Share this page!

Enter URL or ID to Unroll

You can paste full URL like: https://x.com/threadreaderapp/status/1644127596119195649
or just the ID like: 1644127596119195649

How to get URL link on X (Twitter) App

  1. On the Twitter thread, click on or icon on the bottom
  2. Click again on or Share Via icon
  3. Click on Copy Link to Tweet
  4. Paste it above and click "Unroll Thread"!
  5. More info at Twitter Help
Glenn Profile picture
@GlennLuk
Oct 29, 2024 • 45 tweets • 15 min read • Read on X
Contrary to a popular mainstream view, China's trade surplus has likely been overstated by hundreds of billions per year dating back more than a dozen years.

This 🧵 is a direct rebuttal against claims that the recent changes in BoP methodology are leading to systematic understatement of its trade and current account surplus.

Instead, I show how the change in methodology has addressed prior distortions.

@IMFNews @Brad_Setser
To understand why, we need to go back to the the 19th century during the first globalization boom.

This was a time when physical trade flows largely matched funds & value flow, as products produced entirely in one region were traded for those produced entirely in others. Image
Fast forward to present day: Trade has gotten significantly more complex.

Lower friction costs of trade made it possible to separate/outsource different segments of the mfg. value chain.

Int'l tax laws incentived firms to shift profits, which distorts customs data.Image
This is especially true for China, which became the world's factory floor — with the implication that China is the final destination for most of the world's manufactured consumer goods by global brands before they are shipped all around the world. Image
Rising mfg. complexity & profit-shifting increasingly untether measured physical trade flows from underlying value/fund flows.

The iPhone is one of the best illustrative studies.

This diagram shows how China Customs measures it using physical trade flows. Image
But if we examine actual fund flows — which is the ultimate objective in measuring trade — China switches from being counted as a large net exporter ($31.2B) of iPhones to a larger importer ($21.6B).

This is a $52.8B swing/distortion for a single product from one company.Image
Ultimately the direct funds flow approach is more accurate than the physical flows approach.

After all, China Customs' measurement of physical trade flows had merely been used as a proxy for the underlying fund flows & value transfers. Image
We can further break down the physical vs. fund flows distortions into two key categories.

First, is the overstatement of exports using physical vs. fund flows.

This is driven by the difference b/n customs valuation and actual payments to the contract manufacturer.Image
While there is some debate on the exact magnitude of the difference between customs value and payments to the contract manufacturer — as it will vary by industry and product — we know that it can only be distorted in one direction (i.e. overstatement).
Customs value cannot go below amounts paid to the contract manufacturer, but it can be much higher.

This was confirmed recently when analyzing differences in custom valuations between the U.S., Japan and Ireland for the iPhone.

Secondly, there is another key distortion on the measurement of imports between physical and funds flows approaches.

This time it is an understatement — which leads to further overstatement of the surplus.Image
As mentioned earlier, combined these distortions add up to an estimated $52.8B just for the iPhone.

And these distortions are not Apple-specific or limited to bonded zones.

They are features of most relationships between foreign brands and Chinese contract factories. Image
For example, we see the same phenomenon with global footwear brands like Nike and Adidas that manufacture shoes in China for customers both outside and within China.

Within branded footwear, I calculate a net overstatement of $27.5B.

Less than the iPhone, but still material. Image
Image
Indeed, we can generally apply this analysis across all sectors where foreign brands contract manufacturing to Chinese factories. Image
The scope of this net overstatement is large.

I estimate distortions equal to 3.2-4.7% of exports (as measured by China Customs) and 1.1-1.6% of imports, amounting to a combined $142 to 212 billion in '22 — and even this may be quite conservative.Image
Keeping all of this context in mind, the change in methodology in 2021-22 from using China Customs physical flows data to underlying funds flow data kept by SAFE (e.g. FX transactions and reported financials) was most likely to correct for these known distortions. Image
Correcting these known, observable distortions is a far more plausible explanation than speculative claims that the methodological changes were made as a way to understate or otherwise hide its trade surplus. Image
Indeed, as I discussed in my initial thread on the topics a few weeks ago, there are no signs of a the "hidden capital flight" that would be a necessary balancing implication of a current account surplus that is understated by half a trillion dollars.

