Higher prices loom for Chinese products

The Baltimore Sun

SHANGHAI -- Get ready for a new Chinese export: higher prices.

For years, American consumers have enjoyed falling prices for goods made in China, thanks to relentless cost-cutting by retailers such as Wal-Mart and Target.

But the spate of product recalls in recent months - Mattel announced another last week - has exposed deep fault lines in Chinese manufacturing. Manufacturers and analysts say some of the quality breakdowns are a result of financially strapped factories substituting materials or taking other shortcuts to cover higher operating costs.

Now, retailers that had largely dismissed Chinese suppliers' complaints about the soaring cost of wages, energy and raw materials are preparing to pay manufacturers more to ensure better quality. By doing so, they hope to prevent recalls that hurt their bottom lines and reputations. But those added costs - on items including toys and frozen fish - mean lower profits for retailers or higher prices for consumers.

"For American consumers, this big China sale over the last 20 years is over," said Andy Xie, former chief economist for Morgan Stanley in Asia who works independently in Shanghai. "China's cost is going up. They need to get used to it."

Business executives don't anticipate significantly higher prices on store shelves this holiday season, because Christmas goods have already been ordered. But over the next 12 to 18 months, they say, prices for merchandise from China are likely to creep noticeably higher.

Already there are signs: The price of Chinese imports in July rose 0.4 percent from June, the largest monthly increase since the price index was first published by the U.S. Bureau of Labor Statistics in 2003. Prices had declined steadily in the last three years, helping tamp down inflation in the U.S. and elsewhere.

Most economists believe that manufacturing prices will have to rise at least 10 percent to reflect China's current production situation, although it's unclear how much of that could be passed on to consumers. Companies that import goods from China may have to absorb some of the costs or share them with retailers.

And large retailers may be forced to absorb all of the extra costs on Chinese-made products that they commission for their own private labels.

Ronald Boire, president of Toys "R" Us Inc.'s North American operation, said emergency spot testing, such as the kind retailers and manufacturers are doing in the wake of the recalls, was the most expensive kind of oversight. The kind of broad, third-party testing Toys "R" Us is doing on all of its private-label products can run $200 to $600 per test, he said.

For now, those costs are likely to be split between manufacturers and retailers, Boire said, because they affect products already on store shelves. But as federal officials and the toy industry work out new standards and regulations for safety, those increased controls will be figured into the cost of producing future products.

"We don't believe the costs will be materially higher, although there will be some increases," Boire said. "We believe the consumer is wiling to pay those costs because the products will be increasingly safer over time."

Wal-Mart, whose billions of dollars of purchases from China are a key part of the retailer's low-price strategy, has said it is expanding testing and oversight of toys in the wake of the recent recalls but declined to comment on price issues. Target, in an e-mail reply to questions, said it had expanded testing for its brand of toys but had not made any changes in its sourcing program.

Beyond the problems with toys, there has been a slew of recalls of other Chinese-manufactured products in recent months, including toothpaste, seafood, fans, tires and pajamas.

The Chinese government has defended the quality of the nation's exports, saying that 99 percent of shipments meet international standards. By value, 1 percent translates into about $10 billion worth of goods annually.

Some of the product safety problems in China stem from unscrupulous entrepreneurs, a lack of clear standards, faulty designs and deadline pressures. At Lee Der Industrial Co., which made 1.5 million Mattel toys that were recalled in early August because of lead contamination, the factory's chairman blamed inspection lapses partly on pressures to meet production deadlines.

But there also were indications that Lee Der was constrained by costs. A company director said operating costs had surged in the past two years.

"But the price we got not only didn't increase, it decreased," said this company director, who spoke on the condition that he not be identified by name.

Mattel declined to discuss its payments to Lee Der except to say that the majority of Mattel products are new each year and that costs fluctuate depending on what is being manufactured.

The bulk of the world's toys are made in southeastern China, where wages have shot up in the last couple of years amid greater competition for workers and increases in minimum wages and living costs. Booming demand has pushed up commodity prices. The appreciation of the Chinese yuan, up 8.8 percent against the dollar in the past two years, also has hurt some factories, as they are paid in dollars.

It isn't just toy factories that are struggling. Labor-intensive industries, including producers of garments, furniture and processed seafood, say they are being pushed to the edge.

Analysts say many factories have downgraded materials and cut overhead to the bone, including quality assurance staff. Their products' buyers, though, sometimes didn't know where the goods were coming from.

But now U.S. companies that buy goods from China are scrambling to identify their subcontractors, requiring audits and spot testing, narrowing their network of factories and replacing longtime Hong Kong and Taiwanese middlemen with their own staffs.

Don Lee and Abigail Goldman write for the Los Angeles Times.

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