How to understand today's China by looking at one of her richest towns?
Local impacts of trade war, decoupling, environmental regulation, industry consolidation and rising labor costs
Previously, we took a look at some of China's most ordinary cities such as Gaoyou (Part I, Part II) and Leshan, to understand where China is heading to despite current uncertainties. Today, we are going to shift to a smaller, but more developed part of China. We will pose the same question: what macro questions about China can we answer by looking at the micro?
A few weeks ago, we visited an ex-colleague of mine (I will call him Mr. Y), in a "town" called Shengze盛泽, some 1.5 hours' drive from Shanghai.
Mr. Y and I used to work together in an investment firm. Then he got married to a childhood friend and had kids. His father-in-law runs a textile manufacturing business in Shengze, but like many first-generation entrepreneurs, he wants a way to retire but his daughter was not up for the job. So after several rounds of imploring by the father-in-law, both directly and through his daughter, Mr. Y finally decided to quit his investment job in Shanghai and went back to his birthplace, Shengze, to start taking over the family business.
Strategically located on the Grand Canal 京杭大运河, Shengze was an ancient silk manufacturing center in the Ming/Qing dynasties. It is situated at the intersection of Shanghai, Jiangsu and Zhejiang provinces, so effectively at the heart of the prosperous Yangtze River Delta region. With this rich historical heritage and powerful geographical endowment, it is no wonder that today's Shengze is among the 10 richest towns 十强镇 in China, out of over 20,000 towns, on the back of a strong textile industry.
Shengze is a town in the Wujiang District吴江区, Suzhou Prefecture苏州市, Jiangsu Province江苏省. So from a political administration point of view, it is at the lowest of the lowest level of China's administrative hierarchy (to understand how "low" a town is, refer to this handy primer by the wonderfulCrossing the River by Feeling the Stones). But the moment we arrived in Shengze, we didn't feel it is only a town, but almost like a small city. High-rises, markets, public parks, exhibition halls, 5-star hotels (we stayed at Renaissance), you name it. This is one of the few "towns" in China that has ballooned way larger than its official designation. This is what a top 10 town in China looks like:
Mr. Y came to our hotel to pick us up upon arrival, and we wasted no time to follow him in a tour of his family's factories.
Mr. Y runs mainly two factories. One is a textile weaving factory. Another is a textile finishing factory. This is actually my first time visiting any textile factories, so I was super excited.
According to Wikipedia
Textile weaving is a method of textile production in which two distinct sets of yarns or threads are interlaced at right angles to form a fabric or cloth. Cloth is usually woven on a loom, a device that holds the warp threads in place while filling threads are woven through them.
There are many methods for a loom. The loom machine that Mr. Y's factory employs is "water jet loom". Basically, a machine shoots a high-pressure water jet, tagging along a thin thread, across a whole set of threads. This may sound simple but to witness over a hundred water jets bursting simultaneously, non-stop, like some dutiful machine slaves, is quite a scene. You can check the video below to have a taste.
The finishing factory is the process when factories provide finishing touches, such as plastic coating, to fabrics. Think of the surface texture of a Moncler down jacket. That thing will require finishing. Mr. Y's finishing factories not only supply to the clothing industry, but also to manufacturers of tents, umbrellas, photography foil backdrop and even military parachutes. You get the picture.
According to Mr. Y, there are at least 1000 factories in Shengze like his, and his factories are only average in terms of size. So Shengze is really this huge cluster of everything about textiles.
Structural observations
Readers of Baiguan usually pay more attention to the macro picture. What are the structural changes on the ground in China right now? This is precisely what I want to achieve during this visit. I wanted to closely look at the nuts and bolts of an actual actor of the economy, to give you a better sense of how structural changes unfold in reality.
In my trip to Shengze, I have made interesting observations about how macro-themes such as trade war, environmental protection, industry consolidation, government-business relations, friend-shoring, and labor costs actually reflect themselves at the micro-level.
Trade war impact
US-China trade war's impact on Shengze is huge. In fact, woven fabric, a key pillar of Shengze's industry, was included on the list of US$200 billion worth of Chinese goods now covered by the 25 percent tariffs imposed by US President Donald Trump in 2019. Mr. Y believes directly because of the trade war, the business has been very tough compared with the good old days between 2000 and early 2010s.
I went to check some official statistics. In 2019, Wujiang District (of which Shengze is a major town)'s total export to the US was valued at $3.1bn, down 13.5% from 2018. It went down further by 8% in 2020, and further by 13.5% in 2021 (country-specific export data was missing for 2022). But interestingly, the US seems to be the only laggard. Also in 2021, exports to Japan (+20.5%), ASEAN (+20.6%), South Korea (22.4%), EU (51.3%!) and Russia (60.5%!) all went up. In 2021, US only accounted for 12% of total exports of Wujiang, compared with 20.2% in 2019. Now, largest destination of Wujiang's products is EU, accounting for 21.2% of total exports.
Just from the Shengze experience, it seems that if it's decoupling the US is wishing for, then they have got it. It's only that when US decouples from China, China may actually end up doing more trade with the rest of the world.
