Is it time to abandon China? (Summary of 4-part series)

Given the news coming out of China, is it time to head for the exits?

 

Bad news raises questions

In light of all the bad news being reported from China—a slowing economy, mounting debt, rising costs, an increasingly hostile environment for foreign companies, and a political clampdown—we have prepared this series of blogs with the intent of providing some perspective to the dire assessments and predictions that have become so common of late. The issues we address area as follows:

 

Is China’s economy going to crash?

Is China losing its competitiveness?

Is China becoming hostile toward foreign businesses?

Is political risk growing in China?

 

Below we provide a brief synopsis of our perspective on each question. For more detail, please see the link to the blog post for each individual topic.

 

Is China’s economy going to crash?

Debt is high, but crisis is avoidable

China’s economic growth is slowing, but that is not necessarily a problem. Given the size and maturity of China’s economy, it is normal for the economic growth rate to drop below the 8-10% average of the last few decades. More problematic is the rapid build-up of debt China has incurred over the last five years as it tried to boost growth. To avert a crisis, China needs to maintain reasonable leverage in the economy and accept a slower growth rate. To maintain growth, China also needs to continue to liberalize its economy as it has been doing for 30 years. China’s leadership has indicated it will do both of the above. Time will tell. But crisis is not unavoidable.

 

Is China losing its competitiveness?

Chinese manufacturing is undergoing a transition, not a decline

Trade and manufacturing statistics do not indicate that Chinese manufacturing is undergoing a precipitous decline. Lower wages in inland China, productivity gains, moving up the value curve, and a lack of capacity among alternative countries has left Chinese manufacturing more competitive than some think, although a transition away from low value products and toward high value products is certainly underway.

 

Is China becoming hostile toward foreign businesses?

Legal scrutiny has increased.  There are problem areas.  But overall environment still good for foreign companies.

 

All emerging markets are challenging due to weakness in the rule of law. China is no exception. Among other issues, the general lack of transparency and procedural regularity makes it difficult to be confident in the system. For a variety of reasons, including the maturing of the Chinese economy, China is trying to more proactively enforce its own rules. The result is increased legal scrutiny in China—for all companies. Increased scrutiny and a system that isn’t transparent is not a good combination. But, when you look at some of the high profile cases that have received attention, in most of the cases China’s investigations have generally involved legitimate issues. For sure there are issues that are particularly concerning—like business intelligence and cyber security.   But, although the environment has changed a bit and is not easy, it is a mistake to say China is out to get foreign companies.

 

Is political risk growing in China?

Recent political clampdown, while not desirable, is not a major setback if economic liberalization continues

Freedom of expression and access to the internet have been curtailed in China in recent years. Because China is still at a relatively early stage of development, economic liberalization remains the primary driver of societal and political improvement. As long as China continues to offer more freedom and opportunity in the economic realm, political development will follow, as it has in Taiwan, Singapore, and other countries. The likelihood of societal instability resulting from opposition to the recent restrictions seems unlikely. On the other hand, there is the chance that the new internet restrictions will impact non-political spheres like business, technology, and science in a way that forces China to reconsider its approach to the internet.

 

Challenges aren’t new to China

China has always been able to overcome obstacles in the past

 

Development is difficult for all countries, which is why relatively few have developed successfully. Rising from poverty while trying to unwind the failed and convoluted system that was communism doesn’t make it any easier. So China has always faced enormous challenges. The current environment is worse than it was it 2007, but probably not as bad as it was in 1989 (Tiananmen Square Incident) or 1997 (Asian Financial Crisis). So far nothing has brought an end to China’s progress. That doesn’t mean China’s rise is a sure thing. Past accomplishments are no guarantee of future success. But to assess China accurately, it really is necessary to see the big picture and to understand how China is changing. The key to China’s rise has been a gradual approach to economic liberalization. If China continues down that path, without ruining its national balance sheet, other issues should be manageable. To a certain extent, issues that are sometimes described as “crisis” for China—slowing growth or rising wages—are really just reflections of the fact that China’s economy is in transition, moving from a low income to a middle income country. This is a natural transition and there is still a good chance that China can’t manage it successfully.