Chinese Inflation May lead to End of "Ultra Cheap" Consumer Prices

China’s Inflation Hits American Price Tags
SHANGHAI — China’s latest export is inflation. After falling for years, prices of Chinese goods sold in the United States have risen for the last eight months.

Soaring energy and raw material costs, a falling dollar and new business rules here are forcing Chinese factories to increase the prices of their exports, according to analysts and Western companies doing business here.

The rise was a modest 2.4 percent over the last year. But even that small amount, combined with higher energy and food costs that also reflect China’s growing demands on global resources, contributed to a rise in inflation in the United States. Inflation in the United States was 4.1 percent in 2007, up from 2.5 percent in 2006.

Because of new cost pressures here, American consumers could see prices increase by as much as 10 percent this year on specific products — including toys, clothing, footwear and other consumer goods — just as the United States faces a possible recession.

In the longer term, higher costs in China could spell the end of an era of ultra-cheap goods, as well as the beginning of China’s rise from the lowest rungs of global manufacturing.

Economists have been warning for months that this country’s decade-long role of keeping a lid on global inflation was on the wane.

“China has been the world’s factory and the anchor of the global disconnect between rising material prices and lower consumer prices,” said Dong Tao, an economist for Credit Suisse. “But its heyday is over. We’re going to see higher prices.”

Chinese imports constitute 7.5 percent of spending by Americans on consumer goods, but they make up much bigger shares of several popular categories, including about 80 percent of toys, 85 percent of footwear, and 40 percent of clothing.

Even when the market share held by Chinese goods is relatively small, their low prices put pressure on other producers to keep costs down.

Whether Chinese factories will succeed in making wholesalers pay more for their goods and whether retailers will be able to pass much of their higher costs on to American consumers is unclear, analysts say.

But companies that operate in China or buy from here are already reeling from mounting cost pressures that they say will weaken their profits and could disrupt their supply chains.

Those supply lines were already called into question by large-scale recalls of Chinese exports last year, involving everything from toys to pet food to tires.

“This is what I call the perfect storm,” said Alan G. Hassenfeld, the chairman of Hasbro, one of the world’s largest toy makers, during a recent visit to China. “We’ve got higher labor costs and labor shortages, plastic prices have gone way up and we’re doing more safety testing.”

While no reliable figures exist on average Chinese wages, experts say that factory wages have risen 80 percent or more in many coastal areas in recent years, with the lowest wage about $125 a month.

Some of the current cost pressures are actually by design — Beijing’s design.

After years of complaints from the United States and Europe about China’s growing trade surplus, authorities here have removed incentives that once favored exporters of cheap goods.

Starting last June, for instance, China removed or reduced tax rebates on hundreds of items for export, including toys, apparel, leather, wood and other goods, effectively taxing those industries.

But the actions are also part of Beijing’s desire to move China higher up the global manufacturing chain — away from the least- finished products, like plastic children’s toys, toward more advanced exports that require skilled labor, like small electronics and even automobiles.

Whatever the government’s motivation, many Chinese exporters say the timing of the rebate cut was disastrous. Their factories had been struggling to cope with problems that included power shortages, higher raw material costs, rising wages and inflation in other areas.

For instance, the cost of some types of plastic has risen more than 30 percent in the last few years because of higher oil or petroleum costs. Plastic is a major component in toys and other consumer goods.

Many Chinese factory owners say a tough new labor law, which went into effect on Jan. 1, complicates the hiring and firing process and threatens to raise labor costs even more, at a time when parts of the country are already plagued with labor shortages. Some factory owners say there have already been strikes and other turmoil over the interpretation of the new law and how it should be applied.

“We have seen lots of brawls between employees and employers,” said Hong Jiasheng, vice president of the Taiwan Merchant Association, which represents investors in China. “We think the enactment of the new labor law is too hasty.”

Analysts say Beijing is also stepping up its enforcement of environmental laws, putting added pressure on factories that had long skirted regulations. Adhering to those often ignored rules increases cost, too.

These changes take place against the backdrop of a dollar falling modestly against the Chinese currency. The dollar is down about 7.6 percent in the last year against the yuan and is expected to fall further this year.

The weaker the dollar, the more expensive Chinese and other goods become when their prices are converted to dollars.

All in all, toy producers are among the hardest hit by the changes in law and prices. They rely on large quantities of plastic. They face heightened regulatory scrutiny after the product safety scandals last year. Indeed, some toy factories went bankrupt, squeezed between rising local costs and pressures from foreign customers to deliver a better product at an even lower price.

“I’ve been in the toy industry for almost 20 years, but these past two years have been the hardest time,” said Guo Jinshen, manager of the Fenggang Fengyuan Plastic Toys Company. “Costs are rising, there are recalls, stricter regulation, more complicated inspection — all these things make it difficult.”

To reduce costs, some factory owners are considering moving to inland China, where wages are lower, or to other parts of Asia, like Vietnam and Indonesia.

Li & Fung, one of the biggest companies for supplying products worldwide, says its customers are already responding to Chinese inflation.

“There’s a shift in sourcing driven by higher prices in China,” says Bruce Rockowitz, president at Li & Fung. “We’ve already seen a big move in furniture to Indonesia.”

But while relocating production to cheaper countries could keep prices low for Western consumer goods, moving factories and complex supply chains is difficult. Such changes can take years and cost millions of dollars.

In the meantime, makers of toys, apparel and footwear — highly labor-intensive industries — are being forced to consider raising prices even as growth in the United States slows, a rare confluence of events not seen in decades.

Companies that began outsourcing production to China in the 1990s mostly benefited from lower costs, which translated into both higher corporate profits and lower consumer prices. Now, many Western companies have to rethink pricing.

“Companies are now ordering for the spring of 2009,” says Nate Herman, director of international trade at the American Apparel and Footwear Association, based in Arlington, Va., that represents some big clothing and footwear makers. “Factories are coming back and asking for 20, 30, 40, 50 percent price increases.”

Will importers pass those costs on to consumers? “It’s going to be hard to avoid some increase,” he said.