A Vicious Circle

The political and economic mix that fostered China's economic miracle in the last three decades was ideally suited to catapult a poor, underdeveloped nation forward. But it isn't suited to developing an increasingly affluent and industrialized country.

A fundamental flaw of the current model is that the bureaucrats manipulate the flow of money and set key prices -- like interest rates and the currency's external value -- and pump cheap money into the economy as they see fit. This keeps state-owned companies alive that should have gone bankrupt long ago. Private households, compelled to exercise caution in a country with a poor and rudimentary healthcare and pension system, are hording money instead of boosting domestic consumption.

Last year, the party had no choice but to intermittently cool down the boom that had been created artificially with government funds for infrastructure projects, especially in the real estate market. Real estate prices had risen to dizzying heights.

It's a vicious circle, because a significant portion of the Chinese economy depends on the construction boom. In 2011, concrete makers and steel mills saw a sharp drop in demand. At the same time, expiring tax incentives reduced the Chinese desire to buy new cars. Cheap domestic brands like BYD ("Build Your Dreams") were especially hard-hit by the slump. BYD's consolidated profits declined by more than 90 percent in the first two quarters of 2012, compared to the same period last year, and even executives were selling their company stock.

Structural Problems

Prime Minister Wen Jiabao has recognized that there are structural problems in China's economy, which lead to "unstable, unbalanced, uncoordinated and ultimately unsustainable development."

But when he boldly linked thoughts of restructuring the economy with political liberalization two years ago, the state media didn't publish his remarks, and Wen didn't even object. He will not stand for office again at the upcoming 18th party congress in Beijing, which will mark a change in China's leadership and possibly even set a new political course for the country.

When it comes to foreign operations, the party's policy is to encourage activity that can best be described as "swarming out." China is also active in the entertainment industry. The Dalian Wanda Group, a Chinese conglomerate, acquired AMC Entertainment, an American chain of movie theaters, for $2.6 billion in May 2012. And American sports fans no longer have to worry about whether the Chinese should be allowed to invade their sanctum, because it's already happened. In late July, the computer company Lenovo, which had already acquired IBM's PC division in the past, became the technology sponsor of the National Football League. A state-owned company in Beijing has also acquired Italian luxury yacht maker Ferretti.

Mickey Mouse is already part Chinese, while Donald Duck is becoming a Peking duck. Both Disney and director Steven Spielberg's animation factory DreamWorks felt compelled to seek partners in Shanghai so as not to miss out on the important market in the Far East.

Emulating Germany and Buying a Little of It Too

On their long march to the top of the global high-tech industry, China's capitalistic communists have their sights set on one goal in particular: Germany. While a few backward-looking party strategists warn against too much influence from countries in the West, domestic pioneers like economist Li Daokui openly encourage their fellow Chinese to emulate the "outstanding German model." Li becomes very enthusiastic when he thinks about Berlin. Despite the global financial crisis and the troubles facing the euro, he feels that all key indicators are positive for Germany.

China has the world's largest foreign-currency reserves, a $3-trillion treasure chest, from which it's currently scooping money to buy up companies all across Germany. For the Chinese, the weak euro is turning a buying spree into a bargain hunt, with acquisitions of German companies in recent years growing from 84 in 2009, when the People's Republic first unseated Germany as the world's top exporting nation, to 158 in 2011.

The Chinese are primarily interested in acquiring the latest technical knowhow. A handful of German auto parts suppliers have fallen into Chinese hands in the last few months. In late August, it was announced that a subsidiary of the Chinese construction equipment maker Shandong Heavy Industry had acquired Kion, a forklift manufacturer based in the western German city of Wiesbaden. And after lengthy debates, the Düsseldorf-based operator of mobile wireless network provider E-Plus hired the Beijing company ZTE to expand its network. According to industry insiders, ZTE undersold the bids of Western top dogs Ericsson and Nokia Siemens Networks by almost half.

But probably the most strategically important investment of the year for the Chinese was their January acquisition of a traditional German industrial company, the world market leader in its industry. When Chinese construction equipment giant Sany acquired Putzmeister, a maker of concrete pumps based in Aichtal near Stuttgart, it was the first time Chinese buyers had managed to absorb one of the "hidden champions " of the large group of German small and midsized companies known collectively as the Mittelstand. All in all, the Chinese paid about half a billion euros for one of the pearls of German industry.

