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CHINA

To get a glimpse of China's economic boom, drive an hour north from the Hong Kong border and turn left at the giant stainless steel archway. You've just entered Changan Inc., population 30,000. Cruise the palm-tree-lined avenues and you'll pass a gleaming new cultural center, office towers, and a sprawling public recreation complex with an Olympic-size pool and a golf course. More than 100 two-story white townhouses with red tile roofs, sold for $100,000 to Hong Kong families, stand in neat rows with scores more under construction.

A decade ago, before the village's leaders traded their Mao jackets for Italian-styled suits, Changan was so poor that many of its people emigrated to Hong Kong. Now, the village owns nearly 700 factories employing 100,000 workers from other parts of China. Changan will bring in a cool $40 million this year renting the plants to foreign joint ventures making everything from Barbie dolls to precision tools. With four-lane expressways and an entire new downtown in the works, says Changan official Guo Pinji, "we'll be a city of more than 1 million by the year 2010."

No wonder Changan is bragging. It's caught up in China's latest and perhaps most enduring campaign. From the upscale cafes in the southern city of Guangzhou to the gritty steel mills of the industrial north, China is in a dash for prosperity. Even after Deng Xiaoping passes from the scene, there will be no stopping the momentum. With the economy booming at a 12% annual clip and hitting 14% for the first quarter of 1993, China's emergence is already shaking the world. Though these rates cannot be sustained, the signs are that China's growth will continue at an impressive clip despite serious obstacles such as transportation bottlenecks, spiraling inflation, widening class differences, crime, and corruption.

The magnitude of change is breathtaking. China's economic boom, once concentrated in the coastal regions, is now flowing inland to the massive population centers along the Yangtze River and to the vast hinterland. At the national level, powerful ministries are being stripped of their monopolies in strategic industries and forced to compete in the marketplace. At the same time, state and local enterprises are busy transforming themselves into Chinese-style capitalist giants. And some cities are even selling hundreds of their factories to foreigners.

FANTASY MARKET. Smelling opportunity, foreign investors from U.S. multinationals to overseas Chinese billionaires are tripping over one another to get into a market about which they have long fantasized. Talk of China becoming a 21st century powerhouse, dismissed as naive after the Tiananmen Square massacre in 1989, is credible again. "The only thing comparable to what's going on in China is the reconstruction of postwar Europe under the Marshall Plan," says Rajendra Nath, Beijing general manager for GE Aircraft Engines.

The implications for a country of 1.2 billion people are awesome. Even after its overheated growth subsides and some speculative bubbles are popped, many economists predict China will sustain an average growth rate of at least 7% over the next 10 years. That means its gross domestic product, unofficially estimated at as high as $1.2 trillion, could more than double by early next century, firmly establishing China as one of the world's top five economic powers. While its per capita income would remain miserly compared with its developed Asian neighbors, the size of its economy guarantees that China's emergence will affect global trade, investment, and raw material flows.

This new industrial giant will be the world's largest manufacturing zone, the largest market for such key industries as telecommunications and aerospace, and one of the largest users of capital. Over coming years, manufacturing will increasingly move toward the pennies-an-hour wages in once-remote provinces, while coastal cities such as Guangzhou and Shanghai will become the brain centers, providing management and services. Although China will be an economic superpower in size, it won't compete as directly with U.S. or European technology-based industries as Japan does. Instead, its strengths will be mostly light manufacturing and low-tech industries. And unlike the keiretsu of Japan, new Chinese corporations will be more open to foreign participation.

There are important caveats: China is not wholeheartedly embracing Western-style capitalism. The Chinese economy is assuming a structure the modern world hasn't seen before. It is a distinctly Chinese model, a mixed economy in which the leadership is determined to keep the means of production in the public sector. Yes, control of the economy is shifting away from creaky enterprises supported by Beijing, but much of the slack is being taken up by quasi-public companies operated by provinces and towns such as Changan. On the surface, it appears that a brand new class of managers is emerging, but though members of this elite prefer cognac and drive Mercedes, many remain card-carrying party members.

TIGHT GRIP? That's why no one expects Beijing to suddenly embrace the West's vision of human rights and political freedom. Some China-watchers argue that the proliferation of satellite dishes carrying TV programs from Hong Kong and fax machines plugged into the world's capitals threaten Communist Party rule. But Deng is bent on using China's rapid economic strides as a way of maintaining the party's grip, not loosening it. He's betting the Chinese will accept party rule if their lives are improving economically. If he's right, the regime's repressive tools, ranging from its vast propaganda machine to its prison labor camps, will remain. Concern over that prison labor system is why one U.S. company, Levi Strauss & Co., on May 3 announced it is severing its China ties. All of which greatly complicates the debate about what constitutes "human rights" in China.

