RDP 2014-07: International Trade Costs, Global Supply Chains and Value-added Trade in Australia 2. The Structure of Australia's International Trade

2.1 Background

The structure of international trade has changed dramatically in recent decades. A key feature of this structural change has been the increasing role of global supply chains. Global supply (or value) chains are production networks that span multiple countries, with at least one country importing inputs and exporting output. The production of a single good, such as a mobile phone or television, typically now takes place across several countries, with each country specialising in a particular phase or component of the final product (Riad et al 2012).

International trade has risen, as a share of world GDP, from less than 20 per cent in the mid 1990s to more than 25 per cent more recently (Figure 1). More notably, the growth in trade has been dominated by trade in intermediate inputs – goods and services that are not consumed directly but are used to produce other goods and services.^[1] The rapid growth in trade in intermediate inputs has been facilitated by factors that have lowered the cost of trade, such as: advances in transportation and communication technologies; the liberalisation of trade; the removal of foreign capital controls; and the growing industrial capacity of emerging economies.^[2]

A related feature of this structural change in recent decades has been the growth in intraregional trade and the emergence of regional supply networks. This has been particularly apparent in east Asia where a regional supply network has developed that specialises in producing components for computers and other electronic devices (Craig, Elias and Noone 2011). China has played a central role in the development of this supply network, following its accession to the World Trade Organization (WTO) in 2001. China has experienced large inflows of foreign direct investment and has become a major destination for the outsourcing and offshoring of global manufacturing. It is now a core market for intermediate products, such as resource commodities from Australia and complex manufactured components from Asian countries. These intermediate products are used to produce final goods, many of which are exported to advanced economies.

The growing prevalence of global supply chains, and the related rise of trade in intermediate inputs, has a direct bearing on the structure of Australian trade. Australian exports of intermediate goods and services have consistently exceeded exports of final goods and services over the past two decades (left-hand panel of Figure 2). Moreover, the gap between the two types of trade has widened over recent years. This reflects the resource boom, as a significant share of Australia's resource commodities are exported to east Asia where they are used to produce goods and services that are either sold within east Asia or re-exported to other parts of the world. Australia's growing integration into global supply networks is illustrated by the fact that Australia is increasingly a net exporter of intermediate goods and services, and a net importer of final goods and services (right-hand panel of Figure 2).^[3]

2.2 Measurement of International Trade

Conventional measures of international trade based on gross flows of exports and imports do not fully capture the impact of global supply chains on Australian trade. We construct estimates of ‘value-added trade’, which complement conventional measures, and illustrate how the fragmentation of production across international borders has affected Australian trade. Unlike conventional trade statistics, value-added trade statistics identify the contributions of each country and each industry to the final value of an exported good or service. While conventional trade statistics identify the initial destination of a country's exports, value-added measures identify both the initial and effective final export destinations. A comparison of gross trade and value-added trade statistics provides a guide to the extent to which demand shocks stemming from final export destinations indirectly affect Australia.

Conventional trade statistics typically measure the value of goods and services each time they cross a border. These estimates form the basis of international trade measured in the national accounts and balance of payments and are the most reliable and timely source of information on imports and exports. But gross trade flows do not necessarily identify the countries and industries that contribute to the production of the traded good or service; instead, the full value is attributed to the last country and industry that shipped the product. A component of an exported good that crosses international borders multiple times in the process of becoming a finished good is counted multiple times under conventional measures. As a result, gross measures of trade flows can inflate the amount of trade (relative to domestic output) and provide a distorted view of a country's bilateral trade flows.

These measures of trade reflect the way in which economic activity is measured within and across national borders. GDP, the most commonly used indicator of a nation's domestic economic activity, records only expenditures on final goods and services (or ‘final demand’) and excludes expenditures on intermediate goods and services (or ‘intermediate consumption’). GDP therefore measures the value-added in the production process. For example, suppose an iron ore miner produces iron ore worth $100 (without any intermediate inputs) and sells it to another firm, which uses the iron ore as an intermediate input to produce a refrigerator, which is then sold domestically as a finished good for $110. The ‘gross output’ of the economy is equal to $210, while the ‘value-added’ (as measured by final expenditure) is equal to $110. The national accounts will record the ‘value-added’ of the finished good ($110) as GDP, effectively avoiding counting the value of intermediate inputs multiple times.

