The Comparative Advantage of Nations: How Global Supply Chains Change Our Understanding of Comparative Advantage

The iPhone, while designed by Apple in California, is not “made in the USA.”  Instead, the iPhone’s production exemplifies the complexity of a globally fragmented supply chain.  The iPhone’s components, including the flash memory, the DRAM, and the applications processor, are sourced from various suppliers like Samsung of Korea and AKM Semiconductor of Japan, and the phone itself is assembled by a Taiwanese firm called Foxconn in a plant in Shenzhen, China, before it is exported from China to the rest of the world (“Slicing an Apple,” The Economist, 2011).
Does China have a comparative advantage in iPhones because it exports iPhones?   Official trade statistics demonstrate that China has an unusually sophisticated export basket for its per-capita income level—a basket that includes iPhones, of course (Rodrik 2006, 4).  Anyone who understands the iPhone supply chain, however, can tell you that China has a comparative advantage in the assembly of iPhones.  Just because a country is the final exporter of a good does not mean that it is responsible for the majority of that good’s production.  Global supply chains change our understanding of comparative advantage because we can no longer look at official gross export statistics to see who produces goods for whom.  Because of the global fragmentation of supply chains, we must isolate how much value-added a nation contributes to the production of a good in order to illuminate the true comparative advantage of nations.
Misguided perceptions of competitiveness based on gross trade statistics affect the political debate by contributing to calls for protectionist trade policies which hurt consumers, jobs, and the economy.  Inspired by the fragmentation of production exemplified by the iPhone story, through my senior thesis research this past year, I have sought to help policymakers derive reliable interpretations of comparative advantage from official trade statistics so that they can implement better trade and macroeconomic policies.  Although previous research has provided insight into how global supply chains work and the potential of gross trade statistics to mislead, these analyses have been snapshots of an individual product or economy in a single year.  These snapshot analyses cannot answer the question that policymakers and the public care about: how has comparative advantage changed over time?  Moreover, how do trends in comparative advantage in the US compare to those in other economies like Japan, South Korea, China, and Mexico?
These questions can be addressed for the first time in the literature with the World Input Output Database (WIOD), newly released in April 2012.  The WIOD is the first database to provide a methodologically consistent annual time series of world input-output tables to describe global value chains over an extended 15-year period for 35 industries and a range of countries. Using the newly available World Input-Output Database, my senior thesis makes three main contributions.
First, I document how participation in global supply chains has evolved over the fifteen year time period from 1995-2009.  I show that although advanced economies still dominate at the upstream of supply chains, newly industrialized and emerging economies are participating in more upstream activities as they produce more intermediate inputs over time.  For example, Taiwan experienced a considerable transition from 1995, when nearly half of its value-added was exported in final goods, to the present, when most of its domestic value-added is exported through intermediates.  China and Mexico too, have been producing and exporting more intermediates over time while the United States and Japan appear to be utilizing more foreign content.  Thus, while advanced nations certainly still dominate upstream of global supply chains, emerging markets are increasingly providing intermediate inputs as the quality of their input suppliers increases over time and multinationals move more of their upstream production to emerging economies.
My second contribution is to show for the first time in the literature how long-term trends in comparative advantage can diverge significantly when trade is understood in terms of domestic value-added in exports as opposed to gross exports.  Inspired by the iPhone example to focus on electronics manufacturing, I demonstrate that while gross trade statistics tell a sobering story of the decline of US competitiveness in the electronics industry, value-added trade statistics reveal the rising robustness of the United States’ comparative advantage in electronics.  Further, building upon my research on how countries participate in global supply chains, I highlight that relatively downstream economies like China appear less competitive using value-added measures of comparative advantage, as their gross exports tend to overstate their productive capacity.  On the other hand, relatively upstream nations like the US and Japan appear more competitive in value-added terms.
My third contribution is to illustrate how the value-added approach also provides a new understanding of how comparative advantage has evolved over time for the United States by manufacturing industry.  Contrary to popular fears about the declining competitiveness of advanced manufacturing in the United States, I find that rather than losing comparative advantage in advanced manufacturing, the United States’ comparative advantage is growing most robustly in the highest technology manufacturing industries.
In an era in which fears of losing competitiveness have reached new highs in the US, the value-added approach to trade presents a healthy antidote to protectionist arguments.  Value-added measures of trade demonstrate that far from losing competitiveness in advanced manufacturing industries like electronics, the US continues to have a robust and growing comparative advantage in these industries.  Indeed, the dramatic difference in trend for the US between analyzing comparative advantage using the value-added and gross trade approaches emphasizes the importance of helping policymakers interpret official trade statistics correctly.  My research provides strong support for the use of value-added measures of trade in order to obtain an accurate picture of the comparative advantage of nations in today’s globalized economy.