China under attack: an economy amazingly vulnerable to bad news.

• Author: Malmgren, K. Philippa

On January 31, 2014, one of China's many trust companies, the China Credit Trust, nearly went bankrupt and had to be bailed out by unknown sources. Some say it was China's Lehman Brothers moment. In late December 2013, Foxconn, the Chinese assembly firm with 1.2 million Chinese workers, announced its intention to build a production facility in the United States. On December 5, 2013, China's new aircraft carrier, the Liaoning, was sailing in the South China Sea when a vessel from its carrier group came less than 1,400 feet from the USS Cowpens, a Ticonderoga-class missile cruiser. The near-collision was the result of an ever more apparent game of "chicken" between the United States and China. The three seemingly unrelated events may be individually important, but they are symptomatic of changing dynamics affecting China's interaction with the United States and the West more generally.

China's competitiveness has been deeply eroded in recent years. The old revenue and cash inflows China had enjoyed disappeared when the financial crisis damaged consumption in the industrialized world. Since then, Chinese workers have been hurt by both the deterioration of a powerful export engine and the rapidly rising cost of living.

Chinese official data shows inflation is not too bad. But the Chinese government wants to maintain the facade that markets are functioning favorably and the GDP deflator is small, ensuring high "real" growth rates. The actual inflation rate faced by locals is far higher than the data shows. Of course, some argue a gap exists in the United States as well. The reality though, is that the prices of energy and food have been high and rising rapidly in recent years. Food and fuel account for 40 percent to 70 percent of a Chinese worker's expenses. Consider the price of beef, which, like most proteins, has kept hitting all-time record highs in the last few years. Failure to provide the Chinese public with protein at a moderate price is a recipe for serious social unrest. Oil may not seem expensive in the West, but anything over $100 per barrel translates to fuel and other energy expenses high enough to warrant moving production to the United States where energy is increasingly cheap, leading to job losses in China.

These pressures have generated demands for higher pay. Wage demands for skilled Chinese workers are running at a 70 percent annual increase, according to people who run real businesses in China. The government has actively tried pushing up low-end wages by 30 percent per year. Wage demands have escalated to the point that wages in Mexico are already 20 percent cheaper than in China. Meanwhile, China's workers demand more, but in weak job markets Western workers are prepared to work much harder for much less, thus narrowing the wage differential. This is one reason that many manufacturing firms are leaving China for Mexico, the United States, the United Kingdom, Germany, and Eastern Europe. Cheaper energy, better quality control, and shorter shipment times are additional incentives for geographical shift at a time when margins need to be protected.

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