One of the many ways conventional economic theory hinders our discussions of trade is it gets us thinking about goods “produced” in one country and “consumed” in another. Mexicans grow tomatoes, drill oil, sew shirts, and assemble cars; Americans eat, burn, wear and drive them.
Most trade in the real world does not look like this. What you have, rather, are commodity chains, where different parts of the production process take place in different countries. In most cross-border transactions, the buyers are not consumers, or even distributors, but producers who use the imported goods as inputs. And in many cases, the relevant transactions are not arm’s-length market exchanges, but transfers within a single corporate structure. Even the final purchasers may not be consumers: In general, investment goods and exports have higher imported content than consumption goods do.
Case in point: US-Mexico trade. What with the latest eruption from DC, I was curious what US imports from Mexico actually look like. [1] Here’s what the Census says:
| $ millions | % of total | |
| Consumer goods | 84,572 | 26.6 |
| food | 22,432 | 7.0 |
| autos | 23,434 | 7.4 |
| clothing | 5,257 | 1.7 |
| others | 33,448 | 10.5 |
| Industrial inputs | 89,583 | 28.1 |
| oil | 13,689 | 4.3 |
| other raw materials | 7,568 | 2.4 |
| auto parts | 53,175 | 16.7 |
| other intermediate goods | 15,152 | 4.8 |
| Investment goods | 113,312 | 35.6 |
| computers | 41,778 | 13.1 |
| vehicles | 31,943 | 10.0 |
| other machinery/equipment | 39,590 | 12.4 |
| Services and other | 30,872 | 9.7 |
| Total | 318,338 | 100 |
As you can see, consumer goods account for only about a quarter of US imports from Mexico. Given that a large fraction of the service imports are tourism, the total share of consumption in US imports from Mexico will be a bit higher, between 30 and 35 percent. [2] (But presumably tourism would not be affected by a tariff.) The remainder is divided about evenly between industrial inputs (raw materials plus intermediate goods like cloth, steel, auto parts, etc.) and investment goods. Machinery and equipment, including computers, account for an impressive 25 percent of Mexican exports to the US. Petroleum products, despite the widespread perception of Mexico as an oil exporter, account for less than 5 percent.
OK, so why does this matter?
Well, it’s enough, to begin with, that most of us have a distorted idea of what “trade” involves. It’s always dangerous to talk about something at a high level of abstraction without a clear sense of the concrete reality involved — even if, in a given case, the abstract description works fine.
But in this case I don’t think it works fine. I think our model of one country and producing and the other consuming, misleads us in some important ways about the likely impact of something like Trump’s tariff.
First of all, the fact that trade is normally part of a longer commodity chain helps explain why trade flows are often insensitive to changes in relative prices. Notice, for instance, the $50 billion auto parts imported from Mexico — about one-seventh of total Mexican exports to the US. Some of these parts may be generic but most presumably represent investment by the parent company in a specialized supply chain. There’s little or no short-run possibility of substituting components from elsewhere in response to changes in relative prices. In any case, insofar as the importer and exporter are part of the same corporate structure, the relevant price is an administered one that presumably has more to do with internal accounting practices than with exchange rates, tariffs or other macro phenomena. This kind of trade is the excluded category in orthodox trade theory — it doesn’t responds rapidly to changes in prices, but neither does it reflect any fundamental differences in natural resources or other “endowments” between countries.
The second reason the composition of trade matters is when we look at the distributional impact. If Mexican exports were just corn tortillas, as some people seem to imagine, it would be relatively easy to answer “who pays” for a tariff. You just estimate the price elasticities of supply and demand and do the math. (OK, maybe not that easy.) But with a high proportion of intermediate and investment goods it’s much trickier. Especially since there are profits collected at a number of points along the commodity chain, so an increase in the price of Mexican imports at the border is not necessarily passed on to ultimate consumers. Some fraction will presumably come out of the various rents along the way. Even the broad claim that it must ultimately be Americans who pay doesn’t hold, since a large fraction of imports are inputs for export industries.
The third reason follows directly. Insofar as the final users of imports are exporters, tariffs and other relative-price changes will have less of an effect on the trade balance. In the old days of import-substitution industrialization people took this problem seriously — they recognized that the effective rate of protection for a given industry might be quite different from the statutory rate, depending on how dependent the industry was on imported inputs. In this case, if a large fraction of Mexican imports are destined for US export industries — and they are — then a tariff on Mexican goods will improve US competitiveness less than the textbook analysis would predict.
Finally, the disproportionately large share of intermediate and investment goods in international trade should factor into how we think about trade in general. The more I study this stuff, the more I get the sense of international trade and finance as a world unto itself — sitting on top of, dependent on, the rest of the economy, but irrelevant to most of the routine activity of extracting human labor to meet human needs. Imports are purchased to make exports, which will be purchased to make more exports to somewhere else.
