Not a crisis but surely an alarm

Wenzhou's entrepreneurs are paying for their wrong decisions but government should help them defuse speculation bubble

Wenzhou has been in focus in the Chinese media after some entrepreneurs in the city committed suicide or shut down their factories and fled because they could not pay their debts.

Many of the factories in Wenzhou, Zhejiang province, have a profit margin of about 5 percent and, hence, cannot afford to pay 30 percent (or higher) interest rates on the money they have borrowed from loan sharks. More than 80 entrepreneurs have fled without paying billions of yuan in loan. The amount, however, is just a part of the informal debts in the city, which amounts to hundreds of billions of yuan.

So instead of facing a financial crisis, Wenzhou is caught in a speculation bubble. It is surprising, though, that Wenzhou's entrepreneurs agreed to pay such high interest rates when a new government rule says an interest rate more than four times 6.56 percent is illegal and a debtor can refuse to pay the extra amount.

The most critical time of the bubble has passed. But since small and medium sized enterprises (SMEs) generate 60 percent of the exports and provide 75 percent of the employment in China and many SMEs are concentrated in Wenzhou, it is worth taking a deeper look into the matter.

Wenzhou is famous for being one of the first Chinese cities to produce private enterprises. As a result, its entrepreneurs were among the first in China to get rich. Apart from being reinvested in factories, the extra money they generated needed to find ways to multiply. That's why they began speculating in real estate and other fields across China. They even invested abroad with exemplary results.

The same Wenzhou's entrepreneurs now face serious problems. In fact, private enterprises in almost all Chinese coastal cities are facing difficulties and their problem is likely to continue.

For Wenzhou's private companies, the rise in cost and competition, and the decrease in demand from Europe and the United States are a long-term trend. They have to compete with not only countries such as Indonesia, Vietnam and India, but also China's central and western provinces such as Jiangxi, Henan and Qinghai, and Chongqing municipality.

Since most of Wenzhou's private companies have no famous Chinese brand, high technology, customer loyalty or their own sales channels, they had to choose between moving their factories to places where the cost of production is lower or facing bankruptcy. Unfortunately, many chose to turn to financial speculation.

Also, because private investment has fewer choices, some people chose to indulge in high-risk informal loans.

Wenzhou's entrepreneurs turned to speculation in the early 2000s. They did not have or use much capital in the beginning. But when they found that speculating in housing or or other commodities generated more profit than the manufacturing sector, many of them loaned out more money.