China is underway with what can effectively be dubbed an “export equivalent of quantitative easing.” Essentially, China is refunding its 17% value-added-tax (VAT) on exports of key products. Take a look in your closet and dresser and check out how much clothing is made in China. We’d say clothing fits into that “key product” range. China does this to keep its otherwise unprofitable manufacturing base afloat. Companies making apparel are essentially operating at a loss and generating profit on the tax rebate.
So the deal is that most manufacturers run at about a 3-5% margin – which includes a 13-14% VAT rebate. If you have a 17% rebate, that effectively doubles profitability for the apparel manufacturers and also translates to higher wages at some factories. Higher-end manufacturers like Foxconn, the company that assembles all of those fancy Apple products we know and love, will also benefit from the tax rebate. This is China playing hardball in order to prevent its profit stream of its existing factory base from being destroyed and it’s quite crafty to say the least.
The question is whether these benefits find their way down the value-add scale from iPads to things toys and underwear.