Brad Setser

Follow the Money

Cross border flows, with a bit of macroeconomics

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Showing posts for "U.S. trade deficit and external debt"

Offshore Profits and U.S. Exports

by Brad Setser

One important result of my theory about the sources of “dark matter” in the U.S. balance of payments is a concern that “border adjustment” might not generate the expected revenues. American multinationals would have a strong incentive to shift their offshore income on intellectual property rights that are now located in subsidiaries offshore back to the U.S..

A lot depends on the details of any proposed tax reform, but I think a firm with U.S. expenses and export revenues would generate a tax loss on its exports (export revenues are excluded from calculation of revenues for the purpose of the tax, and domestic expenses can be deducted). If that tax loss is refundable, exporters essentially get a check back from the government for a sum equal to their domestic labor costs (see Chad Bown on the “subsidy” component of a border tax adjustment).* Profits that now show up in subsidiaries in Ireland, Puerto Rico, Singapore, and the like** based on intellectual property that is held in the Caribbean, thanks to the low price headquarters charges for the global rights on their intellectual property, might show up back in the U.S.—and I suspect the royalties their offshore subsidiaries pay headquarters for research and design and engineering (e.g. exports) would soar.

I haven’t started to figure out how European companies that now report very little income on their direct investment in the U.S. might try to game the system. I suspect that they have an incentive to try to lower their reported intra-firm imports—e.g. reduce the transfer prices they charge their U.S. subsidiaries to lower their “border adjustment”. Auerbach, Devereux, Keen and Vella have emphasized that introducing a destination based cash flow tax in one country would have quite different effects than introducing a destination based cash flow tax in all countries.

But I also wanted to draw out the implications of the rapid growth in the offshore profits of American companies for the broader debate on globalization.

Consider the following chart: normalized versus GDP, the “reinvested” (tax-deferred, or less politely, largely untaxed as of now) profits of U.S. multinationals have more than doubled over the past twenty years, while U.S. exports of capital goods, consumer goods, and autos (my measure for “core” manufacturing exports) have stayed constant as a share of GDP. Imports of that set of goods have increased by roughly 25 percent on this measure.

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Dark Matter. Soon To Be Revealed?

by Brad Setser

The debate around the House Republicans’ proposal for a border adjusted (destination-based cash flow) tax will, I think, force an important debate about the impact of corporate tax strategies on global trade flows.* My guess is that tax strategies do have a significant impact on the trade data (one hint: the trade deficit in pharmaceutical the U.S. now runs with Ireland and Switzerland). And in turn I suspect that the revenue projections from the House’s proposals will depend in part on how firms are expected to adapt to a world where export revenues booked in the U.S.—including export revenues from the royalties on intellectual property—are not taxed. A world where the U.S. suddenly becomes tax competitive with Ireland, the Netherlands and others.

I suspect that the size of the impact will surprise many people.

I first started looking at the impact of firms’ tax strategies on the balance of payments back in early 2006, as part of a debate over the sustainability of the U.S. trade and external deficit. One argument at the time was that Americans had nearly magical skills at cross-border investing—magic that produced a surplus on net foreign direct investment (FDI) income (the dividends that American firms receive on their foreign investment relative to the dividends foreign firms receive on their U.S. investments) that would perpetually negate the United States’ interest payments on its net external debt. That magical surplus on investment income in the balance of payments effectively made conventional measures of U.S. external debt sustainability moot.

Harvard’s Ricardo Hausmann has always had a way with words. He named the forces that kept the U.S. income balance positive even as the U.S. ran persistent trade and current account deficits: dark matter.

Time, I think, has helped bring the sources of dark matter—or, put differently, the sources of the United States’ exorbitant privilege—into the light. I suspected back in 2006, and now suspect even more strongly now, that “dark matter” is largely a function of the tax strategies employed by firms like Apple (here is a 2005 Wall Street Journal article focusing on another large tech firm).

The “income” the U.S. earns on its equity investment abroad now heavily shows up in low-tax jurisdictions. The “stock” position is now relatively balanced (the market value of U.S. direct investment abroad was $7 trillion at the end of 2015, which is not that different from the $6.5 trillion value of foreign direct investment in the U.S). The net income the U.S. earns on investments abroad essentially comes from the difference between the low cash returns foreign companies report on their U.S. equity investment and the large returns American firms report on their non-repatriated (e.g. tax deferred) income abroad.

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Imports Normally Would Have Subtracted More From 2016 U.S. Growth

by Brad Setser

I follow the news, some would say obsessively. I know there are far more important things afoot than backward looking analysis of the United States’ 2016 economic performance.

