China Factory Closures and the Rise of the Rent Seekers

August 1, 2012

As you may have heard, Adidas recently announced the closure of its last remaining directly-owned factory in China. They’re going elsewhere in search of lower labor costs. However, that decision did not go over well with their local suppliers, who do not seem willing to accept it without putting up a fight.

Chinese suppliers are calling on the clothes manufacturer Adidas AG to compensate them for the consequences of its decision to close the last factory it wholly owns on the mainland, saying that they might otherwise turn to the courts for assistance.

Adidas announced its plan to close the factory last week, saying it will shut down an apparel operation in Suzhou, Jiangsu province, in an attempt to become more efficient by restructuring its business in China and the world. It also said it will terminate its contracts with five suppliers in the country.

Those companies have been working with Adidas for several years. In 2011, they delivered about 8 million garment pieces to Adidas, said Sun Yingli, general manager of Shanghai Manlang Textile Co Ltd, one of the suppliers.

Sun said Adidas informed her and her colleagues in April that it wanted to end the contract it has with Shanghai Manlang Textile. “The original document said Adidas can terminate it whenever they want,” Sun said. “They just have to tell us about that decision six months in advance.” Sun said she has consulted a lawyer and said the contract appears to be a one-sided agreement. (China Daily)

This lawsuit threat looks like a weak negotiation tactic. As I’ve said before, this strategy doesn’t work all that well if you don’t have a real case to back up the threat.

In this instance, going to court would be a joke (unless there are other facts here we don’t know about). A six-month termination clause is quite reasonable and is very common. It’s a valid contract term and should be upheld by a court or arbitration body. Moreover, it sounds as though Adidas exercised the notice provision correctly.

Sorry, suppliers.

The Adidas dispute is simple and limited in scope, but what will happen when more factories and entire sectors start closing down in the years to come? The big picture here is worth thinking about.

Several things are going on in China at the moment with manufacturing. The ones closing up shop are doing so because costs are rising (a long-term trend), and demand, particularly in the export sector,  is falling (hopefully only a short-term trend).

The acceleration of plant closures in some sectors, like textiles, will mean lots of unemployed folks. The government will have to deal with the resulting disputes between labor and management, involving things like back pay, social insurance payments, etc.

But I can’t help thinking about entrenched industries and political power. Maybe I’m simply looking at this like a Westerner, but when you have an industrial sector in decline that has sufficient juice with a government, what usually happens? Well, where I’m from, it ends in recriminations and protectionism.

We’re already on heightened alert for increased levels of protectionism now that China is dealing with sagging exports. Stay tuned for more trade disputes over the next couple years. This is mostly foreseeable and expected.

The decline in labor-intensive industries like textiles is also expected, and since China wishes to “move up the value chain” and leave some of this low-end work to other developing countries, it will probably be quite all right to see those companies depart. In the short-run, of course, it will mean job losses and pain, and perhaps some political turmoil for local officials.

However, if China continues to experience wage increases and sees more manufacturing enterprises flee the country, when will the protectionism kick in? These factories, these industries, represent important constituencies for local and provincial governments, who will no doubt lobby on their behalf. What will that dynamic look like, and how will the Central Government balance long-term national economic strategy against short-term dislocations and pressure from locally powerful rent seekers? This will be fascinating to watch.

Additionally, will we see some sort of backlash against those nations getting all those new jobs? As the U.S. lost huge numbers of manufacturing jobs, it was easy to single out China, a gigantic, identifiable scapegoat. For China, there won’t be such an obvious target. Vietnam? Indonesia? Bangladesh? Not the same dynamic at all.

Those Adidas suppliers are nothing to worry about, but if their ilk band together and push for government assistance, things might get interesting.