MARCUS GEE, BRIAN MILNER AND GEOFFREY YORK
The Globe and Mail (Canada)
TORONTO, BEIJING — Just two years ago, the Shangxing Furniture Company was expanding as fast as it could. Almost all of its profits – about $4-million – were plowed back into new warehouses for the wooden furniture that it churned out for North American and European customers.
And then the slowdown hit. Costs soared and exports slumped. Since the start of this year, its profits have virtually disappeared. “We're spending our savings to keep it running,” says the company's export director, who prefers to be identified only by his surname, Liu.
“If the situation gets worse, we might have to rent out our new warehouses to other companies,” he said. “We're suffering a cold winter in the middle of summer.”
His company is just one of a growing number of struggling producers in China's furniture capital, the southern city of Dalingshan. Traditionally one of the biggest furniture production bases in Asia, the city is in trouble these days. Of its 280 biggest factories, at least 30 to 40 are in serious difficulty, according to a recent survey by the China National Furniture Association.
Furniture is not the only Chinese industry facing unexpected difficulties this year. After three decades of pell-mell rise from peasant society to economic powerhouse, there are signs that China's race to riches may finally be slowing, with repercussions that could spread around the globe.
Most China watchers think the slump will be shallow and relatively brief. Still, there are enough signs of trouble to cause a buzz about China's “post-Olympic slowdown.”
New orders at factories are down sharply. Bankruptcies are up. Last month, industrial production grew at the slowest pace since the spring of 2007. Stock prices are down about 60 per cent since last October. Property is showing signs of weakness too, especially in the booming southeast where flagging exports would have the most impact. Even the Chinese lust for new cars is beginning to cool.
A slowdown in export growth caused in part by the shrinking spending of North American and European consumers is “rippling across the economy,” Jing Ulrich, a China watcher with JPMorgan in Hong Kong, says in her research note this month (though she remains an optimist on China).
Worry at the top
The ruling Communist Party is worried enough that Premier Wen Jiabao and other leading officials toured coastal export industries last month. Mr. Wen professed himself “very concerned about the difficulties they are up against.” Since then, the Politburo has met to underline its support for “steady and fast” economic growth, a shift from the previous emphasis on reining in the excesses of the economy.
After fretting for the past five years or so about how to keep the economy from overheating, Beijing is now faced with the novel problem of how to keep it from cooling. “If you're sitting in Beijing, you're saying, ‘We've already lost two percentage points of economic growth. How much more are we going to lose?'” said Nicholas Lardy, a senior fellow at the Peterson Institute of International Economics in Washington.
“That's a big turning point for the Chinese economy. That means questions of profitability, questions of unemployment, questions of social stability.”
China's gross domestic product growth peaked at a frantic annualized 12.6 per cent in the second of quarter of 2007. Since then it has eased to 10.6 per cent in the first quarter of this year and 10.1 per cent in the second. Most economists are predicting growth in the coming year of between 8 and 10 per cent – still a breakneck pace compared with most economies, but a comedown for China.
If China's growth does slow significantly – even to, say 6 or 7 per cent a year – it would sting every developed economy, including Canada's. China's hunger for oil, metals, potash and other commodities have helped buoy the Canadian economy. Commodities represent half of Canada's exports and China has been the biggest driver of soaring commodity prices. China has been the engine of the global economy, contributing 30 per cent of its growth last year.
To absorb the countless workers streaming from China's poorer interior to work in coastal factories, Beijing reckons it needs to create nine million new jobs a year. Even a drop in economic growth to 8 per cent could compromise that goal and undermine a key pillar of the Communist's Party's strategy for staying in power: sustained, rapid economic growth.
There is no more government talk of discouraging low-cost industries such as textiles and toys and promoting higher-value high-tech sectors. Instead, Beijing has taken steps to shore up the mass-production factories that are the foundation of its economic success, for instance by easing limits on the size of the loans local banks can make to manufacturers and by effectively reducing export taxes.
“The Chinese economy is still beset with problems, including persistent prices rises, uncertainties in demand abroad, squeezed corporate profit margins, difficulty in ensuring energy and power supplies, and undue expansion of foreign exchanges reserves,” the state news agency Xinhua said in a recent report.
