Notes for: The New China Playbook: Beyond Socialism and Capitalism

title: The New China Playbook: Beyond Socialism and Capitalism author: Keyu Jin published: 2023 edition: 1 ISBN: 978-1984878281

Introduction

• The West’s Market Economy model has 2 primary actors: enterprises and consumers
• The government plays a small role in influencing the market, through fiscal, financial and monetary policies.
• The China’s Mayor Market Economy model has 3 actors: government, enterprises, consumers
• The government plays a large role in influencing the market, through the same 3 policies, plus Industrial policies and managing State-Owned Enterprises (SOE)
• China has a hybrid of political centralisation with economic decentralisation. it is a market with both capitalist and socialist attributes. (state guidance at macro level, free market at micro level)

China’s Economic Miracle

• The Industrial Revolution is considered pivotal because it improved the standard of living by 75% within a single lifetime
• China’s growth rate between 1978 to 2016 means that many Chinese will see their standard of living rise by 7500% within a single lifetime. it is indeed an economic miracle.
• The intangible fundamentals of Chinese society are the culture, institutions and history and Confucianism has a big influence
  • pursuit of virtues like frugality and self improvement
  • meritocratic since imperial time through the exam system
  • doing one’s best and to honour their family and ancestors
  • government is an essential part of society and is responsible for compassionate ruling
  • this makes China very different from USSR or other developing or emerging economies like India, Central Africa etc.
• Deng Xiaoping’s multiple reforms pushed China through multiple stages of growth. “Reform is China’s second revolution”
  • first, political reorientation and reinterpretation of communist ideas that are able to integrate with free market economy. economic policy changes to allow private ownerships in agriculture sector improved productivity.
  • second, special economic zones SEZs for foreign direct investments
  • third, SOE reform by privatising them or eliminating those which are not competitive
  • fourth, entering in world trade organization WTO and because the manufacturing hub of the entire world
• stats have shown that in this same period, productivity also improved, therefore growth is not only contributed by capital investment or more labour participation.
• at the current stage, growth is starting to slowdown. China is at risk of getting stuck in the middle-income trap. potentially becoming like Japan with a lost decade of no growth.
  • there is potential for china to orientate towards a more skill based industries to unlock more productivity
  • potential to allow more maturity in the capital market and financial institutions
• target for china is to grow from 10k USD per capita GDP to 30k per capita.

China’s Consumer and the New Generation

• 1.4 billion consumers in China. it is the dream market of all businesses around the world.
• new generation from one child policy, have the financial backing of their family (six wallets) to make large purchases. they are also used to getting whatever they wanted, like little prince and princesses
• families are also incentivised to save for the future of their one child (no other child to compete for their financial assets), and invested more in their one child, leading to a super educated generation
• due to gender ratio imbalance, it also became a golden age for women, who are highly educated, with lots more option for a potential partner
• current savings rate of china household is 30% of disposable income (it is only 7% in USA). if china households consume more (e.g. saving only 20%) it will greatly boost the consumption economy.
• The Chinese are saving more due to rising property prices, and culturally they need to help finance a house for their child in preparation for marriage.
• will china population grows old before it grows rich? that is one risk
• new gen is a socially conscious group, more passionate about environment, sustainability, societal injustice, appetite for purpose and drive and hard work, but also seek happiness beyond wealth.

