Professor Stéphane Garelli on world trade - IMD Business School

To indulge in protectionism (you should first know the "true" nationality of products)

Professor Stéphane Garelli on world trade
4 min.
July 2018

… and in a globalized world, it’s far from easy. When President Trump imposes tariffs on aluminum or steel, it is relatively clear where these products come from. Simply put, steel is made in Germany and aluminum in Canada. When Europe retaliates on whisky or orange juice, it is equally straightforward to determine their origin. They are homogeneous products.

However, it is far more difficult to establish the nationality of products that are made of many components assembled from different parts of the world. A few years ago, researchers at the University of California in Los Angeles traced the origin of the 431 components of an iPod. They came from several different parts of the world to be assembled in the Foxconn factory in Longhua, China. In the end, the Chinese added value of the final product did not exceed 5%. But upon arrival at US Customs, the iPod was statistically considered a Chinese product. Really?

The US trade deficit is the result of imports from, for example, Mexico or China. But 40% of Mexican imports to the United States are made by US companies based in Mexico or by Mexican companies that are dedicated suppliers of US companies. The same is true for China, which has become a preferred source of supply and manufacturing for European and US companies.

Also, how can we account for components that are distributed freely as a part of a business strategy to create a standard? For example, Google’s chief economist Hal Varian estimates that if it were a paying product, Google’s Android software, which is now freely available as a platform for smartphones, would be worth $ 200 billion a year. It would compensate for 50% of the US trade deficit…

In an escalation of retaliation, the US president also threatens the German auto industry. Yet, BMW produces cars in Spartanburg, South Carolina, just as Mercedes does in Vance, Alabama, and Volkswagen in Chattanooga, Tennessee. These factories also produce for export. Of the 371,316 cars produced last year by BMW at its Spartanburg site (essentially the X5 model), 70% are shipped abroad. Are these American or German cars?

The Kyoto convention that came into effect in 1974 tried to bring some order to the definition of the “nationality” of a product. In short, the origin of a product can be derived from a minimum percentage of local content or the most important last transformation process. But that is no longer enough. The globalization and the digitalization of the value chain have increased not only the complexity in defining the origin of a product but also its volatility. For example, the mix of components constituting a product can change from one month to the other and be supplied internationally in a flexible way according to prices and capacities.

The American President seems to ignore, like Brexit supporters, that it has become extraordinarily difficult to disentangle an economy from its global context. The United States has invested about $8 trillion in the rest of the world, while other countries hold nearly $7 trillion in the United States. Overall, direct investment accounts for 35% of global GDP and employs more than 80 million people. In economics, as in private life, a divorce is more complicated and expensive than a marriage.

To get a clearer picture of the impact of international business, we need to focus on the added value content of a product and not just on its geographical origin as customs statistics do; This is also highlighted by several studies by the World Trade Organization and the OECD. But everything is complicated when this added value could also arise from an immaterial data economy or transactions performed with blockchain. In this decentralized and immaterial world, who owns what?

We are far removed from the simplistic and angry tweets of the American president. But unfortunately, we shall have to live with it. As John Maynard Keynes pointed out: “all problems are economic, and all solutions are political. Unfortunately…

Stéphane Garelli is Professor Emeritus at IMD business school and at the University Lausanne. He is former Chairman at Le Temps newspaper.


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