How China Lost Its Mojo: One Town's Story

Once Booming Yantian Looks for New Sources of Growth
By TOM ORLIK 

Low wages and easy access to overseas markets helped transform Yantian in the 1990s from a sleepy agricultural hamlet to a manufacturing hub. Today, the number of foreign firms in town has dropped to about 150, thanks to rising labor costs, land shortages and fading Western demand.

YANTIAN, China—Not long ago, this factory town in southeastern China was an emblem of the country's massive export boom. 

Today, it is a symbol of China's struggle to sustain a growth streak.
Low wages, easy access to overseas markets, and a business-savvy leadership helped transform Yantian in the 1990s from a sleepy agricultural hamlet to a manufacturing hub with close to 150,000 people. 

By 1998, more than 400 foreign firms set up shop, churning out electronics, toys and watches for export. A golf course and high-end hotel sprang up to keep Japanese and Hong Kong factory bosses amused.
Today, the number of foreign firms in town has dropped to about 150.

Rising labor costs, land shortages and fading Western consumer demand drove some out of business; others moved to cheaper locations. 

The number of migrant workers, who once flooded into Yantian for jobs, has also shrunk, by nearly half.
The pileup of bad news has pushed officials here to search for new sources of growth. 

They are regrouping, betting on alternate sources of income such as risky real-estate investments.
"The export sector doesn't have a long future," says Deng Zerong, Yantian's new Communist Party secretary, and—according to local legend—a distant relative of the late Deng Xiaoping, the former leader known for opening China's economy to the outside world after years of isolation.
Yantian's challenges offer a microcosmic view of the problems today facing China. 

According to the National Bureau of Statistics, economic growth in the country fell to 7.5% year-over-year in the second quarter of 2013, down from a high of 14.8% in the second quarter of 2007.
For decades, the world's most-populous nation relied on a simple formula to turbocharge growth. 

It combined vast pools of cheap labor with heavy investment in new factories and infrastructure to unleash economic energy squandered during the years of chaos under Mao Zedong.
Foreign investment flooded in and China became the world's factory floor. 

Annual economic growth averaged 10% in the 1980s, 1990s and 2000s, says the NBS.
But now, much of the fuel that powered China's old model looks spent.
The pipeline of low-wage workers—which kept China's factories humming while holding foreign competitors at bay—is drying up. 

Meanwhile, investments in new equipment and other capital aren't yielding as much growth as before.
Demographics are a large part of the shifting equation. 

China's working-age population shrank in 2012, breaking a rising trend that stretched over the reform era of the past three decades, in large part because of a one-child policy that lowered birthrates. 

From 2010 to 2030, China's labor force is expected to shrink by 67 million workers—more than the entire population of France—according to United Nations' projections.
With fewer available workers, wages have shot up. 

Factory hands have notched three years of double-digit increases, according to official data, pushing some manufacturers into the arms of cheaper competitors like Bangladesh and Vietnam.
Export growth has also declined, from an average of 30% per year between 2003 and 2007 to 9.2% in the first eight months of 2013, according to the General Administration of Customs.
The pileup of problems wasn't immediately evident. 

To a large degree, they were masked after the global financial crisis as China poured trillions of dollars of credit into the economy. 

That infusion kept growth ticking with the construction of massive rail, road and other infrastructure systems.
China's economy has shown new signs of resilience lately—partly because a fresh serving of easy money earlier this year helped support strong data for industrial production and other key indicators.
But few inside or outside the country believe China's economy will power back to its former growth levels. Many predict it will struggle just to sustain its current trajectory in the absence of major reforms. 

While China remains the world's biggest exporter, it is steadily losing some of its earlier leverage, reducing the odds it can repeat its previous feats of superfast export-led growth. 

Rising debt levels add to the headwinds.
A crucial meeting of China's Communist Party elite in November is being billed by the government as an attempt to put the economy on a more sustainable path.
The November summit, held roughly once every five years, is charged with historical significance. 

It was at the same meeting in 1978 that Deng Xiaoping outmaneuvered Mao Zedong's chosen successor Hua Guofeng and put China on the road of reform and openness by repudiating the political extremism of the previous decade. 

Mr. Deng pushed pro-market policies, later saying that for the nation to prosper it must "let some get rich first."
In 2013, new Party General Secretary Xi Jinping again faces the challenge of injecting vigor into an increasingly exhausted economy.
Especially urgent, economists say, is the need to revise a system that ties access to social services for China's 260 million migrant workers to their place of birth. 

Current rules require them to return home in order to access free health care, education, or other services. That system worked fine so long as there was another wave of young rural workers to replace them. Increasingly, that isn't the case.
The lack of support for migrant workers has caused an economic domino effect. 

Many of them rein in spending as they save money for basic services not covered by the state. 

Domestic consumption in China languishes at about 36% of gross domestic product, according to the NBS. That compares with 70% in the U.S. 

The bottom line: China must rely on exports and government-led investment to power growth.
Yantian illustrates many of the advantages of China's previous growth model, as well as the newer uncertainties regarding its durability.
The city is a sprawl of factories with a 27-hole golf course on one end. 

A bust of Deng Xiaoping occupies the place of honor in a family shrine that sits on a hill overlooking the town. 

