The waves from the subprime disaster have reached China, where the bottom has dropped out of the packing-case industry. Americans, in particular, no longer want cheap goods made by migrant peasant women in the southern Chinese sweatshops. What is also plain is the folly of Beijing’s deliberate destruction of the once-prosperous rural economy. Peasant uprisings, the nightmare that has kept Chinese rulers awake since the second century BC, are already causing panic in Beijing, where the official press reports hundreds of rural demonstrations against corrupt, land-grabbing officials.

Now the riots have spread to the cities. About 67,000 factories have shut down across the country. As the owners do midnight flits, sometimes to Taiwan, thousands of rioting wageless workers have been beaten up by the police outside the closed factory gates. In Dongguan, a city of perhaps 10 million in the southern Pearl River delta, 3,000 toy manufacturers, half the total, have shut down, as have 2,000 shoe factories. South China’s railway stations are usually jammed before the Chinese New Year as city workers return to their villages, but now hundreds of thousands are leaving early for the rural homes they so eagerly fled during the past decade.

Why the toy factories in particular? Chinese toys have been found to be coated with deadly lead paint, leaving Mattel, the US toy giant, facing lawsuits and possible ruin. A similar scandal struck contaminated pet food and toothpaste. More recently and worse, Chinese powdered milk was found to be tainted with melamine, a plastic that makes the liquid thicker. This has poisoned 290,000 Chinese children, according to official admissions, and killed six. Nestlé is only one of the foreign companies that has used this milk powder in Asia.

President Hu Jintao recently warned the politburo about the economic crisis. His words, carried in the party’s People’s Daily, could not have been starker, especially in an organ which tends to blur bad news: “In this coming period, we will starkly confront the effects of the sustained deepening of the international financial crisis and pressure as global economic growth clearly slows.” He noted that the crisis would “steadily weaken our country’s traditional competitive advantage.”

The terrified government has just poured $586 billion into what is vaguely called the infrastructure. Leaders know that as millions of peasants return to villages left behind since 1990 because of the communist party’s concentration on urban development, the regime’s newest slogan, “Build a Harmonious Society”, may be losing whatever lustre it may have had. From almost 12 per cent per year, the figure that dazzled experts into predicting that this would be the Chinese century, this year’s economic growth has sunk to 9 per cent. The World Bank estimates it will fall to 7.5 next year. “If economic growth fell below 8 per cent there would be social tension, complaints and job losses,” warned Chen Xingdong, chief economist at BNP Paribas in Beijing. Arthur Kroeber, managing director of Dragonomics, a Beijing-based economic research and advisory firm, predicted: “Next year we might see export growth in the country as a whole go down to 0 per cent.”

But those fleeing to their rural families will find scant relief. In

addition to the 15-year decline in rural prosperity, all over China corrupt officials have seized the small plots that the peasants were told in 1979-1980 they could farm on their own. According to the Ministry of Land and Resources, from 1999 to 2002 alone 300,000 acres were illegally confiscated from 1.5 million farmers. Rapacious local officials seized these holdings and sold them to entrepreneurs who will turn them into privately-run big farms or into factories.

As the villages fell on hard times, the children of newly-poor farmers, usually their daughters, headed for the Pearl River delta and cities like Dongguan. Factory life was exploitative and dangerous, but once the girls became used to the Chinese equivalent of the bright lights, they were alienated from the families to which they sent portions of their wages but visited only briefly each year.

The rural crisis need not have happened. Indeed, it is the result of the intentional undermining of the real Chinese economic miracle – the rural prosperity of the 1980s. This is the revelation of Huang Yasheng, a Massachusetts Institute of Technology professor who was himself, until a few years ago, one of the many China experts convinced that the country’s economic miracle was urban.

In his new book, Capitalism with Chinese Characteristics: Entrepreneurship and the State (Cambridge University Press, 2008), Huang stresses that he now believes that the stupendously corrupt foundations of current Chinese growth are unsustainable. Many manufacturers have been exposed as having “committed fraudulent business practices [toys, toothpaste, pet food, powdered milk] in order to skimp on costs”. Looking forward to 2008, long before the American Treasury and banks did, Huang brilliantly foresaw an American recession, “even a subprime crisis”, and rising energy costs. “The issue,” he warned, “is whether such developments would trigger [Chinese] financial instability in the form of a crisis.” Now 2008 has passed, the southern factories are closing, China’s stock market has dropped by 66 per cent, and the Chinese crisis has arrived as Huang predicted.

Huang’s book is that rare thing, a conceptual earthquake. Its dedication encapsulates its theme. Huang names three Chinese he has never met. In 1982, Nian Guangjiu, a farmer from a poor province, began selling a particularly delicious version of the popular snack, roasted sunflower seeds, which he called “Idiot’s Seeds” because he had a low opinion of himself. Soon, he was well on the way to becoming a corporate giant. The other two dedicatees, both from provincial areas, are Sun Dawu, who ran an animal-feed company, and Zheng Lefeng, an illiterate female

moneylender. In 1989, Nian was arrested for corruption and embezzlement, charges so flimsy, even by Chinese standards, that he was recharged as a “hooligan” who had had “immoral relationships” with 10 women. Nian reportedly replied, “No, 12.” He was sentenced to three years’ imprisonment and his business was closed down. Sun was imprisoned for “illegally absorbing public funds”. He had refused to bribe bank officials. He is remembered for his remark in prison: “Chinese peasants, your name is misery.” Zheng Lefeng was executed.