To take a similar example, consider the trade flows depicted in Figure 3. Suppose the iron ore producer exports the iron ore, produced entirely within Australia, worth $100 to a firm in China. The firm in China then processes the iron ore (adding value of $10) to create a refrigerator which is exported to the United States, where it is sold as a finished good (for a full value of $110). The conventional measure of trade would record total global exports and imports of $210, despite only $110 of value-added being generated in production. The conventional measure would show that the United States has a trade deficit of $110 with China, and no trade at all with Australia, despite Australia being the chief beneficiary of the final demand of the United States. If, instead, the trade flows were measured in value-added terms, total trade would equal $110. Also, the trade deficit of the United States with China would be only $10, and it would run a deficit of $100 with Australia.

This example highlights the two main issues with the conventional measurement approach: gross trade provides an upper-bound estimate of the contribution of trade to economic activity, and the composition of each country's trade balance does not necessarily reflect value-added trade flows. However, while bilateral gross and value-added trade balances can differ, the aggregate level of each country's trade balance is the same when measured in either gross or value-added terms. In the example, Australia has an aggregate surplus of $100, China has an aggregate surplus of $10, and the United States has an aggregate deficit of $110 under either approach to measuring international trade.

2.3 The World Input-Output Database

In recognition of these problems, an alternative measure of trade known as ‘value-added trade’ has recently been developed (Johnson and Noguera 2012). The measurement of value-added trade requires very detailed information on how exports and imports are used as intermediate inputs by various countries and industries. The World Input-Output Database (WIOD) combines information from national input-output databases with bilateral trade data to construct harmonised annual world input-output tables for 35 industries in 40 countries over the period 1995 to 2011.^[4] This database seeks to identify all the input-output linkages between countries and industries and can be used to construct measures of value-added trade. The WIOD can also be used to trace the path of a country's intermediate exports through global supply chains and identify the effective final destination for the domestic content of a country's exports.^[5]

Value-added trade estimates complement, but do not replace, conventional trade statistics as the necessary information on inputs and outputs is typically produced with a significant publication lag (the latest WIOD data cover the period up to 2011). Gross trade statistics for Australia, on the other hand, are produced on a monthly basis with a very short publication lag. Gross trade statistics, therefore, provide a timelier indicator of trends in Australian trade. Furthermore, the construction of value-added trade statistics requires several assumptions, which are outlined in Appendix A. The WIOD can also be used to construct measures of the domestic supply chain that will be discussed in Section 4.

Footnotes

The concept of trade in intermediate inputs (or ‘supply-chain trade’) is closely related to the notion of ‘intra-industry trade’ (Baldwin and Lopez-Gonzalez 2013). However, we focus on supply-chain trade as we believe it is a broader concept that encompasses both inter-industry and intra-industry trade. [1]

Some of the trend increase in the value of intermediate exports relative to GDP over the mid to late 2000s is due to a relative price increase and, in particular, the rise in world commodity prices. [2]

The rise in the value of net exports of intermediate goods and services (relative to GDP) over recent years is also partly due to higher prices for Australia's commodity exports, such as iron ore and coal. [3]

Timmer (2012) provides an overview of the contents, sources and methods used in compiling the World Input-Output Database, and the associated database can be found at http://www.wiod.org. [4]

A joint OECD-WTO initiative has also developed a database of value-added trade indicators, available at http://www.oecd.org/industry/ind/measuringtradeinvalue-addedanoecd-wtojointinitiative.htm. The OECD-WTO database has a similar coverage of countries and industries as the WIOD, but it currently only covers the individual years 1995, 2000, 2005, 2008 and 2009. For these years, the estimates of value-added trade for Australia are very similar to those obtained from the WIOD. [5]