Shenzhen at 25
By George Zhibin Gu

The list of world cities with over 10 million residents isn't very long, and mostly contains familiar names like Tokyo, Lagos, Rio de Janeiro, and New York City. But what if we were to ask: out of these megacities, which had a mere 20,000 residents only 25 years ago? Only one name would remain: Shenzhen, China.

Shenzhen, a "special economic zone" (SEZ) located in south China's Guangdong province just north of Hong Kong, has become the economic locomotive of the region since it was founded 25 years ago as a kind of "laboratory" for market-oriented economic reforms. The city's annual growth rate since then, averaging 28% since 1980, has no equal in the world.

The urban landscape left by the dizzying growth is awesome, with


countless office towers, hotels, shopping centers and apartments. Observant visitors, after spending a bit of time in the city, might notice another odd fact: the average resident is in the twenties.

But Shenzhen is not interesting just for itself: it shows the fundamental changes China is going through, and demonstrates how China's new participation in the global economy, which has put the country on a completely different course, works. Because the boisterous SEZ reflects China's general direction, it offers tremendous lessons for Chinese and foreign observers alike. The most important of these is that an open society and private initiatives are most directly responsible for fast development.

The first key to success: Openness
On August 26, 1980, the central government granted Shenzhen privileges as a special economic zone, placing it literally in a class of its own. The intention was to allow Shenzhen to become an experimental laboratory for dealing with the market economy and the outside world. SEZ status gave Shenzhen at least a decade's head start over Shanghai and other Chinese cities. A key motive for this policy change was that, as absurd as it may seem from today's perspective, Guangdong province was considered somewhat backward: Shanghai contributed up to 40% of central government income as late as 1980.

At the time, making Shenzhen a special economic zone, along with three other small coastal cities in Guangdong and Fujian provinces, was a bold move on the part of Beijing. The central government was desperate to find ways to deal with its woes: China back then was more like North Korea today - widespread hunger, general poverty and increasing discontent following 30 years of bureaucratic abuses within a tightly closed society. Engaging the outside world was a new strategy and would become a vital one for national development.

Initially, Shenzhen lacked capital and other resources, which meant it had to rely on outside help. This required becoming as open as possible to the entire world, creating a friendly business environment so that outside investors have the incentive to inject their capital into the city. This strategy has worked well, to say the least.

Over the last 25 years, Shenzhen has attracted more than US$40 billion in foreign direct investment, becoming a global commercial center in the process. Though it is a key destination for overseas Chinese, especially from Hong Kong as well as Taiwan, it has attracted investors from all over the world as well. More than 113 of the top 500 global multinationals maintain offices in the city today. IBM alone has set up eight companies in the city and Japan's Sanyo Electric has 10 companies there. The current presence of multinationals was not easily obtained, however. Most of the early investments were from neighboring Hong Kong, which did not hesitate to cross the border to pursue the vast opportunities in the SEZ. The multinationals came mostly after the mid-1990s; by then, Shenzhen was already a booming city, and the presence of global corporations simply accelerated the city's development.

Buying foreign brands has become part of daily life for Shenzhen residents. The major shopping districts are packed with foreign retailers like Wal-Mart, Carrefour, Jusco, and H&Q, with more on the way. Countless global brands, like P&G, Unilever, Mars, Coke, Nestle, Sony, LG, Nokia, Siemens, and Philips can be found in these stores; and the foreign vendors have found Shenzhen, with its relatively affluent and brand-savvy population, to be one of their most profitable markets.

The city is connected to the outside world in many ways. Tens of thousands of foreign nationals now live and work in Shenzhen. Countless businessmen from Latin America, Africa, Australia, New Zealand and the rest of Asia have come. In the local schools, hundreds of foreign nationals hold teaching posts.

Having foreign capitalists participate in Chinese development has obviously achieved positive progress for Shenzhen and the rest of China. As a result, China has become more open and more dynamic. In many ways, China is actually more open now than even Japan, despite Japan's much longer experience of industrialization. In this context, Shenzhen leads China in openness as well as development. This openness has directly helped China's development in all sorts of ways.

But foreign investment is only a part of the total picture. The city has attracted substantial investment from other regions within China. There are countless businesses in Shenzhen originating from government units and companies all over China. Countless towers bear names like Sichuan, Henan, Shaanxi, Tibet, Shanghai, Jilin, and Jiangsu; the structures belong to enterprises controlled by various regional government units.

