China's Anxiety About Successful Companies

A mine in Shanxi province, the heart of China’s coal industry. Reuters-Landov

China's high-profile battle with foreign companies makes it seem as though those businesses keep the nation's economic planners awake at night. It has arrested a Rio Tinto executive on trumped-up charges, blocked Facebook and YouTube, and restricted (in practice if not in name) foreign firms from key industries such as oil, media, and metals.

Yet the story of China's battle with private coal miners, mostly in the central province of Shanxi, suggests that the country faces a far greater challenge dealing with its own unruly business sector than perceived threats from abroad. Easy profits and lax regulation spawned a coal industry infamous for greater pollution, more corrupt bosses, and more dangerous working conditions than practically anywhere else in the country. In response, the government has spent the last three years cutting the total number of Chinese coal mines to about 1,000 in 2010 from 2,600 a year earlier, according to Reuters. Local government authorities used declining coal demand during the economic crisis to buy up or bankrupt smaller, mostly private mines (state-owned mines are often much larger). Private coal-mine owners, used to bribing local officials in order to operate with impunity, have been finding that the tide is turning. New regulations make it difficult for private mines to renew their licenses or open new mines, and their owners face restrictions on the size of their mines and the equipment they use.

While the government has claimed it's putting forth better companies at the expense of weaker ones, the root cause remains that an ever-insecure China wants to rein in independent sources of influence (and wealth) that it feels have become too independent to control. This trend, known in Chinese as "the country advances and the private retreats," allows the government to increase its control over the economy by funneling resources and growth potential into more pliable state companies. Aviation, oil refining, and steel, among others, have been hit as well. In one of the biggest cases, a provincial government in 2008 bought a billionaire steel magnate's plant for a fraction of the cost, a move widely interpreted to mean he'd gotten too big.

Tied up with this is China's desire to enrich the public sector at the expense of the private. "It's not a simple issue of economics," said Xia Yeliang, an economics professor at Peking University. "It's concerned with ideological goals." The government is building what the government calls "national champion" state-owned enterprises—market leaders like Sinopec and CCTV—that it hopes can compete successfully abroad with firms like BP and CNN. But today's fragmented coal industry makes that difficult: China's top company produces only some 10 percent of its coal; in the United States, the biggest company controls 17 percent of the market, and the top four companies control fully 40 percent. Safety and environmental issues also play a role: private mines have less oversight and thus can be less eager to comply with regulations or Beijing's coal strategy.

Meanwhile, the massive wealth and corruption of newly created tycoons have spawned a trope in Chinese media: the coal-mining boss. Known for their excesses—in cars and apartments (often purchased in cash), their crude mannerisms, and their penchant for bribery—they symbolize the vulgar side of wealth in modern China: a nouveau riche that many Chinese simultaneously loathe and envy.

Because of a desire in the last decade to grow the private sector, local government officials in Shanxi used favorable investment policies (such as tax breaks) to encourage the private development of coal mines. Entrepreneurs, especially from the coastal province of Zhejiang, flooded into the Shanxi mining sector. Those with seed capital and strong networking skills prospered, sometimes earning returns of a 1,000 percent within a few years. With wealth came power, as they entrenched themselves and used their money to ensure that officials wouldn't be too curious about the unsavory aspects of their dealings, such as unsafe working conditions. One coal owner told Fortune last year that 20 percent of his operating costs went to corruption (like paying off inspection teams and local officials), and that illegal mine owners paid a higher premium. According to someone present in local discussions about accountability—who requested anonymity—officials debated how many workers had to die before they reported it to their superiors in the provincial hierarchy. The number was originally three, but officials from coal-mining towns complained that at that level, "we'd be reporting, like, every day," so it was eventually raised to 10 deaths. The local government press office declined to comment.

Yet Shanxi's days of bounty came to end as it got hit with a succession of mining and natural catastrophes. Between 2005 and 2008, Shanxi had four different governors, who kept getting replaced when coal-related disasters—such as a December 2007 gas blast in an unsafe mine—killed hundreds of people. These highlighted the lack of enforcement, especially of labor laws, in the province: in 2007 kidnapped youths from across China caused a major uproar when they were found working as slaves in clay pits there, in what became known as the black-kiln incident. Shanxi lost its spot as the top coal producer to Inner Mongolia in 2009, partially because of mergers. In the first half of that year, it was the only place in China where the economy shrank.

Under Shanxi's current governor, Wang Jun, the consolidation of coal companies accelerated as thousands of private mines were folded into state-owned mines, which have a reputation for being safer but also much easier to control. Wang said at a provincial delegation meeting that "reconstruction of and upgrading [of coal mines] is the main task this year." Wang had worked for the government in the mining industry for almost 30 years, but in his most recent posting he ran the State Administration of Work Safety. After a rescue team saved 110 miners trapped underground in a Shanxi government mine this past April—in what state media deemed "a miracle"—reporters weren't allowed to speak with the miners. Some family members even claimed that the government underreported the death toll to glorify the rescue efforts—the kind of media manipulation more easily undertaken when it involves a public mine.

Yet the problem with taming the industry by putting it under government control is that the government is part of the problem. In April, China sentenced an official at a provincial coal bureau to 20 years in prison for embezzling enough money to spend more than $24 million purchasing 35 apartments in Beijing. And in March, the vice governor of Shanxi province, who happens to be the well-connected son of a former premier, held a work-safety meeting in the provincial capital for which eight government bureau heads who deal with mining simply refused to show. The incredible snub seems to show that officials believe that their mining connections insulate them from a need to follow their provincial marching orders. In nationalizing these mines, the Chinese government won't be able to grow the economy and reduce corruption, disobedience, and scandal. But, hey, it's a great way to keep wealth in the family.