China Express: Progress at a Cost?

In the last decade, China turned into a manufacturing powerhouse. But in the next 10 years, the country will become something else: a nation of buyers.

According to the International Monetary Fund, per capita income is expected to approach $4,000 in 2010, compared with a scant $945 in 2000. And by 2014 — the furthest that IMF will make projections  — that number will top $6,000.

That’s not to say wealth is evenly distributed across the country, but it does point to a rising middle class with an increasing amount of disposable income, experts said.

“They’re getting richer and they’re spending more money,” said Joe Ouaknine, CEO of Huntington Beach, Calif.-based Titan Industries Inc., which produces and markets the Badgley Mischka, Betsey Johnson and L.A.M.B. labels, among others. “Even the poor people are less and less poor. As consumers, they spend a lot of money. The Chinese people love to go shopping and spend what they have.”

John Florsheim, president and COO of Glendale, Wis.-based Weyco Group, manufacturer of the Florsheim and Nunn Bush brands, added that the Chinese consumer is likely to be a key beneficiary of years of infrastructure investments on the part of the government.

“In the next decade, you’re going to see tremendous growth in the Chinese consumer market,” he said. “China just surpassed Japan as the No. 2 market. It’s now the No. 1 car market. It’s an important consumer area and it’s going to be even more so in the future as the standard of living increases.”

Indeed, the years to come will likely be historic as the investment projects and social programs long under way in the country yield a new China and Chinese consumer.

“I don’t think you can look back at any decade since [President] Nixon’s trip and not say that it was a monumental one, and I don’t expect this decade to be any different,” said Matt Priest, president of the Footwear Distributors & Retailers of America.

But the march to 2020 isn’t without challenges.

For starters, half of China’s population lives in rural areas. That makes it tough for marketers to reach them, and it makes it even tougher for those residents to get to major retail destinations.

What’s more, the nation’s wealth is distributed using a state-run, top-down approach. In other words, the amount of capital the vast majority of Chinese can earn — as well as their potential spending power — is limited.

Still, China’s government is investing heavily. It’s putting money behind new technologies, which will enable workers to boost productivity and factories to crank out more product. And it’s pouring resources into improving education and infrastructure. That, observers suggested, will help continue to elevate the middle class.

Labor Costs to Rise

As the wealth of China’s workers grows, the world economy is waiting to see what impact it will have on the national mainstay: manufacturing.

U.S.-based footwear producers and their Chinese factories, for instance, worry about China adjusting the value of its currency in relation to the free-floating U.S. dollar. Critics of China say this gives them an unfair trade advantage since production prices for products made in the country are artificially low.

The issue is also likely to continue to be a hot button among elected officials.

“It is always one of the political arrows that politicians love to flaunt,” said Priest.

Florsheim said there’s no doubt leaders from around the world would continue to pressure China to revalue its currency, and the government would be forced at some point to adjust its value.

“It’s a very hard thing to project when that will happen,” he said. “At the end of the day, there is going to be pressure worldwide for China to have a valuation that is more consistent with the worldwide market. Over the next decade, there will be some movement on the currency.”

However, Jerry Turner, president and CEO of Aliso Viejo, Calif.-based American Sporting Goods Inc., said government officials would be pragmatic, as opposed to conciliatory, in any currency decision. “They’ll only do it if it’s to their advantage,” he said. “In other words, why should they? In the short term, I can’t think of a good reason why they’d want to.”

If government officials do decide to revalue the country’s currency, one thing is certain: Shoes will get more expensive both on the manufacturing and consumer level over the next decade.

“As long as their money is pegged to the dollar, we’re not going to see much change in prices,” said Ouaknine. “But I don’t think that’s going to last because once they revalue their currency, our products are going to be more expensive. I can foresee some inflation right there.”

Ouaknine said he believes it’s unlikely officials would let the open market determine the currency valuation, but he does expect it to be recalculated. “I can see them revaluing it five or 10 percent,” he said. “That means our products are going to be 10 percent more expensive. Or, if you don’t want to lose your market share, you’re going to have smaller margins.”

But the currency issue won’t be the only challenge to production costs in the coming decade. Labor prices will continue to rise as the standard of living improves and workers have more opportunities for better-paying jobs.

“The next decade — more than any other — will be the decade of the worker,” said Chris Ryan, VP of product development at Matisse Footwear. “Footwear is not exactly the highest-tech item in town, so the smartest and best workers get siphoned off into the electronics fields.”

Ryan added that middle and upper management also have dramatically more employment opportunities, which increases labor costs at all ends of the spectrum.

Added pressure from the international community on issues such as labor conditions and safety, newly implemented workers’ rights laws and higher environmental standards are also adding to the cost factor.

Taken together, Ouakinine said, this could mean a steady and prolonged rise in the cost of labor. “I could see [increases] in the double digits every year,” he said. “Their social needs and social benefits are growing, so they’re going to be more demanding.”

The result will continue to push footwear factories north and into the interior of the country in the years to come, experts said.

“We can’t find factories to accept our prices in the south [for our private-label business], so I have a team that went north to find factories that will accept what we can pay,” Ouaknine said. “There is a big movement going north, where it costs less to live and help is cheaper.”

“The product they make is 10 percent to 15 percent less than the product made in the south,” said Ryan.

Still, Ryan said, the vast population of China ensures a constant supply of affordable labor for many decades to come, and the government is very accommodating and willing to relocate factories to more rural areas where a cheaper workforce can be found. “They have no problem dropping $1 million or more on a manufacturing plant because they know they’ll recoup the cost,” he said. “That’s not going to happen in Brazil or Italy or anywhere they produce shoes because, for them, the future is a great unknown. For China, the future is infinite and open, and they have great confidence in it.”



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