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China’s Growth Model

The west is now surer China is not about to liberalize, as the attached ‘The Economist’ says. Ever since Vice Premier Deng Xiaoping embarked on liberalization of the Chinese economy, the west has rarely doubted its belief that economic prosperity would eventually bring political liberalization to China, until the rise of Xi Jinping as head of the Chinese Communist Party(CCP) as well as the state. While Chinese people may want to express their opinions and feelings more freely on rising levels of affluence, President Xi has been firmly authoritarian, trying to perpetuate the CCP’s one party rule, suppressing dissent of any kind, taking advantage of modern technology in building a highly sophisticated surveillance state. 

China has defied a commonly held view that it takes political liberalism to develop an economy, after witnessing what had happened in central/ eastern Europe since the Berlin Wall’s fall 30 years ago. In East Asia, however, that has not always been the case. South Korea has achieved an economic miracle under authoritarian rulers, and Taiwan’s economy prospered under a marshal law. Singapore has always been a one party state. At least South Korea and Taiwan later reached fully fledged democracy on high levels of affluence, with vocal political oppositions and changes of power. So can China keep delivering growth while defying the west’s conventional wisdom indefinitely?

One factor that could prevent China from challenging the conventional wisdom is finances, notably low returns from its equity market that distinctly underperform the country’s economic growth, nominal growth rates to be specific. Though China no longer delivers double digit growth rates, it still logs one of the highest economic growth rates on earth. However, the Shanghai composite index, as a proxy of the country’s equity market, has been moving sideways at around the 3,000 level throughout the decade, while the size of the economy has more than doubled. The market is totally disconnect from the economy. State owned enterprises (SOEs) are not run to maximize value for shareholders, as already understood, and their presence in the market as well as the economy is growing in recent years. The CCP’s intervention in the management of SOEs gives priorities to something other than profits and shareholders’s value. 

Few investors have a serious interest in SOEs anyway, but what about the highly touted tech sector? It is doing better than SOEs but is outmatched by the U.S. counterparts, at least in terms of stock market performances. While the U.S. tech doubled in the last five years through the end of November, the Chinese counterpart, as measured by Invesco China technology ETF, is up only 40% and has not done anything for the last two years, grossly underperforming American tech. The lure of China has drawn capital into Chinese assets. While the lure has been strong to this date, it would not last indefinitely without properly compensating risks taken by investors, with higher returns to be specific. Could this last another ten years? Maybe, since this being China, but not indefinitely.

The bond market has been experiencing a rise in default rates in the last several years among non-SOEs. On the other hand, defaults are still truly rare for SOEs despite their lower operational qualities, since they are not exposed to market forces. Blatant state assists keep them afloat, and such subsidies cost something to the government. Assisting low quality companies eat up taxpayers’ money and could become unbearable financial burden to Beijing, should this keep going on. As is the case with private capital lured into China, this cannot go on forever and ever, and the question is how much longer can it last, which no one knows. It may last for some time, but China’s inability to compensate providers of risk money should stand in the way one day of the model that drove China’s growth so far. That said, whether stalling growth gives rise to political liberalization is entirely another matter.  

Author: Ichiro Suzuki, a retired Senior Portfolio Manager/ Global Equity Strategist

Nomura Asset Management, lives in Tokyo, Japan. He is a Advisory Group member

Richard A. Mayo Center for Asset Management at Darden School of Business, University of Virginia.


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