China's textile and garment industry built its current dominance on the lowest production costs in the world, but its foundation for success is being undermined by the country's growing wealth. Labor, land, and regulatory costs are on the rise, pushing prices up and driving customers to Southeast Asia and beyond in search of better deals.

The industry will have to adapt. How it does will be determined by the economic objectives of the central government, which are issued every five years as a Five-Year Plan (FYP). The 12th FYP, approved in March, is effective through 2015. Five objectives stand out, according to an analysis by the US-China Economic and Security Review Commission: to restructure the Chinese economy by encouraging domestic consumption over exports; to develop the service sector; to shift toward higher value-added manufacturing; to conserve energy; and to clean up the environment.

Each of these objectives has troublesome implications for textiles, an industry that has been central to China's growth over the past decade, but which adds little value, consumes large amounts of energy, pollutes the environment, and requires cheap labor. As Christopher Runckel, president of US-based international business consulting firm Runckel & Associates, observes, "These are very challenging times for Chinese textile and garment producers." China, he says, is no longer the cheapest producer as it was five years ago.

High Labor Costs

The major factor in this development has been labor costs, says Runckel. Ten years ago, labor was plentiful and cheap in the Pearl River delta, the Yangtze River delta, and other coastal regions where the textile and garment industry has been concentrated historically. Today, labor costs are rising at 15-20% or more each year, he says, and the government wants to maintain that pace to improve living standards and spur domestic consumption.

Labor has become a seller's market in these crowded manufacturing centers. Many firms cannot even fully staff their operations, Runckel says. One factory he recently visited had only about 70% of the workforce it needed—many workers simply had not returned after Chinese New Year. Instead, they were finding jobs closer to their hometowns. High inflation - a rate of 6% in September - and the rising price of electricity and other utilities also add to the cost of production.

To cut costs, some producers are moving inland, where wages remain relatively low. "The smarter ones, especially in the textile area, are using their profits to buy better, more up-to-date, higher-volume spinning and other textile equipment to help give them an edge, as they know the days of competing primarily on a low labor price are fast disappearing, if not gone already," Runckel says.

Many textile producers anticipated the new FYP by retooling last year, says Runckel. He cites industry reports showing that, during the first three quarters of 2010, the textile industry increased spending on fixed assets by 26% year-on-year - 17% higher than the same period in 2009. China made 72% of the world's orders for modern spinning equipment in 2010, 84% of the world's orders for the most modern weaving looms, and three-quarters of the world's orders for new knitting machines.


Lever Style, a leading Chinese garment manufacturer, recently upgraded its factory in Shenzhen, which employs 7,000 workers. It still expects to move 30% of its production out of the country, however. In a July interview with Reuters, CEO Stanley Szeto explained: "If you factor in 5% appreciation of the RMB [Renminbi, or yuan], our labor cost is up by about 50% in US dollar terms." Szeto noted that whereas minimum wages in Vietnam were $60/month, they had risen to $200/month in China. "In the short term," he said, "we want to move the moderate price point items toward cheap locations northern China, western China, Bangladesh, Vietnam and so forth."


The least-competitive producers are being pushed out of business by the weakness of the export market. One local news report described a "wave" of bankruptcies sweeping through Guangdong and Zhejiang provinces.


In past years, such companies might have borrowed their way through lean times, but the flow of credit and subsidies has been severely restricted. Steven Dickinson, an international law specialist at the Hong Kong office of US-based law firm Harris & Moure, believes the government is deliberately allowing these companies to fail. "They have been tolerated in the past solely because they provide jobs," he explained in a July 21 post at the China Law Blog. "They provide no other benefit to China and are, in many cases, actually harmful. Moreover, the jobs they provide are for migrant labor, which is a source of social unrest in China. China wants these migrants to return to Sichuan and elsewhere. They want the businesses to operate according to the requirements of Chinese law." Runckel agrees. "Many of these businesses have not had a net positive effect on China, because they create pollution and are based on inefficient energy use, subsidies and rebates that can't continue," he says. "These businesses are now moving on to other places either inland or overseas, where local authorities in the new locations should most definitely look carefully to see that accepting these projects and on what basis makes sense for their particular situation."


