Sign of the Times - American Recession Makes its Way to China

From Businessweek:

China's Factory Blues
The days of ultra-cheap labor and little regulation are gone. As manufacturers' costs climb, export prices will follow.

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.

My Take: Global markets are a tough business and if Chinese companies can't compete on price then they will have to make the switch to higher-end quality goods (easier said than done). This is the path Japan and Korea took in the 1960's through the 1980's.

As the American dollar continues to fall and American consumers cut back on everything as the recession takes its toll, China will have to find new markets for it's goods and will probably have to change the goods it produces and how it produces them.