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Manufacturers in China Search for the Next Low-Cost Base

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With the revaluation of the yuan and a wave of wage increases, manufacturers in southern China are finding themselves under pressure to reduce costs.  The new economic climate is forcing factories to move inland, and others to leave China altogether.

Just like the 1980's when factories closed down in Hong Kong and moved to China's Guangdong province, today manufacturers in southern China are looking for the next low-cost base.

Cliff Sun, chairman of the Federation of Hong Kong Industries, an organization that represents 3,000 companies, most with manufacturing facilities in China, says costs in southern China's export hub are rising.

"The recent pay rise has a significant impact on a lot of small and medium enterprises as the cost of manufacturing becomes higher.  When they have to compete with other manufacturers in the mainland, if the cost of manufacturing keeps going up, that means their customers are going to give them less orders," Sun said.

The Guangdong provincial government raised the minimum wage by 21 percent in May. Labor strikes at Toyota and Honda plants in recent weeks only added pressure on wages.

And last month, China allowed the yuan to strengthen against the dollar, for the first time in nearly two years. That means Chinese exports are becoming more expensive overseas.

Sun expects at least 3,000 factories in the Guangdong area, still staggering from the global financial crisis, will not survive.

"It's not easy…. Some of our members are diversifying. They're integrating their manufacturing facilities from, for example, Shenzhen manufacturing base, shifting some of the labor intensive production, jobs into neighboring provinces like Jiangxi, Hunan, Sichuan." said Sun. "If that can be done, at least they're going to survive."

Beijing has been pushing exporters to move to the poorer inland regions, as a way to narrow the rural and urban income gaps.

But inland factories may face other problems. When factories move inland where wages are lower, suppliers may not be able to catch up said Standard Chartered Bank's regional economist Kelvin Lau.

"The layout of many of these manufacturing cities or towns is that a big factory is usually surrounded by many of the suppliers that they worked with…. The third way out in the face of rising cost is to actually relocate outside of China," said Lau.

And that is what some manufacturers have been doing in recent years - opening factories in Vietnam, Cambodia and Indonesia, where costs are lower.

Sun said Hong Kong companies in the mainland are looking for opportunities to move labor intensive activities to southeast Asia.

"They can consider the Asian countries like Burma, Vietnam, Laos, Cambodia - these are Asian countries that are not financially developed, their labor cost is still relatively inexpensive. You are talking about maybe $80 per month for casual worker, which [compared to] China, I think in Shenzhen, you have to pay twice as much or more."

Vietnam has invested in infrastructure such as ports and roads and dangled incentives to foreign companies.

Abe Junji runs a Japanese shoe factory outside Vietnam's Ho Chi Minh City. He thinks the future is good here because the government has made it easier for foreign investors to come to the country, granting them tax incentives.

But it may fall short of what China can offer, said Standard Chartered's Lau.

"There are also other considerations that they have to take into account. For example, whether the logistics or the infrastructure support is comparable to what they get in China," Lau said.

At Li & Fung, a major Hong Kong company that is one of the biggest suppliers of consumer goods to large overseas retailers, executives acknowledge that China's low-cost era may be over.  But they expect the country to be a dominant exporter for years to come. Li & Fung said China remains the biggest source of the company's products, with $8 billion in goods a year. The second biggest, Vietnam, supplies just $1 billion of merchandise.

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