078

China’s
factory
blues
By Dexter Roberts Entrepreneur Tim Hsu first started making lamps
Photography more than 20 years ago in Taiwan. And like tens of
by Jade Lee
thousands of other factory owners in Taiwan, Hong
Kong, and Macau, he later moved operations to the
The days of ultra-cheap labor and little
Pearl River Delta region of Guangdong, setting up
regulation are gone. As manufacturers’ his Shan Hsing Lighting in a sleepy hamlet of rice
costs climb, export prices will follow fields and duck farms called Dongguan. Since then
the region has grown into the largest manufactur-
ing base in the world for a host of industries, including electronics, shoes, toys, furniture, and lighting.
The combination of low wages, minimal regulation, and a cheap currency was unbeatable. Hsu was so
confident of Guangdong’s future as the world’s workshop that he spent $7 million on a much larger fac-
tory, which opened earlier this year. ¶ Now many of China’s manufacturers—Hsu included—are under-
going the kind of restructuring that tore through America’s heartland a generation ago. The U.S. housing
market, which generated demand for everything from Chinese-made bedroom sets to bathroom fixtures,
has plummeted. A new Chinese labor law that took effect on Jan. 1 has significantly raised costs in an

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Shan Hsing already tight labor market. Soaring com- gest in the world,” says Philip Cheng, chairman of Strategic
modity and energy prices, as well as Bei- Sports, which produces half the global supply of motorcycle,
Lighting has seen
its already thin
jing’s cancellation of preferential policies bicycle, and snowboarding helmets out of 17 plants in the
margins shrink as
for exporters, have hammered manufac- Pearl River Delta. “Now we are dying.” Cheng says he once
the yuan has risen
turers. The appreciation of the Chinese earned 8% margins. His margins now? Almost zero.
currency has shrunk already razor-thin Comprehensive statistics on shut-
margins, pushed thousands of manu- downs are hard to come by. But the Fed-
facturers to the edge of bankruptcy, and
threatened China’s role as the preemi-
China’s Rocketing eration of Hong Kong Industries predicts
that 10% of an estimated 60,000 to
nent exporter of low-priced goods. Labor Costs 70,000 Hong Kong-run factories in the
Hsu’s new factory, it turns out, is Average one-year cost increase Pearl River Delta will close this year. In
running at just 60% of capacity, and the past 12 months, 150 factories mak-
he predicts that half of China’s lighting tk tk ing shoes or supplying shoemakers have
factories—almost all based in Guang- Management compensation 9.1% closed in Dongguan, says the Asia Foot-
dong—will have to close their doors this wear Assn. More plants will disappear
year. “Shoe factories, clothing, toys, Support-staff wages 10.3 as demand slows: UBS analyst Jonathan
furniture, everyone is shutting down,” Blue-collar wages 7.6 Anderson expects overall export growth
he says. Hsu’s not alone in his alarm. of just 5% or less for China this year.
Raw materials 7.1
“We spent 20 years building up our in- Chinese policymakers so far profess
Data: Booz Allen & Hamilton
dustry from nothing to one of the big- little concern. The closures are mainly

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080
harder and be felt more widely
than officials expect. So far,
many of the factory shutdowns
have been in Guangdong, but the
pain is hardly limited to the re-
gion. When more than a hundred
South Korean-owned factories
closed over the Chinese New Year
in the eastern coastal province of
Shandong, 1,200 miles from the
Pearl River Delta, thousands of
workers were left without jobs—
and with unpaid wages.

losing its allure

The bigger multinationals may
be having second thoughts,
too. The American Chamber of
Commerce in Shanghai found
that more than half of foreign
manufacturers in China believe
the mainland is losing its com-
petitive advantage over coun-
tries like Vietnam and India.
Almost a fifth of the companies
surveyed are considering relo-
cating out of China. “The big
story here is that globalization is
for real—and China is no longer
what it was,” says Ronald Had-
dock, a vice-president at con-
sultant Booz Allen Hamilton,
which wrote the report.
The rise of the yuan may be
the biggest single factor driv-
ing companies to relocate. But
other government policies are
contributing to the crisis. Last
year, Beijing decided to cut or
even cancel tax rebates on more
than 2,000 items used in the
Adidas supplier making of exported goods. The
Apache
Footwear
impact has been huge. “The end
recently opened of rebates has raised the cost of
a plant in India manufacturing many goods by
14% to 17% at the factory level,”
says Harley Seyedin, president of
hitting lower-value, labor-intensive exporters that pollute the Guangzhou-based American Chamber of Commerce in
heavily and use energy inefficiently. Beijing now wants clean- South China.
er industries that produce higher-quality items for the local Now a tough new labor law requires companies to provide
market, from cars and planes to biotech products and software. employees with benefits, including pensions; to boost the
That emphasis not only helps boost domestic consumption—a minimum wage by 12%; and to hire workers for the long term.
key national goal—but also reduces frictions internationally The law is raising operating expenses dramatically—by as
from the ever-swelling trade surplus. “We are not abandon- much as 40% when you add spiraling wages in almost every
ing the [exporters],” said Guangdong Governor Huang Huahua sector. “We knew it was going to be a more difficult year, but
on Mar. 8. “[But] selling domestically is good for the country, no one foresaw 40% more in costs,” says Willy Lin, vice-
good for the collective, and good for the people.” chairman of the Textile Council of Hong Kong. “So when ev-
Still, the shift in China’s manufacturing base is likely to hit erything exploded in our face, we started to ask: ‘What can