Huang says of Nian, Sun and Zheng that “millions like them created the true Chinese miracle”. But they “met the common unhappy fate of being brought down by the illiberal policies of the 1990s”. Nian, Sun and Zheng were smashed, as the Chinese say, because they made money while free of state control.

Before the trio were detained, Huang shows, China was moving “fast and far” towards a laissez-faire home-grown entrepreneurial economy, founded on the rural-based capitalism of township and village enterprises. But that free economy, which created China’s true economic miracle, was swept away soon after Tiananmen in 1989, and its place taken by “crony capitalism”, built on foreign investment, “systematic corruption and raw political power”, in which property rights, the basis of lasting economic progress, are not secure.

As for Shanghai, the city praised by Western businessmen as a model for China’s future, much of its success is based on foreign investment, regime-based land-taking and the impoverishment of the poorest 10 per cent of the population. Shanghai’s accomplishments, Huang observes, are built on a “Potemkin foundation”.

Huang’s research is based on his close examination of banking information beyond the grasp of most foreign observers. He argues that China’s foreign fans are wowed by flashy tall buildings, shopping malls, up-to-date fashions and high-speed transport, which he derides as tourist impressions. These fans are being misled by their maladroit examination of Gross Domestic Product statistics.

Huang attacks some of them: Nobel Prize winner Joseph Stiglitz; Jeffrey Sachs, a universally-admired academic expert on economic reform; the World Bank’s Beijing office; McKinsey consultants; and the authorities and businessmen who hail China as a star of the East Asian miracle. More recently, there is Harvard’s Niall Ferguson who wrote in this magazine in September: “China’s planned economy seems unlikely to be significantly affected by that [US] slowdown because net exports are no longer the key driver of China’s growth.”

The new capitalism of the 1990s, Huang shows, imperils rural welfare. Two key examples are illiteracy and health. Thirty million new illiterates are being added annually for the first time in the history of communist China. The government now invests relatively little in education and, as they become poorer, rural Chinese cannot afford to educate their children, especially girls.

Mortality figures, which fell in the 1970s and ’80s, began to rise again in the ’90s and China is now near the bottom in its region. “China,” Huang says, “is ranked by the World Health Organisation as one of the most inequitable countries in the world in terms of the distribution of and access to health care.” As immunisation fees increase, parents vaccinate fewer girls than boys, and the mortality rates for peasant girls have risen. Hospitals began to charge fees and in the countryside, notes Huang, “65 per cent of those who should have been hospitalised were not because they couldn’t afford it”.

Inequality is widening. In 1989, during Tiananmen, the government feared that peasants would join the nationwide protests. They didn’t, because they were content with their improving incomes, based as much on entrepreneurial businesses as on farming. Even during the Cultural Revolution, peasants often managed tiny private plots or small businesses, while urban dwellers were persecuted for any sign of profit-seeking. After Deng Xiaoping guaranteed individual property rights in 1979-80 and encouraged commerce, rural enterprise flourished. In one of his many felicitous phrases, Hang says: “One should never underestimate the incentive effect of not getting arrested.”

Rural enterprises were encouraged by party general secretary Hu Yaobang and premier Zhao Ziyang (both now dead), men with rural administrative experience, who issued documents inaugurating polices such as “peasants in their private capacity can engage in trade. They can go into cities and leave their counties and provinces.” They did, and even founded an airline and a great pharmaceutical business. The number of Chinese poor – defined at a very low standard – fell by 154 million between 1978 and 1988, but only by 62 million during the next decade. Zhao and Hu, whose reformist politics enraged Deng, were gone by the end of Tiananmen, in June 1989, and their places taken by heavy-hitting urban planners with engineering backgrounds. Having made their careers in Shanghai, these men, including the new party general secretary Jiang Zemin, began curtailing credits to rural

enterprises. Since the 1990s, as rural businesses languished and inequality widened, China has been riven by hundreds of protests of those left behind by the urban reforms. Poor, badly-educated rural migrants swarmed to the urban factories which are now collapsing, as the worldwide crunch hits China.

Now, they are returning to the countryside they fled, where another crisis is sparking riots and demonstrations that the security forces have been called out to suppress. It could be argued that during the past 50 years, China has weathered worse crises. But South China has been the driver of the urban economic miracle. If its collapse accelerates, following those manufacturers of shoes, toys, toothpaste, pet food and powdered milk, “security”, the communist party’s over-arching watchword, could crack. Furious country people will be joined by their disillusioned daughters, whose factory jobs in the Pearl River delta have disappeared. It is part of China’s rural folklore to recall that every dynasty for more than 2,000 years, no matter how mighty, has been brought down by angry peasants.