[Analytics] China’s Northeastern rust belt was once ‘eldest son’, now struggling as runt of the litter

Liaoning, Jilin and Heilongjiang were birthplace of China’s industrialisation in 1950s, but now contribute just 6.3 per cent to gross domestic product combined. People’s Republic of China founding father Mao Zedong called the region the country’s ‘eldest son’ on whose shoulders the family’s future rests. Elaine Chan specially for the South China Morning Post.

The northeast rust belt, once the pride and birthplace of China’s industrial development, is in its biggest economic slump as it struggles to shake off a deep-rooted planned economic mindset and dwindling resources, and a brain drain to regain competitiveness. This is the first article of a five-part series that examines the issues inhibiting reform and changes to revive growth.

Across the vast 448 sq km Shenyang Economic and Technological Development Zone that is a 40 minutes’ drive from Liaoning’s provincial capital in the northeast of China, a third of the land has been used to build factories and facilities, with the remainder awaiting development and investment capital.

The expanded zone, which absorbed Shenyang’s old industrial base and neighbouring Fuxin city’s Xihe Economic Zone, is a microcosm of the aspirations and equally the struggles of China’s northeastern rust belt and its goal of revitalising growth and regaining its place in the world’s second largest economy.
Comprising three provinces – Liaoning, Jilin and Heilongjiang – the region was the birthplace of China’s industrialisation in the 1950s and the area the founding father of the People’s Republic of China, Mao Zedong, called the country’s “eldest son,” on whose shoulders the family’s future rests, according to Chinese tradition.

The son’s special position, however, has been badly eroded over the past 40 years. Inaction on necessary structural reforms as the nation began to transform itself into a market economy after the start of “reform and opening up” in 1978 left many once mighty state-owned enterprises (SOEs) – like Shenyang Heavy Machinery Group, established when the Northeast was part of the Japanese-controlled Manchukuo puppet state in the northeast of China and Inner Mongolia from 1932 until 1945, Shenyang Aircraft Corporation, the country’s oldest aircraft maker, and Shenyang Machine Tool Group – with little firepower to compete at home or abroad.

The region’s problems are a combination of factors, but the biggest difficulty has been removing a deeply-entrenched state planning mindset that continues to obstruct change, resulting in a poor climate for businesses. That mindset, according to Houze Song, a research fellow at the US-based think tank the Paulson Institute, dates back to the 40-year period of Japanese dominance of the region after the end of the Russo-Japanese War in 1905, giving the northeast several generations more of autocratic planning and a tradition stronger than the rest of the mainland.

And the economic numbers show it. The three provinces’ combined gross domestic product (GDP) contribution to the national economy has fallen by more than half in the past 40 years, from 13 per cent when China opened up in 1978 to 6.3 per cent last year. That is a little more than half of the 10 per cent contribution that southern Guangdong province – the nation’s export manufacturing hub.
The powerlessness to do anything about the change in fortune has not been lost, even on the biggest northeastern companies that are competitive and relevant in the current economic landscape.

“But this isn’t just a northeast issue, it’s a problem with the industry and the era we are in. The northeast’s heyday belonged to the last era,” said Qu Daokui, president of the Shenyang-based Siasun Robot and Automation, China’s largest robotics manufacturer.

Qu drew parallels with how Pittsburg and Detroit in the United States, known for steel production and car manufacturing respectively, devolved into rust belt cities as manufacturing gradually moved production overseas in search of cheaper costs.

“If there wasn’t any Industry 4.0, we’re still at 2.0 or 2.5, maybe the northeast’s industries and economic development could still be in a leading position. But because industrial and economic development have undergone huge changes, and the [focus] is on the new economy sector, the southern region is now ahead of us,” Qu said.

Industry 4.0 refers to the current phase of industrial development focusing on interconnectivity, automation, machine learning and the use of real-time data to produce higher quality goods at lower costs.

