New frontiers: The fate of China’s economic reforms will be determined locally. Our first article looks at a wealthy city near the coast; our second, at a poorer one inland

New frontiers: The fate of China’s economic reforms will be determined locally. Our first article looks at a wealthy city near the coast; our second, at a poorer one inland.

Jan 11th 2014 | FOSHAN | From the print edition

THE furniture market in Foshan claims to be the biggest in the world. It boasts a bewildering mix of things to sit on, sleep in and eat at. One shop, named the “Louvre”, offers a range of styles from neoclassical to postmodern, which an assistant defines as a cross between European and modern, suitable for “successful people”.The market, which sprawls over 3m square metres (32m square feet), showcases the manufacturing powers of Foshan, a city of 7m people in the southern province of Guangdong. The city is an archipelago of industrial clusters, dedicated to furniture, textiles, appliances, ceramics and the equipment required to make them. These clusters have produced some of China’s most successful private firms, such as Midea, a maker of household appliances, which began as a bottle-lid workshop, and now employs 135,000 people, generating over $16 billion in revenue in 2012.

Many economists worry that China will succumb to a “middle-income trap”, failing to make the jump from an early stage of growth, based on cheap labour and brute capital accumulation, to a more sophisticated stage, based on educated workers and improvements in productivity. But no economy, let alone one the size of China’s, moves in lockstep from one growth model to another. Some regions always outpace others. Provinces like Gansu, in China’s north-west, are still struggling to wean themselves off state-owned mines and smokestacks (see article). Other parts of China’s economy are already comfortably high-income, according to the World Bank’s definition. For example, Foshan’s GDP per head was almost $15,000 in 2012, higher than in some member states of the European Union.

Foshan best represents China’s “emerging economic frontier”, according to the Fung Global Institute (FGI), a think-tank in Hong Kong. With the help of researchers from the National Development and Reform Commission, China’s planning agency, the institute is studying Foshan for clues about the rest of the economy’s future.

Foshan’s example is relevant to other parts of China, it argues. Unlike the nearby metropolis of Shenzhen, it was never a special economic zone. Unlike neighbouring Guangzhou, it is not a provincial capital. It also shares many of the country’s growing pains. Lacking oil and coal, it is prone to electricity shortages. It is heavily polluted and highly indebted: its government pays 47% of its tax revenues on servicing its liabilities. Wages are going up, land is running out, and growth is slowing down. To tackle such problems, China’s Communist Party endorsed a long list of bold reforms at its long-awaited “third plenum” in November. Economists welcomed the list even as they worried that officials would fail to implement it. But in China, implementation is often a process of gradual diffusion not abrupt transition. Some of the principles proposed by the plenum are already in practice in Foshan. Some may have been inspired by it.

The third plenum resolved that the market should play a “decisive” role in the allocation of resources. In Foshan it already does. In the early 1990s Shunde, one of the city’s districts, pioneered the sale of government-backed enterprises to their managers, workers and outside investors. Foshan now has about one private enterprise for every 20 residents. In 2012 they grew twice as fast as the remaining state-owned firms.

November’s party plenum also called for private capital to play a bigger role in public infrastructure. In Foshan over the past nine years the government has allowed private firms to bid for over 500 projects, including power generation, water plants, and rubbish-incineration plants, according to Liu Yuelun, the city’s mayor. Ahead of the party’s call to consolidate the state bureaucracy, Shunde district had already slashed the number of its departments from 41 to 16.

 

Another national aim is to unify parts of China’s land market, allowing rural land to be leased on similar terms to state-owned urban plots. In the 1980s Foshan had already created a shadow market in communal land, which villagers leased to budding industrialists, contrary to national law that reserved such land for rural purposes. Because these land rights were technically illegal, many big firms eschewed them. But that made them all the cheaper for scrappy, small firms willing to live in the legal shadows. This grey market allowed Foshan’s industrial clusters to grow organically, according to economic logic rather than arbitrary land laws, argues the FGI. It also allowed villagers to reap some of the gains of Foshan’s industrial transformation. By 2010, the FGI calculates, the average Foshan resident owned property worth almost $50,000.

