Growing Pains

ZHENGZHOU, China -- The new musical fountain in this drab provincial capital in central China demonstrates why authorities in Beijing are having so much trouble controlling the world's fourth-largest economy.

Jets of water dance to the patriotic anthem "Love My China," while laser beams shoot into the sky. Soon, the fountain will be overshadowed by a hotel styled after a classical Chinese pagoda, which, at 918 feet, will be nearly three-quarters as tall as the Empire State Building. A waterfront arts complex, almost completed at a cost of $100 million, looks like a clutch of enormous duck eggs. Nearby, a newly opened conference center resembles an unfurled umbrella. An exhibition hall boasts the biggest stretch of free-standing roof in Asia.

Mayor Zhao Jiancai says his vision is to transform backward Zhengzhou into the "Chicago of the East" -- a gateway between the booming coast and the vast interior -- by more than tripling the city's size. Total investment in the area around the business district could hit $35 billion. It is a huge amount of money for the capital of Henan province, one of China's poorest. Aiming to turn itself into the 'Chicago of the East,' Zhengzhou, China, is planning a 280-meter-tall hotel that is modeled after the pagodas at the nearby Shaolin monastery, famous for its kung-fu-fighting monks.

"We can only make achievements with scale," says the mayor, a former tractor factory engineer.

A similar dynamic is at work across China. Local governments are encouraging a frenzy of construction to boost their economies -- even as China's central government seeks to throttle back investment that is producing runaway economic growth. The economy expanded 11.3% in the second quarter of this year from the same period a year earlier, far outstripping the government's target of 8% for the whole year.

Many developing countries would gladly trade places with China: Most suffer from too little investment, not too much. And they worry more about spreading slums than expanding skylines.

The International Monetary Fund, which is meeting Tuesday and Wednesday in Singapore, this week urged China to rein in credit to avoid "tipping off a boom-bust cycle." Construction of a nearly completed arts complex is costing around $100 million.

Though inflation remains low at 1.3%, China's top leaders are worried. Almost every day, they issue edicts to slow economic growth -- with little effect. Leaders can't even be sure how much municipalities are spending because local finances have become so murky. According to official figures that many economists believe understate the true total, fixed-asset investment rose 21.5% in August from a year earlier. While that growth rate was slower than the 27.4% of July, total annual investment as a percentage of gross domestic product, the total value of all goods and services produced in a nation, still is much higher than Japan, South Korea or Taiwan managed to sustain even during their giddy years.

If inflation takes hold, as some economists expect, the effects would be felt globally. Since China is the world's third-largest trading nation, inflation could ripple to the U.S. and other countries through rising prices for its exports. That would complicate the efforts of the U.S. Federal Reserve and other major central banks trying to head off rising inflationary pressures.

More than a quarter century of economic overhauls has produced a striking contrast in China: Politically, the Communist central government maintains a tight grip over the entire country; economically, it is losing control.

Caught in a Trap

China's leaders are caught in a trap as they cast around for ways to rein in investment. The old administrative methods -- ordering state banks to stop lending, restricting land sales, halting government approvals for major projects -- aren't working as well as before, partly because local governments are defying Beijing.

On the other hand, market-oriented measures to slow economic growth, such as raising interest rates, aren't likely to be as effective in China as in more sophisticated economies. One reason is that local bankers still are susceptible to political pressure to extend loans. Also, state-run companies make a habit of not repaying loans, so the cost of funds often is irrelevant. Much of the corporate investment is funded out of company savings.

Already, the big state banks have ignored Beijing and dished out almost all the loans they were targeted to extend for the whole year. The Ministry of Land Resources announced recently that in some cities as many as 90% of all government land acquisitions are illegal.

To be sure, an economy expanding at double-digit rates sooner or later will likely find uses for much of the infrastructure -- highways, bridges and power plants -- that local governments are installing. But when the latest investment boom unwinds, there are concerns that Chinese cities will be littered with white elephant industrial projects that will stand empty for years.

"It's mindless," says Wang Lina, a researcher at the Chinese Academy of Social Sciences, a leading think tank, who says local governments are generating large amounts of wasteful investment.

About 10% to 20% of all investment in China is made by local governments, according to World Bank economist Louis Kuijs, who is based in Beijing. That figure understates their influence. For instance, it doesn't include investment by real-estate developers that are nominally private but often act as agents for local authorities.

Under China's former socialist economy, central planners in Beijing doled out investment funds under an annual quota program -- so much for the railroads, for the power industry, for steelmakers. China's central government grabbed local revenue and redistributed the cash around the country to pay for further investment as well as government services.

This started changing in 1978, when Deng Xiaoping launched economic overhauls that made local governments responsible for delivering growth to their own communities. Economic growth has become the path to career glory for city mayors, like Zhengzhou's Mr. Zhao, who now are driving the national economy to an unprecedented extent. Hong Liang, an economist in Hong Kong with Goldman Sachs, compares modern Chinese cities to corporations, and their mayors to chief executive officers, all competing with each other to expand their business empires.

There are good reasons why China's cities need to expand. Each year, they have to accommodate at least 10 million peasants flooding in from the countryside. Increasingly, cities also have been forced to fund their own health, education and social-welfare programs.

