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 wonderful

Crossing 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:

The view from Renaissance Suzhou Wujiang Hotel, the hotel in Shengze we stayed in. Notice the river is actually the Grand Canal, an ancient mega-project connecting Hangzhou to Beijing

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.

Big textile finishing production lines

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."

Big devices on factory rooftop to absorb bad chemicals

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:

The newly built Huzhou-Shanghai HSR line runs directly at the gate Mr. Y’s textile finishing factory

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.