An eddy of optimism flows through Yiwu International Trade City as brochures are thumbed, hands shaken, sample products prodded and probed, with maybe a good few contracts to be signed at the end of the day. Yiwu, in eastern Zhejiang province, is a focal point for the small commodities market.
Like its southern cousin, the biannual Canton Fair in Guangzhou, the state of business in Yiwu is fairly regarded as a weather vane for the strength of the country’s manufacturing sector, in terms of both domestic demand and export growth. It draws buyers and sellers by the boat load from far and near.
Business isn’t great, but most agree that it’s improving, slowly. Middle Eastern, African and South American purchasers dominate the never-ending halls of Yiwu’s main trade center; American and western European buyers are in short supply.
"Our customers come more from countries like Brazil and Chile to purchase household goods," said Wang Dongping, a sales manager at Yiwu Luckystar Import & Export.
It is further evidence that the landscape of China’s manufacturing sector is changing. Most theses state that more mass produced goods are being shipped to newer markets, while mature markets begin to lean towards value-added products. But emerging markets are not only interested in rubber ducks.
"There’s a significant market in these developing countries, not only for the low-end, but also for the high-end," said Craig Pepples, Chief Operating Officer of Global Sources, a company that puts foreign buyers in touch with Chinese suppliers. He points to a Brazilian client who comes to China to source products from both ends of the spectrum. At one end are low-priced goods that his country can’t make because of higher costs, and at the other are "high-end goods that Brazil doesn’t have the technology for."
These customers are helping to revive the China export story. Shipments are still falling – down 13.8% year-on-year in October to US$110.8 billion – but there has been a significant improvement from the more-than-20% drops seen earlier in the year. The official Purchasing Managers’ Index (PMI) – a key indicator of manufacturing strength – came in at 55.2 in October, the eighth consecutive month above the expansionary threshold of 50. Meanwhile, the new orders index was 58.5 in October, the most rapid pace of month-on-month expansion since April 2008.
"The numbers were even stronger than the headlines suggest. We have noted in the past that the official statisticians leave seasonal effects in the data," Eric Fishwick, head of economic research at brokerage CLSA, said in a recent report.
On-the-ground views reflect those suggested by Beijing’s data. "It’s like someone has just switched on all the lights," said Christopher Devereux, managing director of ChinaSavvy, a Hong Kong- and Guangzhou-based firm involved in sourcing and manufacturing. "Inquiries and orders have increased in the last month or two, and fairly dramatically."
Revival in Guangzhou
There were also positive signs at the Autumn session of the Canton Fair. Observers noticed a pick-up in the number of buyers from the US and Europe, which adds credence to the theory that the West is crawling out of stagnation and that China’s exporters are seeing the benefits.
Export orders at the Canton Fair totaled US$30.5 billion, up 16.2% on the spring session. However, orders are still only a fifth of 2007 pre-crisis levels.
The plummet in China’s exports has sparked much debate as to the future of the country’s manufacturing model. It has long been argued that a decline in US demand for Chinese-made goods would precipitate the downfall of the export sector. But the country’s manufacturing sector isn’t solely dependent on the US.
Paul Cavey, an economist with Macquarie Securities in Hong Kong, noted in a recent report that, although exports to the US are contracting, the data for some other markets are worse.
Even if the US bounces back to "Macy’s in full credit-splurging mode," he argues that exports would still fail to grow as strongly as before. "At least in the sense of not falling so much, exports to North America have actually been a strong point for China this year," he said.
"The rest of the world is of course a broad bunch, containing considerable variation. While exports to the Middle East fell a moderate 13% this year, sales to non-EU Europe (i.e. Russia) have collapsed by almost 50% year-on-year."
As the makeup of the buyers in Yiwu suggests, downward pressure on exports in certain areas is pushing suppliers into new areas, particularly non-Asian emerging markets. In addition to South America, Wang from Yiwu Luckystar has plenty of customers from the Middle East and Eastern Europe.
This move to fresher markets can also be seen in the number of trade fairs opening up in regions with the potential for strong growth. Although the US, Europe and Japan are all high up on the list of export targets, Pepples of Global Sources said, new markets are opening. "When people talk about new markets, they mean the non-developed markets. These new markets are rising much faster on a year-on-year percentage basis."
