On whose turf will the trade war be fought?
Published 05 April 2018
While President Trump believes China's large trade surplus shifts the balance of power in a tariff war to the United States, China can respond by punishing US affiliates, who are sitting ducks in a trade war.
China’s trade surplus is only part of the story
President Trump and his administration often express their concern about trade with China by referring to the size of the US trade deficit with China, which has been growing since 1985 and totaled US$375 billion in 2017. Last year, we wrote that bilateral trade deficits are not a good way to keep score on trade policy. The numbers obscure where value is added to products and only really count where the product last made a transformation. Something “Made in China” could have more than 70 percent of its value created by Americans in the United States, as with the popular example of the iPhone. There’s another reason to avoid hanging importance on the deficit: many US firms do business through affiliates in China rather than rely solely on exports.
American brands are popular in China, but you wouldn’t know it from the trade deficit
American phones and cars (and many other products) sell well in China. According to the Internet Society of China industry association, there were 310 million active iPhones in China in 2016, amounting to one out of six smartphone users. US-headquartered Apple generated US$48 billion in revenue from China in 2016, mostly in iPhones. But these iPhones cannot be found in US-China bilateral trade data because, regardless of the high level of US content in the form of design, engineering, software, and high-value components, iPhones sold worldwide are assembled in China. A product sold where it is assembled is considered domestic, and counts neither as an export nor an import. Apple records the revenue associated with iPhone sales and service, with no effect on the US-China trade balance.
General Motors’ 2017 annual report shows that the company sold 3.6 million cars in the United States and 4 million cars in China. Yes, you read that correctly. In the same year, only 1.2 million cars were imported to China from any firm or exporting country. General Motor’s entire manufacturing and distribution network in China is, for the most part, absent from trade statistics.
Conversely, how popular are Chinese brands in the United States?
Answer: not very.
The iPhone is ubiquitous in China, yet Chinese-brand smartphones are rarely found in the United States. Same for cars: the streets of Shanghai are filled with Buicks, yet Americans have only seen Chinese-nameplate cars in the United States at auto shows. What’s going on here? Why, if we have such a large trade deficit, is the presence of US brands in China so much more prominent than Chinese brands here?
American subsidiary operations in China are a big and important part of the story
The US Department of Commerce’s Bureau of Economic Analysis (BEA) conducts surveys on US enterprises with global operations. Companies are asked to report key statistics on the operation of their foreign affiliates, such as sales and exports/imports. The BEA survey reports that, in 2017, US subsidiaries sold US$223 billion worth of goods and services in China, and those sales have grown at an annualized rate of 18 percent since 2009.
For many firms, sales by the foreign subsidiary are more important than exports. US goods exports to China were US$101 billion, while US affiliates sold US$172 billion of goods in China. Bottom line, goods exports are only one way of reaching consumers, and looking only at exports gives an incomplete picture of a commercial relationship.
Unfortunately, the government of China does not collect data on the operation of Chinese subsidiaries in the United States, so we cannot do a direct comparison. But it is known that Chinese direct investment in the United States is small compared to US direct investment in China, and Chinese affiliates have limited presence in the United States.
Operating close to the customer is a maxim followed by US firms large and small
Many firms operate subsidiaries in foreign markets as a complement to their export operations, as the foreign operation provides distribution and after-sales service support. For others, the foreign affiliate is an essential link in their business plan, such as an express package delivery service firm’s distribution center. “Operating close to the consumer” is a maxim followed by firms large and small, in no small part because local knowledge is a key to success. The Chinese affiliates of US firms use a combination of local and importer goods, and local and imported talent, to achieve success in the marketplace.
American affiliates are sitting ducks in a trade war
The US-China commercial relationship is more than just bilateral trade in goods. How will the Trump administration’s restrictions on Chinese imports, and China’s likely response, affect the larger relationship? While President Trump believes China’s large trade surplus shifts the balance of power in a tariff war to the United States, China can respond by punishing US affiliates, who are sitting ducks in a trade war.