I can't help but wonder, if Shengze/Wujiang is a microcosm of the bigger trend, who will be the net-loser of trade war?
Environmental protection
Environmental protection is a recurring topic I encountered during my trip. On the rooftop of the finishing factory, I saw some huge machines that I couldn't recognize. Mr. Y told me these machines are used to absorb and burn bad chemicals, before releasing them to the air. The heat generated by burning can also be recycled back to production line. According to Mr. Y, these machines were only installed a few years ago, as required by the government.
Me: "Before that time, how was the exhaust treated?"
Mr. Y: "Before, there was no treatment at all."
The "time" he referred to was around the 2013 Eastern China smog, the Chinese equivalent of the Great Smog of London.
Every Chinese remembers those years. For me, I vividly remember that one day when I was a middle-schooler, roughly around 2007, I was suddenly shocked to realize nearly every day now was smoggy. There was always this kind of haze in the air, not really fog or dust, but something, something I didn’t yet know the name of but very annoying. For quite some time, I forgot what the blue sky looked like, and I felt very bad about it. In 2015, a highly influential and controversial documentary about air pollution, Under the Dome, gathered over 150 million views and became the most-watched Chinese documentary I ever know. Although the documentary was later censored, and the creator Ms. Chai Jing almost crucified, the message was out. Public opinions had been inexorably shaped. The same year, Xi Jinping's "Two Mountain Theory" on green development was formally written into official party document. Since then, substantive measures have been deployed to combat pollution.
For those people who dare to claim that Xi (and the late Premier Li)’s administration has not achieved anything substantial, I find them very insincere. At the very least, the environment has gotten much better. Now, it is common to see clear blue sky in Beijing, Shanghai or anywhere I visit in China. That this can be achieved so quickly, while the country is still developing, is one of the greatest socio-political achievements you seldom hear people talking about. Even Britain only got to fix her pollution problem almost 200 years after the start of the industrial revolution.
Mr. Y's factory represents this quick historical transition in real action. And there are more than just his rooftop installments. For his weaving factory, I later found out there are actually fixed quotas for those fantastic water jet looms. In all of Shengze, there are only enough quotas for 150,000 water jet looms, because those looms can actually create pollution for water resources.
But environmental protection is also costly, and this is something Mr. Y doesn't feel comfortable about. The rooftop installments cost him several million RMB. He drearily commented that every year there would be some new devices to purchase, and the environment protection agency had become too powerful to resist. So every year he would be handed a list of suppliers to purchase from. "Who knows what kind of relationships those suppliers have with regulators," he asked, helplessly. After he went through some detailed accounting, it appears almost 2 years of profits were used to comply with evolving regulations.
This shows that even though the environment is for free, protecting the environment is not. And it is businesses like Mr. Y's who bear the ultimate costs.
Overall, I do think the net result for the society at large is positive. Even Mr. Y himself would not want his children to grow up in toxic air, with no memories of a clear blue sky. And without strong government intervention, China could not have achieved strong reduction of pollution within such a short time window. The long-term health benefits are huge. How to make the implementation work smoother, more transparent, and ultimately, more trustworthy for business owners like Mr. Y is the key.
Industry consolidation and supply-side reform
An interesting side effect of strong environmental protection is industry consolidation. For instance, for the weaving and finishing industries that Mr. Y operates in, the permits have already been capped. A more interesting example is the dyeing industry, which is the production stage that takes place after weaving, but before finishing. The reason Mr. Y does not own a dyeing factory is because dyeing is a highly polluting process. So the permits have already been capped a long time ago. According to Mr. Y, there are only ~30 dyeing factories in Shengze right now, half of which were acquired and consolidated by Sheng Hong盛虹集团, the largest company in Shengze.
The story of Sheng Hong is noteworthy. Like anyone else, Sheng Hong also started as a textile player, but over the years, it has grown more and more upstream, to the point now it has become one of China's largest non-state-owned petrochemical refiners. Sheng Hong, like many other industrial names such as Wanhua Chemical and Conch Cement, got a huge boost from 2015 supply-side structural reform供给侧结构性改革, a series of industry consolidation policies in order to decrease energy consumption while increasing competitiveness of over-supplied industries such as coal, steel and chemicals.
For Mr. Y though, he is less lucky. The markets he operates in, weaving and finishing, are highly competitive. But his upstreams, the petrochemicals and dyeing, are more consolidated. So he has to go with whatever pricing and payment terms of his upstream. His downstream are clothing traders and eventually, retailers, but over the past years, low-cost channels such as Pinduoduo and live-streaming e-commerce platforms have created a huge downward price pressure on the entire industry, so margins become smaller. Moreover, in order to compete, he has to allow a few months’ payment days for his customers. But for his more consolidated upstreams, he has to pay upfront. This, along with the pressure to purchase anti-pollution devices, creates a tough cashflow situation for him. He jokes wryly that in his line of business, even if you can be profitable, it is not common to retain any cash beyond daily needs for his family.
More on government-business relations
There are many other interactions between his business and all levels of government. The most interesting one concerns a high-speed railway (HSR) line.
