OCEAN CITY — International trade is considered and reported as a crossborder transaction between Country A and Country B. In the real world, however, it is a bit more complicated. It is companies that trade, not countries. States, to be sure, do matter. Governments are the rule-setters when it comes to what goods and services can be bought and sold overseas and at what costs.
Bi-lateral trade flows are influenced by industry rules and regulations, as well as tariffs, non-tariffs and other quantitative measures set by the policy makers. The latter are responsible for creating the playing field for international trade. But the major players on the field, for the most part, are companies—large and small—engaging in thousands of crossborder transactions every day of the year with other private entities. How, where and why these firms engage in trade is the primary determinant of global trade flows. Firms engage in trade because by gaining access to new markets and leveraging external resources, including labor, they gain economies of scale and are better able to specialize production cycles, generating more efficiencies, in addition to higher sales and profits.
What’s more, often times, trade takes place within the same firm, or between U.S. parent firms based in the United States and their subsidiaries aboard or foreign affiliates based in the U.S. producing for the local market and/or for export to parents and third parties. Per the latter, think of the BMW plant in Spartanburg, South Carolina. The plant is the company’s largest facility in the world, employing over 8,000 U.S. workers at competitive wages. Production is geared not just for the U.S. market but for markets around the world. Indeed, for years, roughly half of the vehicles built in the plant were for export; yet today, the figure is closer to 70%, making South Carolina one of the top vehicle exporting states in the U.S. Indeed, only Michigan exports more motor vehicles than South Carolina, with vehicle exports from the state totaling nearly $10 billion last year, an almost five-fold increase from 2002. Alabama is the third-largest auto exporter only because German auto powerhouse MercedesBenz produces over 200,000 units per year in its Tuscaloosa plant for export to over 75 countries.
Now consider trade between a U.S. parent company and its foreign affiliate. Think Ford Motors in Michigan and the company’s affiliates in Mexico. Although some 2,250 miles separate Ford’s plant in Dearborn, Michigan from its stamping and assembly facility in Hermosillo, Mexico, the facilities are tightly integrated, with parts and components constantly being passed between the two locations. Vehicle production is shared between facilities, with each plant specializing in different stages of production, thereby enhancing the competitive advantage of the company. During the production cycle, bi-lateral trade flows increase with each turn in the assembly process. As a result, by the time the vehicle is finished, some components in the car will have crossed the border multiple times. And because of the constant churn, U.S. imports from Mexico contain roughly 40% of U.S. content. Understanding related-party trade The examples above are classified as “related-party” trade, or trade that stays within the ambit of the firm. Related-party trade is a hugely important yet unrecognized form of U.S. trade.
Quantifying this dynamic, related-party trade in 2014, the last year of available data, accounted for 42.3% of total U.S. trade in goods (exports and imports). Related-party imports totaled $1.2 trillion in 2014, more than half (51%) of total U.S. imports, while related-party exports totaled $489 billion or almost 30% of total exports. As the numbers suggest, a great deal of U.S. trade is conducted within firms, and within the firm’s global supply chains. Globally, roughly 80% of all trade — exports and imports — takes place either within the networks of firms or through supply chains organized and arranged by firms. Hence, the uncommon truth: it’s companies that determine trade, not states.
Only by understanding how trade is conducted in the United States can investors begin to comprehend the potential consequences of the election talk of building walls along the Mexican border, penalizing firms for investing overseas and applying tariffs to Japan and China. Restrictions on U.S. trade flows would likely do more damage to U.S. firms than to the intended targets, whether Mexico, Japan or China. In today’s world, where firms are the key drivers of trade; where the export of a finished product can result in multiple touches of both parent firms and affiliates; and where the bulk of global trade is in intermediate parts and components, not finished products — against this backdrop, government policies that inhibit trade flows could be highly detrimental to the earnings of many U.S. firms.
(A Merrill Lynch Wealth Management Advisor who can be reached at 410-213-8520.)