Paradise and Jungle, The Story of Chinese Firms

• two distinct types of firms, SOE and private
• SOEs are in paradise, provided guarantees, loans, contracts by government
• private firms are in jungle, always tested by ruthless competition and only the best can survive
• private firms have outperformed SOEs, but instead of getting eliminate, SOEs found ways to collaborate and coexists with private firms.
  • SOEs didn’t do well not due to the stereotypes of lack of competition and innovation. executives are motivated to perform well and climb and ladder in the political party. the issues were they often focused on quick wins (like venturing into real estate for high growth) instead of innovating on core businesses
  • private firms was able to flourish thanks to Deng’s reforms. Private firms are flexible in making decisions, able to enter and exit the market, without aligning with political party objectives.
  • SOEs were merged or dissolved in the late 1990s reform and this revitalised them and made them more competitive
• it is more of a yin-yang balance
• private firms need government to help approve and unblock their businesses, and governments also need private firms to improve their local employment and GDP, which is the government’s KPI. this created a symbiosis. this relationship also helps to overcome challenges of immature institutions and imperfect free market in the country
  • state government attracts private firms to help incubate innovative startups (e.g. Nio in Hefei and XPeng in Guangzhou)
  • this old model of collaboration was clamped down by anti-graft sweep in 2013
  • the new model sees SOE becoming share holders of private firms. this allow the joint venture to get preferential loans and contracts. but since SOEs are minority stake holders, businesses still have the flexibility to make sound decisions to remain competitive
• china central government’s shakedown on big tech for monopolistic behaviours rattled some cages, but it was done to protect the consumers and the society
  • moving forward it is a balancing act for the central government to have good communication and predictable policies with the firms
• some foreign firms succeeds in china while others fails
  • it depends on whether the firm can adapt to the government policies
  • it also depends on whether they can respond fast enough to stay competitive to local competitions
  • JV between foreign and domestic firms statistically performs better than pure foreign/domestic firms
• the new gen of entrepreneurs dream big, are nimble and are innovative. prospect remains optimistic

The State and The Mayor Economy

• 3 prominent features of the state:
  • power: it has resources and admin skills to mobilise rapid and collective actions in service of the nation’s goal
  • political centralisation with economic decentralisation: it provides room for creative local business activities under central guidance
  • adaptability: adapt to changing circumstances rapidly and flexibly, dialling back policy measures and shift between priorities
• how China Inc. works?
  • a gargantuan organization, with top management (central govt) trying to maximise both revenue and sustainability by motivating employees (state govt)
  • ensure bureaucracy does not bury innovative ideas
  • the fundamental challenge is how to align the best interests of employees with the goals of the management and the shareholders (general public)
  • the central government is the senior management team, in charge of HR, COO, marketing, CEO, CFO
  • the state government are individual department managers, trying to make their departments meet the central leadership KPI
  • like any large corporation, designing a good incentive structure is key
    • economic achievements of local govt officials will translate to political capital and allow them to move up the party’s hierarchy
    • local govt builds political connections with senior party members by aligning themselves to central directives.
    • political connections and good performance are essential factors to promotions
• china has an adolescent financial system, and inadequate legal system, and if left to the free market, it will result in inefficiencies and market failures.
• the state fulfils the role of interfering and patching does inefficiencies
• maintaining central control and power is always a challenge
  • granting power to local govt creates more flexibility and promotes more innovation.
  • but that also creates opportunity for corruption. anti-corruption drive may reduce motivation and incentives.
  • local govt must achieve a baseline target to qualify for promotion, and then they will be compared with other states. this attempt to create a fairer system.
  • but too much competition may result in local protectionism that doesn’t benefit the nation as a whole
  • so the central govt also address this by requiring officials to rotate from their positions
• beyond GDP, china is looking to grow more sustainably and focusing on higher quality and safety standards
• for CCP to maintain legitimacy of their rule, they must respect the voices of the people
  • this include proactively addressing social issues without waiting for the legal system that may not be so mature yet
  • social media although controlled, also provides an avenue for citizens whistleblowing
  • to match the rising expectations of the chinese ppl
• every economic system has its tradeoff
  • centralised regimes - good for long term commitment, less effective for accountability and flexibility
  • political pluralism - represent more diverse populations, but weak collective action
  • democracy - gives social legitimacy, but competition between parties lead to a race to the bottom. it can also be distorted by money and power of special interest groups.
• is china system robust (resistant to shocks) and resilient (able to absorb shocks)?
  • robust - central power, admin capacity, financial muscle
  • resilient - the states are agile and ready to make changes
  • but overall robustness outweighs resiliency. therefore in the face of shocks, not enough institutions or elements in the economy will help to buffer and recover from the shock, and govt will need to incur capital costs to stir the economy back on track.
  • the risk is, if the economy is always cushioned by the govt, will it ever learn to be resilient and is the cost sustainable.

