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Factory Closings In South China. All Part Of The Plan.

By Dan Harris on Posted in China Business

By: Steve Dickinson 

Yesterday we were greeted in the foreign press with the following headline: Southern China Sees Wave of Manufacturing Bankruptcies. This was predictably followed by vehement denials vehement denials from the Chinese government. For example, the CCTV Channel 9 business news was full of stories today stating that Chinese SMEs throughout the country are operating smoothly. The result being the usual complete lack of clarity about what is really going on in China as the coastal regions restructure their manufacturing base in the face of reduced demand and higher costs.

The basic story is that that low value added/high labor content manufacturers from Wenzhou in Zhejiang down to Zhuhai in Guangzhou are undergoing extreme financial stress. The affected sectors are in the traditional outsourcing industries: textiles, toys, shoes and furniture. The reports are that many of the oldest and largest manufacturers in these sectors are closing their doors, leaving behind bad debts and unpaid workers.

These stories may be true or false.Certainly the bankruptcy of one or two companies in a competitive world does not constitute a trend. So the truth may be somewhere in between the “the sky is falling” and “what me worry” positions we are seeing in the discussion.

What I find interesting is the consistent misunderstanding of foreign observers on the Chinese government position on the matter. Specifically, many observers are surprised at the relatively casual response of the central and local governments to the issue. This is because these observers do not see that this process is completely consistent with central government policy.

Let’s state the situation more clearly. Assume for now that the stories are true. If true, the process is exactly what the central government intends to happen to manufacturing in China’s coastal regions, particularly in the Zhejiang/Fujian/Guanzhou region. Stated bluntly, if Chinese government policy is causing the bankruptcies, this is intentional. If the bankruptcies are the result of market forces, the government intends to do nothing to soften the blow.

Here is a basic explanation of what is going on:

1. The 12th Five Year plan clearly states that a primary goal is to eliminate low value added/high labor content export manufacturing from the entire coast. The intent is to shift to high value added, technologically advanced manufacturing and modern services in this region. The bankruptcies in the low value added sector are entirely consistent with central government policy.

2. Many of the manufacturers in this sector are controlled by foreign capital: Korea, Taiwan, Hong Kong and Singapore. Where not foreign owned, the owners are rebels against the state like the group centered in Wenzhou. The central government is not happy with either group and is quite happy to see them go.

3. It is important to understand that the vast majority of these export based manufacturers are not economically viable. They exist because of VAT rebates, open violation of the Chinese wage and labor laws and subsidized energy and raw material prices. They have been tolerated in the past solely because they provide jobs. They provide no other benefit to China and are in many cases actually harmful. Moreover, the jobs they provide are for migrant labor, which is a source of social unrest in China. China wants these migrants to return to Sichuan and elsewhere. They want the businesses to operate according to the requirements of Chinese law. For these reasons it is a sound policy to force these export manufacturers to either become economically viable and law abiding businesses or to force or allow them to simply go away. It makes little sense to continue to support them with subsidies and loans.

4. On a much deeper level, as the 12th Five Year Plan states, the center seeks to transform the Guangzhou/Fujian/South Zhejiang industrial zone. The goal is to eliminate of most or all of the private, export oriented, low value added/high labor content businesses located in those areas. Though the discussion is couched in economic terms, the underlying reason is political. The center is tired of the independence of the southern coastal regions. Since there is no longer any strong economic reason to tolerate this independence, the center is now moving to reassert control in these regions.

It therefore makes perfect sense that the center is relatively unconcerned about a “wave of bankruptcies” in the south. They believe they can handle the results in various ways. In terms of job loss, the message is: go home and find a job back in Sichuan or Henan or wherever the migrant workers were originally located. There are plenty of jobs for Guangzhou residents, so the issue is really convincing the migrants to go back home.

