Of all the wider implications of the coronavirus pandemic, geopolitically it appears to have magnified perceptions of distance and difference. The near cessation of travel is an obvious factor, but the differing responses to the pandemic, often influenced by differing cultures and political systems, against a backdrop of increasingly nationalistic and sometimes populist tendencies, have strained already turbulent relationships. This is particularly true for the US and China.
In 2021, and early 2022, these stresses coincided with a barrage of state interventions from the Chinese government as they built towards their ‘Common Prosperity Agenda’. This prompted an exodus of foreign capital from its equity markets, a risk that continues to loom large in the mind of investors.
It is worth reflecting on the rationale behind Beijing’s regulatory changes last year. As such, it is important to recognise the motive: the Government wants China to be a developed country, not an emerging market. This is not an easy task, and change was required if these aspirations were to be fulfilled.
Fundamentally, it was vital that the rule of law replaced an entrenched relationship-based system and so it should be no surprise that new rules are coming thick and fast to capital markets. Much of China’s industrial supply is currently positioned to serve export demand, but the intention is to repurpose this resource towards domestic beneficiaries, the so-called ‘Dual Circulation’ strategy.
Ultimately, the changes will address the longstanding problem of inequality, and foster a prosperous, secure middle class. This is obviously a global issue that is challenging many nations, but China’s government seems more attuned to the link between addressing this and its own legitimacy.
Undoubtedly, the pace of such regulatory change may be disconcerting when compared to the more incremental rate of change of developed markets. However, most of the interventions, when analysed in turn, are not unreasonable in substance.
Looking across the economy, is it unreasonable that financial technology companies, systematically critical to China’s credit infrastructure, have been asked to take a greater share of credit risk to align them with the objective of financial stability. Is it unreasonable that the after-school tuition industry, long a source of anxiety and economic burden for parents and students, that stoked inequality in educational outcomes, has been reined in. Is it unreasonable that e-commerce titans no longer wield advantages of scale to create unfair terms for their merchants. Is it unfair that gig economy workers are now given basic rights and protection, like their Western counterparts.
This is not to say that Arisaig admires all of China’s policy interventions, but we choose to look beyond the headlines. Since 1996, we have used cross-cultural insights to try and break through the apparent opacity of this market. We think China is worth it: the obvious scale, together with the high-level of economic complexity, the velocity of innovation, and the dense networks of talent all make for a bottom-up opportunity for equity investors that is incredibly rich.
China is not bent on the destruction of value; it is the deepest capital market in the emerging world. The overarching principle for China’s leadership is pragmatism, and a fair amount of trial and error. Deng Xiaoping’s remark, “black cat, white cat… any cat that catches a mouse is a good cat”, reflects the dynamic approach of the CCP to continually evolving problems. The reality is that no single system has the answer – to think otherwise is hubristic.
Our China exposure focuses on businesses with purpose aligned to that of the government, but which do not rely on government favour. We have chosen businesses who are masters of their own destiny and who grow with autonomous purpose to deliver value for a broad range of stakeholders.
Taking the e-commerce industry as an example, we think that China is undergoing a ‘digital leapfrog’ over underdeveloped, bricks and mortar retail. It differs from the US and Europe in that much higher urban density (there are 153 people per km2 in China compared to 36 per km2 in the US) enables more economic logistics than anywhere else. Put simply, e-commerce in China ‘works’ across a broader range of categories than in other countries – greater urban density increases both the variety and value of available goods, reducing spatial inequality in consumption.
E-commerce also supports the common prosperity agenda: the creation of a domestically focused, high innovation economy, built on a foundation of high quality, inclusive growth. The e-commerce industry bridges China’s enormous industrial supply base and burgeoning consumer class. We invest in a leading e-commerce player which serves double the number of consumers compared to Amazon in the US. It is the world leader in smart logistics, deploying drone delivery, with 3x[1] as many drones as Amazon. Though the company aligns with government objectives, its competitive advantage is internally derived. These companies are best thought of as technologically enabled supply chain solutions providers, and hence play a key role in the long-term development and modernisation of the Chinese economy.
While enabling domestic digitalisation can improve the lives of China’s 1.4 billion people, Chinese companies involved in decarbonisation have the potential to improve the lives of the global population. China, the global powerhouse of clean energy, hosts numerous world-leading businesses that will play a critical role in climate solutions for our co-dependent global ecosystem. Our failure to stabilise and empower emerging economies today, in terms of the climate change transition, is our reality tomorrow. China is prominent in global efforts to decarbonise and is a cost leader in many of the technologies that will enable the rest of us to do the same.
More broadly, China simply must be part of the solution. In the face of political uncertainty and environmental challenges, it would be short sighted to allow the fear of the other to triumph over collaborative strength. China cannot be ignored, and Arisaig intends to play a role in its low carbon transition that will benefit us all.
[1] 1,000 compared to Amazon’s 300, according to https://www.digitalcommerce360.com/article/amazon-warehouses/
