As Ray Dalio of Bridgewater recalled in a recent investor letter, he has witnessed this before whether it was during the market manipulation of 2015 or the Chinese currency plunge in 2015-16. Every time foreign investors interpreted this as policymakers turning away from capital markets, whilst instead we observed steady and fast development of capital markets, entrepreneurship, and openness to foreign investors.
In order to properly understand the regulatory developments we need to separate the changes and the intentions behind them. Away from the capital markets, investors may have noticed that the Chinese government’s references to “common prosperity” have surged in recent weeks. This subject is topical for many in China.
China’s economic reforms have brought tremendous capital growth and lifted the entire population out of extreme poverty but have also deepened income inequality between the rich and poor and made social mobility more difficult. Today, there are about 700 billionaires in China, a close second to the US, but its GDP per capita (PPP adjusted) is only a quarter of that in the US. According to the Global Social Mobility Report 2020 by the World Economic Forum, it would take another seven generations for the bottom 10% income families to reach median income in China. This compares unfavourably to many of the capitalist countries such as Japan (four generations) and the US (five generations). Somewhat of an irony for a socialist regime.
Former Chinese leader Deng Xiaoping famously said that to develop a socialist market economy, China would have to “let some people get rich first”, as he argued that “common prosperity” does not equal “synchronised prosperity”. But we need to remember that common wealth remains a key goal of socialism. Now it is once again up on the Communist Party’s agenda – and may remain so for the coming years.
Party officials have explained that it is less about an even distribution of wealth, but rather about finding a balance between efficiency and fairness. Acceleration of tax reforms and promotion of charitable contributions are among the things to expect. Although more details remain to be seen, the transition process will likely be gradual. Some large corporates are already responding. Tencent, for example, has announced a 50 billion Renminbi fund to support a range of initiatives for low-income groups. Alibaba and JD.com also reaffirmed their commitment to creating value for society.
Although China’s authoritarian regime allows swift implementation of policy, the government usually seeks public consultation and communicates the issues with stakeholders in advance. New rules are sometimes tested out in pilot cities before nationwide implementation. If we look at recent regulatory action through the “common prosperity” lens some of the events take on a different light. Take the after-school education sector. Turning an established profit-making industry to non-profit overnight is no doubt very drastic and alarming to a world that prizes a free market. This time around, the government did not communicate clearly nor have a transition plan and caught the market off guard. After-school tutoring has been a fast-growing sector in China, attracting capital from the private and public markets. In preparation for the college entrance exam, a rising number of families pay for their children to receive (expensive) tutoring after school. At the peak, the sector was worth over $100 billion, and early investors benefited.
However, many social problems have been created. There is inequality since only wealthier parents can afford it; many complain the money spent does not lead to quality education but only to cramming and anxiety. Children of all ages are affected with stories of students burnt out even before they reach high school. Furthermore, many companies have been using aggressive advertising campaigns aimed at parents to create feelings of guilt. The government even links competition for education as contributing to families’ reluctance to have children.
An attempt to reform the industry in 2018 was largely ignored and companies only became greedier. This clearly does not meet the government’s objective of a harmonious and healthy development of society. In that context, a set of rules the “bring the industry back into line” while seeking to address well-documented social inequalities is less surprising.
Uncertainty which stems from government action needs to be properly accounted for as a risk factor and Chinese tech should indeed trade at a discount compared to its global peers. But for investors who are attuned to social objectives like “common prosperity” stand to benefit as changes are brought in.
Lars Hagenbuch, Consultant, at RisCura
