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Construction of new buildings in Hangzhou

Standing outside the freshly built "MixC" mall, retail executive Janet Qian points skyward to one of more than a dozen condominium towers sprouting in a sparsely populated section of this thriving metropolis on China's eastern coast.

"Some people will have views of the river and others will wake up each morning and see Louis Vuitton," she says, nodding toward the French fashion house's latest, and as yet unopened, retail location in China. The LV store serves as a velvet tent peg holding down a rear corner of the high-end shopping centre, which boasts a two-storey Imax cinema and an Olympic-sized ice skating rink.

In China, the boom that has spawned the well-known mega-cities of Shanghai, Beijing, Guangzhou and Shenzhen is on the move. As the world's second-largest economy enters its next phase of growth, the nation's so-called second-tier cities are expected to do the bulk of the heavy lifting.

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Dubbed the "Long Tail" of the Chinese dragon, these mushrooming metropolises pack astounding heft. While a new skyscraper seems to bloom in Shanghai every other month, scores of other towers are popping up just as fast in places most Westerners never consider. Including Hong Kong and Taiwan, there are already 60 Chinese cities with populations greater than one million. By 2025, according to consulting firm McKinsey & Co., there will be more than 220 cities with more than a million people each.

In North America, investors worry about the possibility that Chinese growth might slow, bringing with it lower demand for commodities and other goods, but boom towns like Shijiazhuang, Baotou and Zibo provide evidence that a vast reservoir of opportunity remains to be tapped. These second- and third-tier cities will drive demand for raw materials from commodity-rich countries like Canada as China's expanding municipalities erect new buildings and build more bridges and railways.

Global retailers are already rushing to capitalize on the new affluence on display in China's emerging urban centres. It was, after all, the consumption habits of residents in scores of second- and third-tier cities with names like Kunming and Chongqing that pushed China to become the world's largest auto market this year.

With growing prosperity, though, comes anxieties about the corrosive effect of disparities in wealth. The runaway real estate markets that have elicited so much hand-wringing from Chinese government officials are not confined to Shanghai and Beijing. Potential real estate price bubbles are also forming in much smaller, lesser-known locales.

Take Hangzhou. With 6.7 million people, the Hangzhou district is already larger than Boston, Madrid, Sydney or Toronto. Its population outnumbers Alberta, Saskatchewan and Manitoba - combined.

"I can't afford an apartment," laments taxi driver Wu Liang Liang, who says the cheapest flat in Hangzhou now costs at least 200,000 Chinese yuan ($31,000). "If I go back to my hometown, I could create a valley with that much money."

Rife with social challenges and economic opportunity, second-tier cities like Hangzhou will define China's future. But for foreign companies looking to break into the Chinese market, these lesser-known urban centres already stand out as some of the country's most attractive markets.

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' More purchasing power'

When Intel broke ground on its first major manufacturing plant in China in 2007, it was in Dalian, a second-tier city in Liaoning province. The microchip behemoth's decision to locate there is just one indicator of how investment patterns are shifting in China.

For three decades, four mega-cities - Beijing, Shanghai, Guangzhou and Shenzhen - spearheaded the country's remarkable economic progress and attracted the bulk of foreign dollars. In the first half of this year, these first-tier cities continued to perform, expanding their local economies by an annualized average of 12 per cent.

Their double-digit growth, though, seems tame in comparison to the breakneck pace of activity in provincial capitals such as Changchun, Hefei and Yinchuan. Gross domestic product growth in these second-tier cities averaged 18.5 per cent during the same period. Rich in resources and with a more stable labour force than China's mega-cities, smaller municipalities like these have been the major beneficiaries of China's $585-billion (U.S.) stimulus package, designed to spur infrastructure building and economic development.

In Hangzhou, stimulus projects have widened many of the city's largest streets and are helping build a metro system, with two lines slated to be completed by next year. The new infrastructure is expected to stimulate economic activity and consumer demand.

Major retailers and manufacturers are taking notice and many are shaping their growth strategies around these smaller but fast-growing urban areas.

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Ms. Qian is a merchandising manager for Central Department Store Ltd., a retail conglomerate from Thailand that is using China's second-tier cities as the launch pad for its expansion into the massive Chinese market. The company just opened its first department store in China, the anchor tenant for the MixC mall in Hangzhou. Central is now planning on building more stores in cities like the steel-producing hub of Wuhan, and in Shenyang, an aerospace manufacturing centre. It hopes to add between 30 and 40 locations over the next decade in China's second- and third-tier cities.

"There is more money to be made in the second-tier market," Ms. Qian explains. "The second-tier cities have more purchasing power. The terms are all better as well, such as leasing costs and manpower."

The Chinese expansion plans of some of the world's biggest retail names and service industries are also focused on second- and third-tier cities. Last month, Asia's largest luxury hotel group, Shangri-La Hotel, unveiled a strategy to open 10 hotels over the next two years, mainly in second-tier cities such as Yangzhou, Chongqing, Lhasa and Changzhou. Shangri-La is focusing on these locations because of their "great potential," Zhu Kent, the company's head of sales and marketing, told a Chinese publication.