Sales of sedans, SUVs and light trucks were up 6.8 per cent in July from the same month in 2007, the lowest monthly growth rate in two years. As with many other measures, the slowdown is relative – a matter of slowing, not stalling or much less shrinking, growth. Still, the moderating demand for the country's most prized consumer possession shows that Chinese shoppers are feeling the first puffs of an ill wind.
A purchasing managers' survey found that manufacturing output may actually have contracted last month for the first time since the survey began in 2005. Official bankruptcy statistics, which may well be understated, show that more than 67,000 small and mid-sized businesses shuttered their doors in the first half of this year, putting millions of people out of work. And factory closings designed to control pollution during the Olympics may end up depressing economic growth this year, Goldman Sachs said in a report this month.
Moving production
In the textile industry, which employs 25 million workers, increasing wages and the rise of the Chinese currency, the yuan, have raised costs and made it more expensive for other countries to buy Chinese-made clothing. Energy costs are up too, and a new law forcing companies to provide social benefits to workers has increased labour costs for employers. As a result, hundreds of companies have moved their production to cheaper countries such as Cambodia and Bangladesh.
Furniture, another long-thriving industry, saw profit margins fall to 1.1 per cent from 3.2 per cent in the first five months of the year. One industry estimate said 9,000 of the 40,000 Chinese furniture factories will be forced out of business because of rising energy prices and labour costs, the increasing value of the Chinese currency, and a substantial drop in export orders in the aftermath of the subprime mortgage crisis in the United States.
“For many of us, it's hard to raise our prices, because the orders from our old clients are based on the earlier cheaper prices,” said Mr. Liu, the export director at the Shangxing Furniture Company.
“Some people say that the more they produce, the more they lose money.”
Huitianli Furniture Company, which employs about 500 workers in Dalingshan, is frantically trying to switch to the domestic market because of a sharp drop in orders from overseas customers. The company laid off 100 workers and shut down one of its three production lines last December because of the slump in export sales. It estimates that profit is down at least 50 per cent this year.
“We're getting almost no profits from our overseas orders because of the rising cost of material, labour and transportation,” said Li Yuhua, the company's manager.
Zhu Changling, vice-director of the China National Furniture Association, says the value of China's wood furniture exports increased 7 per cent in the first half of this year – but most of the gain was offset by rising costs and the appreciation of the Chinese currency. The actual volume of wood furniture exports is down 6 per cent this year, mainly because of the U.S. economic slowdown and the subprime crisis, he said.
“American clients are hesitating to send us orders because they're afraid that they won't be able to sell the furniture, and Chinese exporters are reluctant to accept the orders because the profit margins are so low,” he said.
China's problems stem in part from its very success at turning itself into the world colossus in low-cost global manufacturing, an export dynamo whose rapid growth has been fuelled by cheap labour, energy, capital and a willingness to accept narrow profit margins.
It's a condition that Vitaliy Katsenelson labels “late-stage growth obesity.”
The director of research with Investment Management Associates in Denver, he coined the expression to describe what happens when economies and corporations expand at such a rapid clip they fall victim to inefficiencies that worsen as time goes on, particularly in a case like China's, where tight government control over the banking system, rampant crony capitalism and continuing corruption mean that capital is not always allocated on the basis of merit or need.
As a result, growth may be high, but its quality is low, which makes it even more likely that decisions on asset allocation will be poor.
He cites the famous case of the vast South China Mall, which was opened with much fanfare in Dongguan in 2005. Although larger than the West Edmonton Mall, it draws no more traffic than a typical small Canadian strip plaza and most of the 1,500 stores are vacant.
China's long-term future remains bright, Mr. Katsenelson says. “But over the next several years – and I don't know when it's going to start – the next leg is likely to be down. And when the economy declines, it's not going to be a soft recession.”
Trouble at the factories
China's worst short-term problems lie in manufacturing, the engine of its spectacular growth.
As any Canadian producer can attest, manufacturing can be a volatile activity, prone to booms and busts. But the Chinese have enjoyed nothing but growth for 30 years, leaving industry with rising fixed costs, lots of excess capacity and workers they can't easily shed when demand finally declines.
As it becomes harder to meet payments on debt (the primary source of capital) and maintain payrolls, all those millions of people who were encouraged to migrate from farms to urban factory jobs will find their meagre livelihoods threatened.
