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China economy

Perfect storm of trade war, higher costs threatens survival of China’s small export businesses

US tariffs combined with rising costs and taxes are putting tens of thousands of exporters, and the jobs they provide, at risk

PUBLISHED : Friday, 14 September, 2018, 7:17am
UPDATED : Friday, 14 September, 2018, 7:43am

The impact of the US trade tariffs, higher domestic costs for labour, energy and rents, as well as the risk of higher business taxes next year is threatening the survival of tens of thousands of small Chinese export-oriented businesses.

And Beijing, for whom social stability is a key policy goal, is waking up to the possibility that millions of jobs could be at risk if it does not act. In southern Guangdong province, the heart of China’s export manufacturing industry, small businesses account for about half of all employment.

A growing number of small Chinese firms are in the process of deciding whether to close up shop or move to another country with lower costs that is not part of the trade war.

Small businesses in Guangdong are already seeing a sharp drop in orders, even as costs are rising to unbearable levels.

Given the growing threat to its industrial base, the Guangdong provincial government announced on Monday a series of measures to bring down business costs, including reducing corporate taxes, social taxes and land costs. Last week, it also amended a set of rules regulating foreign investment, in which it emphasised supporting automotive and plane manufacturing by wholly foreign-owned companies.

James Zhang, 45, runs a company making and selling electrical cables to domestic and foreign clients in the southeast coastal economic hub of Shenzhen. He said orders had declined sharply since the trade war started in July and he expected a further 30 per cent decline next year.

“Clients are dumping me. Some of them demanded that I absorb part of the additional cost of the tariff imposed by the US government, which I cannot afford. Some have already shifted their procurement to competitors based in Vietnam or India,” he said last week at his factory.

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Shenzhen, the Guangdong city bordering Hong Kong, has been dubbed China’s Silicon Valley and hosts some of the country’s biggest and best known tech firms, such as mobile phone and telecoms equipment makers Huawei and ZTE, as well as drone manufacturer DJI.

From a small fishing village in 1978, the city is now a hub for some of the most comprehensive supply chains in the world, home to tens of thousands of small manufacturers that make components for a wide range of electronic and mechanical products. These small companies account for half the city’s employment.

But the survival of many of these companies is now being threatened, as the trade war with the United States delivers big blows to their thin profit margins, already squeezed by rising costs for labour, energy and rent.

The economy in Guangdong is starting to suffer badly. Its purchasing managers’ index shows the province’s manufacturing industry contracted in August for the first time in 29 months, with new orders falling to a 30-month low and new export orders declining for the third straight month.

STRUGGLING TO SURVIVE

At the centre of the depressing macro picture is the struggle of small businesses like Zhang’s.

His factory has around 800 workers, of which 200 are based in Shenzhen – the other 600 are based in the inland province of Jiangxi, where costs are lower. During the good times, around 2008, workers regularly worked overtime to meet demand for electronic cables, including charging lines connecting smartphones and computers.

Life started getting harder five years ago, when costs for labour, rent and energy surged while competition became cutthroat. But Zhang said he was still able to muddle through.

Last year, his company earned a net profit of around 10 million yuan (US$1.5 million) based on 220 million yuan in revenue.

But Zhang said it would be difficult for him to break even this year.

The products made by Zhang’s company are on the list of US$16 billion of Chinese imports on which US President Donald Trump’s administration imposed a 25 per cent tariff from August 23.

So for a USB cable made by the firm that sells for around 0.8 yuan, a 25 per cent tariff would add 0.2 yuan to the cost – and a US importer would have to make up the extra if Zhang wants to keep his price steady. Zhang’s clients have urged him to cover 40 per cent of the additional cost, or around 0.08 yuan per cable.

But Zhang says he only makes a 5 per cent profit, or about 0.04 yuan per cable. If he were to absorb 40 per cent of the tariff cost, he would take a loss on every cable he sold.

“I cannot sleep at night. There seems no way that I’ll be able to make it this time. The only option for now is to give up everything here and start again with a new factory in Vietnam – some friends and clients have already moved there in the last few years,” he said.

“I heard tax charges are lower there. People work for eight hours, six days a week, and their salaries are less than one-third of the Chinese mainland level,” he added.

An ordinary worker at Zhang’s Shenzhen unit is paid more than 3,000 yuan a month. The average salary in some industrial parks outside Hanoi is the equivalent of around 800 yuan per month, more than 70 per cent lower, according to Zhang’s friends.

Some of Zhang’s clients have already moved their operations outside China to lower their costs. South Korea’s Samsung Electronics, for instance, is cutting its smartphone production in China, while at the same time strengthening its production lines in Vietnam and India, targeting rising demand in these fast-growing markets as well as making them production bases for exports to the global market, Nikkei Asian Review reported early last month.

