The Party: The Secret World of China's Communist Rulers (33 page)

Wang Shi’s stress on the importance of having a ‘red hat’ Haier’s tussles with the Qingdao government; Huawei’s cosying up to the political establishment; and the cultivation of the Party by big firms in Wenzhou all have much in common. The bigger you get, the more important good ties with the Party are and the greater the benefits that flow from a good political relationship. The contrasting fortunes of two entrepreneurs who tried to crack open state-dominated industrial sectors in the early years of this century provide textbook examples of how to manage government relations to develop one’s business, and the steep price to be paid for failure.

Nearly a decade after he launched a push into the aluminium sector, Liu Yongxing mused in an interview about the lessons he had learnt in trying to do business in an industry long monopolized by the state. Liu’s business proposition had been straightforward when he devised his investment plan in the late nineties. He reckoned that China’s industrial output and urban construction were on the cusp of a boom. Demand for aluminium, and the raw materials used to make it, would soar. With the domestic supply of alumina in China under the control of a single state company, Liu saw a once-in-a-lifetime opportunity for his East Hope group to enter the market as a streamlined, low-cost player. Liu aimed to control the entire production process, from mining bauxite to refining alumina to smelting aluminium, so he would not be held hostage by his state competitors at any point along the way.

Liu, who was already one of China’s richest entrepreneurs, got at least one part of the business equation right. The five years from 2002 were a golden era for Chinese heavy industry, an era of record expansion and profits. But managing the politics of entering the sector proved to be much more perilous. Asked in the 2008 interview what he had learnt, Liu replied that he had taken one lesson to heart: to make sure his company did not become the ‘next Tieben’. He said: ‘Tieben is a lesson for us all. It was a tragedy.’

Jiangsu Tieben Iron & Steel is reduced these days to a footnote in the story of the Chinese economy, the tale of a crooked entrepreneur who overreached and got his come-uppance. Dai Guofang, Tieben’s owner, in fact had much the same business plan as Liu. In the early part of this century, Dai saw a similarly huge opportunity in steel. As a low-cost producer, he thought he could easily grab a profitable market share away from the relatively pampered state-owned giants like Baosteel, 150 kilometres away down the Yangtze, near Shanghai. All he needed was scale. The market bore him out in the years to come. Steel demand, and profits, surged in the five to six years to mid-2008.

Only unlike Liu, Dai was not around to enjoy them. Liu’s business survived, only just, multiple attacks on it by the state sector. Dai, however, ended up behind bars in a blaze of publicity orchestrated by the central government. The different fate of the two businessmen was simple. Whereas Liu astutely managed the politics of battling a state monopoly, Dai was out of his depth when the political winds in Beijing reversed course, and started blowing against him.

Dai’s plan to become a big player in the Chinese steel industry was hatched with the party bosses of Changzhou, an industrial city on the Yangtze river, in Jiangsu province. The then 41-year-old businessman owned a small steel factory but dreamed of scaling up to a blast furnace. His proposal to build a big steel mill found a receptive audience when he pitched it to city leaders in 2002. Changzhou jealously compared itself with two dynamic rival cities nearby in the Yangtze river delta, Suzhou and Wuxi, which had both left it far behind. ‘For Changzhou, their thought was: we must grab this chance,’ said Zhou Qiren, a prominent economist at Peking University. ‘It was a simple business decision. Dai needed local government support, land and loans, and they needed to report the project to the centre. Changzhou said to him: “Don’t worry about this. We will handle it.”’

Even by the standards of the Chinese robber-baron era, Tieben was an audacious project. By the time planning had finished, Dai’s new Changzhou company would have a capacity of 8.4 million tonnes, a large mill by global standards, equal to about two-thirds of British steel output in 2008, but less than 5 per cent of China’s. The central government required any steel projects with a value above about $50 million to be cleared by Beijing. To get around this, Changzhou simply broke the $1.28 billion project down into twenty-two individual businesses, and approved the development itself. The local branches of China’s big national banks came on board, pledging loans worth 40 per cent of the start-up cost. In mid-2003, Dai began to build.

