Are Chinese Shares A Unique Opportunity? Part I

International | Jan 29 2021

China plays a vital role in the world economy, yet the West is taking measures to curtail its rise.

-The West to impose controls and restrictions
-China’s reaction to Western constraints
-Investors need to consider political, social and ESG pressures

By Mark Woodruff

The relationship between the US and China will be a determinant in the evolution of many key global themes. These include the nature of globalisation, the future of supply chains, information flows and the proliferation of technology.                          

Despite recent events suggesting the two major competing blocs are on a collision course, China’s current critical global role precludes any thoughts of the US decoupling from its current adversary. The country is a major component of global supply and value chains and the world’s third largest consumption pool, after the US and European Union.

However, the world coming into view for investors may be less concerned by efficiencies or economics and be driven by perceptions of ‘fairness and equality’. A world dominated by politics not rational economic decisions.

In Part I of this article, FNArena examines strategies the US (or the West) may deploy as an alternative to decoupling. It also considers the impact of these strategies upon investors who may be confronted with some difficult choices.

Part II of this article looks at how Chinese government expenditure plans will create tailwinds for certain industries and sectors, while at the same time providing vital clues for share investors.

Before looking forward, it may be timely to explore the history contributing toward China’s current mindset.

China’s historical self-view

China had always viewed itself as the Middle Kingdom, with surrounding lands having a subordinate tribute relationship with it. This was mostly about perception of state glory. Also the domestic standing of the Emperor had always been stronger if foreign lands accepted China’s centrality. 

This demand for respect and tribute was mixed with threats of retaliation or promises of rewards. Rewards for what China would have considered as ‘appropriate behaviour’.

Unlike European states which for centuries were constantly jostling to gain an incremental advantage and/or maintain a precarious balance of power, China never had to build alliances or truly accept other people’s views. 

Rather, surrounding lands were treated either as friends (i.e. those that acknowledged China’s superiority and tribute system of relationship) or enemies (those that did not). 

According to Macquarie, the prevailing and incorrect view in the 1990’s and early 2000’s was that both China and Russia would ultimately become major stakeholders in an essentially western-oriented global trade and monetary system. The subsequent proliferation of internet and technology would then to lead to greater societal liberalisation.

However, the last eight years has seen the full re-integration of the state and party organisations. China has also returned to a far more ‘top-down’ model that steers and determines almost all key decisions from law and governance to prioritisation of strategic objectives.

This reliance on state-owned and controlled enterprises has significantly increased, while the private sector has been co-opted into a unified system. This blurs already unclear dividing lines between public and private assets.

This latter point is one of several perceived weaknesses from a Western standpoint, which sometimes leads to caution in trade relationships.

Western concerns about China

China has shifted towards the more illiberal end of the spectrum with an effective merger between the party and the state. Macquarie notes there is also a rising dominance of state and state-owned enterprises (SOEs) in driving strategic and capital allocation decisions. This has convinced the West that China is unlikely to be a stakeholder in the Western-designed global order. 

The desirability or otherwise of allowing Chinese access to Western technology and information has also been constrained by several factors. These include China’s integration of military and civilian technologies, rising defence spending and an aggressive diplomatic and economic posture.

Finally, China continues to draw heavily on Western intellectual capital. This is shown by large deficits in semiconductors and losses in intellectual products. China has been successful in exploiting its deep pool of cheap labour, but it has not invented much, preferring to commercially innovate. 

China’s reaction to Western constraints 

The deepening rift with the US has led to China’s recent emphasis on a ‘dual circulation’ economy to cut the country’s dependence on overseas markets and technology. Chinese president Xi Jingping raised the idea in May 2020, and later elaborated that the country will rely mainly on “internal circulation” (the domestic cycle of production, distribution and consumption). This will be supported by innovation and upgrades in the economy. The strategy will be later supported by “external circulation”.

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