Will Foshan’s experiments inspire nationwide reform? Its lessons sometimes get lost in translation. Shunde’s sales of government-backed firms is one example. It sold its most profitable firms before selling the lossmakers, a strategy it likened to “marrying off the prettiest daughter” first, according to Linda Chelan Li of the City University of Hong Kong. The national government, in contrast, let small, loss-making firms go but clung tight to big, profitable ones. These SOEs remain powerful and profitable and all the harder to reform as a consequence.

Foshan’s penchant for experimentation also reflects its unusual administrative history. Until 2002 two of its districts, Shunde and Nanhai, were cities in their own right. Their governments still collect more revenues than the city itself. This allows decentralised—and more responsive—decision-making. “When the upper level of government gives more authority to subdistricts, they have a stronger sense of responsibility,” says Mayor Liu.

In response to the demand of local industry, for example, Shunde district built an impressive polytechnic, which now teaches 11,000 students. Its qualifications are not recognised as degrees by the Ministry of Education but they are highly valued by local employers. A skilled graduate can earn up to 6,000 yuan ($990) a month, says Fu Qingju of Keda, an equipment-maker. The quantity of workers will grow more slowly as migration to Foshan slows, but the quality can always improve.

Do you copy?

Foshan’s success may prove hard to imitate or to sustain. Its prosperity rests on the benefit that firms derive from proximity to others. But these clusters are hard to replicate. Why would companies flock to a new cluster when one already exists? China is dotted with ambitious local governments keen to build hubs of high-tech firms and services. Not all of them can succeed.

In addition, when industries cluster in one location, pollution also concentrates in the same spot. Foshan has experienced the stark trade-off between industrial growth and environmental protection. In the past the government would approve a new company before the sewerage system was ready to cope. Four of Foshan’s inland rivers are heavily polluted. In 2003 it tightened environmental regulations on its local ceramic firms, an industry with centuries-old roots in Foshan. Ten years later, fewer than 60 out of 600 firms remained. The rest did not pollute less. They just polluted elsewhere. Pollution is now a barrier to Foshan’s development, rather than a byproduct of it. “We understand that our poor environment does not attract talented people,” notes Mr Liu, the mayor. “We want to provide greener lands for them.”

Mr Liu hopes that new, cleaner clusters will supersede its older, dirtier ones. The east of the city, which is connected to Guangzhou by underground, hosts a cluster of back-offices for Guangzhou’s finance industry. Foshan is also building a new cluster dubbed the Sino-German Industrial Services Zone, dedicated to the services that high-end manufacturing requires. The new zone straddles the Dongping river. One bank represents Foshan’s prosperous, tangible present—a busy port, loading and unloading containers full of manufactured goods. On the other bank is Foshan’s vision of its future: a pleasant ribbon of parkland, decorated with cherry trees, mudflats to attract birds and a skate-boarding rink. The park includes a man-made beach and pond, open to the public, where up to 2,000 people can bathe.

In the past Foshan’s enterprises made great leaps by assimilating foreign technology. Its ceramics industry, for example, imported a German oven in 1983 that increased output tenfold. The Sino-German zone is an attempt to import something else: not German kit so much as German credibility. The international tie-in is a sign of Foshan’s ambition to become a “liveable” city, attractive to the kind of people that a sophisticated service industry needs. Like its furniture, Foshan’s new city aims to be somewhat European, modern and suitable for successful people.

 

Not so grim up north-west

A hub for mining and heavy industry tries to reinvent itself

Jan 11th 2014 | BAIYIN | From the print edition

FOR decades after Baiyin’s largest mine opened in 1956, the city’s state-owned behemoth, the Baiyin Nonferrous Metals Company (BNMC), was China’s main supplier of copper. It also furnished prodigious amounts of zinc, lead and selenium from the region’s mines. Now the stuff in the ground is nearly gone. Although Baiyin, a city of 1.7m on the Yellow River in the arid north-western province of Gansu, still has some mines and smelters, it must find something else to do.

