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November 20, 2012

China recovering, but slowly

Labor costs are rising and sales are down

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BEIJING (AP) — Zhang Hanzhong, who supplies locks for auto manufacturers, is part of a swath of China's economy that is lagging in a two-speed recovery.

Business for retailers, hotels, photo studios and other service industries is picking up as China limps out of its deepest slump since the 2008 global crisis. But exporters and manufacturers who drove its boom over the past decade are struggling.

Zhang's sales are down 20 percent with no rebound in sight, while labor costs are up.

"The second half of the year is even harder than the first half," said Zhang, who employs 60 people at his factory in Meizhou in Guangdong province near Hong Kong.

China is recovering but the days of double-digit growth are gone. Faced with falling returns from a three-decade-old growth model fueled by exports and investment, Beijing is trying to rebalance the economy by promoting consumer spending, service industries and technology. It is a strategy that promises smaller but more sustainable gains. That could have global repercussions by dampening voracious demand for iron ore, industrial equipment and other imports that drove growth for suppliers from Australia to Africa to Germany.

"The world has to get used to the idea that China will grow at a 7 or 8 percent pace, and growth will be far less investment-intensive over the next decade," said Mark Williams of Capital Economics. "So the projections for Chinese demand for commodities, capital goods, construction equipment and so on have to be revised down.'"

The Communist Party has committed in broad strokes to growth based on consumer spending and innovation in its five-year development plan that runs through 2015. A report in February by the World Bank and a Chinese Cabinet think tank said that to achieve that, the government will need to make politically daunting changes including curbing the dominance of state companies.

New leaders including General Secretary Xi Jinping who took power last week are under pressure to deliver on the party plans to overhaul the economy. But how far they will go to rein in politically favored state companies and other vested interests is unclear.

Growth slowed to a three-year low of 7.4 percent in the three months ending in September. That prompted concern the new leaders might feel compelled to boost spending on building bridges and other public works, setting back efforts to reduce reliance on investment. But retail sales and other indicators are improving, easing pressure for abrupt changes.

"The issue is how well they work together and whether they are able to overcome vested interests," said Williams. "We really won't know that until they've been in office for a little while."

This year's growth is explosive by Western standards but well below the 14.1 percent that China racked up in 2007 on its way to passing Japan as the second-largest economy in 2009.

Forecasters expected a Chinese recovery early this year. As the slump deepened, the International Monetary Fund and others cut growth forecasts for the year to below 8 percent — the weakest since the 1990s. Even after a recovery, they see it rising to only about 8.5 percent by 2014.

Beijing has yet to take many of the steps analysts say are required to achieve its goals, including pumping money into health and other social programs to free up household budgets for consumer spending. But the impact in some industries is clear.

A monthly survey by HSBC Corp. of Chinese service companies has shown activity expanding steadily for two years, while a parallel survey of manufacturers has shown activity contracting this year.

Already, retail spending is rising faster than overall growth as wages climb. In October, retail sales were up 14.5 percent over a year earlier.

In Huzhou, a city south of Shanghai in Zhejiang province, business is strong for entrepreneur's Li Yong bedding factory. It employs 10 people and doesn't bother to export because demand from Chinese customers is strong. Costs for labor, rent and materials up but so are sales.

"Our profits are up 10 percent this year from last year," Li said.

Li buys all his materials in China, highlighting another trend that could blunt the payoff for its trading partners. As local companies develop the ability to deliver more sophisticated goods and services, they are serving Chinese consumers from domestic resources, limiting demand for imported materials and technology.

"I will think about using imported materials in the future, but for now, both the customers and I cannot afford it," Li said.

China's slowdown was due largely to government controls imposed to cool an overheated economy and inflation following its quick, stimulus-fueled rebound from the 2008 crisis.

At the same time, steelmakers and other heavy industry was under pressure from a government campaign to cut pollution and energy use by closing older facilities. Construction, a major source of jobs, was battered by a clampdown on land sales and building cool surging housing prices and stop speculation-driven investment.

Easing building curbs would be a quick way to generate jobs, but communist leaders resisted pleas from developers even as growth drifted lower, worried about setting back their rebalancing plans. Instead, the government is pushing companies to construct more low-cost housing, which the general public needs but that produces less profit and requires less imported steel for girders and copper for wiring.

Weaker manufacturing and construction activity already have cut China's demand for foreign goods. Imports of steel products fell 39.9 percent in October from a year earlier. Copper imports were off 12.2 percent and those of raw wood were down 11.1 percent.

Government pressure to raise wages has put more money in consumers' pockets but is squeezing companies, especially in labor-intensive industries that employ millions of people making shoes, toys and other low-tech goods.

Chen Shuhai's 5-year-old wig factory is the sort of labor-intensive business that is being pushed out of China by higher costs.

Rent on his factory in Yiwu, a southern city famous for exporting buttons and other low-tech goods, doubled from 2009 to 2011. Monthly wages are up 10 percent this year to about 3,500 yuan ($550) for each of his 80 employees.

Chen said neighboring companies that exported to debt-crippled Europe have closed. Others are moving to Vietnam, India and other lower-wage markets.

"There is not much room left in China for the wig industry," Chen said. "I don't know what will happen to my factory."

Longer-term, the government's effort to create a consumer-driven economy might turn China into a market for tourism, insurance, health care and other service companies.

"The issue is whether it can do this smoothly, in which case growth can remain strong," said Williams. If it works, "over the next 10 years, it will be another group of economies that are able to ride China's coattails."

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