Business and Finance

Skirting the law in China's private enterprise reform

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Wu Xiaobo is a financial author and publisher who has written extensively about the development of China's private enterprise over the past few decades. He writes a column in The Economic Observer, and contributes to the blog Mind Meters, which is the source of the following essay.

"Reform Begins with Transgression" is the fourth in a series of "Notes on Chinese Business History"; in the essay, Wu examines the legal grey area in which Chinese businesses were forced to operate following the market reforms of the 70s and 80s.

Wu's classic text Great Failures (大败局), a book of fascinating case studies written about the downfall of high-flying Chinese brands, expands on the story of Mou Qizhong, the clock dealer in the essay below. Mou later became president of the Land Economic Group; he received a life sentence for fraud when the company imploded in the late 90s. Wang Shi, the shipping middle-man, is chairman of the board of Shenzhen Vanke, one of the most successful mainland shipping and real-estate conglomerates.

Reform Begins With Transgression

by Wu Xiaobo

1

From the day he was demoted, Lei Yu was a "hero" of reform, often mentioned in the same breath as the upright Ming dynasty official Hai Rui, who died in exile in Hainan. The Hainan Island car trafficking incident erupted in June 1984, and during the course of a year, that region imported and illegally brought to the mainland 89,000 cars. Because of expectations of enormous profit, the entire island went crazy. Even kindergartens made up sales documents. Of 94 administrative work units, 88 were swept up in the car craze. The commerce department actively processed "penalty discharges" for purchasers across the country; with a fine of just four or five thousand RMB and an official stamp, the imported cars could be loaded onto ships and grandly sent on their way. In this way, graft, bribery, illegal currency exchange, and all sorts of illegal activity took place out in the open.

The facts later proved that Lei Yu, who at the time served as administrative head of Hainan, was not ignorant of the obvious illegality of the large-scale car importation, so when the central government opened up an investigation into the matter, he had repeatedly obscured the facts in his reports. Twice he reported to the central government that "all of the cars imported into Hainan were sold on the island." In reality, a thousand cars a day flowed out of Hainan. Apart from cars, 2.86 million televisions and 252,000 video recorders were also imported. During the course of one year, Hainan acquired US$570 million in foreign currency at illegally high prices from 21 provinces and cities as well as 15 central government units. Altogether, companies racked up 4.21 billion RMB in loans, more than 1 billion RMB more than the value of Hainan's industry and agriculture in 1984.

The wave of auto trafficking was brought to a halt in summer 1985, when Lei Yu was busted down to vice party secretary of Huaxian, Guangdong. Objectively, this affair served as a prelude for the sealed and backward Hainan to open up, and it gave the trading-shy Hainan people a dose of real monetary education. The "Hainan fever" beginning at the end of the 1980s was closely related to this affair. In 1996, a financial reporter named Zhu Jianguo carried out interviews for four months in Hainan. He found that "no matter where I went to interview, as soon as I brought up reasons for Hainan's massive changes today, everyone started off by saying that it is all thanks to Lei Yu."

As for his moral character, Lei Yu is one of those rare competent, upright officials. He never pandered, he dared to speak bluntly to his superiors, he acted decisively, he thought clearly — his talents as an authoritative voice had the acclaim of the multitudes. During the three years he served in Hainan, he replied to more than 5000 letters written to him by the public. Though his secretary opened the envelopes, he personally opened and read each letter, and wrote a personal reply. It was discovered during the investigations in the aftermath of the "auto affair" that Lei Yu had not resold a single car himself during the craze, and he had not accepted a single penny in bribes. It is for precisely this reason that more than a decade later he still is respected and loved by the people as a folk hero, a chivalrous, honest official.

However, from an institutional perspective, the affair in Hainan set an extremely unfortunate precedent. It pushed China's economic reforms along a gradual slide to a wanton disregard for the system, and the law was similarly turned into a dead letter. Actions in the name of reform could engage in creative destruction of the system, and were given a tacit permission and tolerance. In a large number of cases, people's disregard for and betrayal of the institution even became a kind of ethical nobility, which resulted in a gradual greying of social absolutes and the casual crossing of the social and ethical bottom line.

Public opinion's verdict on Lei Yu dramatically embodies the conceptual clash and systemic paradoxes of China's reform process.

2

In 1983, two people who would later become quite famous were engaged in the same sort of business. One ended up in prison, and one got rich.

The one in prison was Mou Qizhong, of Wanxian, Sichuan. At the beginning of the year, he discovered that a certain 555-brand desk clock made by a factory in Shanghai sold well in the marketplace. Every young couple getting married would get one. He quickly found an army factory in Chongqing that was half-idle, and asked them to make 10,000 duplicates of the 555-brand desk clock at 25 yuan apiece. He then went to Shanghai and sold the copied clocks for 32 yuan apiece to a trading company. This exchange earned him a neat 70,000 yuan. In September, the commerce department of Wanxian detained Mou Qizhong on charges of speculation and profiteering, and he was held for a full year in a dank, dirty prison cell.

