Another Way to Look at the Canada-China Trade Deficit

Trade is important for Canada, but not all trading relationships are of equal importance. A new way of measuring trade statistics is shedding fresh light on how the international movement of goods and services contributes to domestic wealth creation, and how imports can be just as important as exports for Canadian prosperity. Given the emphasis placed by the Federal government on international commerce, this new perspective on “value added in trade” has important implications for trade policy.

It has long been have observed that many imports are inputs to a production process that lead to the export of a final good. More recently, with the fragmentation of manufacturing into complex supply chains, the final product itself may be the result of multiple transformations in different countries, with each stage in the production process adding value.

Traditional trade statistics capture the value of the product as it enters or leaves the country but they do not net-out the imported components that go into the manufacture of the final good, and they likewise do not measure the amount of value that is generated domestically. As a result, official export and import numbers can be misleading.

It is bad enough that many politicians and commentators lament bilateral trade deficits as an unmitigated negative for the country. How often have we heard that the problem with Canada-China trade, for example, is the large trade deficit in China’s “favour”? A bilateral trade deficit may be a symptom of problems – protectionism, a narrow and undiversified industrial structure, lack of entrepreneurial drive, an overvalued exchange rate, etc. – but the trade deficit itself is not a problem as long as the global current account is in rough balance and can be financed with ease.

By focusing on domestic value-added, we have a further reason to be sceptical about the trade deficit hawks. If imports contribute to the domestic value-added of Canadian exports (by serving as essential inputs to the production process), they in effect are sources of growth for the economy. In fact, a greater variety of imports can increase a country’s productivity. That appears to be the story of Canada-China trade, where the rapid expansion of imports from China resulted in an estimated growth of 1.5% in Canadian productivity between 1988 and 2006, according to an Asia Pacific Foundation of Canada study.

Until recently, it was difficult to get measures of value-added in trade. Statistics agencies typically double count the value of an import that is used as an input for an exported product, hence masking the amount of domestic value-added that is generated.

Thanks to the Organization for Economic Cooperation and Development (OECD) and the World Trade Organization (WTO), a new dataset on trade in value-added (TIVA) was released last month. The results challenge a number of conventional notions about global trade.

On a value-added basis, the Canada-China Trade deficit in the sample years 2005, 2008 and 2009 was between 15 percent and 40 percent lower than the deficit measured in gross terms.

Similarly, the US-China deficit in value-added terms was 25 percent smaller than the recorded gross measure in 2009 -- a reflection of the very high foreign content of Chinese exports. 

The EU turns out to be an important contributor of domestic value-added for the US economy, which accounts for the recent announcement on trans-Atlantic free trade negotiations. On a value-added basis, 45 percent of US non-NAFTA exports go to the EU, significantly higher than the equivalent measure in gross trade terms.

The value of services trade is only 25 percent of global transactions when measured in the conventional way, but rises to about half in the case of OECD countries when value-added is taken into account. It has long been known that services add significant value to manufactured products, and yet are not captured in trade statistics. By breaking out the contribution of services to goods trade, the TIVA approach points to the importance of services sector competitiveness and the importance of liberalization in services as a priority in market access negotiations for Canada.

The OECD-WTO dataset has some disquieting results for Canada. Between 2005 and 2009, domestic value added of exports has been falling, from 26.6% in 2005 to 25.9% in 2008 and 21.5% in 2009. The figures suggest that the Great Recession of 2008-2009 hit Canada badly in value-added as well as in gross exports.

But it is the shock-absorbing role of emerging markets in 2009 that stands out. So-called BRIC countries provided an alternative source of demand for global exports at a time when industrialised country markets collapsed. The role of China as a shock absorber for Canada is particularly important. 

The share of domestic value added in Canadian exports to China compared with value added from global demand rose from 2.4% in 2005 to 2.6% in 2008, and then took a jump to 3.51% in 2009 as the Chinese market continued to grow even as the rest of the world was in a slump. Notably, China’s relative importance for Canadian exports was greater in value-added terms than measured by gross value. While China’s share of Canadian trade is still very small, exports to China are growing fast where it matters – in the creation of domestic value.

There is much more analytical work that can be done with the TIVA database, especially in modelling the effects of free trade agreements on value-added trade, including the proposed Canada-China FTA. But the most important policy conclusions are already evident: Trade expansion is good, but expanding domestic value-added should be the policy priority; imports often are an important input for creating Canadian value-added exports; more attention should be placed on trade in services and expanding market access for Canadian services abroad, especially in emerging markets. Above all, let's stop worrying about bilateral trade deficits as such and focus instead on getting Canadians more plugged-in to international production networks.

This piece was first published in iPolitics on March 1, 2013.

Chen Bo is Assistant Professor at the Shanghai University of Finance and Economics and Yuen Pau Woo is President and CEO of the Asia Pacific Foundation of Canada.

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