Global Sources held its third annual China-focused trade show in Dubai this year, while the equivalent India event is into its second year. A China sourcing fair is planned for Johannesburg in 2010.
The move into newer markets makes sense, according to Shen Minggao, Citi’s chief economist for Greater China. With developed markets close to saturation point in terms of China imports, manufacturers must find new targets – and new products – to keep the numbers going.
"In Japan, you have imports from China already at around 20% of total imports. In Europe and the US, the import share of China-made goods is also rising toward 20%," Shen said.
The fallout from the slump in Western demand didn’t end with exporters having to identify new markets.
It’s hard to put a number on how many manufacturers closed their doors when exports started to feel the squeeze 18 months ago – in January, Beijing estimated that 20 million of the country’s 120 million migrant workers had lost their jobs – or how many firms reopened, in old or new guises, once the order freeze abated.
Nevertheless, industry observers agree that less efficient, labor-intensive operators with a heavy dependency on low-end exports were the first, and hardest, hit. "What happened in the engineering manufacturing segment in the Pearl River Delta (PRD) was a tremendous weeding out of the cowboys… The more professional companies manufacturing good quality products were the ones who survived," said ChinaSavvy’s Devereux.
In this sense, certain symptoms of the export decline weren’t out of kilter with Chinese government policy. Beijing’s long-held objective is to create a manufacturing sector in which the myriad local operators are replaced by larger players that are more efficient – in terms of productivity and energy use – and offer more than just low prices.
Several larger textiles and apparel manufacturers that have spoken to CHINA ECONOMIC REVIEW in recent months said orders were holding up, thanks in part to new customers whose former suppliers went out of business.
"Big state-owned and private enterprises were preparing to move up the value chain long before the financial crisis; small- and medium-sized enterprises (SMEs) still have a long way to go. But the export slowdown, contraction of demand and the decrease in operating efficiency brought by the economic downturn also helped speed up the consolidation," said Zhu Jiang, deputy secretary-general of the Asian Manufacturing Association, which counts the All China Federation of Industry & Commerce and the Chinese Academy of Social Sciences among its backers.
In order to push forward reform, Beijing brought in measures – principally reductions in value-added tax rebates on low-end exports, tougher environmental compliance legislation and the Labor Contract Law – intended to squeeze smaller operators’ profit margins.
Once the full extent of the downturn became apparent, the government backpedaled. Many of the tax rebates were restored, exporters were the target of one of several industry-specific bailout packages, and bank financing was made more available on a nationwide, industry-wide level. Yet SMEs argue that they were largely overlooked, with most of the money and incentives going to larger operators.
"I think there are a lot of bitter people out there," said Devereux. "The SMEs got no help whatsoever. The help went to the big state-owned enterprises or the very large privately help companies," he said. "There has been some help at the local level, but it’s largely to do with contacts – whether you know the right people."
Jason Long, owner of GM Bright Star, a Dongguan-based maker of molds for sporting goods and apparel, describes the government assistance he received as little more than moral support manifested in "reassurances and slogans." He puts his company’s survival down to its use of innovative technology to lower costs and its development of better quality products.
While little cash was awarded to SMEs and lower value-added exporters in the traditional industrial hubs of the Pearl and Yangtze river deltas, massive efforts went into boosting consumption at home. Some manufacturers who had seen the door to overseas markets slammed shut by the global economic crisis suddenly found new ones opening at home.
Auto sales, for example, have been rocketing along thanks to government incentives (See: Car Manufacturers: Inland drive, p36). The Ministry of Commerce also pledged US$2.9 billion in subsidies to rural households, which translated into huge discounts on household goods usually well beyond these people’s means.
The big question is how sustainable this domestic demand is. Much of China’s growth this year has been driven by government stimulus spending, but what happens when the cash stops coming and the preferential policies disappear?
Heinz Fraunhoffer, CEO of CHI Consulting, whose clients include consumer appliances players such as Haier, Midea and GE, believes some manufacturers could face more tough times ahead.
"If, because of the subsidies, most people buy now what they would have bought in a regular pattern of consumption over several years, then as soon as the subsidies go away, future demand will drop sharply," he said. "Sustainability of demand is a cause for concern."
Fraunhoffer is also skeptical about whether it is worth switching focus from exports to domestic demand given the inherent volatility of any market that is driven primarily by government subsidies.
