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The writer is chief economist at UBS Global Wealth Management
Deflation, for an economist, is a little bit more sophisticated than “a falling price”. Individual prices go up and down all the time, indicating changes in supply and demand for a single product. Deflation is a more broad-based fall in many prices.
A general decline in prices is a signal that there is an imbalance in an economy, which is a bigger issue than having an imbalance in one specific product market.
Today China has negative inflation rates across a range of price measures. Consumer prices fell in July for the first time in two years before clawing back into positive territory in August. Food prices (specifically pork and other meats) are a big part of the fluctuations. Meat prices fell 14.0 per cent in July, year on year, before the decline moderated to a 10.5 per cent drop in August.
There are other prices that are falling — home appliances and transport, for instance — but there are also significant price increases in areas like tourism. Producer prices continued to fall in August for the 11th month in a row. Of the 29 main subcategories with published data in August, prices are falling in 20. China’s export prices are falling across most categories of product.
Although consumer prices overall are static, the impression from the broad range of indices is that China has a general decline in prices across its manufacturing sector. This raises the question of whether China will then export this deflation to the rest of the world.
China sits at the end of many global production chains, and is the largest manufacturer in the global economy. While China’s consumer prices and quite a lot of its producer prices can be dismissed as local affairs (as most of the products in these categories are sold locally), a superficial analysis of the trend of falling export prices would seem to suggest a deflationary wave is about to break over advanced economies.
If only things were that simple.
Critically, China is at the end of many production chains, but not at the end of supply chains. Supply chains end in the aisles and on the websites of the retailers of Europe and the US. There is a great deal that happens between factory gate and the end consumer.
The consumer is not just paying for the goods, but also has to hand over money (or, in the case of US consumers, a credit card) to cover the trade taxes, warehousing costs, transport costs, wholesale costs, retail costs, advertising budgets, financing costs and sales taxes — and, of course, profit margins for each link of the lengthening supply chain. Each of those supply chain links are local components to the price the consumer pays, and they will move independently of the exporters’ or domestic producers’ prices.
A very simple way of understanding the importance of post-production pricing is to look at the relative importance of different sectors of the economy. In the US the gross value added of warehousing, transport, wholesale and retail trade is more than 15 per cent of the economy. The value added by US manufacturing is about 11 per cent of the economy. This is only a hint of the relative importance of different sectors of the supply chain, but it hints very strongly at the muted role of producers.
Some sectors of the economy allow a more detailed examination. For certain products we can compare US domestic manufacturers’ shipments (the value of goods leaving the factory), net trade in those goods, and how much the consumer spends on those same items in stores and on websites. In this way we have the value of domestic production sold to the local consumer; the value of goods imported sitting on the dockside; and the value of sales to the final consumer.
Clothing and footwear, and household furniture, combined account for just over 10 per cent of US imports from China. In these sectors domestic and foreign producers get about 30-40 per cent of the price paid by the US consumer.
This does not mean that the exporters receive so low a share of the consumer price for all items. For autos, the foreign and domestic manufacturers get about two-thirds of the consumer price. But generally an exporter selling in the US can expect to receive less than half the price the consumer pays.
This means that China’s export price deflation is likely to be a modest disinflation force for the rest of the world. The costs and, critically in recent months, the profit margins that emerge later in the supply chain will limit the power of China’s export price deflation to influence consumer prices in developed economies.