“This is when you discover how dysfunctional this economy was,” Mr. Katsenelson says.
“It's a highly vulnerable country,” agrees George Friedman, chief executive of Stratfor, an Austin, Tex.-based company that provides global intelligence to clients. “With energy prices rising dramatically as a [cost] component, the ability of the Chinese economy to keep functioning the way it used to is in severe doubt.”
To begin with, China's financial system is not as solid as it looks. According to Mr. Friedman, the government's conservative estimate on the level of Chinese loans on which no principal or interest is being collected is $600-billion (U.S.). Stratfor's research places the actual figure at closer to $1.1-trillion, held by commercial banks as well as so-called asset management corporations, government entities set up to buy debts.
“Japan went south when non-performing loans got to about 20 per cent of GDP. South Korea, about 25 per cent,” Mr. Friedman says. “These guys [Chinese] are conservatively at 40 per cent of GDP. And then they get hit by commodity prices. So for China, it's the perfect storm.”
Most China watchers aren't so gloomy. The country's many foreign boosters list a number of things in its favour, starting with its deep cash reserves – a world-leading $1.8-trillion at the end of June – a growing domestic consumer market, a gradual shift to higher-value manufacturing and a strong savings and investment rate (more than 35 per cent of income, compared with 2 per cent in the U.S.).
“Is it going to grow at 12 per cent forever? Of course not,” says Mohamed El-Erian, co-chief executive of Pacific Investment Management Co. of Newport Beach, Calif., and an expert on emerging markets. “But it can grow at 6 to 10 per cent for the next five years. Most people would be happy with that, especially as the base is getting bigger.”
David Dollar, the World Bank's country director for China, says that “over all, I remain pretty optimistic about China.” Productivity continues to grow rapidly, he says, and millions of workers continue to move from the country to the cities, giving manufacturers a ready supply of labour that should last for years to come.
Most economists say any Olympic effect on the economy should be slight. Though Beijing spent $43-billion on the games and related infrastructure, that's only a sliver of the $3.6-trillion economy.
Fiscal ammunition
China bulls argue that even if the slowdown worsens, China has lots of ways to dig its way out of trouble. Credit Suisse says that with a budget surplus equivalent to 1.5 per cent of GDP, Beijing has more than enough fiscal ammunition to stimulate the economy through government spending. With inflation easing, it should have more room to cut interest rates too.
But inflation isn't licked yet. Though it has indeed moderated after a worrying runup earlier in the year, falling to 6.3 per cent in July from 7.1 per cent in June, a rate of 6 or 7 per cent is far above the average for the past decade of 1.3 per cent a year. And while the consumer price index is down, producer prices – which are what affect companies – rose 10 per cent last month.
Some economists think it is also a mistake to think that increasingly prosperous Chinese consumers will take up the slack in the economy by buying more goods and services. The Peterson Institute's Mr. Lardy notes that, measured as a share of economic output, household consumption has been falling for the past seven years. Chinese consumption is the lowest for any economy in modern times, mainly because Chinese save so much. At 35 per cent of GDP, consumption is as low as it was in the United States at the height of the Second World War, when rationing was in effect and Americans were putting a lot of their money into war bonds.
In any case, it is hard for companies accustomed to serving overseas markets to switch suddenly to the domestic market.
“We have to spend a lot of money on brand promotion and sales networks to develop the domestic market for our furniture,” said Mr. Li of the Huitianli Furniture Company in Dalingshan. “We don't have enough experience and expertise in the domestic market. And about 50 to 60 per cent of the furniture factories in Dalingshan have switched to the domestic market, so we're facing severe competition. It's a real headache for all of us here.”
China's economy has been through tough times before. It weathered a bout of inflation and economic overheating in the late 1980s and sailed through the Asian financial crisis in the late 1990s.
But since the era of economic reform began 30 years ago this December, the economy has grown more than tenfold and per capita income has grown at an average of 8 per cent a year, lifting countless Chinese out of poverty. It has been a remarkably consistent performance by any measure, so remarkable that any sustained slowing would come as a shock.
Whether that shock will come, or whether instead China is simply experiencing a modest slowdown, is still an open question. But in factory cities like Dalingshan, they are bracing for trouble.