But I do think in some ways the U.S. was lucky not to have slowed more in 2016.

Why? Because import growth stalled, and imports did not subtract as much from U.S. growth as normally would be expected (and yes, that obviously wasn’t the dominant narrative of the 2016 election).

Plus the U.S. essentially got a small GDP boost as a result of a bad harvest in Brazil that raised U.S. soybeans exports in q3 (a rise that was only partially reversed in q4). The U.S. isn’t (yet) a commodity-driven economy, but it also isn’t (yet) a robot-based intellectual property rights (IPR) royalty-driven economy totally divorced from natural sources of economic volatility.

Imports are essentially a function of domestic demand growth and the exchange rate. More domestic demand than the exchange rate: the exchange rate in nearly all careful studies tends to have a stronger impact on U.S. exports than on U.S. imports. In the Fed’s U.S. international transactions model, for example: “The equations for goods and services exports predict that a 10 percent appreciation of the real dollar would reduce the level of overall real exports by about 7 percent after three years. After three years, the model predicts that real imports would be almost 4 percent higher.”

Over the last twenty years the negative contribution of imports to growth—think of it as U.S. demand that is shared with the world—has been about 25 percent of U.S. domestic demand growth. So typically 75 percent of any increase in U.S. demand goes toward domestic output, and 25 percent goes to the rest of the world (the U.S. of course also benefits from demand growth elsewhere, as growth outside the U.S. pulls up exports).

That is somewhat higher than that import share of GDP—as one would expect, if, over time, the import share of GDP is rising.

But something strange happened in 2016. From mid-2015 to mid-2016 (I like to look at the change over four quarters, a typical year-over-year comparison is the average over the last four quarters versus the average over the preceding four quarters so it uses eight quarters of data rather than four) U.S. imports were essentially flat (the negative contribution over four quarters was only 5-10 basis points of GDP) while U.S. demand growth—even counting inventories—contributed 1.5 to 2 percentage points to GDP growth.

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The Price of U.S. Imports From China Keeps Falling

by Brad Setser

The way trade is to be taxed at the border may—or may not—be about to change radically. But rather than speculate on the nature of the new world, I wanted to highlight one feature of the old.

I sometimes hear that China is loosing trade competitiveness because of rising domestic costs. And thus Chinese manufacturing firms need to move out of their ancestral homeland, either to low cost manufacturers like Vietnam or even to advanced economies like the U.S., in order to remain competitive.

I do not see it in the data. At least not in aggregate — the stories of individual sectors of course could differ. .

If the price of imports from China (as reported by the U.S. Department of Labor) is compared to the price of U.S. made finished goods and the price of domestic manufactures, Chinese goods not only look very competitive, but broadly speaking have been gaining in price competitiveness against U.S. made goods ever since the yuan stopped appreciating—and with the yuan depreciation of the past year, are poised to become even more competitive.

us-import-price-indexes

China maybe has lost a little of its previous edge over Canada and Europe thanks to the depreciation of the Canadian dollar and the euro over the past couple of years. But broadly speaking, the price of goods imported from China is back to where it was in 2004 (when the data series starts) while price of manufactured goods from the United States wealthier trading partners has gone up since then.

There is one potentially significant problem with the U.S. data here. About a quarter of U.S. imports from China are computers and cell phones. And getting the right “price” for goods marked by rapid technological change over time is hard. I suspect that the gap over time between the evolution of Chinese prices and U.S. finished goods prices would be smaller if computers and consumer electronics were removed. In fact, I would be thrilled if the BLS put out such a series. The area of real overlap between the U.S. and China increasingly is in the production of machined parts and capital goods (suggestions for how best to capture this most welcome, the right measure of U.S. prices might not be final goods excluding food and energy).

Setting that caveat aside though, I do not doubt that the basic story in the U.S. import price data is true: Over the past couple of years, the combination of U.S. workers and U.S. industrial robots has been loosing price competitiveness to the combination of Chinese workers and Chinese industrial robots.

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Chicken Feet And China: Back to the Future

by Brad Setser

Yes, this is a blog about chicken feet exports—technically, NAICS code 311615, “poultry processing.”

Welcome to the glamorous world of tit-for-tat trade spats. The biggest trade case of 2009 was the tires “421 safeguards” case, which prompted China to respond with duties on U.S. exports of chicken parts.

The possibility that the U.S. and China could embark on a cycle of sanction and counter-sanction will, I expect, force a new group of people to explore the nooks and crannies hiding in the data on U.S. exports to China.

Some of the sectors are well known.

