"Made in China" gets more expensive
One of the key components of China’s economic development over the last 10-15 years has been the massive scale ofproduction that has been undertaken. Perhaps nowhere are the effects of thatepitomised better than in New Zealand’s manufacturing industry. Although otherfactors such as reduced import tariffs and distance to market have alsocontributed to the long-term decline in our manufacturing sector, it is clearthat businesses in New Zealand are unable to compete with Chinese firms when itcomes to large-scale production.
The economies of scale and specialisationenjoyed by the Chinese manufacturing sector are not the only advantages it hasover New Zealand industry. Labour costs are also very low. The combined effectof these two factors means that Chinese producers have been able to makeproducts more cheaply than their competitors. By taking away market share frommore costly producers, China has effectively been exporting deflation to therest of the world.
A couple of specific examples should putthis in perspective. Since March 1997 (when our exchange rate was roughly thesame as it is now), men’s footwear prices in New Zealand have fallen 21%. Overthe same period, average incomes have risen 59%. The net result is that shoesare effectively now half the price they were 11 years ago. Some of that changewill be due to tariff reductions or increased competition in footwearretailing, but the rise of China is also a significant factor. Sixty-ninepercent of imported shoes now come from China, up from 34% in 1997.
Appliances are another example. Back in1997 I bought a stereo for $970. Four years ago, when looking to buy anotherone, similar machines sold for under $500. What’s more, the Chinese stereo I endedup buying in 2004 has proven to be significantly more reliable than itsJapanese counterpart.
However, China is now at a turningpoint. After a decade of exporting lower-priced products to the rest of theworld, cost pressures are finally starting to bite. The effects of China’s rapid economic growth on global commodity prices are well documented, with theprice of everything from steel to cement being pushed up as Chinese demand hascontinued to expand. Chinese firms are grappling with increased costs and arestruggling to manufacture products as cheaply as before. Producer priceinflation in China has accelerated from 2.4% to 10%pa over the last year.
It’s not just hard commodity prices thatare affecting China’s cost structures. Food price inflation has been rampantover the last 18 months, reflecting both global trends in food prices as wellas local factors affecting the price of pork in China. Add in the surge in oilprices, and it is unsurprising that wage demands are on the increase. Therising cost of living is affecting not just poorer people in the rural areas,but the rapidly expanding urbanised Chinese middle class as well.
China will alwaysenjoy production cost advantages due to its size, but its cheap labour is setto become increasingly expensive over the next 20-30 years. Major importersfrom China are already reporting significant price increases are on their way,which is the opposite of the situation we have enjoyed over the last 10-15years.
The transformation of the Chinese economyinto an economic superpower bears similarities to the advancement of theJapanese economy following World War II. Between 1950 and 1970, Japanese GDPper capita grew by an average of 8.4%pa, compared with 2.3%pa growth for the USA. The rapid lift in incomes, aided by a generous helping of Western-funded investment,saw Japan advance from a developing economy to one of the most developedeconomies in the world.
If China’s cheap labour is going togradually disappear, where is the next port of call for manufacturers lookingfor low-wage staff? Other countries within Asia have varying degrees ofpotential, with Vietnam, the Philippines, and Indonesia some of the more likelycandidates. Over the longer-term, the economic development of these countriesthroughout Asia will see multinationals shift production into Africa as well. Admittedly, the lack of physical and social infrastructure throughout much of Africa makes this trend difficult to envisage at the moment.
Looking back, we are likely to see thatthe downward pressure on prices since the early 1990s was unusual. Just as theindustrial revolution led to a one-off step down in prices in the late 1800s,China’s own industrial revolution has also led to a structural shift downwardsin prices. For consumers, the best is probably behind us, and the "Made in China" label is only going to become more expensive from now on. But as with the Japaneseexperience, Chinese products are also set to replace their reputation for beingcheap with one of high quality and innovativeness.