PRATO, Italy – Over the years, Italy learned the difficult lesson that it could no longer compete with China on price. And so, its business class dreamed, Italy would sell quality, not quantity. For centuries, this walled medieval city just outside of Florence has produced some of the world’s finest fabrics, becoming a powerhouse for "Made in Italy" chic.

And then, China came here.

Chinese laborers, first a few immigrants, then tens of thousands, began settling in Prato in the late 1980s. They transformed the textile hub into a low-end garment manufacturing capital – enriching many, stoking resentment and prompting recent crackdowns that in turn have brought cries of bigotry and hypocrisy.

The city is now home to the largest concentration of Chinese in Europe – some legal, many more not. Here in the heart of Tuscany, Chinese laborers work round the clock in some 3,200 businesses making low-end clothes, shoes and accessories, often with materials imported from China, for sale at midprice and low-end retailers worldwide.

It is a "Made in Italy" problem: Enabled by Italy’s weak institutions and high tolerance for rule-bending, the Chinese have blurred the line between "Made in China" and "Made in Italy," undermining Italy’s cachet and ability to market its goods exclusively as high end.

Part of the resentment is cultural: The city’s classic Italian feel is giving way to that of a Chinatown, with signs in Italian and Chinese, and groceries that sell food imported from China.

But what seems to gall some Italians most is that the Chinese are beating them at their own game – tax evasion and brilliant ways of navigating Italy’s notoriously complex bureaucracy – and have created a thriving, if largely underground new sector while many Prato businesses have gone under. The result is a toxic combination of residual fears about immigration and the economy.

"This could be the future of Italy," said Edoardo Nesi, the culture commissioner of Prato province. "Italy should pay attention to the risks."

The situation has steadily grown beyond the control of state tax and immigration authorities. According to the Bank of Italy, Chinese individuals in Prato channel an estimated $1.5 million a day to China, mainly earnings from the garment and textile trade. Profits of that magnitude are not showing up in tax records, and some local officials say the Chinese prefer to repatriate their profits rather than invest locally.

The authorities also say that Chinese and probably Italian organized crime is on the rise, involving not only illegal fabric imports, but also human trafficking, prostitution, gambling and money laundering.

The rest of Italy is watching closely. "Lots of businesses from Emilia Romagna, Puglia and the Veneto say, ‘We don’t want to wind up like Prato,"’ said Silvia Pieraccini, the author of "The Chinese Siege," a book about the rise of the "pronto moda" or "fast fashion" economy.

Tensions have been running high since Italian authorities stepped up raids this spring on workshops that use illegal labor, and grew even more when Italian prosecutors arrested 24 people and investigated 100 businesses in the Prato area in late June. The charges included money laundering, prostitution, counterfeiting and classifying foreign-made products as "Made in Italy."

Yet many Chinese in Prato are offended at the idea that they have ruined the city.

"If the Chinese hadn’t gone to Prato, would there be pronto moda?" asked Matteo Wong, 30, who was born in China and raised in Prato and runs a consulting office for Chinese immigrants. "Did the Chinese take jobs away from Italians? If anything, they brought lots of jobs to Italians."

In recent months, Prato has become a diplomatic point of contention. Italian officials say the Chinese government has not done enough so far to address the issue of illegal immigrants, and they are seeking a bilateral accord with China to identify and deport them.

Italian officials say Prato is expected to be on the agenda when Prime Minister Wen Jiabao of China visits Rome in October.

CHINA IN ITALY’S BACKYARD

According to the Prato chamber of commerce, the number of Italian-owned textile businesses registered in Prato has dropped in half since 2001 to just below 3,000, 200 fewer than those now owned by Chinese, almost all in the garment sector. Once a major fabric producer and exporter, Prato now accounts for 27 percent of Italy’s fabric imports from China.

Resentment runs high. "You take someone from Prato with two unemployed kids and when a Chinese person drives by in a Porsche Cayenne or a Mercedes bought with money earned from illegally exploiting immigrant workers, and this climate is risky," said Domenico Savi, Prato’s chief of police until June.

According to the Prato mayor’s office, there are 11,500 legal Chinese immigrants, out of Prato’s total population of 187,000. But the office estimates the city has another 25,000 illegal immigrants, the majority of them Chinese.

With its bureaucracy, protectionist policies and organized crime, Italy is arguably Western Europe’s least business-friendly country. Yet in Prato, the Chinese have managed to create an entirely new economy from scratch in a matter of years.

A common technique used, often with the aid of knowledgeable Italian tax consultants and lawyers, is to open a business, close it before the tax police can catch up, then reopen the same workspace with a new tax code number.

Prato’s streets have slowly become more and more Chinese, as the Chinese bought out Italian-owned shops and apartments, often paying in cash. Public schools are increasingly filled with Chinese pupils.

The work – long hours at sewing machines – takes place in back-room workshops with makeshift sleeping quarters. The heart of the "fast fashion" sector is an industrial area on the outskirts of town, Macrolotto, filled with Chinese fashion wholesalers.

Here, vans from across Europe line the parking lots as retailers buy "Made in Italy" clothing to resell back home at a huge markup. By buying in relatively small quantities and taking advantage of the fluid borders of the European Union, most manage to avoid paying import tariffs. 

THE NEW SHERIFF IN TOWN

Much of the tightening comes from Prato’s new administration. In 2009, the traditionally left-wing city elected its first right-wing mayor in the postwar era, whose winning campaign tapped into powerful local fears of a "Chinese invasion," and who seeks a broader European Union response to Chinese immigration.

"How can China leave a mark like this in the EU?" the mayor, Roberto Cenni, asked. "Noise, bad habits, prostitution. People can’t live anymore. They’re sick of it."

Cenni is a former president and a current shareholder of Go-Fin, a Prato holding company that is behind several midrange Italian fashion companies. At least one of these, Sasch, moved much of its production to China within the last 10 years.

Powerless to reverse the broader economic currents, the mayor has instead focused on small initiatives, including new rules that prohibit drying fish on balconies and require all Prato shopkeepers to speak Italian. These have him won praise from some local people, but also criticism for bigotry.

He has also stepped up raids on Chinese businesses. Critics say they are little more than media spectacles, but local Chinese have seen them as an unwarranted attack.

Many illegal Chinese immigrants arrive by bus from Russia or the Balkans, and either destroy their passports or give them away to the organized crime groups that help bring them. Many others overstay their tourist visas.

"Italy has a 20th-century immigration law; it tends to think of immigrants as a phenomenon linked to work, in which people move from poor countries to rich ones," said Andrea Frattani, a former social welfare commissioner in Prato’s previous center-left government.

Instead, he argued, what Italy is witnessing in Prato is "a precise strategy" on the part of the Chinese government to create an economic foothold in Europe.

Asked recently if that was the case, China’s ambassador to Italy, Ding Wei, said only that Prato had been a central issue in his portfolio since he arrived in spring, and that he had sent advisers to investigate.

The problems will not be resolved easily. "There’s no plan," said Xu Qiu Lin, a local entrepreneur and the only Chinese member of Confindustria in Prato, echoing a widespread sentiment. "There’s no plan; that’s the problem."