Tuesday, August 19, 2008

Thousands of Chinese Factory Closings Predicted Due to Increased Labor, Energy & Manufacturing Costs, Appreciation of Renminbi & Reduced US/EU Imports



Tuesday, August 19, 2008

By Ian Williams, NBC News Correspondent

Blogging from Beijing

GUANGDONG, China – Once the Olympic party is over, is China heading for an economic hangover?

Ben Schwall, for one, thinks the headache is already setting in for the country's seemingly unstoppable export machine.

"If you are a factory owner here, it’s not like you're being kicked around. Somebody has hit you over the head with a baseball bat," he said.

I met Schwall on a recent visit to the southern Chinese province of Guangdong, where he buys decorative lights for a string of U.S. retailers. "It's the perfect storm," he told me. "You've got a drop in demand. Business stinks. At the same time prices are going up."

‘Perfect storm’

The "perfect storm" is being caused by the soaring price of oil and other raw materials, spiraling labor costs, and the appreciation in the value of China's currency against the U.S. dollar, as well as a sharp down turn in demand as the U.S. faces possible recession.

Factories are closing right across the region where China's export boom began, with the most pain being felt at the low end – lighting and shoe factories, for instance. One of the few businesses still booming is scrap metal, teams clearing the remains of shuttered production lines.

Dong Tao, the Chief Asia Economist at Credit Swisse, just across the border in Hong Kong, calls it the end on an era of ultra-cheap Chinese exports.

"We expect that in the next three years, one third of Guangdong's manufacturing export factories will be closed down," he told me.

There are tens of thousands of factories here. If China is the workshop of the world, then this is its engine. A third of China's exports come from Guangdong, feeding the world's insatiable appetite for everything from shoes to lights to electronic goods.

"The entire world had the impression that the happy party of very cheap Chinese goods could last forever," Dong said. "I thought that. But I think perhaps its coming to an end."

The oil price affects the cost of production, but also the cost of shipping raw materials to China and then shipping the finished product to the U.S.

Cheap labor drying up

China's limitless supply of young cheap labor seems to be drying up too. The minimum wage in Guangdong has doubled in three years, and now stands at around $120 a month. With overtime, workers are taking home more than $200 a month.

The one-child policy is beginning to slow the supply of nimble-fingered young women, favored by the factories. And the new generation of migrant workers from the countryside are more choosy about work – and more savvy.

At one big street side labor market, young migrants work their mobile phones, comparing wage rates between factories. A new labor law has given them more muscle, especially since – to the consternation of factory owners – the government seems determined to enforce it.

Labor turnover is running as high as 75 percent annually at some factories.

‘No profit!’

Many of the factories in this region are owned by Hong Kong and Taiwan entrepreneurs. Men like Philip Cheng, whose company, Strategic Sports, is one of the biggest manufactures of crash helmets, bemoan the sharp downturn. "We don't have any profit now. No profit!" he told me, as helmets snaked along on the conveyor belt behind him, workers pasting on the visors. "The days of cheap labor have gone. No cheap labor. OK?"

Down the road, Dongguan Shan Hsing Lighting has just moved into a new factory, but is now operating at fifty percent capacity. It’s been hit by the crisis in the U.S. housing market, its biggest customer. The company's president, Tim Hsu, said profits have dried up.

"With constantly rising prices, we have to raise our quotes to survive. American consumers will have to pay higher prices," he said.

Dong at Credit Swisse agreed."Watch out," he said, "the prices in Wal-Mart, Home Depot, Motorola, they're going up."

Other factories are chasing lower labor costs elsewhere. Dong told me forty percent of factories he surveyed recently are looking to move – either to inland China, where costs are less, or out of the country.

Cheng of Strategic Sports is looking at Vietnam, where labor costs are now around half of those of China; Schwall, the lighting buyer, is planning a visit to India.

For Schwall, there's another headache. His company, Aliya Intenational, also monitors quality, making sure manufacturers aren’t cutting corners in the production process or using sub-standard or dangerous materials, a task made all the more important following last year's spate of product recalls.

He said that even before the latest surge in costs, factories were operating on wafer-thin profit margins, and now some may be more tempted to take short cuts as a way of cutting costs.

"The devil is everywhere," he told me as he examined the fittings on an elaborate chandelier he'd plucked from a busy production line. "And of course there is temptation."

He said he feels much happier when the factories he's dealing with are at least making some money, since the temptation to cut corners then is not as great.

What does it mean for China Inc?

All of which begs the question of what this means for China Inc. The pain seems most acute in the export manufacturing heartlands of the south, and doesn't appear to have yet dented China's overall growth rate, which remains above 10 percent – though many economists are skeptical about the accuracy of the official figures.

The Chinese media has carried stories pointing to a slowdown, but they have tended to follow the official line of keeping bad news off the presses during the Olympic Games. Officials in Guangdong have also played it down, describing the closures as just a normal transition away from low-end production, of the kind that took place in Taiwan, Korea or Japan. Which may well be good in the long term.

The problem is the meltdown is happening so quickly. The head of the Hong Kong Small and Medium Enterprise Association, whose members are big investors, warned in late June that 20,000 of the 70,000 Hong Kong-owned factories in Guangdong could close this year. He said the region is no longer competitive.

Economic ups and downs are not new to the rest of the world, but China has known little but boom for nearly thirty years. Breakneck double digit growth has become the norm. No other major economy has grown like China over that period.