An exaggeration? Yes, but maybe not an extreme one. Somewhere in Civilization and Capitalism, Fernand Braudel describes the early modern world as an archipelago of towns scattered around the margins of an interior world — whether in France or India — that remained focused on immediate, local needs. The boundary regions were more connected to each other than to their own hinterlands perhaps only a few miles away. Mutatis mutandis (and there’s a lot of mutatis!) I think something like this applies today. Traders and producers for trade are mostly much more integrated with each other than with the rest of us. Your t-shirt is a valid counterexample, but not necessarily a representative one.
In summary: Most US imports from Mexico are intermediate and investment goods, not consumer goods. A tariff on Mexican goods is more likely to raise costs for US businesses — including for US exporters — than to lead people to substitute American-made goods for Mexican ones.
[1] This is my own categorization of the more detailed breakdown given by the census. I’ve included computers with investment goods because most computer expenditure in the US is by businesses, not households. Yes, some computers are purchased by households, but on the other hand some autos are purchased by businesses, so it probably balances out.
[2] Under the conventions of the national accounts, when someone from country A visits country B as a tourist, their spending there counts as a service export from country B to A.
UPDATE: I feel obliged to point out that I anticipated the latest iteration of “Mexico will pay for the wall’ towards the end of this post from last summer.
UPDATE 2: As Peter K. points out in comments, my line about trade within corporate supply chains not responding to relative costs doesn’t really make sense as written. As he reasonably asks, in that case why would they relocate production to lower-cost areas in the first place? What I should have said is that intra-corporate trade (1) isn’t responsive to *short-run* changes in relative prices and (2) is responsive to long-run changes, but on the supply side, not the demand side. I.e. if there were a large persistent rise in prices in Mexico relative to the US, that might well eventually reduce Mexican exports, but the main way this would happen would be firms disinvesting in production capacity there. Not expenditure switching by consumers in response to higher prices.
Excellent. I think the big damage to U.S. Labor from NAFTA came from neutralizing the threat of Mexican Nationalization of U.S. investments. The harmonization of property rights was the killer, as it made U.S. firms feel safe enough to move production to Mexico. In many respects, IP threats are the modern day version of that threat — many U.S. firms are reluctant to migrate high value add work to China/East Asia out of fear of IP theft.
So what Trump really should have done is worked with the Mexican government to start nationalizing large amounts of U.S. investment, and torn up all IP protections. 😛
Having said that, over the *long term*, things like tariffs do make a difference in the decision to outsource or not, and more importantly, in making the threat to outsource more credible in the bargaining between labor and capital. Supply chains do move over time, and tarriffs are a factor.
All of these trade deals are about power relations and credibility of various threats to migrate production as much if not more so than actually needing to migrate production. This is an argument between managers and workers over who gets the economic rents, which really boils down to who is more cheaply replaceable without jeopardizing overall product competitiveness.
I like it – weaker IP/foreign investment protections as an anti-outsourcing strategy.
This is an argument between managers and workers over who gets the economic rents
Yes. I don’t know how central trade is to that, at the end of the day.
“A tariff on Mexican goods is more likely to raise costs for US businesses — including for US exporters — than to lead people to substitute American-made goods for Mexican ones.”
There’s also the small matter of the exchange rate, whether there will be less US dollars in the Mexican system and therefore whether there are less dollars to discount for Peso.
So many moving parts.
Yes. Some people are very confident that a tariff will lead to an offsetting depreciation of the peso against the dollar. I don’t share that confidence — another bad habit that conventional theory encourages is to think of exchange rates as dominated by trade flows, when in reality the financial account is much more important, especially in the short term.
“Notice, for instance, the $50 billion auto parts imported from Mexico — about one-seventh of total Mexican exports to the US. Some of these parts may be generic but most presumably represent investment by the parent company in a specialized supply chain. There’s little or no short-run possibility of substituting components from elsewhere in response to changes in relative prices. In any case, insofar as the importer and exporter are part of the same corporate structure, the relevant price is an administered one that presumably has more to do with internal accounting practices than with exchange rates, tariffs or other macro phenomena.”
That doesn’t make sense to me. If change in prices doesn’t matter since it’s part of a the same corporate structure, why did they bother to move to Mexico in the first place?
Trump is talking about corporations selling back into the U.S. The only reason to offshore is to lower costs [including regulation arbitrage] and boost profits.
I believe in internationalism and support internationalist radical populist movements but these arguments against protectionism seem like the same old neoliberal orthodoxy BS.
To me the trade deficit looks like diplomacy. Japan, Germany, South Korea, etc., we’ll buy your exports if you join our alliance against the Russians, Iranians, etc.
China we’ll buy your exports if you don’t do anything crazy like join with the Russians, Iranians, etc.
Trump is done with that diplomacy.
