How big is the US trade deficit with China?

Written by Li Zou 

The black cloud of an impending trade war between US and China is getting thicker,darker, and closer in recent days. After announcing the imposition of 25% tariffs on steel and 10% on aluminum earlier this month, President Trump threatened to use sweeping tariffs on Chinese imports unless China can cut its trade surplus with the US by $100 billion, which is about one-third of the total value of trade deficit on goods (i.e. $347 billion) the US had with China in 2016.  The White House also announced its plan to impose tariff totaled at least $30 billion on Chinese imports to punish China for the alleged use of unfair trade practices causing the US to have such an enormous amount of trade deficit with China and disadvantaging the US companies and industries. But how big, really, is the trade deficit between US and China? What products are exported and imported between the US and China? Are such“walling-off” China practices going to be successful for improving the US competitiveness and the American economy?

According to the Office of the US Trade Representative, China is the third largest country of US exports in 2016, and the total value of goods exported from US to China is totaled $115.6 billion, and the top five exported goods include agricultural products accounting for 12.98% in the US goods exported to China,aircraft for another 12.98%, electrical machinery for 10.38%, machinery for 9.52%, and vehicles for 9.52%. Except for agricultural products, the other four categories of the major US exports to China are typically considered as“high-value, high-tech” products, and in general, these are the types of goods that are well in line with the comparative advantage of the US as the number one developed country having the most advanced technology, and the largest capital market in the world. It is noteworthy to see that the shares of these goods in the US exports to China are very similar, and balanced in terms of the product value.

In comparison, China is the largest importing country for the US with the value of imported goods totaled at $462.6 billion in 2016. What are the main goods imported by the US from China? The Office of the US Trade Representative lists the top five categories of imported goods from China in 2016 including $129 billion of electrical machinery (27.89%), $97 billion of machinery (20.97%),$29 billion of furniture and bedding (6.27%), $24 billion of toys and sports equipment (5.19%), and $15 billion of footwear (3.24%). Among these five categories of imported goods,the latter three are generally considered as goods that are relatively “low-value”and labor-intensive,” and the production of these goods is where the key comparative advantage of China can be leveraged, as the largest developing nation in the world having an abundance of skilled, cheap labor force.  The total share of these three categories of imports, however, only accounts for about 14.7% of US imported goods from China, quite behind either of the first two categories of imported goods –electrical machinery and machinery, and such “high-tech”, “high-capital” goods clearly dominate the trade deficit of goods the US has with China. What causes such a paradox contrary to the conventional trade theory? Is it because China has overtaken the US in the areas of technology and capital efficiency? Or is it as Mr. Peter Navarro in his book “Death by China” and some others often claimed that China steals the technology and forces the technology transfer from the US companies and then “floods the US markets” through government subsidies,currency manipulation, or the abuse of intellectual property?

To answer such an intriguing question, we need to find out what types of electrical machinery are exported and imported between China and US. It is well known that many companies of making electronic goods such as computers, smartphones, monitors, and appliances are far ahead of others in using supply chain internationalization as a strategy for seeking and retaining their competitive advantage in a very competitive global market. The adoption of modular manufacturing and the use of common components across products make it possible for companies to enhance the mobility of production, and the sustained declining transportation cost also helps reduce the monetary and time constraint of distance between various suppliers and the final assembly places. In addition, the overall, persistent trend of declining protectionism and growing market liberalization in both advanced and developing countries especially since the early 1990s provides an increasingly favorable environment for companies to benefit more from internationalizing their supply chain. Indeed, the strategy of supply chain globalization is not only adopted by companies making consumer electronic goods such as Apple, Dell, HP, and Samsung, but also by Boeing, Airbus. These two dominant commercial airliner makers both have increased the degree of supply chain regional diversification in their recent aircraft products as compared to previous ones.  For example, the Boeing 787 Dreamliner program involves 292 first-tier suppliers from 18 countries, whereas its earlier 767 program has only 103 first-tier suppliers from 9 countries.Many of the suppliers of Boeing are from Japan and Japanese suppliers, byproduct value, accounts for 16% in the 767 program, 21% in the 777 program, and 35% in the 787 program, which is related to the long-term, strategic and very close relationship between Boeing and the Japanese aviation/aerospace industry since the 1950s.  Such a “Make with Japan” model is shown in the trade statistics between the US and Japan. In 2016, the total value of aircraft exports from the US to Japan is $7.9 billion,or 12.48% of the total US exports to Japan, while the total value of aircraft imports from Japan to the US is $4.5 billion, or 3.4% of the total US imports from Japan, leading the US to have an amount of $3.4 billion of trade surplus with Japan in the overall aircraft category including airframe, aircraft parts,engines and gas turbines.

