China’s rise and the new contradiction

Held on 14^th December, the Chamber’s annual conference, China’s Rise: The New Contradiction, was an exciting event. Speakers that included ambassadors, business leaders, economists and academics guided attendees through the complex recent political developments and presented some possible outcomes. Over the course of the day one thing became apparent – the recent announcement of the ‘new contradiction’ by President Xi Jinping at the 19^th Party Congress, ensures that the economic environment will continue to rapidly evolve for the foreseeable future.

As the conference panels were conducted under the Chatham House rule, the following summarises some of the key discussion points and does not represent the complete views of any of the panellists who participated.

Keynote speeches
In his opening speech, Mats Harborn, president of the European Chamber, discussed the contradiction inherent in China’s “rules-based regime” – how there is a lack of economic reciprocity and fairness. He stressed that reform would be beneficial to China and that failing to open up would be a blow to the country’s economic development. So far, investment in China has been lacklustre with the European Union (EU) having only invested United States dollar (USD) 8 billion in 2017. President Harborn pointed out, that if one were to look at the investment ratio in reverse, how much China invests in Europe, one would expect Europe to be investing close to USD 120 billion.

Expanding on the EU-China trade relationship, President Harborn reminded the audience of Europe’s “promise fatigue” and asked for clarification on the Communist Party of China’s (CPC) role in the economy. This lack of clarity has resulted in domestic state-owned enterprises (SOEs) jokingly being referred to as opaquely-owned enterprises (OOEs), due to their lack of operational transparency. Despite these setbacks, the European Chamber has had a number of successes in 2017, with its publication on CM2025 and its impact on the future rollout of a comprehensive negative access list.

Also delivering a speech, HE Hans-Dietmar Schweisgut, EU ambassador to the People’s Republic of China and Mongolia, emphasised the recent economic developments taking place in Europe. According to Ambassador Schweisgut, there is a general feeling that Europe’s interconnected economy is getting stronger. The EU has seen 2.4 per cent economic growth in 2017, exceeding that of the United States (US) for a second year in a row. There have been 8 million new jobs and the quality of economic growth in Europe has continued to improve. Contributing to this improvement in quality has been the Junker Fund, which has led to euros (EUR) 250 billion of investment.

While the EU has seen phenomenal growth from openness, the role of the market as it was outlined in the recent 19^th Party Congress was decidedly different. The Chinese Government is tightening party control over joint-ventures (JVs) and is strengthening SOEs. Ambassador Schweisgut noted that in the European Business in China Business Confidence Survey 2017 56 per cent of businesses said they would invest more if the government were more transparent and foreign-invested enterprises (FIEs) received more market access. He went on to say, that despite recent concerning government policies being implemented there are still many possible areas of cooperation with China, including on State Council Document No. 39 and a comprehensive agreement on investment.

The keynote speech was given by Zhang Xiaoqiang, former vice chairman of the National Development and Reform Commission of the People’s Republic of China (NDRC) and executive vice chairman of the China Centre for International Economic Exchanges (CCIEE). Executive Vice Chairman Zhang detailed the economic setbacks in trade the world suffered last year. However, he highlighted how China’s foreign trade might increase to the point that the country becomes the world’s number one trader. China’s consumption levels have stabilised and sales are up in certain sectors of the economy, like the automotive and telecoms industry. Executive Vice Chairman Zhang emphasised that China is entering a new era and if it stays on its current trajectory it will achieve modernity by 2035. He acknowledged Europe’s requests for economic reciprocity but stated that China could not at this time offer reciprocal market access as “China is currently the student and Europe the master”. The executive vice chairman called for Europe and China to “overcome their misunderstandings” and work together in the global economy.

Panel 1: Perceptions from the 19^th Party Congress
Xi Jinping Thought was enshrined in the CPC constitution during the 19^th Party Congress. Over the course of the meeting it became apparent that President Xi was now the unchallenged leader of a national party that is stronger than ever before. No heir apparent emerged during the national meeting and even though he does not appear to be as strong as Deng Xiaoping was in the late 80’s/early 90’s, the panelists were in agreement that President Xi will at least remain in power for another 5 to 10 years. This is important, as the CPC currently governs everything and is moving away from the more technocratic future outlined under former President Hu Jintao.