Hundreds of years ago, locals say, they shared a common ancestor named Deng Sixun.
When China began to open to the outside world in the 1980s, the city was primed for liftoff. 

A strategic location an hour from Hong Kong and adjacent to Shenzhen—the location of a "special economic zone" that was China's first step into the global economy—created the perfect conditions for an export boom.
"It was like finding a hill made of gold right outside the door," Mr. Deng, the local party secretary, says.
Mr. Deng, who says he doesn't put much stock in the rumored family connection, has nonetheless taken Deng Xiaoping's adage on getting rich to heart. 

He drives a gleaming white sport-utility vehicle, speculates on China's roller-coaster equity markets, and waves a wad of bank notes to demonstrate his recent investment gains.
The dangers of overreliance on exports started to become clear as early as the late 1990s, when the Asian financial crisis swept some Yantian firms into bankruptcy. 

The financial crisis of 2008 pushed others into the red. 

More than 200 went bankrupt or moved to other locations where labor and other costs were cheaper, according to a survey by Hu Biliang, an economics professor at Beijing Normal University.
The factories that remain now face lower profitability. 

Rising wages and a Chinese currency that has gained 34% against the dollar since 2005 have both taken a toll.
Hideo Aoyagi, the general manager of a Japanese firm that employs close to 4,000 workers in the town, has felt the economic tremors. 

Wage costs, he says, are up 40% since 2007. 

The company, Dongguan Shinano Motor Co., which produces motors for everything from automobiles to boilers, barely broke even in 2012. 

This year results are expected to be slightly better, with profit margins around 3%, says Mr. Aoyagi.
The parent company has opened another smaller factory 700 miles north in inland Anhui province.
But if more important customers go to Southeast Asia, the firm might open a plant there, says Mr. Aoyagi.
Even companies that remain highly successful are feeling some strains. 

They include Kunki Electronics Co. Ltd., which makes mobile phone and camera cases for the likes of Samsung and Panasonic.
Lin Meihui, the 41-year-old head of the company, says Kunki is still growing and profitable. 

He has just invested 100 million yuan ($16.3 million) into a gleaming new factory in Yantian, which opened earlier in the year.
But so far he has been able to find just 440 of the 550 workers needed for his factory to operate at full capacity.

He says banks were also reluctant to lend to him because his firm has limited collateral. 

Funds for the new factory came from past profits and loans from friends.
For Mr. Deng, the local party secretary, the future of Yantian isn't in producing low-value goods for export because "there are too many people making the same things."
Many of the city's remaining factories are more capital intensive and specialized than those that went bust, but they remain vulnerable to competitors in Southeast Asia.
Like other local leaders faced with slowing exports, Yantian's chiefs have turned to real estate to bolster the economy. 

On a main drag here, three major residential projects are under way, with scaffolding and cranes already up. The town is also shifting into financial services, investing in a loan guarantee company and planning a small loan company that could provide more capital for entrepreneurs.
Local leaders say such moves are a way to make efficient use of the town's savings, better than languishing in low interest bank accounts. 

But given widespread concerns about China's rising debt levels, it could be a risky time to move into the credit business.
The move into property is also a gamble—albeit one that has so far paid off for the town.
At the largest real-estate project, a 270,000-square-meter villa development called Blue Mountain, saleswomen in yellow golf carts drive potential buyers from nearby Shenzhen around the compound's man-made lake. 

The city generates income from such developments from its ownership of land. 

In another neighboring project, the town has taken a 55% ownership stake.
Mr. Hu, the economics professor, says Yantian's leaders are steering a necessary shift in the town's economic model.
"The old party secretary moved from agriculture to manufacturing, the new party secretary is upgrading manufacturing and moving into services," he says.
Still, sharply rising prices suggest a property bubble in the making. 

Yantian home prices have doubled since 2007 as developers offer inducements from Apple computers to gold bars to buyers. 

Many local residents own two homes, suggesting that speculation, as well as actual demand, has driven sales. That fear has become common across China, where frenetic building has left a landscape littered with ghost towns of empty properties.
Economists say more sustainable growth in Yantian, as in other parts of China, will require making the city more hospitable to migrant workers so that they stay there rather than returning home. 

That would provide more demand for local goods and services and make it easier for higher-end factories or other businesses to lay down roots.
By their mid-20s, 37% of China's rural residents move on to work in cities, according to a research by Xin Meng, an economics professor at Australian National University. 

By the time they get to their mid-30s, though, just 18% are still away from home.
Yantian does more than most towns in China for its 80,000-odd migrants. 

Basic schooling, subsidized by the town, is available to some children. 

Eligibility is decided based on a scoring system that takes into account payment of social insurance, homeownership, and compliance with China's single-child policy.
Factories have also expanded coverage of health insurance to more workers—a requirement that is more strictly enforced in Yantian than some other parts of the country that rely less on migrant labor.
But the conditions to qualify for basic schooling, for instance, are too onerous for many migrants, most of whom are too poor to buy a home.
Many still think like Lei Binbin, a 30-year-old woman from Hubei. She says she is in Yantian "only temporarily."
With no local health insurance and no guaranteed place for her 13-month-old son when he gets to school age, Ms. Lei and her husband are planning to move back to their hometown.
"We really need them, but from a political point of view we cast them out," says Deng Manchang, the second in command in Yantian's local government.