China's cheap exports and inflation
By Jon Fernquest[Introduction|Vocabulary|Article]
[Reading Questions|Answers]
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Today's article is about how cheap Chinese export goods have decreased worldwide inflation over time.
Recently, Chinese export prices have began to rise, so their contribution to reduced inflation worldwide is slowly disappearing.
This article looks at the problem from many different perspectives including the stories of businessmen doing business with China, economic statistics, and also from the standpoint of economic theory.
The Phillips curve in macroeconomics shows that over long periods of time, tight labor markets with low levels of unemployment (a good) are associated with increased inflation (a bad). This is easy to see intuitively.
Greater demand for Chinese exports causes faster growth and rising inflation rates. How? Demand for exports leads to Chinese companies hiring more workers, since the supply of skilled labor is fixed in the short-run, companies eventually have to pay higher wages to hire more workers, so the unemployment rate falls and wages rise. In Thailand's case, you can imagine what would happen if demand for Thai auto exports suddenly jumped. The wages for skilled labor in the auto industry would rise. Many more people in Thailand would want to become skilled auto workers so they could earn more, but they would still have to get the right training and experience. The government would have to make changes in educational policy to train these skilled workers. This would take time, so the supply of skilled auto workers would rise only slowly.
In developing economies with export driven growth strategies increases in wages lead to increased export prices and reduced competitiveness for the country on international markets. Sometimes this leads to government policy to control wages and labor unions pushing for higher wages. This happened to South Korea during its development (See Wikipedia on South Korea's Heavy Chemical Industry Drive).
Today's article is full of useful vocabulary and also a great introduction to macroeconomics.
Reading Questions
Here are some questions to guide your reading (See answers at end):1. What industry is Anthony Temple in? In what country?
2. What products does Temple's company produce?
(Note: Some inference needed)
3. What was he searching for during his trips to China?
4. How much were Chinese toy manufacturers marking up their prices?
5. Why were Chinese toy manufacturers marking up their prices?
6. How have Chinese exports helped central banks in the west over the last decade?
7. What recent evidence suggests that low Chinese export prices are contributing to decreased inflation less and less?
8. What is the effect of low Chinese export prices on global inflation called?
9. What statistical evidence from China indicates that Chinese exporters are facing cost pressures?
10. Which countries are customers moving to as the price of Chinese exports increases? Why?
11. What initially led to the China effect?
12. What economic forces seem to be bringing an end to the China effect?
13. To whom are the rising costs for Chinese exporters being passed on to in the west? To consumers? To middlemen and distributors?
14. How have Europeans kept import prices using lower transport costs?
Article
China's cheap exports may soon dry up
Some Western economists fear the impact rising prices will have on global inflation By CARTER DOUGHERTYDuring 20 years in the toy business, Anthony Temple has revelled in the bounty of cheap stuffed animals, coffee mugs and figurines on sale from China. But this year, his buying trip for his London-based company, Rainbow Designs, resulted in a rude awakening.
Travelling through the Pearl River delta north of Hong Kong, Temple found that cost increases - for raw materials, but above all for labour - dominated every discussion he had with suppliers.
Far from being keen to underbid each other, Chinese companies talked so consistently about marking up their prices 5% to 10% that Mr Temple, whose company owns the British distribution rights to cuddly creatures like Paddington Bear and Jemima Puddle-Duck, became convinced that these were not simply negotiating tactics.
"When I went over there, I was under the belief that China is a bottomless pit of cheap product,'' Mr Temple said. "When I left, I was not.''
As the Chinese economy races forward, signs are multiplying that the Asian giant is beginning to slow its export of something dear to the hearts of many consumers in developed countries: ever cheaper products.
For at least a decade, China has provided a boost to a welcome tailwind for inflation-fighting central banks in Europe and the United States by consistently cutting prices on a wide variety of goods, helping counterbalance the upward drift of overall consumer price levels.
At Jackson Hole, Wyoming the chairman of the Federal Reserve, Ben Bernanke, opened an annual conference of central bankers on Friday with a speech that noted how the emergence of China as an export powerhouse has altered the world economy in less than 30 years.
China's role in global disinflation - as the phenomenon is known to economists and central bankers - is not going to disappear. But a few recent numbers, along with anecdotal evidence, suggest that China's contribution to low prices globally may be ebbing.
