SPIRALLING costs and stringent environmental regulations in the Shantou special economic zone are forcing Hong Kong-based Kam Lung Holdings to move some of its silk garment business to the outskirts of Shanghai. The decision by Shantou's largest garment manufacturer to cut back the scale of its Guangdong province operations is part of a growing trend among foreign investors to shift their manufacturing out of southern China's expensive special economic zones before the preferential policies are revoked. Kam Lung chairman and founder Chan Sik-him said his company had begun trial production of lower-end silk garments in Songjiang, outside Shanghai, through a co-operative agreement with a local company. This year, the Shanghai venture was expected to produce about 50,000 garments, and there were plans to expand that to 500,000 next year. 'Wages in Shantou are going up and up,' said 60-year-old Mr Chan. 'The area is fast-becoming a centre for high-end goods, but it is no longer cost-effective to make lower and middle-priced products there. 'Now we're focusing on Shanghai, but we will not move all of our production up there because Shantou still has the highly skilled workers we need.' Once adored by foreign investors for their favourable tax treatment, market-oriented leadership and strong central government backing, China's special economic zones have begun to lose their lustre as cheaper alternatives open up and many cities lay claim to the same preferential policies. Over the past four years, Kam Lung has been squeezed by 20 per cent annual increases in production costs and a weak international silk market. Last year, it reported net losses of about $6 million despite turnover of about $180 million from production of 1.8 million garments. The main cause of Kam Lung's difficulties has been growing competition in the silk garment industry, which drove down prices to far below their peak in 1990. Kam Lung - which claims Liz Clairborne, Calvin Klein, Jones New York and J. Crew among its main international customers - has fared comparatively well in the price wars because of its strong reputation and 30 years' experience in exporting silk garments. But Mr Chan knows that no company can stand still if it hopes to succeed in changing times. This April, he took the drastic step of raising prices on all the company's products by 10 to 12 per cent as a stop-gap solution to the losses, despite a continuing soft market. 'When my customers heard I was raising prices even as everyone else was lowering them, they cursed me. I told them if they cancelled their orders, I would invite them to dinner,' Mr Chan said. 'Then they threatened to take their business elsewhere. I said that if they did so I would start dancing in my house. They thought this was strange and asked me what in God's name I was up to. 'So I asked them: 'Has your boss raised your salary in the past five years?' They said: 'Of course'. So I said: 'How do you expect me to make any money if I don't raise my prices in five years?' Then they understood.' Mr Chan said he planned to raise prices by a further 10 to 15 per cent annually for the next two years to bring them back up to 1990 levels. But over the longer term, he said Kam Lung would need to gradually move some of its production out of Shantou to remain competitive, just as the company had shifted its production base from Hong Kong to Shantou 11 years ago. Average wages for his 1,800 Shantou factory workers are 700 yuan (about HK$650) per month plus lunch. By contrast, workers in Jinshan county, outside Shanghai, earn about 400 yuan per month. Even more significantly, the region around Shanghai is the centre for silk production in China. Kam Lung will save millions of dollars in air freight charges when the silk is shipped to Shantou to be dyed, cut and sewn. In response to strict environmental regulations in Shantou and the potential for additional business up north, the company plans to move its silk dyeing plant to the Shanghai area in the middle of next year. Kam Lung's aggressive mainland expansion plans have been spearheaded by Mr Chan's young team of top executives, which include his sons Philip, 27, and Clarence, 26. Deputy general manager Peter Cheung and financial controller Nicholas Fung are in their early 30s. Besides boosting exports - which generate 90 per cent of sales - with new production bases around Shanghai, the team intends to expand Kam Lung's domestic retail sales with new stores and consignments in Beijing, Shanghai and Tianjin. These plans will be financed by listing Kam Lung on the Hong Kong stock exchange, but they will not be implemented until after 1997, when the management team will have gained more experience. Mr Chan does not plan to abandon Shantou. He has already sunk about $200 million into Pearl Plaza, a classy residential, commercial and office complex in the new downtown area. By the time the project is complete, he will have invested about $400 million. 'Even after the special economic zones' privileges have been revoked, Shantou will still have natural advantages,' he said. 'It is a port city, and there are about 15 million overseas Chinese who will support its development.'