The Financial System

• china financial system is debt-heavy.
  • firms rely on the bank to get credits
  • missing other elements like investment funds, insurances, to provide credits
  • central govt also controls the central bank and allocate credits to specific industries and it is mercurial
  • this results in a primitive system that cannot match the west and this explains the unique behaviour of china financial system
• the central govt use stock market and bond market as a tool to help ailing SOEs secure credit
• the stock market performance does not correlate with economic performance
  • selection process to be listed is stringent, and generally only large cap SOEs made it
  • therefore, there are limited upside for those stocks
  • also, these companies, even if they perform poorly, are allowed to stay afloat in the exchange, which weighs on the overall market performance
  • after raising funds from the market, some of these companies did not deploy their funds to innovating or improving core businesses, resulting in poorer performance over the long run
  • chinese stock market most of the participants are retail investors. the lack of institutional investors caused the market to become highly speculative and volatile
• real estate accounts for 60% of household assets
  • all actors in the economy rely on the real estate industry remaining stable
  • it is currently experiencing a bubble.
  • but china is large, and price rose at different rates for different cities and tiers of cities, so the true state of housing situation is not what we see with common data
• how the real estate industry reached its current state
  • reforms in 1994 changed the legal system
  • state government cannot retain tax revenues and cannot borrow or run budget deficits
  • to fund more projects, they started to lease out their land to businesses
  • and as the land developed, it attracted investments for other projects to service the people moving into the land, like infra and amenities projects
  • construction cost is low, so real estate developer profited while state government gain a good source of revenue
  • so the industry continue to grow and heat up until now where developers become over-leveraged, which caused the housing debt crisis once central government starts to clamp down.
• regardless, it is still in the culture of the chinese society to purchase property
  • financial market don’t offer better returns for them
  • and housing is required for marriage
  • and chinese family can deploy 6 wallets for their one child
• so it is a bubble, but the situation may not be as dire as we think
• shadow banking is huge and important in china
  • banks, commercial trust companies, private banks, etc. act as a bridge to connect deposits to state govt and SOEs borrowing for huge projects
  • these are sold as wealth management products to consumer, and it is off the bank’s balance sheet and not subjected to deposit and liquidity regulation with no capital guarantees
  • the central govt implicitly allowed this system to flourish as they are not able to fund all state govts for all the projects that are happening
  • to combat financial crisis of 2008, central govt announced fiscal stimulus package but didn’t provide full funding for state govt, and state govt had to resort to shadow banking (through state owned intermediaries called Local Govt Financing Vehicles LGFV). LGFVs does not breach the regulations of central govt.
  • shadow banking helped to successfully roll out the stimulus package and fund many projects for state govts afterwards.
• banking in US vs China
  • banks in both countries always want to skirt regulations
  • in the US, banks used more sophisticated and exotic financial products, and entities and institutions are entangled in a web of interdependencies as they repackage and sell the products.
  • in china, it is more straightforward and the shadow funds get funnelled into real estate ultimately.
  • so perhaps the straightforward nature of china’s financial system will not be as damaging if the bubble burst, as compare to the 2008 crisis that caused a chain reaction in the US.
• outlook for china’s financial system
  • high debt. need to look at whether growth rate can exceed interest rate
  • crisis are always a crisis of confidence. the govt has a lot of influence and is able to alleviate fears by bailing out, but may not be sustainable as they need more debts
  • china central govt has also taken steps to deleverage the economy, e.g. allowing property developers to fail instead of bailing out.
  • china financial system is faced with a perennial dilemma. it is not mature yet, so the central govt always wants to intervene and preserve stability. but constant intervention will create more distortions and the system will take longer to mature.

The Technology Race

• two types of innovation
  • from zero to one
  • from one to N
• china is good at one to N innovations. new application of existing ideas and innovations.
• china firms are able to leverage on economies of scale, to gain a cost advantage
• china tech firms also has excess to a bigger set of more relevant data from china consumer and is better able to compete with foreign firms within the domestic market
• china is also able to benefit from technological leapfrog as it started from a more backwards state. the other countries may already build inertia to change as their current tech still works.
• the nature of tech product makes a difference in the market structure. search engine, e.g., is a global product, while ride sharing is a local product that needs more local customization to adapt to the market.
  • so search engine has globally dominating players while ride sharing has local players sharing the market.
  • in the global market typically the better tech wins
  • in the local market, other factors like marketing, local taste and preferences plays a part in success.
• chinese firms are able to adapt to other countries local conditions, as their own domestic state govt are equally difficult to deal with. this experience puts them ahead of western competitors who came from a mature western system
• for zero to one innovation, this is the current situation is china
  • there are 3 important factors, markets, money, talent
  • central govt is able to direct the markets and the resources to focus research on tech that aligns with their strategy
  • what china is lacking is talent
  • even with the enormous investment in research and universities, some innovations can only come from trial and errors, so they must be allowed to fail.
  • but the chinese system is too impatient to accept failures, allow a free market to experiment and come up with innovations
  • the tech war that is happening also stops the free exchange of ideas between US and china
  • but chinese entrepreneurs are hungry and hardworking, and they may be able to come up with the next wave of innovation