Just recently, the European Central Bank promised to step up research into what has been called the "China effect''. Top officials at the Federal Reserve have also begun speaking out about it. And the debate over how much China has contributed to taming global inflation is a central topic at the annual Jackson Hole gathering of the world's leading central bankers and academic economists.
In the US, data shows that Chinese import prices, which have fallen since data collection began in 2003, are levelling off, as are prices from other low-cost emerging markets.
The price of Chinese goods at the factory gates has leapt upward in the last four months, according to the purchasing managers' survey taken by the London-based NTC Research. Its index was a tad below 50 - a level indicating stable prices - in March but now stands at 56, a steep increase by the standards of a survey that usually moves in fractional increments.
For years now, China's galloping economy has been sending ripples through the global economy - as Chinese demand has raised prices for critical commodities like oil and copper and Chinese buying of US Treasury securities has helped keep interest rates low.
And not all economists buy the overall notion that Chinese prices will soon pump up inflation rates in the industrialised world and force central bankers to press harder on the brakes. Skeptics about the "China effect'' tend to focus on the ability of China and its customers to adapt.
As Chinese costs increase, foreign investors can set up shop in places like India and Bangladesh, which lag behind China as low-cost manufacturing centres. Other companies will press into China's vast interior to escape rising labour costs in cities along the coast.
"The global labour 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 labour costs down.''
The cheap clothes and toys that consumers around the world have purchased with seeming abandon have tempered prices, even depressing them over the years. Now, as Chinese makers move to increase their prices in response to higher costs, some central bankers worry that this global salve will disappear.
"Even in China, with its growing manufacturing base and large pool of labour, 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.''
The prospect of higher prices for finished consumer goods has become an obsession of sorts in the supply-chain business, according to interviews with retailers, importers, independent consultants and trade associations in Europe and the US.
"We may well be reaching a situation where prices of both commodities and manufactured goods will go up,'' said Kenneth Rogoff, a former chief economist of the International Monetary Fund. "That's not pleasant at all.''
China's natural development has brought it to this point, economists said. Cheap labour and easy access to a first-class port in Hong Kong allowed China to flood the world with inexpensive goods. But as labour shortages develop, Chinese workers are starting to demand more money, adding to cost pressures from more expensive commodities and 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, in China's booming manufacturing heartland in the Pearl River Delta. On Sept 1, the minimum wage is expected to increase by about 20%, to 780 yuan (3,700 baht) a month, in the province.
Intense competition is still squeezing profit margins, but Mr Keller estimated prices for products made under new contracts would be 5% to 10% higher than as a result of the higher wages and raw material bills.
The good news for consumers is that rising costs in China are not yet feeding into higher prices on store shelves, though they are probably chipping away at the profits of importers and retailers, economists said.
H&M, the giant Swedish clothing retailer, finds itself grappling with how to keep prices down as its suppliers demand more, said Nils Vinge, its director of investor relations.
Some strategies, like shifting production to low-wage Bangladesh or Turkey, with cheaper transport costs to Europe, can reduce the impact, though not forever.
In the long run, this makes its way to the consumer,'' Mr Vinge said. "In the short run, it does not.''
Mr Temple, the toy buyer, said he had managed to largely contain cost increases from China through a mix of tough negotiating and lower profits. But soon enough, the retailers he supplies, like W.H. Smith, Harrods and Selfridges, will find themselves under intense pressure to raise prices, he said.