Still, the northeast’s decline, as Qu conceded, is not just the inevitable result of China’s development history. Long-standing bureaucratic inefficiency and corruption, coupled with political meddling and protectionist policies have kept investors away. This popularised the saying among the Chinese investment community and the media that “investment does not go beyond the Shanhai Pass”, referring to the traditional geographic divide between the northeastern provinces and the rest of China.

Liang Qidong, vice-president of the Liaoning Academy of Social Sciences, a Chinese government think tank, described the costs of doing business in the northeast as having become an “unbearable weight” for the real economy, amid China’s slowing growth and the ongoing trade war with the US.

“Raising capital is so costly that it brings one to his knees; raising capital is more difficult than climbing to reach the sky,” he said in April when considering how to revitalise the northeast.

Calls for revitalisation of the northeast began as early as the 1990s when then premier Zhu Rongji forced debt-ridden state firms to reform. But the real push came in the 2000s, accompanied by massive amounts of capital as part of the 4 trillion yuan (US$594 billion) of central government stimulus in 2008 to arrest economic slowdown after the outbreak of the Global Financial Crisis.

Growth in Liaoning, the biggest and most populous of the three provinces, jumped in the subsequent two years to 21.3 per cent in 2009 and 20.4 per cent in 2010, before slowing sharply to 11.7 per cent in 2011. The money also helped SOEs write off massive debt, but failed to motivate any real structural reforms to eliminate mismanagement and inefficiency.

The latest calls for revitalisation came in 2016, topped with a visit to the region by President Xi Jinping in October.

The stagnation over the past 10 years has turned the region’s outlook from bad to dire as the pace of the decline hollowed out not just industries, but also talent, combined with shrinking populations across cities in the region, especially those in which natural resources were once abundant.

Rich in commodities like coal and oil, as well as fertile land for agriculture, the northeast has also held the strategic role of distributing resources to the rest of the country in the past 70 years, which cemented its strong collectivism tradition. But overexploitation of resources to feed surging domestic demand in the past 40 years has depleted reserves and taken a toll on development. Because Beijing also caps prices of most resources to ensure economic stability, ignoring global price fluctuations, operators have to bear the costs of such interference.

To extend the life of Daqing, China’s biggest oilfield located in Heilongjiang province, China National Petroleum Corporation (PetroChina) – one of the three state-owned monopoly oil giants – had to turn to state-of-the-art technology that raises exploration and production costs and lowers profit margins, while cutting output.

In the province’s coal-mining city Hegang, scores of operators, including Xingshan District Xingda Coal and Hongli Coal, have been forced to shut down in recent years due to rising inefficiency increases, and as a result of Beijing’s move to cut oversupply and pollution. Hegang’s coal production in 2017 slid 9.3 per cent to 1.14 million tonnes according to government data. The city’s population has also shrunk by 4 per cent between 2010 and 2017 due to its declining core industry.

But overall, the economies of the three provinces are growing, albeit at a subdued level compared to some of the cities which are contracting.

“Growth [in Liaoning] is beginning to stabilise from its decline, but it hasn’t rebounded. We’re still be at the bottom this year but the economy hasn’t reach depression,” said Liu Qi, vice-president of the Liaoning General Chamber of Entrepreneurs.

But removing the “Shanhai Pass” label will not be easy as it means curbing widespread political meddling – which does not improve state firms’ efficiency, but would be a means to sidestep structural problems.

Such was the case with Shenyang Machine Tool Group which reduced its interest in its Shenzhen-listed unit in March after the latter posted six years of negative growth. The sale of a 5.23 per cent stake was made to another government entity, Shenyang Shengjing Asset Management, casting doubts over whether there will be any changes made to improve the group or the listed firm’s management and businesses. As a state-owned firm, the group and Shengjing are controlled by Shenyang government’s state-owned assets supervision and administration commission.

Investors will also recall the nationalisation of Brilliance Auto in 2002 by then Liaoning governor Bo Xilai. Brilliance, currently the joint venture partner of BMW in Shenyang, was China’s biggest maker of minivans in the early 2000s, and its then chief Yang Rong, the third richest man in the country. But Yang incurred the wrath of Bo and the government over a plan to locate a production base in Ningbo in eastern Zhejiang province and Brilliance has not regained its status or the robust business it had before the government takeover.