These financial pressures all feed into higher rates of investment, which is the quickest way for cities to expand their economies and increase their revenue.

Economic Giants

Cities in China have ballooned into economic giants. If Shanghai were a country, it would be among the 40 largest economies in the world. Its economic output last year of $114 billion was bigger than the Philippines or the Czech Republic. Shenzhen, in southern China, has an economy much larger than Vietnam's.

Still, many question whether local spending has become excessive. Zhengzhou's new conference hall, for instance, boasts a theater with seats that can be individually climate-controlled. Its vast foyer is clad in shimmering Italian marble.

Zhengzhou's drastic makeover is typical of those under way in cities around China. Shanghai led the way in the early 1990s by setting out to build a national financial and commercial hub on a stretch of rice paddy in an area called Pudong.

Over the years, Shanghai's urban plans have become ever more fanciful. It now is building a series of satellite cities -- each themed after a European country -- to relieve pressure on the city center. Anting, which aspires to be a car-making hub, is re-creating the pastel-colored apartment blocks and Bauhaus offices found in the German city of Weimar. It has even splurged on a Formula 1 race track.

Nearby, the emerging college city of Songjiang turned to a British engineering consultancy to construct an English-style community called Thames Town. There, residents can choose to live in Victorian terraced houses, drink in pubs and marry in a church whose spire rises over cobblestone lanes.

A planned 918-foot-tall hotel in Zhengzhon, China modeled after Shaolin monastery pagodas.

China's leaders sought to curb credit by pushing through two interest-rate increases. They have taken funds out of the banking system by raising reserve requirements -- money that commercial banks must deposit with the central bank rather than lend out -- and slapped new taxes on real-estate transactions.

The two interest-rate increases this year have been too incremental -- each only 0.27 percentage point -- to have a real impact, economists say. Lending rates still are only around 6%, low for an economy expanding 14% in nominal terms, not taking into account inflation. By contrast, U.S. rates are at 5.25% -- up from 1% more than two years ago -- in an economy now expanding around 3%.

Compounding the problem is the way local governments are forced to fund their investments. China's central government doesn't allow them to raise local taxes or issue debt. Instead, they are cashing in their most valuable asset -- land. The sale of land now accounts for 40% to 60% of all local government revenue, according to Ms. Wang of the Chinese Academy of Social Sciences.

This dynamic adds momentum to the geographical expansion of cities. To acquire more land that they can sell, cities simply redraw their boundaries to engulf the surrounding farms. The compensation they pay to farmers for the land is far less than its value to developers. When the city flips the land, the revenue isn't part of regular budgets that can be audited by Beijing.

Zhengzhou, an ancient city on the Yellow River plains of central China, has long been an underachiever. Its 1950s-era textile mills are laying off workers. It has shuttered some of its grimy aluminum works on Beijing's orders to cut back on overcapacity. One of its few claims to fame is that it makes a third of all the frozen dumplings sold in China.

With a population of just two million, it considered itself too small to drive the economy of China's most populous province, with roughly 100 million people, let alone make a national impact.

The Zhengdong New District, left, which covers 150 square kilometers, will double the city's size and add 1.5 million people to the existing population of two million. A nearly completed arts complex, above, is costing around $100 million.

So in 2001, city authorities hired the acclaimed Japanese architect Kisho Kurokawa to draw up blueprints for the new urban area after an international competition. Zhengdong New District covers 58 square miles -- somewhat bigger than San Francisco. The plan will double the size of the city and add 1.5 million people to the existing population. It received the blessing of the State Council -- China's cabinet -- in 1995.

By 2020, Mr. Zhao says, additional enlargement will turn Zhengzhou into a city of five million covering 193 square miles.

Most of the investments will be made by companies rather than the government, says Mr. Zhao, 50, who sports red ties and slicks back his hair. Bank loans will pay for some infrastructure as well.

The skyline of the central business district eventually will be populated by 60-odd commercial and residential towers. The first are already in place and waiting for tenants to move in.

Radiating outward will be arrayed the industries and services of Zhengzhou's future: banking and finance, insurance, logistics, high-technology manufacturing and higher education. "It's the most advanced urban concept in the world," says Vice Mayor Wang Qinghai, who is directly responsible for the construction of the Zhengdong New District. Land prices have quadrupled in two years.

Mr. Wang says Beijing has given the go-ahead to projects covering only about 20% of the planned new area. That is holding up plans for a man-made island on a lake to house dozens of luxury apartments.

Elsewhere, there are few signs building momentum is slowing. The city's own glossy publicity materials boast that Zhengzhou has one of the highest densities of construction cranes operating in China.

Does Zhengzhou have a shot at becoming the "Chicago of China"? True, it sits at a railway crossroads between the main north-south and east-west lines, a major asset in a country where most goods still are moved by train. But there is plenty of competition from other central cities, including Wuhan farther south, as well as Nanchang, the fast rising capital of Jiangxi province.

Mayor Zhao says he is untroubled by the competition. "We all have our strengths," he says. "We'll fly together wing-to-wing."