Instead, this corrects longstanding physical vs. fund flow distortions that have been steadily rising from:

(i) ↗️ exports
(ii) ↗️ use of Chinese contract mfgs, and
(iii)↗️ sophistication of int'l tax optimization strategies via profit shifting to tax havens like Ireland
Indeed, if we apply general assumptions on distortion levels to BoP figures dating back to 2012, we can see how they adjust E&O in a way that is still consistent with known "hidden capital flight" surges like 2015-18 and 2021-22. Image
Further analysis will be helpful to further refine these assumptions but the general conclusion here is that it is far more likely that Chinese trade surpluses have been overstated rather than understated over the past dozen years.
Responses to Brad to follow:
1. U.S. customs price shows material diff b/n reported customs valuation ($400/iPhone) + iPhone BOM ($270/iPhone), creating the distortion.

The chart below actually confirms the idea raised in CF40 report that Chine’s reported customs exports match trading partners’ import data.
I go into detail in this prior thread to calculate the estimated difference between customs valuations & average iPhone BOM.

Brad keeps citing BOMs for high-end iPhones but the avg. iPhone is $885/retail, suggesting a significantly lower avg. BOM vs. high-end models.
Ireland’s much lower customs import price for iPhones strong indication of what is paid to contract manufacturers.

Ireland is a special case because IP is legally domiciled there for international sales.

(U.S. is also special because IP is developed in Cupertino)
2. I do not see the basis for the assertion that customs distortions only arise out of bonded zones.

China and IMF refer to “factoryless” manufacturing, which is much larger than trade our of bonded zones.
I specifically addressed this in my thread here using the example of branded footwear.

Thus Apple and bonded zones cannot represent an “upper bound” on possible export distortions.
3. I also addressed the import understatement issue in my thread.
The specific critique is with Brad’s proposed adjustments.

I agree it would be accounted for in the old methodology as a separate services, royalty or profit line item.
But in Brad’s adjustment, he compares the Customs surplus (which does not include this adjustment) with the new BoP surplus methodology based on fund flows (which does).

This is not apples to apples.
Thus, adding the full gap between Customs data and (post-adjustment) BoP Surplus double-counts this import understatement adjustment.

My position is that the new methodology properly accounts for the export overstatement and this import understatement.
4. If there are valid reasons, such as the rise of these identified distortions, then making the move to the new methodology that ends up reduces E&O should provide comfort, not arouse suspicion.
E&O could be a function of distorted official measures (such as the customs exports overstatement) or it could be a sign of hidden capital flight.

What doesn’t pass the sanity check are logical implications of Brad’s position that China’s CA surplus should be adjusted by $500B.
I discussed why here. There’s just no smoke / evidence that there is hidden capital flight anywhere close to the $500B that would be required to balance out the proposed adjustment.

I’m happy to change my position if evidence can be found of this, but none has been offered.
I have compiled customs data from OEC for 2022 for some of the larger European countries to fill in some of the remaining gaps.

Est. customs value for iPhone is significantly higher than U.S. (as expected) but also higher than Japan. Image
This raises the $/unit customs average to $457. I have used this data to update the previous slide: it now covers >90% of exported iPhones from China.

I've tweaked some of the assumptions (BOP as a % of retail, iPhone/Android price ratio) to be even more conservative. Image
Updated export overstatement of $27B representing ~32% of the customs export value.

Compares to 10-15% on foreign brand exports, which are ~1/3rd of total exports. This is appropriately conservative, as an iPhone has relatively high intangible content.

This '21 paper examines the "factoryless" mfg. and distortion effect on "trade vs. income flows".

Based on five US "factoryless" cos (Apple, Nike, Qualcomm, Cisco, AMD), researchers found $70B (~36%) of trade distortion on $190B in int'l revenue.

ideas.repec.org/p/ngi/dpaper/2…Image
Image
Image
This is consistent with the up-to-date analysis I have done on the Apple iPhone, providing a nice sanity check.

This distortion is generally applicable to all "factoryless manufacturing" where a foreign company works with a Chinese contract manufacturer.

