Photo: Bert van Dijk / Flickr
Wenzhou, a city along China’s coast in southeastern Zhejiang province, has long been known for its booming private enterprise.Since China’s economic opening and reforms in the 1970s, Wenzhou has been treated as a test case for a capitalist model relying heavily on small- and medium-sized enterprises focused on low-end manufacturing for export.
This approach was so successful that it became known as the “Wenzhou model” and was adopted throughout the country. Actions taken by entrepreneurs in Wenzhou — who had a reputation within China for business savvy even before the economic reforms — have been emulated in the decades since by investors elsewhere in the country.
While the Wenzhou model has provided growth, the dependence on exports of low-cost goods and the resulting small profit margins has proven unsustainable.
Over the past decade, businesses in Wenzhou have increasingly turned away from the model, instead focusing on more speculative activity such as real estate investment. Like the Wenzhou model before it, this approach has also been emulated throughout the rest of China.
The city recently experienced a rash of bankruptcies and partial business shutdowns, rampant speculation and a reported massive increase in informal lending. Given Wenzhou’s role as an economic bellwether, these problems may be an ominous sign for the rest of the country.
A city with a high population density but lacking agricultural land and resources, Wenzhou developed its economic model as a way to play to its strength of possessing a cheap available labour pool for the manufacturing of small components and parts.
These factories, often family-owned businesses, supplied parts to other factories nationwide and in the overseas market throughout the 1980s. Several other Chinese cities adopted this model, helping bring China its reputation as the “world’s factory.” Cheap Chinese products flooded overseas markets, bringing in huge export revenues that sustained around one-third of the country’s economy.
However, the success of this model is largely based on manufacturers squeezing their profit margins by reducing labour costs and lowering the quality of their products. This model works when the global economy is performing reasonably well, demand is high and the cost for components and small parts is rising.
However, in a period of low demand — such as the current one — the model is largely unsustainable. This coincided with opportunities for astute Wenzhou entrepreneurs who had accumulated large fortunes from their manufacturing businesses to invest in other sectors. As a result, large private capital flowed to the real estate market, commodities or agricultural products, not only for investment and speculation but also as a financing tool to sustain their enterprises’ profits, particularly when credit is not easily obtained.
Wenzhou entrepreneurs first targeted the country’s real estate sector shortly after the 1998 market-oriented housing reforms. Investment began flooding the sector, and the average price more than tripled in a decade, sustained by strong demand and the incentive by both government and developers to keep prices high.
According to estimates, more than a $100 billion in private capital from Wenzhou went into the real estate market in 2004 alone. Huge profits from real estate soon attracted numerous investors from elsewhere, which sustained and further expanded the real estate bubble that has become a significant threat to the country’s economic stability.
Photo: Bert van Dijk / Flickr
Beijing began trying to contain the real estate bubble in 2007, which temporarily shifted private capital from Wenzhou to speculative investments in commodities or agricultural products such as coal, sliver, garlic and ginger. But as property prices began soaring again due to Beijing’s 2008 stimulus measures, this again sent private capital into real estate until credit tightening policies were implemented in 2011, which also curbed real estate investment.The potential for investors to withdraw their money from the sector, though it has not happened to this point, puts the entire Chinese economy at risk and has further encouraged speculative investments to other sectors. This time, an increasing number of Wenzhou private capital shifted to the grey lending market, dramatically increasing the informal lending rate.
According to an unofficial media report, some 80 per cent of households in Wenzhou are involved in grey lending activities. This grey lending serves a purpose in providing capital for businesses and introduces longer-term risks by enabling investment in weak small- to medium-sized enterprises, the real estate bubble and excessive speculation on collateral.
Many private enterprises, not just Wenzhou entrepreneurs, are contributing to these increasing speculative investments. Given the country’s limited investment channels for private capital and the state’s sometimes unfavorable policies toward private entities, especially those competing with state-controlled sectors, it is probably one of the few viable options for entrepreneurs in need of capital.
While the current situation in Wenzhou may be an extreme example, its development path nonetheless is indicative of the country’s unsustainable economic model, and it comes at an already challenging time for the central government. Beijing’s long-term policy is to have small- to medium-sized enterprises undertake restructuring or consolidation, but it cannot afford to have massive bankruptcies and unemployment threaten social instability in the midst of this uncertain economic and political period.
Chinese Premier Wen Jiabao’s trip to Wenzhou has made long-awaited policy aid available, but the bailout measures have only amounted to an immediate salve and may actually prolong the problem. Ultimately, it is not an issue that can be resolved through extending credit or another stimulus fund; Beijing would prefer to consolidate private small- to medium-sized enterprises into state-owned enterprises, which would enable it greater control over the economy and facilitate attempts to reform the overall financial system.
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