Trade Imbalances

Changing boundaries make it difficult to separate the business from any given function. Large multi-nationals have various centers of production that may span domestic and global locations. Even if they don’t, they’re buying critical intermediate or value additive inputs en route to final assembly (hello vehicles and chips).

A domestic mill, once a stalwart of the Carolina Piedmont, moved most production south of the border twenty years ago with no plans of coming back. The front office and warehousing remain. This example, taken from the OddLots episode What a Fed President Hears When He Goes on the Road, offers a good bit to chew on. Skip to about the 30 minute mark to hear about more headwinds for reshoring.

Distribution, then, becomes a more integral portion of the value chain. Below is a great representation of how the accounting and mental models make of the value chain. On the left is anchored to midcentury understanding of a sequential process of input —> formation —> output. Inbound and outbound logistics link the process as if on one long conveyor feeding in then out.

I look back at the US auto industry that could fit in Michael Porter’s value chain model from 40 years ago. Inbound and outbound logistics were more sequential functions fed out of central production facilities. Areas of the country would be known for automobiles, textiles, furniture, computers, and more. Labor and resources for inputs were derived more locally, if not predominantly by domestic means.

Thanks to Malcom McLean and deregulation efforts, companies have evolved to sourcing and sending product in variable manners of origin worldwide. Global trade has exploded as a result. From 1950 to 2023, trade volumes grew by 44x. Most of that growth comes after the WTO emerges in the mid 90’s.

In its wake, we have all become more reliant on everyone else. The following table from Michigan State Professor Jason Miller shows a boatload of US sectors reliant on imports as a % of supply today.

These realities are becoming more evident in confusing trade balances based on gross declared values. The issue is that today, there are concurrent processes happening that bring a final output eventually. Where it finalizes may be starting from the prime manufacturer’s operations or a forward operating location. It may be both.

VW and Honda and BMW all have US plants that make for the American consumer. These are not co-packed models from a joint venture. Tesla has a Gigafactory in China to make Teslas.

A VW Golf is an imported car while the Atlas from the TN plant is not. They are both manufactured under the VW brand. For tax purposes, distribution channels, and accounting, these are very different types of cars moving across the supply chain.

Let’s take an easy split of 10 cars made in Wolfsburg, Germany and 10 in Chattanooga, TN. On balance, there are 20 VW cars, the US bought 10 cars from Germany but made 10 in the US. If sales slide in Germany but rise in the US to say 5 and 15, it will show German exports/US imports suffering while US production numbers increase. The value of the new mix may differ, but the point is overall output was equal in number of vehicles as before. Still under the same brand.

What transpires under current design is the final assembly point and value is logged, and often double counts or overestimates components. The example below uses a laptop versus a car to illustrate further. Three different regions contributed to this laptop, yet the trade balance takes the summed value leaving the final assembler and exporter.

Under a broader model using value-added trade accounting, these contributions are better delineated. The final assembly value is still recorded for sale or declaration, but its better split on registers of value-added production for each contributor. Keeping to the above, the laptop made in the East is now only contributing its $300 of manufacturing prowess it’s due versus the $650, fully assembled.

This gets further convoluted by something like a US shoe brand. Specifications on color, fabric, pattern, etc are given over to a foreign producer to make said shoe and have it come back over or make another intermediate stop on the way. The added value of manufacturing improvements and proximity add to the declared value of these goods, but they do not care for margins.

Let me explain one step at a time. A shoe box is 12” x 8” x 5” from the one sample I could find in the recycling. A standard pallet is 48” × 48” × 40”. To save on the math, this is 192 shoeboxes per pallet. If we’re assuming a 40’ container it may be 20 or 40 pallets (stacked). On the low end, about 3,800 shoes.

The following numbers are purely fictional but they follow the same restraints as any other. The first is size we’ve already crossed. The next big step is value. The average cargo value inside of a TEU is ~$54,000, so our 40 footer or FEU is about $100K. This is also a usual policy limit for a box. This makes sense for many to keep transit values low. If a container ship of 15,000 TEUs and their insurer value the retail price, no one would be solvent after any major mishap. Instead, they are declared closer to their costs of production.

The example above shows how much this can balloon otherwise. Some may stop here in shock about margins and all, but let’s keep walking. If we go back to the broader model we can sell this good inside the US at $120 but the $40 invoice is now attributed at a 30/70 level where the design and specs contribute $12. This may have begun the opposite years ago, but it nonetheless revises the prime manufacturer’s contribution to $26 a shoe.

This is how US brands come to a head with fakes and low value alternatives. Most like to think of the “fall off a truck” variety where the plant may have product rerouted into black markets. This is direct theft. It is not the major boogeyman in economic terms.

Larger issues arise in pushes to move product that has little demand at home to broader markets while skipping the overhead of marketing, finance, etc.