The management of China’s economy has broken with tradition since President Xi has taken power, as the Party is increasingly being told to play a larger role in the day-to-day operations of the economy. This has resulted in a series of mixed outcomes. For example, one of China’s leading tech firms was told by the government to invest in China Telecom, resulting in recent growth in the telecommunications industry. However, the central government also forced parts of the country to prematurely transition to natural gas, resulting in people suffering from the cold due to coal production being prematurely shut off. Greater party involvement in domestic industries has also meant Chinese overseas direct investment (ODI) being seen as suspect. Western countries have increasingly called for greater investment screening and have resisted Chinese businesses’ attempts to make purchases in sensitive areas of their economies.

Recent developments in China’s economy may seem confusing or overwhelming. Foreign governments and companies must grapple with this recent change in China’s domestic environment and consider the ‘political risk’ of doing business on the mainland. In China, FIEs must tread carefully, a lesson foreign governments have already taken to heart when considering massive international projects like the Belt and Road Initiative. Tighter security for cross-border transfers has made international companies war y and if this trend continues, domestic Chinese businesses might also become fearful that reciprocal action may be undertaken, preventing them from going international.

Panel 2: China Inc’s outbound ambition
China’s ODI rapidly increased in the late 1990s and continued through the early-to-mid 2000s. Every country aims to have foreign influence and China is no different. Most SOE outbound investments in China’s early days were in natural resources. However, China has evolved and is now acquiring foreign companies in order to gain access to Western industries and improve its domestic operability. These recent acquisitions have raised concerns in Europe due to their lack of transparency and level of state involvement.

Despite foreign government concerns regarding the level of Chinese ODI, in 2017, investments declined by approximately 40 per cent. The Chinese Government reacted to foreign suspicion and domestic concerns, regarding high-risk financing and large capital outflows, by limiting the average deal size and restricting the number of overseas investments. After the 19^th Party Congress, central government pressure on capital outflows does not look to be relaxed anytime soon.

Responding to China’s ODI, Western governments and businesses have increasingly called for increased reciprocity. China has consistently claimed that full reciprocity might not be possible since national governments and economic controls are fundamentally different.

While that may the case, it has still not stopped foreign businesses from asking the Chinese Government for more to be done. The country’s Negative List for Foreign Investment does not seem comprehensive enough to many FIEs, and with the recent strengthening of party committee power in private enterprises and the recently implemented Cybersecurity Law, foreign companies are becoming increasingly wary of doing business in China. Overall, there is a perception of China opening its market but doing so at a glacial pace.

Panel 3: Discussion on China’s economic outlook in Xi’s new era
There has been a lack of clarification coming out of the 19^th Party Congress on what economic development should look like and what the growth benchmarks should be. Despite risk management being a prominent economic issue, there was no mention of it. This is important, as the vagueness concerning China’s growth levels could potentially be seen as the Chinese Government moving away from gross domestic product (GDP) targeting.

The central government may be moving towards valuing growth quality instead of quantity. A growth adjustment might take place relatively soon and having a hard target in place that the country must meet might be “poisonous” politically. If China wishes to grow sustainably, it must continue to focus on increasing household income. It is a leap to say that China has become less credit dependent, as the government still derives most of its debt from credit, hurting the economy in the long run. Instead, the government should reduce its debt by shifting it to household income. This shift moves China’s debt into a place that can be more easily monitored.

China is not really a market economy and if there is a major problem the government can restructure and limit the impact of any potential economic bust. Even though China has that capability, it is still dangerous for the economy to remain this unbalanced, with its household consumption percentage of GDP being extremely low. The country must rebalance the economy in order to reduce the amount of debt it has. It can go about rebalancing in one of two ways. It can transition into a more mature and slower-growth economy like Japan or suffer a financial crisis. While a financial collapse might result in a better economic outcome in the long term, the country is much more likely to do a longer adjustment with slower overall growth. This restructuring must happen, as a country cannot grow its way out of debt. Instead, China must deleverage.