This includes most of the $1.1T in exports that include a "foreign-funded" exporter (e.g. Foxconn, Pou Chen)

In other words, it is not just "bonded zones", which are a subset of "factoryless manufacturing" for products like the iPhone where there are large number of finished components that need to be handled logistically.

To calculate the range of potential distortions, I use 10-15% of this $1.1T in exports by foreign-funded entities.

This is actually quite conservative based on the Apple and Nike examples, where intangible asset (e.g. brand, tech) make up the majority of the value.
The value recorded by China Customs for exports is typically based on the Transaction Value method and determined by the importing firm, not by China Customs or the contract manufacturer.

bdo.com/insights/tax/t…
As noted here, intangible value like IP and royalty license should be included in this valuation.

The customs valuation is relevant for the importer because that is the value on which potential duties and VAT are calculated by the importing country. Image
Image
The Transaction Value (TxV) method is the dominant form to estimate customs valuation, used in “90-95%” of transactions.

It’s discrepancies between TxV — determined by the importer — recorded by China Customs and the price paid to the CM that create export overstatement.

• • •

Missing some Tweet in this thread? You can try to force a refresh
　

Keep Current with Glenn

Glenn Profile picture

Stay in touch and get notified when new unrolls are available from this author!

Read all threads

This Thread may be Removed Anytime!

PDF

Twitter may remove this content at anytime! Save it as PDF for later use!

Try unrolling a thread yourself!

how to unroll video
  1. Follow @ThreadReaderApp to mention us!

  2. From a Twitter thread mention us with a keyword "unroll"
@threadreaderapp unroll

Practice here first or read more on our help page!

More from @GlennLuk

Glenn Profile picture
Oct 23
From 4th Plenum communique:

Just want to just emphasize here that Chinese policymakers still highlight domestic *demand* not *consumption*
This is important because there is a group of people that insist on confusing/conflating demand with consumption in the China context.

These are meaningfully distinct terms: Consumption is just one component of demand, alongside gross capital formation. The distinction is driven by GDP accounting definitions.
To further clarify, this is what I mean about the distinction between demand (in the context of supply) and "consumption" in the context of GDP accounting-driven split between gross capital formation / "investment" and expenditures / "consumption"

Read 6 tweets
Glenn Profile picture
Oct 22
I can see that folks are already starting to wildly misinterpreting what this chart says and this seems like another one of these Rorscarch tests on China.

Let's nip this in the bud: this is IP share of services exports, which comes from Balance of Payments accounting.
That China does not license IP is not an "indictment", it's a statistical quirk that requires some deeper understanding of the BoP and how it maps against real-world trade and investment realities.

I'm not 100% sure but my guess is that Steve is saying this shows China has minimal IP that other nations find valuable.

No; it's because China does not export much IP in license form because most of its IP gets packaged with manufactured goods.

Read 15 tweets
Glenn Profile picture
Oct 21
This was a complex/nuanced discussion on "overcapacity". Thanks for writing it @wstv_lizzi as it is an important topic.

It presented a number of interesting ideas which make sense on their own but I struggled to tie them together under a "grand unifying narrative" related to the "China Model".

The challenge of the "overcapacity" narrative is trying to use it to summarize "China Model" into a neat, compact narrative. But trying to summarize something as complex as China's economy into a neat model is exceedingly difficult.

(as an aside, the piece read like a writer struggling to force-fit an article within pre-defined narratives/framing set by an editor)

Two key problems I've found in the "overcapacity" debate that I'll go into more detail in this 🧵:

1⃣ Unclear/conflated definition of the term "overcapacity"

2⃣ As you drill down down from the macro/national level to individual sector level, you find many sector-specific idiosyncrasies that contradict core elements of "grand unifying" theme around "overcapacity".
1⃣ Defining "overcapacity" itself

"Overcapacity" has become a loaded word, especially when described in the context of the broad "China Model" in the current geopolitical environment.

In regular industrial/manufacturing usage, overcapacity is simply a state/condition where capacity utilization is below a certain "normal" threshold. This threshold may very by sector and different operating conditions.

