WOOLLEN car-seat covers come in handy during the freezing winters of north-eastern China, giving drivers a plush layer of extra warmth. But as temperatures have plunged over the past month, seat covers that used to fly off the shop shelves in cold weather have piled up. At the Wu’ai Market, a wholesale emporium in the city of Shenyang, Li Xiaoli surveys her showroom stacked high with covers of every description: thick and thin, red and white, patterned and plain. “It’s getting harder for people to earn money, so they are not spending as freely as before,” she says.

Ms Li’s unsold seat-covers point to a deepening economic malaise in China’s north-east. Her woes stem from a slowdown in car sales that has been exacerbated by a property-market downturn, which has been weak nationwide but especially bad in the north-east. Home sales in Shenyang, the region’s biggest city, fell by 26% year-on-year in the first ten months of 2014. That, in turn, reflects a decline in heavy industry, the backbone of the economy.

The north-east’s provinces—Heilongjiang, Jilin and Liaoning—ranked in the bottom five of China’s 31 provinces for GDP growth in the first three quarters of 2014. Their growth of 6% was 1.4 percentage points less than the national rate. Worse, their industrial output rose just 0.5% year-on-year in October, far below the national average of 7.7% (see chart).

It is a troubling regression for China’s old rustbelt, which is home to 110m people. Until recently the north-east appeared to be experiencing a renaissance after a difficult couple of decades. The question now is whether its lapse is a passing phase, as it makes the transition from being a base for heavy industry to a centre for modern manufacturing and entrepot for north-east Asian trade; or whether its problems are chronic, the legacy of a centrally planned past in which it remains partially trapped. Endowed with coal and oil, the north-east industrialised under Japanese military control in the 1930s. Mao Zedong later made it the heartland of heavy manufacturing. But its star faded as China opened to the world in the 1980s. The deltas of the Yangzi and Pearl rivers made more fertile ground for entrepreneurs; the government-led heritage of the north-east became a millstone. When Zhu Rongji, China’s then prime minister, took a knife to loss-making state-owned companies in the late 1990s, about a quarter of the 30m lay-offs were in the north-east. Unemployment soared and mass protests spread. The government responded in 2003 with a plan to “revitalise the old north-east industrial bases”. The idea was to transform state factories into lean, modern entities; foster trade with nearby countries; and to broaden the economy by cultivating new industries, from tourism to software. Judging by growth alone, the government achieved almost instant results. The north-east caught up with the average national growth rate of 10%, and then pulled ahead. Its average growth of 12.4% in 2008-12 was nearly three percentage points above the national pace, making it China’s fastest-growing region.

A little slowdown for the north-east might have been fine after such a period of outperformance—in line, moreover, with the central government’s efforts to steer the national economy back to a more sustainable pace of growth. But compared with the rest of the country, the north-east’s downturn has been unusually sharp and painful. It has exposed unresolved problems in its efforts to reinvent itself.

The wrong mix

Those efforts have borne fruit: state-owned firms produced more than two-thirds of the region’s GDP in the early 2000s. That has fallen to about 50%, still above the national average of 30%, but progress nonetheless. The structure of the north-east’s economy, however, has worsened in a more important respect. It has become ever more reliant on investment and manufacturing, both geared to the now-slowing property market. State companies and private firms alike have poured into mining, heavy-equipment factories and construction. Even the car industry, in which the north-east has been a national leader, is closely linked to property, as buyers of new homes also tend to buy cars. In any case, home-grown car brands such as Hongqi and Jinbei are falling further and further behind foreign rivals in popularity.

Whereas the rest of China’s economy has become better balanced, with services now accounting for more of GDP than manufacturing, the north-east has gone in the other direction. Manufacturing’s share of the regional GDP rose to 50% in 2013 from 47% a decade earlier, and the contribution of services declined—the opposite of what the original revitalisation plan called for. Even more striking, investment accounted for 65% of the north-east’s GDP in 2013, roughly double its contribution a decade earlier. The national average is a shade under 50%, which is already high by international standards.

An hour’s drive east of Shenyang to the new town of Shenfu offers a glimpse of how much spending has been misallocated. There, rising 150 metres into the air, is a giant upright steel circle—the “ring of life” (pictured on previous page), which was built as a landmark for the town even before anyone moved in. It is flanked by half-finished buildings and faded billboards advertising dream homes.

