For the longest time, many commentators noted that China exported deflation by taking advantage of labor, environmental, and currency arbitrage (i.e., an artificially weak yuan). Those days may be coming to a close, however, as raw materials prices rise. Ironically, Chinese demand for these raw materials is likely a large driving factor behind these price rises. Labor prices are going up as well as workers are unable to make ends meet by working at lower wages while the cost of foodstuffs rises. Even the yuan has appreciated by about ten percent since the currency was unpegged in 2005. Factor all these in and you get the chart to the right. Indeed, it's not a very pretty picture for penny pinchers the world over. (Some have speculated that India might take up the baton in exporting deflation, but that remains to be seen.) Yessirree Bob, China may now be exporting inflation. From the Financial Times:The “China price”, that once unbeatable benchmark retailers pay for the products made in the world’s workshop, is not what it used to be. Data compiled by statisticians in China, Hong Kong and the US all show that, after at least five years of deflation, Chinese export prices have begun to creep up over the past 18 months.“China’s era of exporting deflation to the world is coming to an end,” says Jing Ulrich, Hong Kong-based chairman of JPMorgan’s China equities business. “Manufacturers are raising their average selling prices and feel confident they can pass on any future [cost] increases. Pricing power has returned to a number of industries due to consolidation, the closure of smaller producers with poor environmental and safety records and natural attrition over the past half-decade, when many manufacturers faced severe margin compression.”
This year, the Hong Kong-based Techtronic Industries, one of the world’s biggest power tool makers and owner of brand names such as Ryobi, Hoover and Vax, passed cost increases on to retailers for the first time in more than a decade and said it was reviewing its China expansion plans. “Raw materials are going to continue to inflate,” said Joseph Galli, chief executive of TTI’s appliances unit. “In the early 1990s [the industry] went through inflation. It wasn’t fun then either...”
The wonder, however, is that the China price has not been accelerating at a much faster clip – as it would have to before China’s export juggernaut began to slow. The country’s January-September exports grew 27 per cent to $878bn (£432bn, €620bn). As Jim Leonard, a Boston-based trader for East West Basics, a trade sourcing company, puts it: “Volume covers a lot of sins...”
Labour, land and power costs in the Pearl and Yangtze deltas, for example, have been rising at double-digit rates. There have been exponential price increases for essential raw materials such as copper and petroleum-based plastics. Now China’s general level of inflation is setting off alarm bells in Beijing, having touched 6.5 per cent in August.
Adding to these pressures, the renminbi has appreciated by 7 per cent against the US dollar ever since it was allowed, three years ago, to drift from its mooring of Rmb8.30 to the greenback.
Mr Anderson argues that this last phenomenon is largely academic in export sectors where factories are merely turning around imported – and therefore often US dollar-denominated – components. But that has not stopped exporters from trying out the excuse anyway, especially last year when the renminbi crawled past the Hong Kong dollar, which is still pegged to its US counterpart at a rate of HK$7.80. And why not, asks Mr Leonard, who sources houseware products for American retailers. “You’d be crazy not to ask.”
“Increasing labour and raw material costs are having a significant impact on my business,” says Yu Zhonghua, owner of a hat and sock factory in Yiwu, in the Yangtze River Delta. “We have stopped our sock production because we can’t find enough workers. Three or four years ago, we could easily find workers to make socks for Rmb900 a month. Now, even if we pay Rmb1,400-Rmb1,500, they think the job is too tiring and the pay not enough. Other small sock makers face the same situation.”
Yet Yiwu, which created its own index [that must be the sock index ;-)] in October last year to monitor the effect rising costs was having on local producers, has tracked only a modest 1.42 per cent rise in prices. “The Yiwu index has not gone up significantly since its creation,” says Su Weihua, a professor at Zhejiang Industrial and Commercial University and founder of the Yiwu China Small Commodities Index. “In Yiwu, the degree of competition is high, so traders usually won’t increase their prices. It is quite hard to measure the extent to which factories can absorb rising costs – it varies for different kinds of products. But they are doing different things, substituting materials, upgrading technology and manufacturing techniques and putting more effort into branding.”
The fact that the China price has barely budged relative to its underlying cost pressures is partly a reflection of how fat life was for China-based exporters – most of them owned by Hong Kong, Taiwan and other overseas investors – through the 1990s and the first few years of this decade. Stephen Green, a Shanghai-based economist with Standard Chartered, recently visited some of his bank’s manufacturing clients in Shenzhen, across the border from Hong Kong, and says that net furniture margins there have fallen from an “unnaturally high” 30 per cent a few years ago to a more reasonable 10 per cent...
“We make all the most difficult and expensive styles in Shenzhen,” says Larry Ho, a manager at Top Form’s Longnan plant. “It is our most skilful factory. We can do some styles that have really good margins there.
“It’s hard to find skilled workers here [in Longnan]. That hurts our efficiency,” he adds. While it takes three months to train a worker in Longnan, highly skilled workers can be poached from the Pearl River Delta’s much deeper talent pool. The monthly wage rates at Top Form’s three China factories sum up their capabilities: Rmb1,600 in Shenzhen, Rmb1,200-1,300 in Nanhai and Rmb1,000 in Longnan.
“Ninety per cent of Chinese companies would rather move inland than move offshore,” says Standard Chartered’s Mr Green. “The idea that we are at a point where entrepreneurs are going to move offshore en masse is not true. They do not think of China as a single country but something more akin to the EU, with different wage rates and tax systems in one customs union.”
“[Manufacturing] activity is moving away from the coast,” agrees Bruce Rockowitz at Li & Fung, a trade sourcing company with 16 offices on the Chinese mainland. “Where the product is today is not where it was yesterday. You can’t look at [China] as one country. We look at it as a multi-country sourcing area.”
Yet change beckons even for relatively new-found destinations such as Longnan. “In the beginning, we didn’t choose what type of companies came here,” Mr Zhong, the county’s vice-chief, says in his thick Hakka accent. “But now we don’t want companies that need lots of labour, consume too much electricity or occupy large tracts of land. We now welcome capital-intensive and high-tech companies.”
When Top Form arrived in Longnan, hundreds of people would queue outside its gates looking for work. Now a gathering of 30 or 40 workers would be considered a good-sized crowd. As Mr Ho says: “We can never stick to one place for good. For now it’s Jiangxi. But Jiangxi may not be competitive in five years’ time. Maybe our next factory will be even further inland.”
