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Banging the Drum on China

NEW YORK — The chorus of voices complaining about China's trade practices has grown in recent months to include a diverse range of labor activists,...

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with contributions from John Zarocostas
textiles/news

NEW YORK — The chorus of voices complaining about China's trade practices has grown in recent months to include a diverse range of labor activists, Southern mill owners and U.S. senators.

The criticism has focused on two aspects of China's commercial policies: the fixed exchange rate for the yuan to the dollar, which experts assert gives Chinese goods a 10 to 40 percent price advantage, and the explosive growth of its textile and apparel exports following the dropping of quotas, which shot up 60.5 percent on a dollar basis through the first three months of the year and has contributed to the growing trade deficit of the U.S.

But for all the talk surrounding Beijing's approach to business, even domestic manufacturing executives acknowledge it's easy to understand China's motives.

"China is pursuing a strategy that is in its national interest," said Wilbur Ross, chairman of International Textile Group, based in Greensboro, N.C. "They have a great need for job creation because you have huge numbers of people each month emigrating from the extremely impoverished countryside into the cities. They have to create a lot of jobs every month to avoid social disorder."

Many economists see nothing unusual in China's approach.

"China is going through the same cycles of industry that other countries, especially in Asia, have gone through," said Andrew Bernard, professor of international economics at Dartmouth's Tuck School of Business, located in Hanover, N.H. "It's trying to do the same thing that governments in Japan and [South] Korea have done, which is moving their industry up into higher-value goods and employing as many people as possible."

The comparison with Japan is apt, in that much of the current talk about China in U.S. business circles evokes memories of the Eighties, when "Japan Inc." was the bugbear that kept executives up at night. While Japan remains an economic powerhouse — per-capita gross domestic product there is $29,400, making Japanese consumers among the wealthiest in the world — it has been mired in recession over much of the past decade, and American workers now view low-wage competitors in China and India as more threatening than the Japanese.

Many economists argue that over the coming decades, China will follow Japan's path, becoming wealthier and producing a formidable consumer class. Experts see many similarities between the current outcry over China and the past focus on Japan.

"There are some similarities in that there's a lot of symbolism," said ITG's Ross. "While all the complaints were going on about Japan, the fact is that we had a trade deficit not just with Japan, but with the rest of the world in total. China has become a big symbol. If you notice, even though our trade deficit with Japan has continued, nobody really says anything about a trade deficit with Japan."

According to Commerce Department data, the total U.S. trade deficit last year came to $651.73 billion. The U.S. ran a $75.19 billion deficit with Japan and a $161.98 billion deficit with China.

Consultant Ira Kalish, Deloitte Research's Los Angeles-based global director of consumer business, noted there are also important differences between the current Chinese and past Japanese economies.

"Back in the Eighties, Japan was criticized for closing itself to foreign penetration, to foreign goods, foreign investment, foreign companies," he said. "That's not the case with China. China has had huge growth in imports over the last couple of years. They've dramatically reduced trade barriers as part of their commitment to the World Trade Organization."

While China's government remains a one-party system controlled by a nominally Communist party, leadership in Beijing has demonstrated a clear enthusiasm for capitalism and economic liberalization, joining the WTO in 2001. A recent United Nations report noted that in 2003 and 2004, foreign-funded companies accounted for 57 percent of China's total exports, adding, "China continues to attract a large volume of foreign direct investment to expand its productive capacity in the export sector."

By way of contrast, Japanese firms in the Eighties largely rejected foreign efforts to buy stakes in Japanese enterprises. When they needed capital, they took on debt instead of seeking foreign investors. That left many firms burdened with heavy interest payments, a factor that contributed to the nation's prolonged economic slowdown.

Another more obvious difference between China and Japan is size. China's current population of 1.3 billion people is more than 10 times the size of Japan's.

"China has a tremendously large unemployed labor pool," said Bernard of Dartmouth.

To meet its obligations to the WTO, China is privatizing the state-owned corporations that were the backbone of its economy for the latter half of the 20th century. As those companies switch from a management model geared at maximum employment to the capitalist model of maximizing profit, each year hundreds of thousands of people are being laid off.

Western executives tend to look at China's population in one of two lights. For many, particularly those in manufacturing, it amounts to a veritable army of cheap laborers ready to compete.

"Japan was very limited in terms of available people and I think part of the reason their costs went up so much was that you essentially had a full-employment economy, and that put pressure on wages," Ross said. "I don't think that is at all likely to happen in China. There's this huge, huge mass of population that would be absolutely thrilled to get this kind of manufacturing job."

