folder Filed in News
China Disappoints But Is Still Investible
Peter T. Treadway

There has been a sea change in Chinese policy regarding market capitalism in the last few months. Instead of Deng Xiaoping’s “to get rich is glorious”, Xi Jinping’s new slogan is a more egalitarian “common prosperity”. Instead of a market-driven Milton Friedman world of profit maximization, major Chinese companies are encouraged “to give back”. Instead of Adam Smith’s invisible hand guiding capital allocation, the more visible hand of the Communist Party will intervene to make sure the major companies act in the national interest.

This sea change has led some prominent Western investors to declare China “uninvestible.” I think that’s going too far. There’s been no change in the Chinese lust for technical progress and education, or in the massive size of the Chinese market, or in the high average level of Chinese intelligence, or in the disciplined Chinese work habits.  President Xi Jinping and his top economic adviser, Vice-Premier Liu He, just this week tried to reassure the private sector of its critical place in China’s economy, despite recent regulatory pressure. Xi has even proposed the expansion of a stock exchange in Beijing to serve small startups. This isn’t an ideal Milton Friedman world but it’s not revolutionary China of 1949 either.

What I think has changed is that for international investors there will be a China discount. To allow for this new Chinese policy, Chinese stocks will carry a discount valuation rendering them cheaper than comparable stocks in the West. The markets have already inserted this discount as Chinese stocks have sold off in recent months. Thus for example forward P/Es are 65 and 28 for Amazon and Alphabet respectively vs lower 17 and 18 for Alibaba and Bidu.

Confucius Says…

The world has impression of Chinese people being natural-born merchants. So it may come as a surprise therefore that historically under the Confucian ethic which pervaded China for thousands of years that merchants held a low place in the Chinese social hierarchy. At the top were the scholar officials who achieved their status via success in an imperial examination system. Central to the imperial examinations were the teachings of Confucius which emphasized, among other things, obedience to authority. The scholars got the jobs in the government bureaucracy.

Confucian ways of looking at the world still underlie East Asian cultures such as South Korea, North Korea, Vietnam, Japan and even Singapore, be they communist or not. While Chairman Mao tried to get rid of Confucian thinking, in recent years the Chinese government has returned Confucian thinking to favor. Add to this is Marxian economics which China officially endorses and which hardly venerates merchants.

According to historians John Fairbank and Merle Goldman, merchants often suborned the scholar officials. They wrote:

A ‘merchant official complex’ might have acquired some power in the government had not Confucian values so strongly disesteemed the profit motive. In deference to the Confucian ideology, official pronouncements for the next 2000 years (after Confucius) would generally denigrate merchants, while officials in practice would profit from licensing, taxing, and sharing private deals with them.” 

An unseemly partnership, as it was.

The West views China’s economic success of recent years as the result of dynamic entrepreneurship of China’s private sector. In its quest to become the world’s number one economy, many in the West are in awe of the performance of Chinese companies. The West expects – or perhaps we should say expected– the Chinese private sector to lead the Chinese economy to further heights.

But awe may not be how China’s Confucianist Communist Party views the matter. The Communist Party seems to be asserting a primary role for itself and a secondary role for the private markets. Jack Ma is a hero in Western business circles but right now according to some media reports he is spending his time painting in China. In the “good old days” of Imperial China, the Emperor ordered the beheading of officials who displeased him.

One item that needs mentioning. The new Chinese policies, be they good or bad for China, do not represent some kind of threat to the United States.

One more item. The Chinese can be flexible. The development of China’s potential is a primary goal of its government. If some of the new policies prove unworkable, they can be changed.

Give Back What?

In America and in China one hears the phrase that profitable corporations should “give back” some of their profits. I don’t get it. “Give back” implies that the corporations stole something that needs to be returned. But typically they didn’t steal anything. Instead they created new products that improved countless lives and they created thousands of jobs. Why is that bad? They should be allowed to invest their extra profits in expansions of their business. That certainly is what Amazon did with fantastic results.  Or, when there are no profitable opportunities to expand the business, corporations should recycle their excess cash via dividends or buybacks. Investors can then recycle the funds into other profitable investments.

Many have noted that some of the so-called reforms now bandied about in America are similar to those in China. Monopoly has become a bad word in both countries. Except that in China the reform process is totally top down. The Chinese President and the government decree. Business obeys and begs forgiveness. In the US the reforms must go through a long process of bureaucratic hearings and Congressional wrangling. The companies object every step of the way and the lawyers clean up.

The Chinese will argue their system is more efficient.