Amidst a more than $1 trillion rout of Chinese technology companies, Chinese regulators have been busy — including steps to make tutoring companies not-for-profit, actions against China’s largest ride-hailing platform, Didi, and comments in state media against gaming. Reactions have reached fever pitch and range from “China doesn’t want foreign capital”, “there is a witch hunt”, all the way to fears that China may reverse four decades of reliance on private capital and entrepreneurship.
If we followed Hans Rosling’s advice in Fact-fullness, and discarded fear factor (which clouds clear thinking) and adopted a clinical fact-based approach, things look very different. Here, we connect the dots between the Chinese Communist Party (CCP), Xi Jinping’s approach, geopolitical considerations and the growing emergence of China. Those seeking an opportunity to participate in tech and innovation tend to focus on FAANG stocks/NASDAQ, but China could well present a credible alternative for those willing to take a closer look.
By the time Xi Jinping came to power, a predictable process for succession planning had been developed. With the 20th Party Congress due to happen next Fall, in the normal course, a two-term leader would step aside, but to date, there is no expectation Xi Jinping will do. As Jude Blanchette, Freeman Chair in China Studies at the Center for Strategic and International Studies, succinctly puts it, “Xi’s increasingly singular position within China’s political system will forestall policy alternatives and course corrections, a problem made worse by his removal of term limits and the prospect of his indefinite rule.”
Well reported are China’s attempts to gain global domination, often at the expense of free trade and with scant regard for Intellectual Property. As economist Robert Atkinson outlines, it has often used a four-step innovation mercantilism playbook to usurp technology at the cost of innovation in the West. Not-so-well reported though, are tools the party uses to create popular support including responsiveness to public opinion to varying degrees.
Xi Jinping’s regime
Xi is credited with a sweeping anti-corruption drive and breaking down silos early in his term. Xi sees a convergence of demographic, geopolitical, economic, environment and technological changes that necessitate urgency. The waning power and influence of the West, China’s deteriorating demographic outlook, declining productivity gains, saturated infrastructure and rising pollution, Xi feels merit accelerated attention.
As Xi stated in 2014, first mover advantage will lie with “whoever holds the nose of the ox of science and technology innovation.” Probably the most consequential shifts to have occurred on Xi’s watch are advances in artificial intelligence, robotics, and biomedical engineering. Xi believes that dominating the “commanding heights” of these new tools will play a critical role in China’s economic, military, and geopolitical fate.
It is obvious that science/ technology innovation and private entrepreneurship are an integral part of China’s long term strategic goals. However, it is his haste in challenging the international order and the consolidation of political authority that present the biggest risks to achieving these strategic goals.
Few observers debate China’s potential as an economy. After all it now constitutes around 27 per cent of the world GDP when measured on a PPP basis. Non-State owned enterprises, now contribute 77 per cent of revenues as opposed to a measly 5 per cent in 2005. China is poised to become the largest consumer market overtaking the US. Chinese companies’ R&D expenditure already equals that of the Euro Zone and is 50 per cent of that of the US. It is the accelerated import substitution in products and components with a high technological barrier that present the most interesting opportunity.
When ed-tech companies, flush with capital, were drawn to excesses, resulting in a steep increase in education costs and excessive workload on young students, the CCP did not hesitate to intervene. After all, educating a larger population and making it affordable are stated goals. High costs of education also came in the way of CCP’s objectives at increasing the population.
Within two days of a successful $4.4 billion IPO, Didi was placed under investigation causing a more than 40 per cent fall at one point. It is questionable if Didi has exceptional tech. It is business model innovation but not creation of new IP. It appears that it was under pressure from regulators to delay its IPO, pending a deeper cybersecurity investigation, but went ahead with the IPO, taking on regulators.
Gaming regulations have focussed on their impact on children and similar interventions in 2018 have brought in desirable restrictions, including facial recognition and limits on the number of hours children can use it.
We see the goal of “common prosperity” as being a common thread running through many regulatory interventions.
Xiaokang (common prosperity) as a concept is over 2,500 years old and refers to a moderately prosperous society, where people enjoy a peaceful and happy life. From a singular focus on GDP growth to a more rounded development, the distinct change in focus can be seen in Xi Jinping’s term and seen from this perspective, there is coherence.
Without doubt, political and geo-political risks exist, but the inherent long-term orientation and coherence in state policy-making ought not to be ignored. Seeing Western economies and China with the same lens could lead to misjudgment. While many tend to react, sometimes excessively to political risks, equal attention needs to be paid to changes in technology that puts many old economy businesses at risk of disruption.
The markets in China present an opportunity for investors to participate in tech and innovation at near long term average valuations. As in any investment, having advisors with a deep understanding of the landscape and investing through fund managers with demonstrated ability to identify businesses bottom up would be recommended along with an overarching emphasis on aligning oneself with the direction of the Chinese government’s long term strategic interests, societal good and high quality managements in every sense of the word.
The writer is Chief Investment Officer-Investment Advisory at Entrust Family Office. Views are personal.