China Losing Its Price Advantage

The global economic downturn has dramatically changed the outlook for international trade. The World Trade Organization foresees a nine-percent fall in trade in 2009, as businesses around the world cut back and families stay out of stores and malls. While the international trade body also predicts that China will overtake Germany as the biggest merchandise exporter this year, China is losing cost advantage.

Just as Mexico was becoming the rising star of global manufacturing in the 1990s, China's even cheaper wages turned the Asian country into the world's factory early this decade. But a combination of factors, such as higher labor costs and an appreciating yuan, are making China less competitive for manufacturing firms serving the North American market.

Over the past three years, in fact, the once-formidable China price edge has all but disappeared for a number of manufactured goods, according to a recent study by the US-based consulting firm AlixPartners.

As explained in a recent BusinessWeek report, AlixPartners assessed the total cost of ownership of five categories of machined products, such as large, cast-aluminum engine parts requiring significant labor and small mass-produced plastic components requiring little labor. The consulting firm found there has been a dramatic cost shift since 2005.

Four years ago, the "total landed cost," meaning price after an item had arrived at a California shipping port, was 22% cheaper on average for Chinese parts than those American-made in the sample AlixPartners studied. By year-end 2008, however, the average price gap with the U.S. had dropped to a mere 5.5%, which is often not large enough to be worth the hassle of sourcing something from halfway around the world.

The more surprising reversal is the comparison with Mexico. While China was around 5% cheaper on average than Mexico in 2005, China is now 20% more expensive. Compared with the U.S., the Mexico Price edge widened to 25% from 16%.The North American Free Trade Agreement (NAFTA), which lowered many trade barriers between Mexico and its two northern neighbors, also gives Mexico a cost advantage.

"A couple of years ago, outsourcing to China was a no-brainer" AlixPartners Managing Director Stephen Maurer was quoted as saying in Businessweek. "Right now, Mexico looks super attractive."

So, what are implications for Asia as a result of these shifts in trade patterns? First, the U.S. trade deficit with China and Mexico is not as large as meets the eye. What's more, the United States' deficit with countries that make component parts, such as Japan and Korea, are probably understated. Second, China's exports have dropped significantly since the economic crisis began, but the impact on the country's GDP growth, is much lower than one would expect.

To understand why, take iPods as an example. While millions of jobs in the export have disappeared in the past year, the domestic value added to China's exports remains low. For every iPod that the US decides not to import, the "decline" in recorded exports from China is $150 — but only about $4 of that value was added in China.

Technology for the Apple (AAPL) product comes from many countries. China's GDP declines just $4 for each $150 iPod not sent across the Pacific. Japan, on the other hand, contributes about $100 to the $150 value and takes the far bigger GDP hit from "China's" decline in exports.Overcapacity is expected to plague many industries for some time to come. On the positive side, China's exports fell only 21.4 percent in June from a year earlier, which was an improvement over May's record 26.4 percent decline.

Despite this improvement, things could turn worse. “China has a huge overcapacity problem, with total production exceeding consumption by about 10 percent of GDP,” writes Michael Pettis, a professor of finance at Peking University.

Comments

[Susan Weerts:]

"China has a huge overcapacity problem"
Yet, they continues building factory space /office building. Fixed Asset Investment is The FORCE before china growth. The building occupance is low. As for residual, it is widely known that at least 1/3 apartment in Beijing in China is empty, yet Beijing is one of the top 10 most expensive cities in the world. The average white collar workers can no longer buy an apartment in Bejing alone.

Jul 27 09:57 AM

[Spook:]

Did the report/analysis factor in the freight cost? as well as the materials price increase?

For the past 36-months, several price hikes for good manufacturer in China were attribute to rising metal price such as copper and iron, whereas cost of plastic, electronic parts both passive and active remain flat.

While wage increase did occurred in 2006 and 2007 due to change in labor law and minimum wage law, these increase were not sufficiently high enough to alter the pricing structure.

Overall, material and transport cost increased in 2007 to 2008 were sufficient enough for supplier to re-quote pricing to reflect cost increase, not due to uncompetitiveness.

Jul 27 09:46 PM

[Observer45:]

That is why many companies are moving/encouraged to move to the central and western provinces instead of remaining in the coastal regions.

Jul 28 12:39 AM