‘China price’ is on the rise: changes in the global economy are leading to inflation

A worker welding wheels at a factory in Hangzhou in China’s eastern Zhejiang province. Picture: AFP

Wednesday’s news of a larger than expected rise in the inflation should be a wake-up call for Australians about the broader structural changes in the global economy.

While the Reserve Bank has been arguing for months that upward inflationary pressures may be a temporary response to Covid-driven supply chain issues and dislocations, it is now evident that there are major permanent shifts in the global economy.

At the centre of the change is China, Australia’s largest trading partner and the world’s second-largest economy, which in the past was a driving force behind continued strong global economic growth – directly benefiting Australia as a major exporter to the country – and the source of a concerted global deflationary push.

Now that has been turned on its head, with expectations of China’s economic growth, which was once more than 10 per cent, downgraded to a mere 4.3 per cent this week – a move that has shaken world sharemarkets.

Less obvious has been the long-term unwinding of the great deflationary impact of China on the world – a force which, until recently, has underwritten a benign outlook for inflation and thus a long era of low interest rates. This is now fast reversing.

China’s rise to power as the global manufacturing powerhouse of the world was a global force for ­deflation for decades.

So much so that the world was lulled into a false sense of security.

Factories closed in many Western countries as it was cheaper and more efficient to buy clothes, textiles, footwear, furniture, medical supplies, building supplies, chemicals, machinery, mobile phones, cars, computers, toilet brushes and many other goods from China.

The US’s giant Walmart – a mini economy in its own right – established a global procurement office in the Chinese city of Shen­zhen in 2002 to source cheap consumer goods for its thousands of stores around America. As Walmart lowered its prices, other retailers were forced to follow suit.

Australian companies such as Super Retail, which owns Rebel sportswear, Super Cheap Auto and BCF (Boating, Camping and Fishing) have a significant presence in China to buy the goods they need for their stores.

Once a supplier of cheap goods, the manufacturing sector in China can now supply many high-quality goods at prices that are far more competitive than those made anywhere else in the world.

Writing in 2009, former Financial Times correspondent Alexandra Harney wrote about the “China price” – the forces behind China’s global competitive price advantage in manufacturing.

Perhaps 2009 could be seen as a high point of Chinese-led global deflationary forces.

Well before the emergence of the global pandemic, rising prices in China were prompting companies to diversify their sources of supply to other countries.

Chinese workers were being better paid, companies were coming under pressure to provide higher-quality workplaces and working conditions, and to pay extra costs such as pensions.

At the same time, Chinese industry was under pressure, and will continue to be under pressure to improve its environmental standards.

In short, costs in China – once the cheap manufacturing centre of the world – have been rising.

Companies have also been seeking to diversify their sources of supply for other reasons, realising that it was unwise to have too many eggs in one basket.

Cargo containers stacked at Yantian port in Shenzhen in China’s southern Guangdong province last year. Picture: AFP

Enter Covid two years ago and there was the added shock of supply chain issues. Chinese factories and ports had their operations disrupted – which is still happening today – while global shipping costs skyrocketed.

Suddenly the world began talking about global supply chain problems. Building companies and others in Australia were concerned about delays getting vital supplies from China, as were others relying on global inputs.

Covid was also a wake-up call for countries like Australia, which is heavily dependent on imports for a wide range of products that can be bought from China at a good price and a high quality.

The China Australia Free Trade Agreement, which came into force in December 2015, saw not only a big increase in Australian exports to China but a major increase in imports from China.

There has been much focus on the continued strength of Australia’s exports to China ($177bn in the year to February), but far less attention to the fact that over the same period Australia imported $96bn worth of goods from China.

The wake-up call from Covid has been the need to diversify supply chains – and not just rely on imports from any one country, no matter how well-priced they are.

The events of the past few weeks in China, as President Xi Jinping seeks to oversee a zero Covid policy by shutting down Shanghai and other cities at the slightest sign of a Covid outbreak, highlight how the world can no longer depend on China as a reliable source of imports to the extent that it has done in the past.

In Australia there is more talk about bringing some key areas of manufacturing back onshore.

While this sounds great, manufacturing costs in Australia with its market of only 25 million people and higher labour costs are many times higher than in China.

But Australia may now choose to make more select products onshore for strategic reasons. Yet the collective impact of all this structural change is inflationary.

Manufacturers and retailers around the world once relied on a super low cost “just in time” inventory system. Covid has shifted the thinking to a more reliable but more expensive “just in case” ­approach to inventory.

While the impact of Covid appears to be easing, the painful lessons of the dangers of supply chain disruptions will last for years.

While the world is not de-globalising, there is a shift in thinking by business about doing more at home even at the cost of higher prices, and the need to diversify from a heavy reliance on Chinese- made goods. Add all those factors up and you get longer-term structural inflationary pressures – or at least a reversal of the decades-long deflationary pressures of the “China price”.