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RR RUEHCN RUEHGH RUEHVC
DE RUEHGZ #0092/01 0450749
ZNR UUUUU ZZH
R 140749Z FEB 08
FM AMCONSUL GUANGZHOU
TO RUEHC/SECSTATE WASHDC 6887
INFO RUEHOO/CHINA POSTS COLLECTIVE
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEATRS/DEPT OF TREASURY WASH DC
RUEAIIA/CIA WASHDC
RUEKJCS/DIA WASHDC

UNCLAS SECTION 01 OF 02 GUANGZHOU 000092 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
STATE PASS USTR CHINA OFFICE 
 
 
E.O. 12958: N/A 
TAGS: EFIN ETRD EIND ECON SENV PGOV CH
SUBJECT: Government Incentives Diminishing in South China Investment 
Environment 
 
REF: A) 2007 GUANGZHOU 1094; B) SHANGHAI 0029 
 
(U) This document is sensitive but unclassified.  Please protect 
accordingly. Not for release outside U.S. government channels. Not 
for internet publication. 
 
¶1. (SBU) Summary: Government policies encouraging investment in 
south China have significantly diminished and are no longer a major 
factor in most foreign and domestic companies' investment decisions 
here, according to local manufacturers who met with visiting U.S. 
International Trade Commission (ITC) analysts.  China's regulatory 
environment has grown stricter in recent years, and many firms, 
especially labor-intensive manufactures like textile makers, 
complained that rising labor costs and the appreciation of the 
renminbi (RMB) against the dollar have dramatically reduced profit 
margins.  Currently, the government's main tool for influencing new 
investment decisions is control of land resources.  Even as textile 
manufacturers describe plans to move production elsewhere, south 
China's high-end manufacturers in automobile and telecommunications 
equipment manufacturing see a bright future ahead with plans for 
expansion.  End summary. 
 
Incentives Disappearing, Regulation Tightening 
--------------------------------------------- - 
 
¶2. (SBU) Manufacturers in south China seem to agree that tax 
incentives and export subsidies previously used by the Chinese 
government to encourage investment, both foreign and domestic, are 
no longer major factors in corporate decision making.  This was a 
theme echoed repeatedly by the telecommunications equipment, textile 
and automotive manufacturers visited by U.S. ITC analysts in late 
January as part of a second visit to examine China's economic 
policies on trade and investment.  Corporate decisions to build new 
factories or expand existing ones in south China are now based more 
on factors like production costs, availability and cost of labor, 
transportation, infrastructure, and the quality and availability of 
suppliers, according to Zhai Xiaoping, General Manager of China Silk 
Enterprise Ltd.  He described this as a major change from 5 or 10 
years ago when government connections and tax incentives also 
factored significantly in every investment decision.  Instead, 
elimination of most incentives has made it more difficult for 
manufacturers who previously relied on favorable treatment to 
maintain profit margins. 
 
¶3. (SBU) Stricter regulations have also created challenges for some 
manufacturers.  China's new labor law and tighter enforcement of 
environmental regulations have raised costs for some companies not 
already in compliance as they struggle to raise standards.  However, 
Henry Tan, CEO of Luen Thai Holdings, noted companies that already 
meet the regulations have benefited from the negative effect on 
competitors. 
 
Rising Wages, Appreciating RMB Hit Hard 
--------------------------------------- 
 
¶4. (SBU) Managers across industries complained about increasing 
labor costs and the appreciation of the RMB, but the impact appears 
to be most severe for labor-intensive manufacturing like the 
textiles industry.  (Comment: The comments of textile manufacturers 
in the Pearl River Delta were consistent with those from Yangtze 
River Delta manufacturers as reported in ref B.  End comment.) 
Textile executives Zhai and Tan both said these factors had cut 
their profit margins to as low as 2 or 3 percent.  Zhai explained 
that China Silk's attempt to cut costs by opening a new factory in 
Zhejiang province in 2001 only provided short-term relief.  As wages 
in Zhejiang rose to levels approaching those in the Pearl River 
Delta, higher costs for transportation eliminated the advantage of 
the new location.  Tan told us that Luen Thai would continue 
shifting low-end production from China to Southeast Asia and 
Bangladesh.  He noted that while China still maintained advantages 
for production of quick-turnaround, seasonal and fashion clothing, 
labor costs in Vietnam and Bangladesh were 20-25 percent of China's. 
 
 
Government Allocation of Land Rights Remains Key 
--------------------------------------------- --- 
 
¶5. (SBU) Manufacturing executives also agreed that the government's 
control of land allocation was still a key factor in some investment 
decisions.  Huang Zhixiong, Senior Manager of Planning at Guangzhou 
Toyota described government support for a project as critical to the 
deal's success.  Without such support, land would be difficult or 
impossible to secure.  Li Zanjie, the firm's Marketing Manager said 
subsidized rent was a significant incentive for his firm's decision 
 
GUANGZHOU 00000092  002 OF 002 
 
 
to establish a joint-venture in Guangzhou.  However, he also pointed 
out that the presence of an existing supply chain serving one French 
and two other Japanese automotive manufacturing joint ventures was 
the primary reason to begin production here four years ago.  In 
addition, he commented that China's new labor law, environmental 
regulations and R&D investment requirement did not have much impact 
on Guangzhou Toyota's operations because the requirements were 
consistent with Toyota's own internal policies.  The Guangzhou joint 
venture currently produces 200,000 Camry vehicles per year and has 
another production line under construction. 
 
High-Tech Manufacturers Optimistic 
---------------------------------- 
 
¶6. (SBU) High-technology manufacturers in the telecommunications 
equipment industry told us that despite diminishing government 
incentives their operations are expanding and exports are growing. 
Guangdong Nortel Director of Research and Development Rick Li 
described his company's plans to further expand research and 
development (R&D) operations in China.  Nortel currently employs 
1,300 engineers, approximately 10 per cent of Canadian company's 
global R&D workforce, in the south China joint venture.  The low 
cost of conducting R&D is the main reason for Nortel's initial 
investment and ongoing expansion here.  Li said the firm's Chinese 
joint-venture partners have played an important role in its success. 
 However, the company only conducts research on certain product 
lines inside China, for fear of losing valuable intellectual 
property if sensitive technology for other key products were brought 
into the country. 
 
¶7. (SBU) Carl Liu of Huawei Technologies and Jiang Xiangyang of ZTE 
Corporation, two of China's leading telecom equipment manufacturers, 
separately described strong export growth for virtually all of their 
product lines.  Huawei's international sales accounted for 70 
percent of total revenue in 2007 compared to 60 percent for ZTE. 
Both Liu and Jiang emphasized that labor costs for Chinese high-tech 
workers were much lower than the salaries they paid R&D staffs in 
the United States, India and Europe.  Managers of both firms pointed 
out that expiring tax incentives and export rebates have not 
affected their companies but could affect firms like Ericsson or 
Nokia, which may have based their decisions to invest in China in 
part on those benefits. 
 
¶8. (U) This cable was not reviewed by the ITC delegation. 
 
GOLDBERG