Bankruptcies and Plant Closings Rising in China

We featured reports earlier this year on plant closings in China, and the suffering in manufacturing areas is becoming more acute as the global downturn cuts into Chinese exports.

Reader Michael sent us this report on China’s toymakers, but it also stresses that China may be more vulnerable to a global financial shock than advanced economies. Part of the problem is that many manufacturers were also speculating in currencies or commodities. We also feature a second report from the Guardian, which says that growth in China may fall below 8% due to the drop in manufacturing. While that sounds like a high-class problem, in fact it would be difficult for China, which requires 8% expansion to maintain employment levels. Chinas’ fragile social contract requires more growth to maintain stability. Protests are taking place now, and the worst has yet to arrive.

From China Stakes:

The world financial convulsion is seeping into the Pearl River Delta, base camp of MADE IN CHINA, via Hong Kong. Toy export processing businesses, many owned by HK businesspeople, are closing their doors or going bankrupt because of order reductions from the United States and Europe, or huge losses from inept speculation in financial derivatives…

According to Yu Wenfeng, head of the Assembly Department of Smart Union Group’s Po Shan factory, located in the town of Zhangmutou, Dongguan, orders have actually been pretty good even in early September, and workers have sometimes needed to put in overtime. But insiders disclose that in 2007 Smart Union Group invested and lost 100 million yuan in Fujian Tiancheng Mining, which, along with another HKD 200 million lost in the stock market by some shareholders, brought down the company…

Chuangyi Toys in Shenzhen, a subsidiary of Hong Kong Hua Xing Group, announced its closure on the same day. The boss has absconded, leaving nearly 1,000 employees jobless. The Longgang District Government in Shenzhen had to seal up and sell the property to pay wages to employees who hadn’t received any for a long time.

The spate of closures or bankruptcies of toy companies is not a coincidence. Wang Jun, chairman of the Guangdong Economic Society and vice-president of Lingnan College at Sun Yat-Sen University, points out that the impact of the financial turmoil on China’s tangible economy may be earlier than developed countries. “Economic recession in developed countries triggered by the financial crisis will lead to the reduction of import orders for local enterprises.”

The continuous decline of export growth supports such a judgment. According to customs statistics, during the first three quarters of this year, toy export turnover reached $ 6.31 billion, a growth rate of 3.7%, which is 16.3% below the same period of last year. From January to July, 3507 toy enterprises in China’s showed good export performance, a decrease of 52.7% over the same period of last year.

“Guangdong, whose processing trade accounts for nearly 60% of the whole country’s, will be the first to be affected by the financial crisis,” Wang Jun said. The published data show that from January to July this year, toy export firms in Guangdong dropped by nearly 80 percent. The number of toy exporting businesses in Guangdong now totals only 1404, with 3618 firms having withdrawn from the export market.

Zhao Lei, of Goodbaby Child Products Co., believes that the overwhelming majority of toy businesses in Guangdong are OEM-based with low margins, facing fierce competition, and prone to hiccups in the external environment. That a closures wave is prominent in Guangdong should come as no surprise.

The bankruptcy of toy businesses is only the top of the berg in China. With the spread of financial crisis to the tangible economy, SMEs will go bankrupt one after another when even strong large-scale enterprises are unable to remain unscathed…

As with the last round of closures of a large number of SMEs, many closed companies are OEM businesses with a single product and a high production, generally over-reliant on single market structure. Any substantial reduction in orders makes survival iffy.

Ye Zhongping, on the board of directors of Guangdong Forever Industrial Development Co. and known for his active response to foreign anti-dumping accusations, has extensive experience in foreign trade. In his view, before July, the collapse of a large number of SMEs was due mainly to rising raw material and labor costs, tightening processing trade policy, reductions of the export tax rebate, and continuous RMB appreciation.

“But after July, the collapse of so many large firms is directly related to the financial crisis.” Ye said that along with this, many companies had invested large sums in securities and commodities markets, which have fallen sharply….

With the credit crunch sweeping through western financial institutions, Hong Kong and the Mainland banks are tightening up on credit, which will result in the further tension for many businesses. Henry Tang, the Chief Secretary for Administration in Hong Kong, said a few days ago that the closure and layoff wave among Hong Kong enterprises will have a strong impact on the Pearl River Delta economy.

The Guardian today, in “Chill winds blow through China’s manufacturing heartland,” tells a similar story, abeit with a broader focus than the toy industry:

Two weeks ago, toymaking giant Smart Union was churning out goods for children across the United States and Europe. Now it is in liquidation and 7,000 former employees are in shock.

“One day we went to work as usual, the next it was all closed,” said Wei Sunying, gazing through the barred gate of the factory in Dongguan in southern China where she spent eight years painting plastic components in a fume-filled room…

Few in the west have heard of Dongguan, but the chances are that your shoes, your TV or your children’s toys originated here. Exports have built a city of up to 14 million inhabitants — twice the population of Greater London — almost all migrant workers from the countryside. Its economy has grown 15% annually in recent years.

Now the global financial and economic crisis is proving the final straw for exporters already punished by rising costs and a stronger currency.

