Opening the Chinese firewall

Prottoya Chowdhury | Friday, 20 March 2020

China has historically closed its financial markets to foreign investors and businesses as it strove to support local Chinese businesses and bolster its local economy, yet a recent change in the Asian titan's temperament towards foreign capital and investments reflects a paradigm shift. China is gradually opening the iron gates that have locked foreign investors and businesses from accessing its economy, and the nation aims to transition from a closed economy to a more globalized, interconnected economy that welcomes foreign investments as well as technology. Across the board, Chinese economic policy makers and key figures of the People's Bank of China (China's central bank) endorse the liberalization of the Chinese economy; surprising in a time of trade conflicts and disputes, many key Chinese leaders regard this liberalization of Chinese financial markets as well as ultra-competitive industries such as technology and aeronautics as the path that will propel China into the future. In a nation that has strictly scrutinized foreign investments and limited market access to foreign business, receiving such an appealing, even welcoming attitude to foreign capital and companies seems a little bizarre-it simply doesn't suit China's economic image. Now, while China's hyper-competitive, high-flying private sector in no way reflects and portrays ideals endorsed by the ruling Chinese Communist Party, China has closely guarded its economic treasures and powerhouses, namely its massive manufacturing and tech industries, and stimulated rapid growth and development within these industries by encouraging fierce competition between local rivals. China has rarely allowed foreign companies and investors to enter industries dominated by its local businesses. In the few cases where China has welcomed foreign companies-mostly large, US tech companies like Apple, Intel and Nvidia-into its marketplace, there have been a variety of wide ranging reports that have accused Chinese companies and the Chinese government of exploiting foreign companies to steal their intellectual property. Synonymous with companies in high-tech fields, intellectual property is the lifeblood of many large corporations that determines their profit margins and feasibility; as much as 80% of the value of companies in the S&P 500 index is constituted by intellectual property. For the US itself, US trade representatives have estimated that US companies lose between USD 225 billion and USD 600 billion annually as a result of intellectual property theft on the part of China. Thus, even though China is opening doors to the largest single market on the face of the earth, how should companies and investors who are looking to diversify their operations and investments and looking to access key frontier markets interpret this rather sudden move by the Chinese government?

The underlying market philosophy that drives China's economy has undergone a radical shift within the last seven decades. Upon assuming power as the Chairman of China in 1949, Mao Zedong, one of the most infamous communist dictators of the modern era, was fervently ambitious in industrializing China; he established his economic agenda in the First Five Year Plan (1953-1958), which grossly overemphasized rapid, uncontrolled industrialization at the expense of agricultural development and food source stability. Nevertheless, the Chinese populace labored on under the shadow of Chairman Mao, developing and constructing large industries by enlisting help from the Soviets. There was only one problem-the government dedicated little attention to prosper, and it was undertaking this massive industrialization program in a nation where 80% of the population still depended heavily on agriculture. Thus, by the time the Communist party had introduced China's second major economic policy, named 'The Great Leap Forward', there were gargantuan, hulking industries that employed thousands of people, but these were tin-foil industrial giants; China's manufacturing sector was producing costly, substandard goods that foreign buyers would not buy. The Great Leap Forward Plan, which Chairman Mao heralded as a plan that would revolutionize China's economy, failed miserably. And it brought famine and poverty with it. Ultimately, within five years of implementing China's second major economic reform, between 18-30 million people had lost their lives. As a result of this absolute disaster, Chairman Mao had damaged his reputation; however, he had not expended all his political power yet. Between 1966 to 1976, China underwent its infamous cultural revolution, which was aimed at reinforcing communism as improving Mao's image to the Chinese people-and it failed in spectacular fashion again. The cultural and economic reforms that were enforced on the Chinese people during this time thrust millions of them into poverty and snuffed between 500,000 to 2 million lives in the process. Quite a grim beginning for an Asian Titan.

And yet, Chairman Mao's eventual Successor, Deng Ziaoping was instrumental in eliminating toxic Maoist ideologies from the Chinese economy and embracing a more open, private-sector focused economic policy. After overthrowing Mao Zedong and several key communist figures, Deng stabilized China's agricultural system and food supply by introducing the dual-price system, which allowed price flexibility in agricultural products, and eliminating regulations that had enforced agricultural production during the Maoist era. While these policies delivered political, economic and social solace to a nation that had suffered communist oppression for two decades, the real boon which granted China its current windfall was Deng's gradual privatization of the Chinese economy. Beginning in 1978, Deng introduced an 'Open Door' economic policy which allocated certain regions of the country for large-scale industrialization projects and welcomed foreign investment into China's industrial sector. Within the next 2 to 3 decades, Deng encouraged further privatization of the Chinese economy by allowing local provinces and even citizens to assume control over state-owned enterprises. Allowing local groups of citizens to control businesses created a competitive atmosphere among different companies, which stimulated rapid commercial growth. Ultimately, throughout the 1990s and early 2000s, China witnessed several major economic reforms that catapulted its national economy the pinnacle of the world: the Shanghai Stock Exchange was opened in 1990, China joined the World Trade Organization in 2001, and roughly 50% of publicly owned corporations were sold to private investors and citizens between 2001-2004. 