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081
we do?’ ”
For many companies the answer lies
beijing says cleaner, higher-quality producers
outside China. In early March, Hebei
Yong Jin Cable opened a factory in
will replace the closed plants. But the shift
Vietnam’s Tay Ninh province, near the
Cambodian border. “In Hebei province may hit china harder than officials expect
in China, it costs more than 1,000 ren-
minbi a month [to pay relatively unskilled workers],” says Qu ing setting up smaller plants on the Guangdong border with
Huijun, Vietnam project director at Hebei Yong Jin. “But in Hunan and Guangxi, where costs are lower. It recently opened
Vietnam, it is about 500 RMB. So the cost of labor is cheaper a second factory in India. “We will reduce our percentage pro-
by half.” duced in China because of growth in other countries,” says Bob
The changing cost equation is also affecting sourcing deci- Shorrock, Adidas’ global director for sourcing.
sions by the big apparel labels. Adidas, for example, has told its Shifting manufacturing abroad, though, takes time and
suppliers in Guangdong to look at lower-cost regions in China money. Complicated sourcing and logistics networks that
as well as abroad. So Taiwan-run Apache Footwear, which have grown over more than a decade to support everything
has 18,000 employees in Qingyuan, Guangdong, is consider- from computer makers to shoe factories will have to relocate

a little doesn’t
are the biggest concern of
the people,” said Premier Wen
Jiabao in his annual report to

go a long way
Runaway inflation is putting the squeeze on China’s middle
By Dexter Roberts and Chi-Chu Tschang Bird’s Nest stadium where the opening
For the Wei family, times should be and closing ceremonies will be held.
good. The 41-year-old Wei Bin makes Nevertheless, the family of five is
$634 teaching at a local university, his feeling the squeeze like never before.
wife makes $986 working as a human Monthly living expenditures have
resources specialist at a civil aviation doubled from a year ago, to $282 today.
agency, while her two 60-plus-year- That’s entirely due to a relatively new
old parents who live with them earn a phenomenon plaguing China’s consum-
combined monthly pension of $845. ers: runaway inflation. While last year
They have their own four-bedroom, 600 consumer price inflation was 4.8%, this
sq.-ft. apartment in a plum location in year it has spiked dramatically upward,
northwest Beijing—just several hundred reaching 7.1% in January and 8.7% in
yards from the key Olympics facilities. February—the highest in China in 11
From the balcony off their nine-year-old years. “What we eat and wear—oil, milk,
son’s room, they can just make out the [and meat]—the price of things that we
can’t do without,
they have all gone
up,” laments Wei.
With housing
costs soaring too,
inflation has riveted
the attention of
ordinary Chinese
and the politburo
mark leong/redux
the nation on Mar. 5th. Severe
winter storms will also damage
the harvest. To compensate,
Beijing will expand production
class of grains, meat, and vegetable
oil, increase imports of select
consumer goods, provide
subsidies for the most vulnerable in the
population, and require that provincial
officials ensure adequate grain supplies.
For now, though, inflation surges on.
Rising prices of pork, up 100% over
the last year, as well as beef, eggs, milk,
and cooking oil have forced the Wei
family to search for new ways to cut
costs. (Salary increases have not come
close to matching inflation, with Wei’s
wages up only 10% or so over the last
three years.) That has the family eating
less fried food (vegetable oil has more
than doubled in price to almost $10 a
cask) and more boiled foods—which are
healthier anyway, points out Wei. And
how to cut costs when eating meat?
Simple: “We put less meat inside our
dumplings and add more vegetables. It’s
the same thing,” says Wei.
With gas prices up, too—they’ve dou-
bled to 75¢ a liter in the past six years
since the family bought their Volkswa-
gen Jetta—the Weis are trying to drive