Sany Chairman Liang Wengen, 56, orchestrated the deal. One of the most successful Chinese pioneers operating in Germany, his net worth of $8.1 billion makes him one of the five richest men in China. Liang is a completely different type of person than the colorful entrepreneur-poet Huang. Levelheaded, goal-oriented and always very close to the reins of power, Liang is a self-made man. A former bamboo basket weaver in his native Hunan Province, he worked his way up through a weapons factory and later developed his own, small factory for welding equipment. He joined the party early on, and in addition to receiving an award for being a "model private entrepreneur," he was named an "Architect of Socialism with Chinese Character."

Liang is the kind of business leader with whom politicians feel comfortable, and who they like to have at their side. For instance, he was allowed to accompany Xi Jinping, the current vice president and designated new party leader and future president of China, to the United States. At the upcoming party congress, Liang is expected to be the first private businessman to be appointed to the party's Central Committee, the illustrious circle of China's most powerful men and women.

'German Industry Has No Choice But to Join Forces with Chinese'

Sany, which employs almost 70,000 workers, is headquartered in Changsha, famous as the city where Mao Zedong studied for six years. The former Chinese leader was also born near Changsha. Dozens of souvenir shops sell small images of Mao, and an oversized statue of the Great Chairman stands in downtown Changsha, his outstretched right hand seemingly setting the country's direction.

But little remains of Mao's egalitarian ideas. The new person he once set out to create is no longer in demand, but rather the person who can frequently afford to buy something new.

The modern building where Sany President Xiang Wenbo has his office is called Dangwei Lou, or Party Committee Building, because Xiang is also a Communist Party leader. But the office is furnished at least as luxuriously as the executive suite of a major German company, with heavy, dark mahogany furniture and modern art on the walls. The floor-to-ceiling window offers a view of a park landscaped with bamboo and a decorative pond. There are four Maybach limousines in the parking lot.

Xiang is bursting with self-confidence, but also with patriotic zeal. He was behind a nationalist Internet campaign that successfully derailed a plan by the Carlyle Group, a US private equity firm, to acquire a majority stake in his Chinese competitor, the Xugong Group. "We can sell everything, just not our country," Xiang blogged polemically at the time.

Why, then, should Germany "sell itself" to China, and why is the Putzmeister deal any different?

Xiang chuckles to himself, and answers the question in a roundabout way. "I am convinced that German industry has no choice but to join forces with major Chinese companies like Sany," says the Sany president. He explains that while Germany has the superior technologies, China controls an enormous market. German companies, he says, need that market to expand and generate profits.

German Success in China Comes with a Price

It's true that China became a lifeline for many German businesses, especially during the years of the worldwide recession, 2008 and 2009. Thanks to a massive government economic stimulus program, China remained liquid, allowing chemical manufacturers like BASF and, most of all, German automakers VW, BMW and Daimler to actually grow their earnings. Volkswagen already sells more cars in China than at home.

But this success has its price. Beijing expects foreign companies to produce locally, bring along their knowhow and form joint ventures with domestic partners. Almost all the companies listed on Germany's DAX blue-chip stock index are active in China. The Germans' high-tech expertise is often "fed" into Chinese companies, which have copied the patents so that trains, cars and machine tools and the original products are often as identical as two peas in a pod. Recently, the Chinese company FAW reportedly recreated an entire VW transmission in Changchun in northern China. This practice can turn partners into dangerous competitors, and it also creates bad blood.

China's dumping activities are an equally serious problem for Western companies. The government subsidizes individual, future-oriented industries with so much cash and loans that they are able to displace their competitors in the world market by charging rock-bottom prices. The solar-panel industry is a case in point. Ten years ago, the United States produced 27 percent of solar panels worldwide, while the Chinese made only 1 percent. Today the American share of the global market is only 3 percent, while the Chinese make about 65 percent of solar panels. The Chinese manufacturers are embroiled in ruinous competition, and the party is likely to allow only three or four major companies to remain on the market. When Washington imposed punitive tariffs, Beijing set off a minor trade war by retaliating with measures of its own against US goods in other industries.

Merkel Avoids Making Public Criticism

The cheap Chinese solar panels also did serious damage to German solar companies , costing thousands of jobs. But during a visit to Beijing in late August -- the second this year, with almost half the cabinet at her side -- Chancellor Angela Merkel avoided any sharp criticism  of her hosts, at least publicly, addressing neither human rights issues nor economic problems.

