In October 2002, Stephen Roach, chief economist and director of the authoritative international consultancy, Morgan Stanley, claimed that China had been shifting its own deflation to the whole world by exporting cheap commodities. The allegation was contained in a report putting forward his view that the global economy faces its highest risk of deflation in 70 years. It suggested that the deflation was emanating from Asia and especially China, which accounts for one third of Asian exports (excluding Japan).

Focussing on the low prices of Chinese products, the allegation takes no account of several key factors. China has little influence over either international market prices or domestic pricing in the countries it exports to. China may well benefit from the international transfer of manufacturing capacity, but this is driven by low or negative inflation which exists in a global context rather than on any particular regional stage. China’s output is merely a constituent part of overall world output and China has direct influence on prices only with respect to its own production. The claim that deflation is being exported does rather seem to grossly overstate any adverse impact China could make on the global economy. Let’s look at just some of the points of detail.

China’s Limited Influence on International Prices

Chinese exports are certainly increasing their market share. However though China may have become the top producer in some areas of manufacturing, it is still a far cry from becoming the world factory some commentators might like to suggest.

In terms of industrial production, China still lags far behind America, Japan and Germany. This is not to mention China’s already huge and rapidly growing domestic market, which absorbs so much of its production especially in high volume commodities.

China’s exports of manufactured goods actually account for little more than 5 percent of world totals and these are World Trade Organization figures.

The mid 1990s saw the start of the current round of concern over the risk of global stagflation or even deflation coming in. This was triggered by price cutting in IT products.

Although China’s exports of high-tech products have seen rapid growth, the bulk of the nation’s exports are still the traditional labor-intensive products which account for some 70 percent of total exports to America, Japan and the European countries. Moreover a significant proportion of the exported goods is made up of spare parts or components having no direct effect on the retail prices of new goods.

China’s Limited Influence on Trading Partners’ Domestic Prices

China can exert some influence over the factory gate prices of its exports together with any costs incurred prior to shipping. However after this there is little opportunity to directly influence the further costs and mark-ups that will surely be applied before the retail price is eventually fixed at the point of sale in the importing country.

Western countries can have an extended import chain with intermediaries adding their costs at every step. The retail price of a product may turn out to be several times the original factory gate price, to the disadvantage of the consumer. With so much happening outside its boundaries, China clearly has only limited influence on the eventual retail prices at which its exports are brought to market.

China Does Not Artificially Depress Its Labor Costs

China’s low labor costs are no recent phenomenon. Prior to the Asian Financial Crisis, they were even lower in terms of the US dollar. The nation’s domestic labor costs are determined by the relationship between supply and demand in its labor market rather than by any movements in currency exchange rates.

Even if the value of the Renminbi (Yuan) were to increase by as much as say 10 or even 15 percent against other currencies effectively bringing China’s current account balance to nil, the US dollar would still buy 7.3 yuan against 8.3 yuan as at present. Little would have changed as China’s labor costs would still be well below those of America, Japan, the European countries and even most Asian countries.

Price Cuts in China Follow Global Deflation, They Do Not Drive It

The slow global economic development of recent years has led to increasingly keen price negotiation on the part of importers. Increasingly they insist on striking a hard bargain with their Chinese and indeed their other international suppliers. All of which serves to fuel the risk of global deflation.

To maintain profit levels, manufacturers must reduce production costs and China becomes a very attractive manufacturing location on account of its cheap labor. China’s low labor costs can help trim 20 to 30 percent off the costs of production.

(The author is from the State Information Center)

(china.org.cn, translated by Feng Yikun, January 21, 2003)