And then the slowdown hit. Costs soared and exports slumped. Since the start of this year, its profits have virtually disappeared. “We're spending our savings to keep it running,” says the company's export director, who prefers to be identified only by his surname, Liu.
“If the situation gets worse, we might have to rent out our new warehouses to other companies,” he said. “We're suffering a cold winter in the middle of summer.”
His company is just one of a growing number of struggling producers in China's furniture capital, the southern city of Dalingshan. Traditionally one of the biggest furniture production bases in Asia, the city is in trouble these days. Of its 280 biggest factories, at least 30 to 40 are in serious difficulty, according to a recent survey by the China National Furniture Association.
Furniture is not the only Chinese industry facing unexpected difficulties this year. After three decades of pell-mell rise from peasant society to economic powerhouse, there are signs that China's race to riches may finally be slowing, with repercussions that could spread around the globe.
Most China watchers think the slump will be shallow and relatively brief. Still, there are enough signs of trouble to cause a buzz about China's “post-Olympic slowdown.”
New orders at factories are down sharply. Bankruptcies are up. Last month, industrial production grew at the slowest pace since the spring of 2007. Stock prices are down about 60 per cent since last October. Property is showing signs of weakness too, especially in the booming southeast where flagging exports would have the most impact. Even the Chinese lust for new cars is beginning to cool.
A slowdown in export growth caused in part by the shrinking spending of North American and European consumers is “rippling across the economy,” Jing Ulrich, a China watcher with JPMorgan in Hong Kong, says in her research note this month (though she remains an optimist on China).
Worry at the top
The ruling Communist Party is worried enough that Premier Wen Jiabao and other leading officials toured coastal export industries last month. Mr. Wen professed himself “very concerned about the difficulties they are up against.” Since then, the Politburo has met to underline its support for “steady and fast” economic growth, a shift from the previous emphasis on reining in the excesses of the economy.
After fretting for the past five years or so about how to keep the economy from overheating, Beijing is now faced with the novel problem of how to keep it from cooling. “If you're sitting in Beijing, you're saying, ‘We've already lost two percentage points of economic growth. How much more are we going to lose?'” said Nicholas Lardy, a senior fellow at the Peterson Institute of International Economics in Washington.
“That's a big turning point for the Chinese economy. That means questions of profitability, questions of unemployment, questions of social stability.”
China's gross domestic product growth peaked at a frantic annualized 12.6 per cent in the second of quarter of 2007. Since then it has eased to 10.6 per cent in the first quarter of this year and 10.1 per cent in the second. Most economists are predicting growth in the coming year of between 8 and 10 per cent – still a breakneck pace compared with most economies, but a comedown for China.
If China's growth does slow significantly – even to, say 6 or 7 per cent a year – it would sting every developed economy, including Canada's. China's hunger for oil, metals, potash and other commodities have helped buoy the Canadian economy. Commodities represent half of Canada's exports and China has been the biggest driver of soaring commodity prices. China has been the engine of the global economy, contributing 30 per cent of its growth last year.
To absorb the countless workers streaming from China's poorer interior to work in coastal factories, Beijing reckons it needs to create nine million new jobs a year. Even a drop in economic growth to 8 per cent could compromise that goal and undermine a key pillar of the Communist's Party's strategy for staying in power: sustained, rapid economic growth.
There is no more government talk of discouraging low-cost industries such as textiles and toys and promoting higher-value high-tech sectors. Instead, Beijing has taken steps to shore up the mass-production factories that are the foundation of its economic success, for instance by easing limits on the size of the loans local banks can make to manufacturers and by effectively reducing export taxes.
“The Chinese economy is still beset with problems, including persistent prices rises, uncertainties in demand abroad, squeezed corporate profit margins, difficulty in ensuring energy and power supplies, and undue expansion of foreign exchanges reserves,” the state news agency Xinhua said in a recent report.
Sales of sedans, SUVs and light trucks were up 6.8 per cent in July from the same month in 2007, the lowest monthly growth rate in two years. As with many other measures, the slowdown is relative – a matter of slowing, not stalling or much less shrinking, growth. Still, the moderating demand for the country's most prized consumer possession shows that Chinese shoppers are feeling the first puffs of an ill wind.
