Article from Sunday Times — love the comment that America is urging China to become a more balanced economy. Lehman, Bear Sterns,AIG, Merrill Lynch — yup America sure understands what makes a balanced economy.

From The Sunday Times

September 14, 2008

Is it all over for cut-price China?

Michael Sheridan in Hong Kong

THE huge container ships are still a fine sight as they weave through a maze of islands and head out to the South China Sea, but their cargoes are no longer made in the world’s bargain basement.

The fabled “China price” of cheap consumer goods has kept global inflation low, undercut workers in every industrialised nation and brought millions of Chinese peasants into a raw capitalist economy.

That phase of globalisation may now be coming to an end, economists say. The export machine that powered China’s spectacular growth is slowing as the cost of manufacturing in China and shipping goods to Britain goes up daily.

“We are starting to look elsewhere,” said a UK supermarket buyer, “to Israel, eastern Europe, Thailand, Vietnam and in many cases we are getting better prices than from China.”

It costs about £3,000 to ship a 40ft container stuffed with toys or shoes from Shanghai to Manchester, shipping firms said last week. That is more than double the amount charged in the early years when China was a paradise for outsourcing and oil traded at just over $20 a barrel.

Freight costs have pushed some American firms into “reverse globalisation”, moving their manufacturing operations in steel, furniture, electronics and textiles back to America and Mexico.

The harsh arithmetic of shipping is only part of the explanation. But it illustrates the pitfalls for any business model dependent on going halfway around the world in search of the cheapest labour. Even sweatshops, it turns out, have their bottom line.

The energy shock hit Chinese firms hard. Oil at more than $100 a barrel not only pushed up the cost of shipping, but fed through into raw-materials costs for plastics and led to higher electricity rates.

All of that, in turn, pushed up Chinese domestic inflation to nearly 10% and food prices for staples such as pork by 45%. Workers demanded wage increases. A labour law, enacted this year, gave them rights and made unions stronger.

As the labour market evolved and internet usage rose, literate young migrant workers learnt of opportunities elsewhere and voted with their feet against the worst-managed factories in southern China – often those owned and operated by companies from Hong Kong, Taiwan and South Korea. Last year there were labour shortages in the southern provinces for the first time.

Two more factors raised costs for Chinese firms. Determined to drive out bottom-end manufacturers and move production up the value chain, the Chinese government cut tax rebates that had amounted to a 13% export subsidy. It worked so well that some local authorities are having to step in to bail out big employers.

The biggest blow to exporters was the rise of the Chinese yuan against the US dollar and currencies of other trading partners. Not long ago, £1 bought more than 15 yuan. Today sterling trades at about 12 yuan and the differentials are widening.

“Now the pound is weakening against the dollar I’m in the same situation the Chinese have been crying to me about all year – currency,” said the British buyer, who asked not to be named.

“When they had this problem we helped them out. But now it’s reversed, will they help us? No chance. If this attitude prevails, at the low end at any rate, China may start to price itself out of our market.”

The Chinese have their own tale of woe to tell. “The situation here is very severe,” said Zhang Handong, director of Zhejiang province’s foreign trade research centre. “Last year was disastrous. I estimate Zhejiang exporting companies lost 36 billion yuan (£3 billion) in profits.”

Zhejiang’s provincial government stepped in to save its “big dragon” exporter, Feiyue Group, a company with 5,000 employees and reputed to make almost half the world’s specialised stitching machines.

Zhang said Feiyue’s exports fell 44% when tax rebates were cut, the yuan rose and energy prices soared. It owed more than £80m to its bankers. “Local government intervened by ordering the bank not to call in the loan and to continue to extend credit,” said Zhang.

For Qing Yuan, general manager of the Haoxing textile mill, the story is one of profit margins in remorseless decline. “A couple of years ago I could make money with my eyes closed,” he lamented.

Some small firms, like the Buruoyi garment maker in the port of Ningbo, are offering a preferential exchange rate to keep their customers. “If we don’t, foreigners won’t buy our products,” said Xu Zhaolong, a sales manager.

In the first seven months of this year, 3,600 toymakers shut up shop in Guangdong, the export industry hub. Official figures show 67,000 small and medium firms reported losses in the first half of this year.

Planners in Beijing believe that although exporters may be suffering, China needs to become a more balanced economy in which domestic demand drives growth – something that America and other trade partners have urged for years.

The government has also cut corporate income tax to 25% from 31% this year in a sign of its friendliness to business.

While the macroeconomic theory sounds fine, few Chinese exporters and perhaps even fewer foreign customers comprehended how painful the adjustment process would be.

Competitors in southeast Asia have been quick to step in. Vietnam is emerging as China’s main rival for budget manufacturing, although its own growth pains this year include a currency crisis, a property crash and 20% inflation.

Thailand, the Philippines, Malaysia and Indonesia have all seen their competitive edge improve.

Uncertainty has ruined investor sentiment and led the Chinese stock markets to their lowest levels in 21 months. The Shanghai Composite Index has lost 46% of its value since its record high last year.

China’s state media spoke last week of “renewed fears over slower economic growth”. Yet before gloom turns into a real depression it is worth recalling that China achieved growth of more than 10% in the second quarter of this year.

Export growth slowed last month even though the country achieved yet another monthly record trade surplus of more than £16 billion.

“Exports growth decelerated but imports posted a much bigger slowdown as commodities prices and shipping rates slumped,” a Ministry of Commerce official told Xinhua, the state news agency.

The unnamed official gave a hint of how the Chinese government intended to manage the volatility by holding the currency steady. “This can help exports while giving no further incentives to imports,” he said.

But the authorities in Beijing are likely to discover it is easier to navigate a giant container ship round the channels off Hong Kong than to turn round a giant economy at full steam.