You’re right, that line as written doesn’t really make sense. What I should have said is that intra-corporate trade (1) isn’t responsive to *short-run* changes in relative prices and (2) is responsive to long-run changes, but on the supply side, not the demand side. I.e. if there were a large persistent rise in prices in Mexico relative to the US, that might well eventually reduce Mexican exports, but the main way this would happen would be firms disinvesting in production capacity there. Not expenditure switching by consumers in response to higher prices.
Isn’t the expectation that Americans won’t pay the full amount of the tax worthy of being included in the summary? Seems like a small omission.
Figuring out the incidence of the tax is hard – even harder than estimating its likely impact on trade volumes. And while I doubt much of the tax will be passed on to prices for consumers, much of it may still come out of the profit margins of American firms.
“much of it may still come out of the profit margins of American firms.”
This would be a plus on my book, but then what is the additional government income used for?
1) kindergartens for poor families: good;
2) paying down the debt: perhaps good, but contractionary;
3) tax breaks for businesses/high incomes: definitely not good.
If the additional revenue is used used for 2, the supposed increase in local jobs might not happen. If for 3, in the end everything is paid by the consumers (the most likely outcome IMHO).
I think that there is some confusion between “autarky” (no international trade) and “protectionism” (a policy that is supposed to help local businesses at the expense of international competition).
Historically “protectionism” is associated with mercantilism and with the attempt to become a net exporter, with squeezing the local working classes (so they don’t consume foreign stuff) and finding an outlet for local production (hence varius forms of imperialism).
Trumps want his egg yolks without any egg whites, proble is the eggs are already scrambled.
The above comment say it so well Trumps wants his egg yolks without any egg whites, the problem is the eggs are already scrambled. Trump have to learn to negotiate and leave twiter.
I clicked the link for the Census and I wasn’t seeing the table (or the total figure of $318 billion) that you refer to. I am assuming that you summarized the information presented in the link and also added in additional information. Where did you obtain the additional information?
Yes, I grouped the items at the 2-digit level (with a couple exceptions) in what I hope is a noncontroversial way — 00-01 is food; 10 is oil, 11-14 and 42 is other raw materials; 15-16 is other intermediate goods; 20-22 plus 301 (heavy vehicles) is machinery/equipment, except I broke out 212 and 213 as computers; 300 is autos and 302 is auto parts; 40 is clothing; 41 is other consumer goods; and 50 is other. The only additional information is the total for service imports, which is here.
One of the problems with outsourcng manufacturing is the disappearance of the supply chain, associated maunfacturing engineering skills and know how. Trying to bring some of this back is a feature not a bug of this type of idea, both from an employment aspect and an innovation aspect. Is it expensive to reverse what has been done – yes. Alternatives to this are make work programs and/or as is more likely paying 10% of the population not to work at all. I’d like to see that part of the equation factored in to the admitted inefficineces of tariffs/taxes, not left as an exercise for the reader.
So, are you saying that the only way to re-develop manufacturing engineering skills and know-how and supply-chains in the U.S. is by reversing outsourcing of erstwhile U.S. jobs and production facilities?
Like, we cannot start up brand-new ones, in novel, more environmentally friendly, lines, with federal public funds?
What is this “make work programs” stuff you’re talking about?
What about México ‘s Value Added Tax upon Usa goods exported for final consumption? It is fair? José Ma Villalobos
You had better edit and re-edit this blogpost and all other posts, Sir, as you’ll now have Krugman followers reading your blog, apparently. 😉
I appreciate Krugman’s link. I suppose one of the small silver linings of the Trump regime is that there will be less fighting between liberals and those of us farther to the left.
Can’t do anything about all the critical things I’ve said about him in the past.
“In any case, insofar as the importer and exporter are part of the same corporate structure, the relevant price is an administered one that presumably has more to do with internal accounting practices than with exchange rates, tariffs or other macro phenomena.”
But it does perhaps represent something else – an extension of the economic borders of a nation outside its physical borders.
The question then is whether this really represents imports and exports, or just that the accounting line is drawn in the wrong place and it’s really domestic.
There doesn’t appear to be a lot of difference between the proposed import tariff on this sort of operation and a US state using a statewide corporate levy to pay for, say, new schools.
Perhaps we need to see things from a slightly different point of view.
There doesn’t appear to be a lot of difference between the proposed import tariff on this sort of operation and a US state using a statewide corporate levy to pay for, say, new schools.
That’s certainly the view of its supporters.
One way to look at some of the politics here is to think of it as in part a conflict between the integrated (~traded) sector and the non-integrated (~nontraded) sector. Certainly the situation in the UK looks like that.
Off topic: Was it my imagination or did you post an alt-reading list for what students should know about trade and finance. Apologies.
There are a couple of posts but not really a reading list: http://jwmason.org/slackwire/international-trade-what-are-questions/ and http://jwmason.org/slackwire/what-do-people-need-to-know-abou/
Thanks much!