China's Wealth Gap

Forget the urban glitz. Growth may ride on developing the poverty-stricken interior

Soon after you begin driving westward out of Guiyang, the gritty provincial capital of China's Guizhou province, the landscape becomes increasingly inhospitable. Vegetation-covered limestone hills close in around the narrow, pitted road. The smokestacks of factories making tires, cement, and rice liquor disappear. Even the rice paddies grow tiny as they fight for the last patches of level ground. Before long, it seems as if China's breathtaking economic progress of the past two decades was some fable.

Here in the heart of one of China's poorest and most forbidding interior provinces is the town of Maoying, or "cat camp," some 160 kilometers from Guiyang. With a population of 40,000, it is home mainly to the Miao and Buyi ethnic minorities. Arable land is scarce; factories are nonexistent. Most residents eke out a living coaxing rice and vegetables out of tiny plots. When the work is available, they can earn extra money carving gravestones made of limestone and marble from a nearby quarry. Workers spend 12 hours a day bent over the slabs, caked in choking, white dust as they chip and hack the stones for $2.50 a day. Some are as young as 10. Many more simply abandon this mean existence to search for factory or construction work in coastal cities like Shanghai, where people earn nearly eight times more than the $166 average annual income at home.

Villages like Maoying are Ground Zero for China's most urgent economic challenge: to draw jobs and foreign investment to the country's interior. Ever since late leader Deng Xiaoping began opening China's economy to the outside world in 1978, coastal provinces such as Guangdong, Zhejiang, and Fujian have reaped an inordinate share of the wealth. But nine interior provinces and autonomous regions, plus the centrally administered city of Chongqing, have remained appallingly poor. This poverty belt, stretching from Yunnan in the south to Xinjiang in the north (map, page 29) makes up more than half of China's land mass and is home to 285 million people--a population bigger than that of the U.S. Residents' income is 65% of the national average, a disparity that continues to grow, says Chen Dongsheng, director of the Western Region Research Institute at the Chinese Academy of Social Sciences.

To an outside world that has marveled at China's growing economic might, it may seem reasonable to expect that prosperity hasn't reached all 1.3 billion Chinese. But there is good reason for Beijing's anxiety over the wealth gap. With its Marxist ideology all but dead, the Communist Party has based its legitimacy on being able to deliver economic gains. But now the disparity, as well as widespread corruption by local officials, is sparking resentment--and increasingly frequent protests by farmers and workers. In April, for example, several hundred migrant workers from western China protested outside Xian's city headquarters after being evicted from temporary homes. What's more, the west is home to restive ethnic populations of Uighur and Hui Muslims and Tibetans.

To head off a crisis, Beijing has launched a massive campaign to redress this imbalance and bring the west out of its economic stupor. President Jiang Zemin and Premier Zhu Rongji, who are spearheading the effort, are devising preferential lending and investment policies in a bid to pull in hesitant foreign investors. They are also proposing massive state subsidies. According to Chen of the CASS, plans call for building 35,000 kilometers of new roads, including a Sichuan-to-Guangxi expressway, and 4,000 kilometers of new railway over the next decade. Costs will run into the hundreds of billions of dollars. "This is the second opening of China," says Li Shaoqing, vice-president of Top Group, a producer of software and computer hardware based in Chengdu, capital of Sichuan province. "In scale, this looks greater than what we saw in 1978."

POTENTIAL BOOST. Leaders know that to sustain growth of at least 7% and create enough to provide jobs for the millions who enter the workforce each year, they must diversify China's economic base. Currently, 24% of gross domestic product--and a large share of growth--comes from export industries heavily concentrated in coastal provinces. But China can't count on surging exports forever. Consumer spending has been weak for more than two years. Prices have plunged for many Chinese-made goods, and much of that output ends up warehoused. The economy could get an enormous boost if the populous hinterland joined the mainstream. "If China does not develop the west, our country's products will not have a market," says Chen.

Beijing also is growing alarmed at unemployment, a problem that could grow more serious as China lowers its import barriers to join the World Trade Organization (WTO) and as enterprise reform spreads. Tensions are even mounting in the east. Earlier this year, thousands of workers in Liaoning province, angry over the bankruptcy of their mine, burned police cars in a standoff with the army that lasted for several days. Reforms by bloated, heavily indebted state industries are expected to throw tens of millions of workers out of their jobs. And with incomes of China's 800 million farmers growing only 1% so far this year, compared with 7% for urbanites, massive migration from the interior to the east continues. That could turn China's most crowded cities into tinderboxes.

The only solution is for Beijing to create jobs in the interior provinces. Beijing has pledged 70% of this year's $396 billion budget for infrastructure to building roads, telecom networks, and dams in the west. It plans to issue more than $12 billion in bonds to fund natural gas pipelines and power plants. Banks are being asked to ensure that much of their portfolios also goes to borrowers in the interior. And Beijing is offering low taxes and land-use fees to lure Chinese and foreign companies that invest.

