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Friday, November 26, 2004

"The China Price"

Businessweek writes, A massive shift in economic power is under way due to chinese manufacturing prowess affecting US industry competitiveness. Excerpts from a well written article:

When the U.S.-China Economic & Security Review Commission, a congressionally appointed panel, convened on Sept. 23, it was not to discuss power but decline. One after another, economists, union officials, and small manufacturers took the microphone to describe the devastation Chinese competitors are inflicting on U.S. industries, from kitchenware and car tires to electronic circuit boards.We have faced competition in the past. What is dramatically different about China is that they are about half the price.

"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."

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.

But there's a huge cost to the China relationship, too. Foremost is the question of America's huge trade deficit, of which China is the largest and fastest-growing part. While U.S. consumers binge on Chinese-made goods, the U.S. balance-of-payments deficit is nearing a record 6% of gross domestic product. The trade shortfall -- coupled with the U.S. budget deficit -- is driving the dollar ever downward, raising fears that cracks will appear in the global financial system. We earlier wrote about this and its impact on the US economy in the article Stephen Roach Predicts Economic Armaggedon. By keeping its currency pegged to the greenback at a level analysts see as undervalued, China amplifies the problem.

On a practical level the U.S. is now so dependent on Chinese suppliers that resurrecting trade barriers would just raise costs and diminish the real benefits that China trade confers. Also, unlike Japan 20 years ago, China is a much more open economy. It continues to lower tariffs and even runs a slight trade deficit with the whole world -- which makes the U.S.'s deficit with China all the more glaring. China's low wages are reflected in the entire supply chain -- components, office workers, cargo handling -- you name it. Can China dominate everything? Of course not. America remains the world's biggest manufacturer, producing 75% of what it consumes, though that's down from 90% in the mid-'90s. Industries requiring huge R&D budgets and capital investment, such as aerospace, pharmaceuticals, and cars, still have strong bases in the U.S. "I don't see China becoming a major car exporter in the foreseeable future," says GM China (GM ) Chairman Philip F. Murtaugh. "There is no economic rationale." Murtaugh cites high production costs and quality issues at Chinese car plants, as well as just-in-time delivery needs in the West, as impediments.
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