In the last year, chill winds have blown through the baking Pearl River Delta. Sixty-seven thousand small and medium-sized businesses in China collapsed in the first half of 2008, many in these manufacturing heartlands, says the national economic planning body. Toy firms have been particularly badly hit, thanks to safety scares and product recalls. Textile firms, with wafer-thin margins, are also reeling.

Next came tighter credit for many foreign-owned firms, such as Hong Kong’s Smart Union. And then, in the last two months, a sharp drop in US and European demand as consumers reined in spending.

A local trade association predicts that by the end of January, Dongguan and its neighbours Shenzhen and Guangzhou will lose 9,000 of their 45,000 factories.

“Many factories are looking at completely empty order books,” warned Stephen Green, head of China research at Standard Chartered, who believes the export sector will be stagnant and could even shrink next year.

Green predicts that China will grow 7.9% next year — well below the double-digit figures enjoyed over the last half decade — while others suggest it could fall closer to 7%.

That sounds enviable to western countries facing recession. But with the working age population still growing, China needs at least 8% growth to maintain the current employment rate. And the fall-out will be highly concentrated in provinces such as Guangdong.

“The social impact of this is going to be huge. The problems are getting bigger and bigger,” said Wooyeal Paik, who is researching Dongguan’s industry and migrant workforce at the University of California at Los Angeles.

“Impromptu protests by disgruntled workers left jobless and without pay are becoming more common; they have resorted to petitioning local officials for backpay because they have few other ways to remonstrate and be compensated.

“They will complain more and they will go to local government offices more… You will see demonstrations and picketing. And probably there’s a risk of violence against bosses — especially foreigners.”…

It’s a sobering end to the dream which lures millions of workers to Dongguan each year, where they struggle and study their way towards the promise of a regular income; perhaps even a place in the burgeoning middle classes. At the city’s night schools, thousands of workers end their long days with classes on everything from car maintenance to law.

Bob Li is one of the area’s success stories. He arrived in 1995 as a casual labourer. “Everyone in my hometown had heard Guangdong was covered in gold,” he said.

Now he manages a factory for Richall, which supplies durable bags to companies such as Walmart, Carlsberg and Disney. Twenty-five thousand totes for Tesco are stacked up awaiting delivery.

But he is unnerved by the economic downturn.

“These days it is getting more and more difficult for factories like us,” he said, citing the cost of wages and materials.

“The exchange rate is already a huge issue here; people are losing interest. The price of our materials has risen because they’re made from oil… Taken together, costs have risen by 30%-40%.”

To some extent, Dongguan has become a victim of its own success. The rising prosperity of the region has created inflationary pressures. Workers want higher wages; new labour laws are designed to wipe out sweatshops but bring higher costs, which squeeze many companies.

Manufacturers have already fled inland to cheaper provinces, in many cases encouraged by Guangdong authorities, who hoped to move the province up the value chain — condensing 200 years of western industrial history into fewer than 15.

“We have a policy to empty the cage for the new birds,” Guangdong’s vice-governor, Wan Qingliang, told reporters this month.

“The ultimate target is to build the Pearl River Delta into the core region of modern manufacturing.”

Others are unsure of the wisdom of the policy in the face of a worldwide downturn.

“Places like Guangdong miscalculated the development of the economy. They actually tried to push those labour intensive and small and medium sized enterprises out of the [established industrial] area because they wanted hi-tech industries there. But when something bad happens, like the economic downturn, what are they going to do?” said Paik.

He acknowledges that numerous East Asian economies, such as Japan, have moved up the value chain in just the same way; and that the Chinese government deserves to be confident, given its economic record.

“But they haven’t experienced a serious economic downturn except right after 1989 and have been overconfident in their policy of the quick transformation of industrial structure toward hi-tech in Guangdong,” he cautioned.

The risk is that officials push the city off the economic ladder rather than up it. Whether new subsidies, export tax rebates and other support for small businesses can save them remains to be seen.

Yet China’s rising living standards in the 30 years since economic reforms were launched has left most people optimistic about its long-term prospects. Migrant workers returning home think they may come back in a few years.

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  1. Anonymous

    I’m sure the “8% growth” involves some pretty accounting techniques. I can see China going into a deep and prolonged recession along with the world (if it isn’t already). Excessive overcapacity and malinvestment. The correction will be equal and opposite to the deception that preceded it.

    The GDP growth measures don’t even count the negative externalities from pollution, GDP is a fallacious measure.

  2. thomas j

    Looks as though China’s leadership will have its hands full dealing with pissed off migrant workers who toiled in the factories then used their salaries to pay for night school only to find out their investment was for naught. A little bit of knowledge is a dangerous thing.

    Nothing like having your dream snatched from you after years of hard work and drudgery. Somehow I don’t think these guys will be content to go back and live on the farm again.

    We’ll see how good the government is at blaming all the problems on foreign factory owners.

    Cultural Revolution Part Deux looms large.

  3. Anonymous

    “But they haven’t experienced a serious economic downturn except right after 1989 and have been overconfident in their policy of the quick transformation of industrial structure toward hi-tech in Guangdong,” he cautioned.