"These prices have to be passed down to the retail chain next year,'' Mr Temple said. "Prices have to go up.''NYT
Vocabulary (in discussion above)
revelled in x - enjoyed x a lot
the bounty of - the large amount of
figurines - a small model of a person or animal
a rude awakening - when someone suddenly becomes aware of a very unpleasant reality
underbid each other -
consistently - behaving in the same way all the time
marking up prices - raising prices
distribution rights - the right to sell a product in a country, a license
stuffed animal - a doll that is an animal
cuddly creature - a very cute animal or stuffed animal (so cute that you want to hug it)
Paddington Bear - a character in a children's book (See Wikipedia)
Jemima Puddle-Duck - a naive duck in one of the stories of Beatrix Potter (See Wikipedia on The Tale of Jemima Puddle-Duck)
a bottomless pit - a supply that will never end
a tailwind - a wind blowing behind an airplane making it move faster
to counterbalance - to change with an equal and oppostite effect, for example honey counterbalanced the hot and sour tase of Tom Yam Gung)
disinflation - decrease in inflation (not the same as "deflation" which is decreasing prices, the opposite of inflation; See Wikipedia)
anecdotal evidence - evidence from someone's personal experience (told as a story or anecdote)
ebbing - disappearing, growing weaker and gradually disappearing
European Central Bank - the bank that is in charge of the monetary policy for the European Union's currency the Euro (See Wikipedia)
to step up - to increase
the China effect - the contribution of cheap Chinese products to decreased global inflation
levelling off - gradually no change after a decrease or increase
emerging markets - an advanced developing economy like Thailand, "An economy in the early stages of development whose markets have sufficient size and liquidity and are receptive to foreign investment. Examples include China, Greece and Brazil." (Source)
purchasing - procurement, the department in a company responsible for purchasing things for the company that it uses in its business (See WIkipedia on procurement)
NTC Research - economics research company, one of the world's largest (See their website)
galloping - moving very quickly
sending ripples through x - affecting x, having an effect on x
x lags behind y - x follows y after a delay
arbitrage - trading that tries to profit from small price differences in different markets (See Wikipedia on arbitrage)
with abandon - uncontrolled
with seeming abandon - looks uncontrolled (but may not be)
tempered - made less extreme
salve - an oil put on a wound or skin to help healing
obsession - thinking too much about something
supply-chain - the buying of materials, processing them into intermediate and finished products,
and then distributing the finished products to customers (See Wikipedia on supply chain)
cost increases are passed on - if a product is produced by assembling parts and the cost of the parts increases, then the cost of the product increases
squeezing profit margins - making profit margins smaller
raw materials - material used to produce a product (for example limestone is a raw material used in the production of cement)
chipping away at - slowly making smaller
grappling with x - trying to the problem x
investor relations - the department in a corporation that provides information to investors (See Wikipedia)
Answer Key:
1. What industry is Anthony Temple in? In what country?
He is in the British toy industry.
2. What products does Temple's company produce?
(Note: Some inference needed)
His company produces stuffed animals ("cuddly creatures"). His company has the British distribution rights for the popular children story characters Paddington the Bear and Jemima Puddle Duck.
3. What was he searching for during his trips to China?
He was searching for toy suppliers (Chinese companies that produce toys).
4. How much were Chinese toy manufacturers marking up their prices?
By 5% to 10%.
5. Why were Chinese toy manufacturers marking up their prices?
The cost of raw materials and labor was rising. Chinese companies passed these costs on to the customer by increasing the prices of their products.
6. How have Chinese exports helped central banks in the west over the last decade?
As consumer price levels moved slowly upwards, Chinese exporters cut prices which reduced inflation.
7. What recent evidence suggests that low Chinese export prices are contributing to decreased inflation less and less?
a. Recent statistics ("numbers") - the price of Chinese imports into the United States is levelling off.
b. Anecdotal evidence (stories from business people) - like the story of the British businessman at the beginning of the article.
8. What is the effect of low Chinese export prices on global inflation called?
It is called "the China effect"
9. What statistical evidence from China indicates that Chinese exporters are facing cost pressures?
A survey of purchasing managers indicates that the price of "Chinese goods at the factory gates" has increased sharply in the last four months.
It is unclear whether "factory gate" means raw materials (back gate) or products manufactured (front gate).
10. Which countries are customers moving to as the price of Chinese exports increases? Why?
They are moving to places like India and Bangladesh. These countries have lower costs.
11. What initially led to the China effect?
"Cheap labour and easy access to a first-class port in Hong Kong allowed China to flood the world with inexpensive goods.
12. What economic forces seem to be bringing an end to the China effect?
"...as labour shortages develop, Chinese workers are starting to demand more money, adding to cost pressures from more expensive commodities and creating the classic conditions for rising export prices."
13. To whom are the rising costs for Chinese exporters being passed on to in the west? To consumers? To middlemen and distributors?
Mostly to importers and retailers resulting in lower profits. Prices are not being passed on to consumers yet. ("not yet feeding into higher prices on store shelves")
14. How have Europeans kept import prices using lower transport costs?
They import from low-wage Bangladesh and Turkey which have lower transport costs to Europe.
