Foreign Plants Retreating from China

By Zhang Bin, Rui Bingyou
Published: 2008-07-30

Cover story, issue no. 378 July 28 2008
Translated by Ren Yujie
Original article:

In the middle of July 2008, US-based heating system producer Desa announced to move some production lines in China back to its headquarters in Bowling Green, Kentucky.

The announcement came as Chinese Ministry of Commerce has found that more and more US and European manufacturers considering the relocation of their Chinese plants in response to skyrocketing shipping costs and the continued appreciation of the yuan.

Why did Desa leave? Is this the forewarning of a greater trend? Is China no longer attractive as the factory of the world?

A Long Return for Desa
Desa entered China in the end of 2000. The heating system producer used to manufacture products in China and sell them under the Desa brand in the US and other markets.

According to Claude Hayes, vice president of retail heating at Desa, the company indeed saved when it first moved to China. Most of those advantages, however, disappeared last year. The company experienced two value-added tax (VAT) adjustments in eight years.

James Cameron, the vice director, told the EO that just a few years ago Desa could get a 15% export tax rebates; but they were reduced by 10 percent after Chinese government reduced the rate for certain products in July of 2007. All the while, the yuan continued to hit new highs against dollar.

"Maybe we would have been able to endure the VAT adjustment, but yuan appreciated nearly 12 percent in 2007, and shipping costs, which was the main dealbreaker, soared almost 25 percent this year." said Hayes.

He described the decline of the VAT, yuan appreciation and skyrocketing shipping costs as a perfect storm of rising costs.

Hayes said the three factors led the company's costs to increase 50 percent in the first half of 2008. The decision of relocating their Chinese plants to Bowling Green was made in recent months, but the earliest move had commenced since October of 2007.

Hayes told the EO, Bowling Green would close the distance between Desa and over 70 percent of Americans to within a 12-hour drive, but it would take six to eight weeks from China to United States.

A Global Trend?
The governor of Kentucky, Steve Beshear said at a July 15 press conference that the return of Desa was "a strong indicator of evolving outsourcing trends in the global economy."

The same month, a research report released by the Chinese Ministry of Commerce warned that more and more US and European manufacturers would be considering the relocation of their Chinese plants to bases closer to home. Higher crude oil price accelerated international capital flows and caused the return of developed countries' manufacturing businesses.

One source at China's Ministry of Commerce said the situation had attracted the attention of China's high-ranking officials.

It was reported that 14,544 foreign businesses had been founded in China in the first half of 2008, a 22.15 percent decline year-on-year, with actual utilized value of foreign direct investment (FDI) increasing 45.55 percent year-on-year.

The source said the increase in FDI could only reflect the tendency of foreign investment utilization, but could not show the current situation.

Public data showed that China's Ministry of Commerce approved about 5,900 manufacturing projects in the first half of 2008, a decline of 43 percent year-on-year. Meanwhile, 7,400 projects in the service industry were approved, a increase of more than three percent compared with the corresponding period last year.

China's trade model was characterized by processing, and according to the source, low shipping costs was crucial.

With crude prices soaring, this structure was being dismantled. Jeff Rubin, chief economist for CIBC World Market, mentioned in a report that once oil prices broke up to three-digit, distance meant money. He calculated that fuel cost would raise four or five percent for every 10 percent distance expanding in goods transportation.

The CIBC report also showed that the current cost for delivering a 40-foot container from Asia to the US East Coast was threefold higher than in 2000. CIBC estimated the rise of fuel prices caused skyrocketing shipping costs. Fuel accounted for only 20 percent of container transportation costs in 2001, but it reached up to 70 percent in recent years.

The Chinese Ministry of Commerce said the proportion of Chinese processing trade declined to 48 percent in last year. From January to May 2008, the Chinese labor intensive export growth declined to 16.7 percent from 29.6 percent last year.

Michael Barbalas, president of the American Chamber of Commerce in China, told the EO that when oil prices soared, multinational corporations must reconsider and rearrange their global supply chains.

Ke Bai, a Washington-based consultant agreed that some US-based corporations might retreat from China and return to US or transferred to other Asian economies in the future. 

However, he added that although plants with lower technological requirements could be transferred from one country to another with relative ease, those with higher investment and professional demands would be more difficult.

Not a Goodbye

Zhang Yansheng, a researcher at the National Development and Reform Commission (NDRC), said the decline of foreign investment projects did not indicate much of a problem, and that manufacturing's use of foreign investment had not declined much.

He added: "We are currently facing sub-prime mortgage crisis, a world economic slowdown, and the reduction of global capital flows--thus the decline of foreign investment in China is as expected."

US-based electronics manufacturer Emerson told the EO that although it was phasing out some production from Asia, it was seeing reliable revenues there. Moreover, it said it had not cut down its overall business in China, and actually had expanded overall operations there in 2008, including setting up production lines in Shenyang and Shenzhen.

Barbalas, from the US Chamber of Commerce, said he would like to believe that China was graduating from its role as a manufacturer of low value-added products to a one of high added-value ones.

He said higher oil prices obliged manufacturers to produce more of the latter, which would spur more advances in manufacturing.

He added that most members of the chamber had been attracted by Chinese and other Asian markets nearby, and that the rise of shipping costs would not majorly affect investment or expanding.

China had revised the catalogue of processed products many times since 2006, removing certain kinds of resource-demanding, high polluting products, which shut out some foreign manufacturers.

The researcher at the Ministry of Commerce said that this was the commencement of China's "neutral" foreign investment policies.

A Beijing-based analyst working for a foreign industry association said some foreign businesses in China had adopted a "China +1" policy, basically establishing plants in Vietnam and other regions while keeping production in China.

However, China may face other difficulty in attracting and retaining foreign investment. According to a survey done by the US chamber, US-based businesses investing in China faced the most trouble in human resources.

"In china, to find, train and retain talent were listed foremost among their business challenges," Barbalas said.

Indeed, even Desa would not like to lose China entirely. Hayes told the EO: "We definitely plan on expanding in China in the future. We have been in China for many years and manufacturing here has improved greatly. Our company will be flexible, and once shipping costs decrease or the yuan appreciation slows down, we would consider moving more production there."