But the additional capital they generated found even fewer investment channels thanks to the real estate bubble, the bearish stock market and the monopoly of State-owned enterprises (SOEs) in many fields.

In other words, the prospects for private enterprises and private investment were getting worse, leading to the debt panic in Wenzhou. There were reasons for that. The accumulated effect of the rise in the costs of land, labor and raw materials, accompanied by a sharp decrease in demand abroad and a big increase in the exchange rate of the yuan made matters worse for Wenzhou's entrepreneurs.

The last straw that broke the camel's back was the government policy on real estate, in which many Wenzhou's entrepreneurs had invested. The policy not only decreased the liquidity in the real estate market, but also hampered their cash flow.

To solve Wenzhou's problems, the government has to take some swift measures to deal with the loan bubble. The government has to put a stop to the illegal loan market, though it is justified in fixing the upper limit for interest on loans at four times the standard rate.

The government can deal with the existing debt disputes through legal procedures, too, and along with big State-owned banks it can offer specific types of help to Wenzhou's companies and their employees.

But in the long run, the government should improve the market environment for private enterprises and private investment. First, it should put the "shadow" banks to scrutiny. This is needed because the cost of monitoring small loans for State-owned banks is high, whereas small local loan companies could do the same job at a much lower cost.

Second, the central bank should make more efforts to control inflation and raise the interest on deposits before inflation is controlled. The government has kept the deposit rate so low that people seek other ways to make their money grow. Since there are few other choices, we can say many people will join the illegal loan market.

Third, the government should improve the playing field for SMEs by defusing the real estate bubble, preventing people from making huge profits unfairly in the short term, improving the income of households and increasing their welfare so that they consume more and save less, limiting the monopoly of SOEs and State-owned banks, and allowing efficient private enterprises to participate in the market, issue bonds or go public.

And last, the government should reduce tax to ease the tax burden on private enterprises, so that they are left with enough money for research and development.

The author is a lecturer at the Management School of the Shanghai University and a research fellow at the China Europe International Business School Lujiazui International Finance Research Center.

(China Daily 11/12/2011 page5)