In my own lectures on this issue, I have commented that elimination of low value added manufacturing on the coast seems to be a bad policy on economic grounds. That is, China is still in the situation where low value added/high labor content manufacturing is a good way to take advantage of the large number of low skill workers available in China. However, now that I look at the situation from the standpoint of the center, I find that it makes sense to conclude that there is no benefit to China in keeping these really bad companies alive through loans and subsidies. It therefore seems that the transformation of this sector and the resulting closing of unviable manufacturers will continue unabated. This is because the process makes political sense, which is the most important consideration in China. The fact that it makes economic sense is a secondary, collateral reason for continuing.

What are you seeing in the South?

Update: Dan actually gave a TV interview relating to this subject a few weeks ago when he was in China. That interview can be found here.

  • Mike Bellamy

    Rich Brubaker at AllRoads has instigated this subject, his blog article “Moving Away From China – I Don’t Think So” here: http://www.allroadsleadtochina.com/2011/07/14/moving-away-from-china-the-latest-trend-i-dont-think-so/
    which currently deals with the subject. Otherwise I think it has already been well mentioned elsewhere that many South China based businesses in high labor / high energy cost industries (such as garments, toys and some computer components) are relocating to Vietnam or Bangladesh. It’s been going on for some time. The South of China has different dynamics from Shanghai or Qingdao where you guys know, it needs a different level of understanding there as it behaves seperately from the rest of China due to its large Hong Kong & Taiwanese influence.

  • http://www.procurasia.com Etienne

    Very good summary of the trends I believe are emerging for now more than 4 maybe 5 years.
    One of the first visible sign of that underlining trend or policy was a few years ago when China central government changed the VAT rebate percentages for many products on a July 1st. If I remember well is was in 2007. The result of this policy change was to make it less attractive to export products with low added value and high consumption of resources (raw material or energy), while some advanced products and high tech received increased support.
    Now those who look well at the trend, like you, see that bigger picture coming out in full light.
    This is a very important trend to understand because any company or person developing a business with or in China would better concentrate effort and investment where they can stay longer.

  • chris

    Nice post. Sensible too!
    Now if only some of the MSM could take the time to come over to this blog and read it!

  • Don Vong

    As one of low valued added & high labor content manufacturers in Zhuhai, Guangzhou.
    I strongly feel that our government seems to force us to remove to interior provinces.
    But for most of our so small factories (less than 100 workers), those local govermnent
    will not give us any good advantages. We are not same as Big Brother “Foxconn”.

  • D D

    This is an excellent perspective that stabilizes insecurities the western media would have us hold. Though I would appreciate more statistics to support the claims found here, it does seem only logical that the government is willing to let go of these industries. But who will make all of the US’s crap from now on? Maybe this big manufacturing job push in the US is really just a transfer of high skilled jobs to China in exchange for low skilled? Is China really that smart? Is the US really that stupid? I don’t know, but if the above article is true I’m definitely gonna want to investigate further…thanks for the spark.

  • dan berg

    so much for the argument that China cannot raise the value of the rmb because of “fear of rising unemployment.”

