China's Factory Blues

Entrepreneur Tim Hsu first started making lamps more than 20 years ago in Taiwan. And like tens of thousands of other factory owners in Taiwan, Hong Kong, and Macau, he later moved operations to the Pearl River Delta region of Guangdong in South China, setting up his Shan Hsing Lighting in a sleepy hamlet of rice fields and duck farms called Dongguan. Since then the region has grown into the largest manufacturing 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 factory, which opened earlier this year.

Now many of China's manufacturers—including Shan Hsing—are undergoing 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 already tight labor market. Soaring commodity and energy prices, as well as Beijing's cancellation of preferential policies for exporters, have hammered manufacturers. The appreciation of the Chinese currency has shrunk already razor-thin margins, pushed thousands of manufacturers to the edge of bankruptcy, and threatened China's role as the preeminent exporter of low-priced goods.

Hsu's new factory, it turns out, is running at just 60% of capacity, and he predicts that half of China's lighting factories—almost all based in Guangdong—will have to close their doors this year. "Shoe factories, clothing, toys, furniture, everyone is shutting down," he says. Hsu's not alone in his alarm. "We spent 20 years building up our industry from nothing to one of the biggest in the world," says Philip Cheng, chairman of Strategic Sports, which produces half the global supply of motorcycle, bicycle, and snowboarding helmets out of 17 plants in the Pearl River Delta. "Now we are dying." Cheng says he once earned 8% margins. His margins now? Almost zero.

Comprehensive statistics on shutdowns are hard to come by. But the Federation of Hong Kong Industries predicts that 10% of an estimated 60,000 to 70,000 Hong Kong-run factories in the Pearl River Delta will close this year. In the past 12 months, 150 factories making shoes or supplying shoemakers have closed in Dongguan, says the Asia Footwear Assn. More plants will disappear as demand slows: UBS (UBS) analyst Jonathan Anderson expects overall export growth of just 5% or less for China this year.

Chinese policymakers so far profess little concern. The closures are mainly hitting lower-value, labor-intensive exporters that pollute heavily and use energy inefficiently. Beijing now wants cleaner industries that produce higher-quality items for the local market, from cars and planes to biotech products and software. That emphasis not only helps boost domestic consumption—a key national goal—but also reduces frictions internationally from the ever-swelling trade surplus. "We are not abandoning the [exporters]," said Guangdong Governor Huang Huahua on Mar. 8. "[But] selling domestically is good for the country, good for the collective, and good for the people."

Still, the shift in the manufacturing base is likely to hit harder and be felt more widely than officials expect. So far, most shutdowns have been in Guangdong, but the pain is hardly limited to the region. When more than a hundred South Korean-owned factories closed over the Chinese New Year in the eastern 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. A report by the American Chamber of Commerce in Shanghai found that more than half of foreign manufacturers in China believe the mainland is losing its competitive advantage over countries like Vietnam and India. Almost a fifth of the companies surveyed are considering relocating out of China. "The big story here is that globalization is for real—and China is no longer what it was," says Ronald Haddock, a vice-president at consultant Booz Allen Hamilton, which wrote the report.

The rise of the yuan may be the biggest single factor driving companies to relocate. But other government policies are contributing to the crisis. Last year, Beijing decided to cut or cancel tax rebates on more than 2,000 items used to make exported goods. The impact has been huge. "The end of rebates has raised the cost of manufacturing many goods by 14% to 17% at the factory level," says Harley Seyedin, president of the Guangzhou-based American Chamber of Commerce in South China.

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