The second strategy: Entrepreneurship
The city's greatest strength is its entrepreneurs, who have flocked to the southern boomtown from all over China. Out of 170,000 registered companies in the SEZ, more than 135,000 are private. Key names include Huawei Technologies, already a global brand in the telecommunications equipment industry; "Everyone Happy Store" and "Best Buy Store" are leading Chinese franchise retailers that are competing head-on with foreign retail giants; and more than 800 software companies now aspiring to expand beyond China's borders. The Chinese Internet instant messaging software company QQ.com, which has more than 400 million global users, was born in the city, set up by three young engineers.

For now, the private sector employs about half of the city's workforce and contributes about half its economic output. This heavy reliance on the private sector for prosperity has become a model for the rest of China to emulate; in most inland regions, the private sector remains a small minority in terms of both employment and output. Many less developed cities and areas are still dominated by the state sector today. But many inland cities such as Xian, Wuhan, and Chongqing are now aiming to increase private sector involvement. This type of regional competition, leading to regional emulation, is a driving force in China's development today.

Even some state sector companies in the city have moved ahead of the crowd, despite their imperfections. Among them is Ping An Insurance, the second biggest Chinese insurance player, already listed on the Hong Kong Stock Exchange with shareholders such as Morgan Stanley, HSBC and Goldman Sachs; Merchant Bank, considered by many to be the best-run Chinese bank; and China Container Group, the world's biggest shipping container manufacturer.

Shenzhen has made itself a key business center for China and beyond. Some 22 local companies are in China's top 500; several of them will have a chance to join the global 500 club within a short time. The Shenzhen Stock Exchange is as important as the Shanghai one. It is also a choice location for Chinese investment brokerages and fund management companies. The city's high-tech sector has made huge progress, growing at an annual rate of 46.5% over the past two decades, reaching $39.5 billion in output in 2004. Shenzhen Inc owns some 50,000 brands of its own creation. In addition, foreign banks such as HSBC, Citibank and UBS have increasingly extensive operations in the city.

But Shenzhen is also a heaven for an estimated 300,000 small business owners, who are involved in every conceivable industry all over the city. Some have already become fairly affluent as they get ahead on their own initiative.

The city has set itself a higher goal, however: to become a high-value-added business center. This is actually a matter of economic survival, since rising land and labor costs are already forcing many low-value-added businesses to move to cheaper inland cities. To achieve the high-value goal, the SEZ has encouraged the formation of research and development centers by both international and Chinese companies; and hundreds indeed have been, or are being established. Last but not the least, Shenzhen has become the top export city in China, reaching nearly $150 billion as in 2004.

Hong Kong has long been a good model for Shenzhen to emulate. But today, the winds of fortune have turned; Hong Kong is finding that it has a lot to learn from the city on its northern border. Hong Kong no longer finds growth easy, with high salaries and land prices, and only the service and real estate sectors expanding. But Shenzhen has several growth engines: a fast-expanding manufacturing sector, high technology, and now (albeit at the beginning stage) research and development. Its room for further development is huge, especially in view of its dynamic, aspiring, and youthful workforce. It is no surprise that the city is fast catching up with Hong Kong.

The rising middle class
So far, Shenzhen has created a fairytale of its own. But its most interesting aspect may be the rising power of, and choices for, its citizens. Tens of millions of Chinese have tried their luck in this new frontier, and some 12 million now call it home. They have all come for opportunity. Some have gained enormous wealth, which has made the city even more attractive. The vast income gap, while remaining potentially disruptive, is not without one positive effect: the have-nots work hard as they seek to emulate the haves (who were often have-nots just a few years ago) they see all around them.

As a result of such social dynamics, a new middle class has come to life. The exact number depends, of course, on definitions; but one way to define middle class in China is given by the Chinese Central Academy for Social Science (the top Chinese social research institution in Beijing): an annual family income of at least $7,246. By this yardstick, among Shenzhen's 12 million residents, roughly 5 to 6 million have joined the club.

The SEZ's middle class is just like that elsewhere in China: it consists chiefly of government employees, teachers, professionals, salespeople, small business owners and managers. Certainly, this middle class is the key consumption force in the city. There are more than 1.5 million cars running on the already crowded streets. Equally impressive is that the city has 10.3 million mobile phone subscribers, a result of many people carrying two handsets.

Admittedly, in absolute terms, the Shenzhen middle class has less than their counterparts in developed nations. But on a purchasing-power-parity basis, their lifestyle increasingly resembles that of the middle class in New York, Tokyo, Paris or London. Many returning Chinese students have noted this, somewhat to their own surprise.

The have-nots
What about the less fortunate? Of the several dozen residents I have interviewed, the lowest-paid workers make as little as $60 per month. The lowest paid jobs are those of unskilled factory workers and retail clerks. Indeed, about half of the 12 million residents make $50-200 per month. In numerous ways, millions of rural migrants can hardly enjoy the rising fortunes of the city. Few extra benefits are provided with their low salaries. Furthermore, increasing their pay is very different due chiefly to the fact there are more job seekers than jobs. The small appreciation of the yuan recently may even prompt some companies to cut pay.

