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Critical Eye on Guangdong

China's Powerhouse Shows Its Soft Underbelly

by William H. Hess

Proximity to Hong Kong helped to turn Guangdong into a key export and production center after economic reforms were introduced in China in the late 1970s. By most measures, Guangdong leads all other provinces economically: It has the largest GDP of any province in China—$317 billion at the end of 2006; it is China's biggest exporter and domestic retail market; and it has received the largest proportion of foreign direct investment (FDI). But internal structural issues, such as wage inflation, environmental degradation, and labor shortage, as well as external pressures, such as trade friction, a strengthening renminbi, and intense inter-provincial competition for export and domestic markets, are gradually eroding the province's economic lead.

Guangdong's economy—fueled largely by traditional, labor-intensive exports, including toys, garments, and low-end electronics—is perhaps the most integrated with international markets and supply chains among China's provinces. In 2005, its total trade was equivalent to 166 percent of its GDP. Provincial leaders, however, are attempting to push the economy toward higher value-added output to ensure that the province's future competitiveness is as strong as its recent economic past.

Temporary slowdown?

In the first half of 2006, Guangdong's economy sustained the momentum it gathered during 2005 through an increase in capital spending and strong export growth. The pace of export growth will likely slow during the next few quarters, however, largely because of trade frictions with major Western trading partners, rising production costs, and the impact of a gradually appreciating currency. Macro controls implemented by various PRC government agencies have moderated fixed-asset investment (FAI) spending, which will also likely curb Guangdong's growth. On the other hand, robust infrastructure and consumer spending are expected to pick up some of this slack to sustain impressive growth rates in the coming years.

Although Guangdong remained China's largest provincial economy in absolute nominal terms at the end of 2006, it lost ground to its peers. The economies of Jiangsu and Shandong expanded 14.9 percent and 14.5 percent, respectively, while Guangdong's economy grew at a more modest 14.1 percent (see Table 1). Though strong export demand has significantly boosted most of the coastal provinces, the relative level of FAI growth has helped to determine these rankings. In the first half of 2006, Shandong stood out for its high level of growth in capital expenditures, especially when compared to Guangdong, which has experienced below-average FAI growth.

Officials in Guangdong are sensitive to the fact that per capita urban and rural incomes in Jiangsu have grown much more rapidly than in Guangdong (see Table 2). They cite increases in government wages in Jiangsu and the relatively low proportion of private enterprises in Guangdong as reasons for the difference in wage growth. Moreover, they seem to be aware of the long-run negative correlation between the size of the state sector in a given provincial economy and the growth rates of worker productivity and wages. At the end of 2005, average wages in the state-owned sector were 117 percent of the average wage level in the province, partly a reflection of the state's monopoly in many state industries. Economic planners in Guangdong have taken steps to boost productivity levels in the province—including the promotion of private enterprise growth, especially of small and medium-sized enterprises, and innovative activity—as means to ramp up overall wage levels, though it will take time before these measures bear fruit. Until nonstate firms are allowed to access markets dominated by state industries, their development in all areas will suffer.

Labor market challenges

Guangdong, like other booming coastal provinces, is facing strong upward pressure on wages, which is blunting its edge in labor-intensive manufacturing and processing operations. To retain the necessary supply of migrant workers, provincial officials in July 2006 announced an average minimum wage increase of 17.8 percent, a move that Guangdong's competitors soon followed. Historically, Guangdong has relied more on migrant workers than other provinces. For example, Guangdong's population in 1980 was 88 percent of Jiangsu's and 127 percent of Zhejiang's, figures that jumped to 123 percent and 188 percent, respectively, by the end of 2005, largely because of inflows of migrant workers. Based on estimates from Guangdong's statistical bureau, migrants account for more than 65 percent of the labor force in the manufacturing sector of major producer cities across the province and nearly 60 percent in the construction and services sectors. Though a recent large influx of migrant workers helped to keep wages down in Guangdong, growing inter-provincial competition for such workers and wage hikes have, to some extent, already turned this dependence on outside labor into a competitive vulnerability.

Interestingly, reports of supply shortages for migrant and low-skilled workers have been matched by those for slack demand for white collar workers in Guangdong. These divergent trends show the structural nature of job creation in Guangdong, which appears to favor labor-intensive positions rather than higher-productivity and higher-wage jobs that the provincial government hopes to create through its structural shift toward more advanced and capital-intensive industries.

Wage growth has been offset by consistent productivity gains in some provinces, but in Guangdong's case, productivity gains in its secondary industries (manufacturing and construction) have, on average, been slower and far more inconsistent than those in competing coastal provinces. One reason is that the average firm size in Guangdong is smaller than those in peer provinces. Greater reliance on human capital inputs, rather than on machines, has also put a drag on productivity and scale growth among producers in the province.

Foreign companies in China are increasingly reporting that the available workforce lacks the required technical training and industry-specific manufacturing techniques, which has intensified the pressures that are driving up wages in the region. Employee turnover rates in many coastal provinces have reportedly jumped in recent years, especially at foreign firms, which have been fighting to recruit and retain qualified staff for their domestic operations (see the CBR, March-April 2006, Short Staffed). According to a study by Shenzhen's Institute of Contemporary Observation, the annual employee turnover rate in low-skilled, labor-intensive industries is around 50 percent in Guangdong. At the higher end of the pay scale, several prominent employers in Guangdong have reported normal turnover rates of around 20 percent or more, a rate lower than those of peer provinces.

