Chen Mingyuan has lived here all his life, but he still gets lost every time he drives into Wenzhou. “All the roads in this town were built by businessmen, so none of them make any sense,” Chen says as we back out of what we just discovered is a one-way street. For the last 30 years, private citizens in this southeastern China metropolis have largely taken over one of the least questioned prerogatives of governments the world over: infrastructure.

Driving down the cluttered and half-constructed streets of this 3-million-strong boomtown requires frequent U-turns and the patience of Buddha, but every road eventually leads back to a factory. Each factory is in turn surrounded by a maze of roads filled with hundreds of small feeder shops selling spare parts, building materials, and scraps. Every haphazard street in this town seems to have an economic purpose.

We are driving to see Cai Shuxian, the manager and majority owner of a clothing factory in which Chen owns a 10 percent stake. Cai, a lightly built 32-year-old, is typical of the entrepreneurs who have made it big during Wenzhou’s three-decade boom, vaulting from shop-floor grunt to factory owner in a dizzyingly short period of time. “We earned very little in those days,” the high-school dropout recalls of his first job, “about 600 yuan [roughly $100] a month.” Within six years Cai was able to leverage his money and know-how into building a factory of his own, which now employs more than 100 people.

Cai glides over the source of his start-up capital, although it definitely was not one of China’s state-owned banks. “Banks only give you money when you don’t need it,” he says. He explains that during the 2009 financial crisis, when banks were aggressively lending as a form of stimulus, people would reinvest the money in Wenzhou’s underground financial system, where deposit interest rates are higher than the official lending rate.

Cai says his Horatio Alger story is “typical of Wenzhou.” And it is. Only a few days later I am introduced to the manager of a factory making transmissions for South Korean cars. Although he had the advantage of finishing high school, his starting salary wasn’t any higher. Cai’s dismissive attitude toward the government is also typical. Wenzhou has become one of the richest cities in China under a regulatory regime that borders on anarchism. 

The Wenzhou Model

Foreign businessmen, politicians, and journalists who fly into Beijing or Shanghai often get the impression that the Chinese government is the main driver behind the jaw-dropping development of what was until recently one of the worst large economies in the world. In Shanghai you fly to a state-built airport, ride on a state-built maglev train through the Pudong district, and behold a city of skyscrapers that appeared out of nowhere a little more than a decade ago with the help of generous government subsidies and investment from state-owned enterprises. Whatever local company you’re interested in, chances are the government is interested in it as well.

In southern China, things look rather different. The Chinese say that in this region “the mountains are high and the emperor is far away”—in other words, the government isn’t paying much attention. Companies are mainly small or medium-sized enterprises, government services are slight, and laws are routinely ignored. According to official statistics, the three southern coastal provinces of Zhejiang, Guangdong, and Fujian have the first, second, and fourth wealthiest citizens, respectively, in the country. They are the center of China’s export sector and the primary destination for China’s millions of internal economic migrants. Here is where the real Chinese miracle is happening.

The city and region of Wenzhou play an important role in this story. The Wenzhounese have a reputation for both an uncanny sense of business and an almost pathological disregard for the government. The mountains here are no metaphor: Seventy-eight percent of the Wenzhou prefecture is covered by mountains, a fact that proved pivotal to the area’s early development and the central government’s response to it.

In 1978, when China’s economic reforms were just being launched, Wenzhou was extremely poor, about 90 percent rural, with smaller land allocations than other areas and poor connections to larger markets. Even today, the vast majority of local entrepreneurs have less than eight years of formal education, and the current population of foreigners is estimated at only a couple of hundred. The Wenzhounese government received directives from Beijing but found that without accompanying support they lacked resources to run the economy by diktat. Fortunately, a central government that wasn’t offering much support also wasn’t paying much attention.

So private citizens quietly took over many of the services that elsewhere are either provided or heavily regulated by the state. Local authorities, lacking other options, didn’t try to stop them. The most important development in those early days was the city’s flourishing underground financial system, which according to the local branch of the People’s Bank of China (China’s central bank) currently is used by 89 percent of Wenzhounese private citizens and 57 percent of local companies. 