More often than not, the workload for these low-end workers is outrageously long. Millions of people work for six days straight. Worse still, seven-day workweeks are not uncommon. These people often suffer workplace abuses, even though they are the very backbone of the city's strength. The made-in-China products that flood the globe are mostly made by these workers, many of whom have yet to see the better life promised by Shenzhen's growth.

Though their living and working conditions are improving, there is still a long way to go. In many ways, they are treated like second-class citizens - a term often used by the Chinese media. For example, the city has long denied the children of migrant workers the right to attend public school. Yet, to become a permanent city resident, with all the benefits this brings, is next to impossible. So far, the city has granted permanent resident status to only 1.75 million people out of 12 million residents. Millions have worked in Shenzhen for years, even for decades, but they find it enormously difficult to get permanent resident status. As a result, they must return to their home towns to get driver's licenses and travel documents, among countless other official items.

The city has been trying to relax its residency policy, but progress has been slow. For example, since early this year, the city has granted permission for renewing driver's license within the city, but there is a two-year residency requirement. Furthermore, the city has lately widened the gate for migrants to obtain permanent resident status, but the new policy demands applicants each pay 200,000 yuan (US$24,700) in total tax over 3 years. Millions of low-paid workers, who are still voiceless, are naturally excluded as intended.

Shenzhen's low-paid workers have suffered all sorts of abuses. In particular, the city charges them as much as one month's salary to grant them "temporary" annual residency. Failure to pay can lead to additional fines, abuses and even arrests. This kind of "squeeze" has been true nationwide, not just in Shenzhen. Within the last two years or so, widespread social protests nationwide have helped to reduce such fees to about $1.85, instead of the previous $45 or more - the typical rate in Shenzhen for many years.

Workers still lack adequate legal workplace protections, placing them at the mercy of employers. Very often, employees are not paid for months or more. But getting help is often burdensome, if not impossible. Though the city government has been doing more lately to help the victims, their number is hardly decreasing. This is mainly because legal enforcement remains weak, to say the least. A recently passed local law mandates fines of up to $6,112 if an employer abuses employees' pay. But even if the law was perfectly enforced, what employers can save by shortchanging workers can be many, many times bigger than this small fine. In short, between employees and employers, the employer is always the stronger - and this situation is not going to change anytime soon.

One development that has improved the lives of migrant workers in Shenzhen is the introduction of a health insurance program providing basic health coverage. Each month, workers pay about 50 US cents in premiums, while employers contribute about 1% of monthly salary. Though this program is only six months old, it already covers some 700,000 low-paid workers. Further assistance like this would obviously be welcomed by the SEZ's legions of migrant workers.

Transforming government into a true service provider
The difficult environment for less privileged workers demands the government take on a new and unfamiliar role: a modern service provider to the masses - a new concept for Shenzhen and for China as a whole.

Although the the city's government has tried to adapt to its rapidly changing situation, there are still great challenges. One increasingly pressing issue concerns a true separation of government from the business world. China's modern tradition of government domination is still going strong in Shenzhen; being a reform frontier does not mean that it has totally abandoned the old framework in place since 1949. Government offices may be eager to offload troublesome responsibilities, but none desire less power. All government offices - globally, not just in Shenzhen - have a vested interest in expanding power. And despite Shenzhen's youth, government power has already penetrated deeply into the business sphere.

One key barrier to Shenzhen's progress is the countless governmental demands on the business community. Innummerable transactions that could be privately handled require official involvement. For example, permission is required to engage in international trade, hiring, and travel. As a result, building a hotel demands 105 governmental approvals.

Why are there so many government demands in China, India, Russia, and Brazil, among other developing nations with similar problems? Do these demands work to the benefit of society in each case? Hardly. The Shenzhen business community feels that these government acts have more to do with vested bureaucratic interests than the greater good of society. Many official requirements are, in essence, tactics to increase bureaucratic power at the expense of the larger community. Needless to say, the high cost of government demands sharply increases opportunities for official corruption. It is a small wonder that a small government clerk in the city, Wang Jianye, squeezed literally millions of dollars from businessmen, as businesses were required to get approval from his office for foreign currency exchanges. Wang was later executed, but the systemic flaws that contributed to his case remain in place.

Beset by changing realities, the sharp development of the private sector and the huge international presence, Shenzhen's government has quickened its efforts to turn itself into a modern service provider. Regional competition within China has spurred it along, as has China's WTO entry. Knowing the troublesome consequences of the multiple approval demands, the city government has offered express services and privileges to a select group of some 300 local companies in both the private and state sectors. These businesses can get preferential treatment in international trade, hiring, and travel, among other services. But obviously, over the long term, such services need to be made available to the rest of the business community. Complete abolition of all unnecessary official barriers is the ultimate solution. As one local businessman said, "the only fair way is to abolish these bureaucratic tricks completely."

