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Countdown to 2005: Building Boom in China Despite Quota Worries

Chinese executives are forging ahead on projects to meet the expected demand from the dropping of quotas on textiles and apparel in 2005.

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DONGGUAN, China — The politics of global trade has Chinese manufacturers concerned, but not enough to stop them from forging ahead on massive projects to meet the expected demand from the dropping of quotas on textiles and apparel in 2005.

Almost without exception, top sourcing and manufacturing executives have complained that it’s hard to plan their business, since it’s likely that the Bush administration will in some way restrict imports from China when quotas on textiles and apparel are lifted in 2005.

However, even a casual visitor to the city of Dongguan, in Guangdong province, a few hours’ drive from the Hong Kong border, sees little evidence of that uncertainty in the dozens of factories that are under construction.

“We are looking to increase our operations, but we need to see what is going to happen,” said David Chan, director of Moregoal Industries Ltd., during a recent tour of the factory employing 1,200 people that his company opened early this year at the Chuangye Industrial Park here.

At the Dongguan factory and a 40-person facility in Hong Kong, Moregoal produces basic sweaters for U.S. branded apparel marketers and retail private-label programs. In a typical month, the Dongguan site produces 30,000 dozen pieces, though during peak periods it can ratchet up production to 500,000 dozen a month by staffing up and running for longer hours.

Referring to the possibility that Washington will use the special safeguard provisions in a U.S.-China trade deal to restrict Chinese imports, he said, “Everybody is nervous, and they want to know exactly what is going to happen. We have to know: What will the U.S. government say?”

The U.S.-China accord that paved the way for the world’s most populous nation to enter the World Trade Organization allows the U.S. to restrict imports of Chinese goods if they disrupt the domestic market. The American Manufacturers Trade Action Committee this year asked the U.S. to impose restrictions on Chinese imports in five categories of merchandise where quotas have already been lifted under a 10-year phaseout schedule.

“The safeguard provision is a challenge,” said Willie Tan, executive vice president of Luen Thai International Group Ltd., a multinational apparel contractor with its headquarters in Hong Kong and production in China, the Philippines, Mexico, Cambodia and the Northern Mariana Islands.

Still, he made it clear that he views it as no more than a temporary hurdle.

“Long term, it is clear that there will be no quota. That is what the WTO wants,” he said during an interview at his Hong Kong office. “But for the short term, we’re going to have to overcome these restrictions.”

His concerns haven’t stopped Luen Thai from moving ahead on two massive construction projects in China, sprawling facilities that Tan called “supply-chain cities,” which when complete will more than double the company’s capacity.

In Dongguan, Luen Thai has already opened the first of what will be 20 buildings in the facility — six production buildings, with outlying office and dormitory complexes. That site, which Tan said would be fully functional within 18 months, will employ 12,500 workers and have the capability to boost the company’s sales by $250 million a year.

That’s no small jump for a company with revenues of about $500 million and 23,000 employees in 12 countries.

Farther north, the company plans a 280-acre site in the inland city of Qing Yuan that will provide room for 16,000 sewing-machine operators alone — not counting the cutters, inspectors, managers, cooks, janitors and other support staffers. At full capacity, Tan said, that site will produce $320 million worth of garments a year. Luen Thai has just begun leveling the ground at that location, but hasn’t yet begun construction, Tan said.

In the rugged areas of southern China, leveling the ground is no simple task. Along the highways from the Hong Kong border to Dongguan, construction crews are filling in fish ponds, tearing down old houses and even cutting away chunks of mountains to make room for factories and their supporting infrastructure.

Even the traffic on the roads suggests the breakneck pace of industrialization: There were few passenger cars to be seen on Dongguan’s roads one recent afternoon — people appeared to largely travel by bicycle and motor scooter, while most larger motor vehicles were cargo trucks.

The rapid expansion of China’s apparel industry is indisputable. But the question in many observers’ minds, given the low growth rate of apparel consumption in much of the developed world, is what effect the new factories will have in an industry that many already consider oversupplied.

