Overheard and Observed in China: Part 1: The Economy

I just returned from a way-too-short and rapid trip to China. There are so many angles and facets to explore but for a Part 1, I thought I’d focus on some interesting economic dynamics in China that are highly interrelated with some equally interesting dynamics in the U.S. economy.

As context, note that the overarching paradox of trading with China from a U.S. standpoint is (a) we like China’s cheap costs but (b) we don’t like the trade gap. The burgeoning trade gap is particularly bothersome as the U.S. dollar continues to free fall in the international currency markets, which should make buying U.S. products more attractive than ever. But the trade deficet is going to be a side light and what U.S. businesses and consumers are really going to notice in the near and foreseeable future is that costs in China are on the raise and may increase at a more rapid pace. Here’s why:

1. We’re not the only ones that dislike a huge trade gap; for China’s economy to mature, more of its output needs to be consumed internally, not just by the export market. Toward that end, in the last ninety days Beijing has rescinded a substantial tax rebate (think subsidy) for factories and business that export their goods. That will no longer be part of the formula for quoting costs to U.S. companies that outsource to China.

2. The RMB (China’s currency) is up 20% against the U.S. dollar in the last 18 months. The renmimbi (“people’s currency”) is stronger across against many currencies on the international board, but with the ongoing storyline of a still declining U.S. dollar and its spending power, the bottom line result is higher costs.

3. New labor laws in China include new increases to the minimum wage and a sweeping worker reform act–no company can fire a worker once they sign a third employment contract–equals raising labor costs. On the second element, the reform act, one wonders if most Chinese laborers will now end up working for a new company every four years as many labor contracts are two year deals. Not even an almost limitless labor pool can hold back the simple reality that conditions for workers–from wages to safe working conditions to better factory-owned dormitories or private housing options–have improved and must continue to improve. Some have argued that with the reported 750 million unemployed workers this need not be the case. But what has changed is that people living a subsistance lifestyle in the great rural expanses of China are no longer willing to trade an open air work day for a factory work day that is still based on mere subsistance worker benefits.

4. Rising materials costs are happening across most industry categories, led by rocketing oil prices, but in my world, publishing, it comes as no surprise that the cost of paper keeps marching upward at a particularly steep grade. U.S. standards of “green” are much less stringent than those defined in Europe, but as that gap closes, costs will only continue to climb. Related but off topic: Bill Gates said that we tend to overestimate the impact of new technology over the next two years but underestimate its impact over the next five years (see Business at the Speed of Thought). I wonder: will there be a stampede to ebook readers in the next half decade?

5. When you add up nos. 1-4, not surprising but largely unnoticed in the business community, hundreds of Chinese factories are closing every month. Profit margins and Return on Investment (ROI) are so slim that the Chinese entrepreneurial class is looking for new and greener opportunities. Marching alongside the issue of ROI , the first true generation of entrepreneurs in China is hitting retirement age and the heirs don’t want to run factories–or in some cases can’t afford to run existing operations–so they’re selling off equipment and boarding up buildings. Some argue that this is simple Economic Darwinism and is a positive case of natural selection with inefficient operations falling by the wayside. Perhaps; but it should not come as a shock that as once or emerging third world economies develop, they no longer take on environmentally toxic projects with no questions asked.

Two questions that I predict will become more acute for U.S. (and world) companies that do manufacturing in China in the days ahead will be: are we anticipating and ready for continued rising costs? and are the vendors we are currently relying on going to be in business for the foreseeable future?
Stay tuned for Part 2 of things I observed and overheard in China …

Comments

  1. Anonymous says

    Interesting stuff. I have some dealings with a company that outsources to China. I’ll keep these things in mind.

    On a macro-economic note, isn’t this the inevitable outcome of trade imbalance? Isn’t a trade imbalance naturally a temporary state of affairs? What seems to be happening is a transfer of wealth. Interdependency will ultimately an equilibrium.

    As standards of living grow in the producer country — consumption patterns change in those countries, tastes refine, conditions improve — all because people have the wealth to be discriminating. Countries that are on the consumption side initially change too. As the value of their currency goes down, their ability to produce and compete improves and in the end markets shift and each side gives and takes on a more even basis. In the end it should be a net “win-win” so long as people can endure the pain of the process.

    Mortimus

  2. says

    The move toward stasis is a great point. Other political factors usually intervene, however, including but not limited to wars and rumors of wars! It’s the “other factors” that keep a resource rich region of the world like the Congo in abject poverty.

  3. Anonymous says

    something to think about in the coming election; the 9 trillion dollar national debt the U.S. has accumulated sicne 1776, over half was incurred under the Bush senior and junior presidencies. Add in Ronnie Regan and it’s 70% with just 3 republican presidents.
    elect another GOP and we’ll need teachers here to teach Chinese as a second language so we’ll be able to get jobs from our new owners.

  4. Anonymous says

    I suppose I should get a screen name so as to not be confused with the new anonymous.

    Any hoot, he brings up an interesting point, albeit without intending to — traditionally Republicans have been the party of budget cutting and the Democrats have been the party of federal spending. I think the situation under Reagan was such that the Dems controlled spending while Reagan worked to cut taxes. I think he would have preferred to cut both spending and taxes, but he couldn’t — he had to play a game of chicken with the Dems. A deficit was the result. But I also think the economic booms of the 80s and 90s are partly due to his turning the tide on how we think about the role of Federal spending in relationship to the broader economy. It’s a fact that short of buring money the most inefficient use of capital is federal spending. I’m afraid President Bush doesn’t have Reagan’s dilemma to blame for the current deficit spending.

    Mortimus

  5. Anonymous says

    Mort, I’m sure without intending to you mistated the facts. “traditionally Republicans have been the party of budget cutting and the Democrats have been the party of federal spending.”

    An accurate statement would be that “traditionally Republicans try to sell themselves as the party of budget cutting…”

  6. says

    Dear Anonymous — Without trying to get too involved in a complex political debate, I would say that in the case of Reagan, he inherited a situation with an out-of-date military, which was one of the biggest reasons for his deficit spending; along with a stagnant economy where industries like American biotech were fading fast in terms of world competition; the corporate tax cuts allowed for R&D, which paved the way for our economic boom.

    Conversely, Clinton, who did run in the black, I would argue, inerited Reagan’s “peace dividend.”

    The current Bush in the White House wanted the dollar to “stay low” to cut into trade deficets. At the moment, it doesn’t look like he’s had much else in mind strategically and that one hasn’t been efficacious.

  7. says

    Much of what is leading to rising prices in China is happening everywhere. China should never have been the automatic choice for any company, but it still remains the best choice for many.

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