Heat in the workshop
Saturday, 27 October 2007
Tom Mitchell and Geoff Dyer
The "China price", that once unbeatable benchmark retailers pay for the products made in the world's workshop, is not what it used to be. Data compiled by statisticians in China, Hong Kong and the US all show that, after at least five years of deflation, Chinese export prices have begun to creep up over the past 18 months.
"China's era of exporting deflation to the world is coming to an end," says Jing Ulrich, Hong Kong-based chairman of JPMorgan's China equities business. "Manufacturers are raising their average selling prices and feel confident they can pass on any future [cost] increases. Pricing power has returned to a number of industries due to consolidation, the closure of smaller producers with poor environmental and safety records and natural attrition over the past half-decade, when many manufacturers faced severe margin compression."
This year, the Hong Kong-based Techtronic Industries, one of the world's biggest power tool makers and owner of brand names such as Ryobi, Hoover and Vax, passed cost increases on to retailers for the first time in more than a decade and said it was reviewing its China expansion plans. "Raw materials are going to continue to inflate," said Joseph Galli, chief executive of TTI's appliances unit. "In the early 1990s [the industry] went through inflation. It wasn't fun then either."
Jonathan Anderson, an economist at UBS, cites Hong Kong statistics because "they are closest to the Chinese factory gate". These show the China price inflating at about 3 per cent a year.
Arthur Kroeber, editor of the China Economic Quarterly, argues that Hong Kong data paint a good picture of what is happening in the Pearl River Delta and southern Guangdong province but not necessarily the entire country. "The landed price in the destination country is ultimately the most relevant," he says. According to one index compiled by the US Bureau of Labor Statistics, the price of Chinese exports has risen 1.5 per cent since February.
The wonder, however, is that the China price has not been accelerating at a much faster clip - as it would have to before China's export juggernaut began to slow. The country's January-September exports grew 27 per cent to $878bn (£432bn, €620bn). As Jim Leonard, a Boston-based trader for East West Basics, a trade sourcing company, puts it: "Volume covers a lot of sins."
One answer to the riddle can be found in southern Jiangxi province. The region is famous for being the cultural homeland of China's Hakka or "guest" people, whose name derives from their itinerant history. But county governments in the area, near where Mao Zedong and his ragged band of peasant rebels began their Long March to power, are now playing host to a new generation of migrants - factory owners from Hong Kong, Taiwan and further afield, all seeking cheaper bases for operations away from China's coastal manufacturing hubs.
"We treat the companies that invest in our industrial park as gods," says Zhong Xuhui, vice-chief of Longnan county. "We assign a government official to serve each big company, helping it prepare administrative documents. Companies in our park don't waste their time and energy on paperwork."
The consequences of such hospitality reverberate far beyond Hakka country and other emerging inland manufacturing hubs, by facilitating the steady diffusion of China's export industry from its traditional clusters - such as Hong Kong's Pearl River Delta hinterland or the Yangtze River Delta around Shanghai - to poorer, and more cost-efficient, provinces in the interior. This industrial migration, in turn, is helping to moderate the upward pressure on the China price.
Labour, land and power costs in the Pearl and Yangtze deltas, for example, have been rising at double-digit rates. There have been exponential price increases for essential raw materials such as copper and petroleum-based plastics. Now China's general level of inflation is setting off alarm bells in Beijing, having touched 6.5 per cent in August.
Adding to these pressures, the renminbi has appreciated by 7 per cent against the US dollar ever since it was allowed, three years ago, to drift from its mooring of Rmb8.30 to the greenback.
Mr Anderson argues that this last phenomenon is largely academic in export sectors where factories are merely turning around imported - and therefore often US dollar-denominated - components. But that has not stopped exporters from trying out the excuse anyway, especially last year when the renminbi crawled past the Hong Kong dollar, which is still pegged to its US counterpart at a rate of HK$7.80. And why not, asks Mr Leonard, who sources houseware products for American retailers. "You'd be crazy not to ask."
"Increasing labour and raw material costs are having a significant impact on my business," says Yu Zhonghua, owner of a hat and sock factory in Yiwu, in the Yangtze River Delta. "We have stopped our sock production because we can't find enough workers. Three or four years ago, we could easily find workers to make socks for Rmb900 [$120, £59, €85] a month. Now, even if we pay Rmb1,400-Rmb1,500, they think the job is too tiring and the pay not enough. Other small sock makers face the same situation."