“There are a lot of new facilities coming up and how they are all going to survive, nobody can tell at this point. Probably a lot of them will fade away,” said Joanna M.Y. Ying, deputy managing director of the Hong Kong-based Esquel Group of Cos., a vertically integrated garment producer with factories in China, Hong Kong, Malaysia, Mauritius, Sri Lanka and Vietnam, which sells to major U.S. brands and retailers.

Even with quotas still in place on most categories of textiles and apparel, Chinese exports to the U.S. have been growing rapidly. According to the most recent U.S. Commerce Department data available, in the 12 months ended in August, Chinese shipments were up 40.4 percent, to $10.81 billion worth of garments, fabric and yarn.

In the categories of goods that have already been deregulated, which have been the focus of the safeguard provisions, the growth rates have been much higher. For instance, U.S. imports of Chinese cotton dressing gowns grew last year more than sixfold to $58.4 million and rose another 157.4 percent through the first eight months of this year.

China’s government has been encouraging the growth of exports, as its once largely state-owned industrial sector continues its shift into private hands. According to observers, the state-owned companies are managed more with the goal of employing as many people as possible, rather than maximizing profits. As companies privatize and seek profits, it will be necessary for industries to grow rapidly to create jobs for the country’s 1.29 billion residents, many of whom are still underemployed in rural farming communities.

The apparel industry is not China’s fastest-growing export sector. According to the National Bureau of Statistics of China, in the first quarter of 2003 — the most recent data available — the country exported $62.25 billion of industrial products, up 30.2 percent from a year earlier. Leading areas of growth were the electronics, computer and communications equipment sector, which saw exports grow 42.1 percent, and the electric machinery sector, where they were up 34 percent. Textile exports were up 21.8 percent, and apparel exports were up 17.6 percent. (Chinese government statistics are converted from the yuan.)

The U.S. manufacturing sector has been soft for years, with the textile and apparel sector in particular decline for over a decade. As of September, the twin industries employed 731,200, off 7.3 percent from the prior year, according to Labor Department data. At a time when overall job creation has been stagnant and unemployment is hovering at 6.1 percent, imports and particularly Chinese competition have become a major political issue in the U.S.

But some sourcing executives argued that the issue of Chinese imports has been overblown.

“The Achilles’ heel of the concept of China as the world’s factory is that it has to import a lot of raw materials,” said William Fung, group managing director of Li & Fung Ltd., the $4.82 billion Hong Kong sourcing powerhouse.

He noted that while China exports a lot of finished apparel, it produces none of the oil needed to create synthetic fibers and grows little cotton and no wool. With the exception of cashmere, he explained, China has to import almost all apparel raw materials and as a result runs a trade deficit with many countries, he said.

“The American people are being misled when they say China is running a big surplus,” he said.

In the context of population, China’s exports actually lag the U.S.’s, according to International Monetary Fund data. A recent IMF report noted that last year, China commanded 4.6 percent of the world’s exports, while it was home to 20.7 percent of the population. At the same time, the U.S. was the source of 12.4 percent of the world’s exports, though the U.S. is home to only 4.7 percent of the population.

Regardless of whether the perception of China as a threat to the U.S. economy is well founded, Fung said he believes that nation will be subject to the quota rules created by the Multi-Fiber Agreement decades ago.

“I’m not sanguine about the prospects of the MFA completely disappearing,” Fung said.

Jeff Macho, the Hong Kong-based vice president and managing director for Sears, Roebuck & Co.’s Asia and Caribbean operations, agreed, “It’s sort of a given that there will be some restrictions placed on China. It’s a question of not knowing what, not knowing when and not knowing how they’ll do it.”

As a result, he said, “everyone wants to hedge their bets to ensure a reliable source of supply.”

Most sourcing and manufacturing executives who rely on multiple nations to supply products said they have no plans to shift all their activity into China in 2005 or at any time in the foreseeable future. That’s partly because the sometimes-strained diplomatic relations between the U.S. and China could make such a move highly risky.

But they also contend there are other reasons to maintain a diverse production base.

