Running the red light
On April 28, Premier Wen Jiabao convened an emergency State Council meeting. Nervous cabinet members heard a furious Mr Wen order 'all levels of government and each department to undertake investigations' and demand that 'lessons be learned' from the case he was presenting.
Given the tenseness of the meeting, one might think the subject was smuggling, another gas explosion or a coal mine collapse. But, surprisingly, it was a rags-to-riches tale of a bricklayer turned steel magnate which incited Mr Wen. The story revealed why China's economy is overheating, despite efforts from the top to control it.
Dai Guofang is an entrepreneur from the Wujin district of Changzhou. During the early 1990s, he collected scrap metal from rubbish dumps, eventually amassing 2 million yuan and setting up Changzhou City Steel and Iron Company in 1996. Later, he purchased second-hand smelters from collapsing steel enterprises, and by 2001 his factory employed 5,000 people. The next year, he had made it on to China's Fortune 500 entrepreneur list and New Wealth magazine's top 400 Chinese tycoons.
China's construction boom fuelled demand for steel, and Mr Dai kept expanding. The Bank of China's Changzhou branch gave him a massive credit line of more than 4.3 billion yuan, and immediately, loans of almost 2.7 billion yuan were taken out. The Agricultural Bank of China and China Construction Bank lent Mr Dai 1 billion yuan and 656 million yuan respectively. Soon, banks were crawling over each other to lend money to his booming business.
Meanwhile, China's gross domestic product growth during the first quarter of this year raced ahead of Mr Wen's target of 7 per cent, hitting 9.7 per cent. This was mostly driven by fixed-asset investments in property, and construction material production. Steel and cement had entered the same phase of 'blind production' which characterised the overgrowth of the 1990s in electronics, televisions, refrigerators and textiles. This time, however, oversupply threatened a collapse of the sector, driven by fresh spates of commercial loans.
The hypergrowth of steel, fuelling factory expansions, soon caught the attention of central government economists already concerned about excess production supply, energy wastage, uncontrolled pollution and the illegal expropriation of farmland. But what concerned policymakers most was the inability of local banks to follow top orders and halt fixed asset lending to sectors like steel. All the banks lending to Mr Dai's expanding steel empire registered their credit as 'working capital', clearly aware that funds were expanding factory assets.
At the emergency meeting, Mr Wen, furious at the 'irrational competition' of banks extending incredible amounts of credit, slapped back the macro-control measures of his predecessor, Zhu Rongji. The State Development Reform Commission, China Banking Regulatory Commission, and People's Bank of China jointly ordered the severance or restriction of credit lines to a long list of industries, including steel, oil and chemicals, textiles and pharmaceuticals to cool growth and rationalise lending practices.
Mr Dai does not know what he did wrong. 'To transform China from a large to a powerful steel-producing country, we must have very large factories to compete,' he reasoned. With large state factories in trouble why could he - as an entrepreneur - not make up the difference, he asked.
Today, China's economists and policymakers speak of 'signal economics', expecting a market response to central policy signals, like rush-hour traffic. The tale of Mr Dai and Changzhou's banks proves that when the light is green, everyone rushes ahead. Yet when it is on red, many still insist on driving through. In the end, Mr Wen still has to close some roads and guide the traffic.
Laurence Brahm is a political economist and lawyer based in Beijing