More changes ahead?
On the surface, impressive institutional changes are taking place. Three rounds of administrative reform have been promulgated in the last few years. Total administrative demands on the business community have been reduced to 239 items, from 1091 items in the late 1990s. More recently, 145 temporary government agencies were abolished, out of 225. But Shenzhen's business community still feels the need for further reform, if Shenzhen is to compete with business centers like Hong Kong and Singapore. That is, the government must change its functional role to become a servant of the public, rather than a mandarinate-like institution where supplicants must appear to beg for favors.

One might think that, with 225 temporary government agencies, officialdom would at least have the manpower to effectively enforce existing laws. Regrettably, an examination of Shenzhen's business environment shows that has not been the case. On the contrary, regulators have been unable to curtail abusive business practices. For example, the city has tens of thousands of unlicensed businesses, including illegal retail outlets, restaurants, and even factories, medical clinics and real estate projects. Their inferior products and services pose a serious threat to consumers, not to mention the damage their very existence poses to the rule of law. A recent reform effort has tried to eliminate such abuses, but the task is formidable indeed.

At the same time, attacking abuses outside the government is much easier than taking on problems within. Like everywhere else in China, corruption plagues the SEZ. Hundreds of local government officials have been arrested for corruption, and in some cases involved high-ranking officials. In one case, the former top-three government officials in the city's South Mountain (Nanshan) district - Party Chief Yu Dehai, Chief Administrator He Cuben, and People's Congress Chairman Peng Hu - squeezed millions from local businessmen for many years. The Nanshan trio is now serving 8-12 year prison terms. Such problems occur because government offices tightly control all sorts of business assets and their allocation. Also, of course, some businessmen desire to partner with corrupt officials to take advantage of the officials' power. These officials, in effect, rent their offices for personal gain.

So far, the anti-corruption efforts, although considerable, have taken on a quality reminiscent of the "whack-a-mole" arcade game, where as soon as one bad apple is prosecuted, another one appears somewhere else to take his place. As a result, the number of corrupt cases has not decreased, and the public feels helpless about the situation. One professional Shenzhen investor called corruption "widespread" and said, "it is really time to do something about [this]."

In this environment, the special privileges granted to foreign companies have attracted resentment from local Chinese business owners. A common, creative response is to register their companies in offshore locations, so they can also enjoy the special privileges given to overseas firms.

Can Shenzhen escape the bureaucratic swamp?
Considering the SEZ's youth and relatively relaxed ground rules, it is rather remarkable that the state sector is as large as it has become: the state controls about half the business assets in the city. But the built-in flaws of government ownership make the sector a disaster waiting to happen. In many cases, it has already happened: out of some 90 publicly listed companies in the city, more than 28 are in financial distress. In one case, a major investment holding company, the Shenzhen Chemical Group, went de facto bankrupt after chronic mismanagement. As a result, the local government sold its controlling stake - for $1.20.

Government units don't want to sell their enterprises because they have a vast vested interest. But this very fact makes effective supervision of state companies almost impossible, which has already caused many disasters. In one case, the former chairman and party boss Lao Derong of Shenzhen Energy, a city-owned utility company, was arrested for stealing more than $7.2 million of investors' money over many years during her reign. Cases like this have contributed greatly to the perception of many Chinese that long-term prosperity can only be produced by a fast-growing private sector.

Despite foot-dragging by some, there is a significant trend to sell off state assets, as a way of escaping the corruption trap. Recently, Shenzhen cashed out smartly by selling a badly performing retail bank, Shenzhen Development Bank, to US venture capital firm Newbridge Capital. It has also sold minority stakes in several highly profitable public utility companies to foreign buyers. But critics say the city government needs a firmer commitment to completely withdraw from the business world.

In spite of these built-in problems, China's southern boomtown has made impressive progress. One wonders, how much more progress could it make if the root cause of many of its most serious problems - poor governance - was resolved? The city has countless bright and diligent people, as well as huge capital, but for it to meet its overall development goals, its government will have to evolve into a true, modern service provider. Because Shenzhen is a bellwether for the rest of China in this respect, as in most others, whether it succeeds in official reform will say a great deal about whether similar moves will succeed elsewhere.

George Zhibin Gu, a business consultant based in China, is the author of a newly released book: China's Global Reach: Markets, Multinationals, and Globalization (www.Trafford.com/05-1822, September 2005).

(Copyright (c) 2005 George Zhibin Gu)