Opportunity Knocks


Southeast Asia has become a popular destination. "It offers more opportunities because it not only has a big market, but [also] remains lower cost," says Runckel. More than 500m people live within the 10 countries of the Association of Southeast Asian Nations Free Trade Area (AFTA), he notes, a population larger than either the North American Free Trade Agreement region or the EU. "I believe most European or US companies are not registering the full range of advantages that SE Asia has to offer," he adds.


Of the AFTA nations, Runckel says Indonesia has been particularly aggressive in its pursuit of textile manufacturers, especially non-natural fiber and higher-tech textile firms.


"Vietnam has not done this as aggressively, as it already has a large garment and textile sector, and the government has not had Indonesia's sense of focus, although some areas of Vietnam have been quite effective in working with textile manufacturers to interest them in relocating," he says.

Vietnam is already a top-10 producer of textiles and garments. Exports from Vietnam's textile and garment manufacturing industry totaled $100.5 bn for the first eight months of 2011, up by 31 % year on year. But the industry is desperate to see greater domestic production of raw materials. Currently, 80% of its requirements must be imported.


The July start-up of the new Dinh Vu polyester fiber plant, built in Haiphong by PetroVietnam Petrochemical and Textile Fiber (PVTex) for $324m, is therefore a major development. It is capable of producing 175,000 tonnes/ year of polyester staple fiber and filament polyester, a volume that would meet up to 40% of the textile industry's requirements and reduce imports by $400m/year.


According to Vietnam's Investment & Trade Promotion Center, foreign investors have shown little interest in projects aimed at manufacturing textiles or fibers, in part because there exists too little of the infrastructure required to treat wastewater, but also because the capital required is so much greater than for a simple garment workshop.


Such issues illustrate why China continues to attract investment. "Despite labor costs increasing dramatically in China, one advantage that remains in doing business in China is the quality of the supply chain," Runckel notes. "In China, everything you need in the textile industry is close at hand, and there are generally multiple suppliers and good competition among them. Recently, many suppliers are also investing in more modern equipment and running continuous operations to better increase their competitiveness. This is helping China to stay at the forefront of textile production."


In Vietnam and Indonesia, markets are still being developed and the supply chain tends to be less mature, the pool of suppliers more limited and raw material prices higher than in China, Runckel says.


Transformation in the Making


Indeed, China continues to add production capacity as quickly as ever. According to PCI Xylenes & Polyesters, a UK-based consulting firm, more than 25m tonnes of new polyester capacity will be installed between 2011 and 2016. Capacity for raw materials such as purified terephthalic acid (PTA) and monoethylene glycol (MEG) is also being added rapidly. "[China's] many producers will attempt to run [the system] as hard as [they] can, despite this broader regulated framework [of the 12th FYP], and despite the economic woes being experienced around the world," says Phillip Gibbs, CEO of PCI Xylenes & Polyesters. "But China has to face up to a rapidly changing competitive base in textiles."


Gibbs predicts enormous transformations that will dramatically change the role of China's producers in the global textile and garment market while fostering economic development in South and Southeast Asia.

Real incomes are rising quickly in China, he says. As consumers shift emphasis from saving money to spending, growing demand for clothing and textiles will drive domestic prices toward world prices. At the same time, Unit labor costs in the textile and garment industry will continue to increase, eroding the Chinese advantage in basic commodity textiles. In lower-cost countries such as Indonesia, India, Bangladesh and Vietnam, the production of textiles and garments will increase, he predicts, as will the production of polyester fiber.


"This greater competitive arena will reduce the price that the Chinese receive for their exports and force its system to concentrate more on the rapidly developing domestic consumption trends," Gibbs says. "We believe [these trends] are inevitable and sustainable and support our longer-term growth trends for fibers at 6% per annum from 2016 onwards."


Continued appreciation of the yuan will also hamper Chinese exports, says Gibbs, further driving production toward the domestic market, so that less than 20% is available for export. "China will eventually become such a sophisticated market in terms of its retail structure and consumer demand that it will import more clothes and textiles from key regions such as Southeast Asia," Gibbs predicts. Chinese textile companies are already in these markets to consume fibers initially from China, but eventually from investments in the emerging markets themselves.


This makes the start of a market evolution, which bodes well for key Asian countries outside China," says Gibbs. "Korea and Taiwan, by virtue of their specialization and market connections, continue to do well in this trend. Globalization trends shift backwards to regional specialization, and herein present an opportunity also for polyester makers in regions outside of Asia." (Courtesy: ICB)


Originally Published in New Cloth Market, November-2011