A purchasing managers' survey found that manufacturing output may actually have contracted last month for the first time since the survey began in 2005. Official bankruptcy statistics, which may well be understated, show that more than 67,000 small and mid-sized businesses shuttered their doors in the first half of this year, putting millions of people out of work. And factory closings designed to control pollution during the Olympics may end up depressing economic growth this year, Goldman Sachs said in a report this month.
Moving production
In the textile industry, which employs 25 million workers, increasing wages and the rise of the Chinese currency, the yuan, have raised costs and made it more expensive for other countries to buy Chinese-made clothing. Energy costs are up too, and a new law forcing companies to provide social benefits to workers has increased labour costs for employers. As a result, hundreds of companies have moved their production to cheaper countries such as Cambodia and Bangladesh.
Furniture, another long-thriving industry, saw profit margins fall to 1.1 per cent from 3.2 per cent in the first five months of the year. One industry estimate said 9,000 of the 40,000 Chinese furniture factories will be forced out of business because of rising energy prices and labour costs, the increasing value of the Chinese currency, and a substantial drop in export orders in the aftermath of the subprime mortgage crisis in the United States.
“For many of us, it's hard to raise our prices, because the orders from our old clients are based on the earlier cheaper prices,” said Mr. Liu, the export director at the Shangxing Furniture Company.
“Some people say that the more they produce, the more they lose money.”
Huitianli Furniture Company, which employs about 500 workers in Dalingshan, is frantically trying to switch to the domestic market because of a sharp drop in orders from overseas customers. The company laid off 100 workers and shut down one of its three production lines last December because of the slump in export sales. It estimates that profit is down at least 50 per cent this year.
“We're getting almost no profits from our overseas orders because of the rising cost of material, labour and transportation,” said Li Yuhua, the company's manager.
Zhu Changling, vice-director of the China National Furniture Association, says the value of China's wood furniture exports increased 7 per cent in the first half of this year – but most of the gain was offset by rising costs and the appreciation of the Chinese currency. The actual volume of wood furniture exports is down 6 per cent this year, mainly because of the U.S. economic slowdown and the subprime crisis, he said.
“American clients are hesitating to send us orders because they're afraid that they won't be able to sell the furniture, and Chinese exporters are reluctant to accept the orders because the profit margins are so low,” he said.
China's problems stem in part from its very success at turning itself into the world colossus in low-cost global manufacturing, an export dynamo whose rapid growth has been fuelled by cheap labour, energy, capital and a willingness to accept narrow profit margins.
It's a condition that Vitaliy Katsenelson labels “late-stage growth obesity.”
The director of research with Investment Management Associates in Denver, he coined the expression to describe what happens when economies and corporations expand at such a rapid clip they fall victim to inefficiencies that worsen as time goes on, particularly in a case like China's, where tight government control over the banking system, rampant crony capitalism and continuing corruption mean that capital is not always allocated on the basis of merit or need.
As a result, growth may be high, but its quality is low, which makes it even more likely that decisions on asset allocation will be poor.
He cites the famous case of the vast South China Mall, which was opened with much fanfare in Dongguan in 2005. Although larger than the West Edmonton Mall, it draws no more traffic than a typical small Canadian strip plaza and most of the 1,500 stores are vacant.
China's long-term future remains bright, Mr. Katsenelson says. “But over the next several years – and I don't know when it's going to start – the next leg is likely to be down. And when the economy declines, it's not going to be a soft recession.”
Trouble at the factories
China's worst short-term problems lie in manufacturing, the engine of its spectacular growth.
As any Canadian producer can attest, manufacturing can be a volatile activity, prone to booms and busts. But the Chinese have enjoyed nothing but growth for 30 years, leaving industry with rising fixed costs, lots of excess capacity and workers they can't easily shed when demand finally declines.
As it becomes harder to meet payments on debt (the primary source of capital) and maintain payrolls, all those millions of people who were encouraged to migrate from farms to urban factory jobs will find their meagre livelihoods threatened.
“This is when you discover how dysfunctional this economy was,” Mr. Katsenelson says.