While few Chinese companies is as fortunate as Japanese counterparts in participating the production of Boeing’s airplanes, many of the Chinese electronic goods makers are participants of globalized supply chain for making electrics and indeed,they are the top exporters from China to the US. According to the US International Trade Commission, the top ten imported goods flowing into the US from China are computers, peripherals, and parts (ranked #1), telecommunication equipment (#2), consumer electronics (#6), household appliances (ranked #9), and television receivers and video monitors (#10). Other imported goods in the top 10 categories include apparel (#3), furniture (#4), toys and games (#5), footwear(#7), and plastic products (#8). What is the value of those imported electronics? It is enormous. The break-down values of the leading imported electronics are $66.5 billion for computer goods, $61.3 for telecommunication equipment, $16.5 billion for consumer electronics, $11.8 billion for appliances, and $8.5 billion for monitors and TV receivers. Their total value is$164.6 billion, more than one-third of the US imports from China. Undoubtedly, such a gigantic number is a significant reason behind the US trade deficit with China.But are these numbers accurate?

In the article “Not Really Made in China” that the WSJ published on Dec. 15, 2010,it cites the research by the Asian Development Bank Institute (ADBI). Using the iPhone as an example, the article illustrates how the complexity of globalized supply chain complicates the calculation of the trade statistics between US and China. Since the value of goods traded between countries is calculated based on the product price, an iPhone priced at $178.96 assembled in China by Foxconn and shipped to the US would be considered to add this same amount onto the US import account. Deducting the value of parts ($10.74 or 6% of the iPhone value)such as chips made by the US companies, which is exported to China for the assembly, it is reasonable to calculate that each iPhone shipped from China to the US adds $168 to the US trade deficit. Following this calculation, a total of about 11 million iPhone shipped from China to the US in 2010 attribute to$1.9 billion of US trade deficit with China. But quite different from making airplanes, the assembly work done by the Foxconn in China only accounts for about 3.6% of the value of iPhone, and the rest of its parts are sourced from Japan accounting for 34% of the iPhone’s value, Germany having 17%, South Korea having 13%, and another 27% of the iPhone’s value is from many other countries where the materials and components originate. If adopting the value-added approach in the calculation, each iPhone shipped from China to the US represents a net export of 2.4% of its value, which is the difference between 6% of the value for the US-made parts, and 3.6% of the value generated by the assembly work in China. Therefore, the amount of $1.9 billion of trade deficit associated with shipping 11 million iPhones from China into the US vanishes and turns into more than $47 million of trade surplus for the US with China. Moreover,the use of value-added calculation method not only turns the iPhone-related US trade deficit with China into trade surplus, it also reallocates the trade balance between the US and all the other countries where the materials and parts are originating. For those countries contributing more than 6% of the value to the iPhone, which is the value accounted for by US suppliers, iPhone shipments from China to the US would cause the occurrence of US having trade deficits with them. Specifically, 11 million of iPhone shipped from China to the US in 2010 are found to add about $543 million trade deficit between the US and Japan, about $219 million trade deficit between the US and South Korea, and about $421 million trade deficit between the US and Germany.

Through this simple example, we can see how the calculation results of trade balance change dramatically from using product value to using value-added approach. The traditional standard of using product value in the calculation of trade balance between countries does not accurately measure the different amounts of work and values added into the product by various suppliers and assemblers as the materials and components travel around the globe before being converted into the finished goods and then traded between countries. This is particularly an issue for many of products known as “global” goods, which contain the parts sourced from many different countries and assembled in countries like China and others having skilled, cheap labor force. With the wide adoption of globalized supply chain by many electronic products company, the problem of having such distorted trade balance calculation exists not only for iPhones shipped from the US to China, but also for all the other non-Apple smart phones assembled in China and shipped to the US. In addition to smartphones, the same problem also exists for products such as computers, laptops, monitors, TV receivers, home appliances and every other “global” goods assembled in China under Dell, HP, Acer, Sony, and so on. Without reforming the traditional method for trade account calculation,the more those types of products are shipped from China to the US, the greater that the US trade deficit will be inflated with China.