Shenfu was designed as a dormitory town, roughly equidistant between the cities of Shenyang and Fushun, to which it is well connected by multi-lane highways. But with heavy industry in the area struggling, and Shenyang and Fushun already weighed down by their own gluts of empty homes, Shenfu has not taken off. “Guys used to walk through the door and buy two or three homes at a go,” says a saleswoman at Deshang International Garden, a large housing complex. Its occupancy rate is now about 50%, which, she says, makes it one of the most successful developments in town.

Over-capacity in heavy industry is also pervasive. The north-eastern provinces took the extraordinary step of ordering some 100 cement-production lines to close for four months this winter, in part to alleviate a supply glut. It is estimated that as much as half their capacity is unneeded. Cement production by itself is a tiny part of the north-eastern economy, but as a crucial input for construction, which accounts for 6% of regional GDP, it is symptomatic of the broader excess in heavy industry.

Poor investment decisions mean less money for spending on social services. In late November as many as 20,000 teachers went on strike over low pay and miserly pensions in towns near Harbin, the capital of Heilongjiang, the slowest-growing of the north-eastern provinces.

Old command-economy habits run deep. After the mass bankruptcies of state firms in the late 1990s, some cities decided they needed cash from officials in Beijing to fund yet more state companies. Liang Qidong of the Liaoning Academy of Social Sciences, a government research institution, even argues that the north-east is the world’s best example of a Soviet-style economy, because its central-planning mentality has persisted for so long. “A lot of people still don’t truly understand or believe in the role of the market,” he says.

The north-east has, to a certain extent, been a victim of geography. Unlike the east and south of China, which straddle major international trading lanes, the north-eastern provinces’ two foreign neighbours are North Korea and the sparsely populated far east of Russia and it is not far from the equally desolate expanse of Mongolia. Their dominant commercial relations have been with Japan, but heightened tensions between China and Japan in the past couple of years have got in the way. Japanese investment in Liaoning was 33.5% lower year-on-year in the first three quarters of 2014. South Korean investment, about a third of Japan’s, fell even more sharply.

Demography has also started to hurt. China as a whole is struggling to adapt as the working-age population peaks. The birth rate in the north-east, however, is less than one child per woman: a third lower than the national average. Even Japan’s, at 1.4, is higher. The north-east is beginning to age rapidly. And it is suffering from emigration, with a net 2m residents working in other parts of China, according to Peking University researchers.

Not all is bleak. Some of the investments made in recent years have been useful. Shenyang is slowly establishing its expanded airport as a hub for northern Asia. Despite having a population of 8m, it lacked an underground rail system until 2010, leaving its streets clogged with traffic. The underground’s two lines are now packed during rush hour. Nine more will eventually open.

There is also hope that the north-east’s industrial heritage, long a weakness, can yet become a strength. The evolution of Shenyang Machine Tool Group (SYMG) is an example of what can be accomplished—and what still needs to be done. SYMG is the heir of Mao-era factories that functioned as self-contained cities, providing workers with homes, schools and even theatres. The market reforms of the 1990s tore that sheltered world apart. Three large factories were combined to form a new group; thousands lost their jobs. Around the same time, though, the company charted a course for modernisation. It listed on the stockmarket, bought a German company for its engineering know-how and built a modern factory campus. From ranking 36th among global machine-tool makers by sales in 2002, it shot up to first by 2011. But, like the north-east more broadly, that year was a high-water mark for SYMG. Sales have since fallen as the north-east’s economy has slowed, and foreign rivals have taken a bigger share of the Chinese market.

Government to the rescue—again

The central government is worried. In July it sent inspection teams to the north-east to see what was going wrong. Li Keqiang, the prime minister, has a personal stake, as he served as Liaoning’s Communist Party chief in 2004-07. The inspectors concluded that bureaucracy was excessive and that the falsification of data was rampant. Mr Li, however, hinted that aid would keep on flowing. The nation, he said, owed a debt to the north-east for its contributions to China’s development.

Soon after, the cabinet unveiled a list of 35 measures—a new “revitalisation” strategy to help the region. It pledged to speed up the construction of rail lines, airports and affordable housing, and to support high-tech industries, from robotics to integrated circuitry. The measures once again rely heavily on the state and big investment projects. Encouragingly, however, they dovetail with a new round of market reforms that the government is promoting across China. State-owned companies in the north-east are being encouraged to sell stakes to private firms, to bring in more cash and expertise.

Guan Xiyou, SYMG’s chairman, says the theme of the new reforms is “letting go”. The government, he says, must loosen its grip on the economy and force companies to find their own solutions to their problems. That, he believes, will at last allow the north-east to resume its place as an engine of China’s economy. But as the past few years have shown, letting go is hard to do in China’s old industrial heartland.