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What Is the Secret Behind China's Cheap Prices?

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It might not be what you think it is. Most people would say it's no secret and that the answer is obvious -- lower wages in China compared to the United States. However, that answer is only partially true. Why? Because labor is only one part of the total cost of a product, and in many cases it's as low as 20 percent of the total cost.

Let's compare two simple products that are primarily made in China: a stuffed toy animal for a baby and a frisbee. The stuffed animal is comprised of textile material for the cover, stuffing, two eyes and a nose. The material must be cut into pieces, sewn together and stuffed. The nose, eyes and mouth are usually a pattern of thread that is sewn on the face piece before the toy animal is sewn together and stuffed. The cutting of the pieces may be done by hand or by machine, but the pieces are sewn together by a worker using a high-speed sewing machine. The stuffing is usually blown into the stuffed toy by a machine, but the insertion point is closed by hand. This type of a product is considered to be a high labor content product, with labor being about 70 percent of the total cost.

On the other hand, a frisbee is made of plastic resin (beads or pellets of plastic) in a process that is called plastic injection molding in which the resin is heated in a molding machine to a viscous state and is then injected into a mold, after which the molded part is automatically popped out of the machine in a matter of seconds. The mold can be designed to make several parts at once at the push of a button, and a fully automated machine can be set to run continuously 24 hours a day with very little monitoring by a worker. The highest expense in producing a frisbee is the cost of making the mold (also called tooling) and that cost is amortized into the piece price of the parts so that the higher the volume of production, the lower the cost of the amortized tooling that is added to the cost of the part. A frisbee is considered to be a low labor product, at about 20 percent of the total cost.

What are other factors of the total cost for the "China price"? First, there are the actual costs of the materials used to manufacture the product, which would be the textile material and stuffing for the toy animal and the plastic resin for the Frisbee. Because of the high volume of materials and resins ordered by Chinese companies, the pricing would be as low as it could be.

Second, there are the wages for the workers directly involved in producing the parts. Labor is abundant and cheap in China because even though 300,000 have risen into the middle class and above, this still leaves one billion people living at the poverty level. At any one time, there are an estimated hundred million workers who are unemployed and underemployed, which is about equal to the number of Americans employed in full time jobs.

All employees in China have the right under law to join the ACFTU, which claims some 170 million members and is controlled by the Communist Party. ACFTU has a monopoly on trade unionizing in China and creation of competing unions is illegal. Party leaders have ensured that the ACFTU has a monopolist position. They don't want autonomous unions springing up, because of the potential threat to their authority. In 2008, collective bargaining became a requirement of the Labor Contract Law that went into effect, forcing most companies -- including most foreign owned ones -- to create an ACFTU chaptered trade union within them.

However, there are about 1,000 protest demonstrations occurring every week in China, even at the risk of beatings, demotions, dismissal, and even torture. As a result, wages have finally been rising by about 15 percent per year over the past four years. It took some suicides by workers in the summer of 2010 to achieve additional improvement in wages and working conditions at plants that were more like prison camps with dormitories for workers to live on site and fences around the buildings so workers couldn't leave the premises.

Third, there are the costs of compliance to health and safety regulation and environmental regulations. These costs are less expensive in China than in the United States because the Chinese government imposes few health and safety or environmental regulations. China doesn't provide workman's compensation insurance for their workers so workers hurt on the job don't receive any compensation when they are injured to the point that they are disabled. Although China has its own environmental protection agency, the environmental protection laws are generally ignored and not enforced, especially at the local level. So, Chinese companies have the advantage of being able to dump just about any odious byproduct into the air or waterways. Sixteen of the top 20 most polluted cities of the world are in China, and China has been designated as the world's most polluted nation in several studies. There is one city in China where the land, air, and water are polluted with mercury so the residents are really the "living dead" because there is no cure for mercury poisoning, which is eventually fatal. The World Health Organization estimates that 750,000 people a year die in China as a result of the effects of pollution.

Next, there is the cost of taxes and duties. China is one of over 150 countries that utilize a Value Added Tax (VAT) system. It is a tax only on the "value added" to a product, material, or service at every state of its manufacture or distribution. The VAT rate is generally 17 percent, or 13 percent for some goods. Chinese companies receive a VAT refund from the government for materials of products produced for export. American imports to China are charged a VAT, but the U. S. doesn't have a VAT to charge Chinese imports.

On top of this, China's national government policies allow their manufacturers to use trade cheats. For example, there are unbalanced tariffs, such as the 2.5 percent for a car entering America vs. 25 percent for a car coming into China. In addition, the Chinese government requires foreign firms to have a Chinese "partner" company, who maintains the majority interest, takes most of the profits, and has the real control of the company. More seriously, China now requires U. S. companies to share their technology and relocate their R&D centers to China if they want to have access to Chinese markets.

Above all, there is the ever-present currency manipulation, where China undervalues their currency by an estimated 30-40 percent, which simply makes every product that China ships out 30-40 percent cheaper than those of a potential American competitor.

Finally, China has a national strategy of what is called "dumping." "Dumping" is defined as the act of a manufacturer in one country exporting a product to another country at a price that is either below the price it charges in its home market or is below its cost of production.

The goal of "dumping" is to capture the market or destroy the competition for a particular product or commodity so the price to the end user or consumer is lowered way below the competition, often below cost. "Dumping" is one of the strategies China uses as a neomercantilist country. Neomercantilism is a term used to describe a policy which encourages exports, discourages imports, controls capital movement and centralizes currency decisions in the hands of a central government. The objective of neo-mercantilist policies is to increase the level of foreign reserves held by the government, allowing more effective monetary and fiscal policy.

While dumping is not prohibited by the World Trade Organization (WTO) agreement, GATT Article VI allows countries to act against dumping where there is genuine ("material") injury to the competing domestic industry. Countries are allowed to act in a way that would normally break the GATT principals of binding a tariff and not discriminating between trading partners. Typically, antidumping action means charging extra import duty on a particular product from the exporting country in order to bring its price closer to the "normal value" or to remove the injury to domestic industry.

The number of U.S. dumping cases against imports from China is up, and more than 50 categories of goods from China are now subject to U.S. antidumping duties. Some of these product categories are: steel fence posts, iron pipe fittings, aluminum extrusions, tires, hand trucks, ironing tables, wooden bedroom furniture and paper products.

Thus, the secret of China's cheaper prices is a complex, national strategy of China to become the preeminent superpower of the 21st Century. Sun Tzu, author of The Art of War would be impressed with how his descendants have used his military strategies to dominate the world economy.