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FM AMCONSUL GUANGZHOU
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INFO RUEHOO/CHINA POSTS COLLECTIVE
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UNCLAS SECTION 01 OF 03 GUANGZHOU 000618 
 
SENSITIVE 
SIPDIS 
 
STATE FOR EAP/CM 
STATE PASS USTR CHINA OFFICE 
 
 
E.O. 12958: N/A 
TAGS: ETRD EIND ELAB ECON PGOV CH
SUBJECT: Toy Factory Closure Raises Concern, Foreshadows More 
Difficulty for South China Manufacturing 
 
REF: A) GUANGZHOU 291; B) GUANGZHOU 228; C) GUANGZHOU 498; D) 
GUANGZHOU 406; E) GUANGZHOU 398 
 
(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: Factory closures, especially those like Smart 
Union in the toy industry, have become topic one in south China, 
especially in the Pearl River Delta.  Local governments are now 
scrambling to identify other factories that might be on the verge of 
shutting down; many of these have been in trouble for months, if not 
years, and their situation is not directly attributable to the 
spreading financial crisis.  While some top tier firms are 
expanding, it seems likely that the longer the crisis persists, the 
worse the impact may be on the PRD. At this point, as elsewhere in 
country, job loss and the corresponding impact on social stability 
are being closely watched by the leadership.  End summary. 
 
One Week, Four High-Profile Factory Closures 
-------------------------------------------- 
 
¶2. (U) Smart Union, a large Hong Kong-listed OEM toy manufacturer 
announced the closure of three Guangdong Province factories on 
October 15.  Two of the factories were in Zhangmutou County of 
Dongguan City, a sprawling manufacturing community in the heart of 
the PRD.  The company's other factory was located in Qingyuan, north 
of Guangzhou.  The situation intensified a day later as workers 
gathered in front of the closed factories and local government 
offices to demand their unpaid wages.  Images of the protesting 
workers aired on Hong Kong television broadcasts that evening and 
subsequently on news broadcasts around the world. 
 
¶3. (U) In addition to Smart Union, at least four other Hong 
Kong-listed manufacturing companies have also recently closed their 
doors and left as many as 8,600 unpaid workers in the last week. 
More than 1,500 laid-off workers protested outside a Shenzhen 
factory run by bankrupt small appliance maker BEP International. 
Another factory, watch maker Peace Mark, closed its doors on more 
than 500 workers in Longhua; media report that another 600 workers 
staged two days of sit-ins at an affiliated factory in Xixiang 
Township of Shenzhen.  Managers from each closed factory are 
reported missing and suppliers to some of the factories are filing 
lawsuits for delinquent payments and damages. 
 
Local Government Pays Workers, Assigns Blame 
-------------------------------------------- 
 
¶4. (U) Although local governments have varied slightly in their 
response to the closures, all have been eager to go after deadbeat 
employers and help the laid-off workers.  Zhangmutou County 
announced October 17 it would pay wages of approximately 6,500 laid 
off Smart Union workers, with RMB 24 million (USD 3.5 million) in 
payments disbursed to the company's former employees on October 21. 
Local authorities have so far not been able to locate managers of 
the failed companies, an all too common situation in south China's 
labor-intensive manufacturing industries (ref A).  Guangdong 
authorities have publicly accused companies of "premeditated" 
factory closures, with Vice Premier Zhang Dejiang, former Guangdong 
Party Secretary, reportedly ordering a full investigation after 
directing local and provincial authorities to cover the unpaid 
wages. 
 
¶5. (U) Local governments have also stepped up efforts to identify 
other potentially insolvent factories by publishing the names and 
key information about those who have failed to pay their workers. 
On October 21, Shenzhen published a list of 30 companies that 
collectively owe their employees RMB 12 million (USD 1.75 million) 
in back salaries.  Two thirds of the companies listed are located in 
Shenzhen's Longgang District and represent a variety of industries 
including plastics, apparel, real estate and furniture.  Local press 
has reported that managers for most of the factories had fled after 
their information was published, and the government allocated money 
from its Wage Security Fund to help cover deficits.  Dongguan and 
Zhongshan have also published similar lists in recent years. 
 
Smart Union's Collapse - a Special Case... 
------------------------------------------ 
 
¶6. (SBU) A senior executive for a top western toy company told 
 
GUANGZHOU 00000618  002 OF 003 
 
SUBJECT: Toy Factory Clowuse"Gav),tknQ$MQ regularly with all of its first-tier 
toy suppliers to discuss financial issues, plan new projects and 
improve safety and efficiency.  Smart Union executives contacted the 
western firm 6-8 weeks before the factories closed to brief 
executives on its precarious financial situation.  The two companies 
agreed on a plan to gradually reduce the buyer's exposure while 
contracting for new orders of lower-tech toy lines to help the 
supplier maintain cash flow and production capacity.  The western 
firm began removing proprietary molds and tools shortly after the 
discussion with Smart Union executives, and completed the process 
two weeks before the factories closed. 
 
