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Brad Setser On The U.S., China And The New “Adjusted Trade Balance”

Summary:
Since Donald Trump considers the US trade imbalance as the root of all problems and there is—understandably for many reasons—a resistance to Trump, there is a tendency to deny anything he says. This movement is led by Paul Krugman who repeatedly attempts to play down the supreme importance of the critical imbalance of US trade.One is the trade imbalance with China. In the pre-globalised world, trade deficit would mean what it means. But because of offshoring of production to exploit low wages in Asia, things are more complicated.Consider the manufacturing of iPhone by Apple Inc., everyone’s favourite example. Although it’s more complicated with involvement of countries such as Taiwan and Ireland (or maybe more), let’s simplify and assume that the whole process is just between the US, China

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Since Donald Trump considers the US trade imbalance as the root of all problems and there is—understandably for many reasons—a resistance to Trump, there is a tendency to deny anything he says. This movement is led by Paul Krugman who repeatedly attempts to play down the supreme importance of the critical imbalance of US trade.

One is the trade imbalance with China. In the pre-globalised world, trade deficit would mean what it means. But because of offshoring of production to exploit low wages in Asia, things are more complicated.

Consider the manufacturing of iPhone by Apple Inc., everyone’s favourite example. Although it’s more complicated with involvement of countries such as Taiwan and Ireland (or maybe more), let’s simplify and assume that the whole process is just between the US, China and a third country where the phones are exported to.

This is recorded as a service export to China, goods produced in China, adding to its exports and GDP. The profits of Apple Inc.‘s investment in China adds to the United States’ primary income account of the current account of balance of payments, not the goods and services account.

But if the price was the same had Apple directly exported its phones to the third country (which wouldn’t be the case in reality, since producing in the US is costlier, but let’s ignore), the goods and services account in the current account would have been counted differently.

To put it differently, the goods and services account might give a misleading picture of the trade deficit. But some have exploited this fact to somehow try to convey that somehow, the US trade imbalance with China is nothingburger. 🤦🏻‍♂️

Brad Setser has a great post on his blog Follow The Money addressing the issue. He says:

… rather than providing a better measure of trade, the “augmented” trade balance simply adds to the confusion. It suggests that China doesn’t run a surplus with the U.S. when in reality it does, and it suggests that China isn’t a creditor to the United States when in reality it is.

Brad’s point is that the ones trying to underplay the trade deficit do so by adding gross sales to the US goods and services account in the current account of balance of payments instead of adding profits of US firms’ overseas investment. He gives the true picture.

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