Chinese imports, Wal-Mart, trade deficit

The China FactorA real threat

There has been fierce competition in the past, but the new Chinese competition is dramatically different--they are about half the price. This has been a big factor in the loss of 2.7 million manufacturing jobs since 2000. Meanwhile, America's deficit with China keeps soaring to new records. It's likely to be more than $150 billion this year, and almost 10% of that through the world's biggest retailer: Wal-Mart.

There is a clear message, if you still produce anything labor intensive, get out now rather than bleed to death. Shaving 5% here and there won't work. You need an entirely new business model to compete.

America has survived import waves before, and it has lived with China for decades. But something very different is happening. The assumption has always been that the US and other industrialized nations will keep leading in knowledge-intensive industries while developing nations focus on lower skills and lower labor costs. That's now changed. What is stunning about China is that, for the first time, a huge country can compete both with very low wages and high tech. Combine the two, and America has a problem.

How much of a problem? On one side, the benefits of the relationship with China are enormous. After years of struggling to crack the Chinese market, US multinationals like General Motors, Procter & Gamble and Motorola are finally reaping rich profits. They're making cell phones, shampoo, autos, and PCs in China and selling them to the Chinese middle class--about 100 million people, a group that should more than double in size by 2010.

Also, by outsourcing components and hardware from China, US companies have sharply boosted profits and return on capital. China's surging demand for raw materials and commodities has driven prices up worldwide, creating a windfall for US steel makers, miners, and lumber companies. The cheap cost of Chinese goods has kept inflation low in the US and fueled a consumer boom that helped America weather a recession.

But there's a huge cost to the China relationship. First there is the huge US trade deficit--China is the largest and fastest-growing part. While US consumers binge on Chinese-made goods, the US deficit is a record 6% of GDP. The trade shortfall--coupled with the US budget deficit--is driving the dollar ever downward; raising fears that cracks will appear in the global financial system. By keeping its currency pegged to the $ at an undervalued level, China amplifies the problem.

In the meantime, America's industrial base has eroded to a dangerous level, not only in the old segments, but in more advanced tech-industries. China is adding state-of-the-art capacity in cars, specialty steel, petrochemicals, and microchips. These plants are aimed at meeting seemingly insatiable demand in China. But if China's growth stalls, the resulting glut will turn into another export wave and disrupt American industry.

Meanwhile, US companies are no longer investing in much new capacity and the ranks of US engineers are thinning. By contrast, the number of Chinese engineers is growing by 350,000 annually, young workers and managers willing to put in 12-hour days and work weekends, an unparalleled component and material base in electronics and light industry, and an entrepreneurial zeal to do whatever it takes to please big retailers such as Wal-Mart.

And Chinese producers are hardly standing still. In a recent survey of Chinese and US manufacturers by Industry Week, 54% of Chinese companies cited innovation as one of their top objectives, while only 26% of U.S. respondents did. Chinese companies spend more on worker training and enterprise-management software. And 91% of U.S. plants are more than a decade old, vs. 54% in China.

More innovation. Better goods. Lower prices. Newer plants. North America will surely continue to benefit from China's expansion. But unless it can deal with the industrial challenge, it will suffer a loss of economic power and influence. Can North America afford the China price? In the US, that's the question we urgently need to ask.