The problem has hardly crept up unannounced. Even as Baiyin dug other pits and maintained output, the pit opened in 1956 was exhausted and shut by 1988; in 2003 the central government declared Baiyin a city on the path to “resource exhaustion”, and in 2008 selected it for a pilot programme in a transformation that will affect scores of similar cities.

Several things complicate Baiyin’s renewal, concludes a study by Wang Haifei of Northwest Normal University. Not only is it remote, short of water and too dependent on digging things up from the ground but, according to Mr Wang, poor managers at its state-owned enterprises have failed to restructure its businesses or upgrade its technology. They did not train local technical staff or bring in talented managers from elsewhere in China. “It is obvious that the transformation of Baiyin is still difficult,” he wrote. “It is a long journey.”

 

Although Baiyin remains a grimy industrial city where many struggle to make a living, it is taking a few promising first steps. The BNMC has been reborn as the Baiyin Nonferrous Metals Group (BNMG), with new investors and, it claims, strategies that will outlast the area’s failing mineral endowment. Zhang Jinlong, a BNMG official, acknowledges many problems but says that the company has spent heavily on technology that has already produced gains in efficiency and declines in pollution at the city’s remaining factories. The company has also won control of resources elsewhere in China and in other countries, including South Africa and Peru.

Belatedly, Baiyin is starting to diversify its economy. It is getting help both from Gansu’s provincial government and from the central government, which has announced an increase of 5% in annual grants, to a total of 16.8 billion yuan ($2.7 billion), for the 69 cities that are now classified as “resource-exhausted”.

The broad strategy for these places is managed by the National Development and Reform Commission (NDRC), China’s planning agency. Officials there say the cities are home to 600,000 unemployed miners and 1.8m residents living at subsistence levels. “Resource-rich cities have made tremendous contributions to China’s economic take-off,” says an NDRC official, “but the sacrifice they made is also huge.”

New dogs and new tricks

The planners need these cities to attract new industries. In Baiyin’s case, help has come from the Asian Development Bank (ADB), which since 2008 has given policy advice and $80m in loans for industrial transformation. The head of ADB’s Beijing office, Hamid Sharif, says Baiyin’s new mayor, Wang Haizhou, is modern, business-minded and already making his mark. The ADB has said that since it got involved, the number of enterprises in a high-tech park has grown from 55 to 124. The number of employees has risen from 1,800 to more than 14,000 and annual gross output of the park has gone from 1.2 billion yuan to 14.1 billion yuan.

One of those enterprises is the Kang Shi Da contact-lens factory, where 260 employees use precision equipment from South Korea and Japan to make 20m coloured lenses a year, many of which are exported to South-East Asia. The boss, Tang Shunchu, reckons Baiyin got stuck in the stodgy mindset of China’s state-owned enterprise system. To get the place moving, it needs more outsiders (like him).

He boasts that Kang Shi Da has helped China go from buying lenses from South Korea to competing with it in third-country markets—though his firm is so far only wholesaling to other packagers for resale. He says the firm needs to build brand recognition but, he insists, “Our quality is excellent and we will eventually be able to sell under our own brand name.”

Another new zone, which is funded jointly by the provincial and municipal governments, is the Baiyin Technology Business Incubator, a business park covering 50 square kilometres (20 square miles). An official there, Wang Junying, says it is helping new companies to market themselves and also to raise money from banks and investors.

The first phase has focused on chemical firms, which can use a central testing lab at the business incubator for quality control, rather than send samples out of the province. The second phase, due to open in 2014, aims to attract electronics firms.

Not everyone is as upbeat as Mr Wang. An employee at one of the industrial parks complains of “old-style thinking” that persists in Baiyin. “They think that if they just spend a lot of money then everything will change. But who would want to live here or work here?”

Mr Sharif of the ADB admits that luring skilled workers will be hard. But he also points to the potential in Baiyin’s nascent wind- and solar-energy industries. If it develops those, Baiyin may continue to enjoy a pleasant side-effect of its industrial decline: improving air quality. In 2002 sulphur dioxide concentrations registered 15 times the regulatory limit. In 2013, according to the Baiyin Daily, the city enjoyed 334 “good air days”.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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