If the project had been launched a year or two earlier, Dai and Changzhou might have got away with it. But by early 2004, the alarm bells had started going off in Beijing about the red-hot economy. Heavy industry was especially in the government’s cross-hairs. It consumed too much energy, put upwards pressure on already rising commodity prices, spewed out tonnes of pollutants, including greenhouse gases, and employed relatively few people for all the capital invested in it. Beijing decided it needed to send a strong message–proverbially ‘killing the chicken to scare the monkey’–to rein in further investment. Most of the new capacity was being added by China’s state-owned steelmakers, which were expanding frenetically. None of these companies, however, represented as juicy a political target as Tieben.

The full force of the state soon descended on the project. Construction work at Tieben was stopped in March 2004, on central government orders. A month later, at the end of April, Beijing elevated the project into a full-blown political case. The State Council convened a meeting specifically to discuss Dai’s steel mill. A stern account of the meeting issued by the official media raged against Tieben’s ‘illegal and criminal acts’ and the ‘gross violations’ of the law by the local government and banks. For the mild-mannered Premier, Wen Jiabao, who seldom picked public fights, it was a rare display of political machismo of the kind for which his predecessor, Zhu Rongji, was renowned. Wen dispatched investigation teams from no less than nine central government agencies and ministries to Changzhou to trawl through Tieben’s books for evidence of wrongdoing. Beijing did not doubt its ministerial sleuths would uncover a rich lode of misconduct, as such fishing investigations invariably did. A grand economic show trial loomed.

In the months and years that followed, the Tieben case unravelled in an embarrassing fashion that underlined the farce of the whole episode. Beijing’s investigation team concluded that the primary misconduct in the Tieben affair was the city government’s division of the project into twenty-two separate smaller ones. A number of relatively minor city government officials were sacked and the party secretary of the city formally disciplined. But only Dai was sent to jail. By the time his case got to court two years later, the hyperbole about false accounting and fraudulent bank loans had evaporated. There was no law banning the construction of huge steel plants. The restrictions were government regulations, enforced ultimately by the Party’s ability to remove officials from their jobs if the rules were not followed. Dai was eventually charged with issuing false invoices to claim tax rebates, a common practice in the industry.

Changzhou, bitter about being singled out by Beijing, sensed weakness in the downgraded charges and the failure of the central government investigation to find substantial wrongdoing. When Dai appeared in court in March 2006, he defiantly pleaded not guilty. Defendants will normally plead guilty in such cases in China, as it is the only way to mitigate a potentially harsh sentence. More startling was how the Changzhou court, which is under the control of the city’s party committee, joined Dai in thumbing its nose at Beijing. For four years, the court refused to issue a verdict in the trial. Dai’s lawyer, Qian Lieyang, a Beijing defence attorney, threw his hands up in despair at the delay. ‘This case is quite rare,’ Qian told me in late 2008. ‘We have been pushing and pushing the court for a decision, but now we have given up.’ Qian knew a not guilty verdict was untenable, because it would force the central and city governments to confront the ownership of the company’s assets and land, and compensation for their forced acquisition. ‘There would be all sorts of political complications arising from a “not guilty” verdict,’ Qian said. But the absence of a verdict was a political statement on its own, a way for the city to express its displeasure at Beijing’s veto of a major local development.

In mid-2009, with Dai already out on home detention, the court quietly entered a guilty verdict on a minor charge. The court’s decision underlined the futility of Beijing’s campaign against the company. Crude steel production doubled in the three years to 2004, reaching 280 million tonnes. By 2008, before a slump triggered by the global credit crisis and a domestic property crash, it had surpassed 500 million tonnes, more than the output of the next seven largest steel producers altogether. By mid-2009, steel production was running at an annualized rate of about 550 million tonnes. The political destruction of Tieben had had little economic impact at all. ‘What on earth happened to prompt nine central government ministries to train their heavy artillery on an obscure private company?’ Zhou Qiren, the economist, wrote in a newspaper commentary at the time of the trial in 2006. ‘Big state companies can get involved in huge projects. But when private companies do so, especially in competition with the state, then trouble comes from every corners.’