Just as China's economic and political model could be at odds with the West's, so might sharply increased Chinese influence over East Asia challenge U.S. and Japanese interests. Because some of China's new wealth is being used to build the People's Liberation Army, strategic thinkers worry about Beijing projecting military power throughout the region. Even as President Clinton faces a June 3 deadline on renewing China's most-favored-nation status, a more confident and powerful Middle Kingdom is less and less inclined to heed the admonishments of foreigners who believe they can "manage" China (page 6931).

DAMAGE CONTROL. How is China staging its march for growth in the face of the world's horror over Tiananmen? It's true that newly emboldened conservatives grabbed control of the government following the tragedy and tried to slam the brakes on reform. Some U.S. investors took a deep breath and froze. But neither reaction damaged the underlying economy. Investors from Hong Kong and Taiwan charged into China even in Tiananmen's aftermath. The Asian capital meant that Western recriminations had little impact. And this foreign capital helped create enough liquidity in China's financial system that provinces such as Guangdong and Fujian were able to continue their pursuit of wealth.

At the same time, Deng's reformers have been able to push two main pillars of economic change: an unprecedented degree of economic decentralization and the spread of market reforms from coastal areas to the interior. Suddenly, China looks like a loose federation of regional economies, with provincial and city governments boasting increasing clout. Regional authorities are flexing their muscles: Development zones are popping up across Jiangsu province near Shanghai, despite the central government's efforts to halt them. Beijing fears that the wild construction binge by local governments, whose investments soared by 70% last year, is contributing to runaway inflation and waste. Businesses owned by local governments in Guangdong brazenly circumvent Beijing's tax collectors by setting up front companies in Hong Kong. These "false foreign devils" then enjoy all the tax breaks afforded genuine foreign investors.

Companies controlled at the local and regional levels are striking at the very heart of the old Beijing-dominated system. Consider the case of two refrigerator companies. In the southern city of Rongqi, the Rongsheng Refrigerator Factory is a model of the locally owned factories that are quietly reaching Western standards of quality. As a result, Rongsheng's 3,500 workers are struggling to fill orders for China's most popular brand. The glistening complex, which has a modern steel sculpture in front, a recreation complex nearby, and three Mercedes among the cars in the parking lot, expects to make a $32 million profit this year.

In stark contrast, the nationally owned Shenyang Medical Instrument Factory in Liaoning province has a warehouse full of its Great Wall refrigerators awaiting repairs. While 300 of its 2,400 workers have no jobs, they stay on the payroll. That has helped the factory lose $5.3 million in the past two years. "We should learn from this lesson," says Lu Zizhun, the plant's Communist Party secretary. The factory has given up trying to compete with Rongsheng, turning to new products such as pruning shears and X-ray equipment.

Overall, China is letting regional and locally owned enterprises thrive on their own and allowing its centrally controlled sector to wither much faster than either Russia or former Soviet satellites did. Regional and locally run enterprises now account for a third of all economic activity, while the share for centrally run ministries has dwindled to half and will continue shrinking. Private enterprise, as the West understands it, will become more important but is not likely to eclipse these quasi-public enterprises.

PLENTY OF CASH. That's not to say that Beijing-controlled companies can't be competitive. Some of the most promising state enterprises are getting sweeping authority from the central government to take over weak competitors and to enter new businesses. One favored company is Beijing-based Shougang Corp. The $1.8 billion iron and steel maker is doubling its steel capacity to 10 million tons by 1995, and it's on an acquisition binge. In the past six months, it paid $120 million for an iron mine in Peru and bought for an undisclosed sum a Fontana (Calif.) steel plant that it plans to dismantle and ship home. Shougang also became the first industrial group in China to launch its own commercial bank, with capital of $172 million.

The industrial giant is also trying to move into high tech: It has cut a $200 million deal with Japan's NEC Corp. to make semiconductors. "We are a first-class transnational company," suggests Shougang Vice-President Pan Huayuan. That's yet to be proved, especially for a company that still makes an astounding array of products solely for the domestic market--everything from plastic Christmas trees to assault rifles. But the fact that these new Chinese managers even aspire to international stature speaks volumes about the competitive forces that have been unleashed.

So even though China keeps a tight grip on politics, it is nurturing an unprecedented degree of economic diversity. Instead of having a market guaranteed by central planners, many Beijing-controlled enterprises have to compete with local ones as well as with foreign multinationals. In the past, foreign companies often had to accept a partner dictated by Beijing. Now, foreign manufacturers of everything from mobile phones to giant power generators can go from province to province in search of the best deal. Johnson & Johnson, which has a major pharmaceuticals joint venture in the city of Xian, is now looking for more opportunities. "With the government decentralizing, it's getting easier to cut your own deals," says Jerry R. Norskog, president of the Xian joint venture.

