Unravelling modern global supply chains

Trump's suits made in China: President Trump’s own clothing company mainly makes its clothing in China, highlighting the difficulty of unpicking the world’s complex supply chains. What are the real sources of US working class relative decline?

Supply chain logic

Donald Trump’s 'Signature' clothing collection – ties, shirts, suits – is mostly made in China and sold in the United States online, including via Amazon. This captures the logic of global supply chain management: buy low in one country, sell high in another. And because labour costs are so much lower in China and selling prices are so much higher in the United States, such an arrangement is a match made in heaven for the franchise owner.

The implications of this practice for the US external account have consequences that Donald Trump the politician does not like, even if Donald Trump the businessman does. The factory cost of a tie (usually less than half the US selling price) would appear in the trade account. The profit (unless ownership is routed by an offshore holding company for tax purposes) would arise inside the United States.

US current account defalcation

This pattern writ large has led to the US running a large trade account deficit. Its four largest trade deficits are with China (US$376 billion), the EU28 (US$153 billion), Mexico (US$77 billion) and Japan (US$69 billion). Together these four trade deficits account for 83% of the US’s total trade deficit. (All figures for 2017, source: BEA.)

Figure 1: Sources of US trade deficit: four largest contributors (US dollars) equal 83% of US trade deficit

Source: BEA, for calendar year 2017.

A partial truth

But these numbers tell only half the story. They do not show the other non-trade account flows (services and primary income) with these regions that are also measured by the current account. Nor do they show the (by definition, ultimately balancing) flows on the capital account. Once the services and primary income flows are taken into consideration, for instance, the US turns a trade account deficit of US$153 billion with the EU28 into a current account surplus of US$14 billion. For the same reasons, the US also turns a trade deficit of US$23 billion with Canada into a current account surplus of US$14 billion. In both instances, a deficit to the US becomes a surplus favouring the US, because of the net services that America Inc. sells to the EU28 and Canada and the net income that America Inc. (especially US Big Tech) earns from these markets.

But, at the current account level, China, Mexico and Japan do not eliminate their trade surpluses through these two other flows. China runs an overall current account surplus with the US of US$258 billion, Mexico runs with one of US$88 billion and Japan runs one of US$79 billion. Together these three countries account for 112% of the US’s current account imbalance with the rest of the world: $467billion.

Feeding the populist pyre

Is this then the proof positive that for instance the US’s trade with China is grossly imbalanced? No. Because without the link that China provides in the global supply chain, a sizeable proportion of the profit that America Inc. (and especially US Big Tech) generates would not materialise. President Trump's decision to take on China's largest technology exporter Huawei may change this link, as US and Chinese businesses unwind their mutual dependence. However, it does not change the way a supply chain gets measured in trade statistics, for profit generated on goods sold inside the US, that transferred value-added profit shows up nowhere in the trade numbers.

Arguably the main fuel piled on the populist pyre in the West has been the constrained pricing power of industrial labour over the past three decades. Add to this the fact that blue-collar jobs have been lost – to technology or to lower cost labour in other countries or even immigrants at home – and this has increased job insecurity and created a sense of ‘my life is not getting better’. This is captured in the growing belief that many Westerners predict that their children will be worse off than their parents. The result is a potent political cocktail that populists are only too willing to exploit.

US statistics show this cocktail in various ways: the share of wealth accruing to capital at the expense of labour has risen steadily and that the 1% has become far wealthier even as the bottom half of the pyramid has become poorer. In 2017, the top 1% of the US earned 20% of national income (1980: 10.5%), the bottom 50% earned 13% (1980: 21%). (For Western Europe, the figures were far less inequitable: in 2017, the Top 1% earned 12% (1980: 10%) and the bottom 50% earned 22% (1980: 23.5%).)

next in the seriesIn Part 3, we look at Apple's cost abitrage mechanism and whether it distorts the balance of trade.