HONG KONG, China – Americans are used to hearing about the growing influence of China. Every week seems to bring another screaming headline about how the communist nation is an economic juggernaut set to dominate the world. Yet the country may be in danger of losing its competitive edge. Over the past two decades, China has transformed itself into a manufacturing machine. The country has been able to convince companies to set up factories there with its cheap labor, huge market potential, and business-friendly rules. Chinese manufacturers have been churning out everything from T-shirts and toys to television sets for cheap, helping to keep global consumer prices down. These exports have been fueling China’s economic boom, accounting for roughly 40 percent of gross domestic product.

New labor laws are likely to make China less competitive.

However, soaring costs are now threatening China’s manufacturing might. Prices of fuel and raw materials are up, eating into manufacturers’ dwindling profit margins. Surging prices of food staples such as pork have propelled Chinese inflation to an 11-year high, driving up workers’ wages. Wages, by some estimates, are already growing by up to 30 percent every year as companies compete for skilled labor.

In addition, a new labor law, requiring stronger employment contracts, is complicating the hiring and firing process for manufacturers. A dispute arbitration law comes into effect in May. Employers say the new laws restrict them from laying off substandard workers even in times of economic difficulty. They say the rules shifts the bargaining power in favor of employees at a time when factory owners are already facing labor shortages and the possibility of a U.S. recession. These laws, combined with tougher environmental standards, higher corporate taxes, and an appreciating Chinese currency — which makes goods from China more expensive overseas — are adding to manufacturers’ financial woes.

These changes are due largely to the Chinese government’s recent campaign to start prioritizing human welfare over speedy industrial growth. For decades, authorities emphasized the need for rapid economic development, often overlooking poor working conditions or pollution. The new labor and environmental policies are meant to address those problems, by prodding manufacturers into better corporate behavior. Beijing authorities are also looking to encourage Chinese manufacturers to move away from producing basic goods towards advanced products. They want China to follow in the footsteps of Japan, South Korea, or Taiwan and step up the global manufacturing ladder.

Yet China may not be ready for this economic transition. Unlike its exporting Asian rivals, China has to consider the welfare of over a billion people, many of whom are still unemployed. Low-end manufacturing is a labor-intensive industry, requiring tens of millions of workers. A shift of support away from this sector could lead to an unwelcome loss of jobs at a time when the government is desperately trying to raise the standard of living for the nation’s poor and prevent social unrest.

China’s economy, though growing fast, is also said to be at a less developed stage than the economies of Japan, South Korea, or Taiwan. Some pundits say consumers there had greater purchasing power than the Chinese do now, allowing governments to rely more on domestic spending as a driver of economic growth. China is in the midst of deploying the same tactic — encouraging citizens to shop — yet the average Chinese consumer is still inclined to save.

Moreover, the competitive environment for countries has dramatically changed. Companies can open and close factories more swiftly than they have been able to in the past as governments compete aggressively to attract investment by offering tax breaks and other financial incentives. In other words, nations can gain and lose competitiveness more quickly than in years prior.

China has already started losing thousands of manufacturers. According to an industry body, the Federation of Hong Kong Industries, over 10-percent of the 70,000 factories operating in the Pearl River Delta, the country’s manufacturing belt, will shut their doors this year. Some manufacturers are investing heavily in new equipment and technology, thereby reducing their workforce, but many are moving operations to lower-cost countries such as Vietnam. Beijing’s frequent trade rows with Washington are also prompting manufacturers to look to diversify their production bases. Some U.S. politicians, fairly or unfairly, criticize the Chinese for their safety standards and their currency, the yuan. These lawmakers argue the yuan is artificially cheap, contributing to America’s ballooning trade deficit.

However, that criticism may soon subside. With the threat of inflation growing in China, authorities there have little choice but to allow the yuan, which only de-pegged from the U.S. dollar in 2005, to appreciate further. A stronger yuan would help reduce import costs and curb economic growth by muting demand for Chinese goods. China’s efforts to protect workers’ rights and the environment could also silence Beijing’s critics in Washington. And though China will likely remain a formidable player in manufacturing due to its economies of scale, the country is no longer the mecca for manufacturers it once was. Other nations stand to benefit if investment is diverted away from China.

China, in the coming years, may appear to be less of a threat to the U.S. economy than it is today.

Watch my report on China’s economic shake-up