ON STRIKE. Beijing also is allowing market forces, as opposed to edicts, to drive the spread of prosperity from wealthy coastal provinces into the nation's much poorer interior. While the rest of China was still in the grip of Beijing's central planners in the early 1980s, Guangdong and Fujian, in particular, had high degrees of autonomy. Workers there provided a cheap labor pool for foreign manufacturers. But today, the two provinces have a budding middle class that can afford air conditioners and color TVs, and it's hard to find local residents willing to accept jobs paying $54 a month making sneakers. In fact, some 300 workers at a Canon Inc. compact-camera factory in the Guangdong city of Zhuhai went on strike Mar. 30 for three days, demanding 30% to 50% wage increases to make up for skyrocketing prices. Canon settled the strike by offering raises of 7.8% to 13.6%, depending on seniority.

Those rapidly rising wages are driving both Chinese and foreign enterprises to tap workers from the interior. Leading the way are savvy Taiwanese and Hong Kong companies. Yue Yuen Industrial (Holdings) Ltd., a $200 million Taiwan and Hong Kong manufacturer of Nike, Reebok, and other athletic shoes, now recruits workers for its three Guangdong factories from outside the province. Says Steve Li, Yue Yuen president: "We decided to hire workers from inland provinces because there's less turnover."

And new investment is flowing deeper into the mainland. For instance, Taiwan's President Enterprises Corp. has four factories in China, including a tomato processing plant in the remote western region of Xinjiang. In March, local officials in the northeastern city of Dalian sold off controlling interests in 101 local companies to China Strategic Investment, an industrial venture capital group in Hong Kong.

The main obstacle keeping prosperity from traveling even faster to the inland regions is China's decaying infrastructure. In a building frenzy, Beijing plans to pump billions into major transportation, power, and telecommunications projects over the next decade (chart, page 5723). Much of it is going to Shanghai. The central and city governments are spending $18 billion on bridges, power plants, and a huge industrial and commercial zone in the Pudong district, east of the city. Pudong's rice fields are gone, replaced by a mammoth, dusty construction site where the foundation is being laid for China's most ambitious projects. A particularly impressive one: the Yangpu Bridge, scheduled to be completed by yearend.

FAST LANE. From Shanghai, future development is expected to spread up the Yangtze River to the central city of Wuhan. That's where Hong Kong's Wharf (Holdings) Ltd. has begun building a multibillion-dollar container port. Further up the Yangtze, work is scheduled to begin on a $10 billion dam that could boost shipping traffic to the interior metropolis of Chongqing tenfold.

The government is also enlisting outside help for other infrastructure projects. In a few months, Hong Kong magnate Gordon Wu, managing director of Hopewell Holdings Ltd., will finish building a privately financed, $1.2 billion, six-lane toll road, bringing high-speed travel to southern China for the first time. New World Development Co., a Hong Kong property developer, is investing $86 million in a highway in Wuhan, linking the city's new international airport to the downtown area.

Peasants and workers are sure to pay a big price for this prosperity drive. The Yangtze River dam, for example, will uproot more than a million people, flood one of China's most scenic areas, and cause other damage to the environment. Elsewhere, peasants are squeezed by the rising costs of fuel, fertilizer, and other raw materials as well as by arbitrary taxes levied by local authorities. Millions of farmers are leaving rural areas and flowing into the big cities in search of jobs. With their sun-baked skin, calloused hands, and modest clothes, these mang liu, or blind migrants, are easy to spot among the more sophisticated residents of China's cities. Mang liu have been crowding into Guangzhou's main railway station for years, and now they are turning up in Shanghai, Beijing, and other big cities. Government officials estimate that there are 80 million of them nationwide, and Beijing sees them as a source of crime and instability.

SECURITY NET. The restructuring of China's corporations could make the unemployment problem worse, at least in the short run. Steelmaker Shougang, for example, has 220,000 employees--some of whom spend their days idly chatting in front of untended computer terminals in a control room littered with discarded food wrappings and cigarette butts. With its "iron rice bowl," or cradle-to-grave security net, still firmly in place, Shougang has laid off very few of its nonproductive workers.

Even so, the government promotes Shougang as one of the better-run steelmakers. As Beijing cuts off subsidies and forces its state enterprises to face competition, Wuhan Iron & Steel Complex is now talking about cutting two-thirds of its 120,000 work force. "In the '90s, labor mobility and unemployment will be China's biggest problem," says Dai Yuanchen, a senior fellow at the Institute of Economics in Beijing.

The new China Inc. also faces some big management challenges. The country has only 13,000 accountants--and they all need to be retrained. They face a monumental task. Before Brilliance China Automotive Holdings Ltd. could become China's first listing on the New York Stock Exchange last October, Arthur Andersen & Co. accountants spent an estimated 10,000 hours over two years getting the Shenyang based company's books in order. Foreign investors say that much of China's new corporate stratum needs similar straightening out before it can tap global financial markets.