Yet Yiwu, which created its own index in October last year to monitor the effect rising costs was having on local producers, has tracked only a modest 1.42 per cent rise in prices. "The Yiwu index has not gone up significantly since its creation," says Su Weihua, a professor at Zhejiang Industrial and Commercial University and founder of the Yiwu China Small Commodities Index. "In Yiwu, the degree of competition is high, so traders usually won't increase their prices. It is quite hard to measure the extent to which factories can absorb rising costs - it varies for different kinds of products. But they are doing different things, substituting materials, upgrading technology and manufacturing techniques and putting more effort into branding."
The fact that the China price has barely budged relative to its underlying cost pressures is partly a reflection of how fat life was for China-based exporters - most of them owned by Hong Kong, Taiwan and other overseas investors - through the 1990s and the first few years of this decade. Stephen Green, a Shanghai-based economist with Standard Chartered, recently visited some of his bank's manufacturing clients in Shenzhen, across the border from Hong Kong, and says that net furniture margins there have fallen from an "unnaturally high" 30 per cent a few years ago to a more reasonable 10 per cent.
Other manufacturers are flocking to places such as Longnan - some 400km, or five hours by expressway, from Hong Kong - and other counties and cities in southern Jiangxi. Hong Kong managers working in factories there caravan up every Monday and return to their homes on Saturdays to spend the weekend with their families.
Huajian International Footwear, a Sino-Taiwanese joint venture, employs 11,000 - or 40 per cent of its workforce - in Ganzhou, a city 125km north of Longnan, where it turns out footwear for clients such as JCPenney, the US retailer, and the shoe brand Nine West. An aerial photograph of the 170,000?sq?m compound, snapped by Huajian's chairman while flying into Ganzhou's rudimentary airport, is on display in its lobby and captures the factory's sheer scale. Across the road, the company is undertaking a 100,000?sq?m expansion project.
The facility succeeds because Huajian can juggle orders between Ganzhou and its sister factories in the cities of Shenzhen and Dongguan. "Labour costs are lower here," says Li Weimin, a manager at the Huajian plant. "Water and electricity are also cheaper. However, transportation costs are higher and there are no nearby suppliers, which makes us less efficient."
More importantly, 80 per cent of Huajian's workers in Ganzhou were recruited from southern Jiangxi and are less skilled than their Pearl River Delta counterparts. Higher-margin orders that are either time-sensitive or require more skilled labour are handled in Shenzhen and Dongguan; less valuable ones in Ganzhou.
Top Form, a Hong Kong-based bra and underwear maker, employs a similar division of labour between its factories in Shenzhen and Nanhai, also in the Pearl River Delta, and its facility in Longnan. Frillier lingerie bound for France and other European Union markets tends to be processed in Shenzhen and exported by air from Hong Kong. Top Form's Longnan factory focuses on simpler bulk orders for the American market that are sent by the container-load through Yantian.
"We make all the most difficult and expensive styles in Shenzhen," says Larry Ho, a manager at Top Form's Longnan plant. "It is our most skilful factory. We can do some styles that have really good margins there.
"It's hard to find skilled workers here [in Longnan]. That hurts our efficiency," he adds. While it takes three months to train a worker in Longnan, highly skilled workers can be poached from the Pearl River Delta's much deeper talent pool. The monthly wage rates at Top Form's three China factories sum up their capabilities: Rmb1,600 in Shenzhen, Rmb1,200-1,300 in Nanhai and Rmb1,000 in Longnan.
"Ninety per cent of Chinese companies would rather move inland than move offshore," says Standard Chartered's Mr Green. "The idea that we are at a point where entrepreneurs are going to move offshore en masse is not true. They do not think of China as a single country but something more akin to the EU, with different wage rates and tax systems in one customs union."
"[Manufacturing] activity is moving away from the coast," agrees Bruce Rockowitz at Li & Fung, a trade sourcing company with 16 offices on the Chinese mainland. "Where the product is today is not where it was yesterday. You can't look at [China] as one country. We look at it as a multi-country sourcing area."
Yet change beckons even for relatively new-found destinations such as Longnan. "In the beginning, we didn't choose what type of companies came here," Mr Zhong, the county's vice-chief, says in his thick Hakka accent. "But now we don't want companies that need lots of labour, consume too much electricity or occupy large tracts of land. We now welcome capital-intensive and high-tech companies."
When Top Form arrived in Longnan, hundreds of people would queue outside its gates looking for work. Now a gathering of 30 or 40 workers would be considered a good-sized crowd. As Mr Ho says: "We can never stick to one place for good. For now it's Jiangxi. But Jiangxi may not be competitive in five years' time. Maybe our next factory will be even further inland."
