Fwd: [LeftLibertarian2] China's Countereconomic City

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http://reason.com/archives/2011/11/15/chinas-black-market-city/singlepage

China's Black Market City
by Bradley Gardner
Reason, December 2011

Chen Mingyuan has lived here all his life, but he still gets lost every
time he drives into Wenzhou. "All the roads in this town were built by
businessmen, so none of them make any sense," Chen says as we back out
of what we just discovered is a one-way street. For the last 30 years,
private citizens in this southeastern China metropolis have largely
taken over one of the least questioned prerogatives of governments the
world over: infrastructure.

Driving down the cluttered and half-constructed streets of this
3-million-strong boomtown requires frequent U-turns and the patience of
Buddha, but every road eventually leads back to a factory. Each factory
is in turn surrounded by a maze of roads filled with hundreds of small
feeder shops selling spare parts, building materials, and scraps. Every
haphazard street in this town seems to have an economic purpose.

We are driving to see Cai Shuxian, the manager and majority owner of a
clothing factory in which Chen owns a 10 percent stake. Cai, a lightly
built 32-year-old, is typical of the entrepreneurs who have made it big
during Wenzhou's three-decade boom, vaulting from shop-floor grunt to
factory owner in a dizzyingly short period of time. "We earned very
little in those days," the high-school dropout recalls of his first job,
"about 600 yuan [roughly $100] a month." Within six years Cai was able
to leverage his money and know-how into building a factory of his own,
which now employs more than 100 people.

Cai glides over the source of his start-up capital, although it
definitely was not one of China's state-owned banks. "Banks only give
you money when you don't need it," he says. He explains that during the
2009 financial crisis, when banks were aggressively lending as a form of
stimulus, people would reinvest the money in Wenzhou's underground
financial system, where deposit interest rates are higher than the
official lending rate.

Cai says his Horatio Alger story is "typical of Wenzhou." And it is.
Only a few days later I am introduced to the manager of a factory making
transmissions for South Korean cars. Although he had the advantage of
finishing high school, his starting salary wasn't any higher. Cai's
dismissive attitude toward the government is also typical. Wenzhou has
become one of the richest cities in China under a regulatory regime that
borders on anarchism.

The Wenzhou Model

Foreign businessmen, politicians, and journalists who fly into Beijing
or Shanghai often get the impression that the Chinese government is the
main driver behind the jaw-dropping development of what was until
recently one of the worst large economies in the world. In Shanghai you
fly to a state-built airport, ride on a state-built maglev train through
the Pudong district, and behold a city of skyscrapers that appeared out
of nowhere a little more than a decade ago with the help of generous
government subsidies and investment from state-owned enterprises.
Whatever local company you're interested in, chances are the government
is interested in it as well.

In southern China, things look rather different. The Chinese say that in
this region "the mountains are high and the emperor is far away"—in
other words, the government isn't paying much attention. Companies are
mainly small or medium-sized enterprises, government services are
slight, and laws are routinely ignored. According to official
statistics, the three southern coastal provinces of Zhejiang, Guangdong,
and Fujian have the first, second, and fourth wealthiest citizens,
respectively, in the country. They are the center of China's export
sector and the primary destination for China's millions of internal
economic migrants. Here is where the real Chinese miracle is happening.

The city and region of Wenzhou play an important role in this story. The
Wenzhounese have a reputation for both an uncanny sense of business and
an almost pathological disregard for the government. The mountains here
are no metaphor: Seventy-eight percent of the Wenzhou prefecture is
covered by mountains, a fact that proved pivotal to the area's early
development and the central government's response to it.

In 1978, when China's economic reforms were just being launched, Wenzhou
was extremely poor, about 90 percent rural, with smaller land
allocations than other areas and poor connections to larger markets.
Even today, the vast majority of local entrepreneurs have less than
eight years of formal education, and the current population of
foreigners is estimated at only a couple of hundred. The Wenzhounese
government received directives from Beijing but found that without
accompanying support they lacked resources to run the economy by diktat.
Fortunately, a central government that wasn't offering much support also
wasn't paying much attention.

So private citizens quietly took over many of the services that
elsewhere are either provided or heavily regulated by the state. Local
authorities, lacking other options, didn't try to stop them. The most
important development in those early days was the city's flourishing
underground financial system, which according to the local branch of the
People's Bank of China (China's central bank) currently is used by 89
percent of Wenzhounese private citizens and 57 percent of local companies.

More dramatically, private citizens were the first to connect Wenzhou to
neighboring regions by building roads, bridges, and highways, as well as
the city's airports and substantial portions of the dock. Even today the
city is scattered with infrastructure investment firms through which
groups of businessmen pool money to build the transport routes they all
need to get their goods from factory to the point of sale. The result is
not pretty. Aside from the confusion faced even by residents driving
into the city, it is not uncommon to see sidewalks torn up to insert
piping, with seemingly no intention of replacing the concrete.
Nevertheless, the system is crudely efficient, merchants can all easily
access factories, and the factories in this geographically isolated city
now have sales networks that span the globe.