  • Twofish

    dan berg: so much for the argument that China cannot raise the value of the rmb because of “fear of rising unemployment.”
    Exactly. But what Chinese did was rather than raise the RMB first and then deal with unemployment, you create employment elsewhere, and then appreciate the RMB.
    Also, Taiwanese manufacturers are getting very little help from the Taiwan government, because Taiwan itself is moving its economy toward things like tourism and bio-tech. It doesn’t help that Taiwanese factory owners in Guangdong tend to vote green.
    Dickinson: They provide no other benefit to China and are in many cases actually harmful. Moreover, the jobs they provide are for migrant labor, which is a source of social unrest in China. China wants these migrants to return to Sichuan and elsewhere.
    That’s not true. One reason that factories are shutting down, are that they are not attractive for migrants.
    The problem for these factories is that migrant workers now have other options. Your typical migrant worker in a textile plant is a female in their 20′s that wants to see the world, and this generation of those workers are now more interested to moving to Beijing or Shanghai or staying in Sichuan and working as an office lady for an insurance company. Think of things from the point of view of a young 20 year old in rural Sichuan in 1990. They have an elementary school education, and if they don’t go off to Guangdong, they’ll be married off quickly on the farm. Today, that 20 year old is likely to have had a high school education and is internet savvy.
    One thing that is killing export companies is that they can no longer pay cheap wages, and the supply of migrant labor has dried up. What is happening is that companies are now forced to either increase wages or hiring workers that they never would have considered before (40 or 50 year olds).
    Something to realize is that the “new generation” of Chinese youth are not badly-educated peasants, but usually have high-school degrees, been living in a rapidly growing economy, and want to shop. Factory owners that I’ve know have mentioned that young people are spoiled, and to some degree they are right.
    There’s another generational shift in that a lot of the factory owners are in their 50′s and 60′s and now is a good time to cash out. One thing that is interesting is that factory owners in Dongguan are not known for the “stable family relationships” that this is hitting them, because they don’t have kids they can pass their business to.
    Also, there is still a lot of money to be made in light manufacturing in China, but this is mainly directed at internal demand. It’s extremely painful for a factory that has been geared toward export to switch to domestic production, because this requires changing all of the human networks. Some of the factories are making this painful switch, but others are just giving up.
    4) The center is tired of the independence of the southern coastal regions.
    The amount of “independence” has been vastly over stated. One thing that export factories to is to give local governments more funds, but this also makes them financially not subject to provincial rules.
    4) Since there is no longer any strong economic reason to tolerate this independence, the center is now moving to reassert control in these regions.
    That presumes that the center lost control at some point, which never happened.
    a. However, now that I look at the situation from the standpoint of the center, I find that it makes sense to conclude that there is no benefit to China in keeping these really bad companies alive through loans and subsidies
    The SME’s in Guangdong never received loans and subsidies from the central government. The loans and subsidies to SOE’s and construction companies, one reason that these companies existed was that they were started in the 1990′s with foreign capital, but that is even deader than Chinese capital.
    Also, they weren’t “bad companies.” They were great companies at one point, and China would not have gotten where it is without them. But things change, and times change. Also, it’s not quite the end. A lot of companies will fail, but they aren’t all failing. The statistic that 10% of companies will go bankrupt means that 90% won’t.
    One thing that this does mean is that China is not likely to end up with economic stagnation. The thing about the Soviet economy that killed it in the 1970′s was that it had a 1950′s style economy and as things changed the Soviet economy failed to adapt. This doesn’t seem to be happening to China.

  • http://lily@ptl-group.com Lily

    nice post. here is my article regarding how to choose a location for your Chinese factory
    http://china4business.net/?p=258#more-258

  • http://alexandraharney.com/ Alexndra Harney

    I agree completely.
    Before the financial crisis, factory managers told me that local government officials in Dongguan had told them that they hoped to cut the number of migrant workers in the city by half going forward. This obviously would be achieved through a massive consolidation of the light industrial base. The point (which you make and I am only reinforcing) is that the closure of low-value-added, labor-intensive factories has long been a policy goal, centrally and (less consistently) locally in Guangdong.
    While this may not be a driver of national policy (though to a certain extent I think it is), demographically, these factories are increasingly untenable, at least the way they are managed.
    The workers I know don’t want to work in factories, and only stay because they can’t find anything better. But with food and rent inflation, life on the coasts is increasingly unaffordable. And ironically (given the wage increases), as the gender imbalance worsens, these factory jobs do not offer the kind of attractive careers for migrant workers that parents want for their sons in law. Which is to say, parents of increasingly scarce daughters are not all keen on marrying them off to ordinary factory workers. And migrant men know this.

  • Nate

    I suppose Twofish hinted at a possible answer to this, but who is going to start these high value added, technologically advanced manufacturing companies in the coastal regions? Who has the capitol? If the private low value added / high labor content companies go bankrupt or at the very least are strapped for cash, it won’t be them. Who does that leave? SOEs?