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By Jesus David Cano Romano
December 15, 2014

Is the “China price” back? After years of hearing about rising wages ending the era of the China price when cheap exports lowered the prices of global manufactured goods, it seems that China has a surprise for the world. Deflation, that is, falling prices, is an issue for the world’s second biggest economy, just as it is for many others.
That was the topic on this weekend’s In the Balance on the World Service. It certainly resonated with me as I presented the programme from Tokyo. After its early 1990s crash, Japan has struggled with deflation for 15 years and has not yet been able to turn it around.
In China, there’s deflation in factory prices, which have fallen continually for two and a half years, and the increase in the consumer price index (CPI) has slowed to 1.4%, the lowest since the 2009 global recession.
My guests, who are well-known experts on China – George Magnus, Michael Pettis, and Patrick Chovanec – joined me from London, Beijing, and New York, respectively, and we discussed what was driving the deflation trend and why it matters for the rest of the world.
The panel debated the various causes of deflation: domestic versus international, as well as whether it was cyclical or structural.
Some of the reasons mentioned included falling global commodity prices and over-capacity in Chinese industry. Patrick Chovanec pointed to the spare capacity in a variety of businesses that could contribute to lower producer prices.
And structurally, China’s growth is slowing down as it matures and changes from an investment-led to a consumer-led economy.
As China shifts gear, that implies slower price rises, so any deflation would reflect more of a structural change in the economy.
Economic transition
Any transition can be difficult, and China’s structural transformation is on a scale never seen before.

The panellists were sanguine that it was possible and happening already. Indeed, one of the indicators of the re-balancing of the Chinese economy is the growth of the services sector versus manufacturing.
I’ve written before about how last year was the first time in which the services was a larger part of the economy than manufacturing. And it still has some room to grow.
So, that brings us back to whether the lower prices from China are here to stay. Slower economic growth, but on a more sound footing, would imply lower inflation.
Michael Pettis sees economic growth slowing to 3-4% by the end of President Xi Jinping’s decade in office, but household incomes growing more rapidly, just as they did in Japan.
The slowing of prices, though, isn’t just due to domestic factors. As I mentioned earlier, globally, falling commodity prices are pushing down prices.
As one of the biggest energy importers in the world, China’s prices are affected by oil, gas and of course hard commodities like iron ore.
So, taken together, it looks like the downward pressure on prices in China isn’t another cyclical blip similar to when China experienced a couple of years of outright deflation after the Asian financial crisis.
China competitiveness
There are structural issues underlying the change in prices that is shifting along with China’s growth model.

Michael Pettis sees China exporting its deflation worldwide. Will it mean, though, that the China price will return? Not necessarily.
Deflation and inflation measure the change in prices. Once prices settle at a level, then it’s possible to have minimal change but at a lower or higher level.
Ultimately, the cost of Chinese goods and services will be determined by the equilibrium the economy settles at. That will have a lot to do with productivity, wages, costs, etc.
In other words, China’s competitiveness is yet to be determined.
Until then, however, the rest of the world will be affected by the prices of the world’s biggest trader. It’s just more uncertain than what we have been used to when the US was the main setter of global market prices.
And that will be the state of the world economy that we’ll need to get used to: being affected by the two biggest economies in the world, although one of them is still in a state of development and transition.
That’s the China effect on the world economy that will be felt in a variety of ways for years to come.
Source: BBC NEWS
Author: Linda Yueh