Made on earth

Two weeks ago the Cato Institute released a wonderful new paper entitled Made on Earth: How Global Economic Integration Renders Trade Policy Obsolete. On Tuesday I attended a forum where the paper was presented by author Dan Ikenson, who made at least three points which deserve to be highlighted:

1. Defining products by their national origin is increasingly difficult. What is an American car? Is it simply one with a U.S.-brand nameplate or one built here in the U.S.? What if the car is built here but uses parts which primarily come from abroad? Ikenson also notes the example of Arcelor-Mittal, which is the largest U.S. producer of steel, majority Indian-owned and has corporate headquarters in Luxembourg and Hong Kong. How should such a company be classified?

Once one concedes the futility of classifying products based on national origin, and acknowledges the increasingly globalized state of supply chains, it has some rather profound implications. Perhaps most significant is the self-destructive nature of protectionist actions (not new information) as they raise the cost of inputs -- goods used in the production of finished products -- and harm U.S. competitiveness.

This isn't mere academic theorizing, with high-profile examples of this taking place such as the auto industry being harmed through increased tariffs on imported steel or candy makers relocating due to the artificially high cost of sugar in this country.

2. Indeed, because of this realization that tariffs come at considerable cost to competitiveness, a number of countries have engaged in unilateral tariff reductions. As Ikenson points out:

Australia, New Zealand, China, India, Mexico, Chile, and many other countries undertook significant reforms because the governments reckoned it was in their interest to do so, regardless of what other countries did. Between 1983 and 2003, developing countries slashed their tariffs by two-thirds (from 29.9 percent to 9.3 percent on average) and unilateral reforms accounted for fully two-thirds of those cuts.

While bilateral cuts may be superior to unilateral action in theory, Ikenson points out such bilateral action is usually accompanied by compromises which reduce their effectiveness. On a related point, he argued in favor of dispensing with the Doha Round of trade negotiations, arguing this would free up energy and momentum to engage in further unilateral cuts.

3. The smile curve. Imagine a smile, where the y-axis represents value and the x-axis is a timeline. James Fallows, as quoted by Ikenson, writes:

The significance is that China’s activity is in the middle stages—manufacturing, plus some component supply and engineering design—but America’s is at the two ends, and those are where the money is. The smiley curve, which shows the profitability or value added at each stage, starts high for branding and product concept, swoops down for manufacturing, and rises again in the retail and servicing stages. The simple way to put this—that the real money is in brand name, plus retail—may sound obvious, but its implications are illuminating.

Thus, in bilateral trade with China much of the value of the product being sold actually accrues to Americans rather than China. Much of our trade outsources low-value functions such as manufacturing overseas while preserving the higher-value functions here at home. To raise barriers on such trade would be incredibly self-defeating.

One can also think of the role trade plays this way: if a company built a new machine which greatly increased its productivity and reduced costs, this would be an unambiguous economic win. For many companies that machine is simply called China.

Also make sure to see Scott Lincicome's post on Ikenson's paper here.