Amazing Shanghai

Located at the mouth of the 3,000km Yangtze, Shanghai has three trump cards: size, location and manpower – masses of it, skilled and unskilled. It also offers modern transport and telecom infrastructure – and the vast Yangtze delta, which offers up land and a market that runs to nearly 500m people. Aside from cheap migrant labor from outlying provinces, the city draws talent from some of China's top universities.

In a bid to hasten catching up, the city government announced plans to double the size of the city's financial services talent pool each year over the next several years: Shanghai could only count 100,000 white collar professionals in 2004. Hong Kong boasts 350,000 finance professionals, New York 770,000.

Itching to move upscale, Shanghai today is pitching for financial services and technology industries. But high property prices discourage some investors, while Shanghai's stock market, bloated with losers, has made banks slower to move than they might otherwise.

A grandiose scheme to return the city's famous riverfront Bund to its previous glory as Asia's Wall Street appears to be in limbo only a year after its launch. Flashy boutiques and restaurants far outnumber banking houses along its neoclassical facades, now restored to their 1930s heyday.

Today, plans to see financial services contribute 18% of GDP by yearend 2005 reveal almost desperate overreaching. They accounted for 10.1% of GDP in 2003, less than 10.2% the year before. Grim performance by Shanghai's A and B share stock markets hasn't helped, through regulators have been making an effort to clean out deadwood companies and brokers – and improve rules on corporate governance and how offerings are structured and priced.

All change in 1993
Shanghai's development pace puttered along in the early days of China's "Open Door" policy – on the back of foreign investment promotion schemes, like the Hongqiao Development Zone, devised in 1982 to blossom near Shanghai's sole airport at the time. But progress was uneven till 1993, when the pace suddenly became turbocharged.

After decades of wringing tax revenue from the city, the central government began to pour money back into Shanghai. By 2000, the city had an elevated expressway system, a subway and a second airport. Soaring office towers and commercial complexes sprouted everywhere. Across the Huangpu River, wharves and old brick compounds eddying into farmland gave way to the Pudong New Area, a special economic zone aimed at drawing financial services and industrial investors – with the best incentive packages the Mainland had on offer, it was said.

The big banks moved in on cue, as did major industrial players like Philips, Bayer, Hitachi and other semiconductor companies, and others. But higher prices came with the new age and industrial investors: many, hardly just arrived, have already begun to migrate to cheaper satellite cities up the Yangtze – although many multinationals still maintain their admin and finance operations in Shanghai.

Irish food giant Kerry is an example. Ten years in Shanghai, the company in January completed its new US$20m plant in Hangzhou, two hours' drive southwest of Shanghai. "Shanghai has the services and all the transport links," a Kerry executive explains. "But it's a lot costlier for manufacturing. We'll do sales from the city but manufacturing and product development will be consolidated in Hangzhou."

Soaring property prices have made life difficult for some foreigners. Punting by local speculators with few investment choices is to blame, says Sam Crispin, managing director of Crispin property consultants in Shanghai. "Pricing is generally not supported by the returns and risks. It is a capital gain play rather than a long-term yield play," he asserts. "Local investors, who are bigger risk takers, will keep investing while foreign investors will tend to wonder how to make sense of the market." Locals have few choices but to play the game, he says. "Most cannot invest in London or Vancouver."

Foreign industry may run shy, but not necessarily foreigners operating on their own. Big Shanghai property developers, like Hong Kong's Shui On Group, report more and more of them buying into the city's residential market.

Shanghai certainly has more money around. Shanghai's GDP grew 13.6% year-on-year in 2004, to RMB745.027bn, according to the National Bureau of Statistics. Shanghai contracted about US$10.72bn in foreign direct investment – about a sixth of China's inward FDI – from January to November 2004, up 9.18% on the year earlier. The Shanghai Municipal Foreign Economic Relations and Trade Commission (SMERT) says of those commitments, US$5.8bn had already been realized by end-November, a 14.2% jump on the previous year's fulfillment pace.

Foreigners do well
Although performance varies wildly sector to sector, foreign businesses as a group have done spectacularly relative to Shanghai's economic growth. Foreign-funded companies posted RMB934.1bn sales and RMB61.63bn profits over the January-November period, up 31.3% and 56.5% year-on-year. Service sector investment, US$4.2bn, accounted for 39.2% of Shanghai's inward FDI.

Government data on annual per capita disposable income certainly helps explain the property picture. It nearly doubled between 1995 and 2004, rising from US$800 to US$1,500.

Beijing is bent on making Shanghai the Mainland's center of shipping and finance. On the industrial side, the city's promoters are targeting overseas capital to keep building up several key industries: microelectronics, automotive, optical electronics, chemicals, fine steel, shipbuilding and equipment manufacturing.

Shanghai has organized it so each snaps into industry-specific zones neat as Lego blocks: microelectronics in the east, automobiles in the west, petrochemicals in the south and steel in the north. Shipbuilding centers on Changxing Island just offshore.