More dramatically, private citizens were the first to connect Wenzhou to neighboring regions by building roads, bridges, and highways, as well as the city’s airports and substantial portions of the dock. Even today the city is scattered with infrastructure investment firms through which groups of businessmen pool money to build the transport routes they all need to get their goods from factory to the point of sale. The result is not pretty. Aside from the confusion faced even by residents driving into the city, it is not uncommon to see sidewalks torn up to insert piping, with seemingly no intention of replacing the concrete. Nevertheless, the system is crudely efficient, merchants can all easily access factories, and the factories in this geographically isolated city now have sales networks that span the globe.

The government’s indifference didn’t last forever. But when the authorities got around to paying attention, they decided not to mess with a good thing. In 1985 Liberation Daily, a paper sponsored by the Shanghai Communist Party, referred to Wenzhou as a “model” for other parts of China to study. In the next year 15,000 government officials visited the city to learn, not crack down. Although bureaucrats still occasionally try to impose state controls on the city, the futility of the effort quickly becomes apparent. By now the local Chamber of Commerce has taken to negotiating trade deals both domestically and internationally because, as in most other things, the private sector is more effective here.

Today Wenzhou is the center of China’s light manufacturing empire and the richest city in China’s richest province. (Nationwide, Shenzhen, Shanghai, and Guangzhou narrowly edge out Wenzhou—in the official figures, at least.) A quick walk down a Wenzhou street reveals a bewildering display of commerce. The streets around the railway station are covered in stalls selling $3 blue jeans and $5 boots. There’s a city block dedicated to baby clothes next to a street that sells plastic signs for bathroom doors. In one run-down alleyway you’ll see people repairing televisions, making blankets, and selling fruits, vegetables, and poultry (live or dead). Further outside the center, you can find small shops dedicated to aluminum rods, sheet metal, tire rims, and tires.

Much of this low-level commerce depends on the same official negligence that fuels the factories. Pool halls are set up wherever there’s open space that you can set a tarp over. Gambling dens are openly advertised. Taxi drivers often drive off the meter. The karaoke parlors are numerous, and almost all of them double as brothels. The poorest residents take part in one of the largest citizen recycling programs anywhere in the world. In an alley one family collects scraps of fabric to sell to the local textile mills, another hoards scraps of paper and cardboard to send to the paper mills, and in front of a lot that looks like it is being used for a garbage dump, a man has set up a secondhand goods shop.

Unskilled workers in Wenzhou are paid one of the highest wages in the country, roughly $380 a month according to official figures (even higher—between $450 and $600—according to entrepreneurs’ estimates). It is here that people like Cai make their fortune.

Medicis on the Yellow Sea

China’s formal financial system generally disfavors lending to smaller companies. Interest rates are capped, state institutions come with a government guarantee, and Beijing regularly issues lending decrees, all of which make banks reluctant to throw money at small, private actors with poor or nonexistent credit histories. 

Wenzhou was one of the first cities to develop methods to work around the financial sector’s aversion to private enterprise. According to local entrepreneurs, it was this secondary banking system that made the biggest contribution to Wenzhou’s early development. “While northern people kept the money they made, Wenzhou people immediately lent it to their friends to help get ventures off the ground,” says Weng Yuwen, a Wenzhou native now running a clothing design company out of nearby Hangzhou.

Dozens of financing options are available, and although most of them intrude on the jurisdiction of the state-controlled banking system, they are not all illegal. Or at least not completely illegal. The different levels of legality that Wenzhounese perceive are a bit of a puzzle to an outside observer. Weng quickly disavows any knowledge of “underground banking”; like every other Wenzhou entrepreneur I speak to, he has “friends” who have dealt with gray-market lenders but declares he would never do so himself. A more standard form of getting a loan, he explains, is borrowing from a contact…who also happens to be lending to a large number of other entrepreneurs at interest. Weng contemplates this arrangement, then admits that the whole thing might be “somewhat illegal.”

