Good Fruit Grower / July 2006 / IMPACT on Trade

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IMPACT on Trade

Is China the low-cost producer?

An increase of China’s agricultural exports to the United States places fear into the hearts of most U.S. fruit and vegetable producers.

China has proven its ability to rapidly become an important player in various world markets throughout the past decade. It has become the powerhouse for products such as apples, tomato paste, and honey, because of low labor costs, government subsidies, and a unique banking system.

Along with a booming economy and World Trade Organization membership come policy changes. From an economist’s point of view, the recent changes in Chinese policies are hindering China’s status as the low-cost producer.

Some of China’s agriculture subsidies include input subsidies to purchase trees and equipment and tax rebates on exports (an export subsidy). Other types of subsidies in China are less obvious—such as holding the value of the yuan (Chinese currency) at artificially low levels to encourage exports, or easy access to capital funds at low interest rates.

Until recently, China’s state-owned banking system made loans to encourage new investment. In many cases, particularly when local governments were involved as partners, the loans were never repaid, but were never declared to be nonperforming. This allowed China’s government to funnel money to certain industries such as food processing, by lowering their costs and making it cheaper to export.

While the interest rates on loans may or may not have been subsidized, the lack of repayment of the loans provided a type of subsidy. Recipients of these loans could also use the same collateral for more than one loan. This policy also likely encouraged overinvestment in some industries, resulting in the Chinese building new facilities and buying new equipment rather than consolidating existing plants and equipment.

Loans must be repaid

The good news for U.S. producers is that now, under the WTO, China’s state-owned banking system must conform to international banking standards including those for nonperforming loans. This means the Chinese government and its banking system must hold companies responsible for loan repayments.

Each bureaucratic division of the Chinese government has its own bank: the agricultural bank, the commerce bank, the tourism bank, etc. Apparently, since it was possible to get more than one loan from various lenders for the same equipment, these various banks do not share information with one another. For example, with a bit of creativity, juice-processing equipment could be related to agriculture, commerce, and probably other sectors. If the loans never reached a nonperforming status, companies that could generate sufficient cash flow had a significant cost of capital advantage.

The WTO international banking system reforms are to be completed by the end of 2006, which will force loans that are nonperforming to be called and repaid, and no longer allowed to be used as subsidies. With the loans now having to be repaid, the cost of production in China will increase.

Currency

Also, as China allows its currency to appreciate against the dollar, Chinese products will cost more in the United States, and, therefore, U.S. products sold to China will cost less. This means that as the value of the yuan has gone from the official fixed rate of 8.29 yuan per U.S. dollar last year, to 8 yuan per U.S. dollar recently, the cost of Chinese agricultural products in the United States has increased by about 3 percent. Some economists have predicted that the unconstrained exchange rate would be about 6.5 yuan per U.S. dollar. Even a 10 percent change to 7.2 yuan would further increase the cost of Chinese goods by about 10 percent. This increase would benefit U.S. agriculture since it means that the cost of U.S. products to China would decrease by about 10 percent. However, for the United States as a whole, such a change would increase the cost of many other products we purchase. U.S. consumers would not necessarily be better off overall with this change, even though it is a positive change for agriculture.

Until last year, the supply of apples in China for processing had been essentially unconstrained. Last year alone, apple production in China decreased by about 40 percent and resulted in a price increase for both fresh and processed apples. China’s apple juice concentrate industry experienced its first short crop in its ten-year existence. This sudden shortage, which few predicted, caused a dramatic increase in the price of processing apples; as a result, Chinese apples cost more than U.S. apples.

Since both China and the United States have similar economic costs, state-of-the-art processing equipment that has low labor requirements, and similar interest rates on loans that have to be repaid, should we still consider China a lower-cost producer? The major differences between China and the United States are that Chinese producers operate plants only about five months of the year since there is limited controlled atmosphere storage to extend the marketing year for fresh apples. They also have lower labor costs to operate equipment that uses little labor.

Is China the low-cost producer? Not necessarily. Given the changes that are occurring in China, some of the artificial cost advantages will be gone.