But as a visit to remote villages in Guizhou and Sichuan provinces shows, persuading companies to go west is proving difficult indeed. Much of the impoverished interior is landlocked, mountainous, and hard to reach by rail, highways, or rivers, while its officials have little experience with business. It's also unclear whether the lavish spending will really help the rural poor, given Beijing's emphasis on infrastructure megaprojects and working through state organs. Plus, industry in the west is still hobbled by the failed policies of Mao Zedong and the Great Leap Forward, a disastrous experiment in collectivized farming and small-scale manufacturing that left as many as 30 million dead through starvation in the late 1950s. Many factories were originally marooned in difficult-to-reach regions because a paranoid Mao wanted them out of range of Soviet and U.S. missiles. And unlike in the coastal provinces, many of these plants only now have started the long and painful process of reform. They will be especially hard-pressed to compete when trade barriers fall after China enters the WTO.

Guizhou Jonyang Machinery Industry Co. illustrates the challenge. The Guiyang factory's dark and dank warehouse is lined with dusty yellow and orange excavators for mining and construction. Outside are the crumbling headquarters of the original state enterprise, which made howitzers for the military. Jonyang is responsible for housing, feeding, and providing health care for 3,000 employees and 2,400 retired workers. It has already made several payments to the local government to try to rid itself of this responsibility but also must deal with repaying $7 million in debt. So Jonyang isn't buying new machinery to produce equipment good enough to sell abroad. In 1997, it signed a $25 million joint venture with Conex Continental Inc., a Canadian investment firm. But it now faces competition from rival Chinese ventures with Caterpillar Inc. and Komatsu Ltd. So Jonyang is continuing to cut workers and slash social services. "We've already handed over the schools," says President Fang Chongping. "Next will be the hospitals and construction units." It's a dilemma faced by inland companies making everything from aluminum to fertilizer.

To speed the economic transition, Beijing is pushing to redirect foreign investors from the rich coast toward the underdeveloped interior. In typical socialist style, leaders have assigned quotas to each province. Officials are racing each other to reduce land and utility fees, offer easy access to financing, and send official delegations to court foreign investors.

A handful of multinationals have tested the waters. Siemens has invested in a fiber-optic cable venture in Chengdu and railway and traffic control systems in Xian. And Pratt & Whitney is producing aircraft engine parts in three factories in Chengdu, Xian, and the city of Zhuzhou in Hunan.

Still, the going is tough. Of the more than $300 billion in foreign investment that China has drawn, only $9.9 billion had gone into the west as of 1999. Landlocked Guizhou has lured a mere $100 million. Sichuan, the richest western province, attracted only $6.8 billion--compared with $11 billion pulled in by Shanghai's Pudong development zone in the last few years. "Many of our neighboring provinces also offer preferential policies," says Tang Limin, director of the Sichuan Foreign Investment Bureau. So do coastal cities.

One reason for reluctance is other multinationals' bad experiences doing business in the interior. Some are so frustrated they are pulling out. Local officials often have their own interpretation of Chinese law, and corruption is notorious. Houston-based Enron Corp., for example, is threatening to halt a $50 million investment in a natural-gas drilling and sales venture near Chengdu. Enron started pumping gas last summer. But it complains its local partner, Sichuan Petroleum Authority, a unit of recently listed PetroChina, has not honored agreements on production levels and payments. Enron also says it has been pressured to use state-owned suppliers of construction and old field supplies that charge much more than competing local companies. It has also fallen victim to its partners' social welfare burdens. Local farmers, angry at the noise and lights from wells, have besieged the operation, once trapping foreign staff and twice forcing the wells to shut down. "I give us a 30% chance we'll still be here in a year," says Daniel Krause, Enron Oil & Gas China Ltd.'s production manager, who says the Sichuan project costs twice as much as a similar U.S. operation.

LOW TAXES. Beijing also has had trouble persuading successful Chinese companies to invest in the interior, despite a propaganda blitz calling it a patriotic duty. Having already implemented reforms themselves, many are not eager to sacrifice profits and take on the burdens of providing social services to workers just to curry favor with Beijing. Top Group, for example, took over a state-owned factory making machine tools in Sichuan's remote city of Zigong in October, 1998. But Top was mainly interested in the enterprise's domestic stock listing, which could give the company access to equity capital. After regulators made it easier for private companies to list, "there's not much incentive now," says Top's Li. So his company is looking at opportunities in the east and even at software companies in Silicon Valley. Last year, Top acquired a cable modem maker in coastal Jiangsu province.

There are some signs of progress. Xian has attracted domestic and foreign companies to its high-tech industrial zone, for example. The lures: low taxes, cheap land, decent power and roads, and a plethora of research institutes. In early April, telecom switch maker Shenzhen Zhongxing Telecom decided to invest $6 million in a Xian R&D institute. IBM has recently agreed to develop software to be used in managing the zone, and Hewlett-Packard will open an e-commerce R&D center expected to cost $7 million. In April alone, zone officials hosted more than 70 delegations of investors from inside and outside China. The zone also has launched an $18 million venture-capital fund earmarked for small companies.

