Made in China - now sold in China

On the shelves of Chinese shops is the usual assortment of toys, clothing, appliances and cookware. But over the past month the quality of many of the goods on offer has improved.

In part this is because scandals over toxic paint and poisoned milk have brought closer scrutiny from inspectors and hence less corner-cutting. But it is also partly because of falling demand for Chinese goods from America, Europe and the Middle East, which has given China's manufacturers and local government a big incentive to work around the country's formidable export-promotion policies and to sell at home.

Chinese manufacturers are well aware that they operate in one of the few large markets that is still showing a pulse. Retail sales in October were up by 22 percent compared with the same month in 2007 -- a slight drop from 23.2 percent in September, but an impressive figure nonetheless. That exaggerates the country's economic vigor (growth in car sales, for example, is declining), but it would be a stretch to believe China is in recession.

As domestic consumption booms, China's export-oriented manufacturers are under siege. Figures announced Dec. 10 showed that exports fell by a startling 2.2 percent in November, compared with a year earlier. Analysts had expected an increase of around 15 percent; it was the first fall in exports for seven years.

The news followed a government survey, released Dec. 1, that showed a precipitous decline in the fortunes of export manufacturers, confirming lots of anecdotal evidence.

Every week brings fresh reports of factory closings. Unpaid workers have been staging violent protests. Diverting goods intended for export to the domestic market makes sense for factory owners, who want their firms to survive, and for local officials, who wish to maintain order.

There is, however, a problem. This scheme conflicts with government policy, which is to promote exports.

As a result of pressure from China's trading partners, these tax rebates on exports had been contracting. But in November a new stimulus plan was announced that increased the rebates on more than 3,000 items. Evidently China's officials hope the country can once again export its way to higher growth, despite the financial troubles in its main markets.

Given that demand is more robust at home than abroad, the market is pushing in the opposite direction to the government. But circumventing policy is difficult. Along with the loss of the rebate, say manufacturers, comes an increase in attention from public authorities that most companies prefer to avoid. Some manufacturers therefore avoid the domestic market in China entirely; others run separate factories for domestic and foreign goods.

The Hong Kong end run

One solution is to route goods to the domestic market via Hong Kong, so that they qualify as exports, but this takes time and money and strikes many operators as a huge waste of both. China and Hong Kong are filled with small trading companies noted for their ability to handle these problems using one murky method or another. The sudden appearance of higher-quality goods suggests officials are being less zealous than usual in enforcing the export rules, for fear of causing job losses.