Don’t Believe the Shanghype

Over the next few weeks we’re going to be hearing a lot about Shanghai. Expo 2010 — this year’s version of the venerable World’s Fair — has just opened in China’s biggest city. Two years ago Beijing used the Olympics to showcase China’s achievements to the world; now it’s Shanghai’s turn. So get ready to absorb an economy-sized dose of superlatives: The world’s second-busiest port. The largest stock market on the mainland. Double-digit growth since 1992. The Paris of the East.

Let’s wish the Shanghainese all the best as they gear up for their party. The Expo looks like it will be a lot of fun, and we certainly hope that’s the case. But beware. Tradition teaches us that fairs also make great occasions for hucksters and con artists. So a word of friendly advice: Should you happen to hear people assuring you how Shanghai ought to serve as a "model" for China, or even the rest of the world — put a hand on your wallet. Somebody might be trying to pull a fast one.

Foreign business people, in particular, love to gush about Shanghai. Look at Pudong, the city’s financial district, where a forest of skyscrapers has sprouted in the course of a few years. Look at the state-of-the-art hotels, the fizzy night life. Look at the awe-inspiring infrastructure, from the city’s immense container port to the maglev train that whips visitors into town from the airport at 268 miles (431 kilometers) per hour. So it’s easy to understand why in 2004 the World Bank, which often praises Shanghai for its strong business spirit, chose the city for a conference designed to celebrate China’s success at combating poverty. Earlier this year, the New York Times‘ Thomas Friedman invoked Shanghai, along with Hong Kong, as the embodiment of China’s vibrant new business culture, "a highly entrepreneurial sector that has developed sophisticated techniques to generate and participate in diverse, high-value flows of business knowledge."

But what if Friedman and the World Bank are wrong? That’s one of the conclusions that emerges from Capitalism with Chinese Characteristics, a new book by Yasheng Huang, a China-born economist at the Massachusetts Institute of Technology. "I never bought into the idea that Shanghai was a laissez-faire capitalist city, like Hong Kong," said Huang in an interview. "That simply wasn’t true. And a lot of Shanghainese know that. They know that it’s not a free market environment."

In his book, Huang argues that China’s economic reforms can be divided into separate eras. In the first, which extends from Deng Xiaoping’s 1978 "opening and reform" to the early 1990s, the Communist Party emphasized rural development with relatively little interference from above — and the result was an explosion of small- and medium-sized businesses that created an enormous surge in employment and grassroots wealth. Deng created his first "special economic zones" in places along the coast — such as Shenzhen and Xiamen — where there was relatively little established industry. So the new companies that sprang up there were almost entirely private. Foreign investors piled in, but mostly under conditions that didn’t disadvantage local entrepreneurs. Everyone got rich together.

The second phase, which started in the early 1990s and has continued more or less until the present, reversed or slowed many of these earlier reforms. Now policy concentrated on big cities. Here, Huang argues, the government played a much more active role, pouring money into showcase infrastructure projects and favoring state-owned companies over private ones. What’s more, regulatory regimes and tax structures tended to privilege foreign investors over domestic businesses — a trend that reached its apogee in Shanghai. As Huang writes: "Shanghai represents the political triumph of the Latin American path, anchored on the prominence of statist interventions, huge urban biases, and distorted liberalization in favor of FDI [foreign direct investment] at the expense of indigenous entrepreneurship."

Pretty drastic stuff. But what makes Huang’s analysis compelling is that he has the numbers to back it up. And those data tell a dramatically different story than the usual anecdotal accounts from enthusiastic foreign drop-ins. For one thing, Shanghai turns out to be strikingly bad at creating local businesses. Private start-ups are thin on the ground. Those that exist tend to employ fewer people and generate lower sales than companies pretty much everywhere else in the country. Many of the ones born in Shanghai — like Alibaba, one of China’s most successful Internet companies — tend to move away to more business-friendly climes. (Alibaba opted to transfer its operations to Zhejiang province in the late 1990s.)

Huang also took a close look at the stats for patent grants, a key indicator of innovation. He concluded that Shanghai "consistently under-performed two of China’s most entrepreneurial provinces, Zhejiang and Guangdong" — a surprising finding when you consider that Shanghai is home to some of China’s leading universities and a leading recipient of government largesse. It’s a picture, in short, that sharply contrasts with the popular image of Shanghai as a high-tech hub. Huang wryly writes that tours for foreign investors put on by Shanghai officials invariably include visits to the same pharmaceutical company — precisely because there are "so few prominent private-sector success stories in Shanghai."

It should be added that Huang isn’t the only one who’s arguing this point. "You talk to Chinese private entrepreneurs, and they will moan and complain about how much the state sector dominates there," says Gordon Chang, a Forbes magazine commentator who worked in Shanghai during the 1990s. "It was a city that saw its future based on the state enterprises." City officials tend to push foreign investors into the embrace of these public champions — companies like Shanghai Automotive, which ended up as the partner for U.S. auto company General Motors when it came to invest in China.

This same top-down approach has found expression in Shanghai’s tax and regulatory regimes, which have tended to suppress the creation of the small businesses that provided so many jobs for Chinese elsewhere in the country. "State-owned companies remain the dominant players in Shanghai — which is not the case in Guangdong, Zhejiang, and Jiangsu," says Jean-François Huchet, director of the French Center for Research on Contemporary China in Hong Kong. As Huchet points out, it’s probably no coincidence that it was a group of Shanghai politicians — like Jiang Zemin and Zhu Rongji — who dominated Chinese politics for most of the 1990s.

Given this brand of elite-led development, it may not come as a complete surprise to discover that many ordinary Shanghainese have failed to benefit from their city’s increasing wealth. As Huang shows in his book, employment in Shanghai actually contracted in the 1990s; the city’s employment level in 2004 was the same as it was a decade earlier. Meanwhile, the government was fueling the city’s development by requisitioning land from residents, paying them minimal compensation, and selling at above-market rates. For every Shanghai resident who has netted a nice job with a foreign company, there are countless others who have been shooed off their land for a pittance. Shanghai’s much-vaunted Pudong development, for example, was predicated on the involuntary resettlement of 1.7 million people — very few of whom received market-based compensation for the loss of their living space. (For the sake of comparison, there are some 75 countries and territories around the world with populations of less than 1.7 million.)

Does the same spirit live on? Thousands more Shanghainese — though not as many as back then — have been displaced to make room for the Expo. Shanghai-based author and marketing expert Paul French argues the Expo is all too typical of traditional top-down thinking. "It’s no mistake that the first-ever Expo was in London in the middle of the 19th century," he says. "But the idea that innovation and technology are based on countries is outdated. It doesn’t work like that anymore." That might be one reason, he says, why a surprising number of Shanghai netizens have been filling the blogosphere with critiques of the Expo. (Of course, another reason could be that the authorities have banned them from wearing their pajamas in public — a typically quirky Shanghai custom.)

But Huang, intriguingly, sees grounds for hope. He thinks the old policies are beginning to show their age — and that, he says, could be a blessing in disguise. The city’s growth figures have begun to slow in recent years, and the level of foreign direct investment actually declined in 2008 and 2009. Some foreign investors have even been leaving town. Huang says that might be why he has been seeing some positive signs that the city’s leaders realize that they need to loosen up conditions for small businesses if they want more Shanghainese to enjoy the benefits of the city’s rise. Let’s hope he’s right — for Shanghai’s sake, and China’s.