For Guangdong province, the export-oriented powerhouse whose rise has underpinned China’s dramatic growth, 2008 was a memorable year for all the wrong reasons. Due partly to the global slowdown, export growth plunged from 22.3% in 2007 to a mere 5.6%. Meanwhile, Guangdong authorities say GDP expanded 10.1% in 2008, versus 14.7% in 2007.


As Western consumers’ spending power has shrunk, orders have fallen and the pain inflicted on Guangdong’s manufacturers has intensified. According to official figures released in early January, as many as 62,400 companies went bankrupt and 600,000 migrant workers left the province in 2008. The situation continues to deteriorate on a daily basis. Local governments have been forced to compensate thousands of angry unemployed workers out of their own coffers.


Though experts see Guangdong moving up the value chain in the future with a more domestically focused and service-oriented economy, there are many immediate obstacles and the province needs to do more to encourage service-sector development, they say. The provincial government’s resolve to pursue a restructuring agenda will face a stiff test as the global economy worsens.


Guangdong’s Troubles


Whether a toy or electronic gadget, if it bears the ‘Made in China’ mark there is a fair chance it came from Guangdong: The province contributes almost a third of China’s exports. Since China’s reform and opening-up policy took hold, the cities of the Pearl River Delta – the provincial capital Guangzhou, Shenzhen, Zhuhai, Dongguan and others – have been at the heart of its growth story. The region’s light manufacturing outfits, many owned by Hong Kongese or Taiwanese businessmen, have made their money through mass producing low-cost goods for Western consumers. However, around two thirds of the province’s exports are processed goods, including everything from textiles to TVs, meaning low profit margins.


Even before the financial crisis hit, Guangdong’s low value-added manufacturers were contending with new pressures. A number of factors have been in play. Climbing raw material prices had been slicing further into producers’ margins, and then a stronger yuan made Guangdong’s exports less competitive.


Another factor is China’s new labor law, which took effect in early 2008. Among other things it introduced written contracts and mandated higher company contributions to pension and insurance schemes. This has had a big impact, says Zhang Jiaqi, the head of Shanghai-based Li Nai Er Shoes Company, which has around 30 outlets in China and draws on Guangdong suppliers. “It means a big burden on factory owners’ costs,” he explains.


Labor costs have been further pushed up by a dwindling supply of migrant workers, the bedrock of Guangdong’s economy. “One of the reasons we’ve found why Guangdong’s not working any more is because workers don’t want to work there anymore,” says Shaun Rein, chief executive of China Market Research (CMR). Millions of migrant workers have flocked to Guangdong from around China, but based on CMR’s investigation of workers’ attitudes, many migrants are now unwilling, instead seeking work near their families.


Stricter implementation of environmental regulations, meanwhile, has played a further important part in the region’s declining prospects. Cities in the Pearl River Delta have been more serious about enforcing the rules. “The city sees itself as high tech now, and industries that support that image are being encouraged to stay and develop,” says David Lodge, whose Shenzhen-based company, Foreverbright, designs and manufactures illuminated bar and beer signs for beer and liquor companies. “Low-value added polluting industries are being driven away,” he says, and new applicants for foreign-owned company registrations encounter stricter environmental standards. Lodge’s company does not fit the profile of the polluting industries Shenzhen is making unwelcome, he says. Nevertheless, inspectors regularly check waste water content and the health of workers at the factory.


These trends have placed an increasing strain on Guangdong manufacturers, and for a growing number the financial crisis has proved the last straw. Many factories have closed because, as Lodge puts it, a 5% drop in sales in stores in the West equates to a complete cancellation of orders. A consumer electronics factory in Lodge’s industrial park recently sent its staff of three thousand home for three months, he notes.


Other low-value added producers have remained in business but have left the Pearl River Delta. Some have stayed within Guangdong: “Some areas of the province are still scrambling to attract industries that are moving out of Shenzhen,” notes Lodge. Others have gone elsewhere, either to other provinces or lower cost countries, especially Vietnam. “The further down the food chain you are, the further away people seem to be moving,” he observes.


Government Responses


The global slowdown’s full impact on China’s exports has yet to be felt, Stephen Joske, director of China forecasting at the Economist Intelligence Unit (EIU). Joske is optimistic about the long-term trajectory of Guangdong’s economy, which he says most observers believe will become more like a developed economy, manufacturing for the domestic market and with a bigger service sector. However, in the near term things are “clearly going to get a lot worse” this year, he warns, citing expectations of a deepening U.S. recession. “That’s having a big confidence effect on the private sector,” he notes. “They’re putting investment on hold.”


Indeed, the Asian Development Assistance Board (ADAB), a non-profit member of the World Bank Group which recently completed a six-month survey of the Shenzhen-Dongguan-Guangzhou area, believes that the various pressures on Guangdong’s low-cost, export-driven model are likely to endanger the employment of at least 2 million to 3.5 million workers in the Shenzhen-Dongguan-Guangzhou area alone, says William Kusters, ADAB’s senior executive director in China.


All this leaves Guangdong’s government with a serious dilemma.


Even as many observers have come to believe that its heydays as export manufacturer for the world are behind it and its growth model is outmoded, Guangdong’s leadership has been changing tack. Its recent approach has been to support the shift away from low-end, labor-intensive and polluting manufacturing toward processes that are higher up the value chain – or, in the Chinese phrase, to “Open the cage and change the birds”, as Kusters notes. The plan is that factories mass producing light industrial products like toys, clothing and lower quality footwear should be phased out and replaced with high-tech production and research and development centers.


This strategy was restated on January 8 when China’s top economic management body, the National Development and Reform Commission (NDRC), published a plan charting the province’s future course. The plan states the intention of turning the province’s Pearl River Delta region, Guangdong’s coastal production hub, into a “globally competitive” base for modern services, advanced manufacturing and innovation by 2020.


