It’s the Balance of Profits, Stupid


More fodder for the irrelevance of trade deficit figures in a piece by Hal Varian in the New York Times via a reader of Greg Mankiw’s blog (whew!) on the contributions of various countries involved in the manufacture of the iPod and the associated accounting in the trade statistics:

I found this article by Hal Varian, and a sentence at the end caught my attention. It says that although the Chinese only add 1% of the iPod’s value, each unit exported to the US contributes about $150 to the bilateral deficit. This left me wondering: could bilateral trade numbers, namely the US deficit with China, be a fiction?

Mankiw’s response focuses on the meaningless of bilateral trade deficits but the broader question is how meaningful are aggregate trade deficits or surpluses?  Just as you wouldn’t judge a company without looking at its profits, you can make the same argument for nations.  China looks remarkably like Japan pre-1989: big surpluses, but tiny or non-existent profits.  Don’t tell Lou Dobbs.

The money quote from Varian:

Those clever folks at Apple figured out how to combine 451 mostly generic parts into a valuable product. They may not make the iPod, but they created it. In the end, that’s what really matters.

The iPod example supports the arguments made by Andy Kessler (whose How We Got Here is the best cutting room floor product ever, assembled from a lengthy aside on the history of technology and markets cut from another of his books) and “Mr. Black Swan” Nassim Nicholas Taleb that I mentioned previously:

He [Taleb] arrives at a similar conclusion as Andy Kessler on globalization and division of labor.  Don’t sweat the US’s trade deficit.  That is just revenue: just look at the balance of profits (where the US runs a surplus).  He believes the US has focused on scaleable businesses where your revenue is not limited by your number of labor hours, but rather those that involve creativity and are often winner-take-all in the global economy.  We export jobs for the non-scaleable elements to others who are happy to be paid by the hour: “There is more money in designing a shoe than actually making it; Nike, Dell and Boeing can get paid for just thinking, organizing and leveraging their know-how and ideas while subcontracted factories in developing countries do the grunt work and engineers in cultured and mathematical states do the noncreative technical grind”.

I also remember a wry comment in The Economist years ago that if you added up all the reported trade balances, the world ran something like a $70 billion trade deficit with itself (cursory search on the site doesn’t turn it up, but they say things like “trade deficit” and “$70 billion” a lot).  So not only is it a questionable metric to act upon, but the data itself may be questionable as well.

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