Aircraft, of course. They are one of several sectors that account for about 10 percent of total U.S. exports to China and Hong Kong. Along with autos. Auto exports fell a bit in 2015, but in 2014 auto exports were almost as big as aircraft exports. Mostly SUVs I think, with many coming from the German transplants. In numeric terms, the legacy of the United States once powerful electronics manufacturing sector matters—though there hasn’t been much growth, alas, since the crisis.

Hopefully everyone now knows about the bling—gold and jewelry are about a third of U.S. exports to Hong Kong (and have at times been as much as ten percent of combined exports to China and Hong Kong).

And then there are the commodities. Soybeans of course. They can account for as much as 10 percent of total U.S. exports to China and Hong Kong if the price of beans is high. Cotton and hides and other inputs for clothing are a decent chunk — around 3 percent — of U.S. exports to China and Hong Kong. Wood pulp and timber account for about 4 percent of combined exports to China and Hong Kong. Metals are about 4 percent of US exports to China and Hong. And so on. Not all U.S. exports to China are super high-tech.

U.S. chicken part exports to China are mostly feet, from what I understand. A clear case of the gains from trade that emerge from different culinary preferences.

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China’s WTO Entry, 15 Years On

by Brad Setser

Late last year Tim Duy asked for an assessment of the decision to allow China to join the WTO, now that 15 years have passed.

Greg Ip met the call well before I did, in a remarkable essay.

But I will give my own two cents. Be warned, this isn’t a short post. Frankly it is an article disguised as a post. I added the subheadings to make it a bit easier on the eye.

Autor, Dorn, and Hanson Deserve All the Attention They Have Received

It now seems clear that the magnitude of the post-WTO China shock to manufacturing was significantly larger than was expected at the time of China’s entry into the WTO. China already had “most-favored-nation” (MFN)/“normal trade” access to the U.S. market, so it wasn’t clear that all that much would change with China’s WTO accession. But China’s pre-WTO access to the U.S. came with an annual Congressional review, and the resulting uncertainty seems to have deterred some firms from moving production to China.

The domestic labor market adjustment to the “China” shock was not smooth. Autor, Dorn, and Hanson’s research shows the China shock left a significant number of Americans temporarily without jobs and left some workers and communities permanently worse off. The U.S. labor market isn’t as homogenous or as flexible as many thought; displaced workers in the most exposed regions often dropped out of the work force rather than finding new, let alone better, jobs.

Similar effects to those that Autor, Dorn, and Hanson found in the U.S. also seem to be present in manufacturing intensive parts of a number of European countries (France, for example). Bob Davis and the Wall Street Journal also deserve credit for their reporting on this topic: Davis and his colleagues really helped flesh out the narrative that goes with the Autor, Dorn, and Hanson data.

Not All China—The Underreported Impact of Dollar Strength (2000-2002)

All that said, the shock from the rise in imports that came with China’s WTO entry was not the only source of the enormous decline in manufacturing jobs between 2000 and 2005.
The broad strength of the dollar from 2000 to 2002 mattered.

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The U.S. Needs More Manufactured Exports

by Brad Setser

I previously have noted that—if you exclude processing imports—China’s imports of manufactures are low relative to its GDP. I suspect the interlinked “China, Inc” connections between Party and State (described well by Mark Wu) have something to do with this. Manufactured imports, net of processing imports (processing imports are re-exported), peaked as a share of China’s GDP back in 2003.

ae-manufacturing-imports

The other “trade” outlier among the world’s big economic blocks is the United States. U.S. imports of manufactures aren’t out of line with those of say the eurozone. Or for that matter with Japan, which imports a lot more manufactures now than it used too. The U.S. though does stand out for the low level of its manufactured exports.

ae-manufacturing-exports

I am using an imperfect proxy for U.S. manufactures here—the sum of capital goods, autos, and consumer goods in the end use data. That leaves out manufactured goods in industrial supplies (notably chemicals, which sort of blur the line between manufactures and commodities given that competitive advantage is often determined by proximity to a low cost supply of ethane and the like). Adding in chemicals and plastics though would not significantly alter the picture (and would make the data harder to replicate). I confess that I prioritized using easy to reproduce (and easy to update) data that tells the basic story over analytical perfection.

I also adjust the Chinese data by netting out processing imports from China’s exports in a way that I do not adjust the other countries data. Without that adjustment, China is on a different scale.

The result of this pattern of exports and imports is that the U.S. runs a sizable trade deficit in manufactures, while the other big integrated economic blocks run surpluses in manufactures.