¶7. (U) Southern Metropolis News (Nanfang Dushi Bao) published an 
in-depth analysis of the Smart Union collapse (the company may have 
owed as much as RMB 227 million, USD 33 million, to suppliers and 
workers) that identified many internal factors that contributed to 
the company's failure.  Among internal causes, the paper claims 
Smart Union faced financial problems after losing RMB 67.5 million 
(almost USD 10 million) when its factory flooded in June 2008, 
destroying inventories and forcing a one-month closure.  Rumors have 
also circulated that Smart Union lost RMB 269 million (USD 39 
million) on failed investments in a major Chinese mining company, or 
possibly in the stock market.  In addition, news reports said 
trading of the company's Hong Kong-listed shares were suspended 
following a fifteen month decline that ended with shares valued at 
RMB 0.099 (USD 0.014) each. 
 
¶8. (SBU) According to the western toy company executive, Smart 
Union's failure was an unusual case because of the speed with which 
it went from having "cash-flow problems" to insolvency, unusual 
especially for a relatively large publicly-listed Hong Kong company 
with a well-known reputation as a profitable, first-tier toy maker 
that supplied top-tier overseas clients.  He said most other recent 
toy industry failures were among smaller second- and third-tier 
firms, many of which were not publicly listed and would never 
qualify to supply a major buyer like his company.  A Nike executive 
reinforced this notion, commenting to us recently that the factories 
closing down in the PRD are not part of the firm's supply chain. 
 
¶9. (SBU) At the same time, the western toy company executive 
commented that his top suppliers are faring well despite all of the 
long term economic pressures, and several major toy firms are 
expanding within the PRD and in other areas of Guangdong Province as 
opportunities arise.  The executive said he buys approximately 75 
per cent of his toys from a select group of 15 top suppliers, 
spending almost USD 1 billion per year on those suppliers of a total 
USD 1.3 billon procurement budget.  He pointed out that his 
company's earnings statement this week showed strong third quarter 
results and should not be affected by current economic conditions in 
south China, even as more small firms close and consolidate. 
 
...and Part of a Trend 
---------------------- 
 
¶10. (SBU) As has been widely reported, many external factors also 
drove Smart Union's demise and are squeezing labor-intensive 
manufacturers in the PRD.  Many of these are challenges that are to 
be expected in a maturing manufacturing sector, such as rising 
wages; higher raw material costs; appreciation of China's currency; 
tighter regulation, ranging from the new Labor Contract Law to 
stricter enforcement of environmental laws; and higher product 
safety standards after last year's toy recalls (ref B).  Other 
factors include policies aimed directly at labor-intensive export 
manufacturers, like reductions in the value-added tax rebate (though 
apparently the Chinese government has recognized this problem and 
has increased VAT rebate for a variety of exports from textiles to 
furniture to toys).  These are consistent with Guangdong's "double 
transfer" economic strategy aimed at pushing labor-intensive 
manufacturing and its workforce out of the PRD and into less 
developed areas of the province. 
 
¶11. (SBU) These factors are largely independent of the global 
financial crisis, and there are today fewer media reports that 
attribute Smart Union's collapse to the global financial crisis. 
However, another key factor is slowing demand for China's exports. 
Manufacturers have been complaining about this for months, often 
arguing that U.S. buyers aren't willing to pay enough for their 
 
GUANGZHOU 00000618  003 OF 003 
 
 
products (ref C).  Smart Union's troubles started well before the 
most recent turmoil in global markets, but there are clearly 
expectations in the PRD that the market outlook for China's 
exporters will continue to deteriorate.  Many observers are 
predicting that thousands of toy factories and other 
foreign-invested manufacturers will close by year's end (ref B). 
 
Comment: Harbinger of a Crisis? 
------------------------------- 
 
¶12. (SBU) The difficulties currently facing the PRD's 
labor-intensive manufacturing industries are by no means new or 
unexpected.  However, the global financial crisis suggests that they 
may become worse than previously anticipated.  With factories 
currently filling orders placed months ago, we have not yet begun to 
see the full impact of the crisis on south China's exporters. 
 
¶13. (SBU) The answers to many questions about the future of the 
"world's factory floor" will remain unclear until that impact starts 
to emerge.  What does this mean for Guangdong Party Secretary Wang 
Yang's "double transfer" vision?  It appears that officials are 
already looking at ways to mitigate the forces pushing factories out 
of the PRD with new policies aimed at helping small and medium 
enterprises.  In explaining the policy, many have cited the Chinese 
expression of "emptying the cage and changing the bird." (ref D) 
Now some of our contacts are talking about "expanding the cage and 
strengthening the bird" instead.  What will the new approach look 
like? 
 
¶14. (SBU) More importantly, how will laid-off workers react to their 
changed circumstances?  This confronts PRD officials with a critical 
challenge: they are ready to compensate the unemployed to maintain 
stability, but will their efforts be enough? 
 
GOLDBERG