China factory doom and gloom plays into state plans

When production lines close in the United States, protectionism tends to rear its head. In China, the opposite is happening.

A volatile mix of inflation, a rising yuan and new labour legislation has corroded profits in the country's manufacturing heartland. Hundreds, possibly thousands, of factories have been forced to close or leave the Pearl River Delta, which churns out more than a quarter of China's exports.

Some are moving inland. Others are going to places like Vietnam, where labour is even cheaper.

But analysts say the factory bloodbath dovetails with -- and in no small way results from -- state policies designed to propel China's economy up the value ladder. Guangdong led reforms, and it is leading the reinvention of China's manufacturing industry.

China, like other rapidly industrialising economies, is learning it cannot compete forever by churning out cheap, simple goods while gobbling up increasingly costly resources such as oil and iron ore. Policymakers are keen to promote more efficient industries and higher-value products as a route to more predictable and sustainable economic growth.

"The factories that are closing are really victims of creative destruction," said consultant Edith Terry, author of a report on the changes in the Delta published in February.

Industry estimates put the number of factories closing in the Pearl River Delta as high as 15,000, although the Guangdong trade bureau has said fewer than 300 were shutting. Most were labour-intensive, small- or medium-sized producers of metal or plastic products, toys, garments and shoes, the government said.

About 90 percent are based in Hong Kong or Taiwan, which explains why industry groups there have been so vocal in calling for relief from the pernicious effects of fast-rising costs.

"It's like a tsunami," said Clement Chen of the Federation of Hong Kong Industries.

POLICY PUSH

But the cries are falling on deaf ears. As input costs rise, the government wants more developed parts of China to price themselves out of low-end industries.

Guangdong's provincial government has aggressively raised minimum wages in the face of a labour shortage and will lift them again by 13 percent at the start of April to China's highest.

The labour bureau says the rise will help lift standards, which it says suffer when companies rely solely on cheap labour.

Other policies are also at play. State media quoted one Guangdong official as saying factory closures were "just normal" as the province pushes out polluting firms or big energy users.

State economic blueprints, too, urge officials to improve the structure of their economies, but there's been some opposition.

In Dongguan, a city of 7 million with tens of thousands of factories, the Communist Party boss recently complained about entrenched interests, raising the case of a town where one huge shoe factory is the top employer and main source of tax revenues.

"There would be a great deal of resistance if this shoe factory were to be moved," Liu Zhigeng told other leaders.

To attract "better" firms, localities have also been offering sweeteners, like tax breaks and cheap loans. Guangzhou lured Japan's big car markers that way and it is now an auto hub.

On top of it all, the central government continues to let the yuan appreciate, which hurts exporters, and this year enacted a tough labour contract law.

HIGH STAKES, HIGH RISK

The risks of inaction are high.

"If they maintain the economic structure they have now, they run out of energy, they run out of resources and they face social rebellion," said Terry. "Guangdong is the leading edge of that."

But there are big risks, too, in aggressively pushing change.

"If the Pearl River Delta was forced tomorrow to leave behind all the traditional light manufacturing and only do 'high-tech' stuff, basically there would be a huge economic collapse," said Michael Enright of the University of Hong Kong.

So far, Guangdong's economy remains strong. Last year, its gross domestic product grew 14.5 percent and topped 3 trillion yuan ($422.2 billion). That was one-eighth of China's total, surpassing Taiwan's and equal to two-thirds of Australia's.

Jimmy Hexter, a director at McKinsey & Co. and co-author of the book "Operation China", says the pressures will spark consolidation and could make the region healthier economically.

"These are the exact types of natural economic factors that encourage better companies to improve productivity and to capture the opportunity for consolidation," he said.

In recent years, 3,000 to 4,000 factories have closed each year in Guangdong and a higher number could fold this year, said Edward Leung, of the Trade Development Council in Hong Kong. But at the same time, 8,000 to 9,000 new factories open each year.

"Guangdong's obituary has been written quite a number of times," said Arthur Kroeber of the research firm Dragonomics. "They've managed to adapt to a lot of changes so far and I think they'll continue to adapt."

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