What is trade made of?

Emma Maersk, one of the world's largest container ships (picture Nils Jepsen)

Emma Maersk, one of the world’s largest container ships (picture Nils Jepsen)

It is a familiar complaint from eurosceptics that the UK does not trade enough with the countries of east and south east Asia.  Membership of the EU has distorted the UK’s trading patterns, they say, focussing too much on Europe and not enough on the world outside.  Given that those countries we are not focussing on are the fastest growing economies in the world, we are foolishly missing out.  That’s the story.

The truth, of course, is a little different.  First, there is the fact that Germany is trading with the world outside the EU very happily: Germany exports, per capita, to the rest of the world 1.6 times and to China 3.7 times as much as the UK does, and its exports to China have been growing 60 per cent faster than Britain’s have.  Membership of the EU does not seem to be holding Germany back, so why should we imagine that it holds the UK back, too?  British economic problems have causes other than EU membership.

There is a second fact, too, which limits even German exports to east Asia (and would certainly limit our own), and that is the question of what trade is.  Why do companies in different countries trade with each and what are they trading?

The most rapid growth in trade is made up not of finished goods for the consumer but of parts and components that will be assembled into those finished goods.  The supply chain for consumer products now stretches across borders, with companies seeking to buy what they need from the best available source.  A true picture of world trade should report not just overall volumes of trade, but information about where the value is added.  (Note that the value lies not just in the physical parts, but in intangible aspects such as design, marketing and maintenance: all of these count, too.)

This trade in components is an increasingly important part of the global economy.  Between 1995 and 2009, while global GDP increased by 85 per cent, gross exports increased by 140 per cent and the foreign content of exports (i.e. re-exported components) by 190 per cent.

And looking more closely at the patterns of trade in components reveals the limits to the growth in this trade.

First, as one might expect, larger countries’ exports tend to contain less foreign-produced value added, e.g. Germany 73.4 per cent, France 75.3 per cent compared with a European average of 72.2 per cent, because companies in large countries are more likely to find the suppliers they need within their own borders.  A lower proportion of domestically produced value added implies that manufacturers are looking further afield to find the best value and quality in their suppliers.

Domestic value added content of exports (vertical axis) vs population (horizontal axis) for EEA/EFTA countries

Domestic value added content of exports (vertical axis) vs population (horizontal axis) for EEA/EFTA countries (data OECD, 2009)

The graph above shows the proportion of value added exports that is domestically produced (vertical axis) vs population in millions (data from 2009), for the EEA/EFTA countries.  Larger countries, to the right of the graph, are shown with have higher proportions of domestically produced value added.

The UK, marked in red, has the second highest domestic proportion of value added output (82.7%) in the EEA/EFTA area, lower only than Norway (84.7%), and higher than France, Germany and Italy.

(Norway is an exception to the size rule because it is a major oil exporter.  The value added in oil exports is overwhelmingly domestic: for example, note the equivalent figures for Russia (93 per cent), Saudi Arabia (97 per cent) and Brunei (89 per cent).)

The low figure for foreign-produced value added in UK exports indicates a weakness in the British economy: its companies are not integrated enough into the international economy in order to be competitive.  And that international economy, for British companies, will be European.

The table below shows the origin of the value added exported by countries in Europe and east and south east Asia:

Domestic Europe East and South East Asia Rest of the World
Average European country 72.2% 15.9% 3.0% 8.8%
Average East/South East Asian country 63.2% 5.4% 17.8% 13.6%
UK 82.7% 9.6% 1.8% 5.9%

To an even greater extent than in Europe, south east and east Asian countries are exporting each other’s value added, showing how integrated their supply chains are, but European and Asian companies are using each other’s value added to a much smaller extent.  The growth in international supply chains is continental, not global.

Origin of foreign produced value added in exports

Origin of foreign produced value added in exports (data OECD, 2009)

The graph above shows the origin of the foreign value added in European and east and south east Asian exports.  It shows that the UK has the same pattern as the rest of Europe.  If British companies were to increase the amount of foreign value added in their export in order to become more internationally competitive, that extra value added would come predominantly from elsewhere in Europe.

There is a final observation to make regarding the fear that European regulation is keeping British companies out of Asian markets.  We have already seen that German companies are not being similarly held back by European regulation; and also that if British companies were more internationally competitive, it is European markets that offer them more prospects; but if we did try to go for the east Asian option, British companies would still be part of an internationally-regulated supply chain and, guess what, those regulations would still be European.

Europe is the world’s biggest trader, responsible for 26 per cent of world exports and 24 per cent of imports.  It is also, for better or worse, the most advanced and sophisticated writer of regulations for business.  It tends to be the first to set standards in a particular field, and those standards either have to be followed by companies in third countries in order that their products can be exported to the EU, or those third countries adopt the EU standards in any case.  (The CE mark has been found on Chinese toys made for the Australian market, for example.)

If Europe is regulating too much or too inefficiently, and in some cases it may be, then the right course of action is to change those regulations.  But do not imagine that those regulations are the cause of Britain’s economic difficulties, or that leaving the EU will cure those difficulties. Other countries manage perfectly successfully in those same conditions.  A closer look at our foreign trade reveals that our problems lie at home.

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