DRAGON UNDER FIRE

China is fighting off growing competition from Vietnam and India to maintain its level of foreign investment, writes Clifford Coonanin Beijing.

CLOTHES, SHOES, toys, bags - anything you want made, you take it to southern China.

With cheap labour, easy access to ports and special economic zones that offer duty-free imports and tax incentives, the biggest brands in the world have been drawn there at an incredible rate.

Companies from all over the world have been lured to China's southeastern coastal regions, including Guangdong, Jiangsu, Fujian and Zhejiang.

The driving force behind China's remarkable economic boom has been manufacturing, with half of the world's finished goods made in China, either as components or as finished articles. But now, because of rising costs and a changing competitive environment, thousands of firms are looking elsewhere in Asia to invest. A report by Credit Suisse's Asia economist in Hong Kong, Tao Dong, forecasts that a third of manufacturers in Guangdong province - which produces 30 per cent of China's exports - will be closed in three years.

The Japanese electronics manufacturer Canon decided late last year to merge its two factories in China and invest 700 million yuan (€65 million) to set up factories in Vietnam to reduce costs. These days, China's manufacturing hotspots are facing tough competition from the neighbours. Vietnam and India have become more aggressive in luring low-cost industries. Vietnam joined the World Trade Organisation in 2007, giving it greater access to world markets.

In July last year, PricewaterhouseCoopers ranked Vietnam as the most competitive destination for manufacturing businesses among the world's top 20 emerging markets; China was second. No one thinks that Chinese competitiveness will disappear overnight and the broad consensus among economists is that goods from Asia's most populous nation will remain cheap for years.

But the situation is not as clear-cut as it was and within China, there is recognition of a changing investment pattern, even if no one is panicking just yet. "Since the first quarter of 2008, the pace of growth in the entire electronic industry has been slowing," says Gao Sumei, an economist at China's ministry of industry and information. China's growth figures make for amazing reading, slight slowdown or not.

According to calculations by Bloomberg, China's shipments of higher-technology products increased 412 per cent since 2002 to 347.8 billion yuan (€32 billion) last year, or 28.5 per cent of total exports, accounting for a 11.9 per cent growth in gross domestic product. The economy is forecast to expand 10 per cent this year and 9.5 per cent in 2009. So no one is breaking a sweat quite yet.

"At the same time, neighbouring countries continue to improve their investment environments, which has led to some foreign investment switching from China to Vietnam, India and other countries," says Gao.

Vietnamese unskilled workers earn 1.669 million dong (€54) a month, 41 per cent less than China's lowest-paid workers in the central province of Jiangxi, according to the World Bank. And India is even cheaper - 3,843 rupees (€57) a month on average. The Indian government is building over 400 special economic zones to woo foreign investment. Among the big changes to take place in China have been a new labour law, implemented on January 1st of this year which offers protections for Chinese workers, including those working for foreign companies, and has boosted labour costs by some 22 per cent in some areas.

The new law basically requires employment contracts to be put in writing within one month of employment. It makes hiring of temporary workers much more difficult, and it gives recourse to employees whose rights have been violated. The reaction among domestic and foreign employers has been predictably negative. Local media reports show Wal-Mart's four purchasing centres in Shenzhen, Shanghai, Putian and Dongguan parted company with hundreds of employees in October.

Huawei in Shenzhen offered a voluntary redundancy package worth one billion yuan (€90 million) for 7,000 employees. A number of South Korean investors in Shandong suddenly fired hundreds of employees without salaries before the law was introduced.

Meanwhile, many Taiwanese printed circuit board companies are actively looking elsewhere in the region because of changes in environmental rules. China's environment is a disaster zone, and it has tightened up regulations to stop a wider political problem emerging. Dongguan City in Guangdong was once the shoe capital of the world, but now hundreds of factories have closed because of rising costs and companies are looking to other countries in the region, including India.

"China has started to pay great importance to environmental protection. And employees' rights and benefits are also being protected. This means that some companies will see rising costs, and they will choose to invest in other places. "It's natural, because right now the world is an open market," said Wang Yukun, a former researcher at the State Council Development Research Centre, a consultant to the World Bank and a well-known management consultant who has published numerous books on globalisation and business in China.

"But as far as I know, a lot of big companies choose to stay here because their main suppliers and supply lines are in China. A lot of companies are in China. It is not convenient for them to move entire companies. They will choose Vietnam or India to produce, but they will not move the entire company there," said Wang. "The Chinese government is not worried about the decisions of some companies to move plants to other countries," says Wang.

Other factors include yuan's strong rise of 4.5 per cent against the dollar in the early part of the year - this is a major appreciation when you consider that China's exports are priced in greenbacks. The currency appreciated 7 per cent last year. The first move for many entrepreneurs has been within China itself. Companies based in the rich cities of the eastern seaboard and the southern regions within Guangdong have often headed inland where rent and labour costs are cheaper. The government has also introduced all kinds of incentive programmes to get people into the lower-wage provinces.

But in the Chinese provinces, you face similar problems in Vietnam, India or Thailand - inexperienced workforce, poor infrastructure and too far to travel to a port. The reaction in China has been ambiguous and most analysts agree that shifting manufacturing elsewhere is unlikely to dampen growth in the world's largest, and fastest growing, major economy.

No one likes to see foreign direct investment move elsewhere, but the kind of manufacturing that China was attracting was less than ideal. For the Chinese government, the focus was on the production of higher-value goods - computer chips, electronic gadgets, cars.

There are also growing fears that rising Chinese prices are having a domino effect on worldwide inflation, especially in the United States. For the government, the key has always been promoting stability, and the strong manufacturing bases were widening the wealth gap between those living in the wealthy coastal areas and the more than 700 million people in inland provinces - more than half China's population - who live on less than €1 a day and find themselves excluded from the country's success story.

The "Go West" policy to encourage people to move to the western areas has cost one trillion yuan since 2005.

A report from Royal Bank of Scotland believes that ultimately Vietnam's impact will be marginal. At 84 million, its population is smaller than that of Guangdong's 93 million and while labour-intensive manufacturing might move to Vietnam, capital-intensive production is likely to remain in China, as barriers to entry are higher and profit margins wider.

A recent survey of Hong Kong-owned mainland Chinese factories indicated that just 14 per cent of respondents are considering switching production to Vietnam, while 29 per cent are thinking of remaining in China and simply moving further inland where land and labour costs are lower. China's manufacturing boom has a while to run yet.