Gray-market lenders are often established, though technically illegal, financial institutions that lend primarily working-capital loans at rates as high as 10 percent a month. Contacts often modify interest rates based on how well you know them. Forms of repayment enforcement differ. Weng points out that in a community so dependent on guanxi—relationships—defaulting on a contact’s loan could blackball you from future business opportunities. Weng doesn’t clarify how defaulters are treated by underground debt collectors, but he does say they “aren’t the type of people I’d want to get involved with.”

Lending also takes place through a number of formal lending institutions that have become informal depositing institutions. Pawnshops in Wenzhou are very different from those in the West. The shops can give out loans of millions of dollars backed by property and stocks, and they can pay depositors interest rates three to four percentage points higher than the official lending rate at banks. Similarly, credit guarantee institutions, which were originally set up to co-sign on riskier bank loans to small private firms, eventually began lending their own (or depositors’) money. These institutions are essentially legal, however, because they call their depositors “investors.”

As Wenzhounese have become more wealthy, they have found it easier to operate within the formal financial system, although they still frequently subvert state intentions. Every wealthy Wenzhounese I interview, for instance, boasts of owning five to six apartments. Part of the motivation for these purchases is the high return on real estate in China, but the other major reason is that remortgaging real estate is a relatively easy source of capital in both the formal and informal banking systems. 

The Wenzhounese are also well aware that government support is a ticket to greater banking support—and doesn’t come with significant oversight—so they will often raise funds with state-owned enterprises in order to get support for projects that are not always completed in the form originally planned. “It helps being from Wenzhou,” says Weng, because “people just assume that Wenzhounese have the resources to complete the projects they’re pitching.”

By far the most common form of start-up financing is something akin to venture capital: investing in an entrepreneur’s project on the hope he will eventually buy you out with a decent return. This approach also is used to manipulate the banking system. Once you get your business up and running, it is much easier to get loans to buy your investor out.

Although Wenzhounese quibble about degrees of illegality, there is no question that stepping over the line can lead to serious consequences. In April, Wu Ying, a 29-year-old Wenzhou woman, was sentenced to death for illegal fund raising. The case touched a nerve, with numerous articles published supporting Wu in the Chinese media, because none of the public evidence pointed to anything out of the ordinary about her actions—except perhaps the 80 percent returns she was offering investors, and the similar interest rates she charged on loans, which led some to suggest her mistake was lending to someone with political connections. 

 

The State

In Wenzhou local commercial institutions generally have more representative power than the local government. The Chamber of Commerce has been known to independently approach government delegations with potential investment opportunities—or challenges to trade sanctions—without consulting the Chinese state. 

Local officials, by contrast, are notorious for graft, especially through land sales. The party chairman of one Wenzhou district refused to return from France after being indicted in 2008. Internet vigilantes at 703804.com have taken to tracking down individuals who have fled after embezzling funds.

Corruption is particularly commonplace in the prefectural taxation bureau, an agency that has been asserting more control over the local economy. “In the ’90s paying taxes wasn’t that important,” says one Wenzhou entrepreneur, “but these days you can’t avoid it.” Despite having one of the highest corporate tax rates in the world, however, China has a very generous deduction scheme, and if you have friends in the taxation bureau, the same entrepreneur says, “you don’t have to file all the paperwork.”

I see this process up close when I interview the head of an auto parts factory over dinner. Several of his friends are present, the beer and Baijiu rice liquor are flowing freely, and the food is far more than all of us could eat. Halfway through the dinner, three members of the local taxation bureau join us. The factory owner introduces them as friends and proceeds to treat them on his tab. Afterwards he takes the officials to a local karaoke bar to meet prostitutes.

The Wenzhounese have mixed feelings about this situation. As the factory owner’s friend escorts me back to my hotel, he adopts a cynical look and says, “People do business differently here.” But later, when I describe the scene to Weng, he shrugs. “It’s the same all over the world,” he says. “People who have good relationships are more successful in business.”

The local government has helped Wenzhou enormously in one area: protecting the city from more distant levels of government. Even during the Cultural Revolution, authorities were relatively permissive toward private business, and they defended the city against conservative attacks in the 1980s. Many entrepreneurs acknowledge that local leaders’ laxity is deliberate. “Hangzhou has a good government: They ignore you unless you’re making more than RMB 10 million [$1.5 million],” says Weng. “In Wenzhou you can make twice as much, and they’ll still ignore you.”