Luen Thai’s Tan said his company plans to continue operating its factory in Tampico, Mexico, after 2005 because of the advantages of NAFTA benefits, as well as its close proximity to the U.S. border. Shipments from that city to the U.S. take about 10 hours by truck, as opposed to well over 10 days by boat from the closest Asian ports.

“Asia cannot compete on the speed,” Tan said.

Other Chinese-owned companies continue to expand into the Western Hemisphere. For instance, Hong Kong-based Lana Fashion Group recently acquired an apparel factory in Guatemala, according to Martin Richter, vice president of its Kazu Apparel Group division.

“We do not believe that every retailer and supplier is going to shift all their business into China,” he said in an interview in New York. “It’s just not logical. It just doesn’t happen.”

Another growing political issue is China’s fixed exchange rate. The yuan, also known as the renminbi, is kept at an exchange rate of roughly 8.29 to the dollar. Many economists believe that undervalues the currency by about 40 percent and makes Chinese exports appear cheaper than they would otherwise be.

On a trip to Asia this week for the Asia Pacific Economic Forum, President Bush was expected to take up the exchange-rate issue with Chinese officials, as well as the leaders of Japan, who manage the yen-dollar exchange rate closely. On Sunday, Chinese President Hu Jintao agreed that Chinese and American experts would study how Beijing could move toward a floating exchange rate, following a meeting between Bush and Hu.

Hong Kong-based executives said they believed the Chinese government would not take any sudden action on the their exchange rate in the near future, particularly given that the per-capita gross domestic product still hovers around $4,400.

“I don’t think, for the time being, they will float the renminbi,” said George C.V. Ling, board chairman of Newtimes Group Holdings Ltd., a $1 billion sourcing concern, with 22 offices around the world. “They will manage it in the interest of the country, and they want to boost exports.”

However, the Chinese government will likely continue to take other actions to ease the pressure the peg causes, sources said.

Chan, of the knitter Moregoal, noted that China currently rebates 17 percent of the taxes companies pay on their earnings from exported products. On Jan. 1, that rebate will be cut to 13 percent he said.

Corporate income taxes in China average around 40 percent, he said, meaning that the 13 percent rebate still represents more than one-quarter of the tax bill.

“That has released a lot of pressure,” he noted. But given WTO rules, he acknowledged that China will eventually have to let its currency float, He said, “By 2006, 2007, they must adjust the currency.”

Fung also cautioned that the Chinese government is not likely to respond well to pressure campaigns.

“China is not a country where if America says jump, China says, ‘How high?’” he said. “The Chinese government does not want to be seen as following the U.S.”

He said he believed it would be more likely that Beijing officials would address the exchange rate issue “if the political pressure comes off and America quiets down about it.”

Ultimately, he said, the phenomenon that will smooth balance-of-trade concerns between the U.S. and China will be when the Chinese consumer sector blossoms.

“The economy is the fastest-growing large economy in the world,” Fung said. “Eventually, the consumer market is going to catch up.”

But he acknowledged that it would likely take more than a decade before China’s net consumer spending was on par with that of neighboring Japan, though Japan’s population is just 10 percent of China’s. Still, the nation’s manufacturers remain committed to aggressive expansion, despite all the uncertainty surrounding China’s trade. Their only question is how aggressive they can afford to be.

Another Dongguan knitter, Jazzing Knitting Co. Ltd., recently began construction on a new factory outside Dongguan that would be five times larger than its existing site, which employs 700 people and produces 150,000 dozen pieces of knit apparel a month.

“If there is no quota in 2005, it will give us more help to compete with the big factories,” said managing director Joseph S.C. Lai, who added that the facility would also produce woven garments.

If not, his plan is to temper the expansion — by closing its existing smaller site.

Many executives said the number of garment factories currently under construction and the potential for quotas to be lifted in 2005 sets the stage for an intense price war, which will take a heavy toll on an industry that is already intensely deflationary.

“Right now, they are building a lot of capacity, and what will happen is a big question,” said Harry N.S. Lee, managing director of Hong Kong-based TAL Apparel Ltd., which produces shirts and blouses in eight countries. He added that he expected to see intense price competition follow the quota phaseout, asking, “How low will be low in 2005?”

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