grain of salt. [Source: Peter Schott “The Relative Sophistication of Chinese Exports”]


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