BEIJING (Reuters) - Call it the price of success.
China is starting to pass on the rising cost of labor and other manufacturing inputs as it restructures its economy, creating a potential new inflation headache for Western countries already grappling with surging commodity prices.
The threat for now is no greater than a distant cloud in a clear blue sky. Excess capacity and high unemployment in the United States and Europe mean that most companies will be unable to pass on higher costs from China and will have to accept lower profit margins instead.
But the evidence is clear.
The U.S. Bureau of Labor Statistics reported earlier this month that its China import price index rose 0.9 percent in the fourth quarter after holding broadly steady for the previous 18 months.
The index had dropped 3.4 percent during the global financial crisis, erasing part of a 6.7 percent jump between the end of 2007 and the middle of 2008.
As economists at Bank of America Merrill Lynch noted, that earlier spike coincided with rising inflation and shortages of unskilled labor in the coastal provinces that are home to most of China's exporters. And those are exactly the same conditions prevailing today.
Recent data suggest that, after a two-year pause, China is on track to become an inflationary force for the global economy again, the BoA Merrill report said.
Guangdong, the biggest exporting province, said last week that it would increase minimum wages by around 19 percent in March. In late December Beijing ordered a 20 percent rise in the capital, just six months after a similar increase.
Rising labor costs reflect the paradox that in a country of more than 1.3 billion people, China is running short of labor. Or, more precisely, there is an emerging dearth of younger, nimble-fingered workers willing to work long hours for a pittance.
The cost of energy, buying land and complying with environmental legislation is also steadily rising as China strives to increase the puny share of national income that goes to labor and to reduce pollution.
Prices of products sourced in China are likely to rise at least 10 percent in the first half of this year, Bruce Rockowitz, president of global consumer goods exporter Li & Fung Ltd (0494.HK), told Reuters Insider TV in Hong Kong recently.
To the extent that the "China Price" is rising, it is exactly the outcome sought by U.S. policymakers who have been urging China to scrap subsidies and let the yuan's exchange rate rise in order to remedy what they see as artificially low production costs that make China super-competitive in global markets.
Dominique Dwor-Frecaut, a strategist with Royal Bank of Scotland in Singapore, said that China's strong growth was undoubtedly pushing up global commodity prices.
Indeed, the world appeared to be going though a commodity price shock similar to that in the 1970s, partly a reflection of generalized asset price reflation engineered by the Federal Reserves loose monetary policies.
"But it's unfair to say that China is exporting inflation to the rest of the world through manufactured goods. It is rebalancing its economy, which means it's paying higher wages to workers, including in the export sector, and that has stabilized the price of exports. And it is increasing the value of its currency to meet the demands of the Americans and the Europeans. So it's unfair to single out China," she said.
Given the determination of the ruling Communist Party to keep a lid on inflation, few economists expect price pressures to get out of hand, even if 4 percent has now become the new normal rate that officials expect as they seek to leave more money in workers' pockets to tackle anger over income inequality.
For one thing, labor usually accounts for no more than 5 percent of a manufacturing company's sales costs. And although minimum wage increases are grabbing the headlines, double-digit increases have been the norm for several years with the exception of 2009.
Tao Wang, UBS's chief China economist in Beijing, said the main reason she does not expect consumer price inflation to get out of control is that core manufacturing goods prices are still well behaved and supply is likely to keep pace with demand.
The worries about a wage-inflation spiral are exaggerated, given strong labor productivity growth and lack of collective bargaining in China, she said.
The picture is similar across Asia. Wages are gathering pace, but the increase in goods prices has been modest despite the leap in commodities.
Part of the explanation, according to J.P. Morgan, is that unit labor costs have softened around the region since the 2008 recession, although they are picking up in Singapore.
To the extent that unit labor costs adjust modestly, this should continue to restrain price pass-through, though this needs to watched especially in the context of countries where labor markets are tightening, J.P. Morgan's economists said in a report.
If rising costs do trickle through the pipeline, expect to hear cheers from Japans deflation-fighters. Because Japan now sources 40 percent of its imports of consumer goods from China, a marked rise in Chinese unit labor costs would have a direct impact on Japanese inflation, argues Naokazu Koshimizu at Nomura in Tokyo.
As for the United States, Harm Bandholz, chief U.S. economist at UniCredit Research in New York, expects Chinese import prices -- and food prices -- to keep climbing.
As rents rise and more businesses are forced to pass on higher costs to consumers, the core inflation rate could rise to 1.5 percent by the end of 2011 from a record low of 0.6 percent last October. But it would require a much stronger job market for the Fed to become alarmed, he said.
The bottom line is that headline and core inflation rates are clearly pointing north. But thanks to the low starting level the Fed will be able to continue its ultra accommodative monetary policy in the current year. The central bank's primary goal remains fighting unemployment, Bandholz wrote in a note to clients.
In a nutshell, for now it is in Asia where the wrenching adjustments to relative prices required to rebalance the global economy are being felt most acutely.
It's creating more inflationary problems for China than it is for the rest of the world, said Dwor-Frecaut at RBS.
(Additional reporting by Emily Kaiser in Washington)
Editing by Kim Coghill