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Posted by on May 16, 2016 in Tell Me Why |

How Does China Make Such Cheap Fountain Pens?

How Does China Make Such Cheap Fountain Pens?

The conventional explanation is simply that the Chinese manufacturers are producing fountain pens in such vast quantities that the unit costs are very low: make one pen and it might cost you $30 or $50 or something.

Make 10,000 and you might get the costs down to $1 or $2 a unit.  This is known as scale economies in the econ jargon, and it’s quite common in manufacturing, particularly where you have a few large upfront costs – say, designing the pen, setting up a production run, paying workers to turn up and make the thing.

When you produce a large run of pens, those upfront costs can be spread out; the more you produce, the more they get spread out and the lower your costs become. So if the Chinese manufacturers are making an enormous number of pens, it makes sense that they can get their costs pretty low.

This explanation works for a lot of people but it’s overlooking an even more important factor, something that separates the Chinese manufacturers from most others in the world: subsidies.

A subsidy is some kind of financial support from the government for a particular business or industry. The explosive growth in Chinese manufacturing in the last few decades has been underpinned by an enormous amount of subsidies – one book from 2012 claimed that 90% of all publicly-listed Chinese companies received government support while another from 2013 claimed that direct subsidies from 1985-2005 were worth more than US$300bn.

Direct subsidies are the easiest to understand and generally go to upstream firms – not the pen manufacturers themselves, but the companies that provide the raw inputs like electricity or metal.

When these companies are privately owned, subsidies can take the form of direct government payments; when they are owned by the government (State-Owned Enterprises, or SOEs) they often sell their products well below cost, deliberately running at a loss so that the downstream firms (such as pen manufacturers) can have lower costs. The main industries which benefit from this are the power companies, steel producers, and shipping companies.

Although I’m sure the government didn’t set out to boost the Chinese fountain pen industry, the fact that it uses each of these inputs means that it gets a big boost. The subsidies push down the cost of their inputs and make it cheaper to produce pens, meaning they can be sold at a lower price and capture more of the market. If they had to pay the real costs of production, there’s no way these pens would be as cheap as they are.

Indirect subsidies are a little more complicated but they have the same effect of lowering a fountain pens production cost. The two main indirect subsidies are currency manipulation and discount loans from government-owned banks.

Currency manipulation pops up in the news from time to time – the US used to routinely criticize China for deliberately undervaluing its currency (it has been quieter on that front lately). Keeping their exchange rate low meant that Chinese exports were artificially cheap – today they are perhaps 20% cheaper than they would be if the yuan was not subject to manipulation.

When you put all of this together, it means that Chinese pen manufacturers enjoy significant advantages from their government’s industrial policy that allows them to avoid paying full production cost.

The loan to establish a factory is discounted, the steel for the factory is discounted, the electricity the factory uses is discounted, the metal and steel used in the pen is discounted, the shipping to buyers is discounted, and the currency exchange is discounted. Without all of these benefits, it’s hard to believe that you could pick up a new Jinhao from your letterbox for less than $2.

Although this subsidy program won’t survive in the long run, but when it does, it’s going to be hard for the pen manufacturers to keep on producing the same kinds of products: their costs will rise substantially and fountain pen buyers will ask whether it’s worth paying Metro prices for lower quality pens.

Unless Hero and Jinhao respond by offering much better products, they’re unlikely to stay in the market for the long term. The main threat that they pose is to entry-level pens, but the quality control is so poor that I don’t think anybody sees them as a serious player in the market. These companies are likely just a flash in the pan: here today, but once the subsidies disappear, they will too.

Content for this question contributed by Caroline Riendeau, resident of Springfield, Hampden County, Massachusetts, USA