November 29, 2004

AND LOWER...:

"The China Price" (Business Week, 12/06/04)

"The China price." They are the three scariest words in U.S. industry. In general, it means 30% to 50% less than what you can possibly make something for in the U.S. In the worst cases, it means below your cost of materials. Makers of apparel, footware, electric appliances, and plastics products, which have been shutting U.S. factories for decades, know well the futility of trying to match the China price. It has been a big factor in the loss of 2.7 million manufacturing jobs since 2000. Meanwhile, America's deficit with China keeps soaring to new records. It is likely to pass $150 billion this year.

Now, manufacturers and workers who never thought they had to worry about the China price are confronting the new math of the mainland. These companies had once held their own against imports mostly because their businesses required advanced skills, heavy investment, and proximity to customers. Many of these companies are in the small-to-midsize sector, which makes up 37% of U.S. manufacturing. The China price is even being felt in high tech. Chinese exports of advanced networking gear, still at a low level, are already affecting prices. And there's talk by some that China could eventually become a major car exporter.

Multinationals have accelerated the mainland's industrialization by shifting production there, and midsize companies that can are following suit. The alternative is to stay at home and fight -- and probably lose. Ohio State University business professor Oded Shenkar, author of the new book The Chinese Century, hears many war stories from local companies. He gives it to them straight: "If you still make anything labor intensive, get out now rather than bleed to death. Shaving 5% here and there won't work." Chinese producers can make the same adjustments. "You need an entirely new business model to compete."

America has survived import waves before, from Japan, South Korea, and Mexico. And it has lived with China for two decades. But something very different is happening. The assumption has long been that the U.S. and other industrialized nations will keep leading in knowledge-intensive industries while developing nations focus on lower-skill sectors. That's now open to debate. "What is stunning about China is that for the first time we have a huge, poor country that can compete both with very low wages and in high tech," says Harvard University economist Richard B. Freeman. "Combine the two, and America has a problem."

How much of a problem? That's in fierce dispute. On one side, the benefits of the relationship with China are enormous. After years of struggling to crack the mainland market, U.S. multinationals from General Motors (GM ) to Procter & Gamble (PG ) and Motorola (MOT ) are finally reaping rich profits. They're making cell phones, shampoo, autos, and PCs in China and selling them to its middle class of some 100 million people, a group that should more than double in size by 2010. "Our commercial success in China is important to our competitiveness worldwide," says Motorola China Chairman Gene Delaney.

By outsourcing components and hardware from China, U.S. companies have sharply boosted their return on capital. China's trade barriers continue to come down, part of its agreement to enter the World Trade Organization in 2001. Big new opportunities will emerge for U.S. insurers, banks, and retailers. China's surging demand for raw materials and commodities has driven prices up worldwide, creating a windfall for U.S. steelmakers, miners, and lumber companies. The cheap cost of Chinese goods has kept inflation low in the U.S. and fueled a consumer boom that helped America weather a recession and kept global growth on track.


This lack of any pricing power and the resulting deflationary pressure is why interest rates even here, but especially in Europe, are too high. Similarly, Wal-Mart tried getting away with not discounting aggressively this past weekend and got their heads handed to them.

Posted by Orrin Judd at November 29, 2004 11:27 PM
Comments

"They're making cell phones, shampoo, autos, and PCs in China and selling them to its middle class of some 100 million people, a group that should more than double in size by 2010."

A middle class that won't be happy to work for the "very low wages" they are making now, which will raise the "China Price". And if price is your only selling point, you've got a problem.

Posted by: Raoul Ortega at November 30, 2004 12:21 AM

China also bids on some mfg stuff, wins the bid and has it made in America for American firms.

Posted by: Sandy P at November 30, 2004 12:22 AM

Raoul,

The PRC has vast armies of unemployed people so I don't think they'll be reaching that point of middle income protest anytime soon.

The article misses the other 'China Price.' Their economy is tremendously inefficient, their workers are terrible, untrained, undisciplined, uninterested for the most part. There is a lot of 'they pretend to pay us and we pretend to work' over there. Another related issue is the extensive corruption and unreliable legal system hinder investment, presenting costs from the small ones to the local inspectors or cops, to the big ones paid to local mandarins so you can set up shop. Lots of sons, nephews and in-laws make lots of money there simply because of a connected family member.

Posted by: Bart at November 30, 2004 6:18 AM

I wonder if deflation is bad for Walmart. Being able to live on a 2% markup when the other guy needs 5% may not matter when everything is so cheap that the time and trouble of the shopping trip dominates the cost of buying.

Posted by: mike earl at November 30, 2004 10:37 AM

Take away the artificial peg of the yuan to the dollar.

According to the Big Mac Index in The Economist, a McDonalds Big Mac sells for $1.26 in China vs $2.90 in the US. This indicates that the yuan is currently undervalued by 57%.

The Fed is going to let the dollar sink until the peg snaps.

Posted by: Gideon at November 30, 2004 11:35 AM

What Gideon said.

Bart, I've read many accounts of Chinese workers that contradict what you are saying. China is not just taking jobs from the US, on price, but is taking jobs from other low cost producers, like Mexico, because their workforce is superior.

Posted by: Robert Duquette at November 30, 2004 1:49 PM

Robert,

The articles I've seen indicate that the labor costs in Mexico are significantly higher than in China. I've also read numerous pieces about the problems American companies have with the Chinese workforce, which at the basic level is pretty terrible.

Posted by: Bart at November 30, 2004 4:52 PM

And companies have bought into the notion that China, because totalitarian, is stable.

Posted by: oj at November 30, 2004 4:59 PM
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