Surviving China's Deep Contradictions

Wednesday's Financial Times had a fascinating article describing the rather incongruent business climate in China.

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.

The poster child for these contradictions is the city of Wenzhou, and as a further example, a company called Juyi Shoes.

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.

And the "contradiction"?

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.

The loosening by Deng helped spark the capitalism revolution, but for the most part it is still "tolerated" and not fully supported. As the global economy slows down, the ability of underground capitalism to overcome the controls of state planning and communism becomes more difficult.

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.

Which is unfortunate considering the growth that has "pulled tens of millions out of poverty." Wenzhou is a good case for how being free of government intervention can spark growth.

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.

Some of the stories are truly spectacular.

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 grew up on its own.

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.

And that mesh of informal and formal financial systems is now creating the problem, or conundrum, of how to move forward into the future. A future where low-cost manufacturing now competes against "good manufacturing," which will require additional infrastructure investment.

The Wenzhou model of informal financing, though useful for starting factories from scratch, is not so effective at taking companies to the next stage. 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.

Which brings us back to that odd historical room at Juyi Shoes.

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.

I wonder... with everyone and their mother getting in line for a U.S. federal bailout, should companies create a "party cell room" at their factories, paying homage to Bush, Bernanke, Paulson, and presumably Obama? It might be a good last ditch idea for the Detroit Three.

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