Moreover, China's communist leaders, presiding over one of the world's most rapacious capitalist economies, have traded on their ability to deliver economic growth to dampen demands for political change.

The massive Olympic rebuilding – with its $40 billion price tag – also provided an economic stimulus, which will soon be over. The Games have given a big "feel good" lift to Chinese, about what they've achieved and where they are going.

This, and the seemingly unstoppable boom, have set expectations very high about the future, which could make a post-Olympic economic slowdown all the more difficult to manage.



Don't Bet on the Renminbi

by Calla Wiemer

Far Eastern Economic Review

July 30, 2008

Rumor has it that hot money is betting on a sharp appreciation of the renminbi. China’s official reserve assets seem to accumulate at ever increasing rates, and recent increases are not accounted for by the trade surplus and net foreign direct investment. It appears there’s money coming in, but why would speculators be betting on a big-time revaluation? It doesn’t fit with macroeconomic fundamentals.

The fundamentals rest with the domestic relationship between saving and investment. The difference is the trade imbalance since saving not channeled into domestic investment becomes a capital outflow and a capital outflow is financed by export revenues not spent on imports. In a span of just six years, China's national saving rate rose by a dramatic 12 percentage points of gross domestic product, from 38% in 2000 to 50% in 2006 (see nearby graph). From an already high level then by international norms, it went stratospheric. The investment rate was also high and rose in parallel until 2004. During this stretch, the saving/investment gap ran at about two and a half percent of GDP. Then the investment rate flattened out at around 43% while the saving rate pushed inexorably upward, and correspondingly the trade surplus soared.

My own research shows that most of the increase in the saving rate can be explained by China's extremely high GDP growth rate in the post-2000 period (www.lkyspp.nus.edu.sg/wp/wp08_08.pdf). When countries experience breakneck growth in income, consumption as a general rule tends not to keep up. Also contributing to China’s rising saving rate is a falling dependency ratio as saving is higher among those in their working years versus the young or the elderly.

The exchange rate has played a passive role in this story. The peg in place at the outset of the post-millennial growth surge dates essentially to 1994. Exchange rate unification at that point established a rate that was in line with market forces, yielding a small, arguably prudent, surplus in the trade account (i.e., a small gap of saving over investment as visible in the nearby graph). Indeed, in the wake of the Asian financial crisis a few years later the Chinese government made much of holding the line against devaluation. For a decade, the pegged exchange rate was a boon to trade and investment because it provided stability, not because it distorted the market. To have prematurely revalued the currency would have choked off exports and stimulated imports at a cost of slower income growth and job creation.

The growth spirt post-2000 was stupendous, beyond what the official figures reveal (a claim that is empirically supported in the paper referenced above). But with growth of this order came the saving rate increase and hence, when investment was administratively restrained in 2004, the gaping trade imbalance. Until the 2004 juncture, a peg at 8.3 had been credible. With the mounting trade surplus though, the exchange rate came under pressure. The Chinese government’s response to that pressure has been to move gradually away from a peg and develop the institutional structure for market-based exchange rate determination. In that context, the central bank has been caught holding the bag, absorbing surplus foreign exchange inflows as the trade surplus widened and private investment inflows stepped up. There was not a deliberate policy stance to run up the trade surplus by leaps and bounds and accumulate massive foreign reserves. It just turned out that way given the existing peg and phenomenal GDP growth.

Growth momentum was sustained through a feedback loop to the U.S. economy. The accumulation of forex reserves in China had its counterpart in a capital inflow to the U.S. Such an inflow tends to push up the value of the U.S. dollar which undermines U.S. exports and boosts U.S. imports. This slows down the U.S. economy. The ready antidote to a threat of slowdown is monetary stimulus which there was in full and which found an outlet in rising asset prices. This made Americans happy to go on consuming. The bottom line was the U.S. kept growing and buying Chinese goods and China kept growing and lending money to the U.S. For awhile both sides enjoyed strong growth and increasing wealth. The problem, we found out belatedly, was that the U.S. financial system was not capable of allocating burgeoning investment funds effectively, and the fallout from that spells the end of the cycle.

There are Chinese observers who blame U.S. monetary policy for the imbalances and the whole upward spiral which bore the seeds of its own collapse. And Americans of course blame China's "artificially low" exchange rate. Actually, the forces were symbiotic and both sides enjoyed the boom times while they lasted.

The inevitable slowing of China’s growth rate will only gradually contribute to a decline in the saving rate. But there are policy measures that can be brought to bear with very substantial prospects for pushing the saving rate down, and these measures are worthwhile for intrinsic reasons as well. Such measures include: building the social welfare system; improving the financial system; and absorbing profits from SOEs in the fiscal budget.

Increased fiscal spending on social welfare programs has an expansionary impact, and this at a time when the economy is already showing signs of rising inflation. This is where the exchange rate finally comes in. There is a role for currency appreciation within the broader scope of macroeconomic policy now where there had not been previously, in my view, strictly for purposes of reducing the trade surplus. In combination with expansionary fiscal policy used to stimulate domestic consumption, currency appreciation acts to divert resources out of tradable goods production (less exports and import substitutes) and into social welfare service provision. In this way inflation is kept in check despite the increased fiscal spending. However, the appreciation called for in this context is modest and gradual, and as such should not be cause for any onslaught of speculative capital.

Ms. Calla Wiemer, a Ph.D. in economics and longtime specialist on the Chinese economy, lives in Los Angeles and is writing a macroeconomics textbook for Asia.

No comments: