In recent years, the question of what’s happening in Chinese factories has become one of global interest. As international firms have found ways to reduce costs through outsourcing, China’s share of global manufacturing output has risen. It is projected to become the world leader in the next decade.

A common criticism is that China’s ability to maintain its competitive advantage stems from its weak enforcement of workers’ rights. The argument is simple: it is easy to keep costs down when you aren’t paying workers minimum wage or investing in health and safety protection. Such accusations have proven damaging to corporate reputations since the 1990s, when the anti-sweatshop movement gained attention and put working conditions on the radar of the American public. Companies are facing pressure to take responsibility for working conditions throughout their supply chains.

“There are generally two reasons why companies decide to take these issues on,” explains Dan Viederman, executive director of Verité, a nonprofit organization that monitors labor conditions in off­shore production sites. “One reason is that they are scared about the reputational risk they face at being linked to bad working conditions. And the other is they internally have some set of values that they want to try to export throughout their supply chain.”

Individual companies have designed codes of conduct outlining supplier expectations, such as freely chosen employment, industrial hygiene, emergency preparedness, and adherence to regulations surrounding minimum wage and overtime. Highly visible sectors such as toys, apparel, and electronics have each designed industry-wide codes.

Meanwhile, standards within China are changing. In March 2006, the government proposed the Labor Contract Law. The new law gave workers the right to sue employers who failed to provide them with a labor contract and required factories to maintain written employee handbooks disclosing rules. This promised to have a significant effect on the employer-employee balance of power.

Not surprisingly, while labor rights advocates argued that this legislation had come none too soon, multinational corporations raised concerns that the ensuing costs would be prohibitive. Indeed, in the nine months after the law took effect in January 2008, labor costs increased by 2%, according to Chinese officials.

What effect is this combination of voluntary reforms, codes of conduct, public scrutiny, and new laws having on conditions inside factories? The best source for an answer may be someone who sees those conditions on a day-to-day basis. Auditors spend their days visiting factories on behalf of the companies the factories supply, observing conditions and inspecting company records in search of inconsistencies which suggest false documentation.

Samuel Wong is a youthful but experienced entrepreneur who has his own auditing business based in Hong Kong. According to Wong, rampant false documentation and other efforts by factory management to mask violations of workers’ rights are standard in Chinese factories. During one first-time factory visit, he says, his team uncovered an internal memo demanding that the supervisor evacuate all underage workers for the audit day. The memo named 25 people who were instructed to remain absent for the audit, some because they were in violation of child labor laws and others due to other documentation issues.

“If we were not lucky enough to uncover this internal memo,” says Wong, “then based on what we saw in the factory, we couldn’t say they have a problem. But since we uncovered that internal memo, we have strong reason to believe that the factory was hiring child labor and hiding other problems.”

While he has developed a nose for deception over the years, Wong needs hard evidence to present to the companies that commission his audit reports. And Chinese factory management has a reputation for being shrewd in disguising infractions. Loopholes are easy to abuse; for example, since major brands usually require audits of direct suppliers only, it is not uncommon for factories to set up Potemkin villages, allowing auditors to investigate direct vendors while conducting the work to create inputs into the vendors’ product in a separate location not subject to audits. Wong believes that many requirements, such as minimum wage provisions, are widely disregarded as Chinese factories struggle to stay afloat in a low-margin business.

Dan Viederman of Verité argues that techniques for managing supply chain issues have to be considered on a case-by-case basis. He says, “The better companies are looking at their supply chain and matching a particular problem with a particular tool — an unannounced audit in one case, a collaborative capacity-building initiative with a supplier in another, and an investigation of the way sourcing practices create bad conditions for workers in a third.”

Each solution has its tradeoffs. For example, an unannounced audit prevents suppliers from concealing violations by asking il­legal workers to stay home on days when inspectors are expected, while an announced audit conveys a message of trust and respect more conducive to developing collaborative relationships with vendors. “For me,” explains Viederman, “no single approach is a panacea, but the difference between good and less good really is the degree of honesty with which companies look at their own supply chain.”

The auditing process can be expensive and complicated. General Electric, for instance, conducts approximately 2,000 assessments of suppliers per year, according to Ann Condon, the company’s director and counsel for environmental health and safety programs. She says that the company experienced diminishing returns in repeated audits of the same factories over time. One approach GE is using to make the process more efficient and effective is to support initiatives to train Chinese EHS professionals and empower them to take leadership roles in maintaining acceptable standards in the factories they oversee. “We looked intensively at about 24 suppliers in China that we had assessed before and saw dramatic improvement in the suppliers who had brought on board a full-time trained environmental health and safety manager compared to those that had not,” explains Condon. It was because of this observation that GE and the GE Foundation decided to partner with the Institute for Sustainable Communities to establish the Guangdong Environmental Health and Safety Academy in order to create a training institute for EHS managers in southern China.

Another approach is that of the Fair Factories Clearinghouse, which seeks to enable collaboration in compliance among companies by creating technological mechanisms that allow companies monitoring the same factories to share information. Spearheaded by a group of former Reebok employees, the FFC is unique in that it has secured a Business Review Letter from the Antitrust Division of the Department of Justice, allowing brands to share findings about suppliers in accordance with antitrust and anticompetition guidelines. According to executive director Marianne Voss, the FFC’s product has the potential to decrease auditing costs by providing cost-sharing opportunities, by improving leverage with suppliers, and by making it easier for major brands to select factories with better track records.

Voss argues that the next step is for companies to partner more closely with suppliers to help improve business practices. As she sees it, programs that focus on assessing fault and forcing remediation drive a vicious cycle of hidden problems and repeated monitoring, ultimately resulting in increased costs for all. Voss suggests that companies collaborate with suppliers and with other brands purchasing from those suppliers to find structural improvements that benefit the industry. “The financial crisis actually presents the opportunity to transform corporate responsibility initiatives into truly core business functions,” says Voss. “Corporate responsibility initiatives that are focused only on managing risks don’t have the positive impact they could have on the overall business environment.”