Unmade in China

Sticking to the last: shoe production in Wenzhou, known as China’s most entrepreneurial city but now hit by a fall-off in export demand

Juyi Shoes is the sort of entrepreneurial company that has helped turn China from a poor rural country into a manufacturing powerhouse. In 1988, Li Anlian borrowed money from relatives to start a workshop making shoes from spare bits of leather. Managed these days by her son, the company now employs 3,800 and produces 10m pairs a year for clients that include Zara of Spain.

Many of Ms Li’s neighbours have similar stories. Juyi is based in Wenzhou, a city 250km south of Shanghai whose resilient entrepreneurs have made it the standard-bearer of China’s private-sector economy. By some estimates, the city has 300,000 small businesses.

But there is one thing about Juyi that does not quite chime with Wenzhou’s reputation for rugged individualism. An entire floor of the company’s office is given over to celebrating the Chinese Communist party and one of the rooms for party members boasts six imposing framed portraits: in order, Marx, Engels, Lenin, Stalin, Mao, Deng.

China this week celebrates the 30th anniversary of its “reform and opening up” policy, when Deng Xiaoping loosened controls on the economy and unleashed a long stretch of high-octane growth that has pulled tens of millions out of poverty. Concerts, seminars and speeches will mark the event.

Yet the anniversary is taking place during a period of soul-searching about whether the impressive run of growth can continue and whether Chinese capitalism can survive its deep contradictions. In the short term, Wenzhou is a useful weather vane for the health of the global economy and the strength of consumer demand. A slump in export hubs such as Wenzhou means depressed consumers elsewhere. Beyond that, the fate of Wenzhou’s entrepreneurs will be an important test of China’s ability to move on from low-cost manufacturing and build a more sophisticated economy.

The immediate threat is from the global slowdown – news that Chinese exports declined in November heralds tough times ahead. But the weak economy has also reignited a debate about whether the entrepreneurial dynamism at the root of China’s success is being stifled by the remaining government controls over the economy. After three decades of reforms, the financial system is still dominated by the party-state, which means that funding often follows political connections rather than business acumen.

“China’s financial system has not opened up enough,” says Yao Xianguo, dean of the College of Public Administration at Zhejiang University. “Big private companies increasingly rely on the government while smaller firms suffer from their inability to get loans from state-owned banks.”

Wenzhou helps demonstrate how capitalism flourished from nothing after Deng took over. Little known outside the country, the city is legendary within China – evidenced by the many explanations for its success. Isolated by mountains on three sides, Wenzhou businesses just got on with it, some people say, at a time when Beijing still frowned on capitalism.

Some also say Mao refused to put important state-owned companies in the region because its location across the strait from Taiwan made it vulnerable to invasion, meaning it had to create its own economic base. Churches with red neon crosses dot the city’s skyline, prompting theories that Wenzhou’s business culture is rooted in a form of protestant individualism.

Whatever the reason, the city’s factories have become a global force in light manufacturing. For anyone who uses a cigarette lighter, there is a 70 per cent chance it was made in Wenzhou. Something similar goes for light switches, zippers and even sex toys. Nearby towns are big producers of hinges, plugs, bras, socks and ties.

Tales of cunning entrepreneurs abound. Nan Cunhui repaired shoes until he and a few friends started to make light switches from spare parts in the evenings. From that he has built up Chint, China’s biggest manufacturer of electrical power equipment, with sales of $2.3bn (£1.5bn, €1.7bn) a year. (One of his friends in the early business left to found his own company, Delixi, which is now the second biggest Chinese company in the industry.)

“The interesting thing is that the guys at Chint and elsewhere started off as peasants and have got where they have all on their own,” says Xie Jian, professor at Wenzhou University’s City College. Manufacturing success, he argues, has often come despite rather than because of the authorities in Beijing: “The companies have always been one step ahead of the government.”

Wenzhou’s private sector is also rooted in the city’s network of informal banks. Many of the factories got off the ground using money raised by a handful of relatives and family friends from underground banks, which exist in a legal grey area, tolerated but not formally approved by the authorities. This combination of light manufacturing and extended-family microfinance can be found elsewhere in China in smaller versions but it is often referred to as the “Wenzhou model”. Yet that model is under pressure. As exports drop off, low-cost manufacturing companies are particularly feeling the pinch.

Gaining an accurate picture of what is happening to Wenzhou’s industry is difficult – there have been few reports of bankruptcies among companies or underground banks, unlike the export hub in Guangdong in southern China. But Zhou Dewen, head of the association that represents the city’s small and medium-sized companies, says production has stopped or been cut at 20 per cent of Wenzhou’s factories, while exports have fallen 15 per cent this year.

