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The mystery of the EU’s trade surplus with itself

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Hello from London, where — as Trade Secrets discussed yesterday — 2020 has begun with a warning from the European Commission that securing a full trade deal by the end of the year is “basically impossible”. Fun times.

But for all the EU’s fear of an aggressive competitor on its doorstep, there is one problem that will seem smaller, seen from Brussels at least, once Britain has left. Today’s post looks at the puzzle of the EU’s persistent trade surplus with itself, where the UK turns out to be a large part of the explanation. Our Policy Watch looks at talks in Washington DC today on addressing Chinese industrial subsidies, while our chart of the day looks at Vietnam’s growing exports to the US.

Don’t forget to click here if you’d like to receive Trade Secrets every Monday to Thursday. And we want to hear from you. Send any thoughts to trade.secrets@ft.com, or email me at delphine.strauss@ft.com.

A €307bn anomaly

It should be a logical impossibility for the world to run a trade surplus with itself. Yet for the past 15 years, it has done so. Since 2004, the reported value of exports has been greater than the reported value of imports, and this global “self-surplus” has grown steadily, to reach about $422bn, or 0.5 per cent of world gross domestic product.

Researchers at the Kiel Institute for the World Economy and the Ifo Institute in Munich say the problem is largely “made in the EU” — and that the most plausible explanation is VAT fraud on a grand scale, facilitated by the creation of the EU’s single market.

In a paper published last week, they flagged up the extraordinary size of the EU’s trade self-surplus, which at €307bn accounted for 86 per cent of the entire global self-surplus in 2018. Since intra-EU exports must by definition be equal to imports this can only be due to measurement error or deliberate misreporting.

In reality, the data recorded by buyers and sellers rarely mirror each other perfectly. But a statistical error of this size “is not something the EU can shrug off as an intriguing outlier . . . given that the size of trade surpluses is fuelling international disputes”, write Martin Braml and Gabriel Felbermayr, the paper’s authors. “The underlying problem is broader: international transaction data are of poor quality, due to negligence, strategic government manipulation and fraud.”

Braml and Felermayr argue that the persistence of the EU’s self-surplus “may result from massive fraud in value added tax declarations”, depriving EU governments of up to €64bn in tax revenues.

Companies have an incentive to report domestic transactions as exports, since sales to other EU countries are exempt from VAT. Systematic misreporting of this kind will lead to a discrepancy between the exports recorded in one country and the imports recorded by its trade partners.

VAT fraud is a well-known problem in the EU, and Braml and Felbermayr’s research corroborates existing evidence. They found some countries seemed far more prone to over or under-reporting than others. Data discrepancies were higher for goods traded between neighbouring countries — where there is more scope, thanks to transport costs, for forms of VAT fraud involving back and forth cross-border transactions — and between countries where VAT rates varied most.

Rising data discrepancies in services could reflect the growth of ecommerce and micro transactions for cloud, streaming and software services © Getty Images/Cultura RF

But VAT fraud is not the only thing going on.

The research also found that data discrepancies were growing rapidly in services, where the EU’s self-surplus has increased fivefold since 2010. This could reflect the growth of ecommerce and in particular micro transactions for cloud, streaming and software services, where companies would record aggregate sales as exports, but import data might not capture the multitude of small purchases by individual consumers — for example, paying to download a single film.

Data for services trade has always been less reliable than data for goods trade, and this is true in particular of financial services. Braml and Felbermayr found bigger discrepancies in countries where the financial sector plays a big role, including Cyprus, Ireland, Luxembourg and the UK.

In fact, one of the most surprising findings in the report is just how much of the overall problem may be due to the poor quality of UK statistics on trade. (This is a well-known problem, which the UK’s Office for National Statistics is trying to fix.)

The EU self-surplus in services is about €141bn, but within the euro, the discrepancy is just €39bn. The researchers say any major difference can “very likely be largely attributed to the UK” — and that the main issue is probably measurement error, rather than fraud.

Without the UK, the EU would account for less than 40 per cent of the overall global self-surplus, they conclude, adding that “in the event of a Brexit, average data quality in the EU would improve”.

There is, of course, a flip side to this. As the UK presses to include services in a future trade deal with the EU, its negotiators may — at least until the ONS’s efforts pay off — be flying blind.

Charted waters

As the US and China prepare to sign their trade war truce this week, a clear winner of the tensions and tariffs has been Vietnam, which has seen a surge in exports to the US. But this has not gone unnoticed by US president Donald Trump, and further tariffs could surface this year.

Bar chart of South-east Asian exports to the US ($bn) showing Vietnam enjoys surge in exports to the US

Policy watch

A worker walks over bundles of steel pipe stacked at a stockyard on the outskirts of Shanghai, China, on Thursday, July 5, 2018. U.S. President Donald Trump’s attempts to re-balance global trade have already sent the metals world into a tizzy. As countries respond to U.S. tariffs and sanctions, the disarray is set to increase. Photgrapher: Qilai Shen/Bloomberg
Steel pipes at a factory in Shanghai. The US, EU and Japan want to combat China’s use of industrial subsidies to boost its companies © Bloomberg

Today’s policy watch comes courtesy of Jim Brunsden in Brussels, who tells us that the US, EU and Japan are holding a crunch meeting on how to combat China’s use of industrial subsidies to boost its companies.

Senior officials will meet early on Tuesday in Washington as they seek to wrap up two years of negotiations on how to toughen the World Trade Organization’s restrictions on state support. The trilateral talks have focused on how to beef up an existing WTO agreement on subsidies and countervailing measures.

Will a deal be concluded today? If so, it would mark a rare example of the Trump administration acting multilaterally on trade. The plans would still need the support of the rest of the WTO’s membership to come into force, but Brussels, Washington and Tokyo believe that by adopting a common line they will send a strong signal.

A deal would come in the same week that the US signs its “phase one” trade deal with China, showing Washington’s determination to keep up the pressure on Beijing even as it throws it a bone elsewhere by, for example, dropping the designation of China as a currency manipulator.

Don’t miss

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  • EU trade chief Phil Hogan heads to Washington this week aiming to soothe tensions with the Trump administration, as the two sides spar over aircraft subsidies and digital tax.
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Tokyo talk

The best trade stories from the Nikkei Asian Review

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  • China’s imports fell in 2019 for the first time in three years as the trade war took its toll, with the US slipping to third place among China’s biggest trading partners, behind the EU and the Association of Southeast Asian Nations.
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