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FM AMCONSUL GUANGZHOU
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UNCLAS SECTION 01 OF 03 GUANGZHOU 000228 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
STATE PASS USTR CHINA OFFICE 
STATE FOR EAP/CM 
 
E.O. 12958: N/A 
TAGS: ECON EINV ELAB ETRD EFIN CH
SUBJECT: Leaving the PRD - Regulations and Market Conditions Forcing 
Some Factories Out 
 
Ref: A) 07 GUANGZHOU 1180, B) GUANGZHOU 121 
 
¶1. (SBU) Summary: The numbers differ dramatically, with some 
investors hyping a massive exodus of factories from the Pearl River 
Delta (PRD) while local government officials spout figures that 
obscure the scale of the trend.  But one thing is clear:  many firms 
are choosing to move production to new centers of low-wage 
manufacturing in other parts of China and elsewhere.  Executives 
frequently cite China's new Labor Contract Law as the driving force 
behind relocations, but it only one in a list of factors that have 
weakened the investment environment here and may not even be the 
most important one.  (In fact, U.S. companies say they are already 
compliant with contract law requirements and the new rules will 
compel competitors to come up to these standards.) Others include 
wages that were already raising steadily, value-added tax and export 
processing regulatory changes, and the appreciation of the renminbi 
against the dollar.  Even as labor-intensive, often Hong Kong- or 
Taiwan-invested, factories move, many others are choosing to stay 
for reasons that include robust supply chains, well-developed 
infrastructure and human capital, which continue to be enduring 
advantages of the PRD.  The composition of economic development in 
the Delta is changing and the difficult choices facing business 
today are in large part intentional: the central and local 
governments are implementing policies aimed both at spreading 
development to other, less-developed parts of China and at creating 
space to upgrade industries in the PRD.  If the strategy succeeds, 
the PRD could once again be in the fore as China moves into a new 
stage of economic development.  No one wants to contemplate what 
failure to change will mean.  End summary. 
 
Looking at the Numbers - Media Hype,... 
--------------------------------------- 
 
¶2. (U) Reports of factories leaving the Pearl River Delta (PRD) have 
been spreading in recent months.  A Wall Street Journal article 
cited estimates by the Federation of Hong Kong Industries that 10 
percent of Hong Kong-owned factories in the region will close this 
year.  Another frequently cited statistic is the Asian Footwear 
Association's calculation that 1,000 shoe factories in Guangdong 
have closed in the past year out of a total of 5,000 to 6,000.  A 
China Daily report cited an estimate that 5,000 to 6,000 Hong 
Kong-invested companies would close in the PRD by the end of 2008. 
One American business leader told us that 1,000 factories had closed 
down in Dongguan alone.  A Taiwan investor in Dongguan put the 
number at 5,000 (ref A). 
 
Official Propaganda,... 
----------------------- 
 
¶3. (U) Local officials have tried to downplay the reports.  In early 
March, Guangdong Governor Huang Huahua told reporters that, 
according to government statistics, only 244 enterprises had moved 
out of the PRD while more than 7,000 new enterprises were 
established during the year.  Dongguan Party Secretary Liu Zhigeng 
recently said that although 289 shoe factories had shut down in 
Dongguan during 2007, 501 new ones had opened.  More recently, 
Guangzhou Bureau of Foreign Trade and Economic Cooperation announced 
that 347 foreign-invested enterprises closed or moved out of 
Guangzhou in 2007 while 959 new foreign enterprises invested in the 
city.  However, local statistics may not capture the closure of some 
facilities, which the statisticians classify as having "concluded 
their contracts."  These firms may have signed contracts with local 
partners and obtained business licenses that have expired but will 
not be renewed, because the foreign investor is no longer interested 
in doing business here.  They might not appear in the government's 
accounting even though they have ceased production in the PRD. 
 
