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Bull in a China shop

China’s economic reforms offer huge temptation for Western investors, but significant risks linger
Bull in a China shop

China’s emergence over the past four decades from the wreckage of the Cultural Revolution to become a political, economic and technological superpower to challenge the US for the position of the world’s largest economy has been unparalleled in history. 

The story of the country’s transformation is well known; the long period of post-war rule by Chairman Mao Zedong had resulted in a centrally planned economy comprised mostly of state-led production and collectivised farming, largely closed off to the outside world and poor. In 1979, three years after Mao’s death, China’s economy accounted for just 1.8 per cent of global gross domestic product (GDP) and just 0.8 per cent of global exports. 

That changed quickly under the eye of his reforming successor Asean Xiaoping. Out went Mao’s economically catastrophic Cultural Revolution. In came market reform that opened China to the world. By 2010 its GDP had risen to represent approaching a tenth of the global economy, and over 8 per cent of its exports. An abundance of cheap labour meant Chinese factories became essential cogs in the global supply chain, surpassing the US as the world’s largest manufacturer in 2011. Capitalist methods had worked; as Deng had put it: “Poverty is not socialism. To be rich is glorious.” Now investors are eyeing the country with the same mentality.

At first embracing the opening up of China, the US is now understandably rattled and doing everything it can to remind China who is still top dog. This tug of war and the resulting trade dispute had, until Covid-19, proved the most destabilising force for global stock markets as the two countries imposed a series of tit-for-tat tariffs on each other. Tentative hopes of rapprochement now seem unlikely, as the virus has magnified the hostility between the two countries and given rise to serious questions over what comes next for the globalised system that had underpinned China’s economic ascent. 

Until Covid-19 struck, few had really questioned whether the so-called ‘Asia pivot’, led by China and its inexorable trend of rapid GDP growth, would continue well into the foreseeable future and beyond, even if there were concerns over the means with which it did it. Controversy surrounds its Belt and Road initiative, the management of its currency, industrial subsidies and ‘dumping’, the loose regard for intellectual property rights of western companies, and the treatment of its minority populations. Western security concerns over telecoms infrastructure or nuclear energy were dismissed as xenophobic trade war rhetoric, and promoted as economic necessity. China had appeared unstoppable – even if its immature and volatile stock markets have rarely reflected that. 

That future looks less certain now. Thanks to Covid-19, every aspect of China’s involvement in the global economy – and the geopolitical intentions behind it – is facing deeper scrutiny. Conspiracy theories aside, there is real anger at its handling of the Covid-19 crisis, and its attempts to block investigations into its origins, and its application of diplomatic pressure to do so. Australia has become the latest victim, facing tariffs for pushing for an inquiry. Consumers, long happy buyers of cheap Chinese goods, are unhappy too; #BoycottChina frequently trends on Twitter, as an angry world kicks back at a regime that many believe has callously put their lives at risk for economic and political gain. 

As investors have also discovered, it is almost impossible to disentangle politics, and its role in today’s fiendishly complex geopolitics, from anything that happens in China. For all the fruits of its rapid growth, the country remains a communist state in which the ambitions of its politburo have always reigned supreme. Now, it is the ambitions of one man that matter most – when Xi Jinping declared himself president for life in 2018, it showed once and for all that whatever democracy had appeared to exist in the county was little more than window dressing. 

At the centre of this struggle sits Hong Kong, and China’s ongoing attempts to exert authority over one of the rare beacons of democracy in what is, ultimately, an authoritarian dictatorship. Explosive protests in the city were halted only by the Covid-19 lockdown, but China’s latest move to extend its powers over the semi-autonomously governed region and crack down on dissent with its new security law has left the world reeling. The G7 has urged China to reconsider the legislation, but a reversal seems unlikely. What China does next, particularly with long-disputed Taiwan, and how the world responds could cast a long shadow over markets in the years ahead.

 

China: still the world’s engine room?

For all of these risks, the sheer scale of the Chinese opportunity is temptation enough for many to look past its troubles – western financial institutions, in particular, have remained uncritical of China’s recent actions for fear of jeopardising the prize they see there. 

There is plenty of financial incentive for them to turn a blind eye. China is a vast country, home to 1.4bn people and long the world’s most populous. Its recent rapid growth correlates closely with the migration of its population from country to city. Today, more than half of its population lives in urban areas. According to United Nations data, six of the world’s 33 megacities are in the country, and a dozen more are close to achieving that scale as rural-to-urban migration continues. 

More recently, as the population began to share in its growing wealth, it has become the world’s biggest market for many products, too, from cars to luxury goods. And its citizens are on the move around the world, too; in 20 years, China has become the world’s biggest spender on tourism, spending £277bn on non-domestic tourism last year, nearly twice the size of the next largest market, the US. Its travellers took 150m flights, a 15-fold increase in two decades.

But although China’s GDP per capita has risen sharply since China’s opening, at $21,000 according to the IMF’s latest estimates, it is still significantly lower at purchasing power parity than developed economies such Japan ($46,000) or the US ($67,000). It also belies the massive disparity between China’s super rich – big spenders on western luxury goods – and the country’s poorest. With 1 per cent of China’s population controlling a third of its wealth, China’s wealth inequality as measured by the Gini coefficient has become one of the highest in the world. 

Academics have argued that if left unaddressed the extent of China’s wealth gap is a serious risk to social and political stability, and could impede further expansion of its middle class. However, China bulls argue that closing the gap is an opportunity, seeing room for further growth that will continue to drive Chinese spending power. Unsurprisingly, many western companies remain very keen to tap into this trend as China continues its shift from a low-value-add manufacturing economy to a high-tech service economy led by the consumer, as outlined in its Thirteenth five-year plan ‘Made in China 2025’. 

Whether China’s growth rates can survive this transition remains to be seen – all the more so in the wake of the damage inflicted by Covid-19. China’s official annual GDP growth rate has held steady at above 6 per for three decades, sometimes reaching well over 10 per cent. The veracity of its economic data may have frequently been called into question, but there is little doubt that the country’s growth has been rapid even if the sheer scale of its economy means the rate is now slowing. That is a worry, given the scale of the country’s public and private debt, often described as a ‘time bomb’.

The major concern now is whether China’s transition to an innovation-led, domestically-focused economy can happen quickly enough to sustain its growth – especially if there is further escalation of the trade dispute with the US. Trade between the two countries amounts to around $660bn a year, with the US the largest single market for Chinese exports. China has thrown huge amounts of stimulus at maintaining growth, including $500bn in fiscal support provided in the wake of Covid-19. Given China’s dominance of emerging market indices, investors should be paying very close attention. 

 

Read all nine elements of our Investing in Asia guide here: 

Asia's mega potential

The outlook for Asian economies

Bull in a China shop

India: still a favourite?

Ambitious Vietnam

Thailand: home to oustanding buinesses

Accessing growth and income

Titans of the East

Tech, tariffs and political turbulence