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Two Trade Variables To Watch in 2017

by Brad Setser

I suspect that few variables will tell us more about the course of the global economy, and perhaps global policy, than the evolution of Chinese and U.S. exports. Sometimes the most important indicators are simple and straightforward.

China’s exports matter for a simple reason: they could provide the basis for a true change in the narrative around China’s currency.

I tend to think controls can play a role in stabilizing expectations. The trade account doesn’t signal an underlying overvaluation of the yuan. China’s goods surplus is quite substantial. And China’s exports, as the chart below shows, have outperformed U.S. exports both during the period of dollar weakness (05 to 13) and in the recent period of dollar strength (chart uses a volume index, Chinese data starts in 05).

us-v-china-real-goods-exports

With an ongoing trade surplus, the right exchange rate is ultimately a function of the scale of outflows—and those are in part determined by expectations about what others are likely to do. If everyone wants out and can get out, it is rational to try to get out first. That is why the controls could work, especially as the nominal return on safe assets in China (still) exceeds the nominal return on safe global assets. There is also a normative judgment here too: a new China shock from a significant further depreciation against the basket and against the dollar would not help the global economy, and would add to the already considerable risks of trade conflict.

At the same time, there are likely to be limits to how tight the controls can be. It should be relatively easy for China, if it wants too, to keep its state banks from running up their foreign assets. And to keep state-run financial institutions from buying U.S. corporate bonds for their portfolio. It is far harder to control the activities of China’s export sector. Chinese exporters will be far more likely to sell their dollars and euros for yuan if the exporters believe that there is real two-way risk on the currency.

And one thing that could convince the exporters that they risk losing out if they hold their export proceeds abroad is a run of decent trade data. China’s November exports were pretty strong—China releases its own export volume data with a month lag, and the latest data shows that exports were up 8% in November. In today’s global environment that is a solid increase—though the November increase needs to be evaluated in light of October’s weak numbers. December data (out Friday) will be interesting.

And U.S. exports matter for a host of reasons.

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Why Doesn’t Apple Export More Services (Wonky)

by Brad Setser

A big caveat. Apple is being used to represent a lot of companies with very valuable intellectual property (IP) that have built up similarly outsized piles of cash outside the United States; it is the most high-profile case, but it is hardly unique.

The iPhone, famously, is designed in California and is assembled in China out of parts manufactured (mostly) in Asia.

I do not think the recent coverage about what it would take for Apple to manufacture the iPhone in the United States has added much to Keith Bradsher and Charles Duhigg’s spectacular reporting back in 2012. And, to my mind at least, the big revelation in the Bradsher/Duhigg article was that even the high-end components of an iPhone, and even those high-end components that come from American companies, typically aren’t made in America. Corning now manufactures its gorilla glass mostly in Asia, the chip designers farm out production to Asian fabs, etc.

I suspect not much has changed since then.

I digress.

No one questions that the iPhone is designed in the United States. And a lot of the software that makes an iPhone an iPhone is also created in the United States. And the export of intellectual property rights—the U.S. design and engineering embedded in a “designed in California” iPhone sold in Asia or Europe—should in theory enter into the balance of payments as a services export.

I would think it should show up in the line item for the export of “charges for the use of intellectual property, computer software” though in practice it may enter as a payment for research and development services (see below). Like I said, this is a wonky post.

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The (No Longer) Almighty Soybean

by Brad Setser

The U.S. trade deficit rose in October.

One reason (no surprise): Soybeans. Seasonally adjusted, monthly soybean exports are now $3 billion off their July and August peak. Actual soybean exports—in billions of dollars—rose in October. As they should. Soybeans have real seasonality: U.S. exports peak after the harvest. The seasonal adjustment seeks to smooth out this natural month-to-month volatility.

soybeans-nsa-sa

The good news from the summer is now mostly behind us. Still, as a result of the out of season exports—and higher prices—the U.S. has already exported $7.5 billion more soybeans this year than last.

I want to highlight two other points, both of which are—I fear—a sign of things to come. What I suspect is the beginning of a sustained—though modest by past standards—rise in the petrol deficit, and, more concerning, the growing U.S. deficit in high-end capital goods.

I will not try to replicate Calculated Risk’s always excellent graphs. There is no doubt that the nominal petrol deficit has started to tick up, after big falls for several years (in nominal terms, the non-petrol deficit is back to where it was before the crisis, a shift that hasn’t gotten the attention it deserved).

In real (volume) terms, the U.S. petrol deficit is also starting to rise. The large tailwind that rising oil production, falling oil imports, and falling prices provided for the the overall U.S. balance of payments in the past few years is in the process of turning into a modest headwind.

petrol-deficit-real-v-nominal

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