The emerging Chinese corporations also could fall short because many CEOs refuse to delegate authority. They make nearly all the decisions--down to signing every check. "The top man is clearly in charge," says a senior executive of a Chinese multinational. "Everyone else is an executor." Given these drawbacks, China simply may not be able to take on Japan or Korea in technological industries such as autos, advanced chemicals, and microelectronics. "It's hard to see how China will ever produce a Sony or a Toyota," says S. Gordon Redding, a management professor at the University of Hong Kong.

Even though Beijing's role has been reduced, it maintains some crucial levers of influence and is trying to respond to these different economic challenges. Through administrative fiat, the central authorities are trying to get the provinces to cut back on construction projects. They blame this construction fever, at least in part, for the 30% increase in money supply and resulting inflation. And since there is no independent central bank to fine-tune the economy, crude clampdowns on credit remain the most effective way to rein in the growth of borrowing. Even so, the vast amount of private savings and willing offshore investors could undercut any stringent no-loan decree.

`RED CHIPS.' The central government is also moving quickly to introduce new regulations that will help whip China's corporations into shape. In July, it will put in place new accounting procedures that require enterprises to use income statements, balance sheets, and cash-flow statements. It has also recently flung open its doors to foreign accounting firms, including the Big Six. They are doing a thriving business getting China's future "red chips" in shape to be listed on the stock market. To address the absence of legal protections, the government has licensed 16 foreign law firms to act as consulting companies.

But the biggest challenges could prove to be political, not economic. Many Western experts are convinced that rapid economic growth will fuel greater demands for political liberalization. "Pressure for change in the direction of democracy is strong," says Andrew Nathan, director of Columbia University's East Asian Institute and a specialist on Chinese politics.

Acutely sensitive to this prospect, the Chinese government is hoping to severely limit the spread of democracy in Hong Kong, lest it move onto the mainland after 1997. It is determined to cling to a one-party state similar to Singapore under strongman Lee Kuan Yew and South Korea in the 1970s under dictator Park Chung-Hee.

Deng's strategy is clever: By giving party officials a vested interest in keeping growth going, he is helping to ensure stability as China overhauls its economic system. With communist ideology now discredited, China's leaders need to keep the economic engine revving to maintain their political legitimacy. As long as the economy continues to thrive and the Chinese people see their standard of living improve, the leaders may be able to maintain their control.

STREET WARFARE? Always looming in the background is the question of who will replace an increasingly frail, 88-year-old Deng. China-watchers have long expected a fierce power struggle once he dies. While few in the current leadership advocate a return to state planning, strong disagreements remain over the pace of economic and political reform. The worry is that Deng's death could prompt one side to take its case to the people. If that happens, the combination of unemployment, inflation, and rising expectations could again spark street protests.

All this means that China's emergence as an economic powerhouse will surely not follow the steady, incremental growth that Japan experienced. But despite the tumult ahead, China has reached the point of no return. The pursuit of wealth has become a wildfire that is sweeping through a people once consumed by class struggle. Even if Deng's death were to prove disruptive, there is little chance that the Chinese would accept any effort to roll back the clock to economic stagnation. In a very real sense, the octogenarian may have succeeded in creating a class of communist-cum-capitalists who have a huge stake in preserving their gains.

The odds are that no matter who prevails in Beijing, a quarter of humankind is going to continue moving ahead with economic changes that are helping to create a 21st century colossus. The shock waves, for better and worse, will be felt around the world.THE FOREIGNERS CHARGING IN

A Sampling of Recent Investment and Trade Deals with China

TELECOMMUNICATIONS

AT&T has reached a $1 billion agreement to manufacture switches, wireless

phones, and integrated circuits. NEC is building a microwave telecommunications

plant.

AUTOS

The U.S. Big Three sold $160 million worth to a Chinese buying delegation in

April. Nissan Motor is investing in a $44 million factory making pickup trucks.

Volkswagen is spending $315 million to double capacity at its joint venture

near Shanghai.

ENERGY

ABB Asea Brown Boveri has a $400 million slice of a coal-fired power station

being built in Guangdong. Total of France has a 20% share in a $450 million

refinery that will open next year.

CONSTRUCTION

Hong Kong's Wharf (Holdings) Ltd. plans a multimillion-dollar container port in

Wuhan. Hong Kong magnate Gordon Wu is completing a $1.2-billion superhighway in

Guangdong.

DATA: BUSINESS WEEK

Joyce Barnathan in Beijing and Pete Engardio in Guangzhou, with Lynne Curry in Shenyang and Bruce Einhorn in New York


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