The teddy bears selling for $1.40 in Shanghai's IKEA store may be just about the cheapest in town, but they're not made in China — they're stitched and stuffed in Indonesia.
The fluffy brown toys reflect a new challenge for China: Its huge economy, which has long offered some of the world's lowest manufacturing costs, is losing its claim on cheapness as factories get squeezed by rising prices for energy, materials and labor.
Those expenses, plus higher taxes and stricter enforcement of labor and environmental standards, are causing some manufacturers to leave for lower-cost markets such as Vietnam, Indonesia and India.
Costs have climbed so much that three-quarters of businesses surveyed by the American Chamber of Commerce in Shanghai believe China is losing its competitive edge.
The higher costs mean Western consumers are bound to face steeper prices for iPods, TVs, tank tops and many other imported products made by small Chinese subcontractors.
"Americans continue to want to buy at lower prices," said Kevin Burke, president and CEO of the American Apparel and Footwear Association. "They are used to going to the store during Christmas and getting something cheaper than a year ago."
That's no longer a sure thing.
For instance, American toy makers, who rely heavily on Chinese factories, expect prices to increase 5 to 10 percent for the 2008 holiday season, largely because of rising manufacturing costs.
Costs in China are climbing nationwide, but the greatest pain is being felt in the south, where about 14,000 Hong Kong-run factories could close in the next few months, said Polly Ko of the Economic and Trade Office in Guangdong, which neighbors Hong Kong.
To adapt, many multinational manufacturers — including Intel Corp., iPod-maker Hon Hai Technology Group and Japanese companies like Canon Inc. and Sony Corp. are expanding operations in Vietnam.
Auto parts makers are decamping for the Middle East and Eastern Europe, textile-makers to Bangladesh and India.
Thousands of smaller Hong Kong, Taiwan or Chinese-run factories in south China's traditional export hub of Guangdong are closing or moving out.
Meanwhile, Chinese inflation has risen to its highest point in more than 11 years, jumping 7.1 percent in January, as snowstorms worsened food shortages. The biggest price hikes have been for food, but analysts say longer-term pressures on prices for manufactured goods will persist.
"China needs to reprice its exports, and that has to be accepted by international buyers," says Andy Xie, an independent economist based in Shanghai.
But raising prices may be tough for Chinese manufacturers given the suspicions about product quality raised by a slew of scandals over tainted or potentially dangerous products.
Despite its huge pool of unskilled rural laborers, China's supply of experienced, skilled talent falls far short of demand. The gap has been pushing wages up by 10 percent to 15 percent a year.
A new labor law requiring stronger employment contracts is expected to raise costs even more.
Prices for plastics and other materials have climbed 30 percent or more, and electricity rates are surging, too. The government has also slashed export tax rebates — originally given to promote exports — on more than 2,800 products accounting for nearly 40 percent of all Chinese exports.
The steady appreciation of China's currency, the yuan, also contributes to the problem.
At IKEA's Shanghai store, a stroll down the aisles finds most products made in China, rather than Europe or the U.S. But a growing share of the goods come from less developed markets: stuffed toys from Indonesia, wooden train sets from Bulgaria, colorful rugs and throws from India, bed sheets from Ethiopia, baskets and wooden trays from Vietnam.
"We are constantly having to compete with other countries and suppliers," said Linda Xu, public relations manager in China for the Swedish retailer.
For many companies, especially those focused on the potentially huge Chinese market, leaving the country would be a last resort, says Jonathan Woetzel, co-author of "Operation China," a book that outlines strategies for competing in the country's fast-changing business environment.
"You'd have to start over, essentially," he said in an interview. "There's still quite a lot of opportunity to take cost out of the system. What we do see is supply chains extending inland, for example, going inland for final assembly."
In inland China, wages still lag far behind the richer eastern and southern coastal areas.
Despite those strategies, prices for Chinese-made products will probably continue to rise in the next few years, causing some companies to invest elsewhere, says UBS economist Jonathan Anderson.
"Over the medium-term, where are you going to invest if you're building a factory? Maybe not China anymore. Maybe Bangladesh, Vietnam, Indonesia. Maybe India."