Export Trade Processing in China ‘To Become Extinct’

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Factories must either relocate elsewhere in Asia or remodel to sell to China

Nov. 24 – The trade processing industry in China, traditionally concentrated in the Pearl River Delta region, is becoming extinct, and businesses urgently need to reinvent their business models, according to Thomas Chan, the director of Hong Kong Polytechnic University.

Chan, who is also the head of the China Business Center, made his comments in the South China Morning Post. Much of China’s trade processing is invested in by Hong Kong and Taiwanese factories. Stating that China had lost its long term, low cost advantages in labor, land and a low RMB exchange rate, Chan identified higher prices in raw materials, coupled with a reluctance by U.S. and European retailers to accept higher prices as sounding the death knell for the industry.

Trade processing factories will be forced out of business within the next 12 months unless they change their business models and either migrate their work to other production bases such as Bangladesh, Cambodia, India or Vietnam, or change their China business model to sell to the booming domestic market, Chan said.

The Chinese government also sees the trade processing industry as undesirable as it deems it outdated, and wants to shift the economy to a service based consumer driven model. Trade processing is typically labor intensive, energy wasteful, environmentally poor, and produces exports mainly by processing cheap imported materials. China wants to develop an added value economy and become innovative rather than rely on processing trade.

Such business will flow instead into the emerging economies in Asia, and especially those that can provide low cost labor and land, and that have less stringent environmental and labor laws. Guangdong Province alone is home to some 38,000 factories involved in the industry. Adding that “many factory owners do not want to face the facts,” Chan said that many factories would cease being financially viable. Meanwhile, attempts by trade processing factories to relocate within China have largely been unsuccessful due to rapidly rising labor and land costs in other inland provinces.

Hong Kong-based Li & Fung, the world’s largest sourcing and trade processing business, now sources and processes an increasing volume of its garments from elsewhere in Asia as it seeks to depend less on China for such activities. Matters to be aware of in trade processing are the costs:

China is committed to doubling the national minimum wage within the next five years, meaning an average 20 percent increase per annum on a national basis until 2015.

Commodities prices
These remain volatile and, in the case of cotton, subject to price spikes. However markets such as India are able to actively compete with China in terms of volume, delivery timescales, quality and finishing.

Global Financial Crisis
A potential second round financial crisis, and one that may seriously affect China, is now more likely following the United States pumping US$600 billion into the markets last month. That will keep the RMB high against the dollar and increases the cost of Chinese export manufacturing.

That being said, all is not doom and gloom. Mentioning that China would enter a “golden age” and a “domestic consumption revolution,” Chan indicated that China based trade processing factories should look at supplying the domestic market instead, and capitalize on the national policy to boost domestic expenditure. This was echoed by Morgan Stanley Chief Economist Wang Qing who stated that he expected China’s total consumption to reach two-thirds that of the United States, or 12 percent of the global total, within the next decade.

“We are seeing a trend of nearly all LLJG operations (licensed foreign investment entities sub-contracted to Chinese factories, and unique to South China) now converting to WFOEs to allow them to sell to the Chinese domestic market. It is a growing trend and one that is rapidly increasing,” said Alberto Vettoretti, managing partner in China for Dezan Shira & Associates based in Shenzhen.

“Our firm has an increasing number of China-based clients now expanding their operations into India and Vietnam while they also restructure their China operations,” says Chris Devonshire-Ellis, the firm’s principal. “The trade processing industry is moving away from China to Southeast Asia, while China operations are restructuring to focus on domestic sales. Investors in the trade processing industry must act now to rethink their business model and either relocate their trade processing elements elsewhere, refocus on the China domestic market, or both. If they do not, they will face serious financial difficulties in the form of increased costs within the next two years if they continue to concentrate purely on China based export trade processing.”

Dezan Shira & Associates can assist with the conversion of China LLJG contract manufacturing operations to WFOEs in order to permit trade processing businesses to sell to the China domestic market. The firm maintains ten offices in China, including three in Guangdong Province, and has a further five offices in India and two in Vietnam. The practice can assist with business financial modeling and provide regional cost comparisons in addition to corporate establishment and tax advice in China, India and Vietnam. Please email info@dezshira.com for assistance.

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