TWN Info Service on WTO and Trade Issues (Apr11/03)
14 April 2011
Third World Network

WTO catching up with two-century-old manufacturing models
Published in SUNS #7128 dated  12 April 2011

Geneva, 11 Apr (Chakravarthi Raghavan*) - Perhaps there is hope, and a future after all, for the World Trade Organization (WTO)-centred multilateral trading system, though that for the Doha Round is very uncertain.

In publishing their first forecast of world trade prospects for 2011 (in a press release on 7 April), the WTO economists said: "The factors that contributed to the unusually large drop in world trade in 2009 may have also helped boost the size of the rebound in 2010. These include the spread of global supply chains and the product composition of trade compared to output."

"Global supply chains," they added, "cause goods to cross national boundaries several times during the production processes, which raises measured world trade flows compared to earlier decades. The quantification of this effect would require data on trade in value added that are not currently available. The goods that were most affected by the downturn (consumer durables, industrial machinery etc) have a larger share in world trade than in world GDP, which increased the magnitude of the trade slump relative to GDP in 2009, and which had a similar positive effect during the recovery of 2010."

The same point was made by the WTO Director-General, Mr. Pascal Lamy, in an opinion piece published in the Financial Times (on 25 January), "As recently as 30 years ago, products were assembled in one country, using inputs from that same country. Measuring trade was thus easy. 2011 is very different. Manufacturing is driven by global supply chains, while most imports should be stamped ‘made globally', not ‘made in China', or similar. This is not an academic distinction. With trade imbalances causing friction between leading economies, the measures we use can gravely exacerbate geopolitical tensions at a time when co-operation is more vital than ever."

In his opinion piece, Lamy used the example of Apple's iPhone, and the "value-added" (and numbers employed) at its various stages and centres of production to final assembly and sale to consumer - perhaps the figures are more easily available from Apple (and in general at the company levels).

But Lamy's argument that China's trade deficit would be halved if trade were measured in value added terms is obscure and does not appear to follow from the data he quotes: imports are also in gross values and so is the surplus. Probably, all we can say at present is that since the import content of China's exports is around 60 per cent, gross exports clearly exaggerate the economic and social welfare gains to China of its export boom. Also, a significant share of China's domestic value added in the export industry must go into the profits of the multinational companies which organise much of this trade - just as 200 years ago, much of the profit from Portugal's wine exports went to the English merchants who organised the business.

While the Portuguese peasant grew the vines, pressed the grapes, and fermented the grape-juice to make them into wine (in barrels), the bottling and sale of the wines was done by the Bristol sherry merchants, and the bottled wines were carried from Portugal to England in English bottoms. As a consequence, while Portugal was stuck until late 20th century in a backward economy without technological advance or capital accumulation, England benefited (with capital and technology innovation and accumulation) and became the foremost industrial power and remained so until the First World War and perhaps a little later.

After Lamy's opinion piece, trade officials said that in their reports and analyses so far - neither in the days of the old GATT, nor its "progeny", the WTO - had they dealt with or analysed this issue of goods crossing several frontiers in manufacture until production and export of the final consumer product. The reference in the WTO forecast to goods crossing national boundaries several times during the production process (before final export of a finished product and its consumption) perhaps will be discussed further by the WTO economists in their annual report to be issued later in the year.

However, despite Lamy's belated discovery, this kind of "intra-industry" specialization (or trade in intermediate and capital goods) has been a prevalent and growing part of international trade in manufactures since the early years of industrialization, at least from the late 17th or mid-18th century. The Annual Register (a publication first edited by Edmund Burke in England, and still going strong) has this recorded entry for 2 May, 1785 (Annual Register for 1784-1785, on p. 232):

"Such, in France, is the rage for English carriages, that upward of eight hundred sets of London-made springs, as many coach wheels of the Soho manufacture, together with large quantities of plated furniture from Sheffield, are now shipping to France, for the purpose of manufacturing carriages there a-la-mode d'Anglois".

The first work in the modern economic literature to counter the till-then neo-classical view that saw "two-way trade" as driven by consumer preferences for differentiated consumer goods (Budweiser beer being exchanged for Carlsberg beer etc), was by Paul Rayment (former chief economist of the United Nations Economic Commission for Europe - UN ECE).