The "China price", that once unbeatable benchmark retailers pay for the products made in the world's workshop, is not what it used to be. Data compiled by statisticians in China, Hong Kong and the US all show that, after at least five years of deflation, Chinese export prices have begun to creep up over the past 18 months.
"China's era of exporting deflation to the world is coming to an end," says Jing Ulrich, Hong Kong-based chairman of JPMorgan's China equities business. "Manufacturers are raising their average selling prices and feel confident they can pass on any future [cost] increases. Pricing power has returned to a number of industries due to consolidation, the closure of smaller producers with poor environmental and safety records and natural attrition over the past half-decade, when many manufacturers faced severe margin compression."
This year, the Hong Kong-based Techtronic Industries, one of the world's biggest power tool makers and owner of brand names such as Ryobi, Hoover and Vax, passed cost increases on to retailers for the first time in more than a decade and said it was reviewing its China expansion plans. "Raw materials are going to continue to inflate," said Joseph Galli, chief executive of TTI's appliances unit. "In the early 1990s [the industry] went through inflation. It wasn't fun then either."
Jonathan Anderson, an economist at UBS, cites Hong Kong statistics because "they are closest to the Chinese factory gate". These show the China price inflating at about 3 per cent a year.
Arthur Kroeber, editor of the China Economic Quarterly, argues that Hong Kong data paint a good picture of what is happening in the Pearl River Delta and southern Guangdong province but not necessarily the entire country. "The landed price in the destination country is ultimately the most relevant," he says. According to one index compiled by the US Bureau of Labor Statistics, the price of Chinese exports has risen 1.5 per cent since February.
The wonder, however, is that the China price has not been accelerating at a much faster clip - as it would have to before China's export juggernaut began to slow. The country's January-September exports grew 27 per cent to $878bn (£432bn, €620bn). As Jim Leonard, a Boston-based trader for East West Basics, a trade sourcing company, puts it: "Volume covers a lot of sins."
One answer to the riddle can be found in southern Jiangxi province. The region is famous for being the cultural homeland of China's Hakka or "guest" people, whose name derives from their itinerant history. But county governments in the area, near where Mao Zedong and his ragged band of peasant rebels began their Long March to power, are now playing host to a new generation of migrants - factory owners from Hong Kong, Taiwan and further afield, all seeking cheaper bases for operations away from China's coastal manufacturing hubs.
"We treat the companies that invest in our industrial park as gods," says Zhong Xuhui, vice-chief of Longnan county. "We assign a government official to serve each big company, helping it prepare administrative documents. Companies in our park don't waste their time and energy on paperwork."
The consequences of such hospitality reverberate far beyond Hakka country and other emerging inland manufacturing hubs, by facilitating the steady diffusion of China's export industry from its traditional clusters - such as Hong Kong's Pearl River Delta hinterland or the Yangtze River Delta around Shanghai - to poorer, and more cost-efficient, provinces in the interior. This industrial migration, in turn, is helping to moderate the upward pressure on the China price.
Labour, land and power costs in the Pearl and Yangtze deltas, for example, have been rising at double-digit rates. There have been exponential price increases for essential raw materials such as copper and petroleum-based plastics. Now China's general level of inflation is setting off alarm bells in Beijing, having touched 6.5 per cent in August.
Adding to these pressures, the renminbi has appreciated by 7 per cent against the US dollar ever since it was allowed, three years ago, to drift from its mooring of Rmb8.30 to the greenback.
Mr Anderson argues that this last phenomenon is largely academic in export sectors where factories are merely turning around imported - and therefore often US dollar-denominated - components. But that has not stopped exporters from trying out the excuse anyway, especially last year when the renminbi crawled past the Hong Kong dollar, which is still pegged to its US counterpart at a rate of HK$7.80. And why not, asks Mr Leonard, who sources houseware products for American retailers. "You'd be crazy not to ask."
"Increasing labour and raw material costs are having a significant impact on my business," says Yu Zhonghua, owner of a hat and sock factory in Yiwu, in the Yangtze River Delta. "We have stopped our sock production because we can't find enough workers. Three or four years ago, we could easily find workers to make socks for Rmb900 [$120, £59, €85] a month. Now, even if we pay Rmb1,400-Rmb1,500, they think the job is too tiring and the pay not enough. Other small sock makers face the same situation."
