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People visit the International Bag City's investment promotion center in Pinghu, Zhejiang province, on Sept. 28, 2012. The $236-million trading centre is the sort of initiative China’s leaders want to see sprouting across the economy. (ALY SONG/REUTERS)
People visit the International Bag City's investment promotion center in Pinghu, Zhejiang province, on Sept. 28, 2012. The $236-million trading centre is the sort of initiative China’s leaders want to see sprouting across the economy. (ALY SONG/REUTERS)

Secrets of China’s economic future revealed Add to ...

Chinese luggage magnate Karohy Shi wants to add another name to the list of chic cities synonymous with style. Move over Milan, look out London, forget Paris. Say hello International Bag City, Pinghu.

But the $236-million trading centre Mr. Shi is building in this coastal town about 100 kilometres from Shanghai is more than a place for foreign fashionistas to find the perfect purse.

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It aims to help local firms develop their own domestic brands and markets and start scaling the global value chain.

“If we don’t do this, maybe five years from now most of the factories around here will have only one thing in their future - going bankrupt,” said Mr. Shi, chairman of International Bag City (IBC) and local luggage maker, Newcomer Group.

Newcomer is one of many Pinghu bag factories that employ some 40,000-50,000 people, operate on razor-thin margins after a decade of rising labour and raw material costs and where Europe’s slump is a fresh threat to survival in an industry where 70-80 per cent of output is for foreign clients.

It’s a familiar story everywhere in China’s vast manufacturing sector, which generated most of the roughly $2-trillion of revenues derived from exports last year.

Mr. Shi’s example is the sort of initiative China’s leaders want to see sprouting across the economy and provides a case study of the benefits and challenges the country will face as the government shifts the focus of factories away from exports.

Beijing wants home-grown firms to tap into China’s fast-growing, foreign brand-focused, consumer class and transform the country’s factories from low-end assembly lines for the likes of Apple Inc. and Wal-Mart to high value-added product originators of their own.

Chinese leaders need manufacturers to move up the value chain to avoid the so-called “middle income trap” where wealth creation stagnates as market share is lost to lower cost competitors overseas and the attainment of high-income country status stays hopelessly out of reach.

The Communist Party fears the popular discontent that that could stoke, even though jobs are likely to be lost as China ditches its labour-intensive export model.

“Right now, we take overseas orders and earn processing fees, but we cannot survive just on processing fees. This model is dead,” said Cao Liang, head of Pinghu municipal government’s news department and the vice chief of propaganda for the local Communist Party branch.

Mr. Shi’s IBC plan will bring together retailers, wholesalers, traders, raw material suppliers, designers and service providers into one location - with the aim of cutting costs and export dependency and developing home markets and brands.

Aggregation around a centre of excellence is a well-trodden path to prosperity. Edward Lloyd did much the same in 1688, turning his coffee shop meeting venue for ship brokers, merchants and financiers into the Lloyd’s of London insurance market that remains the world’s leading provider of specialist insurance cover more than 300 years later.

Mr. Shi and his partners see IBC -- a 400,000 square metre development of office towers, wholesale market and design studios -- as the way to roughly double the value of annual bag revenues in Pinghu to 10 billion yuan by 2020, while cutting export exposure to 50 per cent of the industry’s output.

Mr. Shi has proposed to the local Jiaxing government in Zhejiang province that it uses Pinghu’s IBC - which will employ 10,000 people when it opens in September next year - as a template to build a fashion capital modelled on Milan and Paris. But his motivation is more about making a profit than leaving a mark on China’s economic landscape.

“Now Chinese people have more money,” 46-year-old Mr. Shi, who has an MBA from the China Europe International Business School, said in English.

“In the past, one bag was used for every purpose. But now, especially for young people, if they take the wrong bag to the wrong event, they are out, they will be laughed at,” he said. “It’s a big potential market.”

Faltering foreign demand and soaring costs add urgency to the need for change. Many exporters are running at reduced capacity and some are struggling to survive.

The second slump in orders in four years has left China’s export growth this year averaging around 7.8 per cent versus 2011. It was just 2.7 per cent in August from a year earlier and the Commerce Ministry has said things could get worse in the months ahead - jeopardising the official 2012 target for a rise of 10 per cent.

That’s not great news in a country where exports generated 31 per cent of gross domestic product in 2011, supported an estimated 200 million jobs and where analysts expect the weakest year of economic growth since 1999 at 7.7 per cent.

Domestic retail sales growth meanwhile is averaging 14 percent this year, reinforcing Beijing’s belief it must change China’s economic mix towards domestic consumption.

A Beijing-backed World Bank report envisages per capita income rising to $16,000 by 2030 from about $5,000 now, with two thirds of economic activity forecast to come from domestic consumption against less than 50 per cent at present.

Other reports suggest the shift could come sooner than policy makers expect. Analysts at McKinsey reckon China’s mainstream consumer class will comprise 400 million people with household incomes between $16,000 and $34,000 by 2020. Boston Consulting Group says China will be the world’s No.2 consumer market by 2015.

The switch to a domestic focus forces up logistical costs as firms switch from exporting containers of gear straight off production lines to shipping individual cartons through China’s fragmented retail network, in which producers bear the risk of unsold output.

“The cost of expanding domestic sales is high. Most companies that are switching to home markets are not successful,” Li Yushi, vice head of the Commerce Ministry’s think-tank in Beijing.

Others are investing to reduce labour costs. Linda Zhao, Newcomer’s general manager, said the company spent 10 million yuan on automation in 2011.

New machinery and new processes need new skills. Pinghu, with a small permanent population of 480,000 supplemented by a migrant population of 250,000, has responded by providing city-sponsored re-training for workers laid off from low-end jobs.

If they up sticks in search of jobs elsewhere, Pinghu’s enterprise zones and business parks will empty and a bustling city - where small businesses line streets intersecting housing developments built on ample waterside plots and a newly-finished fashion mall gleams at its edge - will shrivel.

Get the balance right and China could secure its manufacturing base years into the future, even for those in the low margin textiles business, like David Tien, executive vice president of Quang Viet Enterprise Co Ltd.

His firm makes sportswear for the world’s biggest household names. Mr. Tien, from Taiwan, has no ambition to create his own brand or come up with his own designs. That makes him acutely sensitive to maximising margins in a business where he says 3 to 5 per cent is about as good as it gets.

Tien is bucking the apocryphal trend of textile makers leaving China for lower cost locations such as Vietnam. Instead, he set up a factory in Pinghu a decade ago to try to squeeze more profit from a business he’s run from Vietnam for 20 years.

“I have 3,000 staff in China and 10,000 staff in Vietnam, but I get the same production volume and profit from both locations,” Mr. Tien said.

Higher skill levels, adaptability to new technology and the willingness to work plenty of overtime to complete rush orders give his Chinese factory the edge.

The only downside is staff turnover, which leaves him recruiting and training roughly a third of his Chinese workforce every year. And it’s getting harder to do so.

“We know that China’s getting richer,” Mr. Tien said. “It’s got lots of young consumers and they know how to spend, but they are not so keen on the hard work to earn it.

“The real long-term problem for manufacturing business in China is that young people just don’t want to work in factories anymore.”

 

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