The government's indifference didn't last forever. But when the
authorities got around to paying attention, they decided not to mess
with a good thing. In 1985 Liberation Daily, a paper sponsored by the
Shanghai Communist Party, referred to Wenzhou as a "model" for other
parts of China to study. In the next year 15,000 government officials
visited the city to learn, not crack down. Although bureaucrats still
occasionally try to impose state controls on the city, the futility of
the effort quickly becomes apparent. By now the local Chamber of
Commerce has taken to negotiating trade deals both domestically and
internationally because, as in most other things, the private sector is
more effective here.

Today Wenzhou is the center of China's light manufacturing empire and
the richest city in China's richest province. (Nationwide, Shenzhen,
Shanghai, and Guangzhou narrowly edge out Wenzhou—in the official
figures, at least.) A quick walk down a Wenzhou street reveals a
bewildering display of commerce. The streets around the railway station
are covered in stalls selling $3 blue jeans and $5 boots. There's a city
block dedicated to baby clothes next to a street that sells plastic
signs for bathroom doors. In one run-down alleyway you'll see people
repairing televisions, making blankets, and selling fruits, vegetables,
and poultry (live or dead). Further outside the center, you can find
small shops dedicated to aluminum rods, sheet metal, tire rims, and tires.

Much of this low-level commerce depends on the same official negligence
that fuels the factories. Pool halls are set up wherever there's open
space that you can set a tarp over. Gambling dens are openly advertised.
Taxi drivers often drive off the meter. The karaoke parlors are
numerous, and almost all of them double as brothels. The poorest
residents take part in one of the largest citizen recycling programs
anywhere in the world. In an alley one family collects scraps of fabric
to sell to the local textile mills, another hoards scraps of paper and
cardboard to send to the paper mills, and in front of a lot that looks
like it is being used for a garbage dump, a man has set up a secondhand
goods shop.

Unskilled workers in Wenzhou are paid one of the highest wages in the
country, roughly $380 a month according to official figures (even
higher—between $450 and $600—according to entrepreneurs' estimates). It
is here that people like Cai make their fortune.

Medicis on the Yellow Sea

China's formal financial system generally disfavors lending to smaller
companies. Interest rates are capped, state institutions come with a
government guarantee, and Beijing regularly issues lending decrees, all
of which make banks reluctant to throw money at small, private actors
with poor or nonexistent credit histories.

Wenzhou was one of the first cities to develop methods to work around
the financial sector's aversion to private enterprise. According to
local entrepreneurs, it was this secondary banking system that made the
biggest contribution to Wenzhou's early development. "While northern
people kept the money they made, Wenzhou people immediately lent it to
their friends to help get ventures off the ground," says Weng Yuwen, a
Wenzhou native now running a clothing design company out of nearby Hangzhou.

Dozens of financing options are available, and although most of them
intrude on the jurisdiction of the state-controlled banking system, they
are not all illegal. Or at least not completely illegal. The different
levels of legality that Wenzhounese perceive are a bit of a puzzle to an
outside observer. Weng quickly disavows any knowledge of "underground
banking"; like every other Wenzhou entrepreneur I speak to, he has
"friends" who have dealt with gray-market lenders but declares he would
never do so himself. A more standard form of getting a loan, he
explains, is borrowing from a contact…who also happens to be lending to
a large number of other entrepreneurs at interest. Weng contemplates
this arrangement, then admits that the whole thing might be "somewhat
illegal."

Gray-market lenders are often established, though technically illegal,
financial institutions that lend primarily working-capital loans at
rates as high as 10 percent a month. Contacts often modify interest
rates based on how well you know them. Forms of repayment enforcement
differ. Weng points out that in a community so dependent on
guanxi—relationships—defaulting on a contact's loan could blackball you
from future business opportunities. Weng doesn't clarify how defaulters
are treated by underground debt collectors, but he does say they "aren't
the type of people I'd want to get involved with."

Lending also takes place through a number of formal lending institutions
that have become informal depositing institutions. Pawnshops in Wenzhou
are very different from those in the West. The shops can give out loans
of millions of dollars backed by property and stocks, and they can pay
depositors interest rates three to four percentage points higher than
the official lending rate at banks. Similarly, credit guarantee
institutions, which were originally set up to co-sign on riskier bank
loans to small private firms, eventually began lending their own (or
depositors') money. These institutions are essentially legal, however,
because they call their depositors "investors."

As Wenzhounese have become more wealthy, they have found it easier to
operate within the formal financial system, although they still
frequently subvert state intentions. Every wealthy Wenzhounese I
interview, for instance, boasts of owning five to six apartments. Part
of the motivation for these purchases is the high return on real estate
in China, but the other major reason is that remortgaging real estate is
a relatively easy source of capital in both the formal and informal
banking systems.

