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China's Private Manufacturers Are Reinventing Themselves

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  • Manufacturers at Canton Fair innovate, shed staff for survival
  • China retains share of global exports as companies restructure

China’s private manufacturers, scorched for years by surging wages and anemic foreign demand, are reinventing themselves.

In coastal Zhejiang province’s Anji county, which produces 70 million chairs annually, chair maker Dakang Holding Co. is competing with lower cost Vietnamese rivals and facing rising costs at home. It spent 71 million yuan ($10.5 million) on automation in 2013, shifted to making chairs for gamers, and restructured management. Now sales are surging 20 percent annually and profit margins are up almost 8 percent.

"Our order book is full through 2020," says vice president Yuan Guofei, 35.

Such success contrasts with China’s bloated state sector, where pledges to restructure have given way to the need to boost activity in old industries as a prop for growth. While state firms often operate in industries with limited competition, Yuan says he’s up against about 800 chair manufacturers in Anji alone.

"These kind of restructurings are what you get when industries are exposed to genuine competition and global standards for quality," said Andrew Polk, Beijing-based head of China research at Medley Global Advisors, which advises institutional investors. "China’s government hasn’t done well implementing those types of measures and should be more focused on them rather than propping up struggling and outdated state-sector firms."

State enterprises, traditionally a source of political patronage and economic power for the Communist Party, account for about 40 percent of the nation’s industrial assets and 18 percent of employment, according to Bloomberg Intelligence economists Fielding Chen and Tom Orlik. These government creations drag on growth, with their return on assets in 2015 estimated at 2.8 percent, versus 10.6 percent for private sector-firms.

While the SOEs are spared the rigor of reform, private firms must restructure or die.

Innovating to survive was a recurring theme among companies interviewed in Guangzhou last week in the vast aisles of the biennial Canton Fair, where 25,000 exhibitors and 180,000 foreign buyers hammer out export deals.

For a story on how China’s exporters are mulling price increases, click here

Bag maker Rogerlin from Quanzhou in coastal Fujian province creates 60 designs a year to get attention at the fair and has invested in printing machines to reduce labor and improve quality, said sales manager Yu Jinling.

Clock maker Dannol Electronics Co. in Guangzhou is adding features including temperature and humidity gauges, and licensing rights to make clocks featuring soccer teams and Disney characters, said senior sales representative Fan Miaochang.

For a story on how a depreciating yuan isn’t translating into export gains, click here

Acknowledging the problem, policy makers vow to quicken state industry reform. Guidelines for reducing corporate debt published last month said the government won’t bear final responsibility for company borrowing. That could erode the implicit guarantee that has long made it borrowing easier for SOEs.

Economic reforms proposed in 2013 with considerable fanfare haven’t generated much pressure for change, according to Barry Naughton, who studies the Chinese economy at the University of California at San Diego. "Fears about the growth rate have blocked effective implementation of critical reforms," he wrote in a paper published Thursday by the Reserve Bank of Australia following a conference held by the monetary authority earlier this year.

As private investment almost halted this year, a top policy-making agency commissioned a study which recommended one of the biggest openings of private businesses since the 1990s. Proposals include allowing private companies greater access to restricted industries, investor protections, less official meddling and involving businesses in policy making.

The dramatic moderation of private investment is worrying because it generates triple the return of state firms’ spending, Nicholas Lardy, a senior fellow at the Peterson Institute for International Economics in Washington, said in another paper published after the RBA’s conference on how structural changes in the Chinese economy affect Australia and the world. The resulting drag on productivity is the "real source of concern" associated with the rapid growth in China’s debt, Lardy said.

"We’re starting to see state-sector restructuring begin, but it’s slow, lumbering and without a clear endgame," said Michael Every, head of financial markets research at Rabobank NA in Hong Kong. "The private sector is ahead of the game."

Thanks to private sector restructuring, China is keeping its share of world exports even as wage and material costs rise and low-cost competition intensifies from Cambodia to Ethiopia.

For a story on how China’s exports to emerging markets are struggling, click here

What’s needed now is state-sector restructuring, said Frederic Neumann, co-head of Asian economics at HSBC Holdings Plc in Hong Kong.

"The two are interlinked," he said. "Private activity will not revive unless some of the privileges state firms currently enjoy are pruned. Conversely, the government will be reluctant to accelerate public sector restructuring unless there are signs that private companies will carry growth. In the end, what matters is that China unleashes another burst of productivity growth."