Robbing Peter to pay Paul

Another way in which the conventional understanding of the current account balance does not jibe with the reality of the modern global economy is the role of intra-firm trade. Cross-border transactions between multinational enterprises and their affiliates, or between two affiliates of the same company, account for a significant part of world trade. The United Nations estimates that more than a third of world trade is accounted for by intra-firm activity.

In 2002, the most recent year the U.S. Department of Commerce published disaggregated data, intra firm trade comprised nearly a third of U.S. merchandise exports and almost 40 percent of U.S. merchandise imports. Intra-firm trade accounted for significantly less trade in services — only 26 percent of U.S. service exports and 20 percent of service imports were between affiliated partners. In dollar terms, this means that almost $196 billion of the $422 billion trade deficit the U.S. recorded in 2002 reflected movement of goods and services within the same company.

In essence, one dimension of globalization is the extension of a division of labor that distributes around the world different functions of a factory floor or a back-office. Another way to conceptualize this process is that national borders zigzag through a factory or office.

Movement of goods from one side of the factory to the other counts as a trade deficit, according to our archaic national accounting system. But this intra-firm trade differs from classic trade between two unaffiliated parties
in significant ways.

First, intra-firm trade may be less sensitive to currency fluctuations than classic trade. For example, if an auto manufacturer’s Canadian affiliate makes a braking system and exports the component to the parent factory in Detroit, where it gets assembled into the car, a marked appreciation of the Canadian dollar may have little impact on the company’s geographic division of labor and therefore trade patterns. Second, and arguably more important, such intra-firm trade does not require external financing. Many observers argue the U.S. trade deficit needs to be offset, or paid for, by borrowing from foreigners. But because almost half the 2002 U.S. trade deficit reflects intra-firm trade, paying for the braking system in the previous example does not require financing the way it would if the trade was between unaffiliated parties. It amounts to little more than the old proverb of robbing Peter to pay Paul. This means the amount of foreign borrowing that is required to finance the U.S. trade deficit is significantly less than most pundits claim.