In fact, the totaled $164.6 billion of trade deficit the US has with China alone in those major categories of computer, telecommunication equipment, consumer electronics, appliances, and TV receivers and monitors has hidden a significant amount of trade deficits that the US has with many other leading sourcing countries for these so-called “global” goods. In 2016, the US imports from China in electrical machinery and machinery are totaled at $226 billion, its imports from Mexico in these two categories totaled at $113 billion, while it is only $26 billion from South Korea, and $45 billion from Japan. The big difference of imports value from China and Mexico vis-à-vis that from South Korea and Japan, again, is consistent with the general truth that these two countries are doing more assemble work for the electrical machinery and machinery goods, while the parts of those goods are primarily sourced from countries having more advanced technology.

Reuters published an article on March 21, 2018 titled “Designed in California, made in China: How the iPhone skews U.S. trade deficit” reporting the similar problem for iPhone X. Further, the article points out that as the retail price of iPhone X and shipments increase, the trade deficit it causes between the US and China will get more exaggerated. In the example of iPhone X, its manufacturing cost is about $378.25, and the value added in China from doing the assembly work and providing some minor parts is only about 3-6%, and the suppliers from the US account for about 15-18% of the manufacturing costs. Using the 3-6%estimated added value by Chinese companies as a proxy to make adjustments in the total US imports from China in 2016, the added-value in those five major imported electric goods categories will range from $4.9 billion and $9.8 billion. Using the product value in the calculation would lead to the $164.6 billion of US imports from China, which is skyrocketing but misleading, in terms of measuring the true value being created and earned by Chinese workers as a major force participating in the assembly stage of making “global”goods.  Alas, it will be a very difficult and tedious task to calculate the exact extent of the biased exaggeration contained in the $347 billion of US trade deficits in all the goods imported from China in 2016. But using the example of iPhone and iPhone X, it is not difficult to find that the downward adjustment can be as high as $150 billion.

With the continued globalization of supply chain into the 21st century,more and more companies are accessing global resources to optimize their entire value chain for research, sourcing, production and distribution. Certainly, the reform to adopt the value-added approach in calculating trade statistics will not be easy, and possible for the near future. However, it is very essential to realize that the increasing flow of raw material, components, and semi-finished goods across national borders already makes international trade become more interwoven and multilateral. Any trade policy only based on numbers shown on the trade balance account between two countries bilaterally will not be efficient and reasonable.

The look at the overall trade statistics of the US shows a more realistic and accurate position that the US has with the rest of the world. One of the many factors causing the US to have the growing deficit in goods trading during recent years, and small trade surplus in services is related to the phenomenon that both the regulatory and non-regulatory barriers of doing trade in services are much higher than merchandise trades. Worldwide, merchandise trade accounts for about three quarters of total international trade, while service trade is only about one quarter. Therefore, those countries that still have a great reliance on manufacturing tend to have an overall trade surplus, while countries like the US that has already made transition into service-dominant economy tend to have trade deficit. Between the US and China, for example,while US has an inflated $347 billion of trade deficit in goods, its trade surplus with China is totaled at $87.6 billion, including $49.5 billion of service surplus through FDI. By contrast, US has trade deficit in services provided through FDI with South Korea and Japan, totaled at $3.6 billion, and$76.1 billion, respectively. 

At the recent news conference following the conclusion of the 13the NPC meeting, when asked about how China will react to the punitive tariffs to be imposed from the US, Premier Li responded that the occurrence of trade war will hurt the interests of both the US and China. He further mentioned two solutions to reduce the trade deficits – the export of more high-value goods from the US to China, and the opportunities for the US companies to enter China provided through the further liberalization of the Chinese financial market. Both of these solutions certainly will help address the trade deficit problem. Nevertheless, it is also important to acknowledge that the current $347 billion of the US trade deficit with China in goods is an exaggerated number, and it contains a significant amount of deficit between the US and other countries that are the main sourcing countries for the “global” goods. Should China be considered as the provenance of these goods and as a result, be framed by President Trump and others of causing US trade deficits? While the US presses China to further open the service market, it is also expected by China that the US provide a reciprocal treatment to Chinese companies without blocking them from doing FDI in the US economy. Last but not least, to successfully fix the overall trade deficit the US has with the rest of the world, it is certain that more efforts are needed from both governments and companies in order to reduce and overcome every barrier deterring service trade worldwide.

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