    I just don't understand commentary like this. For one thing, there was no "serious economic downturn" right after 1989… economic crisis in the form of a hyperinflating dual-price planned/market economy preceded and (as is often the case) motivated the 1989 Tiananmen protests. 1993-1996 saw inflation in the 15%-20% range. 1997-1999 saw urban unemployment nearing 10%.

    As far as GDP growth being greater than >8%, not sure when that became such a magical number… but China's GDP officially grew 7.6% from 1998 through 2001 (after the Asian financial crisis), with critics (like Thomas Rawski) claiming this was a smoothed number, with real GDP growth at half that number.

  4. Yves Smith

    Anon of 2:48 AM,

    Thanks for your comment on the 8% number. I have frankly doubted it myself (how can China need 8% growth when it has had its longstanding one child policy?) but whenever I would question it or China’s ability to continue to grow at that level or higher, I’d get a lot of brickbats. Not being a China expert, I wasn’t well equipped to reply. Hence the reliance on orthodoxy.

  5. Anonymous

    China has surprised us on the upside for so long that some people think the usual laws of economic advance don’t hold for them. They do, and there will be a crash.

    It’s not the toy and shoe industry in Guangdong that should be worrying us. China’s foreign trade will weaken considerably, and there will be job losses as a result, but that’s just a normal cyclical downturn.

    The scary part is the vastly overexpanded investment sector. Last year, investment contributed 4.3% to the 11.4% increase in China’s GDP, compared with 4.3% domestic consumption and 2.7% net exports. For years there have been reports of vast overcapacity buildup in heavy industry and a growing bubble in real estate.

    If the global trade downturn (or collapse) triggers a breakdown in the investment sector, then we will see the chinese economy contracting – yes, contracting. The Financial times reported yesterday that over half of chinese steel capacity is already lying idle and steel prices have collapsed. Let’s see what happens next.

  6. fresno dan

    I believe it was Brad Setser (I don’t know how to find his old posts) who had some analysis about China’s devaluing the Yuan and buying treauries. In this analysis, China knocks off another 15% of the nominal price of its exports.
    We must have exported some of our internet geniuses to China – We don’t make any money on the content we give away, but we make up for it with increased eyeballs. (you can’t eat eyeballs…well, you can but you don’t want to)

  7. fresno dan

    me dumb

    It was about the hit to the economy as a whole – not exports
    “Charles Dumas of Lombard Street Research estimates that China makes 1-2 per cent on its (largely) dollar reserves. It then loses up to 10 per cent on the exchange rate and suffers a Chinese inflation rate of 6 per cent for a total real return in renminbi of about minus 15 per cent. That is a loss of $270bn a year, or a stunning 7-8 per cent of gross domestic product.”

    Of course, it that is really true, wouldn’t China be losing less money if it exported less, because it will have less ?yuan or dollars? to buy dollars (i.e., treasuries)??? Man, my brain hurts… I’m gonna take a nap.

  8. Phil

    Agree with ANON 12:58
    “I’m sure the “8% growth” involves some pretty accounting techniques….. Excessive overcapacity and malinvestment.”
    Last year there were a couple of articles that stated that many of the profits of Chinese companies were from (at the time) the ever rising stock market. That plus the other stories of how many Chinese citizens were hocking everthing to get into the market was the tell tale sign for what is occurring now.

  9. Anonymous

    I too worry about the figures that are bandied about as well as political stability in China, but at the same time, this is marathon, not a sprint.

    As long as (i) the social institutions in China hold together through this downturn and (ii) China continues to invest in its physical and educational infrastructure, the next 20 to 30 years are going to see a huge redistribution of wealth from the West to China. If communications costs continue to dwindle toward zero and technology finds a way to bring cheaper, greener transportation, the vast gap in per capita income between the West and China will be reduced one way or another.

    I wouldn’t get too caught up in the minutia and or the short term.

  10. Anonymous

    Two weeks ago, reports on this blog had Paul Volcker in China as part of some economic negotiations. Now, I am reading other websites that suggest the White House global economic conference may involve some type of dollar devaluation. Personally, I have my doubts that another Plaza Accord ( 1980’s) could be orchestrated or tolerated. In any event China would have to be part of any dollar devaluation discussion. As the global recession begins, this may be the last chance the USA gets to convince the world that the American consumer can somehow save the world from a long cold winter.

  11. Ether_S

    China is going through its own 1929.

    “Giving rise to an inherently unbalanced dynamic of accumulation resulting in an over-accumulation of capital, culminating in periodic crises of devaluation of capital. The origin of crisis is thus located firmly in the sphere of production, though economic crisis can be aggravated by problems of over-production in the manufacturing and related production sectors and the lowered demand.”

  12. mxq

    The one child policy is going to be devastating to this country…that’s probably one of the reasons why the savings rate is so high…older couples probably cannot rely on a massive web of their children or grandchildren to support them after retirement or in case of health problems. They’re pretty much on their own.

  13. Anonymous


    You’re right about China in the long run. But, as Keynes said, in the long run we’re all dead. The next ten years may be very, very bad.

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