Although he did not disclose it in his writings on the case, Zhou had sought permission to interview Dai in jail. It was a highly unusual request, prompted by Zhou’s interest in the politics of the private sector. The Changzhou party referred Zhou’s request to the city police which sent it up to the province, which in turn referred it to the Public Security Ministry in Beijing, which finally approved his visit. Behind the bars of the prison Zhou found a sharp businessman, but with no political antennae. ‘Dai knew the whole industry inside out, all about the basic costs. He thought Tieben would have the lowest cost for new steel capacity in the country,’ Zhou said. ‘His investment was based on the market, but China is a political economy.’

This was a lesson that Liu Yongxing had learnt well in the late eighties and early nineties, when he made his first fortune, with his brothers in the pig-feed business. Now running his own company, his strategy had remained constant: stay an inch ahead of government policy, and no more. ‘Many times, we walked in front, as there was no policy,’ he said. ‘So within the confines of current regulations, go half a step further. Feel the way. You need to have good controls, otherwise, you could get stuck.’ And, he added, end up in a ditch like Tieben. ‘Government support for private enterprises is less than that given to state companies. This is characteristic of the reform,’ he said. ‘Since it’s the character of the reform, we cannot change it. We take it as a rule of nature.’

Liu had long before internalized the inbuilt bias against the private sector. In the twenty years to 2002, before he split with his brothers, his businesses had never relied on borrowing from the state banks. The banks hadn’t initially been interested in lending to the Liu brothers. And when the banks did start to chase their business, the Lius did not need them. Like most entrepreneurs, they had learnt to fund themselves from their profits. Once he accepted this was the way of the world in China, Liu said his attitude changed for the better. ‘Otherwise, you will be full of spite, and then either do nothing or do something extreme, which could be illegal.’

Liu Yongxing’s hard-won self-reliance influenced more than just the way he did business. His determination to have a very disciplined relationship with officials and not do shady deals to get ahead also dictated the sectors he invested in. He gave up on real estate, he says, because he could not bear socializing with officials. ‘Real estate requires lots of [insider] trading, and constant wining and dining and gift-giving,’ he said. Likewise, he decided not to list his new company on the stock exchange because this ‘would take a huge amount of personal energy on lobbying [the regulators] and various other government departments…and walking too close to the path of illegality.’

Liu confronted even greater obstacles to break into the aluminium business than Dai faced with steel. Up against him was a state monopoly, the Aluminium Company of China, or Chinalco, one of the elite fifty or so large firms controlled directly by the Party in Beijing. Not only was Chinalco one of the most powerful, sophisticated and aggressive state firms in the country, it also controlled the raw materials and technology needed by any competitor wishing to enter the industry. Most importantly, Chinalco had a virtual monopoly over alumina, controlling 98 per cent of domestic market supplies. There were two weaknesses in Chinalco’s well-fortified armour, one political and one related to technology. Liu cleverly, and legally, got around the political obstacles. One of the most intriguing questions about Liu is how he surmounted the second hurdle, getting his hands on the key technologies to make alumina.

Liu first trained his sights on targets distant from the capital. Chinalco might have been all-powerful in Beijing, but it was a very different story in the provinces. The central government had given Chinalco the mining rights over most of the country’s bauxite when the firm was restructured and partially listed overseas in 2001. Whereas Chinalco had an interest in hoarding bauxite, to keep prices high, the cash-hungry provinces housing the resource wanted to dig it out of the ground as fast as possible. Liu found himself pushing at an open door in Henan, which had about 60 per cent of China’s bauxite reserves. With an eye to generating extra tax revenues, the province quickly decided it would not be bound by Chinalco’s agreement with the central government. Henan began issuing bauxite mining licences to Liu and other entrepreneurs trying to break into the industry.

Chinalco fought Liu every inch of the way. It used its clout in the central government to have Liu’s projects delayed as part of investment controls. It demanded a controlling share on the Henan project as a condition of allowing it to go ahead. In the meantime, it slowed down the issuance of import licences for alumina in general, so as to fortify its monopoly on the resource. But gradually, the pieces began to fall into place for a fully integrated private aluminium business. Liu got the bauxite mine in Henan, where he could refine ore to produce alumina. He fended off Chinalco’s demand for a stake in his company. And he established smelters in Inner Mongolia and Shandong, both of which were serviced by power stations fed by nearby coal-mines, in which he had an interest as well (aluminium production requires substantial electricity).