Economy rocks China factories

SHAOXING, China -- In the good old days — oh, three months ago — Tao Shoulong would prowl the streets of this ancient city in his Mercedes-Benz. His wife and partner, Yan Qi, would cruise around in her Toyota Land Cruiser. Together, they would drink into the night with clients, suppliers and creditors, hatching plans to expand their Zhejiang River Dragon Textile Printing & Dyeing Co.

Tao built River Dragon from a start-up with four employees into one of China's biggest textile printing firms in just five years. He had even grander dreams: He wanted to see his company's stock trade on Nasdaq alongside the likes of Microsoft and Intel.

The dreams are dead. River Dragon shut down on Oct. 7. Tao and Yan have vanished, leaving behind more than $290 million in debt and a lot of anger in this city 140 miles south of Shanghai in the Yangtze River Delta. The company's demise put 4,000 workers on the street and jilted hundreds of suppliers and creditors.

The speedy rise — and speedier fall — of River Dragon is a depressingly familiar story in China these days. Thousands of Chinese factories have shuttered in the past year, done in by:

•An export-killing global slowdown that began with the collapse of the U.S. housing market and the ensuing financial crisis. Local textile merchant Fang Xingquan, a River Dragon creditor, is among many who believe a sharp drop-off in exports was a key factor in the company's demise.

•Rising materials costs that have squeezed profit margins.

•A deliberate Chinese government campaign to regulate sweatshop factories out of business.

China's National Bureau of Statistics this week said the nation's economy grew at an annual rate of 9% in the quarter ended Sept. 30, the lowest since 2003. The state-run Xinhua news agency said the government is considering a series of actions to boost exports and stimulate home sales.

Many economists, including Yu Yongding of the Chinese Academy of Social Sciences, believe that China needs to keep annual economic growth of 8% or 9% to absorb the 24 million people entering the labor force every year or risk social instability.

Earlier this month, the International Monetary Fund predicted that Chinese economic growth would cool from 2007's sizzling 11.9% to 9.7% this year and 9.3% in 2009. Private forecasters are even more pessimistic. UBS Investment Research, for instance, forecasts 8% growth in 2009.

"China is being hit over the head by both the global crisis and the domestic slowdown," says Stephen Green, economist at Standard Chartered Bank in Shanghai.

Exports account for nearly 38% of China's economic output. JPMorgan Chase calculates that Chinese exports fall 5.7 percentage points every time global economic growth shrinks by a percentage point. And the IMF is predicting that global growth will drop 2 percentage points — from 5% last year to 3% in 2009. Chinese appliance maker Haier has already seen export growth drop to 10% the first three quarters of this year from 30% a year earlier, the official English-language China Daily newspaper reported.

What happens to China has big implications globally: China contributed 17% of world economic growth last year, the same as the United States, according to the United Nations.

Home prices collapsing

The Chinese economy is absorbing another blow beyond crumbling exports: collapsing home prices. Nicholas Lardy, senior fellow at the Peterson Institute for International Economics in Washington, D.C., reckons a slowdown in construction could shave another 1 to 2 percentage points off China's economic growth.

"The property bubble is already starting to burst," says Yan Yu, a business management scholar at Peking University, researching the export center of Dongguan in southern Guangdong province. "House prices here in Dongguan have fallen by up to 50% this year," leaving many homeowners owing more on their mortgages than their homes are worth.

"People have worked all their lives and believed the hype and bought overvalued properties, then saw their savings vanish," says independent economist Andy Xie in Shanghai. "That carries more political risk" than rising joblessness.

The good news: The forecast growth rates are still pretty impressive by any other economy's standards; Chinese exports have proved surprisingly resilient, growing nearly 22% in September from a year earlier; and the government in Beijing is sitting on enough cash — $1.8 trillion in foreign exchange reserves — to go on a spending spree if needed to rescue the Chinese economy from catastrophe.

"Chinese authorities appear to be well aware of the global economic situation," JPMorgan Chase reported this month. The bank expects government to turn the spigot on spending, quadrupling the budget deficit to the equivalent of 2% of economic output from 0.5% this year.

The authorities aren't going to save everyone. The Chinese government has put pressure on small firms that foul the environment, pay miserly wages and turn out cheap products. "Beijing no longer wants to be the world's sweatshop for junk," CLSA Asia-Pacific Markets says in a recent report.