Aliquat alike. “The current less. That means fewer trips to the Carre­
ulput dolore
dolestrud eum
price hikes and four that required a TK minute drive, and
mmmmm incilit, increasing infla- more shopping closer to home. Now
se adigna tionary pressures eager to buy a new car (the family has

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082
as industries move. “We have more than
100 suppliers in the Dongguan area,”
explains Hsu. “Moving is not easy.”
Even in countries like Vietnam, labor
costs are already rising, and shortages
are emerging. Other costs may far out-
pace those in China. The bill for con-
structing Apache’s India factory was
almost three times what it would be
in China, the company estimates, be-
cause the Indian government required
that it be built to British specifications.
Frequent power and water shortages
mean Apache has had to provide its
own expensive backup systems for its
Indian plant as well. “Adidas says we
should move as fast as we can to India.
But productivity in India is 65% to 70%
the level of China,” says Charles Yang,
Apache’s executive general manager. This shuttered
Dongguan
“If we ramp up too fast in India, we may factory is one
shoot ourselves in the foot.” of many, with
more to come
kindergarten and camp
Fear of stumbling abroad has led many
manufacturers to seek even more pro- “there will be a rise in the prices of shoes,
ductivity gains in China. “The most
important thing we can do to cope is
to raise our efficiency,” says Li Dong-
textiles, and all kinds of household products,”
sheng, chairman of top Chinese elec-
tronics maker TCL. Reducing employee
says an american chamber of commerce exec
turnover—which nears 75% annually at
many Guangdong companies—is one way to do that. That’s as 25% this year. He recently passed on price hikes of up to 10%
why Apache offers perks like a kindergarten and even a summer to his customers, including Wal-Mart and Kmart.
camp for employees’ children to learn English. It has just fin- Some manufacturers will try to avoid those increases by
ished building 280 apartment units it will sell at below-market finding really cheap locales deep inside China. “The answer to
prices to its married employees. “We are trying to make it feel high prices in China is more China,” says William Fung, Hong
like home here,” says Yang. “It stabilizes your workforce.” Kong-based group managing director at the world’s biggest
Will these efforts keep a lid on the prices of products coming consumer-goods sourcing company, Li & Fung. “There are
out of China? Probably not. For years manufacturers have met still places like Sichuan or Hunan that are cheaper.”
the demands of U.S. retailers to lower their prices. But their But there are plenty of signs that labor costs are rising even
backs are finally to the wall, says Charles in Chengdu, Sichuan, and Wuhan.
Swindle, a senior vice-president at Hong And no matter where they relocate on
Kong’s Flora Forte, which sources from the mainland, manufacturers face the
20-plus China factories for Bed Bath & same newly stringent labor law, high
Beyond, Wal-Mart, and major U.S. de- commodity prices, and pressure from
partment stores. “I know factories are the ever-climbing currency. That has
(from top) bw photo; chart by ray vella/bw

turning down millions of dollars in or- major implications for the global econ-
ders because they will lose money if they omy. “Unlike in the last 20 years, when
take them.” China exported deflation, from now on,
The next step is inevitable, says the China will export inflation, ” says Peter
American Chamber of Commerce’s Lau, CEO of Hong Kong retailer Gior-
Seyedin: “There will be a rise in the prices dano International, which has extensive
of shoes, textiles, and all kinds of house- operations in China. “Consumers will
hold products.” Geoffrey Greenberg, have no choice but to accept the new
president of Creative Designs Interna- reality. They should get psychologically
tional, saw the cost of toys and costumes prepared for that.” ^
he sources from Guangdong rise as much –With Chi-Chu Tschang in Beijing

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 By Dexter Roberts
Photography
by Name Here

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 Deck goes here (3 lines)

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 CREDIT HERE

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 DESK QUERIES: Please DO NOT return story to desk without confirming or correcting.
(Do not delete the sentence above)
we show Asia Footwear Assn.
we show American Chamber of Commerce in Shanghai
Aliya Internaitonal
Ben Schwall
Hong Kong Textile Co. -- we show Textile Council of Hong Kong
Hebei Yong Jim Cable
Shorrock’s title
Shan Hsing
Charles Yang
Charles Swindle
Flora Forte
we show Fung as group managing director

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 COMPANY INDEX
(Do not delete the sentence above)
Strategic Sports
UBS
Booz Allen Hamilton
Aliya International
Hong Kong Textile
Hebei Yong Jin Cable
Apache Footwear
Adidas
TCL
Flora Forte
Bed Bath & Beyond (BBBY)
Wal-Mart Stores (WMT)
Kmart (SHLD)
Li & Fung
Giordano International

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 CopyDesk Header Info
(Do not delete the sentence above)

Slug: china14
Reporter/Writer: roberts
NY Editor: power
Copy Editor: purcell

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