In a paper of 1983 ("Intra-industry specialization and the foreign trade of industrial countries" in Stephen Frowen ed., Controlling Industrial Economies, Macmillan London, 1983), Rayment pointed to the fact that parts of a final product may be made in different countries and may cross international borders several times before ending up in a final product, which may in turn be exported. The paper estimated the intra-industry exchanges in the total trade in manufactures of the industrial countries to be around 50 percent in 1962, and over two-thirds by 1973.

The Rayment paper argues that the vertical disintegration of complex manufacturing processes across international boundaries has been in existence for centuries, albeit expanding very rapidly since 1945. In a concluding paragraph, he writes (in 1983): "But interdependence, particularly among the industrial market economies, has been growing, with a brief setback in the 1930s, since the mid-nineteenth century and probably earlier. Intra-industry trade, or specialization within narrow activity sets, cannot be measured over very long periods because of the data problems, but specific examples abound. Charles Babbage noted in 1851 that British bootmakers imported superior French uppers to be joined to superior British soles, while international trade in bicycle components and parts of motor cars was already flourishing in Europe before 1914".

Rayment's broad explanation of the intra-industry trade and specialization phenomenon combines Adam Smith's proposition that the division of labour is limited by the extent of the market with Allyn Young's analysis (1928) that saw the process of industrial differentiation as the principal type of change associated with economic growth. As Young put it: "notable as has been the increase in the complexity of living, as shown by the variety of goods offered in consumers' markets, the increase in the diversification of intermediate products and of industries manufacturing special products or groups of products has gone even further." Young, in his elaboration of Adam Smith, said that the principal economies of scale derive from "roundabout" methods of production which are even more dependent on the extent of the market.

Economies of large-scale production, Rayment stressed, play an important part in the intra-industry trade specialization story - one reason perhaps why orthodox neo-classical economists shied away from such an explanation.

In more recent times, "the extent of the market" has spread across the globe, and the component parts and activities associated with manufactured goods, and to a lesser extent services, can be scattered across the globe. The risks involved in this increased interdependence, the problems (now to the fore in the aftermath of the Japanese earthquake, tsunami and nuclear accident), arising from the ‘just-in-time' model of production and long supply lines raise important questions about the balance of costs and benefits for all the parties involved, questions that require some cool and objective analysis.

The problems of international trade being "currently measured in gross values" (Lamy in the FT article), and the lack of "trade in value added" making difficult quantification of this effect of goods crossing national boundaries several times (WTO press release of 7 April) were recognized long ago by the UN ECE (following up on the Rayment paper) in the Economic Survey of Europe in the 1980s (in the Economic Survey of Europe in 1987-88), and subsequently by the UN Conference on Trade and Development (UNCTAD) in its Trade and Development Report in the 1990s.

Trade liberalisation undoubtedly has played a role in "extending the market" by removing or reducing trade barriers, but so have changes and advances in communications technology and the industrialization of what used to be clubbed together in the past as the periphery (the developing countries stretched across Asia, Africa and South America that for decades after the second world war remained as "hewers of wood and drawers of water" - producing and exporting raw commodities and importing finished consumer goods).

Over the last three or four decades, as these countries began industrializing and trying to get out of their colonial-era economic and trade structures, and as intra- and inter-regional trade and intra-industry specialisation and trade in manufacturing among the industrializing countries grew, new tensions have begun to emerge. Partly, the problems of adjustment in a fast-changing world, partly too behind the tensions lie old colonial-era hangups, which viewed civilization as stopping at the shores of Europe and North America, and viewing the rest of the world as uncivilized, and sometimes as sub-human.

However, during this period, instead of recognizing and assessing the implications of these developments, the WTO and the Washington-based Fund-Bank institutions, and their economic theologians, were taking credit for and boasting about how much faster world trade, especially in manufactures, was growing relative to output. However, a significant part of this excess of trade growth must have been due to the double-counting of intermediate goods, since intra-industry trade was growing rapidly.

