Is China exporting deflation to the rest of the world?

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(The author is chief economist of UBS Global Wealth Management)

To economists, deflation is more complicated than “falling prices.” The price of a single product has been rising and falling, showing changes in supply and demand for a single product. Deflation is a broader decline in many prices.

A general decline in prices is a sign of an economic imbalance, which is a bigger problem than an imbalance in the market for a particular product.

China now has negative inflation across a range of price indicators. Consumer prices fell in July for the first time in two years before recovering in August. Food prices (especially pork and other meats) are a big part of the volatility. Meat prices fell by 14.0% year-on-year in July, and the decline slowed to 10.5% in August.

Other prices are also falling – such as household appliances and transport – but there are also sharp increases in areas such as tourism. Industrial producer prices fell for the 11th consecutive month in August. Of the 29 major subcategories for which data were released in August, 20 experienced product price declines. China’s export prices are falling across most product categories.

While consumer prices remained unchanged overall, prices across China’s manufacturing sector generally fell across a broad range of indices. This raises the question of whether China will export this deflation to the rest of the world.

China is at the end of many global production chains and is the largest manufacturing country in the global economy. While China’s consumer prices and quite a few producer prices can be seen as local issues (since most products in these categories are sold locally), a superficial analysis of the downward trend in export prices seems to suggest that a deflationary wave is brewing. middle. It is about to break through developed economies.

If only it were that simple.

Crucially, China is at the end of many production chains, but not the end of supply chains. The supply chain ends in the aisles and websites of European and American retailers. A lot happens between the factory gate and the end consumer.

Not only do consumers have to pay for goods, they also have to pay (or, for American consumers, a credit card) to cover trade taxes, warehousing costs, shipping costs, wholesale costs, retail costs, advertising budgets, financing costs, and sales taxes and, of course, extending profit margins at every link in the supply chain. Each supply chain link is a local component of the price paid by consumers, and they will change independently of exporter or domestic producer prices.

A very simple way to understand the importance of post pricing is to look at the relative importance of different sectors of the economy. In the United States, the total added value of warehousing, transportation, wholesale and retail trade accounts for more than 15% of the economy. The value added by U.S. manufacturing accounts for approximately 11% of the economy. This is just a hint at the relative importance of different parts of the supply chain, but it hints very strongly at the understated role of producers.

Certain economic sectors allow more detailed inspections. For some products, we can compare U.S. domestic manufacturers’ shipments (the value of goods leaving the factory), net trade in those goods, and how much consumers buy the same items in stores and on websites. In this way, we can sell the value of domestically produced products to local consumers; the value of imported goods at the dock; and the value of sales to the final consumer.

Clothing, footwear, and household furniture together account for a little more than 10% of U.S. imports from China. In these areas, domestic and foreign producers receive about 30% to 40% of the prices paid by U.S. consumers.

This does not mean that exporters’ share of the consumer price of all goods is so low. For cars, foreign and domestic manufacturers receive about two-thirds of the consumer price. But generally speaking, exporters selling in the United States may receive less than half of what consumers pay.

This means that China’s export price deflation may be a mild deflationary force for the rest of the world. Costs emerging later in the supply chain, particularly on profit margins in recent months, will limit the power of deflation in Chinese export prices to affect consumer prices in developed economies.