A Different View of World Trade: Why National Accounts Can Be Exciting

Imagine that, for some reason, you were forced to choose between having to read a long, turgid novel like Westward Ho or Middlemarch, or a book on the methodology of the national economic accounts. Most people, however reluctantly, would plump for the former. But the latter can at times be very exciting. A recent paper uses national accounts concepts to revolutionise the conventional view of world trade.

Robert C Johnson of the National Bureau of Economic Research has a long article in the latest issue of the top ranking Journal of Economic Perspectives, entitled ‘Five Facts about Value Added Exports’. He uses the fundamental national accounting distinction between gross value and value added. International trade data record the gross value of goods and services as they cross borders. The value added measure subtracts from the gross value of, say, American exports, all the imports into the United States which have been used to produce the exports. Like it says on the tin, the value added measure tells us how much value has been added to the American economy by the exports from that country to the rest of the world.

The measurement of GDP is based on the principle of value added. A company may, for example, produce a car for £10,000. But the value added by that company is not the gross figure of £10,000. It is what is left when the value of all the materials and other inputs bought by that company have been subtracted from the sale price of the car.

Until recent decades, it was reasonable to assume that there was a not a vast difference between the gross value of exports and their value added. But the rapid rise of global supply chains has altered this dramatically.

Johnson’s most spectacular finding has important implications for the UK and the debate about our place in the world. On the conventional measure, manufacturing accounts for some 70 per cent of gross exports across the world, and services for 20 per cent (the rest is basically agriculture and mining). Using the value added measure, manufacturing and service exports are very similar in size, at around 40 per cent of the global total of exports. There are two reasons for this. Manufacturing firms buy substantial amounts from domestic service sector companies, and manufacturing exports in general contain a higher import content. The UK, of course, is very strong in service exports, but apparently less dominant than we believe.

The value added approach can also lead to different conclusions in terms of evaluating exchange rate movements. Strikingly, Johnson finds that the real value of the Chinese currency in these terms is 20 per cent higher than suggested by the conventional approach, so the Chinese exchange rate is not all that misaligned. But intra-EU rates are more misaligned, especially for the peripheral countries which are currently in trouble. So the problems of the Euro zone are worse than is perceived.

Yes, national accounting conventions can certainly be more gripping even than The Killing!

Paul Ormerod is an economist at Volterra Partners LLP, a Visiting Professor at the UCL Centre for Decision Making Uncertainty, and author of Positive Linking: How Networks Can Revolutionise the World