China's newest export: Inflation

China isn't so cheap anymore.

Over the past decade, U.S. manufacturers have come to rely on inexpensive Chinese labor to help keep costs low, an advantage they passed along to U.S. consumers in the costs of finished products.

But inflation has hit China hard in recent months, squeezing margins, forcing price hikes on some products and putting pressure on companies to find new ways to cut costs.

The effects are being felt on a variety of fronts.

China's intense appetite for steel, for example, is pushing up prices and creating shortages. Meanwhile, Chinese wages are rising at a furious pace. U.S. companies also complain that China recently reduced exporter tax breaks and pumped up the value of the yuan 16 percent in 18 months.

While economists can't agree about how much of China's inflation will spill over into the United States, most expect an impact.

"I think you are going to start seeing [U.S.] price increases this year as a result of all these factors," said Patricia Mears, director of international commercial affairs for the 10,000-member National Association of Manufacturers. Two NAM members, one a steel wire company and the other a steel furniture firm, recently pulled some operations out of China because of rising shipping and wage costs, she said. Other U.S. companies, including Minnesota manufacturers such as Donaldson, Andersen Windows, Ecolab and 3M Co., all are crafting new strategies for coping with China's changes.

"Companies say that, all of a sudden it's not as competitive to make their product in China," and are looking at other locations, Mears said.

China's consumer price index in January jumped to 7.1 percent, from 2.2 percent a year earlier. The Chinese government hiked interest rates six times last year to slow its speeding train, with almost no effect. The economy still grew 11.4 percent.

"Clearly, inflation has accelerated. And it really started accelerating toward the end of 2006," said Manufacturers Alliance economist Cliff Waldman. "Much of the problem is food. Food price inflation in China is running about 18 percent year-over-year."

Chris McNally, China specialist for the East/West Center in Honolulu, said a massive diet shift toward grain-fed livestock and a recent swine disease "ratcheted up grain and meat prices" in China, which has led to pressure from workers for higher wages.

"Factories in China are hit with a triple whammy with higher wages, higher exchange rates as the yuan is up about 15 percent since 2005. The third whammy is transportation costs for those shipping out of China and to the United States," McNally said.

Last week a Wal-Mart Stores Inc. official acknowledged inflationary pressures, but said that the retail giant will continue to source "a major" percentage of its merchandise from Chinese factories. Wal-Mart, which buys about $9 billion in goods each year from China, will look to compensate for higher Chinese costs with "productivity improvements," the company said.

At Bloomington-based Donaldson Co., which has 2,500 workers making disk drive filters and diesel truck filters in Wuxi and Guilin, China, Assistant Treasurer Rich Sheffer said, "We are seeing some inflationary pressures there for things like steel or plastics or plastic components or anything we are sourcing there. Wages for higher-skilled laborers are especially [high]. China is growing fast and there is more competition for their managers, engineers, sales people and skilled laborers. You end up with a fair amount of turnover there, just because people are going to jobs that are paying more."

In some sectors, wages for high-skill professionals are doubling.

"I know companies that are paying $200,000 or more a year for a comptroller to oversee their business in China," said Phil Mason, president of Asia Pacific and Latin American operations for Ecolab, the St. Paul-based $5.4 billion maker of cleaning products. "The market has become extremely competitive. ... There is not a lot of difference today for us to be hiring somebody in China vs. putting in someone from the United States. That's for a high-level, skilled, experienced person going into a leadership position."

Ecolab, which has been in China for 20 years and operates two plants there for the Chinese market, works closely with the American Chamber of Commerce in China.

"For most of the businesses that we have been in touch with, wages are the big deal," Mason said.

"There are significant wage pressures and that is what will drive inflation more than commodities," Ecolab spokesman Mike Monahan said.

Some economists estimate that Chinese wages are rising about 15 percent per year.

The situation in China is one of the reasons Ecolab recently bumped up its overall pricing 2 percent.

Other companies have less leeway on pricing.

For the disk drive filters Donaldson makes for original equipment manufacturers, there is no room for price adjustments. Prices for the consumer electronics items that use some of those filters, for example, tend to go down every year, not up.

"So, we are doing the typical Donaldson blocking and tackling, and taking costs out with 'lean' and 'Six Sigma' practices," Sheffer said.

Jim Humphrey, CEO of Bayport-based window and door maker Andersen Corp., said Andersen buys metal door latches and knobs and other hardware items from Chinese suppliers.

"When you look at the world economy around raw materials and especially metals, that has put a lot of pressure on all manufacturers including those in China," Humphrey said. "We are trying to do everything we can to keep our costs in line and take costs out of the business and be a better value to our customer."

To do that means "continually working with suppliers who are faced with various changing cost structures in China," Humphrey said.

McNally said a few U.S. manufacturers such as Intel have moved factories into inner China to take advantage of cheaper land and local laborers who don't have to be fed and housed in corporate dormitories. Companies from South Korea, Taiwan and Hong Kong are taking similar steps.

"It's an accelerating trend," he said. "In the future, companies will have to do it because of the [cheaper] labor and land costs." But he said that it will be difficult for U.S. companies because they are less familiar with how to get products from inner China to ports.

Dee DePass • 612-673-7725