“We have no immediate plans to change the pricing policy of our products,” says Anne Putz, the head of adidas corporate public relations at head office in Germany.
But other low-wage manufacturers are making their intentions clear. They are moving, skimping on inputs and fighting as to give consumers some of their pricing pain.
“The consumer, our customers, have pushed for years to get the lowest possible price and they feel because it’s made in China it’s got to be cheap,” says Michael Morosin, who runs an electronics packaging company called PRT Manufacturing in Shenzhen. His main cost is plastic, derived from oil.
“The cost of oil is killing us,” he says. “But we can never pass on more than 50 per cent because on the other end of the phone you hear these guys scream.”
WESSCO International supplies a large proportion of the world’s airline bags, with their disposable toothbrushes and socks, to companies such as Qantas. Last year, its managing director, Petros Sakkis, shifted his efforts from trying to squeeze ever-increasing quantities of cheap plastic goods at ever-diminishing prices out of his Chinese production lines. Instead, he’s been roaming Vietnam, Thailand and India for factory space.
“Rising cost pressures are pushing us to be more aggressive in moving our production out of China,” Sakkis says. “Where to? That’s the big question. You’ve got to start from scratch because there is no paradise.”
Sakkis will not talk about his prices, as each contract is negotiated individually. But Jo Austin, who edits a trade magazine called OnBoard Hospitality, spells it out.
“The rising costs will be passed on to airlines and airlines are passing them on again,” she says. “But rather than pay more, airlines are reducing product, particularly at the back of the plane.”
Whether consumers pay higher airfares or receive a lower-service flight, they are paying more for less. For decades, consumers have had the better of the world’s manufacturers. But the tide is starting to turn. The battle between them will affect the political fortunes of leaders such as China’s Premier, Wen Jiabao, who last week said inflation was the biggest concern of the Chinese people, and the Prime Minister, Kevin Rudd, who says the consumer price index is his biggest economic challenge.
This week, China’s Bureau of Statistics shocked the economic world with consumer price index growth of 8.7 per cent for the year to February. Most of that was driven by food prices, but upstream inflation pressure is growing just as fast.
China’s producer price index jumped 6.6 per cent in the year to February, from a virtual standing start in the middle of last year.
The United States Bureau of Labor Statistics reports import prices from China fell by about 1.5 per cent annually from 2004 through to mid-last year. But the latest annual figures show China import prices rising 2.5 per cent. Chinese statistics show its export prices are up 6.5 per cent in a year in US dollars, the currency in which most China export deals are set.
Australia does not compile country-specific import price data. But a China economist for UBS, Jonathan Anderson, says China export prices are rising into the US, Europe and Japan – so it’s a fair bet they are rising in Australia, too.
“It is accelerating,” Anderson says. “And the reason we expect it to continue to accelerate is that labour pressure is unabated.”
So far, the Reserve Bank Governor, Glenn Stevens, has been spared the added inflationary headache of rising Chinese import prices thanks to the mercurial Australian dollar. The rising dollar means Australia’s purchasing power is rising faster than China’s US dollar-denominated export prices. But that relief will last only for as long as the Australian dollar out-runs the Chinese yuan.
Macquarie Bank’s China economist, Paul Cavey, says it is only a matter of time. “Whichever way you look at it, Chinese export prices are moving up,” he says. “At some point, it must begin to have an impact on Australian inflation.”
China’s cost pressures are spreading deeper and further through the system. More than half of the increase in China’s producer price index was caused by coal and steel, and those shocks will be amplified by a second round of cost increases as steel and energy-intensive producers pass their pain down the production chain.
Australian consumers and businesses have enjoyed an unprecedented, sustained rise in buying power because prices for the commodities that Australia exports to China are going through the roof and, at least until now, prices have been falling for Chinese goods that are coming the other way. But booming commodities prices are starting to embed themselves in many of the manufactured goods Australia buys from China.
China’s steelmakers have more than offset the huge rises in iron ore and coking coal costs by simply pushing them down the line. Steel-intensive users, in turn, are pushing those costs on to the next line of producers.
An employee at Morimatsu Industry, a Japanese company that manufactures in Shanghai, says steel accounts for half of the costs of the huge steel tanks it makes for chemical and mineral processing. He said he will add the 20 per cent rise in steel prices this year directly onto his product prices – and charge it to customers that include BHP Billiton in Australia.