Merkel suggested that the solar dispute ought to be resolved through negotiations, and the large delegation of German business leaders traveling with the chancellor also proved to be tame and timid. Outgoing Premier Wen Jiabao told members of the delegation that they could write to him if they had any problems, as if he were an advice columnist. A few days later, it became clear just how isolated the chancellor is with her soft-line approach, when the European Union refused to be palmed off with vague offers to negotiate and launched an anti-dumping probe into Chinese solar manufacturers.

Sebastian Bersick, professor of international relations at Fudan University in Shanghai, says: "It wouldn't be smart for Germany to expand its bilateral relations with China to such an extent that its success ends up alienating other EU member states." The government in Berlin, says Bersick, should rethink its "sino-centered approach" and diversify its interests. Are China and Germany entering into a partnership that's "too close for some," as the New York Times writes ?

German Firms Expand in China

In fact, German companies are expanding in China more than ever -- and this with Beijing's blessing. Chemical producer Lanxess has just broken ground on a new €235-million synthetic rubber plant in Changzhou, near Shanghai. But not all DAX-listed companies are entirely pleased with their Chinese operations. The new BASF numbers are reportedly disappointing, and the mood is somber at the company, where everyone is hoping that a new leadership in Beijing will bring greater transparency.

The liberals' greatest hope is Wang Yang, 57. The party chief for Guangdong Province is China's most interesting politician at the moment. He advocates increasingly opening up China's economy to private enterprise, and to do so he wants to "open the cages and replace the birds." He has included the typically American pursuit of happiness in the five-year plan  for his province, and he has strayed from convention by mediating in citizens' protests in ways that favor the demonstrators. He is also willing to grant more freedoms to entrepreneurs. When asked whether this development could end the monopoly of the Communist Party one day, Wang, whose nickname is "Little Marshall," says nothing.

Even a reformer like Wang knows that anyone who sticks his neck out too far can jeopardize his own prospects of advancement. Wang differs markedly from Bo Xilai, the former party leader in the southwestern city of Chongqing, who had called for more government control and a revival of Marxism. At the party convention in November, Wang stands a chance of being elected to the Politburo Standing Committee, the group of the country's top nine leaders that will shape China's future. But Wang, who, ironically enough, was Bo's predecessor in Chongqing, could also fall victim to Bo's friends in the Communist Party, who want to deny his rival the chance to rise to the top out of revenge.

'Accessories of Power and Corruption'

In China, with its lack of legal certainty, it's possible to plunge precipitously. In both politics and business, there is a thin line between success and failure, and between a successful corporate leader who enjoys the party's support, like Sany Chairman Liang, and someone whose connections aren't quite as good, and who once took one step away from the correct path, someone like Wu Ying.

She was considered China's Wonder Woman, a woman who succeeded at everything she did. A farmer's daughter and former hairdresser with strong entrepreneurial instincts, she built a chain of beauty salons. In 2005, with assets of more than $500 million, she was already among the wealthiest people in China -- and had not even celebrated her 26th birthday yet. But her career ended suddenly, after she had illegally borrowed money from private individuals in return for the promise of high returns, and was unable to pay back a large portion of the funds.

She was sentenced to death for financial fraud in December 2009, but the severity of the punishment was even criticized in the official press. In May 2012, the courts reduced her sentence to death with a two-year reprieve, the same sentence that was recently handed down to Bo Xilai's wife, although she was convicted of a capital crime for the murder of a British businessman. In the Chinese justice system, that two-year reprieve means the sentence will likely be commuted to a life term.

At least the excitement over young entrepreneur Wu prompted leaders in Beijing to violate an ideological taboo. They announced that private shadow banks were to be legalized. The new rule was to initially apply only to Wenzhou, the port city that the great reformer, former Communist Party Chairman Deng Xiaoping, also used for especially bold experiments. Premier Wen even seemed to want to take things a step further, by proposing that the state-owned banks' de-facto monopoly be lifted. Some already envisioned the dawn of a new era.

But now the enthusiasm has given way to a more sober assessment, even in Wenzhou. "Where is the real relief for smaller private companies like ours?" asks Zhou Dewen, chairman of the local small-business association. Lending has proven to be tenuous, says Zhou, while there is still considerable resistance to fundamental reforms in Beijing. And, once again, the prime minister has been exposed as little more than a figurehead and feel-good politician.