Looking to the east

As part of its economic transition and 11th Five-Year Plan (FYP, 2006-10), the Guangdong government in late 2006 announced plans to invest ¥270 billion ($34 billion) in 390 industrial and infrastructure projects in the eastern part of the province. Discrepancies between Guangdong's eastern and western regions have become more prominent in recent years. As the Pearl River Delta region in the west attempts to climb the value chain and stem the migration of traditional heavy industries to other provinces, Guangdong's leaders are looking east for new sources of development and industrial growth. Chaozhou, Jieyang, Shantou, and Shanwei, all in eastern Guangdong, are targeted for new development, particularly in industries such as petrochemicals, equipment manufacturing, electronics, and energy. At the same time, the provincial government is developing plans to boost the technological level of western Guangdong by supporting industries such as biotech and software.

More infrastructure spending through 2010

Guangdong's government also recently reiterated its commitment to spend ¥290 billion ($36.3 billion) on infrastructure projects during the 11th FYP period. The plan calls for new roads, port berths, an interregional bridge network, and a high-voltage electric transportation system. Under this program, about 140 new berths for large vessels will dot the coastal and inland ports; 3,300 km of new roads will be built, extending the province's network to 140,000 km; and 22 new power projects will add a total of 7.2 million kilowatts of generation capacity.

A large portion of this investment will focus on Guangzhou, but funding will also aim to integrate poorer areas with more prosperous regions and Hong Kong. Many of the new expressways will improve the links between major cities in southern Guangdong and Hong Kong and Macao, the centerpiece being the construction of a bridge connecting the coastal city of Zhuhai with Hong Kong. With construction slated to last from 2007 to 2015, the 45 km bridge is estimated to cost ¥55 billion ($6.8 billion). Overshadowing all of these infrastructure investments is the highly anticipated completion of the second phase of the Guangzhou Baiyun International Airport. Once fully completed at the end of 2008, this facility will be able to handle around 40 million passengers and 2 million tons of cargo annually, almost doubling its current capacities of 25 million and 1 million, respectively, according to provincial authorities.

Further urbanization

Guangdong contains some of China's most modern and prosperous cities, namely Guangzhou and Shenzhen. Nationwide, roughly 300 million rural dwellers are expected to move to cities in the next few years. Provincial officials are currently drawing up plans for Guangdong's cities to absorb 5 million rural residents by the end of 2010, the majority of whom will be employed in the rapidly expanding manufacturing, construction, and services sectors. The provincial government has emphasized the development of the services sector and views its growth as a symbol of prosperity. To this end, it seeks to promote everything from legal, financial, and accounting services to tourism. Moreover, Guangdong Governor Huang Huahua has pledged significant fiscal support to ease workers' transition from the countryside into alternative forms of employment.

Currently, about 26 million, or 28.2 percent, of the province's total estimated population of 91.9 million are originally from other parts of the country. Officials have also announced that they intend to limit Guangdong's population to 97.3 million by the end of 2010 to prevent population pressure from overwhelming the province's physical and social infrastructure. Specific measures for population control have not been issued, though administrative restrictions on residency and employment statuses will likely be employed. Individual cities are also instituting their own measures. For example, Guangzhou recently announced that it will tighten restrictions on the "low-quality floating population," such as roadside peddlers and other groups it deems undesirable.

Slower, but more balanced growth

In the medium term, growth in Guangdong's economy will gradually slow in step with the national economy, but will remain an above-average performer among China's provinces (see below). Despite the structural shifts taking place in its economy, Guangdong will remain an exporting power and leading destination for FDI. Above-average growth in per capita GDP and population will keep retail sales growth strong. As a result, overall demand in Guangdong will become more balanced than in many peer provinces, which have typically relied more on FAI.

When viewed from the outside, Guangdong, like China's overall economy, appears to be an economic fortress with high growth rates, strong export earnings, and robust consumer markets. Behind the fortress walls, however, structural weaknesses in Guangdong's economy, many of which mirror those at the national level, have emerged as the provincial leaders attempt to steer the economy toward a higher value-added future and deal with growing developmental and income gaps within Guangdong's borders. Though Guangdong's economy will continue to grow rapidly, this expansion will be accompanied by many social challenges and the task of maintaining competitiveness in tougher domestic and international markets.

Table 1: Growth in Coastal China, 2006
*Year-end estimates Source: Global Insight China Regional Service
	Nominal GDP (¥ billion)	Real year-on-year growth (%)	Margin of growth over 2005 (%)
Guangdong	2,600	14.1	-0.3
Shandong*	2,148	14.5	-0.7
Jiangsu*	2,129	14.9	-0.5
Zhejiang	1,560	12.0	-0.6
Shanghai	1,030	13.6	-0.5

Table 2: Income in Coastal Provinces, First Half, 2006
Source: Global Insight China Regional Service
	Urban disposable income	Year-on-year growth (%)	Rural cash income	Year-on-year growth (%)
Shanghai	¥10,704	10.9	¥5,855	9.2
Zhejiang	¥10,046	12.6	¥4,733	10.6
Guangdong	¥8,531	9.0	¥2,899	7.9
Jiangsu	¥7,315	14.8	¥3,239	14.5
Shandong	¥6,126	14.3	¥2,671	16.1

William H. Hess is manager, China Regional Service, at Global Insight Inc. in Beijing.

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