It was not a difficult choice to make. Between 1998 and2001, US imports of house

Question

It was not a difficult choice to make. Between 1998 and2001, US imports of household cooking equipment from China more than doubled to $640 million, forcing National Presto to decrease the price of its pans from $49.99 to$29.99 during that period. Cheap labor—Chinese labor is six times lower than Mexican labor—accounts for this price deflation. Continuing operations in the United States and remaining price competitive was simply not feasible. Competition on quality, which can shelter domestic manufacturing from outsourcing to developing countries, was not an alternative because Chinese products for export are just as good. When high labor intensity is tied to quality, the Chinese can outdo industrialized countries.

Another factor is that the Chinese have a combination of highly skilled management and low-skilled labor, ensuring that production is efficient and that quality standards are met. This ability to produce high-quality goods is also what allows China to move from export manufacturing of Christmas decorations, toys, footwear, and clothing to household, consumer appliances, and, increasingly, the IT manufacturing sector. National Presto, a US firm that makes high-quality pressure cookers and electric frying pans, had a difficult decision to make in the early 2000s. It could either outsource its production to China or see its market share continue to deteriorate. In 2002, the company closed plants in Mississippi and New Mexico, reducing its US workforce to less than half, and expanded its production in China. By 2003, all significant products marketed by the company were to be sourced from China. Proponents of free trade argue that political rhetoric against trade with China is meant to appease US fears of job losses. Yet, as seen in the following table, only 2.5 percent of all job losses in the United States in the first quarter of 2004 were the result of overseas relocation. While some argue that this percentage is undervalued because it does not take into consideration potential job gains that never materialized, others argue that given economic conditions there was no assurance that firms that created new jobs in China would have chosen to create these jobs in the United States if outsourcing to China has not been a possibility. Like many other US, European, and Japanese companies, National Presto uses an agent in Hong Kong to subcontract production to manufacturing plants in mainland China. Larger companies like Motorola, Philips, IBM Toshiba, and GE have more control over their manufacturing plants in China. Kyocera of Japan, for example, invested $90 million in the early 2000s to construct a high-tech industrial park in Shilong Town of Dongguan City, Guangdong Province. Only 20 years ago Guangdong was dominated by paddy fields; today it is China’s largest manufacturing cluster. China has become the world’s fourth largest manufacturer, after the United States, Japan, and Germany. It has outpaced Japan to become the country having the largest trade surplus with the United States. US politicians and lobby groups blame Chinese protectionist practices for the growing trade deficit between the two nations, which in 2003 was estimated at $124 billion. Among the barriers the United States claims prevent a free flow of its goods to China are import barriers, unclear legal provisions applied in a discriminate manner against US imports, limitations on foreign direct investment, and an undervalued yuan. The last one has generated the most controversy in the last few years. The Chinese yuan has been fixed at8.28 to the dollar since 1994, a rate that critics argue to be up to 40 per cent undervalued. Yet economists do not all agree that the yuan is undervalued. Some fear that a sharp deterioration would hurt not only the Chinese economy but also those trading partners that are most heavily dependent on Chinese imports.

Does the theory of comparative advantage apply to China’s trade with industrialized countries? How?

Explanation / Answer

Comparative Advantage in simple terms is when a given country can produce a good or service at a lesser cost compared to other countries. Considering the opportunity cost theory which is basically the benefit one is losing to gain another benefit, China clearly has a comparative advantage. Since many currencies have a higher exchange to the Yuan ( Dollar, Euro, Pound ), the cost of investment in material or labour etc. in China will be lower than the cost incurred in such countries. Also, due to the abundant availability of labour, the cost of labour further goes down.

Let us take a very simple example to decode this: A firm in USA would like to manufacture daily wear T-shirts.

Assuming the only costs involved are material: cotton, some machinery, land and labour, let us list down the costs for a single T-shirt. (imaginary figures)

Cotton : $5

Labour : $10

Land rent ( annum ) : $5000

The total cost of fixed machinery is $5000.

Hence, if 1000 such T-shirts are produced per annum, the cost would be $5 * $10 = $50 * 1000 = $50000 plus the machinery and rent = $50000 + $5000 + $5000 = $60000.

If the same is produced in China ( although the initial investment is high to set up a factory etc. ) the cost of material, labour, rent and machinery very less compared to the costs in the USA. Comparing China's cost with other developing countries is important. However, China's manufacturing and industrial base is huge and labour is abundant. In most cases, it overpowers what other countries have. That is due to :

1. Lower cost of living (as compared to the US) - Hence cheaper land and material rates.

2. Cheap labour. ( if cost of labour in the USA per product is $10, the cost of labour in China (converted into dollars) might be around $2 (assumption) ).

Hence the cost per unit reduces drastically, even if the export, capital costs and taxes are additional expenses, there will still be a higher profit compared to produce it in the home country.

This is the case with other countries like India, however, China has a better advantage due to its trade policies, abundant labour, high industrialisation, unlike India where farming is the major sector.

It is necessary to note that more than 40% of China's GDP s attributed towards the industrial sector and value-added services.

There is also a concern that China's high labour-intensive manufacturing has hit other developing countries especially Africa and Latin America.  

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