Business Optimism,... 
--------------------- 
 
¶4. (SBU) Many companies in the PRD, especially the larger, more 
successful ones we have more frequent contact with, have indicated 
that they continue to believe the investment environment here is 
strong.  Some of them, like Hong Kong-invested toymaker Silverlit, 
have told us they would stay put in the PRD even as their less 
profitable competitors moved elsewhere (ref B).  Executives at 
American toy makers Mattel and Hasbro have emphasized to us that 
their long-term investments in China were profitable decisions, and 
to relocate production outside of the PRD would be a step in the 
wrong direction.  A former Dongguan Taiwan Businessmen's Association 
vice chair said the PRD was still the best place for him to do 
business while lamenting the problems other Taiwan firms faced (ref 
A).  During a recent visit to Zhuhai and Zhongshan on the western 
side of the PRD, executives at Flextronics, a Singapore-based 
 
GUANGZHOU 00000228  002 OF 003 
 
 
electronics manufacturer; Wiseman Company, a major Chinese garment 
maker; and Foxconn, the Taiwan electronics giant, all described to 
us ambitious plans to expand operations. 
 
...and Hidden Impact 
-------------------- 
 
¶5. (SBU) However, there is also downsizing among some firms staying 
in the PRD that is not captured in official statistics or other 
reports.  An executive in the Dongguan Taiwan Businessmen's 
Association explained that many Taiwan companies are maintaining 
some manufacturing presence in the PRD to hedge their bets even as 
they build new facilities or expand operations elsewhere.  He 
identified one factory in the Humen area of Dongguan that had 
downsized from 5,000 to 2,000 employees recently.  Despite expansion 
in its facility just across the river, Foxconn's massive campus in 
Shenzhen continues to reduce employment as it moves manufacturing 
operations elsewhere to focus more on research and development and 
other high-end processes in the PRD (ref B). 
 
What's Driving Them Away? 
------------------------- 
 
¶6. (SBU) There are several factors that are causing many factories 
to consider moving production out of the PRD: 
 
--Labor Contract Law - Many firms and industry associations have 
complained loudly about the new law, which went into effect on 
January 1.  Estimates vary, but the Hong Kong SAR government 
representative in Guangdong recently said the law had increased 
labor costs by 15 percent.  In addition, the law limits the 
flexibility employers had previously exercised in hiring, and 
especially firing, decisions.  Although this law is one of the 
causes most often cited in reports about factories leaving the PRD, 
it is only one of several having an impact and raising production 
costs here.  With many factories moving to other locations in China, 
it may not even be the most important factor.  Investors may 
complain more about the effects of the Labor Contract Law because 
they calculate it to be the area where the Chinese government is 
most likely to offer some redress. 
 
--Rising Wages - Wages were already rising steadily in the PRD 
before the new Labor Contract Law and continue to do so.  Hewitt 
Associate's annual survey of wages in Guangzhou and Shenzhen showed 
8-9 percent increases in 2007 and projected similar increases for 
¶2008. 
 
--VAT/Export Processing Reforms - In 2007 the Chinese government 
reduced the value-added tax rebates available to exporters in some 
industries and locations and started requiring some export 
processing firms to pay a guarantee deposit for duties on imported 
inputs that are refunded at the time of re-export. 
 
--RMB Appreciation - Ongoing appreciation of the renminbi against 
the dollar has squeezed profits for firms making exports for the 
U.S. market.  The Hong Kong SAR representative estimated that RMB 
appreciation was increasing the cost of Hong Kong businesses in the 
PRD by an additional 15 percent. 
 
--Other Factors - In addition, firms in the PRD have been hit with 
continuing power shortages, rising costs of other inputs and 
reported stronger enforcement of environmental regulations. 
 
Who's Moving Out? Who's Staying Put? 
------------------------------------ 
 
¶7. (U) These factors are hitting some types of businesses much 
harder than others.  The labor-intensive, export-oriented industries 
that were the main drivers of the PRD's economic boom from the 
beginning are most affected.  Many of these are Hong Kong and Taiwan 
enterprises, but some sources have also reported Japanese and Korean 
firms choosing to the leave the PRD too.  (In fact, the Korean 
Consul General told the Consul General earlier this month that 
whether and/or when and/or where to move were subjects Korean 
companies were constantly discussing with him.)  "Export processing" 
industries, which assemble imported inputs into finished exports, 
have been disproportionately harmed by recent regulatory and market 
trends.  Shoe manufacturers appear to be among those that have 
suffered the most impact.  Many apparel, toy, and hardware 
manufacturers have also been seriously affected, according to 
Guangdong's Department of Foreign Trade and Economic Cooperation. 
 