The wealthy one was Wang Shi of Shenzhen. One day he was walking idly on a street in Shekou when he saw two tin-clad metal cisterns standing on the north side of the road. They were rice storage units belonging to the Thai Chia Tai Group that had just brought in a feed plant. The rice was grown in the US, Thailand, and northeast China, and passed through Hong Kong before returning to Shenzhen. Wang Shi impetuously crossed over and asked a person on duty, "Why don't you bring in rice from the northeast directly instead of going through Hong Kong?" The reply: "China's transport has quotas. We're a foreign company, and we don't know where to go to get rail cars." Wang Shi had a relative who was an official with the railway, so he became a middleman for the rice business. Within a year, he had earned 3 million RMB.

There's a prophetic black humor here. In many instances, Chinese businessmen don't know if their actions are in accordance with national law or not. A few years back, there was a good deal of spirited discussion about the "original sin theory" of private enterprise in China, but no conclusion was reached in the end. The largest — and most ambiguous — point of contention was whether the "original sin" born by private entrepreneurs was their own initiative or a passive selection.

During the several decades of reform and opening up, the establishment of national law seems to have always lagged behind the pace of change. At many times, there is even the sense that it is intentionally delayed and obscure. One particular example explains this problem quite well: beginning in 1978, whether private enterprises were able to employ more than eight people was a sensitive question, and by 1983, the central government's position was still the "three no's principle": "Do not encourage, do not openly promote, and do not be quick to ban." After two more years, in again came under discussion, and Deng Xiaoping's opinion was "examine it some more." It was only in 1987, after another two years' examination, that the Document #5 of the Central Committee finally removed the staff size limitation. The "three no's principle" became a sixteen-character guideline: "Permit existence, increase management, encourage benefit and curb harm, lead by degrees." But at that time, private enterprises employing large labor forces could be found everywhere, and there was no longer any debate about the matter whatsoever.

From this past example we can see that during the reform and opening up period, the effective strategy of policy makers toward sensitive issues was: feel the way forward, don't debate, don't make any clear demarcations of government policy, and let the way facts eventually transpire decide the direction in which to go. During those years, there was never any clear definition for matters like whether engineers could sell their patent rights to private individuals, or whether private companies could enter resource-related industries. This was a direct source of enterprises' unpredictable fates; what yesterday was a model of reform, might tomorrow be targeted in a sweep of illegal activity. In 1998, the State Council proposed using three years to revitalize state-owned enterprises, but it never brought up any applicable legal text for the details of administration — large numbers of small- and medium-sized enterprises completed the clarification of their property rights using methods of questionable legality. But when in 2001 this reform was suddenly halted, large, slower-acting companies were left in limbo. Businessmen falling from grace in the scandals that occurred afterward were tied in a large part to this affair.

Reformist thinking permeated with this sort of utilitarianism had two direct results: First, China became a massive economics laboratory and adventure park; every sort of passion and ambition was given free rein, and the fuel spurting up from the lowest rungs of society finally ignited a raging fire throughout the land. Second, active resistance and rebellion against the system and institution became common behavior amongst reformers.

3

"Reform always begins with transgression"

This sentence was uttered by Chen Dingmo, a grass-roots official in Wenzhou who created China's first "farmers' city." In the mid-80s, holding a blueprint in the tidal flats, he founded the Longgang Farmers' City. According to national policy at the time, "state-owned land may not be turned over to private commercial use," but Chen Dingmo boldly flouted this law, and through land sales collected financing to build the city. One Autumn day in 1992, I went to Longgang for an interview, and he took me for a drink at a shop on the bustling streets. Slightly tipsy, he shouted this sentence.

That sentence had me completely surprised, and because of this, from then on it became my private private perspective from which to observe China's problems.

I discovered that through twenty-odd years, Chinese companies always gave the impression of rushing about in a fog, and this was due for the most part to holes in the legal framework, as well as the reformers' resulting disregard for and breaking of the laws in force. This nexus of conditions fully displays the utilitarian aspects of China's reform. Enterprises growing up in this atmosphere will always exhibit an instinctive uneasiness; they will easily produce short-term actions, but will lack the proper sense of responsibility and long-term planning they ought to have for industry and market shortcomings. And in an increasing globalized economic environment, the unsuitability of these recurring problems will demonstrate more and more frequently.

I also discovered that for a relatively long time, Chinese society has made extremely varied legal judgments on the economic activities of officials and businessmen — involving a range of degrees — and it ultimately comes down to whether an individual can be said to have "accepted bribes" or not. It's obvious that whether an official's policy or a businessman's activities are illegal may not necessarily be related to whether he has accepted bribes.

Everything exists for a reason. In looking for a way out of a rigid planned system, there is a practical necessity to utilitarianism; "running around the red lights," or "choosing to break the law" are perhaps the most efficient and unavoidable strategies. However, one real question remains: must this thinking continue to be appropriate and conventional? Now, and in the future, will it become an reason or a pretense for a few profit-oriented conglomerates to snatch at the fruits of China's reform?

Reform or development are no excuse for breaking the law — I cannot say with certainty whether this has become the mainstream mentality of China's business sector. But I hope that it has.

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There are currently 2 Comments for Skirting the law in China's private enterprise reform.

Comments on Skirting the law in China's private enterprise reform

Joel, you're awesome! Nice post.

Thanks, Gunslinger, but I can't take any credit for it. Wu's business history is fascinating, and someplace a bit more finance-oriented than Danwei should really translate more of it.

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