Business - China's "world factory" struggles to find its feet

James Pomfret

DONGGUAN, China (Reuters) – Strolling the production lines of his toy factory in southern China, Peter Lin barks orders as hundreds of workers in green overalls snap wheels onto toy cars and affix tiny batteries into die-cast replica jets.

Twelve months ago Lin could rest easy. Despite the shadow of U.S. toy giant Mattel's massive recall of China-made toys, business was good.

Most of his orders were locked in, and containers full of his toys were steaming for ports in the United States and Europe to fill store shelves in time for Christmas.

This year, with over half China's toymakers having gone bust, he's racked with doubt.

"We're carrying a big boulder across a river right now," said Lin, who started his Dongguan factory 12 years ago.

"In January, things may get even more serious. My conservative estimate is that orders will fall 30-40 percent more," said Lin, whose orders were down 15 percent this year.

Over the past year or so, China's southern manufacturing hub of Guangdong has taken a flurry of different blows that have devastated their "factory of the world" business model.

The voracious demand of Western consumers for cheaply made Chinese goods has shriveled with the global financial crisis; the appreciating yuan has made goods more expensive; quality concerns hit orders after the Mattel lead-tainted toy scandal; and a new labor law has raised production costs.

In many of the dusty boomtowns dotted about the industrial hinterlands of the Pearl River Delta, the effects of a sharp slowdown are increasingly evident.

Main streets that once bustled with factory workers on their evenings off are now much quieter; fewer container trucks rumble to the nearby port in Hong Kong, and hordes of disenchanted migrant workers have hopped on trains home.

Social tensions have also risen, with blue-collar crowds more and more willing to protest against layoffs at stricken firms.

"Even without the financial crisis, many of the firms have been in a difficult situation ... and the scale of difficulty for those affected regions may be unprecedented since 1978," said Xiang Bing, dean of the Cheung Kong Graduate School in Beijing, referring to the year when China embarked on market reforms.

OUT OF WORK

Outside the shuttered Winbest Electronics and Plastics Factory in Dongguan's Fenggang township, a few down-and-out workers pecked around on the sidewalks, scouting for work.

"I want to find a stable, good job. But relatively speaking, jobs are few and competition for work is great," said Wang Jinse, who recently lost his job in a nearby factory making MP3 players.

The credit crunch has also seen a tightening of bank loans to small-and-medium enterprises already struggling with late client payments and erratic, stunted cash flows.

All this has had a domino effect among the region's vast web of suppliers, which churn out a mind-boggling array of products from cars, toasters and watches to bras, leather sofas and iPods.

Jessey Chen, general manager of the Keystone Electric Wire and Cable Co, said the new labor contract law, aimed at protecting employees' pay and rights, has aggravated workplace disputes and reduced the flexibility of firms to hire and fire at a time of great business uncertainty.

"There's been a big conflict between employees and employers. Workers have been grabbing as much money as they can and their expectations can't be met, so a lot of arguments ensue," he said.

In November, hundreds of workers at a toy factory in Dongguan rioted and clashed with up to a thousand police, smashing up offices and overturning police cars in a violent dispute over severance payouts for laid off workers.

More than half China's 3,631 toy exporters went bust in the first seven months of 2008, according to the Xinhua news agency, citing statistics released by the General Administration of Customs.

Guangdong, which produces more than 30 percent of the world's toys, according to mainland media reports, has suffered 1,391 toy factory closures in 2008 so far.

The Federation of Hong Kong Industries has warned that up to a quarter of about 70,000 Hong Kong-owned factories could close in a worst-case scenario. While official projections are not so dire, many are bracing for serious damage in vulnerable low-value sectors such as textiles, toys and furniture.

An October survey of 200 Dongguan manufacturers of toys, electronics and plastics said production costs had risen 29-43 percent this year, while profits were down between 20-27 percent.

ALLEVIATION MEASURES

Little was done when factory owners first began asking the central government to grant assistance to ease their woes.

In November, however, Premier Wen Jiabao paid a high-profile visit to Dongguan that was swiftly followed by support measures, including more generous export tax rebates for industries such as garment-makers and assistance in seeking bank loans.

Several cities in the Pearl River Delta, including Dongguan, Shenzhen and Foshan, have teamed up to staunch the pain by guaranteeing bank loans, pruning various fees and charges and reversing tax rebate cuts. Huizhou even suspended its minimum wage law.

"I've been making very daring proposals to local officials that I wouldn't normally even voice," said Eddie Leung, a Hong Kong industrialist who has lobbied hard for support measures.

"They can see the situation now is critical," added Leung, who heads the Dongguan City Association of Enterprises with Foreign Investment, the group that conducted the profits survey.

On a national level, the central bank has slashed interest rates and the government has trumpeted a 4 trillion yuan ($586 billion) stimulus package to bolster domestic demand.

Guangdong was one of several provinces that rushed to capitalize on the government's intention to boost investment, announcing plans to launch 222 projects over five years worth 2.3 trillion yuan .

At a recent banquet in Dongguan's Qishi township to honor overseas industrialists, the mood was convivial. But as the rice wine and red wine flowed, officials struck a realistic note.

"Dongguan enterprises are still facing many problems. Financing is a big factor, and the new labor laws have sparked differences in interpretation," Liu Shuji, a senior local politician, said in a dinner speech.

Looking ahead, experts say the Pearl River Delta must innovate and upgrade its manufacturing sector to regain its edge.

The Bauhinia Foundation, a Hong Kong think-tank, sees a bright future for the region and says the value of its output could match that of the New York metropolitan area by 2038.

To do so, however, the delta must integrate its infrastructure more closely with that of services-oriented Hong Kong, the Bauhinia Foundation said in an October report.

The region also needed to upgrade industries now dominated by the export processing trade, which it said was "relatively low in the industry chain and value chain, with a high degree of homogeneity, low technology content and little added value."

For Bernard Ho, investment manager with Hong Kong-listed Luen Thai apparel group, which manufactures for global brands such as Polo Ralph Lauren and Adidas in factories across the Delta, the stakes couldn't be higher at this testing time.

"Guangdong is China's southern gateway and economic engine," he told Reuters during an interview in Dongguan.

"If it fails, then China fails. It's as simple as that."

(Editing by Alan Wheatley and Megan Goldin)