A facility is incentivized when others are shut down or chooses to use spare capacity, maybe at a discount. Another down the street using design knowledge and increased production innovations to send in kind products at much lower price points. Plant B can make a shoe at $18 per with inferior materials, allowing them able to sell indiscriminately in a larger ecosystem after transit and duties at $40 instead. A kicker is to use the high value chain in air transport to chase fast fashion trends while slow boating the larger shares at pennies per item. In many cases until recently, some duties were curbed by the low value and low batch orders via section 301

If this same product is not meant for a home market, was not induced by foreign demand orders/signals, or able to be sold at home price parities domestically, then its a duck.

TEMU and SHEIN are savvy businesses. Neither are a fashion brand. They sell fashionable clothing - cheap. They are fiercely competitive marketplaces that take the aforementioned product from low cost operations, allowing buying power and brand identity cover to end up in a high demand market.

The US consumer, given the option between good and good enough when price differentials are 2 or 3:1 will make the jump too often. Of course the US manufacturer cannot compete with these prices, but that has been the case for decades now.

The real risk is in the services sector powering higher incomes. US service companies and software help facilitate demand out of the US market and abroad. Sales, Marketing, R&D and others all contribute to finding, building, pulling and providing all sorts of services to drive FOMO that propels revenue. These things cost a lot. Us, we cost a lot, but we have also crafted roles and means to make this happen.

First, this is where the margin between declaration and retail pays for itself. It’s also what’s missing in the accounting of these trade flows. There can be arguments that these particular dresses do not have the same pattern as the newest fashions in home markets, but the arrival of flowery designs that follow the service providers and artisans efforts to induce demand are now co-opted but not paid for twice over.

A cute $6 dress or $10 power block from any of these aggregators first takes a sale from a US counterpart. It is not isolationist to say, either. If these were domestic brands that have spent the money and expertise to build out foreign markets like DJI or BYD, it would be very different. They are unfortunate innovators caught in the middle.

The lowering sales turns into cuts. This arrangement, is thus, bad for exporter and importer. Weak western markets cannot prop up the surpluses. They’d both go down.

But how does this happen? Well, that’s in how trade is facilitated. Most US businesses import under FOB or CIF. Domestically it happens too, essentially once it’s off the origin’s dock or port, the liability is on the buyer. This is because the buyer assumes the coordination, taxes, insurance, and final destination considerations.

Many are doing this based on projections about their sales volumes, trends, political realities and so on. This is where that demand is induced and met well in advance of a sale in many cases. The buyer is carrying the risk. The shoe company orders 200 containers at a time to ready for their next release or holiday buying season.

It’s also why trade should be included in these balances and labor considerations that I’ll get into for the next installment. The US company has already paid a producer to make an allotment at agreed upon terms. There’s fair compensation here. If these flop, the buyer goes kaput on that inventory. They’re also unable to find value through discounting if a considerably lower priced alternative is chasing the product releases as well.

Today, these sales are then recorded at their gross value levels. Instead of the US importing the shoes in advance, and being recorded as an import tracked to a US buyer, these companies are mostly exporting their retail values = declared values.

This does not mean these entities aren’t large customers for distribution networks that end up matriculating these transactions. The aggregated outputs offer volume discounting and more. On their own, no one producer would get this kind of penetration.

But this is where a value additive or broader model may also help. Going back to the much cheaper shoemaker at $18 per shoe. If instead of taking the $18 good at face value, it is estimated 30, 50, 80, 90% of the actual value resides back with the designers and marketers elsewhere. These do not have to be boomeranged back to the importer, it may be IP of another country altogether.

The point would be there would be claim of $18 in manufacturing output and export value. That would now be changed to $18 in production output but maybe $6 or $10 in export value taking into account contributors to the demand for these goods, stylings, and so on.

The exporting country can say this is unfair but then they’d have to prove where the demand signals and drivers of this production came from. If not the supplier, but the aggregator, the question remains for them. If they did not buy these insights from the countries of consumption we can track from their own service exports, where is the entity providing it?

If its a domestic firm, where is the proof? If the state is using total import data from all of the country’s suppliers, giving it for free only domestically or using it to compel production, then it’s either an admittance of subsidizing supply or of being a far less value add center in global output, sharply reducing standing.

The best course would have been for the foreign manufacturer to enlist its own service side to increase their export presence and value. A shoe could still be sold at $90 all in where only $10 is recorded via distribution of the import country. $26 or $28 goes to the export manufacturer, $30 to domestic overhead of helping market and figure order volumes, and so on. If they can’t exist in their own markets at similar parity, then they should promptly be insolvent instead of continued permittance to run.

BYD is again a great example of an innovator and scaled operation promoting a worldwide brand that runs counter here. They’re a household name domestically, and participate in advanced operations as with other multinationals. That is a threat of a different manner, yet on fairer footing. There are other budding industries worth promoting as well.

It is why this piece should be met as a way to promote transparency versus pushing blame. It should also become evident that tariffs do come to US buyers anyway. Either by directly paying these duties per standard shipping arrangements or having them passed through on a final sales price. Left to take the brunt are first large US buyers, then consumers if and once prices have to get passed onward.

The world needs better bookkeeping, not boundary.