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.

2 thoughts on “It’s the Balance of Profits, Stupid”

  1. On the other hand, I suppose what would concern a *labor* (Mincer) vs. an information-(Varian) or macro-(Mankiw) economist is that since 2/3rd’s of our economy is driven by consumer spending, which is spurred on by net job gains, concomitant with wages + credit-use growth. And while we export hourly jobs to China, the same can’t be said that domestic jobs are being replaced fast enough by"new economy" markets that stimulate and provide for net new jobs (be it measured by headcount or aggregate wages), as conventional economics prescribes (think new Boeing Dreamliner as a pertinent business model, which invests in R&D locally, sources internationally for its composite inputsand garners 80,000+ net new high-wage *manufacturing* jobs, or think of Toyota’s hybrid investments in Japan while sourcing lower-end car manufacturing to rest of world).And as Mankiw indicated, the economic and trade balance numbers aren’t "fake"; rather international trade can be very nuanced and certain views of [bilateral] trade have very little concrete economic meaning. What is troublingfor me is that for a while now, many think of new information-based markets as the economic panacea, asserting that as long as corporate profits grow, little else matter. This faction also imply that a significant portion profits accrue to workers’ [wages], in this case it’s Apple and its shareholders (primarily Jobs; for Microsoft it’s Gates but he’s been giving back a bulk of that to worthy causes). Others, like myself, assert that growing profits accrue to investors and the owners of capital, but collectively, American workers haven’t benefited much, and have resorted to "house-of-cards" financing, over-leveraged, to the point that overall Americans have a net negative 0.5-1% *dis-savings* rate, that continues to encourage end-to-end economic exuberance. One fundamental indicator of "dis" trend is the stagnant wage growth of the past 6+ years. Whereas unless wages rise and we pay down our debt by saving a larger potion of our income (which ironically means that the Chinese with their 1.2 trillion dollar reserves and other Asian net savers who have chosen to buy fewer iPods and such, at least to-date, has been fulfilling our money needs via global credit markets, yet are just financing their own demand, and having Americans ultimately owe up to the IOUs), deficits in the end will matter once the ratio of wages-to-credit reach a critical mass and profit growth collapse as credit-driven expansion slow drastically, unless wage growth re-align to be more proportional to our consumer spending rate, which is doubtful at this point.We may now be at the cusp of such a slowdown, with housing and mortgage markets solidly deflating; only time will tell.Just like noone knows many decades later what exactly the tipping point was for the Great Depression, no can say now what that "breaking point" wage-to-credit ratio is. But smart folks like Warren Buffet to the economic arbiters @ NBER assert that at some point, net (not bilateral) trade balances indeed have to balance, e.g. be paid back within a bounded future time horizon, and for more then a decade, the vaunted consumer economic workhorse has largely been using inferior-grade credit-subsidized monies to drive this spectacular market boom (and reaching DJ 14,000 in a record time). Many seasoned economists and market pros see few economic fundamentals to justify this torrid rise, other than US companies vested in rapidly-growing, savings-rich developing markets whose populations are booming and demanding basic infrastructure and commodities, which do benefit US trade and engender spectacular returns for emerging market ETF-holders.Still, it’s important to understand that trade only account for a quarter of US economic activity/GDP, and as such, there’s a firm need to reform American economic policy to be more balanced and to hone

  2. Coincidentally, there was a story in today’s NYT about Taiwan being the Silent Hands Behind the iPhone ( It’s stunning that we don’t have a similar competitiveness policy, other than outsourcing to the bottom of the value chain, with little focus on formulating a national policy to significantly engender R&D sectors that are the basis for the next set of new markets and technologies (and better jobs). "…Taiwan’s evolution from computer-making giant to telecommunications Goliath has gone largely unnoticed in the United States because companies here make most of their money as made-to-order manufacturers, not sellers of their own brand products. But Taiwan’s industrial makeover has helped its companies remain competitive in a world increasingly dominated by low-cost Chinese assemblers and by Japanese and South Korean companies with strong footholds in high-end components like flash memory chips.The strategy of repackaging — finding new uses for computer components — has paid dividends. Companies on the island have captured 87 percent of the global market for wireless modems, 84 percent of the D.S.L. modem market and 70 percent of the market for personal digital assistants.In the competitive cellphone business, Taiwan companies made 12.4 percent of the world’s handsets last year, up from 9.8 percent in 2005, according to the Institute for Information Industry, a government-affiliated research center. That share is expected to grow as brand-name companies like Sony Ericsson outsource more of their production to companies here.In all, Taiwan companies produced $31.5 billion in communications equipment and services last year, more than 50 percent above the total the year before, according to the institute, which expects production to reach a value of $46 billion by 2010. Less than a quarter of that was manufactured on Taiwan, with the bulk made on the Chinese mainland. “It’s been a fairly natural progression because handsets are really a mini-version of the PC, and Taiwanese are adept at adjusting,” said Gary Chia, president of the Yuanta Research Center.The transformation did not happen by accident. As in much of Asia, the government played an active role in steering businesses into new markets by showering them with tax incentives, cheap property to build factories and research money.Companies on Taiwan have also been able to shift gears smoothly because the concentration of component producers on the island has made it easier to gather the technology and engineers to design and assemble new products…."“…The iPhone is a great example of where Taiwan is still strong: reliable sourcing, leading technology and complex integration,” said Allen J. Delattre, chief of the electronics and high-technology practice at the consulting firm Accenture. “Does the average person who buys an iPhone know it’s from Taiwan? Maybe. Do they care? Probably not. But if you look at the companies in Taiwan, they are behind the scenes, and that’s a good place to be because that’s where the value is.”"…The key for Taiwan companies, Mr. Delattre and other analysts said, is to invest in next-generation products early. For example, companies here are fast becoming important players in the development of WiMax wireless and fiber optic broadband equipment.They are again getting a healthy push from the government, which is spending more than $200 million over five years to help create the world’s largest high-speed WiMax network. By next year, with 2,000 base stations spread across the island, companies will be able to start testing new applications, like the sending of video from ambulances on their way to hospitals.“We are trying to make the infrastructure more complete,” said Tsung-Tsong Wu, deputy minister of the National Science Council, which has a $1 billion annual budget. “If the highways are built, companies can go as fast as they li

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