Standard capacity utilization is defined not only by physical capital stock, but also by an active labor force operating on a normal shift schedule (typically 2 shifts per day, 5 days per week, or 80 hours / week).
But the way that it is being used in policy/economic/geopolitical discussion is in a much more undefined/amorphous way that goes well beyond the standard industry/mfg definition.

For instance, in this passage it is implicitly defined as production beyond domestic demand. But the implication here is that Chinese companies should not be able to have free access to global markets.

IOW how the term is used/defined appears to reflect implicit policy objectives of one particular side in the ongoing trade war.

Carefully inserted vocabulary like "deluge" and "sinister" peppered throughout the piece subtly signal how "overcapacity" is being normatively framed.Image
Image
Image
Read 16 tweets
Glenn Profile picture
Oct 15
If you read the official court documents (link in ALT), it is very clear that the underlying reason driving the eventual takeover of the company were the prospect of escalation in U.S. trade sanctions under the 50% rule, which was officially released on September 29th.Image
A detailed timeline of the events described in the legal brief clearly show that the entire series of events were instigated by the addition of Wingtech, which indirectly owned/controlled 100% of Nexperia, to the Entity List. Image
To characterize the primary reason for the takeover as "financial misconduct" ignoring that the the "financial misconduct" was directly linked to Wingtech's addition to the Entity List is highly misleading and disingenuous.
Read 20 tweets
Glenn Profile picture
Oct 14
No. The reason why it has a monopoly today is because China has:

(i) made significant technology and process advances that effectively isolate/mitigate the effects of the environmental damage — concentrated in the up/midstream mining and separation phases — on society, and

(ii) invested in human capital / specialized manufacturing equipment and optimized steps in the downstream processing stages, including deep integration with end-product manufacturing (e.g. permanent magnets which make up the bulk of use cases by economic value)

Whether simply ignorance or worse, inability to recognize — e.g. by implicitly attributing it on Chinese society simply having a higher tolerance for pollution through this type of moral grandstanding 👇 — is frankly one of the key reasons why minimal real progress has been made to address a strategic vulnerability that has been known for decades.
I'd once again encourage folks to listen to this podcast from @twittwoods who has been studying the development of China's rare earths industry and was really the first one to clue me into just how much investment has bene made to raise environmental standards, especially since the mid-2010s.Image
Listen to the podcast here:

Read 10 tweets
Glenn Profile picture
Oct 14
It's always helpful to understand the "variant view" and I'd encourage you to read Alex's for his.

I DM'ed him why I thought this one was flawed, in supporting the prediction of a 2027-2030 crisis point.

Here are the key points:

1⃣ Systemic risk from the property and LGFV sector have been contained

2⃣ American MNCs make more money off China than vice versa

3⃣ There are more vulnerabilities beyond rare earths

4⃣ Assumption of stasis in China's efforts to catch-up in its areas of vulnerability (advanced chips, global financial system)

5⃣ Last but probably most significantly: ignoring what have actually been China's greatest vulnerabilities — dependence on fossil fuels and iron ore — and the rapid progress China is making to address this — which ultimately affects its geopolitical calculus / internal assessment of leverage.
1⃣ Systemic risk from the property and LGFV sector have been contained

This is the sub-topic where we have had the most back and forth on so I'll just link to previous threads.

Here is one where we were debating the amount of embedded NPLs in the system

As you can see, his numbers/definitions keep changing. $3.0T in "NPLs" earlier, now $5.4T in losses.

Frankly, this doesn't provide me with a ton of confidence in the robustness of the forecast. Image
Image
Read 48 tweets

Did Thread Reader help you today?

Support us! We are indie developers!

This site is made by just two indie developers on a laptop doing marketing, support and development! Read more about the story.

Become a Premium Member ($3/month or $30/year) and get exclusive features!

Become Premium

Don't want to be a Premium member but still want to support us?

Make a small donation by buying us coffee ($5) or help with server cost ($10)

Donate via Paypal

Or Donate anonymously using crypto!

Ethereum

0xfe58350B80634f60Fa6Dc149a72b4DFbc17D341E copy

Bitcoin

3ATGMxNzCUFzxpMCHL5sWSt4DVtS8UqXpi copy

Thank you for your support!

Follow Us!

Send Email!

:(