Nike Inc. and adidas AG are also targeting smaller cities for their next phase of retail locations in China. "We are planning to introduce low-priced products in the second-tier, third-tier and even fourth-tier cities in China to appeal to more Chinese consumers," Charlie Denson, Nike Brand's president, said on a recent conference call.

Swedish furniture giant IKEA already has eight stores in China and is planning to build four more over the next two years. It says a store in the second-tier city of Chengdu posted revenue growth of 135 per cent last year, the best sales increase among the company's 300 stores around the world.

"That indicates the huge potential in China's tier-two cities and provides us confidence to go further to tier-three cities," Gillian Drakeford, IKEA China's retail president, told China's People's Daily.

And it's not just middle-market brands that are turning to China's smaller cities. In addition to its new location in Hangzhou, luxury goods maker Louis Vuitton has opened stores this year in the second-tier cities of Xian, Xiamen and Tianjin.

Ms. Qian of Central Department Stores says the appeal of China's second-tier cities like Hangzhou is obvious. Buoyed by the area's rich factories and resources, Hangzhou boasts the eighth-highest per capita GDP in China, and the sixth-highest retail sales and disposable income levels. "We expect these second-tier cities to keep growing," she says.

Real estate speculation

The continued growth of second-tier cities is vital to China's future, according to economists. The major coastal cities of Shanghai, Shenzhen and Guangzhou now boast productivity levels that could soon rival the world's highest. Productivity in those cities is unlikely to keep increasing at the same rapid pace as it has done in the past. For China to continue growing, the baton must be passed to cities in the interior, where productivity is much lower.

China's government has embarked on a program to encourage development in the country's still rural western region. It has also vowed to relax its hukou registration system of residency permits, allowing workers from more backward regions to migrate to productive areas and still receive medical care and other social services.

The hope is that such efforts will not only boost productivity, but also spread prosperity more widely through the country. "The success of programs that intend to reverse China's rising income inequality is critical if China is to sustain its rapid growth of GDP and living standards," writes Gary Jefferson, a professor of economics at Brandeis University in Boston.

Purchasing power is already migrating beyond the coastal regions. Coal-rich Inner Mongolia, for example, posted the strongest per capita retail sales growth in 2008 among Chinese provinces. Retail sales increased 23.9 per cent, topping Beijing's 23.1 per cent rise.

Real estate speculators are also shifting their attention to second-tier cities. In downtown Shanghai, Song Hui Yong sighs wearily as he lays out the impact of the government's policy initiatives to cool the real estate market in China's mega-cities and the surprise effect they've had on smaller centres.

The director of property developer and reseller Centaline China says sales of second-hand apartments in Shanghai have plunged by 70 per cent since the government introduced policies that boosted down payment levels and imposed a sales tax on properties sold within two years of purchase. Prices are starting to fall too, dropping from an average of 26,000 yuan per square metre to 19,000 yuan.

Mr. Song figures there are 6.5 million square metres of new apartment space sitting empty in Shanghai right now, as owners hope to wait out the slump. Another 138,000 second-hand apartment units are unoccupied, he says.

So where have all the buyers from Shanghai's real estate market gone? Mr. Song believes that some of the speculative money has shifted to second-tier cities such as Xian and Wuhan where local enforcement of the government policies has been more lax.

"I am very worried about the enforcement of the policies in second-tier cities," he says. "There is certainly a strong possibility that the speculators have gone to the second-tier cities."

Xuzhou, a dusty mining and steel city that sits halfway between Beijing and Shanghai, is just one of China's unlikely boomtowns. The city's new prosperity surprises even the locals.

A cab driver who gave only his surname Li pointed out the greening and beautification projects designed to transform Xuzhou's image as a dirty industry town. In the centre of the city, which is home to about two million urban residents, he drives past the man-made lake built to rival Hangzhou's more famous (and natural) West Lake.

Mr. Li says the value of his apartment in Xuzhou increased to 8,000 yuan per square metre from 5,000 after the city built new bridges, roads and new businesses moved here. "This is the best city in China," he beams.

Many residents of China's smaller cities are feeling the same way as they watch their local economies bloom. Even as the mega-cities and their property markets slow down, China's second-, third- and fourth-tier cities are picking up the slack, contends Celia Wang, an analyst with research firm Shanghai Metals Market.

China's rush to urbanization is far from over, she says. And she has a bit of advice for observers concerned about the country's growth prospects. "You don't need to worry so much," Ms. Wang says. "Chinese economic development is on an upward spiral that will last for 20 or 30 years."

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A CITY CALCULUS

60

Number of Chinese cities with a population of more than a million

220

Number of Chinese cities with a population of more than a million by 2020

379 million

Increase in the size of China's urban population over the past 20 years

633 million

China's urban population today

1 billion

China's urban population by 2030

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About the Author
Asia-Pacific Reporter

An award-winning journalist, Andy Hoffman is the Asia-Pacific Reporter for Canada's national newspaper, The Globe and Mail. More

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