Appendix 1 International work and recommendations

The case of merchanting is straightforward with statistical agencies agreeing on how it should be treated. Essentially, the purchase of the good by the domestic firm should be recorded as a negative export for that firm’s economy while the re-sale of the good is reported as a positive export. The net effect will appear in the balance of payments as an export of goods.^{Note 1, Note 2} As an example of this, take the book example from the previous section. Suppose Firm A in Figure 1 purchased the books for $20 and then subsequently sold the books for $40 to Customer C. This would be recorded as a net export of $20 by the balance of payments compilers in country A. Moreover, the margin on the merchanting sale ($20) will be counted as an output of a service in the resident countries production account.

Further challenges arise, however, when considering FGPs in the context of industrial classification – specifically whether they should be considered wholesalers (following the International Standard Industrial Classification 4) or as a type of manufacturing entity (following some recent thinking on the matter). The current version of SNA08 and BPM6 argue for the former, but at the same time raise some questions with their rationale. More recently others have argued that this definition is too restrictive and does not reflect the economic realities of the FGP arrangement.

The International Standard Industrial Classification (ISIC), which is used by most of the world with the notable exception of North American countries, treats FGPs as being part of the wholesale trade sector. An FGP would be considered a manufacturer if and only if it owned the material inputs used in the production process.

“A principal who completely outsources the transformations process should be classified into manufacturing if and only if it owns the input materials to the production process – and therefore owns the final output.”^Note 3 – Paragraph 144 of ISIC

A number of National Accounts compilers see the ISIC treatment of FGPs as being problematic for a variety of reasons. Firstly, a firm could change industry classifications by simply changing how they acquire input materials. For example, a company that is responsible for producing a good (and owning the intellectual property for the product) but outsources the production process to a firm in another country would be considered a manufacturer if they also provided the material inputs to the production process. If the company decided that it would be more efficient to allow the foreign company to acquire the material inputs on its own (without making any other meaningful changes), it would then switch from being classified as a manufacturer to being categorized as a wholesaler. This could have important impacts on the measurement of manufacturing and wholesale activity in economies where there might be considerable FGP activity. Secondly, classifying FGPs under wholesale trade may not capture their true economic impact and may not properly reflect the importance of the intellectual property inputs in the production process. For such reasons, there has been a growing consensus to classify FGPs as a type of manufacturer.

A substantive amount of research has been undertaken regarding the issues surrounding the classification of FGPs and the ISIC recommendations. Notably, the United Nations ECE, Task Force on Global Production (TFGP) and the Economic Classification Policy Committee (ECPC) of the Office of Management and Budget (OMB) in the United States have analyzed the issue extensively. In their view, the ISIC recommendations require a review, both conceptually and practically. The general consensus of this research suggests that, rather than using the ownership of input materials as a classification rule, the ownership of intellectual property products (IPP) should be used.

According to the NAICS^Note 4 2012 supporting documents produced by North American countries, the characteristics of FGPs (and the criteria for their inclusion in the manufacturing sector) should be^Note 5:

• owns rights to the intellectual property or design as a key input;
• may or may not own the input material;
• does not directly own production facilities;
• does not perform physical transformation activities on the product;
• owns the final product produced by manufacturing service providers; and
• is responsible for the distribution of the final product.

The United States National Account compilers were planning to incorporate this classification change in 2017; however, at the time of writing this paper, that project had been delayed.

Although Statistics Canada agrees with the treatment of merchanting and FGPs presented in this section, the agency currently does not measure either phenomenon.

Notes