I Bet Lou Dobbs Is Not Happy With Mattel

Thomas A. Debrowski is Mattel's executive vice president for worldwide operations. After a meeting with Chinese product safety chief Li Changjiang, Mr. Debrowski decided his company should take a lot of the responsibility for the recent product recalls:

"Our reputation has been damaged lately by these recalls," Debrowski told Li in
a meeting at Li's office at which reporters were allowed to be present. " And Mattel takes full responsibility for these recalls and apologizes personally to you, the Chinese people, and all of our customers who received the toys," Debrowski said … The recalls have prompted complaints from China that manufacturers were being blamed for design faults introduced by Mattel. On Friday, Debrowski acknowledged that "vast majority of those products that were recalled were the result of a design flaw in Mattel's design, not through a manufacturing flaw in China's manufacturers." Lead-tainted toys accounted for only a small percentage of all toys recalled, he said, adding that: "We understand and appreciate deeply the issues that this has caused for the reputation of Chinese manufacturers." In a statement issued by the company, Mattel said its lead-related recalls were "overly inclusive, including toys that may not have had lead in paint in excess of the U.S. standards. "The follow-up inspections also confirmed that part of the recalled toys complied with the U.S. standards," the statement said. Li reminded Debrowski that "a large part of your annual profit... comes from your factories in China. "This shows that our cooperation is in the interests of Mattel, and both parties should value our cooperation. I really hope that Mattel can learn lessons and gain experience from these incidents," Li said, adding that Mattel should "improve their control measures."

I mention Lou Dobbs as his show has been on a tirade of China bashing as if we should stop importing goods from this trading partner. The reality is that most of the toys purchased by American households are made in China. During 2006, we imported $22.2 billion worth of toys from China according to this source. Mattel sales were $5.65 billion during 2006 and its operating margin was just shy of 13 percent. Mattel’s 10-K filing notes:

The foreign countries in which most of Mattel’s products are manufactured (principally China, Indonesia, Thailand, Malaysia and Mexico) all enjoy permanent “normal trade relations” (“NTR”) status under US tariff laws, which provides a favorable category of US import duties. China’s NTR status became permanent in 2002, following enactment of a bill authorizing such status upon the country’s accession to the World Trade Organization (“WTO”), which occurred in 2001. Membership in the WTO substantially reduces the possibility of China losing its NTR status, which would result in increased costs for Mattel and others in the toy industry. All US duties on toys were completely eliminated upon implementation of the Uruguay Round WTO agreement in 1995. The European Union, Japan and Canada eliminated their tariffs on most toy categories through staged reductions that were completed by January 1, 2004. The primary toy tariffs still maintained by these countries are European Union and Japanese tariffs on dolls of 4.7% and 3.9%, respectively, and a Canadian tariff of 8.0% on children’s wheeled vehicles.

I realize that the Lou Dobbs crowd is pushing hard for higher tariffs on imports from China, but such tariffs are not exactly the right incentive structure to promote better quality control in terms of toy production. Mattel and the Chinese government both have incentives not to wreck the flow of Mattel profits and Chinese jobs that would come American parents not trusting the products they produce. Sure – there are incentives to cut production costs and maybe the lower cost of lead paints may have been part of the problem here – as argued by this Angrybear. But as Mr. Debrowski notes, one can overemphasize this one aspect of the incentive structure.

I say this because Mattel and other companies that design and distribute toys with production outsourced to third party Chinese manufacturers have established the type of Hong Kong sourcing companies that I discussed here. OK, my Angrybear post from over a one ago was complaining that the IRS allows too much transfer pricing manipulation. But as one digs into the facts about these sourcing companies, one sees that these subsidiaries of companies like Mattel hire a lot a quality control personal. Are they spending enough on quality control? Perhaps not, but let’s see if the toy industry learns a valuable economic lesson from these product recalls.