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Cablegate: Uncomfortable Squeeze for South China Shoe Factories

VZCZCXRO1534
RR RUEHCN RUEHGH RUEHVC
DE RUEHGZ #0291/01 1440627
ZNR UUUUU ZZH
R 230627Z MAY 08
FM AMCONSUL GUANGZHOU
TO RUEHC/SECSTATE WASHDC 7182
INFO RUEHOO/CHINA POSTS COLLECTIVE
RUEHBK/AMEMBASSY BANGKOK 3848
RUEHHI/AMEMBASSY HANOI 0495
RUEHJA/AMEMBASSY JAKARTA 0227
RUEHHM/AMCONSUL HO CHI MINH CITY 0237
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEATRS/DEPT OF TREASURY WASH DC
RUEHC/DEPT OF LABOR WASHDC
RUEAIIA/CIA WASHDC
RUEKJCS/DIA WASHDC

UNCLAS SECTION 01 OF 02 GUANGZHOU 000291

SENSITIVE
SIPDIS

STATE FOR EAP/CM
STATE PASS USTR CHINA OFFICE


E.O. 12958: N/A
TAGS: ETRD EIND ELAB ECON PGOV CH
SUBJECT: Uncomfortable Squeeze for South China Shoe Factories

REF: A) GUANGZHOU 228; B) GUANGZHOU 121

GUANGZHOU 00000291 001.2 OF 002


(U) This document is sensitive but unclassified. Please protect
accordingly. Not for release outside U.S. government channels. Not
for internet publication.

1. (SBU) Summary: What do you do when it costs more to close a south
China shoe factory than to continue operations? Some Hong Kong and
Taiwan investors downsize and keep their production lines open,
adopting a wait-and-see approach. Others turn the key on the door
one evening and abscond at night, leaving unpaid workers and
helpless landlords to clean up the mess. Increasing costs have led
many investors to consider closing or moving their factories, with
availability of capital, dependence on local supply chains, age
(their own as well that of their equipment) and ownership succession
as key factors in such decisions. What could trigger a move outside
China? If there are signs of footwear supply chains moving out, a
mass exodus might happen fairly rapidly. End summary.

High Costs to Quit, Not as High Costs to Continue
--------------------------------------------- ----

2. (SBU) Closing a south China shoe is not cheap, according to Una
Tang of Brilliant Footwear in Dongguan. The largest cost is
severance pay for workers, which recently increased with passage of
China's new Labor Contract Law in January 2008. Under the new
regulations, each employee is eligible for one month's salary for
each year worked in the factory, which Tang estimates would quickly
add up to RMB 5,000,000 (USD 715,000) at her factories. In
addition, Hong Kong and Taiwan investors -- who dominate many
labor-intensive manufacturing industries in the area, including
shoes -- would likely also incur substantial losses of real estate.
Tang explained that because they are not citizens of the PRC, these
investors are ineligible to hold land after they close the
businesses for which the land was leased. Instead, Hong Kong owners
like Tang face a stark choice -- they must liquidate the lease
immediately or risk forfeiture if it sits idle without a registered
"Chinese legal entity" to hold it. In Tang's case, she believes in
the long-term potential of her businesses, and these regulatory
factors helped her choose to keep her factories open but downsize
their operations. She transferred one to her eldest son and
continued managing another even though she was ready to retire, in
hopes of eventually attracting another son into carrying on the
family business.

3. (SBU) Tang's eldest son hesitated to take the reins two years
ago, according to his mother. Despite well-established customers
like Gap and Gymboree, first pick of all his mother's employees and
equipment, and no capital costs except materials, William Tang of
Ever Bright Footwear was not sure he wanted to live in Dongguan and
work the long hours it would take to keep the business viable and
growing. William said total costs for his small 500-person factory
had risen approximately 20-30 per cent in the two years since he
took over, and economic slowdowns in the United States and Europe
have meant buyers are less willing to negotiate prices or place
large orders. As a result, Ever Bright's production has been cut to
approximately 180,000 pairs per month. He commented that small- and
medium-scale manufactures have turned to in-house product design,
increased automation and substitution of materials in order to lower
costs while continuing to meet demand. In one room of his factory,
15 skilled employees operated computerized sewing machines, each
with the daily output of eight people. This is part of a trend
towards automation in a market where even monthly salaries as low as
RMB 1200 (USD 170) make it difficult to compete for customers buying
labor-intensive footwear and apparel products.

Some Owners Simply Run Away
---------------------------

4. (SBU) Reports of runaway factory owners have been widespread in
the Pearl River Delta (PRD). Many describe owners shuttering
facilities in the dead of night and leaving without paying workers.
The situation hit home for Una Tang on the day we visited her
factories. Government officials called her to report that an
overseas investor who rented and independently operated another of
her factories had fled without paying worker salaries or utilities
for approximately two months. After heated discussion between
officials and Tang's staff, she agreed to take responsibility for

GUANGZHOU 00000291 002.2 OF 002


the delinquent renter -- selling the land and factory and paying all
overdue bills, including worker wages. When asked what would happen
to the former renter, Tang indignantly said he would be impossible
to find or prosecute, having already changed all of his phone
numbers and contact information, and probably even his name.

Factory Owners Getting Older
----------------------------

5. (SBU) Many Hong Kong and Taiwan investors in the PRD have reached
retirement age and are ready to reduce their role in day-to-day
operations, but succession is often a problem as many adult children
are uninterested in living or working near the factories their
parents built and operated for the last 20 years or more. Tang
pointed out that neither of her two younger sons seems willing to
take control of one of her factories. Instead, Tang's long-time
general manager continues to run the downsized facility with almost
no profit. Meanwhile, she lives in Hong Kong and plans new
strategies in a market fraught with constantly rising costs and
tougher regulations.

Considering a Move, But Not Yet Moving
--------------------------------------

6. (SBU) Michael Yu, President of Pegasus Footwear in Panyu district
of Guangzhou, said although he is exploring options for relocation
or closure of his 18-year old shoe factory, he believes a
wait-and-see approach is more prudent at this time. Yu's family
shoe business has operated since 1956, but was relatively late in
relocating from Taiwan to Guangzhou in 1990. Despite dramatically
increased costs for PRD shoe factories and other labor-intensive
industries in recent years, Yu said his factory currently employs
20,000 workers and produces shoes worth USD 150 million per year,
and he is not convinced that it makes sense to relocate again to an
area with even lower wages. Land and machinery at existing
factories are completely paid off, and severance pay for workers
would be costly, making the cost of continuing operations low
compared with moving to inland areas of China or nearby southeast
Asian countries like Vietnam, Thailand or Indonesia.

7. (SBU) In addition, Yu identified supply chains as the most
critical factor in deciding where to locate a factory. According to
Yu, the lack of a local supply chain in southeast Asian countries
means the total cost of production is often higher than in China.
Yu singled out Indonesia as the most dramatic example, saying the
country's shoe industry has no supply chain and all materials must
be imported from abroad. A stable political system, the size of the
labor market and domestic consumer markets are also important
factors for companies hoping to relocate outside China, according to
Yu. Despite no immediate plans to leave, he is watching closely for
signs of China's footwear supply chains moving out, predicting that
such an exodus would quickly spell the end of his industry here. He
described how each of the previous migrations of the shoe industry,
from Japan to Taiwan and later from Taiwan to China, were preceded
by massive disappearances of supply chain industries from the
established markets. Yu warned that such a change would be so rapid
as to catch many people by surprise, likely happening over a 12-24
month period.

GOLDBERG

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