China’s Role in Global Trade

• china’s entry to global trading system is unprecedented
• after joining WTO in 2001, china’s share of global GDP more than doubled by 2020 (from 7.8% to 19%)
• the world was gripped by hyper-globalization between 1986 to 2008. countries embraced open trade enthusiastically
• china joined WTO in this receptive environment with an inexhaustible supply of cheap labour and a large consumer base
• the world today is interconnected by a global value chain. any disruption in china can cause a ripple effects to all parts of the world
• china presents a both a threat and opportunity for the world
  • yes other countries manufacturing firms will be under threat of cheap labours and cheap imports from china
  • but other firms will be able to lower their production cost by buying from china suppliers and also boost revenue by selling to china consumer
  • so the winners and losers of global trades are in different sectors, and these tends to be hidden from politically charged narratives
• it is hard to establish fair trade
  • developing countries feel that some trade agreements are unfair as advanced economies are trying to flood them with higher end goods without giving them a chance to develop their nascent advanced manufacturing industries
  • developed countries feel that some developing countries like china are abusing their status in WTO, subsidising some industry which artificially made some goods cheaper, which out competed their domestic firms.
• conclusion
  • china’s success as a global trading power is thanks to its own domestic economy
  • and the hyper-globalization environment of other countries
  • and the inevitable decline of uncompetitive manufacturing industries in other countries
  • no other country, except maybe india, will rise up as a global trading power of equal
  • and that is what the world needs to adapt to. the world cannot move forward without china, and neither can china without the world.

On the World’s Financial Stage

• china adopted capital controls and held fast to a stable exchange rate.
  • china seeks long term FDI, but discriminated against open flow into stocks and bonds
  • this prevented major currency crisis or banking crisis
  • but this also prevented participation of institutional investors in china’s market
• but there is some weakness is this system
  • china companies exploit carry trade, borrowing overseas for cheap to make higher returns on domestic interest rate, knowing that exchange rate is held constant
  • the flood of capital eventually need to be pulled back to return the debt, causing the largest flight in 2015 and caused devaluation of the RMB that even china govt could not stop
• USD is the default currency for trade settlement
  • this protect US companies from fluctuations
  • and it is self-reinforcing, as more overseas businesses are willing to borrow in USD
  • which becomes an enormous political leverage for the US govt
  • and being such a financial anchor to the world is indeed appealing for china
• for china yuan to play the role of a fully international currency, it must
  • be held in reserve by central banks around the world
  • be used to invoice trade around the world
  • the currency of denomination used for corporate and government bonds and back loans
  • other countries can peg their exchange rate for stability
• if RMB do become a counterweight to USD, it is good for the world
  • the world will be less affected by USA domestic crisis
  • trade and govt around the world can fallback to alternative currency if USA abruptly change their USD policies
• china still has a long way to go to meet the criteria
  • it is a leading trade nation, so role of yuan in central bank reserves and trade settlement has potential to grow
  • but its financial market is not mature, which is preventing more financial activities to happen in RMB
  • all international players also need the currency, and therefore the central govt, to be predictable, credible, and stable. so this aspect is still considered risky for most players when they look at china
• a likely situation for the near future, will be regional currencies dominating
  • Asia will use RMB
  • Europe will use euro
  • everywhere else will still use USD
  • in the longer term, likely 2 central banks will dominate the world, US Feds and China central bank

Toward a New Paradigm

• China’s economic model represents a unique synthesis that transcends traditional classifications of socialism and capitalism
• China’s distinctive blend of state control and market forces has propelled its rapid economic ascent, challenging the notion that there is a singular path to prosperity.
• China’s approach is deeply influenced by its cultural and historical context, which has shaped its economic structure and policies
• understanding these unique characteristics is crucial for comprehending China’s role in the global economy and for fostering more effective international engagement
• China’s experience offers valuable insights into alternative pathways for economic development. This new paradigm calls for an appreciation of diverse economic systems and acknowledges that different cultural and historical backgrounds can lead to varied yet successful economic models