The Wenzhounese are also well aware that government support is a ticket
to greater banking support—and doesn't come with significant
oversight—so they will often raise funds with state-owned enterprises in
order to get support for projects that are not always completed in the
form originally planned. "It helps being from Wenzhou," says Weng,
because "people just assume that Wenzhounese have the resources to
complete the projects they're pitching."

By far the most common form of start-up financing is something akin to
venture capital: investing in an entrepreneur's project on the hope he
will eventually buy you out with a decent return. This approach also is
used to manipulate the banking system. Once you get your business up and
running, it is much easier to get loans to buy your investor out.

Although Wenzhounese quibble about degrees of illegality, there is no
question that stepping over the line can lead to serious consequences.
In April, Wu Ying, a 29-year-old Wenzhou woman, was sentenced to death
for illegal fund raising. The case touched a nerve, with numerous
articles published supporting Wu in the Chinese media, because none of
the public evidence pointed to anything out of the ordinary about her
actions—except perhaps the 80 percent returns she was offering
investors, and the similar interest rates she charged on loans, which
led some to suggest her mistake was lending to someone with political
connections.

The State

In Wenzhou local commercial institutions generally have more
representative power than the local government. The Chamber of Commerce
has been known to independently approach government delegations with
potential investment opportunities—or challenges to trade
sanctions—without consulting the Chinese state.

Local officials, by contrast, are notorious for graft, especially
through land sales. The party chairman of one Wenzhou district refused
to return from France after being indicted in 2008. Internet vigilantes
at 703804.com have taken to tracking down individuals who have fled
after embezzling funds.

Corruption is particularly commonplace in the prefectural taxation
bureau, an agency that has been asserting more control over the local
economy. "In the '90s paying taxes wasn't that important," says one
Wenzhou entrepreneur, "but these days you can't avoid it." Despite
having one of the highest corporate tax rates in the world, however,
China has a very generous deduction scheme, and if you have friends in
the taxation bureau, the same entrepreneur says, "you don't have to file
all the paperwork."

I see this process up close when I interview the head of an auto parts
factory over dinner. Several of his friends are present, the beer and
Baijiu rice liquor are flowing freely, and the food is far more than all
of us could eat. Halfway through the dinner, three members of the local
taxation bureau join us. The factory owner introduces them as friends
and proceeds to treat them on his tab. Afterwards he takes the officials
to a local karaoke bar to meet prostitutes.

The Wenzhounese have mixed feelings about this situation. As the factory
owner's friend escorts me back to my hotel, he adopts a cynical look and
says, "People do business differently here." But later, when I describe
the scene to Weng, he shrugs. "It's the same all over the world," he
says. "People who have good relationships are more successful in business."

The local government has helped Wenzhou enormously in one area:
protecting the city from more distant levels of government. Even during
the Cultural Revolution, authorities were relatively permissive toward
private business, and they defended the city against conservative
attacks in the 1980s. Many entrepreneurs acknowledge that local leaders'
laxity is deliberate. "Hangzhou has a good government: They ignore you
unless you're making more than RMB 10 million [$1.5 million]," says
Weng. "In Wenzhou you can make twice as much, and they'll still ignore you."

A sign of how much the city government has internalized the local
business culture came last January, when the Wenzhou foreign trade and
economic cooperation bureau began a pilot program to allow Wenzhou
residents to invest up to $200 million a year abroad. The program was
canceled a week later because local officials had forgotten to run the
idea by Beijing.

Spreading the Wenzhou Model

The government may not allow Wenzhounese to invest freely abroad, but
they do it anyway. Across continental Europe and in much of the emerging
world, people from Wenzhou are by far the largest component of the
Chinese diaspora. Wenzhounese make up the majority of Chinese restaurant
owners from Madrid to Vienna, and in some places they have recreated the
Wenzhou experience on European soil.

In no place is this more true than in Prato, Italy, near Florence, where
12,000 of the city's population of 188,000 are legal Chinese residents,
mostly from Wenzhou. The local government estimates that there are
10,000 more illegal Wenzhou residents, while estimates from the
right-wing party that runs the city reach 35,000. Forty percent of local
businesses are owned by Chinese.

Many of Wenzhou's business practices have carried over from China,
although Italians disagree about how much lawbreaking is going on.
According to Prato Mayor Roberto Cenni, between January and May 2010
police carried out 152 inspections on Chinese-owned premises, resulting
in 152 penalties. The region also has the highest level of tax evasion
in Tuscany, according to Vinicio Bacio of Invitalia, the Italian
investment promotion agency, although he argues that the situation is
getting under control. "While there is still a large quantity of
activities undeclared," Bacio says, "most of the manufacturing and trade
promoted by the Chinese community in the textile area is regularly
reported."

Despite a campaign by Mayor Cenni to crack down on Wenzhou business,
Bacio notes that the Chinese presence has revitalized the local textile
industry, which had long been in decline. "The relationships [between
Wenzhounese and Italian factories] are closer than what it appears
externally," notes Bacio, with contracts, supplies, and investment
crossing over between the two communities.

The global reach

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