A sign of how much the city government has internalized the local business culture came last January, when the Wenzhou foreign trade and economic cooperation bureau began a pilot program to allow Wenzhou residents to invest up to $200 million a year abroad. The program was canceled a week later because local officials had forgotten to run the idea by Beijing.

Spreading the Wenzhou Model

The government may not allow Wenzhounese to invest freely abroad, but they do it anyway. Across continental Europe and in much of the emerging world, people from Wenzhou are by far the largest component of the Chinese diaspora. Wenzhounese make up the majority of Chinese restaurant owners from Madrid to Vienna, and in some places they have recreated the Wenzhou experience on European soil.

In no place is this more true than in Prato, Italy, near Florence, where 12,000 of the city’s population of 188,000 are legal Chinese residents, mostly from Wenzhou. The local government estimates that there are 10,000 more illegal Wenzhou residents, while estimates from the right-wing party that runs the city reach 35,000. Forty percent of local businesses are owned by Chinese.

Many of Wenzhou’s business practices have carried over from China, although Italians disagree about how much lawbreaking is going on. According to Prato Mayor Roberto Cenni, between January and May 2010 police carried out 152 inspections on Chinese-owned premises, resulting in 152 penalties. The region also has the highest level of tax evasion in Tuscany, according to Vinicio Bacio of Invitalia, the Italian investment promotion agency, although he argues that the situation is getting under control. “While there is still a large quantity of activities undeclared,” Bacio says, “most of the manufacturing and trade promoted by the Chinese community in the textile area is regularly reported.”

Despite a campaign by Mayor Cenni to crack down on Wenzhou business, Bacio notes that the Chinese presence has revitalized the local textile industry, which had long been in decline. “The relationships [between Wenzhounese and Italian factories] are closer than what it appears externally,” notes Bacio, with contracts, supplies, and investment crossing over between the two communities.

The global reach of Wenzhou entrepreneurs, combined with their liberalized financial system, has made the local community much more attuned to international supply and demand and much more able to transfer capacity to the appropriate regions. Weng’s clothing business is one example. The company employs 60 people, with designers getting paid between RMB 10,000 to RMB 30,000 ($1,500 to $4,500) per month. The latter amount is an almost unheard of salary in China. Weng outsources all of his factory work to about 30 different factories in three neighboring provinces, and those factories often outsource to others that produce even more cheaply. Weng has heard of many Wenzhounese moving production to Southeast Asia, although he says his company isn’t big enough to make the shipping worth it.

Weng and Cai both produce solely for the Chinese market. “There is so much untapped demand here that there’s absolutely no need to export,” says Weng. A reputation for poor quality has made it just as hard to sell Chinese goods for high margins in China as abroad, so the Wenzhounese are making concerted efforts to market themselves and China as a whole. The Wenzhou store for JNBY, a local clothing brand that has successfully expanded globally, features a poster of a white woman proudly holding a sign declaring “Made in China.” Cai sends all his designers on trips to Italy twice a year to study Italian fashions.

Local businesses have also been looking toward emerging markets. The Wenzhounese population of Dubai is significant, which is no surprise given that the city, with its “Dragon Mart” selling a variety of low-cost goods from China, has become a staging point for trade across the Middle East and Africa. Chinese textiles have taken over the South African market, as have Chinese plastic goods in Egypt. Both are mainstays of the Wenzhou economy.

Perhaps more important, the Wenzhounese have become untethered from their city of origin. Wenzhounese businessmen seem to take credit for every private-sector industry in China, from coal mines in northern China to cell phone factories in southern China, and they always seem to have a few friends in the business to back up their claims.

These investments across China are bringing not only Wenzhounese money but the Wenzhounese way of doing business to obscure parts of the country. The future of Wenzhou will now lie in providing services to these less developed areas, argues one button and zipper factory owner. What sort of services? “Finance, karaoke parlors, that sort of thing,” he says. It doesn’t seem to occur to him that all the services he mentions are technically illegal. 

Bradley Gardner is a business writer based in Beijing. Names in this story have been changed to protect the interviewees.