China starts to ship higher costs abroad
By Carter Dougherty International Herald Tribune

Published: August 23, 2006

During 20 years in the toy business, Anthony Temple has reveled in the bounty of inexpensive stuffed animals, coffee mugs and resin figurines on sale in China. But a buying trip this year for his company, Rainbow Designs, based in London, was a rude awakening.

Traveling through the Pearl River Delta north of Hong Kong, Temple found that cost increases - for raw materials, but above all, for labor - dominated every discussion he had with suppliers.

Far from being eager to underbid each other, Chinese companies talked about marking up their prices from 5 percent to 10 percent so consistently that Temple, whose company owns the British distribution rights to such cuddly creatures as Paddington Bear and Jemima Puddle-Duck, became convinced that these were not simply negotiating gambits.

"When I went over there, I was under the belief that China is a bottomless pit of cheap product," Temple said. "When I left, I was not."

As the Chinese economy races forward, signs are multiplying through the global flow of goods from suppliers to manufacturers - and deep in some statistical tables - that the Asian giant is beginning to slow its exporting of something dear to the hearts of the world’s central bankers: lower prices.

For at least a decade, China has provided a welcome tail wind for inflation fighters in Europe and the United States by supplying inexpensive goods that depressed overall price levels.

But more and more this year, China’s role in global disinflation - as the phenomenon is known to economists - has toughened the agenda for central bankers. Striking anecdotes and evermore statistical evidence suggest that China’s contribution to low prices may be ebbing.

And that, combined with more expensive raw materials like oil, means that central banks once again could be stuck with the painful dilemma that they faced in the early 1980s: to stop inflation by tightening credit, despite the potentially negative effects on economic growth and unemployment.

"Even in China, with its growing manufacturing base and large pool of labor, some indicators are showing upward pressures on export prices," Mervyn King, the governor of the Bank of England, said in a recent speech. "And in turn that is raising our import prices, over and above the increases resulting from higher energy costs."

After discussing the "China effect" this spring, the European Central Bank pledged to increase research into the phenomenon. Top officials of the U.S. Federal Reserve have begun speaking out about it. China’s role in global inflation is also likely to be an important topic at the annual conference of central bankers in Jackson Hole, Wyoming, which starts Friday.

In recent months, China has already been exporting higher prices indirectly, given that its voracious appetite for oil and other commodities has helped drive up costs for everyone. Now, however, the prospect of higher prices for finished goods has become an obsession of sorts in the supply-chain business, according to interviews with dozens of retailers, importers, independent consultants and trade associations in Europe and the United States.

"We may well be reaching a situation where prices of both commodities and manufactured goods will go up," said Kenneth Rogoff, the former chief economist of the International Monetary Fund. "That’s not pleasant at all."

China’s development has brought it to this point, economists said. Low-cost labor and easy access to a world-class port in Hong Kong allowed China to flood the world with inexpensive goods. But now, atop high prices for raw materials, Chinese workers are starting to demand higher pay, creating the classic conditions for rising export prices.

"Raw materials are going up, the price of oil is going up, wages are going up," said Peter Keller, managing director of Merton Co., a plastic-toy manufacturer based in Hong Kong. "It is true that costs in China are rising and where possible cost increases are passed on."

Merton is facing rapid increases in wages at its plant in Guangdong Province, part of China’s booming manufacturing heartland, the Pearl River Delta. On Sept. 1, the minimum wage is set to increase by about 20 percent to 780 yuan, or $98, a month in the province.

Intense competition is still squeezing profit margins, but Keller estimated that prices for products produced under new contracts would be 5 percent to 10 percent higher than they would otherwise be as a result of the higher wages and bills for raw materials.

The good news for consumers is that rising costs in China are not feeding into higher prices on store shelves yet.

The Swedish retailer H&M, which last year had sales of €7.8 billion, or $10 billion, is trying to keep prices down as its suppliers demand more, said Nils Vinge, director of investor relations. Some strategies, like shifting production to low-wage Bangladesh or Turkey, with lower transportation costs to Europe, can mitigate the impact, though not forever. "In the long run, this makes its way to the consumer," Vinge said. "In the short run, it does not."

Data suggest that Europe and the United States are, like H&M, somewhere between the short and long runs.

Inflation has hovered slightly above 2 percent for most of this decade in the 12-nation euro zone, but has been rising lately. It was at an annual rate of 4.8 percent last month in the United States.

The Bank of England’s most recent inflation report notes that even stripping out volatile energy and metal prices, the country’s inflation was at an annual rate of 5 percent. It also highlighted a turnaround in prices of British imports since 2004. The ECB pointed out a similar euro-zone trend in its latest monthly report. It also noted that low-cost countries like China had helped to reduce the inflation rate for imported goods by two percentage points yearly from 1996 to 2005.

In the United States, data show that Chinese import prices, which have fallen since data collection began in 2003, are leveling off, as are prices from other low-cost emerging markets.

The few leading indicators on prices out of China paint a much starker picture. The price of Chinese goods at the factory gates has climbed in the past four months, according to the purchasing managers survey taken by NTC Research in London. Its index was below 50 - a level indicating stable prices - in March but now stands at 56.

Still, not all economists buy the overall notion that Chinese prices will soon pump up inflation rates in the industrialized world - and force central bankers to press harder on the brakes. Skeptics tend to focus on the ability of China and its customers to adapt.

As Chinese costs increase, foreign investors can set up shop in lower-cost manufacturing centers like India and Bangladesh. Other companies will investigate China’s vast interior to escape rising labor costs on the coast. "The global labor arbitrage is alive and well," said Stephen Roach, chief economist at Morgan Stanley. "It still pays very much to relocate production and employment to China to keep your labor costs down."

ASDA, the British subsidiary of the U.S. retail giant Wal-Mart, just invested £20 million, or $37.8 million, to build its own deepwater port on the eastern English coast, and 80 percent of the goods moving through it are likely to come from China. A spokesman for ASDA, Dominic Burch, said that the company also saw Chinese prices rising, but that China’s deep pool of high-quality goods meant that it had to buy there.

"From a trading aspect, we are not going anywhere," Burch said.

Temple of Rainbow Designs said he had managed to contain cost increases from China through a mix of tough negotiating and lower profit. But soon enough, the retailers he supplies, like WH Smith, Harrods and Selfridges, will find themselves under intense pressure to raise prices, he believes.

"These prices have to be passed down to the retail chain next year," Temple said. "Prices have to go up."

Donald Greenlees contributed reporting from Hong Kong.

Study backs 3% rise in yuan

China can afford to let its currency, the yuan, climb by 3 percent a year as part of steps to rebalance the economy, but a sharp rise in the currency would affect jobs, according to a Commerce Ministry research group, Reuters reported Wednesday from Beijing.

The Chinese Academy of International Trade and Economic Cooperation, in a report published on the ministry’s Web site, urged the central bank to handle the currency cautiously.

The Commerce Ministry has been among the staunchest opponents of a sharp rise in the yuan. But the academy said a gradual climb would help rein in excess liquidity and head off inflation.

Donald Greenlees contributed reporting from Hong Kong.