As investors look at the dizzy rate of reported economic growth in China – averaging almost 10% a year in recent years – it is easy to forget the downside. Here are five myths about the economy that need more debate.
1. Invest in the Chinese Stock Market to Share the Growth
Investors look at the dizzy rate of reported economic growth in China – averaging almost 10 per cent a year – and say to themselves that they must get exposure to that. The Chinese stock market is large, has many listed companies and large daily volumes. However, the attempt to benefit from China’s economic growth generally ends in disappointment as the stock market has a secular history of not reflecting the performance of the economy.
The reasons for this are simple. The main driver of economic growth over the last three decades has been the explosive emergence of the private sector, which has gone from being three per cent of the economy to an estimated 70 per cent (as estimated by Fan Gang in Business Week in August 2005). However nine of the ten largest companies on the Shanghai Stock Exchange are state-owned companies. For a long time it was difficult for privately-owned enterprises to have a flotation in China and even now they represent a minor part of the market’s capitalisation. Investing in Chinese stocks is not investing in the Chinese economy.
2. Fast Growth, Full Employment
A common assumption is that China’s high reported growth delivers jobs at a satisfactory rate. However, this is not the case. It is assumed, and particularly by the Chinese government, that a certain level of growth – usually said to be eight per cent – is needed to generate sufficient new jobs to employ the new entrants each year to the labour market. During the 2008-9 Western downturn, the expression “bao ba”, or “protect eight”, became an official slogan. However in fact there has been a decreasing linkage between economic growth and employment growth. If there ever was any validity in it even when the theory first arose in the 1990s, it has continuously unlinked. An estimate is that one per cent economic growth generated one per cent employment growth in the 1990s, but this later fell to 0.3 per cent employment growth and then to 0.1 per cent (see Pierre Bottelier, Jamestown Foundation, February 2009).
Now there is possibly no connection. This is a phenomenon we have seen in America and also in Western Europe since the 1950s. Economies often grow quite successfully without increasing jobs. What we perhaps need to appreciate is that the highly-prized productivity increases often mean raising economic output without a commensurate increase in the work force. In China’s case this often comes from increasing capital expenditure, and this is particularly true in manufacturing, which the country has emphasised. The official unemployment rate is a scarce changing four per cent figure, but quite misleading.
It is essentially an urban construct in a country where half the population are still rural residents. Until 2011, it did not include the up to 200m migrant workers who are at the marginal end of economic fluctuation. Total national unemployment is actually not officially measured but has been put at nine per cent and could have reached 12-25% during the downturn (the Beijing Review, January 2011 and this writer’s own research). It is an interesting phenomenon that, as the working classes disappear from the political lexicon, they are also disappearing from the workplace. However, they are still being born. The idea that China’s economic growth delivers sufficient jobs is very shaky.
3. China has never been a Colony
There is a widely-held view that China is unusual in the non-Western world in never having been under the authority of foreign rulers. This is a fallacy. There are two forms of prolonged foreign sovereignty which China has enjoyed during the last thousand years. One is the outright invasion by a foreign race from regions way beyond China’s borders, then or now. This is exemplified by both the Yuan dynasty (1279-1368), inaugurated by the Mongol Khublai Khan, grandson of Ghengis Khan, and the Qing dynasty (1644-1911), established by the Manchus, who originated in the Amur basin.
Both these dynasties limited the use of Han, or native, Chinese as officials to posts in government and brought their own languages. The Manchu specifically discouraged intermarriage between Manchu and Han Chinese. Sinologists, often obsessed with private visions of China’s unique position, will sometimes assert that nonetheless the foreign rulers eventually adopted Chinese customs and thus became “sinicised”, implying that in some way China had ultimately triumphed. One might say that occupying France and appreciating its culture during the Second World War did not Gallicise the German occupation. Any observation of history will make clear that the Ming dynasty (1368-1644) which replaced the Yuan was seen universally by the Han as a restoration of native sovereignty and even scant study of the 1911 rebellion against the Manchu will notice the driving racial imperative amongst the Chinese revolutionaries.
The other form of foreign sovereignty which China experienced was during the Sung dynasty (960-1279) when Sung emperors were regularly obliged to pay tribute to neighbouring foreign – non-Han – rulers, often accepting vassal status and being required to adopt such formulae as addressing the foreign ruler as “uncle emperor” from themselves as the “nephew emperor”. As a result, for two-thirds of the last millennium China was under the sovereignty of foreign rulers.
4. China is a Communist Country with a Socialist Economic System.
There is a flat 20% tax on capital gains tax, interest and dividends. Income tax rates do not exceed 45%. Corporate tax is 20-25%. There is no tax on inheritance. Those on the left would probably describe this as a deeply regressive tax system. Income inequality is roughly the same as in America and possibly higher. This is usually measured by the “Gini coefficient”; the higher figure being less equal. America is now at about 47 and China somewhere between 47 and 50. There is a large and vibrant stock exchange. Homeless people can be detained for “affecting the city’s appearance”. In 2010, a home in a big city cost 11.5 times average income and two thirds of employees had no pension arrangement.
The government of China accounted for a smaller share of national health spending than the US government even before Obama’s healthcare reforms. There are 119 dollar billionaires. One quarter of all luxury cars are bought by children of coal mine owners. A Tibetan mastiff was bought for $1.5m by a coal mine owner. An opinion survey found 42% feel that income inequality is the most urgent social issue.
5. China is becoming an Innovation and Research Powerhouse
China has a strategic goal to move from low-cost manufacturing to building a knowledge-based economy. Some large-scale state projects such as supercomputers, cyber activity and low cost space efforts are doing well. Foreign observers often seem to be impressed that there is broad and steep progress. However, in building a modern innovative and research-driven economy it is not impressing. In 2011 it spent 1.8 per cent of its GDP on research and development (R&D). This is called research intensity and compared with America’s 2.8 %. In fact a 2008 UNDP report didn’t place China in the top 20 countries for research intensity.
Academic work suggests that national R&D spending should best be driven by the private sector, not government, if the result is to be innovation and a vibrant economy. China’s research spending is driven by the government and foreign multinationals. Corporate expenditure on R&D is poor by international comparison. Even that is largely conducted by state enterprises. Private sector companies conduct little R&D. Multinationals spend on research in China largely to make their products more suitable for the Chinese domestic market rather than for innovative work to improve their global standards. Moreover, their goal is not to raise the Chinese knowledge base. They fiercely protect any IP they develop. Hence when we see estimated research spending in China it does not necessarily contribute to domestic prowess.
Patents won are generally the more humdrum utility patents rather than innovation ones. Moreover, we should question the wisdom of granting bonuses to officials in Chinese patent offices for patents granted. Plagiarism in the academic world is rampant and weakens any drive for excellence. INSEAD, the French business school, in its Global Innovation Index 2011-12 increased China’s ranking to the 34th most innovative economy out of 141 countries, placing it below Malaysia. The country is not well rated in surveys on innovation or brands.
The exception is surveys of emerging brands which use as a basis stock market capitalisation and unsurprisingly conclude that quasi-monopolistic Chinese companies in oil, banking and telecoms with fat domestic profit margins and thus large stock market valuations have somehow become global brands, merely because their valuations are higher than similar companies in the West. China is currently far from achieving its strategic goals in building a knowledge economy.