Wenzhou's 'Annus Horribilis' Shakes China

Model of Entrepreneurial Zeal Unravels in City of Shoemakers, Nouveaux Riches; Indebted Factory Bosses Flee

By JAMES T. AREDDY

WENZHOU, China—The mystique of Wenzhou—the birthplace of China's private sector, where entrepreneurs have splurged on Bentleys and helicopters—is cracking.

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This seaside city spearheaded Chinese manufacturing, building export industries around cigarette lighters, buttons and shoes, and transforming itself into a seedbed of investment capital. Its nouveaux riches captivated the rest of China with their special brand of unapologetic consumption, whether they were buying Shanghai apartments, Shanxi coal mines or French wine.

Now, the trust-based financing networks that took the place of banks in Wenzhou and fueled its binge are collapsing in the face of slowing exports, a trend made worse by Europe's economic woes. Property prices are down. Captains of local industry have fled from debts, sometimes escaping loan sharks by taking their own lives, local authorities say.

Wenzhou Wobbles

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Two stone lions in front of a shoe factory in Wenzhou are a symbol of wealth and power and are believed to have protective powers.

The Wenzhou Model

See key events in Wenzhou history, and the city's influence on China's business culture.

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Add to that strikes, heavy-handed policing, food scares and grisly score settling—for an "annus horribilis" in the Zhejiang province city of 9.1 million. Images of a bullet-train carriage dangling from a Wenzhou viaduct after a July railway collision seemed to illustrate the city's bad luck.

Its stumbling local economy has much of China fretting whether trouble for Wenzhou's famously nimble manufacturers heralds broader danger.

"In Wenzhou, you see the temperature of China," says Geng Xiao, director of research at Fung Global Institute, a Hong Kong think tank. "This is the capital city of China's private enterprises."

Anxiety is mounting that Wenzhou's troubles are a bad omen beyond the hills that ring it. Ruthless price competition from factories in places like Wenzhou helped China become the No. 1 merchandise-exporting nation. But this year's disorderly unraveling of Wenzhou's financial-industrial model marks an inauspicious finale to China's first decade as a member of the World Trade Organization.

After Wenzhou granted the country's first private business license in 1980— to a woman whose store was a tabletop— it built factories that churned out cheap stuff that could be shipped easily. Wenzhou is defined by one-industry clusters that make only buttons or zippers. And unlike Dongguan in Guangdong, Kunshan in Jiangsu and other Chinese industrial boomtowns, Wenzhou never depended on foreign investment—or support from China's banks.

The city's tight-knit diasporas trade throughout China. Two million Wenzhounese are estimated to live abroad, with footholds in Italy's fashion industry and the Africa trade through Dubai.

The worry now centers on how Wenzhou wealth capitalized a nonbank financing system where relationships matter more than collateral. Traditionally a system for channeling friends-and-family money, the shadow financial system has ballooned. IHS Global Insight analysts estimate Wenzhounese control capital of 800 billion yuan (about $157 billion), or 2% of China's 2010 gross domestic product.

"It's a process of building a pyramid on top of these entrepreneurs," says Graeme Johanson, a Monash University professor in Melbourne.

From an oversize chair trimmed in snakeskin, Huang Weijian repeatedly cites "panic" to describe how in recent months his fellow Wenzhou moneylenders decided cash was safest in their own pockets. Past global downturns never seemed to weigh heavily on China, explained Mr. Huang, president of Wenzhou Financial Harbor Development Co., for instance when cash briefly got tight in 2008 before authorities released waves of credit to sidestep global recession. "This year it was like a fire in your backyard," he said.

During last month's National Day celebrations, Premier Wen Jiabao spent two days with central-bank Gov. Zhou Xiaochuan touring factories around Wenzhou and pledging support for smaller businesses. The ominous subtext: Mr. Wen marks most holidays with mercy missions to disaster zones.

City of Commerce

Wenzhou's long legacy of trade has started to show cracks

• 1876: The Qing Dynasty is forced to open Wenzhou to foreign trade.
• 1978: Business in Wenzhou is already under way when Beijing signals first economic reforms.
• 1979: A cluster of button-making begins in Wenzhou
• 1980: A Wenzhou woman gets China's first small-business license for her store—a tabletop.
• 1991: Wenzhou is named one of 14 special economic zones in China; local authorities propose a stock exchange.
• 1991: Local entrepreneurs found China's first private airline.
• 2001: Wenzhounese pour money into Shanghai property, helping spark a national frenzy of real estate investment.
• January 2011: Wenzhou authorities propose individuals can invest up to $200 million abroad each year, but the measure is squashed by Beijing which fears it signals capital-flight risks.
• February 2011:A Wenzhou business group says 70% of its smallest members are having cash-flow problems
• July 2011: A bullet-train crash in Wenzhou kills at least 40.
• September 2011:An eyewear tycoon is the highest-profile boss to appear to flee debts.
• October 2011: Premier Wen visits Wenzhou factories pledging support.

—WSJ Research

Wenzhou's Financial Services Office, in a statement sent in response to questions, confirmed the city had faced instances of foolish investment, usurious lending rates, worrisome bad debt, absconded entrepreneurs and some suicides. Still, the note concluded, "generally speaking the operation of Wenzhou small- and medium-size enterprises remains quite positive this year."

Financial strain is serious at Chinese factories, says Merle A. Hinrichs, chairman of Hong Kong trade-services firm Global Sources, and Wenzhou's high-risk business strategies make it particularly vulnerable in an economic downturn.

Numerous Wenzhou factories appear recently abandoned, including Jiadian Shoes Co., where witnesses said police clashed last month with unpaid workers after the indebted owner fled.

A factory owner surnamed Wang says Wenzhou's niche is cheap products, like his newest $4 item: a Steve Jobs lighter-combination-USB drive. Citing news about the collapsed empire of an eyewear tycoon who got indebted expanding into solar power, Mr. Wang scoffs, "What does he know about high-tech?"

The moneylender, Mr. Huang, assures financing remains available in Wenzhou, as he leads a reporter through crowded offices designed like a Chinese tea house where he says borrowers from as far as Korea seek cash.

He takes a moment to sign a contract granting $1.25 million to a local businessman to let him pay off one bank loan before a new one kicks in. It is a two-day bridge loan offered for a fee that is the equivalent of an annualized interest rate of 36.5%.