Rising costs and policy changes are forcing low-end manufacturers out of business, or out of China

HONG KONG: A deathly silence hangs over karaoke bars in cities and towns in the Pearl River Delta in southern China, across the border from Hong Kong.

These entertainment establishments in Guangdong province, which is better known as the ¡®world¡¯s factory floor¡¯, resonated with the raucous warbling of boisterous Chinese businessmen during the boom years when low-cost made-in-China goods flooded the world¡¯s markets.

In recent months, however, escalating costs, a sharp slowdown in the US and European markets, a galloping Chinese yuan and a slew of policy changes by the Chinese government have forced the closure of tens of thousands of low-end export-driven factories in southern China, which used to churn out everything from shoes to toys to clothing to furniture. And many of the factories that remain in business are seriously considering relocating ¡ª to inland provinces in China, where costs are relatively lower, or even to other countries, like India, Vietnam, Bangladesh and Mexico.

Regional trade associations estimate that by the end of 2008, over 100,000 factories in China, most of them in the low end of the manufacturing spectrum, will have closed down. But even those higher up on the manufacturing scale have been impacted.

Indian conglomerate Videocon, which manufactures colour picture tubes at its Guangdong facilities, is scaling back production lines. And Taiwanese technology major Foxconn is hedging against the rising ¡®China price¡¯ and opening new factories farther afield in India and Hungary.

Earlier this year, M. Arunachalam, a Hong Kong-based garments manufacturer who sources from China for the world markets, moved some of his supply lines from China to Vietnam and Bangladesh. ¡°Exporters are finding it very difficult,¡± Arunachalam told DNA. A labour contract law, introduced this year, has pushed up wage costs, and a tighter enforcement of pollution control laws is forcing factories to upgrade their technology - or shut shop. ¡°Many low-tech industries, squeezed by shrinking margins and severe credit constraints, are closing down,¡± he observes.

¡°At the margin and in some areas, China is not the cheapest place to do business anymore,¡± CIBC World Markets senior economist Benjamin Tal told DNA from Toronto. High transport costs, driven by high oil prices, are changing the geography of manufacturing, he argues. ¡°We¡¯re seeing a situation where, in the steel industry, for instance, transport costs can make a difference between ¡®Made in China¡¯ and ¡®Made in the US¡¯. American companies are doing the math and shifting some businesses from China... And if energy prices remain high, as we believe they will, you¡¯ll see more and more industries leaving China.¡±

All this ties in with the Chinese government¡¯s efforts to reposition China higher up the value chain of manufacturing, says Chris Devonshire-Ellis, Beijing-based senior partner at Dezan Shira & Associates, which provides legal, tax, accounting and due diligence services for multinational clients in China, India, Hong Kong and Vietnam. ¡°China no longer wants to be the manufacturing capital of the world,¡± he adds. ¡°It wants to be the added-value production capital of the world.¡±

China, observes Devonshire-Ellis, has introduced a range of measures to ¡°push a certain type of manufacturing¡± - typically energy-intensive or environmentally polluting businesses - out of China and into other countries. ¡°On the other hand, China has put in place a raft of incentives to attract high-tech businesses and those that can offer added value.¡±

China still offers cost advantages in many verticals, argues Richard Brubaker, managing director of China Strategic Development Partners, a Shanghai-based business consultancy. ¡°It¡¯s hard for many manufacturers to leave China because there is no business case to move.¡± It¡¯s not just that China has superior infrastructure and a huge supply base; increasingly, firms are manufacturing not just for export but for the China market. Besides, adds Brubaker, China is a familiar place: ¡°firms have already negotiated and closed deals here. To start over in a country like India or Vietnam would require a long process.¡±

Yet, with all the merits, the business environment for factories in southern China has become severely challenging, says Hong Kong Federation of Industries director-general Dennis Yau. If things don¡¯t get better by the year-end, many more factories may be forced to shut down or move out to South East Asia or elsewhere, he adds.

In that event, the karaoke bars in the Pearl River Delta may just have to get used to the sounds of silence...