As costs climb along the coastal region, some domestic companies from the rich provinces also are starting to discover the west's untapped markets and cheap labor. Its urban workers earn half the $1,160 average wage in prosperous coastal cities such as Xiamen. In 1997, Hisense Electronic Co., an appliance maker in the coastal port of Qingdao in Shandong province, paid $2.4 million for a stake in a failed state-owned maker of color televisions in Guizhou. Hisense has tripled the factory's sales, to $30 million, by improving quality and marketing. "We will make a major investment in technology and expand our production," says Hisense marketing manager Wang Ruiji, who predicts sales of $63 million this year. "The market in the western area has huge potential."

NO DENT. Some of China's aggressive new breed of private entrepreneurs also are managing to overcome the obstacles. For years, officials discriminated against private companies like Chengdu-based New Hope Group, an animal feed and chemical concern, by denying it bank loans and investment approvals. But this year, it won a contract from the International Finance Corp., the World Bank's private investment arm, to build a chemical factory. Now, New Hope is taking over ailing state-owned enterprises. And state-owned banks, under pressure from Beijing to become profitable, are falling over themselves to lend to it. New Hope also is the biggest investor in China's first private bank, located in Beijing.

But while attracting industry to big western cities will certainly help, some economists think that won't seriously dent hard-core poverty. To do that, money must flow much deeper inland. China's Agriculture Bank is trying to tackle that challenge by starting a microcredit program in such places as Erguan, a Guizhou village of 2,300 people reachable by an unpaved road. Farmers there live in simple wood and brick houses, and till small plots between the hills. The few dashes of color are the traditional blue and green patterned dresses with bright embroidery still worn by Miao women.

The money has been a godsend to farmers like Ma Yingxue, 41, who barely feeds his family of five on the rice, tomatoes, and cabbage that he grows. Thanks to a $144, one-year loan, he bought a pregnant sow that has just given birth to six piglets. With a broad smile creasing his deeply tanned face, he outlines his plans to go into a business of sorts. "I'll sell them and use the proceeds to buy a male pig. Then I'll raise another litter, and sell them," says Ma, who has a gash on his forehead where he hit himself with an ax while trying to fell a tree. "Then I'll buy new clothes, tools, and fertilizer."

DUBIOUS VALUE. It's an intriguing strategy, and one that could perhaps make a big impact in a country where small-business credit is virtually impossible to get at affordable rates for those lacking powerful connections. But such programs account for a microscopic portion of the billions Beijing is throwing at its development campaign.

Instead, the lion's share of money goes to huge infrastructure projects, some of which are of dubious value. Or it goes to inefficient heavy industries. Industrial & Commercial Bank of China has been told by Beijing to make 70% of its loans in the western provinces, compared with 40% previously. But some analysts note that the interior has few strong companies capable of investing and managing the money well. So there's a danger that China's frail banks, already laboring under some $250 billion in nonperforming loans to state enterprises, will take on more bad loans just as they are trying to operate more like real commercial banks. "As a commercial bank, of course, we are very concerned about getting our loans paid back," says a cautious ICBC official.

The overemphasis on big public works also boosts chances that funds will be squandered by corrupt or spendthrift officials. Take the massive Ertan hydroelectric project on Sichuan province's Yalong River. Completed at a cost of $3.4 billion in 1998, it has been able to sell only some 60% of the power it generates. Graft also is likely at big projects such as the planned Xinjiang-to-Shanghai natural-gas pipeline and petroleum pipelines from Lanzhou, Gansu, to Chengdu. Premier Zhu himself rails at "tofu projects," so-called for their flimsy construction, such as bridges that have collapsed. In other cases, outraged peasants have been forced to resettle to new homes that don't exist. This has happened at the gargantuan Three Gorges Dam, a project estimated to cost nearly $30 billion that already has generated allegations of corruption and waste three years before it is expected to open.

Worried over polls showing that Chinese people consistently rate corruption as the country's biggest problem, Beijing is trying to crack down. In late April, the government revealed that National People's Congress Vice-Chairman Cheng Kejie, previously a top official in Guangxi province, is being tried on charges of taking $4.5 million in bribes from contractors and trading companies. But to skeptics of China's war on poverty, the waste and corruption highlight fundamental flaws in the government's approach. "The basic question of developing the west is who dominates it," says Mao Yushi, director at the Unirule Institute, a private economic consultancy in Beijing. "If the market dominates, the policy may succeed. If the government dominates, it will be a failure."

Even if Beijing gets its policies right, though, nobody is expecting fast results. The geographical and social barriers to rapid development will take decades to surmount. Ethnic and labor unrest will continue to cause tensions. It will also take the interior provinces years to win credibility with foreign investors by compiling a track record of living up to their promises, as the coastal provinces did in the 1980s. "The jury is still out on that," says a Western diplomat who deals with foreign companies exploring the interior. Investors "are waiting to see if all of this is real."

If Beijing can manage to ignite the west with the same kind of fervor for reform and investment that has already engulfed the east, it could open up a vast frontier that could boost the Chinese economy for years. For now, the chances of success don't look good. Meanwhile, the exhausted peasants and workers of the interior impatiently wait for better times.

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