Textile executives see a threat in China's focus on exporting.

"For someone to develop a strength on their own, they need to develop a consuming middle class," said Keith Hull, president and chief operating officer of Avondale Mills Inc., based in Graniteville, S.C. "You can't always export your way to national wealth. That's where Japan was going, the export way. And they did it to a point, but past the point, there was stagnation. Of course, their consumers weren't quite as willing to go into debt as the U.S. consumer was."

For other industry executives, China's population represents an awe-inspiring pool of potential shoppers.

Joe McConnell, vice president of strategic sourcing at Kellwood Co., who is based in New York, said he believes there is "a lot of opportunity for American companies over there."

"Traditional American companies have not been in the export mind-set," he said. "The American companies that will succeed will be the ones that grasp that opportunity to export and grow in foreign markets."

The U.S. last year exported $34.7 billion worth of goods to China, primarily things like heavy equipment to fuel the country's industrial growth, a number that's dwarfed by the $196.7 billion in goods the U.S. imported from China.

But Chinese consumers are also interested in spending.

"The consumer market is growing very rapidly," said Deloitte's Kalish. "China is already the largest market for many consumer products. It's the largest market for cell phones in the world, it's a sizable market for consumer electronics ... .It's a very good potential market for American companies."

While China's economy is growing — GDP rose 9.1 percent last year, according to Chinese government statistics — it remains on shaky footing. The country's banking system is seen as weak, as is its energy infrastructure. Today, companies that build major apparel and textile factories in China tend to construct their own electrical plants on site to ensure they'll be able to operate a normal schedule.

Given that uncertainty, many experts assert that the drive in the Senate to force China to stop managing its currency to maintain a fixed exchange rate of about 8.28 yuan to the dollar is misguided.

"To hold down the value of their currency, they are funding our current account deficit," said Deloitte's Kalish. "If they let their currency go up in value, they will stop buying U.S. Treasury securities. We will have to sell those bonds to the [U.S.] public, who will demand a higher return, interest rates will go up and we will have a recession."

Dartmouth's Bernard added, "China would like nothing better than to have a financial system that was well developed, an exchange rate that floats freely and open capital markets ... .If they were to do that before they were ready, an economy that includes a quarter of the world's population would be heading south fast."

He offered an example of the shortcomings of China's financial system: Chinese citizens, who are limited in their ability to invest outside the country, lack places to put their money where they can expect to earn a rate of return that exceeds inflation. So for many Chinese, saving for retirement means putting back half their income.

However, most experts say it's unlikely that China will respond to U.S. requests to float its currency anytime soon and almost certainly not before the 2008 Summer Olympics in Beijing.

But even as they dismiss the likelihood of action on currency, trade experts regard it as all but certain that China's apparel and textile exports will face restraints by the end of the year. Domestic manufacturers and importers both expect the U.S. and European Union to impose safeguard quotas on at least some categories of Chinese goods.

Tom Haugen, executive director of Li & Fung Ltd., the $6.06 billion Hong Kong-based sourcing powerhouse, described the current surge in Chinese apparel exports as "just a natural correction."

"The key thing to remember is that China has been very suppressed by quotas," he said. "In a free market, China's share of apparel ... would be significant."

Haugen also noted that placing safeguards on China will mostly result in those orders being shifted to other Asian countries, particularly India and Indonesia, rather than back to the U.S.

ITG's Ross concurred: "I don't believe that, whatever is done by way of safeguards, is going to create any incremental jobs in the U.S."

In addition to its manufacturing operations in the U.S., where it employs more than 5,500 workers, ITG has been expanding its presence overseas and recently established its first manufacturing operation in China.

"China is going to be the world's next big player in textiles," Ross said. "Therefore, if we wish to be a major player globally, we're going to have to be there."

While the pragmatic approach is increasingly common in the industry, some textile executives continue to ask whether the U.S. is allowing China to take advantage of free-trade rules.

"The potential for unfair disruption is definitely in our future," said Avondale's Hull. "If anybody believes that China is not trying to manage their trade position, they're very naive."

However flawed the relationship, most experts conclude that the economies of the U.S. and China have become so interdependent that both sides must tread carefully on trade.

"To blame China for our trade imbalance is incorrect," said Deloitte's Kalish. "To criticize their currency policy is to misunderstand the fact that they are cheaply funding out deficit."