First, China cut tax breaks for exporters and imposed new export taxes on polluters, even targeting producers of disposable chopsticks. Then it introduced a labor law in January, requiring companies to give workers written contracts and making it harder for them to lay off employees or to hire informal part-time help.

The combination of tougher regulations, weakening exports, rising costs and a stronger Chinese currency has hammered thousands of small factories. The pain has been especially agonizing in Guangdong, a low-cost manufacturing center across the border from Hong Kong in southern China.

Guangdong's exports rose just 14% the first seven months of 2008 after growing 27% a year earlier. Industrial profits were up just 4% this year through May, compared with 49% a year earlier and puny compared with 21% growth nationwide. "Guangdong's weak performance is a signal of the government's determination to restructure the low-value-added export process sector and to force out of business firms that abuse labor and the environment," CLSA concluded.

Trouble in toyland

Firms that were already struggling with narrow profit margins have been squeezed. More than half of all China's toy exporters — 3,631 firms — shut their doors the first half of the year, the official Xinhua news agency reported. "Many toy factories have gone bankrupt this year," says Luo Yunzhang, founder of toy exporter Guangzhou Sixiren Toy, which makes playground equipment for Ohio-based Little Tikes, among other products.

"We saw exports start to dip in May, when the government began restricting businessmen's visits ahead of the (August) Olympic Games. … Now the global crisis is causing problems. When people are in difficulties, they spend less on things like toys," Luo says. Luo predicts that Sixiren's export revenue will drop by half this year, to $500,000.

China's textile industry is also enduring a deep slump. Textile exports have been tumbling since March. More than 10,000 small textile manufacturers went out of business the first half of this year alone, the government says. "The global crisis is seriously affecting the local textile industry," says Yu Xin of the China Chemical Fibers and Textile Consultancy in Hangzhou.

China's 30-year economic boom has produced towns that specialize in one product. There are shoe towns, zipper towns, air conditioner towns and sock towns. Shaoxing — a city of 4.3 million long known in China for opera, rice wine and scenic river vistas — has sold itself as China's Textile City.

The textile sector has been "an easy market, as it is not complicated, has low entry barriers and is a big employer," says Standard Chartered's Green. The local government gives tax breaks, and the industry has benefited from having a large number of suppliers and trained workers close by.

For a while, River Dragon looked like one of the winners. After working as a clerk at another firm, Tao started the company in 2003 with his wife, Yan, and four colleagues. River Dragon went public in Singapore two years ago, and Tao bought another textile firm last year, hoping the acquisition would give River Dragon the heft to list on Nasdaq. In July, Yan, the company CEO, announced that River Dragon had landed a $10 million contract to supply apparel to 76 U.S. universities. But the deal proved a mirage. The end came quickly. A day after the factory stopped production, River Dragon stock was dropped from the Singapore exchange. Corporate documents are missing, and Tao and Yan are long gone.

"I think they are still on the run in China," says Fang, the supplier. He says he was stiffed for more than $860,000 when River Dragon went under.

Keeping society 'stable'

About 300 suppliers and creditors descended on the River Dragon complex, looting warehouses in the hopes of salvaging something. Hundreds of workers demonstrated in the streets, demanding back pay for August and September. Worried about the unrest, the local government coughed up cash. "The government paid the workers to keep society stable," textile analyst Yu says.

As their export orders dry up, Chinese manufacturers are likely to look for customers at home in China or in other emerging markets such as the Middle East and Africa. "Soon we will see vicious price competition between companies who have lost exports," Green says.

In Guangdong, toymaker Luo hopes to push domestic sales up to $1.5 million this year from $1 million in 2007.

"The situation in the U.S. and other countries will not turn around quickly," he says. "We must rely more on the domestic market, as Chinese consumers increasingly have money to spend on toys. Profits are very thin in the toy business, both in export and domestic sales. I prefer exports. … Domestic sales involve more work. There are more customers. But their orders are small."

Independent economist Xie says China became overly dependent on demand from the U.S. and Europe that was stoked by too much borrowed money and inflated asset values. "It's all coming to an end," he says. "You need to look elsewhere for livelihood. Americans cannot spend money anymore."

Contributing: Sunny Yang. Paul Wiseman reported from Hong Kong.