Any transition of this kind is not undertaken lightly. As Devereux of ChinaSavvy points out, an exporter’s horizons stretch no further than taking a deposit, making a product, and shipping it out. "If you are talking about the home market, you have so many other things to consider, he said. "You’ve got to have the capital to make your product, get it distributed across the country, establish warehousing facilities, and get a sales team to sell your goods."
David Levy, the general manager of a US-based factory in Dongguan, Guangdong province, stresses that setting up a local sales division is tantamount to creating an entire new operation. Issues such as local licensing and tax must be addressed. "You don’t just make a decision and turn on a faucet and get local sales," he said.
Even if an export-oriented manufacturer surmounted these obstacles, selling to the domestic market requires something extra: a recognizable brand.
Manufacturers who manage to straddle both markets will inevitably face challenges balancing the two – especially when export demand fully recovers and rivals start building out capacity. It is a big ask and one that comes at a time when firms have other things to worry about.
One key issue affecting manufacturers in the Pearl and Yangtze river deltas is the tightening of the labor supply. "It’s a little counterintuitive," said Levy. "On the one hand you have all these factories closing down, orders have been down, and now when you need the labor. Where is it?"
The answer appears to be – inland. Since the inception of China’s "Go West" strategy in 1999, a host of favorable taxation policies have been pushed through to attract both foreign and domestic manufacturers to set up shop in the hinterland.
Low-end manufacturers in particular have been drawn by the large volume of low-cost workers in inland provinces. This wage differential with the coastal regions, however, has since substantially narrowed and migrant workers, the manufacturers’ core labor force, are therefore less inclined to travel far for work. Anecdotal evidence suggests that with tougher times for coastal manufacturers, many are now considering the move inland. Long of GM Bright Star told CHINA ECONOMIC REVIEW that he believes that Dongguan, where his company has its main plant, will soon no longer be an attractive production base.
"It is hard to hire labor here – migrant workers are heading home and they are just not coming back to coastal areas," he said. "Many of these workers have fields in their hometowns and they can also find part-time jobs. This means their income will not be any less than on the coast."
With wages in coastal areas still rising – according to reports in October, salaries at factories in Guangzhou and Dongguan rose by 19-38% in the first quarter – Long fears that many manufacturers won’t be able to afford to retain staff. In addition, the new Labor Contract Law is implemented more strictly in coastal areas than inland, which further adds to a manufacturers’ cost base.
Long set up operations in Wuhan back in 2006 and is considering Chong¬qing or Chengdu as new production bases to serve local markets.
For some manufacturers, Chengdu isn’t far enough or cheap enough. Vietnam, Thailand, and other locations in Southeast Asia have been thrown around for some time now as the future destinations for manufacturing.
While there have been some relocations, particularly towards the low end of the spectrum, Levy believes the strategy might be misguided. Rising costs, he notes, are nothing new. Before the export decline hit, manufacturers had to contend with renminbi appreciation against the US dollar and rising raw material costs in addition to increased wage demands, the burdens that came with the Labor Contract Law, and the tax rebate cuts.
"People were shaking their heads saying, ‘How are going to make any money?’," he said. "Costs are important, but in the grand scheme of things the cost factor of labor is still pretty low. The factories that are bean-counting the cost of workers are the same ones that are throwing money down the drain in wasteful operations. They could create a lot more value than squeezing money out of the labor force."
Devereux of ChinaSavvy adds that the ones most likely to move are footwear and textiles manufacturers – who are cost-conscious and fleet of foot precisely because they are low-end and not overly reliant on technology. A firm with particular engineering requirements would need a greater incentive to relocate.
Skill and scale
The consensus appears to be that China will maintain its position as a leader in global manufacturing, whether the products end up on shop shelves in Buffalo or Beijing. Necessity may have driven producers toward the domestic market, but this won’t last forever. What seems likely to remain for some time, though, is China’s competitive edge in terms of scale, skilled labor and quality infrastructure.
"The export market will open up again and I’m sure China will promote it while at the same time encouraging manufacturers to open up the domestic market," Deveruex said. "There is virtually nothing you can’t get manufactured in China, and get it done well, if you’ve got the right quality control and a good relationship with the suppliers."