China Begins to Open its Global Thinking

We have seen some very interesting news this last week.  After revisions to its system of calculating purchasing power parity (“ppp”), the World Bank’s International Comparison Program released revised GDP ppp forecasts that indicate China’s economy is on track to overtake the U.S.A.’s and ascend to the position of world’s largest economy in ppp terms later this year.  But as they say, size is not everything, and both countries might wish to have smaller and smarter economies.

The implications of these revised calculations are significant.  Still, there have been two other recent news items about China that I found both more interesting and more in accord with my sense of important trend lines.  The first was the report by The Telegraph on 2nd May of an interview with Ren Zhengfei, the founder of Huawei Technologies Co, China’s largest telecom equipment maker and the world’s second largest.  In the interview, he reasoned against an IPO for his company, because going public would put the fate of his company in the hands of private investors whose focus on short-term profits and lack of concern for the long-term success of the company would undermine the company’s position.

He suggested, as I read it, that the corporation’s mission was inconsistent with the chief goal of most private shareholders, immediate returns.   How right he is.  I have often said that Western company leaders do not yet realise that profit is not the number one consideration for Chinese companies, that not only have a different focus on long-term growth and stability, but that also view the Western drive for quarterly profits as our Achilles heel.

These primary foci suggest very different modes of thinking about how and why to invest.  Rather than highlighting differences and drawing lines in the sand, perhaps it is more prudent to focus on areas of mutual interest to both Chinese and Western businesses, such as joint companies with specific areas of interest and enabling each other’s companies to access each other’s markets more freely.

Unfortunately, working on developing these areas of mutual interest is obfuscated by competing free-trade areas (“FTA’s”) that collide with and hinder one another.  It is possible to imagine a post-WTO world where global companies accept regional companies and state companies as thriving parts of the innovation and sustainability that we all need.

For now, however, the U.S.A. and China appear to be in competition over whom should hold the leaders chop for FTA’s.  Shared leadership would suit both countries and the rest of the world better than competition over this issue.  It will take another 5 -7 years for this issue to resolve one way or the other.  In the meantime, spin will predominate, and the world’s smaller economies will take time to try to evaluate the best way forward.

To me, it seems, the protectionist, proposed North American Free Agreement – European Union super bloc, and the Trans-Pacific Partnership Agreement project are based on a concept of the globe as being manageable by powerful forces. I suspect the global market may be too fluid for that to happen.  But who can be sure?

The second story is about the new Chinese ownership of Western brand House of Fraser and its plans to move into China with at least fifty new stores, in a move similar to that of the new Chinese owners of Weetabix.

It seems that because UK retailers have not been able to grasp the Chinese retail market that the Chinese have decided to buy them out and introduce their products and brands in China themselves.  Why can’t Western companies succeed in China on their own?  Is it a Western failure or simply a case of the Chinese preferring to do things in their own way?

I remember asking the head of a large UK retail chain what he thought the Chinese meant by raising their export value. He replied that it meant exporting higher value goods. Yes, but what goes into that concept of value?  In the west export value is equivalent to the selling price of a good inclusive of freight, insurance, and other charges—essentially the selling price for goods at their port of export if not sold.

The Chinese, however are not speaking of export value in the black-letter definitional sense, but rather of the value added to exported products through retail service, often worth much more than the product itself.

The Chinese have learnt this from the Japanese and are buying Western firms to build retail capability in China; thus we have the purchase of Smithfield Foods in the U.S.A., Volvo in Europe, and Weetabix and House of Fraser in the UK.  I expect this is just the beginning of a major trend in Chinese investment.

The best entities to handle Mr. Ren’s concerns and the advent of Chinese buying of brands and products to export back to China, are private equity companies.  Arguably these are business organizations that led with junk bonds in the late 70’s, exploited the unregulated financial bonanza of Reagan and Thatcher, and morphed through the Savings and Loans crisis of the late 1980s and early 1990s, coming out in more recent times as practitioners of medium-term growth.

It is the 5-7 year portfolios of these firms coming from investing in future growth that can most easily appeal to and work with the Chinese.  Perhaps the Chinese had already worked this out in 2008 when they bought a ten percent share of Blackstone.  Regardless, I think the Chinese will increasingly find sophisticated, Western, private equity firms as good partners. They will show China how to manage and grow a Western company, and they will exit after 5-6 years in pre-agreed formulae, leaving the Chinese with healthy, well-run companies, at least in a supermajority of instances.

Business is changing and the Chinese and private equity will outfox corporates like Pfizer and Astra stuck with the mentality of quarterly profits that requires ever larger, ever more costly acquisitions as the only way to grow.  Western private equity will succeed with China outside China, and then inside China.  True, China may block foreign majority ownership of certain core industries, as was the case there with Carlyle Group, but this policy is practiced actively in Western countries as well, so it should not shock foreign investors or prejudice them from investing in China. And aside from those relatively few core industries, foreigners will be able to acquire leading companies, provided they innovate in China, pay their taxes, and follow Chinese laws and regulations.

Marx wrote 150 years ago about the inevitable formation of ever, fewer, bigger companies as the destiny of capitalism.  He had foresight, but could not have foreseen all the faces of versatility capitalism would demonstrate, such as the role that private equity firms are now playing and will increasingly play.  Our Western leaders ought to look more to them to grow economies.  The Chinese will.

Interesting times …



Categories: China growth, Financial services, Investment, Policy

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