The Rising "China Price"

Stephen DeAngelis

September 16, 2008

In an earlier post [Changing Supply Lines], I discussed how rising fuel prices are changing manufacturers thinking about maintaining long supply lines. A recent article in the Washington Post reiterates that concerns about long supply lines continues [“China’s Outsourcing Appeal Dimming,” by Ariana Eunjung Cha, 8 September 2008]. As I pointed out in the above mentioned post, rising fuel prices have forced some manufacturers to look for closer regional suppliers. I warned that while regionalization is good for many product chains, it could also slow globalization’s advance into areas that are currently mired in poverty, such as Africa. Supplier companies can only survive when they are positioned within the logistics paths of production chains. As those logistics lines shrink, they are likely to bypass some geographical regions that are anxiously awaiting for the rest of the world to discover them. Without being embraced as part of disintegrated production chains, these regions will never attract enough capital to build up a sustainable regional economy. As Cha reports, even mainline supplier countries, like China, are starting to feel the pinch. She writes:

“Harry Kazazian built his business on sleeping bags that are made in China and shipped across the ocean to the United States, but he realized recently that the math doesn’t work anymore. With fuel prices at record highs, the cost of sending a standard 40-foot container of goods has gone from $3,000 in 2000 to about $8,000 today, squeezing profit. So this summer Kazazian, chief executive of Exxel Outdoors, a Los Angeles-based maker of recreational equipment, did something radical: He moved the manufacturing back to Haleyville, Ala. Soaring energy costs, the falling dollar and inflation are cutting into what U.S. manufacturers call the ‘China price’ — the 40 to 50 percent cost advantage once offered by Chinese producers. The export model that has powered China and other Asian countries for three decades will be compromised if fuel prices continue to rise, said Stephen Jen, a managing director for Morgan Stanley.”

Jen goes on to assert that “globalization has gone a little bit too far” and that “energy shock” is quickly changing conditions.

“The ripple effects have been far-reaching. The trade imbalance between the United States and China — a source of political tension for years — is beginning to right itself as Chinese exports fall and U.S. exports rise. Global trade routes are being transformed, suggesting a possible return to a less integrated world economy. The model of outsourcing to China emerged at a time when oil was going for $20 a barrel. In the past few months, oil has been trading at about $110, and many experts say it will eventually hit $200. This has led some companies to move production from China to northern Mexico, next door to the U.S. market. But others have chosen to relocate inside the United States.”

The shift in manufacturing, according to Cha, is not just in the consumer goods sector, but in more basic industries as well.

“Midwestern steelmakers are doing booming business as steel exports from China to the United States slowed down by 38 percent in the first seven months of the year while U.S. steel production rose 10 percent. Manufacturers of furniture, electronic appliances and textiles are also among those shifting production back. The most prominent company in the group might be Thomasville Furniture, which was criticized a few years ago for sending several thousand American jobs overseas. It announced in June that it was returning production of an entire line of upholstered and wood furniture to the United States. The company says it will add 100 jobs in North Carolina.”

In earlier posts, I have noted that not all companies will relocate production now being conducted in China. The reason is simple. They have too many sunk costs in production facilities in China and cannot afford another expensive facilities move in the near term. Even in the long term, such a move might not make sense for them. As I wrote earlier, “such dramatic changes in so short a period of time make it more important than ever for companies to involve themselves in alternative futures planning. Companies need to consider a number of possibilities about the future because no one can predict how the competitive landscape is going to change with any certainty.” Cha agrees:

“It’s unrealistic to think that all or even the majority of factories lost to China will return to the United States if the price of oil continues to rise. A lot of equipment was disassembled and shipped abroad years ago, and it would require a massive reinvestment to move or replace it. And despite the high shipping costs, China still offers advantages: Many raw materials remain cheap, and millions of skilled laborers work for wages that are a fraction of what their American counterparts get. A survey released in June by the audit and consulting firm Deloitte found, however, that U.S. manufacturers consider locations in North America, including Mexico, the most desirable for expansion over the next three years.”

New York Times’ columnist Tom Friedman has argued that the “world is flat” as a result of trade liberalization and technology. Cha quotes two economic analysts, Jeff Rubin and Benjamin Tal, who claim that “rising transport prices will once again make it rounder.” Cha notes that other factors are also contributing to changing supply lines.

“Other factors are helping drive a flight from China: the increasing value of the Chinese currency, the yuan, vis-à-vis the dollar; a new labor law; the repeal of some export tax rebates; and inflation. Many companies say they are also motivated by a sense of patriotism and environmental concern.”

Using the sleeping bag company as an example, Cha explains why rising transportation costs are such a big deal. .

“Eight years ago, Kazazian was an entrepreneur producing family-style outdoor gear and looking to expand his operations. Sun Yun was a 25-year-old salesman at his father’s down factory in an industrial part of Shanghai who wanted to get into the export business. They met online in 2000 and started making inexpensive sleeping bags that quickly became a bestseller at Wal-Marts, Kmarts and Targets across the United States. But as oil prices started to rise, Kazazian began to worry. Given that 1,800 sleeping bags could fit in each container, Exxel was soon paying about $4.44 to ship a bag that retailed at Wal-Mart for $9.99. ‘Even if they made the bag for free in China, it would still be too expensive,’ he recalled thinking. Kazazian began to research what it might cost to produce the bags in the United States. The company still had a factory in Haleyville that had been mostly idle for the past few years. He was surprised to find that with transportation costs factored in, it would be 4 to 5 percent cheaper to produce there than in Shanghai. Last month, he began hiring the first of what he hopes will be 50 new workers in the United States. Kazazian is working on a plan to cut overall production in China of all his products — tents, backpacks, folding chairs, tarps, apparel — from 80 percent at the beginning of this year to 20 percent by the next.”

Chinese business and political leaders have to be concerned about this turn of events. I’ve heard that if Walmart were a country, it would be China’s fourth leading export partner. Concern, however, does not equal crisis.

“The Chinese economy still ranks among the 20 fastest-growing in the world, even though it has had four straight quarters of decelerating growth. Industry groups in China say tens of thousands of manufacturing companies have shut down in recent months. Official statistics show that from January to May, the growth of labor-intensive exports fell to 16.7 percent, from 29.6 percent the year before. Morgan Stanley’s Jen said that in the short term, high oil prices are ‘clearly a negative shock to Asia,’ but that in the long term, they could help China achieve its goal of producing more high-tech goods and becoming more of a service economy.”

In other words, China is quickly learning the lesson that the United States is still learning. A national economy is not static and it must change with events or it will wither. China has more change to make than United States. America’s problem has been that it has been slow to recognize that change is needed and has therefore tried desperately to cling to the past rather than move forward. Fortunately, the tenor of the presidential campaign has begun to move away from populist drivel and the candidates are finally admitting that it is time to move forward rather than look back. The quicker that America retools its economy, the more resilient it will become. My concern remains for countries that were counting on globalization reaching their shores and now see the timeline pushed back as dispersed supply lines tighten up. In the end, even a regionalized economy will help impoverished nations, but regionalization (as a part of globalization) is a new twist that will take time to work out. Time, unfortunately, is often the enemy of economies in crisis.