Many Chinese Embittered

A grimly smiling old man is sitting between stacks of American and Chinese business publications and books (15 of which he authored) in Beijing, in an apartment in the district were senior party officials live. Mao Yushi, 83, is a business guru hated by many and deified by some.

He doesn't mince words. He describes Mao Zedong as a "totalitarian" ruler, and calls the Marxist theories that are still taught at Chinese universities "hopelessly outdated." China's progress is solely dependent on other countries, Mao Yushi says coolly. "That's where all technological innovations and progressive ideas come from." In his view, China urgently needs to become politically liberalized, and the Communist Party should compete with other parties. "We have no human rights guarantees, no democratic institutions and no economic planning certainty. That's why many of our most talented entrepreneurs emigrate, even though China is still a fabulous place to make money."

Mao Yushi has low expectations for the upcoming party congress. The party elite, fearful of losing its privileges, will not take the necessary step of strengthening the private sector, he says. "Things would be different if Deng were still alive. He was open to new ideas, and he was a flexible man for whom solutions to problems were paramount, not an ideology." In May, Mao Yushi was awarded the Milton Friedman Prize for Advancing Liberty in Washington. He is a man who no longer needs to make allowances for anything or anyone.

He is worried about the gradual aging of and growing income disparity in Chinese society, and the social tensions that could arise as a result. Based on the so-called Gini coefficient, which measures the inequality of wealth distribution in a country, the differences between rich and poor are even more dramatic in China than in India. In China, more than one in four people lives on less than $2 a day. At the other end of the spectrum, the country will be the world's largest market for luxury goods by 2015.

Provocative Displays of Wealth

Many Chinese are embittered over blatant corruption, in a country where the relatives of politicians are usually the ones who become multi-millionaires, often without any discernible effort.

When the members of the Beijing Sports Car Club, founded in 2009, meet once a week in their own, exclusive lounge near the city's football stadium, they like to show off their toys, the Lamborghinis and Ferraris parked on a well-guarded parking lot. Zhang Kuan, 32, the chairman of the club, is eager to show off his dark-gray McLaren MP4-12C, a car worth hundreds of thousands of dollars, which he picked up in person at the Tianjin customs port in May. The club's 700 members also travel on luxury trips together, to places like Las Vegas and London. It's an insular group, and when they race at night, it's usually against each other. During the day, members are often spotted in the company of fashion models.

Cigar smoker Zhang bought his first car, a VW Santana, in 1999. Things went uphill very quickly for him after that, and he made a fortune with "investments, real estate and insurance," as he put it, somewhat vaguely, in an interview with Time in June. In addition to his Lotus, Zhang, who also has good political connections, owns several sports cars, including a fire-red Ferrari. He also collects luxury watches. "My father's generation isn't as keen on the things that interest me," says Zhang. "For him, luxury means the entire family getting together. But for people my age, it's always the latest toy that counts. That's how we express ourselves and live our dreams."

Ferrari Becomes a Red Rag for the Party

The provocative display of wealth troubled almost no one until recently, and certainly few government officials. But the word "Ferrari" recently became a red rag for many politicians, and it's even blocked on the Chinese Internet. Things aren't going well for the Communist Party and with preparations for its party congress. After the murder and corruption affair of former Chongqing party chief Bo Xilai and his wife , a new scandal surrounding an Italian sports car, its driver and an accident he had threatens to cast a shadow on the carefully planned political show.

Early one morning, seven months ago, a man driving a Ferrari in Beijing lost control over the car, possibly while engaged in sexual activity. The driver, who was allegedly naked, was killed immediately, while his female companions reportedly survived, but were seriously injured. The police covered up the circumstances of the accident. But soon the Internet was filled with rumors that the driver could have been the son of a prominent individual.

In early September, it was apparently no longer possible to conceal the details, or someone deliberately leaked them to the public. The dead driver of the Ferrari, Ling Gu, 23, was the son of a top official and a graduate of Peking University. His father is the long-standing secretary of party leader and President Hu Jintao. After the incident, he lost his influential job as head of the main office of the Central Committee and was demoted to an insignificant position. He was replaced by Li Zhanshu, a close associate of the new "emperor" designate. Was the scandal misused as a tool in the power struggle in Beijing?

For Dali Yang, a professor of political science at the University of Chicago, one thing is clear: "Chinese politicians are extremely concerned about the fact that the party is being so closely associated with expensive cars and watches, these accessories of power and corruption. They want to do everything in their power to prevent public anger from turning towards them."