Yet Yiwu, which created its own index in October last year to monitor the effect rising costs was having on local producers, has tracked only a modest 1.42 per cent rise in prices. "The Yiwu index has not gone up significantly since its creation," says Su Weihua, a professor at Zhejiang Industrial and Commercial University and founder of the Yiwu China Small Commodities Index. "In Yiwu, the degree of competition is high, so traders usually won't increase their prices. It is quite hard to measure the extent to which factories can absorb rising costs - it varies for different kinds of products. But they are doing different things, substituting materials, upgrading technology and manufacturing techniques and putting more effort into branding."
The fact that the China price has barely budged relative to its underlying cost pressures is partly a reflection of how fat life was for China-based exporters - most of them owned by Hong Kong, Taiwan and other overseas investors - through the 1990s and the first few years of this decade. Stephen Green, a Shanghai-based economist with Standard Chartered, recently visited some of his bank's manufacturing clients in Shenzhen, across the border from Hong Kong, and says that net furniture margins there have fallen from an "unnaturally high" 30 per cent a few years ago to a more reasonable 10 per cent.
Other manufacturers are flocking to places such as Longnan - some 400km, or five hours by expressway, from Hong Kong - and other counties and cities in southern Jiangxi. Hong Kong managers working in factories there caravan up every Monday and return to their homes on Saturdays to spend the weekend with their families.
Huajian International Footwear, a Sino-Taiwanese joint venture, employs 11,000 - or 40 per cent of its workforce - in Ganzhou, a city 125km north of Longnan, where it turns out footwear for clients such as JCPenney, the US retailer, and the shoe brand Nine West. An aerial photograph of the 170,000?sq?m compound, snapped by Huajian's chairman while flying into Ganzhou's rudimentary airport, is on display in its lobby and captures the factory's sheer scale. Across the road, the company is undertaking a 100,000?sq?m expansion project.
The facility succeeds because Huajian can juggle orders between Ganzhou and its sister factories in the cities of Shenzhen and Dongguan. "Labour costs are lower here," says Li Weimin, a manager at the Huajian plant. "Water and electricity are also cheaper. However, transportation costs are higher and there are no nearby suppliers, which makes us less efficient."
More importantly, 80 per cent of Huajian's workers in Ganzhou were recruited from southern Jiangxi and are less skilled than their Pearl River Delta counterparts. Higher-margin orders that are either time-sensitive or require more skilled labour are handled in Shenzhen and Dongguan; less valuable ones in Ganzhou.
Top Form, a Hong Kong-based bra and underwear maker, employs a similar division of labour between its factories in Shenzhen and Nanhai, also in the Pearl River Delta, and its facility in Longnan. Frillier lingerie bound for France and other European Union markets tends to be processed in Shenzhen and exported by air from Hong Kong. Top Form's Longnan factory focuses on simpler bulk orders for the American market that are sent by the container-load through Yantian.
"We make all the most difficult and expensive styles in Shenzhen," says Larry Ho, a manager at Top Form's Longnan plant. "It is our most skilful factory. We can do some styles that have really good margins there.
"It's hard to find skilled workers here [in Longnan]. That hurts our efficiency," he adds. While it takes three months to train a worker in Longnan, highly skilled workers can be poached from the Pearl River Delta's much deeper talent pool. The monthly wage rates at Top Form's three China factories sum up their capabilities: Rmb1,600 in Shenzhen, Rmb1,200-1,300 in Nanhai and Rmb1,000 in Longnan.
"Ninety per cent of Chinese companies would rather move inland than move offshore," says Standard Chartered's Mr Green. "The idea that we are at a point where entrepreneurs are going to move offshore en masse is not true. They do not think of China as a single country but something more akin to the EU, with different wage rates and tax systems in one customs union."
"[Manufacturing] activity is moving away from the coast," agrees Bruce Rockowitz at Li & Fung, a trade sourcing company with 16 offices on the Chinese mainland. "Where the product is today is not where it was yesterday. You can't look at [China] as one country. We look at it as a multi-country sourcing area."
Yet change beckons even for relatively new-found destinations such as Longnan. "In the beginning, we didn't choose what type of companies came here," Mr Zhong, the county's vice-chief, says in his thick Hakka accent. "But now we don't want companies that need lots of labour, consume too much electricity or occupy large tracts of land. We now welcome capital-intensive and high-tech companies."
When Top Form arrived in Longnan, hundreds of people would queue outside its gates looking for work. Now a gathering of 30 or 40 workers would be considered a good-sized crowd. As Mr Ho says: "We can never stick to one place for good. For now it's Jiangxi. But Jiangxi may not be competitive in five years' time. Maybe our next factory will be even further inland."