Not far from Zhang’s factory in a suburb of Shenzhen, his friend Hu is facing a similar tough situation. He spoke with the South China Morning Post on the condition that his full name not be used, out of concern that his comments may trigger resentment from the government.

Hu, 48, started his business as a small cable workshop in 2000 after spending a decade on the assembly line at a Taiwanese-owned electronics factory. Eighteen years on, the farmer’s son from a small village in Sichuan, in the southwest, has managed to build up a factory that employs 500 workers who make products ranging from copper lines and plastic tablets to electronic cables.

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The company had export revenues of about US$7 million last year, but he expects that to fall to less than US$3 million this year. That will be barely enough to break even, as a sharp deterioration in the outlook has caused a plunge in demand, he said.

“We began to feel the pinch from this April, when the US government started the export ban on ZTE. For suppliers like us, orders were frozen in the following months. Even now, with ZTE having resumed operations, business sentiment remains severely depressed,” Hu said.

TAX TROUBLE

To make things worse, Hu said pressure on his business was also coming from Beijing at a time when entrepreneurs were desperate for the government’s help to cushion the sharp fall in exports.

“We understand that the trade war is a big issue, that even the government has no overriding say. But there is still a lot they could do to help us ease the pressure. We do not see them doing so. On the contrary, the pressure from the top is suffocating us,” he said.

One of Hu’s major headaches comes from updated social tax collection rules that take effect next year. The change in the rules is likely to force him to pay an extra monthly cost of 1 million yuan, which could push his company into the red.

In China, employers are obliged to pay several social taxes every month based on their workers’ wages. These contributions for health insurance, pensions and other social costs are paid into the national social security fund.

Implementation of social tax payment rules, however, is often lax, especially among small, private sector manufacturers, and the authorities in charge of collection often tolerate underpayment.

Both Hu and Zhang pay under 50 per cent of the total social taxes they owe, and, until now, this had been tolerated by local regulators.

“Local government understands perfectly well that we will not be able to keep the factories open if we have to pay the duties in full,” Hu said.

But from January 1, the responsibility for collecting the fees will shift to national taxation bureaus.

China merged the operation of local and national tax authorities in July to improve the efficiency and enforce fiscal income collection rules. The new tax authority has access to accurate information on salaries and so has a better ability to enforce full payment – which means entrepreneurs like Hu and Zhang will have to pay a lot more in social taxes every month.

That would wipe out their profits completely and possibly force them to close or relocate.

A wave of complaints from entrepreneurs like Hu and Zhang appear to have reached the cabinet. Last Thursday, Premier Li Keqiang promised the government would study lowering social welfare contribution rates to ensure “there is no increase in the corporate burden”.

Hu said they were nervously following how the issue develops.

RISING RENTS

Another heavy blow to small businesses has come from soaring land prices. Hu said the rental prices for his factory building and warehouse had almost tripled in the last eight years to 30 yuan per square metre per month, up from 11 yuan in 2010.

“Rental fees go up by at least 2 million yuan for me in a year. This is crazy. How can the government stay on the sidelines? If this goes on, all the manufacturers will be killed by the landlords,” he said.

Analysts say many smaller Chinese export businesses will not survive.

“Smaller exporters, particularly low value-added ones, will suffer more in the next year, and some of them will have to close up,” said Iris Pang, greater China economist at ING Bank in Hong Kong.

Pang expected export growth for China to slow further, to just 5 per cent in 2019, as Trump slaps punitive tariffs on more Chinese goods.

Since July 6, the US has levied 25 per cent tariffs on US$50 billion worth of Chinese goods. Over the weekend, Trump threatened to impose duties on US$517 billion of Chinese imports.

Last year, the US imported US$505 billion worth of goods from China.

Chinese government data released on Saturday showed that export growth weakened to 10 per cent in August, down from 12 per cent the previous month.

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“On the one hand, the transformation and upgrading of the Chinese economy requires better resource allocation, so some of the low-end manufacturing businesses have to exit,” Pang said. “But on the other hand, the process must be managed very, very cautiously, as this sector still holds a significant role in providing jobs. The rising industries like AI will not be able to digest the lay-offs.”

Official data released by the Guangdong provincial government in late 2016 showed that small and medium-sized enterprises – basically companies with under 1,000 employees but more than 20 – accounted for more than half of the jobs in the province and contributed nearly half of its tax income.

In Shenzhen, entrepreneurs like Hu and Zhang have met often in the past few weeks to discuss how to survive. Some of them are considering hiring more temporary staff to circumvent the social tax requirements, or even faking salary records to avoid duties.

“But the key is the government’s attitude,” Hu said, referring to whether Beijing would support small businesses like his. “I’m confused. Is the country just going to give up on us?”