The tyre maker Goodyear, which also sells to Australian mining companies, says it is lifting productivity to absorb rising rubber, energy and shipping costs. Nevertheless, it is also asking customers to pay.
“But yes, eventually consumers bear the brunt, just like they pay for increases of other products from raw materials or natural resources,” says Goodyear’s regional communications director, Ron Castro.
It helps resource-intensive producers that they can easily point to record commodities prices in order to explain their cost problems to customers. It also helps they tend to sell to other producers, such as mining and Asian construction companies, which are flush with cash.
Philip Kirchlechner, a marketing director at West Australia’s Aurox Resources, says prices for iron ore processing equipment such as crushers and ball mills have jumped about 30 per cent in three years and delivery times have doubled.
“This price and delivery situation will get worse by the end of this year,’ he says.
Tom Ren, a Shanghai businessman who runs a chemicals company called FineKing, says his inputs are derived from oil and therefore getting more expensive. He sold the world Yuan300 million ($45 million) in polyurethane gap filler products last year – the stuff that builders use to seal the cracks between windows and walls.
Ren writes his key financial variables on the back of a notebook to show how rapidly his costs are rising. They are not rising as fast as his efficiency gains.
“Our cost keep going up and up and up, but so is our productivity,” Ren says. And then he adds a crucial detail: the prices of the products he sells are slated to rise 20 per cent this year.
Makers of heavy machinery and equipment tend to start from a less efficient base than their labour-intensive cousins, meaning they have more room to raise their productivity and preserve margins. More importantly, they have pricing power.
One observer, whose private equity fund controls $US4 billion ($4.29 billion) in the Asian region, including in China and Australia, said rising costs are sorting Chinese exporters into three groups.
“The guy who sell products that are really super-commodities are passing their cost increases on because their customers understand what’s happening in the world market,” he says. “The low-end manufacturers like hardware, textiles and low-end auto-part suppliers, like cooling fans, are being hammered. But those who can differentiate on product or use a lot of technology are OK. Anybody who has a bit of technology in their product can pass that on.”
It turns out that cost pressures are far from defeating China.
Meguri Aoyama, who is the head of China affairs at Keidanren, Japan’s top business association, says China’s labour-intensive manufacturers will struggle. But prices for resource-intensive products such as cement, paper and steel will keep going up. But the overriding theme of Chinese industry, he says, is that rising costs are pushing the world’s most competitive manufacturers to scramble faster up the technology chain.
For Toyota, he says, rapidly improving technology will easily counter rising steel costs. The car maker, which is likely to overtake General Motors as the world’s top car maker this year, is helping to turn cities such as Guangzhou from low-wage manufacturing centres into high-wage, high-tech capitals.
“Guangzhou’s becoming the Detroit of Asia. In five years the situation has totally changed,” says Atsuo Kuroda, who is responsible for China trade and investment at Japan’s Ministry of Economy, Trade and Industry.
Other leading brands such as Canon, and Panasonic are steering clear of rising costs by using ever-improving technology to produce increasingly high-tech digital cameras, flat-screen TVs and industrial machinery.
It is a little more than a decade since China cemented its name as “the world’s factory” for being the home of simple, low-wage manufacturing. But the country is moving on.
Rising costs are igniting yet another round of creative destruction. They are forcing some firms out of business, others deeper into China or into southern or South-East Asia, while giving others the impetus to advancing up the technology ladder.
The Chinese Government is encouraging the transition. “They’re saying, ‘We want to move up-market, upscale, we prefer auto to apparel,”‘ says Anderson at adidas. And so his company is shifting its China manufacturing inland, where it can provide jobs to China’s remaining low-wage workers and direct its products towards the country’s rapidly growing domestic market.
China is treading a similar path to Japan, Korea and Taiwan before it, albeit on a much larger scale. With these precedents, economists expect consumers might hurt a bit during the transition but will end up back on top.
“Cost pressures are rising so everybody is talking about whether China will push up the prices of its products and therefore inflation everywhere,” says Huang Yiping, the chief Asia economist at Citigroup. “But I don’t think that will happen. If China succeeds in exporting autos, for example, then China will remain a deflationary force for a long time to come.”
The times of an ever-falling “China price” for labour and resource-intensive manufactured goods is probably over. But the era of a new China price for cars, sophisticated electronics and even aircraft is probably around the corner.