More Connected Than It Looks

We've written often on this page about the importance of trade and the interconnectedness of the global economy, and how in turn these promote greater total economic growth. But one regular objection to this view is: "If everyone is benefiting from global commerce, why are giants like Wal-Mart still such a big component of retail sales? Isn't trade simply favoring the big guys?"

No. In fact, quite the opposite. To see why, let's break down a couple lines in Wal-Mart's income statement. Last year, the company sold $285 billion worth of goods and services. But it's "Cost of Goods Sold", that is, what it had to pay other manufacturers for the goods offered a Wal-Mart store, was about $220 billion (77% of sales)!

In a very real sense, Wal-Mart is simply a middleman between the original manufacturers and the consumer. In effect, all the discount retailer is really doing is selling the products of thousands and thousands of smaller companies in one storefront. Most of the real value in any product sold at Wal-Mart is created by the smaller guy.

But this isn't just a one step dance. The toaster someone bought at Wal-Mart was supplied by a smaller manufacturer, yes. But that manufacturer probably got most of the electrical parts from another producer (likely from another country), and that producer probably got the raw materials from another producer in a still different far-off land. And so on.

The point is this: a giant company like Wal-Mart is contributing to the interconnectedness of global trade, not acting as a drag on it. That it has huge annual sales is only a reflection of what its role is in the cycle. But the value created in an economy, that is, what GDP is really trying to measure, is spread out amongst the entire global economy at every stage. These companies are more connected than top-line sales numbers indicate, and that could be a reason why small cap stocks have trounced big cap stocks since the bull market's start.