In today’s interconnected global economy, traditional measures of trade deficits often fall short of capturing the full picture. A glaring example of this is the US’ trade deficit, a topic of frequent concern and debate. While this deficit, representing the excess of imports over exports, has historically been a key indicator of a country’s economic performance, it fails to account for the intricate web of Global Value Chains (GVCs) that underpin modern international trade. As we delve into the world of trade economics, it becomes evident that a closer examination is needed—one that considers not just what is imported and exported, but how these goods and services are produced and where their value truly originates. This exploration leads us to the concept of Revealed Comparative Advantage (RCA), a measure that offers a more nuanced and accurate perspective on a country’s trade position by considering the complex dynamics of GVCs. To fully appreciate the significance of RCA, it’s essential to understand why traditional measures, such as the US trade deficit, often fail to provide an accurate representation of an economy’s trade reality.
With significant reduction in transportation and communication costs over the past three decades, the landscape of international trade underwent dramatic changes as the manufacture of final consumption goods can now be distributed across several countries with relative ease. This phenomenon has brought about the prevalence of GVCs wherein networks of interlinked stages of production are established in different parts of the world wherever costs are lowest. Within this process, the transformation of products involves a combination of imported intermediate goods and domestic goods and services that are then exported for use as intermediates in the subsequent stage of production.
Comparing GVC with traditional trade statistics can reveal significant disparities. The traditional RCA (TRCA) is calculated using the export value of a sector. If this ratio exceeds 1 for a particular sector in an economy, it suggests a comparative advantage, warranting policymakers’ attention for more efficient economic outcomes. However, in today’s world of fragmented production across countries, trade value no longer represents the true value an economy adds.
This is where the new revealed comparative advantage (NRCA) comes into play, using value-added information. The disparity between TRCA and NRCA has been in shown in studies to give rise to three critical factors in international trade:
- Vertical Specification (VS): Gross exports of a country-sector include foreign value-added and double-counted terms due to intermediate goods trade.
- Domestic Backward Linkage: Value added in a country-sector’s exports may include domestic value added from other sectors.
- Domestic Forward Linkage: A country-sector’s value added may be indirectly exported through other sectors of the country.
A conceptually sound measure of comparative advantage should exclude foreign-originated value added, double counting, and domestic value added generated in other sectors, while considering indirect exports of a sector’s value added through other sectors within the exporting country.
NRCA accomplishes this by estimating the share of a particular country-sector’s domestic value added and indirect exports concerning the total domestic value added in exports (first term), and the total domestic value added and indirect exports of all countries in that sector relative to global value-added exports (second term), effectively revising the TRCA as expressed by:
Departing from TRCA, NRCA includes the three additional components mentioned above emphasizing the inclusion of domestic value-added and indirect exports and can be expressed as:
By incorporating domestic backward and forward linkages, NRCA properly accounts for the value added by domestic components exchanged among different sectors. Vertical specialization factors in the presence of foreign value added and double-counted terms in a country’s total exports, with a smaller CVS indicating a higher participation in GVCs.
In summary, supplementing the TRCA with the measures for indirect value added yields a more accurate measure of competitive advantage for a sector in an economy. NRCA focuses on domestic factors, excluding foreign value added, considering domestic value added shared among different sectors’ exports, and adjusting according to the sector’s level of vertical specialization.
Take the US as an example, where many Multinational Corporations (MNCs) have shifted their focus towards brand marketing and technological innovation, outsourcing the manufacturing and assembly of their products to foreign companies. These American giants effectively export their intellectual property embedded within goods produced abroad. While these intellectual exports generate substantial profits in foreign markets, they remain conspicuously absent from traditional trade statistics, leading to a significant underestimation of US exports and an overestimation of its trade deficit. A statistical gap that the Bureau of Economic Analysis is currently addressing by building up the US Trade in Value (TiVA) table first released in December 2021 to give researchers the necessary information to provide a more accurate measure of US value added to international trade.