“It's a highly vulnerable country,” agrees George Friedman, chief executive of Stratfor, an Austin, Tex.-based company that provides global intelligence to clients. “With energy prices rising dramatically as a [cost] component, the ability of the Chinese economy to keep functioning the way it used to is in severe doubt.”
To begin with, China's financial system is not as solid as it looks. According to Mr. Friedman, the government's conservative estimate on the level of Chinese loans on which no principal or interest is being collected is $600-billion (U.S.). Stratfor's research places the actual figure at closer to $1.1-trillion, held by commercial banks as well as so-called asset management corporations, government entities set up to buy debts.
“Japan went south when non-performing loans got to about 20 per cent of GDP. South Korea, about 25 per cent,” Mr. Friedman says. “These guys [Chinese] are conservatively at 40 per cent of GDP. And then they get hit by commodity prices. So for China, it's the perfect storm.”
Most China watchers aren't so gloomy. The country's many foreign boosters list a number of things in its favour, starting with its deep cash reserves – a world-leading $1.8-trillion at the end of June – a growing domestic consumer market, a gradual shift to higher-value manufacturing and a strong savings and investment rate (more than 35 per cent of income, compared with 2 per cent in the U.S.).
“Is it going to grow at 12 per cent forever? Of course not,” says Mohamed El-Erian, co-chief executive of Pacific Investment Management Co. of Newport Beach, Calif., and an expert on emerging markets. “But it can grow at 6 to 10 per cent for the next five years. Most people would be happy with that, especially as the base is getting bigger.”
David Dollar, the World Bank's country director for China, says that “over all, I remain pretty optimistic about China.” Productivity continues to grow rapidly, he says, and millions of workers continue to move from the country to the cities, giving manufacturers a ready supply of labour that should last for years to come.
Most economists say any Olympic effect on the economy should be slight. Though Beijing spent $43-billion on the games and related infrastructure, that's only a sliver of the $3.6-trillion economy.
Fiscal ammunition
China bulls argue that even if the slowdown worsens, China has lots of ways to dig its way out of trouble. Credit Suisse says that with a budget surplus equivalent to 1.5 per cent of GDP, Beijing has more than enough fiscal ammunition to stimulate the economy through government spending. With inflation easing, it should have more room to cut interest rates too.
But inflation isn't licked yet. Though it has indeed moderated after a worrying runup earlier in the year, falling to 6.3 per cent in July from 7.1 per cent in June, a rate of 6 or 7 per cent is far above the average for the past decade of 1.3 per cent a year. And while the consumer price index is down, producer prices – which are what affect companies – rose 10 per cent last month.
Some economists think it is also a mistake to think that increasingly prosperous Chinese consumers will take up the slack in the economy by buying more goods and services. The Peterson Institute's Mr. Lardy notes that, measured as a share of economic output, household consumption has been falling for the past seven years. Chinese consumption is the lowest for any economy in modern times, mainly because Chinese save so much. At 35 per cent of GDP, consumption is as low as it was in the United States at the height of the Second World War, when rationing was in effect and Americans were putting a lot of their money into war bonds.
In any case, it is hard for companies accustomed to serving overseas markets to switch suddenly to the domestic market.
“We have to spend a lot of money on brand promotion and sales networks to develop the domestic market for our furniture,” said Mr. Li of the Huitianli Furniture Company in Dalingshan. “We don't have enough experience and expertise in the domestic market. And about 50 to 60 per cent of the furniture factories in Dalingshan have switched to the domestic market, so we're facing severe competition. It's a real headache for all of us here.”
China's economy has been through tough times before. It weathered a bout of inflation and economic overheating in the late 1980s and sailed through the Asian financial crisis in the late 1990s.
But since the era of economic reform began 30 years ago this December, the economy has grown more than tenfold and per capita income has grown at an average of 8 per cent a year, lifting countless Chinese out of poverty. It has been a remarkably consistent performance by any measure, so remarkable that any sustained slowing would come as a shock.
Whether that shock will come, or whether instead China is simply experiencing a modest slowdown, is still an open question. But in factory cities like Dalingshan, they are bracing for trouble.
3 comments:
not sure about the economy, but I would not want to use any china 's products...also be careful with chinese food....
....unless you're living in another planet....no one resist not to drink Coke so does Chinese food !
I totally agree with 6:09pm. How cld u resist Chinese food?!
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