“But the question is, what does it all mean in the current environment?” the EIU’s Joske asks. On the one hand, an economic squeeze could offer a good opportunity to speed up restructuring by weeding out weaker, low-value producers with thin profit margins. On the other hand, many wonder whether the province may have pushed its restructuring agenda too hard.


Central and provincial government share a fear of the implications of mass migrant redundancies for social stability, and as the crisis has deepened, the central government has signaled support for small- and medium-sized enterprises (SMEs). Meanwhile, although Guangdong will receive some benefits from the central government’s infrastructure-heavy, four trillion yuan fiscal stimulus package, as an export-oriented economy it stands to gain less than more domestically oriented provincial economies, Joske says.


There is therefore a temptation to prop up manufacturers to shore up the export sector and safeguard social stability. Guangdong has now earmarked new funds for supporting SMEs, and recently announced that it will delay full implementation of the new labor law to prevent the burden on manufacturers from growing heavier. According to Kusters, it is also considering relaxing recently introduced cost-increasing measures, many of them environmental.


Guangdong’s response appears to have been inconsistent, though. “Implementation of environmental regulations has been patchy, and has become laxer in some places as the pace of factory closures has quickened,” says Zhu Wei, whose company executes environmental certification projects in Shenzhen and Dongguan. Enforcement in Shenzhen, which has been working hard to polish its image, remains relatively strict, but in Dongguan, whose officials made a concerted effort at the beginning of last year, has been less stringent of late, he says.


Exporters Look Inward


Nevertheless, Zhu Wei stresses that the overall trend is towards stricter enforcement of environmental measures. Despite some apparent softening of the provincial government’s stance, observers generally agree that Guangdong authorities has tended to play hardball, allowing low-value added enterprises to go to the wall — an impression confirmed for ADAB by township officials, Kusters says.


Guangdong’s exporters are being encouraged to help themselves by shifting their focus towards the domestic market. Joske notes that this makes sense given that China is a rare case of a major economy still growing strongly, and will be possible in some product categories such as white goods, which may be suited to this due to their generic nature (and have recently been given a boost by a rebate scheme for rural residents).


Nevertheless, Joske stresses, this cannot happen overnight, and in product classes where China dominates world production, its domestic market will not be able to take up all the slack. The province has been urging manufacturers to concentrate on the indigenous market since well before Guangdong’s recent surge of factory closures, notes Steven Shi, senior economist at Golden Bridge Capital in Guangzhou, but without obvious success.


Businessmen we spoke to suggested that for most exporters – the majority of whom are relatively small fish – switching focus to the domestic market is simply not an option. According to Wang Yi Fei, who runs an export company in Shenzhen that purchases local products to export to the U.S. market, despite seeing dramatically falling orders, most small export manufacturers are not even attempting to adapt their business models. “They don’t know anything about the domestic market,” says Wang. “They don’t even have a sales force in the factory. For many years, they have just been waiting for people like me to find them and give them orders.”


Greater risks associated with selling in China is one disincentive, Wang points out. It often takes a long time for producers to get paid, “and in lots of cases, people just don’t pay you,” he explains.


More fundamentally, the challenges of export and domestic oriented business are poles apart. “It’s a totally different kind of game,” says Zhang Jiaqi of Li Nai Er Shoes. Whereas manufacturing for export is essentially a question of making and delivering goods, retailing is more demanding. Domestically oriented firms must operate a business chain from procuring raw materials right down to establishing and maintaining sales channels, he points out.


Zhang offers an example of a company run by an acquaintance in Wenzhou. The city’s second-largest manufacturer of shoes for export, it invested more than six million yuan last year in an attempt to break into the domestic market. After more than six months of trying to master this new ball game, however, the company gave up: The financial demands and effort required were too great.


Looking to the Future


In the face of these problems, experts are skeptical about the government’s ability to aid exporters’ efforts to expand into the domestic space. Nevertheless, the recently released NDRC blueprint sets out some ambitious targets on other fronts.


Under the plan, by 2020, the modern service sector, advanced manufacturing and hi-tech industries should be the region’s economic staples. The document also calls for the building of 10 China-based multinationals with annual sales of 200 billion USD, and envisages creating one hundred state-run laboratories for engineering innovation and R&D in the next three years.


EIU’s Joske agrees that provinces such as Guangdong will derive much of their future growth from the service sector. “There’s very low productivity right across the service sector, which they can work on and improve,” he notes. Kusters identifies sectors including hospitality, tourism, leisure and entertainment; convention and exhibition centers and supporting infrastructure also need to be established, he says.


Interviewees suggest, however, that there is much to be put right before these aims can be met. Admittedly, the province has attracted some higher tech companies such as telecoms equipment maker Huawei and electronics producer TCL albeit, according to ADAB’s Kusters, mainly via financial incentives. Overall, however, to date the “open the cage and change the birds” strategy has not been clearly developed and its implementation has been patchy, Kusters says. Judging from ADAB’s research interviews, it “appears to lack proper coordination by provincial or regional authorities.”


Furthermore, experts caution that the province’s scarcity of top-notch higher educational institutions equates to an under qualified local workforce. “To turn this around, opportunities should be created for the establishment of high-quality educational institutes,” Kusters advises.


While Guangdong’s services have received some support from officialdom (the central government offered help in mid-January, for instance, by relaxing restrictions governing the involvement of investors from Hong Kong and Macau in Guangdong’s medical institutions) some service sector actors would like to see more being done.


China’s biggest provincial economy and trade base has a strong need for wide ranging and diverse financial services – not least among small companies hoping to make the journey up the value stream and into domestic markets. But Guangdong</st1:place