A new HSR line, connecting Shanghai to the lake-side city of Huzhou is scheduled to operate by the end of 2024. This line runs literally at the gate of Mr. Y's finishing factory. See pictures:
Mr. Y told me that in the original plan, the train actually meant to go directly over the top of his factory, and 3 factories including his would need to be demolished. As the three factory owners refused to sign the compensation agreement, slight changes were made to the original plan. So now, when you travel from Shanghai to Huzhou for vacation in the future, you will probably see Mr. Y flashing ouside of your window.
To imagine a high-speed railway line, usually a state-level planning project, can be diverted simply because 3 factories don't agree to it, is quite interesting for me. It contradicts some people's assumption that in China, if the government wants something, it will have its way with no consideration of the interests of other stakeholders.
In fact, for us on the ground, it's never so simple. There are some things that are non-negotiable, but most things people encounter in their daily lives do not belong to this category. Yes, there might be some extreme cases, such as “forced demolishment强拆”, especially in the go-go days of the early 2000s. But it's just the extreme cases that made their way to the headlines. Most of the time, it is just negotiation, gives-and-takes, and, old-fashioned haggling. (Does it sound familiar to you?)
This is what people who simplistically label China as "authoritarian", "regime", or even "totalitarian" will not be able to understand, but I think it’s an important perspective to help you to have a true grasp of China.
Labor pressure
Another pain point I observed from Mr. Y's factories is that, his workers all seem...very old. In the finishing factory, the handful workers there seemed to be at least 50 years old. The few women roaming among the highly-automatic water jet looms looked at least 60 or even 70 years old. Only in the accounting room can I see 1 or 2 relatively younger faces.
Mr. Y confirms this observation. He said it is very hard to hire young people now. Take the finishing factory as an example, the work is boring and repetitive. The smell in the factory is stingy. In summer, the temperature in the factory can be super hot (It's already quite hot during our visit in mid-October!) Clearly, no young person is willing to work in such conditions with only 7000 yuan ($1000) per month of pay.
Obviously, this trend will only get worse. I can only imagine a combination of higher level of robotic automation and higher level of wages to salvage Mr. Y from the situation when he would not be able to find any labor in the future. But both ways will lead to higher costs for him, adding to his already thinner margin and tighter cashflow. So if demand is not improving, I will not be surprised if he just quits one day.
Reshoring, friend shoring, or simply, inland shoring?
With so much cost pressure, is he seeing a trend of factory owners leaving China to invest in Southeast Asia, India or Latin America?
Mr. Y said, to be frank, just from what he can see, it's not so much about moving factories overseas. Most of his peers are looking to move to inland provinces, mainly Anhui, Henan and Sichuan provinces. His observation is in line with a previous WSJ article titled China’s Factory Floor Is Moving—But Not to India or Mexico.
These inland movements posed a new challenge for Mr. Y. When those factories move inland, they are often incentivized by local governments to build capacity that's much larger than what they have in their hometown. If they used to have 2 production lines in Shengze, they might build 20 lines somewhere in Henan. In short, Shengze's "quotas" do not work beyond Shengze. The net effect is adding even more pressure to over-capacity.
When in 2022 the central government announced a series of measures to push for a "unified grand market"统一大市场, this is exactly the type of problem they try to tackle. China has strong economic and fiscal federalism. All localities are competing with each other. Sometimes it is good, but sometimes it leads to waste and overcapacity, which requires higher level authority to coordinate.
The future
We concluded our visit with a dinner Mr. Y hosted for us. The location is a hidden restaurant only local people know, not listed on any website such as Dianping platform. It is so hidden, that even Mr. Y for a time drove into the wrong alley.
The restaurant was built by one of his fellow factory owners in traditional Chinese style. The food was so delicious. My favorite is the braised local free-range chicken. Super chewy and tasty, it has a kind of taste you can never have in big cities. We also tried Shengze-style shumai烧麦, which is very unique.
We were joined by Mr. Y's wife and two sons. The older son is 12 years old, at the age of cramming pre-middle school exams. The younger one is 8 years old, a jovial little fellow with sparkling eyes. The two kids struck me as very bright. Although their schoolwork is tough (they have to stay at school until 8pm, which is common in China), they did not appear to me as nerdy, but full of bright ideas. The older son can already argue with adults very eloquently. The younger son is sharp at guessing your implied message.
They also surprised me with their sophisticated knowledge of different electronic products. For example, they can pretty much tell what model of iPhone I have just by seeing it, even though they themselves only use secondhand iPhone 6 passed from their parents and only have access to their phones during weekends. At school there is an extra-curricular class for drone-driving. Each student is required to bring their own drones. All the classmates agree DJI has the best drones. They also know a lot about cars, especially EVs. I remember I only started to pay attention to gadgets and machines when I was in high school, but not at such a young age.
Ms. Y, their mother, not so excited, commented:
"Yes. That's the general atmosphere today. Don't you see that the state国家 just wants every kid to get interested in those fancy technology? Selling fabric卖布 is so out of fashion. Our business has no future."
Perhaps, here lies the solution to Mr. Y's business problems.
Great vignette! Keep 'em coming.
Fascinating read especially as a downstream apparel factory.