May 07,2008

Shanghai's Financial Center Ambition at a Crossroad

By Ma Wenluo

Storied Shanghai, the focal point of China’s industrial and commercial might, appears to have lost its way. So much of what is now happening in Shanghai is running away from its earlier goals. Its dreams have been to grow into a center of international finance, a money and services nexus to rival the other great financial hubs, a London or New York of the East.

  It’s not happening. Financial firms who rushed into Shanghai 10 years ago are now escaping from the city, and industrial and commercial enterprises are moving out with them.  Shanghai is not about to turn into a ghost metropolis, but change has to come if it is to regain its lost momentum., a Nasdaq listed firm with an over 50% total share in China’s online travel service market, will move its call center to a new site it is now building in Nantong across the Yangtze River to the north. Four years ago, multi-national mega-corporation Unilever, owner of many of the world's top consumer product brands in foods, beverages, cleaning agents, and personal care products, moved its production base 600 km away, to Hefei in Anhui Province. Intel built factories in Pudong, a special economic zone across the Huangpu River from Shanghai’s old town, 11 years ago but recently decided to construct a new high-tech chip factory up in Dalian, in China’s northeast. Other big companies not intending to expand production capacity in Shanghai include Siemens and Motorola.

To comfort itself, Shanghai will explain that labor-intensive is not on its list of favorite industries, and the headquarters of Unilever and other multinationals are still in Shanghai. But since 2007 securities companies have also begun to move away, from Pudong’s Lujiazui Finance and Trade Zone. Orient, a big securities dealer, has already moved its headquarter to the old city zone, and another big dealer, Everbright, is also moving out of Pudong District. Some small and medium-sized securities companies have removed to Shenzhen in south China, a reversal of the trend from 2000 when many securities companies, commercial banks, insurance companies and fund companies moved their headquarters from Shenzhen or other cities to Shanghai, or established credit card, clearing or database centers there.

Shanghai’s commercial costs are going through the roof and are forcing these enterprises and financial institutes out of the urban area and even to other cities. Due to soaring property prices, even by 2005 rent for high grade office space in Pudong was approaching that of Manhattan. Within three years, the rent for Shanghai’s office space ballooned by 100%, and has entered the world’s top 50. Though this price is still lower than in Singapore, Tokyo or Hong Kong, "considering tax and maintenance costs, the total price is 50% higher than that in Paris and London," said Jean Marc Levet, chairman of International Real Estate Federation. Rates for Shanghai’s five star hotels are almost as expensive as in Hong Kong and Singapore. And with RMB rising against the USD, many property owners now require rent and management fees to be paid in RMB, adding exchange risks and costs for companies that used to settle in dollars. To save money, some firms ask staff to share an office on a shift basis, and allow some staff to work at home. Others reduce costs by requiring several staff to share one desk.

The attraction of improved traffic in Shanghai’s neighboring areas has also accelerated the withdrawal, especially of manufacturers. The Sutong Yangtze River Bridge, connecting Suzhou and Nantong, has shortened the drive from Shanghai to Nantong to one hour. "The bridge was a main reason for choosing Nantong," said a public relations manager of The Hangzhou Bay Cross-Sea Bridge connecting Shanghai and Hangzhou opened to traffic on May 1, shortening the distance from Shanghai to Ningbo by over 120km. That and labor costs there 60% lower than in Shanghai drew Shanshan Group, a big apparel maker, to move back to Ningbo.

China’s tax policy and Shanghai’s industrial policy are also playing major roles in the desertion. Shanghai’s labor costs are China’s highest. Firms must pay 400 yuan of various employee insurance costs for every 1000 yuan in wages. And China’s new income tax law has unified income tax rates for domestic and overseas enterprises. The law now recognizes "high-tech enterprises" with a favorable tax rate of 15%. Pudong, as a "special economic zone," has used its special tax rates of 15% to lure potential tenants, but with the new unified tax rates Pudong is no longer special. Shanghai’s neighbors, on the other hand, are attracting enterprises with income tax rebates. Since the profit margins of "made in China" are already lower than loan interest, manufacturers are fleeing high cost regions for areas where they can stretch a bit.

Shanghai used to attract financial institutes by offering cheap land. PingAn, for instance, China’s biggest insurance company, and China Merchants Bank were each granted two pieces of land. The profit they made selling one piece of land covered the costs of constructing office space on the other. But Shanghai no longer has land to gift, so the China Foreign Exchange System, an important part of the financial market, had to move to the suburbs, much to the annoyance of its staff.

In addition, it seems Beijing policy makers will no longer favor Shanghai. With the support of the central government, Tianjin, an industrial and commercial neighbor of Beijing, aims to become the financial center of northern China. And the Growth Enterprise Market, China’s Nasdaq, will be launched in Shenzhen, another attraction for securities companies to move back to Guangdong in the south.

According to Shanghai’s plan, the financial industry should account for 20% of Shanghai’s GDP, but the actual number has hovered around 10% because the headquarters of most of China’s major financial companies remain in Beijing, and Chinese banks are unable now to conduct cross-regional loan business. To offset this weakness, Shanghai’s government has encouraged development of the real estate industry, hoping to make up the deficit through real estate taxes and rising land prices, but the result has been massive real estate speculation and concomitant sky-high land prices. Rising rents eliminate some of the "less desirable" labor-intensive manufacturers but also add to the sourcing costs of multinational companies and big enterprises, as Shanghai, in its rush to attract domestic and overseas corporate headquarters, has given little thought to the infrastructure of smaller firms needed to support the big guys. Wang Liang, Director of the Shanghai Current Economics Research Institute under the Shanghai Academy of Social Sciences, complains, "Pudong has paid too much attention to big companies and ignored the supporting of small and medium-sized enterprises. With the sharp increase in rent costs and the lack of smaller enterprises, big companies will face severe troubles."

"Why couldn’t Shanghai keep Ma Yun?" asks Yu Zhengsheng, secretary of Shanghai’s Municipal Party Committee. Ma, the founder of China’s greatly successful B2B site, Alibaba, which not long ago swallowed Yahoo China, years ago moved the firm’s HQ from Hangzhou to Shanghai. But later he moved it back again to Hangzhou.

Yu’s plaint reveals a key concern for Shanghai’s industrial development. Since 2005 the output value of Shanghai’s service sector has exceeded 50% of Shanghai’s GDP. But during the past three years it has grown by only one percentage point, while in China’s other global cities this number can be over 70%. Its high costs, withdrawal of manufacturing and diminishing presence of financial and service firms are putting Shanghai at a crossroad.

Shanghai’s municipal government is summoning brains to formulate a new policy for industrial development, especially its service sector. Shanghai must stop the hemorrhaging and somehow reclaim the magic that first made it a magnet for all those enterprises that have left. The alternative is to stand as an example of how a city can waste enormous gifts and mismanage itself into insignificance.


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