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The World Trade Organization’s annual report released today is well worth reading, not only for the data on recent trade flows, economic and unemployment trends, and trade financing but also for the cautions against protectionism and the analyses of trade policy.

Policymakers should particularly take note of the discussion on trade imbalances and why current ways of measuring trade flows don’t take account of value added, that is, currently the full value of a product’s imported value is attributed to the exporting country, even when that country has had a very small part in its total production.  Apple’s iPad – produced through a global supply chain – was a prominent example in the media of the distortions that current measurement of trade flows produces.

Here’s the WTO’s discussion (on p. 17):

A factor that is of particular relevance when situating trade and trade policies in the context of current tensions over trade imbalances is that trade flow statistics are recorded universally in gross terms;  the full value of an imported product is attributed to the country that exports it, even if that country contributes only a small proportion of the product’s value-added.  This has long been recognized in trade policy terms, for example when imposing rules of origin requirements on products that are eligible for preferential tariff treatment.  Even so, it can send misleading signals to trade policymakers.  With many manufacturing processes today broken down into separate parts and spread across different countries before the finished product is assembled for export in one of them, attributing the full value of the product to the country from which it is exported to its final consumer destination will give an exaggerated idea of the real importance of trade with that country.

The report notes that when a value-added approach is used to calculate bilateral trade flows between China and the U.S., for example, it would result in “a reduction of the [US] deficit by more than 40%.”

Here are the calculations (p. 19):

US-China trade balance, 2008: Traditional and value added measurement

(Billion dollars)

Item	Value
USA exports to China (traditional statistics)	71
USA exports to China (in value added terms)	60
USA imports from China (traditional statistics)  *	356
USA imports from China (in value added terms)	224
Trade balance (traditional statistics )	-285
Trade balance (in value added terms)  **	-165

* Adjusted for China processing trade.

** While individual bilateral balances are affected by the value-added measurement, the total trade balance of each country -as measured by the balance of payments- remains the same.

Source: A. Maurer and Ch. Degain ”Globalization and trade flows: what you see is not what you get!”,  WTO Staff Working Paper ERSD-2010-12, June 2010.

That is certainly a significant fact that policymakers should have beaten into their heads before they are allowed to discuss U.S. trade imbalances with China.