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Factory Closings In South China. All Part Of The Plan.

Published: 31 May 2013 01:07:04 PST

By: Steve Dickinson 

Yesterday we were greeted in the foreign press with the following headline: Southern China Sees Wave of Manufacturing Bankruptcies. This was predictably followed by vehement denials vehement denials from the Chinese government. For example, the CCTV Channel 9 business news was full of stories today stating that Chinese SMEs throughout the country are operating smoothly. The result being the usual complete lack of clarity about what is really going on in China as the coastal regions restructure their manufacturing base in the face of reduced demand and higher costs.

The basic story is that that low value added/high labor content manufacturers from Wenzhou in Zhejiang down to Zhuhai in Guangzhou are undergoing extreme financial stress. The affected sectors are in the traditional outsourcing industries: textiles, toys, shoes and furniture. The reports are that many of the oldest and largest manufacturers in these sectors are closing their doors, leaving behind bad debts and unpaid workers.

These stories may be true or false.Certainly the bankruptcy of one or two companies in a competitive world does not constitute a trend. So the truth may be somewhere in between the “the sky is falling” and “what me worry” positions we are seeing in the discussion.

What I find interesting is the consistent misunderstanding of foreign observers on the Chinese government position on the matter. Specifically, many observers are surprised at the relatively casual response of the central and local governments to the issue. This is because these observers do not see that this process is completely consistent with central government policy.

Let’s state the situation more clearly. Assume for now that the stories are true. If true, the process is exactly what the central government intends to happen to manufacturing in China’s coastal regions, particularly in the Zhejiang/Fujian/Guanzhou region. Stated bluntly, if Chinese government policy is causing the bankruptcies, this is intentional. If the bankruptcies are the result of market forces, the government intends to do nothing to soften the blow.

Here is a basic explanation of what is going on:

1. The 12th Five Year plan clearly states that a primary goal is to eliminate low value added/high labor content export manufacturing from the entire coast. The intent is to shift to high value added, technologically advanced manufacturing and modern services in this region. The bankruptcies in the low value added sector are entirely consistent with central government policy.

2. Many of the manufacturers in this sector are controlled by foreign capital: Korea, Taiwan, Hong Kong and Singapore. Where not foreign owned, the owners are rebels against the state like the group centered in Wenzhou. The central government is not happy with either group and is quite happy to see them go.

3. It is important to understand that the vast majority of these export based manufacturers are not economically viable. They exist because of VAT rebates, open violation of the Chinese wage and labor laws and subsidized energy and raw material prices. They have been tolerated in the past solely because they provide jobs. They provide no other benefit to China and are in many cases actually harmful. Moreover, the jobs they provide are for migrant labor, which is a source of social unrest in China. China wants these migrants to return to Sichuan and elsewhere. They want the businesses to operate according to the requirements of Chinese law. For these reasons it is a sound policy to force these export manufacturers to either become economically viable and law abiding businesses or to force or allow them to simply go away. It makes little sense to continue to support them with subsidies and loans.

4. On a much deeper level, as the 12th Five Year Plan states, the center seeks to transform the Guangzhou/Fujian/South Zhejiang industrial zone. The goal is to eliminate of most or all of the private, export oriented, low value added/high labor content businesses located in those areas. Though the discussion is couched in economic terms, the underlying reason is political. The center is tired of the independence of the southern coastal regions. Since there is no longer any strong economic reason to tolerate this independence, the center is now moving to reassert control in these regions.

It therefore makes perfect sense that the center is relatively unconcerned about a “wave of bankruptcies” in the south. They believe they can handle the results in various ways. In terms of job loss, the message is: go home and find a job back in Sichuan or Henan or wherever the migrant workers were originally located. There are plenty of jobs for Guangzhou residents, so the issue is really convincing the migrants to go back home.

In my own lectures on this issue, I have commented that elimination of low value added manufacturing on the coast seems to be a bad policy on economic grounds. That is, China is still in the situation where low value added/high labor content manufacturing is a good way to take advantage of the large number of low skill workers available in China. However, now that I look at the situation from the standpoint of the center, I find that it makes sense to conclude that there is no benefit to China in keeping these really bad companies alive through loans and subsidies. It therefore seems that the transformation of this sector and the resulting closing of unviable manufacturers will continue unabated. This is because the process makes political sense, which is the most important consideration in China. The fact that it makes economic sense is a secondary, collateral reason for continuing.

What are you seeing in the South?

Update: Dan actually gave a TV interview relating to this subject a few weeks ago when he was in China. That interview can be found here.

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