By Matthew Benjamin and Nerys Avery Bloomberg News
BEIJING Rising production costs in China might soon turn the smiley- faced Wal-Mart logo on that rack of $7 cardigan sweaters into a frown.
Higher wages and new environmental regulations, along with higher raw- materials prices, are pushing up the costs of manufacturing in China. That will lead to higher prices for the clothing, toys, electronics and other products the nation exports, said economists, manufacturers and others involved in the China trade.
"Companies are telling us they just can't keep going much longer without passing on these higher costs," said Richard Ellert, a Hong Kong-based director of the consulting firm Alvarez & Marsal, which has been sourcing goods in Asia for U.S. and European companies for two decades.
Price pressures on Chinese goods are an unwelcome development for the chairman of the Federal Reserve, Ben Bernanke, the president of the European Central Bank, Jean-Claude Trichet, and other central bankers, who are sounding the alarm about inflation as they raise interest rates around the world. Seven central banks, including the ECB, raised borrowing costs last week, while at least four Fed officials said that they were concerned about inflation.
"Normalization of China's production is a major source of cyclical inflation," said Andy Xie, chief Asia economist at Morgan Stanley in Hong Kong. "Part of the unsustainable disinflation between 2002 and 2005 has to be regurgitated."
Xie said that rising Chinese wages would drive up export prices on such labor-intensive items as knitted garments by as much as 30 percent, while tougher pollution standards would do the same to many chemical products. Higher production costs in China will add half a percentage point a year to U.S. inflation and help push global inflation up 0.7 percent each year, he says.
Prices on Asian goods are starting to accelerate, the U.S. Department of Labor reported last week. Costs of goods from countries in the Pacific Rim, including China, rose 0.2 percent in May, the first increase since August 2005. Overall, import prices jumped 1.6 percent, more than twice as much as expected.
Labor costs in China last year, at $1.36 per hour, were 72 percent higher than in 2001, according to the Economist Intelligence Unit. In 2010 they will be double the 2005 level, the EIU estimates - though that's still just four percent of the equivalent rate in the United States.
At least five Chinese provinces and municipalities, which generated 55 percent of the nation's exports last year, plan to raise minimum-wage standards this year. Those regions include Shanghai and the province of Guangdong, the heavily industrialized area around the Pearl River Delta.
Almost half of the members of the American Chamber of Commerce in Beijing said that they were being hurt by growing personnel costs, according to a survey the office conducted this year.
So far, Chinese companies have been slow to pass along cost increases. Only 8.7 percent raised prices on export products last year, the People's Bank of China said in a Feb. 17 report. Still, that is double the number that pushed through increases in 2004.
A survey by Global Sources of Hong Kong, which helps companies source goods from China, found that more than 60 percent of 1,139 exporters contacted plan to raise prices this year, with increases ranging up to 10 percent.
Not everyone thinks higher prices are inevitable. Productivity gains of 19 percent to 25 percent over the last three years have more than compensated for higher wages in China, according to a report last week by Joan Zheng, an investment strategist with Merrill Lynch in Hong Kong.
While higher prices are possible, "we think Chinese firms facing cost pressures would squeeze their profit margins rather than pass on rising costs to consumers, particularly in the intensively competitive environment that prevails," Zheng said in the report.
Tyco Electronics, a unit of Tyco International, based in Bermuda, sustained higher labor costs from its Chinese operations in 2005 and expects the trend to continue this year, said Mike Ratcliff, a spokesman for the company in Harrisburg, Pennsylvania.
So far, Tyco, which makes connectors, relays and other components used in such consumer products as laptop computers and home appliances, has been able to offset the increases with productivity gains.
That hasn't been an option for other companies trying to recover some of their increased costs.
"The only leverage we've been able to gain is when we launch a new product," said Jack Perkowski, chairman and chief executive officer of Beijing auto parts maker Asimco Technologies, which supplies DaimlerChrysler, General Motors and Ford Motor.
Strategic Sports, a Hong Kong maker of bicycle helmets, had its first unprofitable year in 2005 after having to raise wages in China, where it employs 2,500 workers at three factories in Guangdong. This year, the company is trying to restore profitability by raising prices, said the company's chief executive, Norman Cheng.
Tight labor markets in parts of China are also pushing up turnover rates, which rose to 14 percent last year among members of the American Chamber of Commerce in Beijing, from 8.3 percent in 2001.
"It's very difficult to get people," said Cheng. "Once the factory down the road pays 50 yuan more a month, everyone goes there."
As Chinese employees come to expect better working conditions, benefit costs are rising too, according to Michael Kleist, author of Global Sources' China Supplier Survey.
"It's not just wages that are going up, it's the overall cost of labor," Kleist said. "Companies are having to buy air conditioners for dormitories, provide better food and make the environment better for workers."
Chinese industry regulations, some overlapping and contradictory, also add to manufacturing costs. The American Chamber survey describes "a patchwork of laws and regulations generated by regulatory silos that grows each year."
Many of the regulations are part of an attempt to address environmental degradation in China, where pollution is 12 times the world average per unit of gross domestic product, according to Xie, of Morgan Stanley. The Chinese government estimates that 300 million Chinese lack access to clean water.
As for those sweaters, Wal-Mart Stores says it will be prepared to look elsewhere if it has to, said Beth Keck, director of international corporate affairs. Noting that the company already buys a lot of apparel from Central America, she said that "we are focused on providing our customers the best prices, and this continues."