Snuggled in Pudong's Waigaoqiao free trade zone, foreign-invested companies have long been doing distribution and reselling, activities prohibited for foreigners in other cities till recently. With last year's deregulation of distribution, Pudong has changed its pitch. Manufacturers in favored enterprises now get, besides low-tax benefits, extra landuse privileges – and preferential utility rates normally set aside for state enterprises.

Tax incentives
Standard corporate tax starts with a 6% revenue tax automatically levied against companies on the assumption everyone is avoiding profits and the standard 33% tax that goes with them. Foreigners currently pay less in tax, although the government is committed to putting everyone on the same tax regime. According to SMERT, the tax incentives go like this: Manufacturing FIEs in Shanghai start off with a two-year corporate income tax exemption and a three-year 50% reduction on tax after their first profit-making year. Technology firms get a 50% tax break for six years after their first profit-making year on top of the start-up two-year tax holiday. Software houses do even better with exemptions and tax breaks, with extras like tax breaks on R&D spending for new products.

Foreign-invested banks and JV banks are entitled to a reduced income tax rate at 15%, with an exemption for one year and 50% tax reduction for another two years. R&D investments aren't taxed and can be exempted from customs duty – and VAT on technology imports. At the lower end of the industrial tech spectrum, Shanghai has built up a portfolio of integrated circuit board makers. Revenue in the segment topped RMB14bn in 2003 and was set to top RMB20bn last year, according to Jiang Shoulei, secretary-general of Shanghai's Integrated Circuit Industry Association (SICA). "Manufacturers are moving to Shanghai and the Yangtze delta because they need to service important clients here," he says, citing mobile phone makers Nokia and Motorola, both big local buyers.

While manufacturing investment is pouring in, one academic questions the city's parallel drive to turn Shanghai into a service-based economy. "There is no need for Shanghai to hurriedly adjust its industrial structure to focus on the service industry," says Hua Min, an economics professor at Fudan University. Hua argues Shanghai should keep moving up the industrial food chain – and focus on snaring more multinational R&D.

Rebuilding SOEs
Going that route also argues for getting a move on with restructuring state-owned enterprises (SOEs). According to the city's Guidelines of Merger and Acquisition of State-owned Enterprises by Foreign Capital, released in August, Shanghai will be stepping up efforts to get foreign capital to invest in state firms. Nestled among healthy state-owned giants, like Baosteel, Shanghai Petrochemical and Shanghai Automotive Industry Corp (SAIC), are some of Shanghai's serious underperformers: stripped to their essentials, some argue, many could be brought back to life. "Shanghai needs more private capital and better corporate governance [to achieve this]," Hua says.

The 2010 World Expo is one big reason for Shanghai's increasing interest in services. Speaking at a symposium in January, Shanghai Deputy Mayor Tang Dengjie described the 2010 event as a "tremendous opportunity? to facilitate the co-development of Shanghai with the Yangtze River Delta." Key to soaking up more Yangtze trade is Shanghai's port, which just last year bested Rotterdam as the world's busiest seaport by tonnage throughput. Total cargo passing through the port hit 380m tons by year-end 2004. Shanghai is the world's third-biggest port in annual container throughput, behind Hong Kong and Singapore, according to an official at Shanghai International Port Group, the city-owned port operator. (Figures vary, but Shanghai claims it moved 14.6m 20-foot equivalent units (teu) in 2004, compared to Hong Kong's 20m teu and Singapore's 19m teu.) Most of the container traffic originates in Yangtze cities upriver – national policy backing development of Shanghai as the country's leading international port calls for integrating delta cities into its cargo feeders.

Delta cities are drawing closer to Shanghai in other ways: new rail lines to Tongzhou and Zhapu will ferry passengers into three new railway hubs in the city – all set for completion before 2010. One of them, the massive new Southern Railway Station, will be ready by 2006. Besides new transit lines being planned for the city, the central government has ordained that several high-speed lines be ready by 2010, linking Shanghai to Beijing, Nanjing and Hangzhou.

There is more airport capacity coming, too: Shanghai Pudong Airport's second waiting hall will go into service in 2007 – to handle an additional 40m passengers a year by 2010. Investors deciding whether or not to plunge into China often do their thinking with Hong Kong in the background – and its much admired "rule of law". "Comparing Shanghai's legal environment to that of Hong Kong may be like comparing an onion to a pearl," says Neal A Stender, a Coudert Brothers lawyer who has practiced in both cities. But it is steadily improving, he says. And compared to any other Chinese city, Shanghai offers "a more confident and internationally oriented business culture".

"The development plans for Shanghai can scarcely be more ambitious: bridges, tunnels, flyovers?," Lynn Pan wrote in her introduction to An Illustrated Guide to Shanghai in 1987. "Shanghai has huge potential, but much foreign investment – and a change of attitude – will be necessary if Shanghai is to make a comeback as China's trendsetter."

Attitudes have changed, of course, and investment did come – and Shanghai still pushes the envelope of ambition.