It does not help that the region’s backbone rests on SOEs and the military industry of manufacturing fighter jets and aircraft carriers, which means the state exercises absolute control over the operations of companies like Shenyang Aircraft Corporation, controlled by the Aviation Industry Corporation of China, China Shipbuilding Industry Corporation’s Dalian Shipbuilding Industry and Harbin Electric Corporation.

The state’s overbearing presence was once again displayed in October when First Auto Works in Jilin province received a staggering 1 trillion yuan (US$149 billion) credit line from 16 Chinese banks even though had Beijing promised to support private firms and open markets further to competition.

Over the years, state support has proven to harm more than help, breeding inefficiency and mismanagement of assets. Dongbei Special Steel in Liaoning had chalked up at least 55 billion yuan (US$8.2 billion) in debt, way more than its total assets when it went into bankruptcy and reorganisation in 2017, according to a report in the Securities Times. The company’s former party chief and chairman, Zhao Mingyuan, was also put under investigation by the Communist Party earlier this year.

Zhao is among a number of Liaoning officials to fall from grace in recent years. A massive vote-buying scandal between 2011 and 2013 claimed six top officials including former provincial Communist Party chief Wang Min and vice-governor Liu Qiang. Liu was also an executive at PetroChina, an arrangement that reflected the murky relationship between politics and SOEs.

The Paulson Institute’s Song estimated that the average debt to equity ratio of Liaoning SOEs is more than 50 per cent higher than it was in the 2000s. The domestic market share of the province’s industrial goods, he said, had also declined since 2000, from chemical pesticides and salt to vehicles, because of local protectionism which destroys competitiveness.

“It’s a vicious cycle,” he said, as the more protective local officials are of state firms, the less motivated the SOEs are to improve.

Song believes one of the more effective ways to tackle the complexity of reforming the region is to use “the power of market competition to counter the over-interference of local governments”.

Entrepreneurs like Liu said officials realised the need to reform has become more pressing and are implementing policies that help businesses and attract new investors, but the gap with the market-oriented southern and coastal regions continues to widen.

In March, at the annual meeting of the National People’s Congress, Premier Li Keqiang pledged the nation’s commitment to improving the overall business environment with the passage of the new foreign investment law that bans forced technology transfer and illegal government interference in foreign business practises to come into effect in 2020.

The European Chamber of Commerce in Shenyang said in a position paper that for the size of the market and its growth potential, European companies have for several decades accepted the uncertain nature of governance in Shenyang. But they are becoming increasingly intolerant of intransparent policymaking and inconsistent enforcement of regulations as other developing countries offer stronger alternatives as investment destinations.

Investors will only be drawn to the northeast if the business climate improves and the government is credible, efficient and resolves companies’ problems, said Siasun president Qu.

The region also needs to figure out how to leverage technology to teach workers new skills and upgrade manufacturing, while bringing in new capital and talent, he said.

Like some American rust-belt cities, China’s northeast has some of the country’s top research and teaching universities, including Dalian University of Technology, Jilin University, China Medical University, Northeastern University and Harbin Institute of Technology, that are assets that would help the transformation. The American city of Pittsburg created a new lease of life by becoming a university-centred technology hub through collaboration with institutions like Carnegie Mellon University and the University of Pittsburg.

As the region’s economic hub, Shenyang is also building a regional technology platform with a 170 sq km Shenyang Hi-tech District. A national e-commerce demonstration base is located in the district, which is also home to Siasun Robot, and China’s largest software outsourcing provider, Neusoft.

It is a base for start-ups such as autonomous flight control system developer Woozoom.net, which picked the northeast over the south where there is more capital and a critical mass of technical knowledge and talent.

“Shenyang is a barometer of the northeastern economy, its development,” said Woozoom.net founder Su Wenbo. “[Shenyang’s] biggest unique trait is that we are still young in the marketisation process (transitioning from planned to market economy), which means the potential is great.”

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