Friday, February 10, 2006

Trade Deficit Debunked Definitively

This is probably the most important post to date. So if you typically skim the blog I suggest you read this one in full.

I've finally figured this trade deficit problem out. It's been nagging at me for a long time, knowing that the data wasn't giving us a clear picture of trade on our economy, but not knowing precisely where the problem resided. The consensus view of the trade deficit is that we spend more money on goods and services imported than we export and this is a problem that will eventually bite us on our big fat American butts.

But we're not seeing any of the problems all sorts of experts say we should be seeing because of the trade deficit. I've been trying to figure out why and the more I learned the more I saw how little the experts really know about trade and how it's calculated. I finally took the time to really dig into the documentation comparing the methodologies used to calculate and the answer was really quite obvious once I began to understand how trade is calculated and how it related to the business practices of individual companies.

I was pleased to see the BusinessWeek article previously mentioned taking a contrarian view on trade and GDP, but I wasn't satisfied with the explanation. The major problem I had with it was that the idea of accounting for intangible transactions doesn't do a whole lot to offset the trade deficit because what the article fails to consider is that if you account for the value of intangibles here then you have to account for intangibles elsewhere as well. In other words if we are exporting intangibles, then we're also importing foreign intangibles that have gone unaccounted for. So they offset each other quite a bit. Granted we might be exporting more intangibles than we are importing. But what I'm interested in understanding is in the here and now how can Americans afford to buy more stuff from foreigners than they sell to foreigners?

And I'm very proud to say that I can answer that question now. In the past I've said that I thought trade calculation methods were antiquated and weren't properly accounting for complex global transactions. But I had no hard proof of this. Now I do and here it is.

I'll start by briefly telling you what we do calculate. The import and export of goods are, which simply means estimating the value of goods coming into and out of the country. There are few adjustments made to that data to account for transactions in which goods do not leave the country such as if gold if it remains stored here, which is often the case.

There's also an adjustment to account for the value private, as opposed to commercial, shipments via the USPS. Not UPS, or FedX, just USPS. With the rise of the Internet, eBay, and uncountable numbers of small business web sites selling every sort of thing imaginable, much of which is first imported from another country this item is likely vastly being underestimated.

In other words, if I set up an online hobby shop website I will buy slot cars in bulk that were made in China and counted as an import when they arrived in some container loaded with a gazillion other gadgets and gizmos. People come to my website from all over the world because they like the way I've organized my items by specialized interests. So I mark up the price of the slot cars, which I imported and the government counted, then I ship some of them back out to the UK via UPS, a transaction for which the government knows nothing about. I've earned a profit. What do I do with that money? With some of it I buy something made in China. I've effectively increased the trade deficit by the value of my import plus by the portion of the profits I spend. And chances are someone doing this in their spare time isn't reporting these individually meager profits on their taxes. But collectively this really adds up.

So now lets say that this sort of transaction is in fact increasing the trade deficit and we come up with a way estimate these semi black market transactions, but it doesn't completely offset the trade deficit and bring us back into balance.

There's an even bigger problem with the way we calculate trade that's coming out of our globalization. I've suspected and now verified that the trade data doesn't account for the goods and services sold by American companies that they both make and distribute overseas. As far as I can tell the GDP does a decent job of accounting for this sort of thing because it looks at reported revenues on corporate taxes and since companies want to report revenues as high as possible to investors and they have to report the same thing they are going to report for their taxes the GDP therefore picks up the income related to these transactions. But these transactions are not considered exports and perhaps rightfully so since seemingly no Americans are being employed or profiting directly in a meaningful way from these transactions.

Aha. But that's not true at all and it's getting less true by the day. To try and understand this I turned to the 2004 annual report of Amazon.com. In that year Amazon reported total revenues of $6.9 billion. Amazon breaks their financial data into two primary geographical regions; North America and Internation. Of the $6.9 billion in sales $3.8 billion came from North America and $3.1 billion from everywhere else in the world. Now Amazon has a lot of distribution centers, but it services all of North America through U.S. distribution centers. So every book it sells to someone in say Canada, theoretically should be accounted for as an export. But for the servicing of the rest of the world it's distribution centers are all overseas. One thing I don't know is how trade counts a book shipped from one Amazon distribution center to another Amazon distribution center. If no sale was made then this is an internal transaction and not really an export at that point. Though I wouldn't be surprised if this is mistakenly counted as an export. What is clear is that if a book is printed in German, in a German printing facility, sent to Amazon's distribution center in Germany, and finally sold and shipped to someone in Germany or anywhere else in the world, such a transaction is not a U.S. export.

But many people in the U.S. have jobs because of Amazon's international dealings. Very many! Amazon's annual report says that Amazon has more than 700 thousand square feet of office space leased in California and Washington for its corporate offices. Yet, although almost half the companies sales come from its International division the company only leases 185 thousand square feet of office space overseas. They need more than three times the space in the U.S. to support the entire company. If Amazon suddenly shut down it's international operations, how many employees would it lay off in the U.S. because of that move. It's hard to say precisely how many, but it's safe to presume that it would be a heck of a lot, likely in the hundreds. The other way to look at it is that hundreds of people are employed in the U.S. because of the business Amazon.com does overseas and each of those employees, whose jobs exist partly or wholly because of what Amazon sells, but doesn't export, buys things made in China and other parts of the world that are counted as imports. And they buy things from companies that buy parts from China. On and on this goes.

Now consider all of the major companies in the U.S. that operate similarly. Skim through the various lists of top U.S. companies with the view of how global they are and you will be amazed at the number of them that generate substantial portions of their revenues selling goods and services overseas that aren't counted as exports.

Add all that up and we've got a reasonable and plausible explanation for why both our GDP and trade deficit keep rising. We're simply making a larger percentage of our income from doing business overseas that's not considered part of trade.

posted at 4:41 PM