As Rayment points out, there is a gearing effect: the growth of trade relative to output is inflated during a period of output growth, but the collapse of trade is magnified when output slows or falls.

During the long period of rising global output, the WTO and its cheerleaders were happy to claim that the faster growth was due to the WTO and showed how the system works. However, when trade collapsed in 2008 and 2009, they began warning, repeatedly, against protectionism. But, when the evidence of actual protectionist measures showed they were insignificant, the WTO trade officials and economists discovered that the statistics were distorted because of double-counting and the lack of data in value-added.

The 1983 Rayment paper, when it was published, received an enthusiastic review in Kyklos, Vol 38 (1) 1985 by Prof. G.L. Shackle who expressed the hope that administrators, policy-makers, City editors and academic economists everywhere will read it. Subsequently, Greenaway and Milner, in their major survey, The Economics of Intra-Industry Trade, Basil Blackwell, quoted the Rayment paper and said "it was an issue that could fruitfully be explored further" (p 191).

Alas few seem to have read the paper (at least not in the old GATT, or the new WTO), let alone explored the issue further. Part of the explanation perhaps lies in a New England ditty by John Collins Bossidy, who said in 1910:

And this is good old Boston

The home of the bean and the cod

Where the Lowells talk only to the Cabots

And the Cabots talk only to God

The IMF, the World Bank, the old GATT and now the WTO, only talk to each other (and that too in hierarchal order); and while they come to talk at the UN, they don't appear to listen to it very much or to bother with the work of some of its more heterodox economists.

If they had paid more attention to what others were saying, they would have long ago realised the complications arising from intra-industrial specialisation and intra-industry trade, as well as the problems of gross values in trade and the lack of value-added data. They could have by now put in place a methodology for the collection and correlation of such data, as well as data for trade in services (according to the GATS definitions - in force now for 16 years) - instead of relying on the Balance-of-Payments (BOP) and Extended Balance-of-Payments (EBOP) data, which are based upon transactions between residents and non-residents, and are not applicable to trade transactions under GATS, and are to be supplemented in future on FATS (foreign affiliates trade statistics).

In the light of all that has come to be known about the shenanigans that went on in the financial industry, with assistance from accounting firms, and resulting in the 2008 crisis, it will be difficult to ask any host country to rely on such data in order to estimate the costs and benefits of its liberalising services trade.

This lack of "trade in value added" data, as well as the lack of data on "trade in services" according to the definitions of the GATS, is partly due to the failures of the UN Statistical systems to follow up on the mandates given to them at the time the Uruguay Round was launched and reiterated subsequently at Marrakesh in 1994. But part of the reason also lies at the door of the WTO, the OECD (Organization for Economic Cooperation and Development), the IMF and the World Bank and the roles they played in frustrating the attempts to formulate a proper manual for the collection of data so as to promote and protect the neo-mercantilist interests of global corporations as well as Wall Street and the financial services industry.

Now that the WTO head, and its economists, have acknowledged the problems and issues of intra-industry specialisation, especially the manufacture of components and parts crisscrossing several national frontiers before their final assembly, they need to go further to ensure proper data collections and their availability for analysis, not only for the WTO, but also for trade authorities in its member countries - and independent economists and researchers.

This may help to set the WTO on a new path and ensure it has a future.

As for the current preoccupation, the Doha Round, while releasing the 7 April trade forecast, Lamy also spoke on the Doha Round of trade negotiations, and said it was "going through a very difficult stage". He then compared the WTO to a "mule" - a reliable, durable and dependable animal. "And the mule, much like the multilateral trading system... does not go backwards... they sometimes get stuck - they don't go backwards, but they refuse to move forward either". (See SUNS #7126 dated 8 April 2011.)

Lamy's speech-writers and spin-doctors, who are always on the lookout for new analogies and metaphors, would have done better to use a different analogy for the Doha Round. After all, a mule, the progeny of an ass and a female horse, because of the inherited hybrid chromosomes from the parents, is sterile and can beget no progeny.

(* Chakravarthi Raghavan, Editor Emeritus of the SUNS, contributed this comment. In writing this comment, he has drawn on the 1983 paper of Paul Rayment, and benefited from further communications with him, which are gratefully acknowledged.)