Why China Keeps Falling for Pyramid Schemes

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Promotional material for an illegal pyramid scheme at an office in Beijing during a police crackdown, taken on August 18, 2017. (Greg Baker/AFP/Getty Images)

Pyramid schemes are big business in China – much to the government’s chagrin.

05 March 2018 | Eugene K. Chow | The Diplomat

“In China, cheap knives and questionable nutritional supplements are the least of regulators’ worries when it comes to pyramid schemes. Crafty scammers have bilked unsuspecting Chinese out of billions of dollars, draining the meager savings accounts of recent college graduates, migrant workers, and pensioners.

One pyramid scheme alone defrauded 900,000 people of $7.6 billion. But that’s only the tip of the iceberg. More than 40 million people have been ensnared by these sham investments, according to the China Anti-Pyramid Selling Association.

Fearing financial instability and social unrest, the central government announced a sweeping nation-wide crackdown on organized crime, naming pyramid schemes as a top priority alongside drugs, gambling, and human-trafficking.

But in a surprising twist, those duped by these scams are some of their greatest defenders. Firmly believing in the legitimacy of these fake companies, the defrauded have even publicly rallied against the government’s efforts to shut them down.

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An Environment Primed for Swindlers

According to Zheng Zichen, an economist and sociologist with the state-run Guangdong Academy of Social Sciences, pyramid schemes have gained widespread appeal across vast segments of China’s population because of “China’s deep-rooted problems – its wealth gap and unbalanced development between urban areas and hinterland provinces.”

While China’s economy has grown at unprecedented rates, large portions of the population have been left out of the country’s meteoric rise. The wealthiest 1 percent of Chinese households own a third of all wealth, while the poorest 25 percent own 1 percent, according to a 2016 study from Peking University.

Eager to get rich, but with few opportunities, migrant laborers, workers laid off from state-owned enterprises, and recent college graduates in second and third tier cities are particularly vulnerable to pyramid schemes.

But unlike in the United States, pyramid schemes in China use far more insidious tactics. Authorities aptly call these scams “business cults,” as they rely on heavy brainwashing to trap participants and entice new ones.

Potential recruits are lured to an isolated place by a friend or family member, and for the next week recruiters will psychologically break them down, emphasizing the benevolent nature of the business, promising wealth, and appealing to personal ambition and their responsibility to provide for their family.

Those that agree to join then spend every moment with their “co-workers,” eating and singing communal songs.

Li Xu was one of the many who believed what recruiters told him. His family had put him in touch with Tianshi, a company claiming to sell cosmetics in Jiangsu province, and after paying his “joining fee” of 2,800 yuan ($340) he quickly climbed the ranks by recruiting others.

After a year Li began to grow suspicious. He was surrounded by his co-workers 24/7 and rarely saw customers or profits. Eventually he figured out that the company’s only revenues came from the “donations” he and other recruits continued to give in the hopes of striking it rich.

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“Pyramid sales are like spiritual opium,” Li said. “The organizers brainwash people to believe they will definitely get rich. Like drug addicts, you have to get them out of that environment to help them.”

Li left the company before it was shut down by authorities, but his co-workers stayed, convinced that it was legitimate until the end.

Kindhearted Exchange

The case of Shan Xin Hui shows how successful these scams are at duping participants. Shan Xin Hui, which means Kindhearted Exchange, marketed itself as a charity-minded investment group that focused on alleviating poverty and conserving forests.

With promised investment returns of 10 to 30 percent within weeks as well as bonus payments for those who recruited new members, Shan Xin Hui enrolled more than 5 million people within a year.

When investigators shut the scam down in 2017 and arrested its founder Zhang Tianming, thousands gathered in Beijing for the largest protest in nearly two decades. In a rare public rebuke, demonstrators called on President Xi Jinping to allow the company to continue to operate and asked for Zhang’s release.

“They call us a pyramid scheme, which is absolutely not true. We came here today first to save ourselves and the platform. Second, we want Mr. Zhang to be released. Mr. Zhang is such a fine man,” said one protester.

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People involved in a pyramid scheme waiting to be questioned by the police in Wuhan City, in China’s central Hubei Province, on August 23, 2017. (STR/AFP/Getty Images)

Although pyramid scams are illegal in China, business cults often masquerade as direct sales organizations, which are legal. There are about 90 government-approved direct sales organizations like Avon and Amway, which recruit individuals to sell products.

Crooked companies will claim official status, but do not sell any actual goods, instead promising payment to recruits who sign up additional members. These are essentially Ponzi schemes as they use registration fees from new recruits to pay existing members.

Continued Popularity

Despite increased efforts by authorities to take down business cults, they continue to proliferate faster than authorities can contain, moving online and becoming smaller and more targeted.

While they cannot employ many of the brainwashing techniques that rely on physically isolating recruits, online business cults are still able to use tight-knit social media chat groups to successfully brainwash participants.

Though smaller in size, these online schemes have penetrated deeper into society, targeting new groups like the affluent, poor students, and the children of migrant workers.

“There is a business cult for everyone” now, said Li.

These cults are able to continue attracting new recruits and investors as they promise much higher returns than most Chinese investments.

For years the central bank kept interest rates below inflation to ensure industry could borrow cheaply, but it left few options for investors. Seeking better returns, investors are readily enticed by the claims of pyramid schemes.

Zhao Xijun, deputy dean of the school of finance at Renmin University of China, believes that people will continue to fall victim to these scams due to a lack of financial literacy.

“People are eager to achieve high returns, but they do not have adequate knowledge of the financial risks or how to screen for them,” Zhao said.

“Chinese people have invested heavily in financial products, such as wealth management funds, but only for a very short period of time. They have very little experience.”

Eugene K. Chow writes on foreign policy and military affairs. His work has been published in Foreign PolicyThe Week, and The Diplomat.

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