What ruffled the feathers was a report in the second week of July 2007 by the US Bureau of Labour Statistics showing prices of imports from China rising 0.3 per cent in June from May. It was also a turnaround from the declining trend dating back when the index was first published in December 2003. For the full year it was 2.4 per cent. This was no doubt a modest rise, but began to work on the American psyche.

In October 2007, Mr Alan Greenspan, former Federal Reserve Chairman, warned of the coming sea change in the global economy when “the glory days of low-cost imports from China were over.”

Coming on top of growing financial turmoil, mortgage crisis and recession, the threat of inflation should be traumatic for an average US consumer already over laden with housing and credit card debts. Further, the dependence on Chinese imports for an array of consumer products ranging from footwear, apparel, clothing and toys to household items is near total.

Data suggest that Chinese imports account for 7.5 per cent of consumer spending in the US. On individual items like toys and footwear, the dependence is over 80 per cent. On clothing, it is around 40 per cent. On average, it could result in an increase of 10 per cent in consumer prices. With inflation rate running at 4.1 per cent in 2007, up from 2.5 per cent in 2006, the burden could be onerous.

In recent years, most Americans lived with the hope that the era of low-cost Chinese goods bursting through the shelves of Wal-Mart and other superstores would never end. They were shaken from the belief by the reports of rising Chinese prices. Though, in competitive terms, China was not losing its edge, costs were going up. A part of it is due to internal developments; but a larger part is due to external factors.

Most analysts refer to China’s inflation running over 6 per cent as a major factor. Exchange rates for yuan and dollar play a key role, Yuan appreciating and dollar depreciating. Some refer to low levels of productivity in China’s factories, especially state-owned-enterprises (SOEs).

A more important reason cited is rising wages due to high rate of economic growth across the regions and to the unionisation of labour and minimum wage legislation.

Then there are costs attached to environmental protection. More significant, in the context of China’s disputes with the US and the EU over its exports, is the need for ensuring quality and safety standards.

Inflation is no doubt a serious issue. In the Chinese context and with due regard to social stability, it is vital to maintain price stability with high growth. Economists like Prof. Kenneth Rogoff of Harvard University take the view that China is on the verge of collapse. (See Financial Times, February 4, 2008).

However, the World Bank’s recent report (China Quarterly Update, February 4, 2008) is more balanced and suggests that while policy challenges remain, including inflation, growth prospects are robust.

On date, it does not appear that exports are affected by domestic inflation. This is because, as one Chinese economist put it, items in the consumer price index such as food, pork and agricultural produce are not items in China’s exports and China’s strength lies not in its low price, but in its being more economical compared to other countries. (Fu Yong, China Daily, January 7, 2008).

In RMB terms the prices remain unchanged. They turn higher when expressed in dollars. Since last year, yuan has been appreciating and it is expected to rise 9-10 per cent this year. Along side, US dollar has been depreciating.

Taken together, Chinese imports at the US ports are higher. As the Economist added, “It is the weak dollar, not cantering cost inflation in China, that is to blame for higher American import prices. China’s manufacturing costs and exports prices in yuan terms are still falling overall.” (August 2, 2007.)

“Even if China’s export prices start to rise, they will curb America’s inflation rate as long as they remain lower than the global average and China’s share of America’s market continues to rise.” Senators and US politicians should rue the day when they commenced their campaign against the yuan rate.

On wage increases and productivity it is difficult to agree with the criticism. Many China watchers had taken note of the improvements in productivity and its moderating role on wages.

A World Bank study released in October 2007 (World Bank China Research Paper No.8) on raw material prices, wages and profitability showed that “the ability of China’s industry to offset rising raw material prices by increasing efficiency has so far remained undiminished.”

Wage increases along with other costs such as on environmental protection and maintenance of quality and standards have to be viewed in a different context. It is not denied that they have to be reflected in the final costs and prices. In the early years of Chinese growth, it was possible for US retailers, led by Wal-Mart, to beat down prices by playing Chinese companies against each other.

They were in fact arbitraging on cost differentials – not only wages but also other costs such as environment and quality – between the US and China.

This was the very essence of global outsourcing and the US retailers pocketed huge profit margins – estimated at 80 per cent for toys – generated by Chinese imports. They were supposed to maintain supply chains and also to ensure quality, etc.

In recent years, especially since last year, when the disputes about lead paint and poisoned pet food, etc raised by the US public, the strategy had to be revised. They had to take note of the anger of civil society and human rights advocates.

While reworking the strategy, it was no longer practicable to pass the buck entirely to the Chinese producers. Systems to ensure product quality, etc had to be introduced. These costs had to be reflected in the final price by foregoing, if necessary, a part of the profit. Some Chinese companies may go out of business but there would be a new balance.

As the Chief of Hasbro, a leading toy retailer, said, “We’ve got higher labour costs and labour shortages, plastic prices have gone way up and we’re doing more safety testing.” Indeed, the prices will go up. Sadly, in the foreseeable future, the US retailers cannot move away from China as no other country offers the same advantages for the whole range of goods. They have to bear the higher costs, which are in the nature of self-inflicted wounds as in the case of yuan appreciation.

However, the larger economic rationale will continue to hold good and Chinese imports will not quiver US inflation. Indeed, it can come about when the winds of globalisation are reversed.

In its World Economic Outlook 2006, the IMF studied the impact of globalisation on inflation. It took the view that import effects cannot be relied upon to prevent higher inflation and globalisation is “no guarantee of low inflation in the next year or two.”

In a seminal study on the subject (Globalisation and inflation: New cross-country evidence on the global determinants of domestic inflation, BIS Working Paper No.227, Claudio E.V. Borio and Andrew Filardo, May 2007) two authors argue that the prevailing models of inflation are too “country centric” and fail to take account of global factors. They plead for a “globe-centric” approach as the process of global integration has gathered momentum.

For long the US could rely on the slacks in the Chinese economy and fill its output gaps. On the demand side also the raw material prices are driven by global demand. It has become the fashion to refer to the rise in fuel and mineral prices and blame on it China and India.

It is a Eurocentric view, which is unjustified in the current global economic balances. Thus, in the medium term, there would be inflationary forces driven by these trends. To that extent, there is a case for fearing emerging economies exporting inflation. But in the limited US-China context, it is an ill-advised bogey.

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