“We have actually had a very strong year but the impact from the crisis is only just beginning,” says Lin Kefu, vice-president of Chint.

In Shuangyu, a Wenzhou suburb where the narrow streets once hummed with small workshops making shoes, the signs of the slowdown are visible – closed doors at some and large piles of inventory at others. Ye Yonglin, who owns Dilun Shoes, says that most of the factories have had to cut back. “If you are a small company and do not have regular contracts with clients or some edge in terms of quality or branding, you are suffering badly at the moment,” he says.

Building a brand and investing in technology cost money, however, and that is where the slump among Wenzhou manufacturers collides with one of the biggest debates about the future of economic reforms in China.

The Wenzhou model of informal financing, though useful for starting factories from scratch, is not so effective at taking companies to the next stage. Not only do loans in the informal market tend to be small but interest rates are also high – borrowers can pay as much as 40-50 per cent a year.

Formal finance in China is dominated by the state. The main commercial banks provide the bulk of the credit in the country and they mostly lend to other state-owned companies. So as private businesses grow and require more capital or land, some feel the need to get close to the various arms of the party-state.

In Wenzhou, this has led to an odd courtship over the last decade: companies looking for official patrons and the Communist party, nervous about the creation of a new power base, seeking to penetrate the private sector. The homage to the party and Stalin at Juyi Shoes is one example, but Chint boasts it was the first Wenzhou company to set up a party cell, even if founder Nan Cunhui has not been accepted as a party member. State media reported last year that 3,400 party cells had been established in Wenzhou businesses.

Forging close contacts with government is good business in any country – witness the photos of handshakes with the president-of-the-day in US executive suites. But for Yasheng Huang, a professor at MIT and author of a new book, Capitalism with Chinese Characteristics, it is part of a broader trend of the party-state smothering the country’s entrepreneurial instincts. The problem is not the photos with senior leaders, he says, but all the backroom deals that entrepreneurs have to enter if they want political protection.

According to Prof Huang, China has not seen a gradual transition from state control to capitalism over the last three decades. Instead, the real boom in entrepreneurship came in the 1980s when controls in rural areas were relaxed. But since the 1990s, the state has reasserted more control over the nascent private sector and focused more on government-led urban investment. By starving private companies of funding, he argues, China is risking a decline in its productivity that will damage future growth.

“One of the reasons Wenzhou is now in trouble is that the companies do not have enough capital to modernise,” he says. “China today resembles an oligarchic version of state-led capitalism” which could become “crony capitalism built on systemic corruption and raw political power”.

Prof Huang’s thesis has its critics, who point out that policies such as joining the World Trade Organisation in 2001 did a huge amount to stimulate the private sector. But his book has come at a time of intense debate within China about liberalising the financial sector – including tentative proposals for legalising underground banks.

The idea is opposed by some of the big state-owned banks, which fear more competition, and by some officials who worry it could lead to an explosion in new bank credit. There is also ideological opposition to ceding more state control of finance. But supporters say it will provide a shot in the arm to the economy at a crucial time by providing more and cheaper credit to well-run smaller companies.

“One of the most important things the government could do to help the economy is to legalise the underground banks,” says Mr Zhou from the small companies association in Wenzhou.

China’s leaders will rightly boast this week about the economy’s achievements over the last three decades. Yet if they are to sustain that growth record, they face some tough questions about just how much of the commanding heights of the economy they wish to keep controlling.

OPENING UP: LAND AT THE HEART OF REFORMS

At a Communist party meeting on December 18-22 1978, Chinese leaders took the first steps away from collective agriculture. In official histories, the meeting began the transition from a command economy, which later became known as “reform and opening up”.

In fact the timeline is a little hazy. Many of the decisions had actually been taken at a separate meeting the month before and peasants in Anhui province had already started dividing up communal land among themselves. But the December meeting has gone down in history as the victory of Deng Xiaoping (left) over the Maoists.

In the following three decades, China introduced a series of further reforms – most products are now based on market prices, swaths of state-owned companies have been privatised and China joined the World Trade Organisation in 2001. Liberal economists have called for two further totemic reforms – allowing farmers to use their land as collateral and reducing state control of the financial system.

Copyright The Financial Times Limited 2008

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Author: Geoff Dyer
Original Source: Financial Times
Date Published: December 16 2008
Web Source: http://www.ft.com/cms/s/0/e8cd9db2-cba3-11dd-ba02-000077b07658,s01=1.html
Date Accessed Online: 2008-12-20