Analysis: Disinflationary wave from China already waned

WASHINGTON Thu Mar 29, 2012 8:23pm EDT

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WASHINGTON (Reuters) - A big improvement in labor conditions at plants that produce Apple's iPhones, iPads and iPods in China, which was announced on Thursday, is unlikely to create much more than a ripple in prices across the West.

While the reduced overtime hours, increased hiring and improved safety will raise labor costs for the gigantic contract manufacturer Foxconn that Apple uses in China, they are such a small part of the overall cost of the smart phones, tablets and music players that the shift can be largely absorbed, economists said.

Any impact from higher Chinese labor costs is also being offset by the feebleness of the global economy after the financial crisis. The disinflationary wave that swept the world from the 1990s onwards because of cheap Chinese production has been fading for some years and is now close to an end, yet prices in the United States and Europe have not surged.

Wages in China have been rising steadily by 15 percent a year for rural migrants since 2005, making the latest agreement between Foxconn Technology Group and Apple part of a broader trend already underway.

A range of other factors also has boosted the price of exports carrying the Made in China label -- China's land prices, domestic inflation, rising energy costs and a tightening supply of labor, particularly as the Chinese population ages.

"We don't expect China to be exporting disinflation again," said Bill Adams, senior international economist at PNC Corp.

Beijing is trying to rebalance its economy away from exports toward domestic consumption. To that end, it has declared it wants average incomes to grow more quickly than nominal gross domestic product over the next five years -- essentially welcoming higher wages.

Yet the shifting China effect has not tipped the scale toward inflation in advanced economies, still struggling in the aftermath of the credit crisis. The IMF forecasts they will see 1.4 percent inflation this year, compared with the 2.4 percent average for 1993-2002.

"It's fair to say that we have moved from an extended disinflation from China to an extended period of at least weaker disinflationary pressure from China," said Derek Scissors, senior fellow at the Heritage Foundation's Asia Studies Center.

"But the effect is being masked in the U.S. and elsewhere by consolidation of household balance sheets after the financial crisis. We can't see a pricing shift because the global economy is too weak," he said.

U.S. IMPACT

While the price of Chinese goods imported to the United States rose by 3.6 percent last year, the fastest pace since the United States started keeping China import price records in 2003, there are few signs this has had much impact on overall U.S. inflation.

Firstly, Chinese imports accounted for only 2.7 percent of all spending by American consumers on goods and services in 2010, and less than half of that reflected the actual cost of the Chinese imports. The rest was mark-ups by U.S. businesses that transported, warehoused, distributed and sold the goods, the San Francisco Federal Reserve said in a study last year.

In other words, for every dollar spent on a Made in China item, 55 cents on average went to U.S. businesses and workers.

"This suggests that Chinese inflation will have little direct effect on U.S. consumer prices," the regional Fed concluded.

More precisely, if China were to pass through a 5 percent inflation rate, it would raise the Fed's favorite price index, the personal consumption expenditure index, by only 0.1 percentage point, it said. China's inflation currently is running below that at a 3.2 percent annual rate.

The University of California at Irvine has illustrated the point graphically. It broke down the value of an Apple iPad and found that Chinese labor costs accounted for only 2 percent. Materials were 31 percent of the value, Apple profits second at 30 percent and distribution and retail costs 15 percent.

"U.S. costs are a far bigger factor on the order of 10:1," said Scissors.

RENMINBI

A study by the U.S. Bureau of Labor Statistics suggests that the revaluation of China's currency, known locally as the renminbi, or yuan, could be more significant than labor costs.

The yuan has risen in value by 30 percent since depegging began in June 2005. BLS data show that Chinese import prices have risen more or less in tandem, albeit with a lag (see attached graphic). Import prices slid 3.3 percent when the yuan stalled from the summer of 2008 during the financial crisis and then resumed their climb when revaluation started up again.

China's exchange rate policy "undoubtedly" affects import prices in the United States. "However, other factors such as labor costs, input costs and China's export mix will also have an impact," the BLS said.

Another factor dampening the effect of rising labor costs on the final price charged for products is that Chinese manufacturers are moving inland, where labor and land are cheaper, and they are raising labor productivity.

Investing in capital equipment and automating manufacturing processes is essential if China wants to remain competitive and its pool of cheap labor starts to dry up, said PNC Corp's Adams. He noted that entrants to the labor force between the ages of 17 and 20 are already declining year on year.

"Chinese labor is a small share of the retail prices in the United States," Adams said.

(Reporting By Stella Dawson; additional reporting by Alan Wheatley in London; Editing by Dan Grebler)

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