China Brakes, World Slows

China's economy is labor-light and commodity-heavy. This might seem counterintuitive, given that half of the stories you read these days are about the effect of China's cheap labor force on U.S. manufacturing. But precisely because Chinese labor is so cheap, it makes up a very small percentage of the cost of goods produced there compared with the cost of the commodities used to make those goods.

In the U.S., raw materials might make up about 10% of the cost of the finished goods and services churned out by the U.S. economy. Labor accounts for as much as 65%.

Exactly the reverse is true in low-wage China. According to the South China Morning Post, the average wage for a worker in Shanghai at the end of 2002 was about $1.26 an hour (assuming a 40-hour week). With labor this cheap, the commodity inputs used to make a product add up to a bigger part of the whole.

Leverage: The Chinese economy is far more weighted to commodities than the economies of the U.S., Europe or Japan.

China has become the marginal consumer that sets global commodity prices. Blame this on tight worldwide commodity supplies. If key commodities were in excess supply worldwide, the huge growth in Chinese demand for commodities wouldn't have much effect on prices.

That's not happening today. Take the worst case: the global supply/demand story for oil and natural gas. The International Energy Agency estimates that global demand for oil will climb to 79 million barrels a day by the end of 2004. Supply will stay ahead of demand, climbing to 82.3 million barrels, but that's not much of a margin -- only 3%.

That margin seems even smaller when you factor in the growing Chinese demand for crude oil. It was up 9% in 2003. In fact, the IEA says, China accounted for 35% of total global growth in oil demand in 2003 and will account for 30% of demand growth in 2004. The drop isn't due to moderation in the Chinese appetite for oil. The real reason is increased oil demand in Japan, the U.S. and elsewhere.

Leverage: As the buyer at the margin, China "sets" key commodity prices.