Guangdong's Factories are Shutting Down

It hasn't been determined precisely how many factories succumbed to the flooding that ravaged southern China last week. But Mother Nature has become yet another push factor now driving small, low-tech manufacturers to quit the Pearl River Delta, a former rice-growing region remade by 1980s capitalist reforms into a world-beating export platform for textiles, sporting goods and toys. Many of the delta's factories were underwater even before the summer rains started falling. During a trip through the industrial city of Dongguan recently, Credit Suisse's top economist for Asia, Dong Tao, witnessed five factories in the process of shutting down. Workers had queued outside and "bosses were making severance payments," he says.

Such scenes are reminiscent of bygone industrial transitions in Japan, South Korea and Taiwan in which low-end factories—the engines that powered economic takeoff—lost competitiveness and either migrated or shut down. Twenty years ago Guangdong was the place most small, family-owned manufacturers in Asia flocked to, making it China's top exporting province and a magnet for migrant labor from the hinterland. But since 2005, wages have risen 14 percent a year and the yuan began to appreciate, the trend has reversed. Tougher labor, tax and environmental rules implemented this year, combined with spiraling energy and material costs, have driven thousands of factories to quit the delta, the start of an inevitable "hollowing out," says Tao. "Twenty years ago [Taiwan's southern industrial city] Kaohsiung was the fifth largest container port in the world, but today it's an angry town with 20 percent unemployment. This is what's going to happen in [China's] Guangdong province."

In certain respects, Guangdong's transition is all part of Beijing's grand plan. In recent years national and provincial leaders have stressed a newfound desire for "quality investment" in the province—meaning funds for high-tech projects farther up the value chain, not labor-intensive assembly. They're also pushing services including logistics, information technology and banking, much of which is now handled in neighboring Hong Kong. Their aim: to maintain Guangdong's double-digit growth rate, create higher-paying jobs and decrease the province's dependence on low-end manufacturing, which is often resource intensive and highly polluting. To hasten that transformation, Guangdong has repealed tax rebates for exporters and adopted a new Labor Contract Law that guarantees compensation for overtime work, offers mandatory severance and requires employers to make social-security payments that together "increase production costs 25 to 30 percent," says Chu-Chia Lin, an economist at National Chengchi University in Taipei.

The stakes are high. Guangdong alone accounts for a quarter of China's exports and employs an estimated 17 million migrant workers from interior provinces, the bulk of which labor at low-tech, foreign-owned factories of the sort that are under intensifying cost pressures to leave. "Cleaner and greener is good, but I'm not sure [the shift from sweatshop to high-tech or service-sector jobs] will be a one-for-one replacement," says Albert Ting, chairman of CX Technology Corp., which owns factories in Taiwan, China and Vietnam.

Credit Suisse estimates that a third of Guangdong's export factories could be shuttered within three years. On June 2, the influential Taiwan magazine Business Weekly ran a cover story headlined THE EXODUS OF TAIWAN BUSINESSES, which claimed that 10,000 factories, some of them with a two-decade history in the area, have already fled the delta in favor of Vietnam, Cambodia, Bangladesh or Indonesia. Analysts estimate that one in six Hong Kong-invested factories in Guangdong has already closed or moved deeper into China. Wu Chin-ching, a Taiwanese investor who owns four chemical factories on the delta, says he knows of some 200 companies that have closed thus far in 2008. It's an example he may be forced to follow if his losses continue to mount. "I will grit my teeth and try to hang on," he says.

Some larger manufacturers are maintaining current operations on the delta, but expanding in other countries—a strategy known as China plus one. For example, Hon Hai Precision Industries, a massive Taiwan-owned contract manufacturer of computers and cell phones, runs a key facility in Shenzhen but has opened two new manufacturing centers in central China and broken ground on a planned $5 billion facility in Vietnam. Likewise, Compal Electronics, which currently assembles notebook computers in Guangdong, has announced plans to build a $500 million facility in northern Vietnam.

There are those who view the exodus as more of an opportunity than a loss. American Chamber of Commerce in South China president Harley Seyedin recently wrote that the migration of low-end companies farther into China's interior is "freeing land and resources for a new stratum of cleaner, more efficient and higher value-added industries."

Still, the province's share of China's total exports is declining precipitously in certain sectors. Guangdong's garment and textile exports plunged 11.3 percent during the first three months of 2008 from a year earlier. That doesn't make it another Kaohsiung—yet. But with the global economy continuing to weaken and China's export boom starting to wane, there's no guarantee that the transition underway on the Pearl River Delta will proceed as fast or as seamlessly as the planners in Beijing envisage.