¶8. (U) High-tech manufacturers that rely on more highly skilled 
labor are less affected.  The same is true for firms that invest 
 
GUANGZHOU 00000228  003 OF 003 
 
 
heavily in design or marketing their own brand name.  In general, 
American firms appear relatively unaffected because they are more 
likely to fall into these categories.  They are generally more 
focused on selling to the Chinese domestic market than other foreign 
investors, who dedicate more production to exports.  In addition, 
several contacts have commented that U.S. firms have actually 
benefited from the new Labor Contract Law because their practices 
were already compliant with the new rules, and now their competitors 
must raise their standards as well. 
 
Staying in the Neighborhood 
--------------------------- 
 
¶9. (U) For those firms that are choosing to leave the PRD, anecdotal 
reports suggest their preferred destinations are not that far away. 
According to one toy manufacturer, many Taiwan firms in the industry 
have moved to Jiangxi Province.  Other reports identify Guangxi, 
Hunan, Fujian, Anhui and some more remote parts of Guangdong as 
favored destinations.  Vietnam is the most frequently cited option 
for companies that are looking to leave China altogether.  Some 
investors have commented to us that tax policies and other 
investment conditions in Vietnam are similar to those of the PRD ten 
to twenty years ago.  However, other investors have dismissed it and 
other Southeast Asian countries as a suitable alternative, citing 
smaller workforces and local markets, lack of infrastructure, 
cultural differences and other disadvantages. 
 
Why Stick Around? 
----------------- 
 
¶10. (SBU) Those companies that choosing to stay in the PRD named the 
following factors as enduring advantages: 
 
--Supply chains - Many industries have developed sophisticated 
industrial clusters with complete supply chains providing all inputs 
in one convenient location.  In fact, Toyota established a new 
Guangzhou factory in 2005 and is already engaged in an expansion 
project that will increase capacity by almost one third.  Executives 
emphasized the emergence of robust supply chains as one of the most 
important factors in the company's decision to expand here. 
 
--Infrastructure - The PRD has a well-developed transportation 
system.  One investor told us he had looked at moving his factory to 
Jiangxi, but calculated that what he gained in lower wages would be 
lost -- and then some -- due to higher transportation costs. 
 
--Human capital - The availability of skilled labor is much higher 
in the PRD than many cheaper alternative destinations.  An executive 
at one apparel firm explained to us that she wouldn't be able to 
convince the designers she relies on to live in more remote areas. 
 
--Diminishing advantages in alternative locations - Several 
manufacturers have told us their research shows that the gap in 
wages and tax benefits enjoyed in less-developed parts of China will 
diminish within a couple of years relocating to these areas. 
Executives from one Hong Kong apparel company said that they opened 
a second factory in Jiangxi three years ago when wages were just 60 
percent of those in the PRD, but wages had been rising more quickly 
than in the PRD and tax incentives had gradually phased out. 
 
All Part of the Plan 
-------------------- 
 
¶11. (SBU) These complex sets of factors are having a real, but 
difficult to quantify, impact on factories in the PRD.  Some of this 
impact is intentional -- central and local government officials want 
to create conditions that will encourage some factories, especially 
labor-intensive ones, to move out of the PRD.  Changes in the VAT 
rebate and export processing regulations target these industries 
directly as do some environmental regulatory changes.  These 
policies are aimed both at spreading development to other, 
less-developed parts of China and at creating space to upgrade 
industries in the PRD toward services and more advanced 
technologies.  If the strategy succeeds, the Pearl River Delta area 
could once again be in the fore as China moves into a new stage of 
economic development.  In the meantime, there will be a difficult 
adjustment period as the exodus of labor-intensive, export-oriented 
factories, which have been the backbone of the local economy for 
many years, continues. 
 
GOLDBERG