Judging from China's economic development in the last 40 years, it suggests that the nation had rid its economy, at least, of invidious communist influences and embraced western business models. In fact, among developing economies like India, Brazil and others, China maintained the lowest level of tariffs on foreign imports, suggesting that the nation welcomed and accommodated foreign trade relations after the turn of the millenium. However, after President Xi Jingping assumed political power, the Communist Party tried extending its power over private and state-owned corporations in an effort to regulate certain key economic sector and restore political influence. This has led to the Chinese government carefully vetting foreign investors and companies before allowing them to conduct business and investment activities in China; in addition, the government limited stakes in local companies to not more than 51% of the company and restricted private foreign investment to less than USD 300 billion. Thus, China seems to have adopted western business practices and policies for its local economy, utilizing it as an impetus for competition between companies and industries, and a quazi-communist, protectionist ideology for its foreign trade relations.

Ultimately, China is opening its financial markets and its consumer markets to foreign capital and businesses for three main reasons: to curb China's economic slowdown, to stimulate competition within key high-tech growth industries, and to prevent its national economy from overheating.

Currently, China envisions one single goal: to reign supreme among global economies while exerting control and influence over key high-tech industries such as AI, IOT (internet of things) etc. Unfortunately, the engine that had been driving China's economy is losing its steam; China's GDP growth has slowed down to 6% for the most recent fiscal quarter of 2019, the giant's slowest pace of growth in three decades. While the skeptics may view China's economic demise as only temporary, caused by the nation's grueling, heated trade war with the US, one must accept this simple truth-the impoverished China that existed 50 years ago can hardly compare itself with the mighty, imposing East Asian force of modern times. In 1975, which marked the advent of China's meteoric ascent into the financial pinnacle, the median age stood at 21. As of 2015, the median age stood at 37, and it is on an upward trajectory.  In addition, in 1966, over 80% of the Chinese population was of working age, yet that number has plummeted to 37% as of 2016; the draconian one-child policy imposed during the Deng era is largely to blame as it limited natural population growth in China for a period of 36 years. Ultimately, the apparent shortage in the working age population of China is stalling its economic growth as a larger portion of its population have to depend on others for their livelihood. In addition, hiring in China's beating economic heart, its manufacturing sector, is on the decline. This implies China has saturated its manufacturing sector. Thus, if China is to achieve economic supremacy across the globe, it requires additional stimulus to drive its economy.

Technology is becoming a prized possession of sovereign governments, an object government like to use to show their abilities and powers, a bargaining chip government negotiators love to brandish to gain the upper hand. And past actions have shown that the Chinese government will undertake any measure to access key pieces of technology. The Chinese government and Chinese tech firms have been misusing their agreements and deals with foreign tech companies to gain unauthorized access to important pieces of technology; just examining local Asian market places for the plethora of fakes that are being circulated confirms this suspicion. Thus, foreign companies, especially US tech firms, are adopting more cautionary policies when conducting business with Chinese companies and state agencies. Thus, welcoming foreign companies into their local markets and allowing these companies to regulate themselves much like local firms helps calm foreign companies and opens negotiation pathways with them. Tech companies, like every other type of company, are hungry to amplify their profits and secure growing frontier markets as consumers because they guarantee their growth and future sustenance-and China satisfies all these criteria. China boasts a population of 1.4 billion people that will continue to grow for the next few decades, and its growing middle class can afford more luxuries as it enjoys the benefits of the growing Chinese economy. Thus, allowing foreign tech companies to operate in China will guarantee access to these technologies for Chinese consumers, companies and the Chinese government at a much cheaper cost than having to develop these technologies by themselves. However, in the grander scheme of the Chinese economy, to stimulate further growth, it is imperative to encourage competition in the local market among companies; competition has driven innovation and has also spurred commercial growth and expansion.

China has received a conventional approach to tackling low economic growth-lowering lending rates by sweeping margins. While China's central bank, the People's Bank of China (PBoC), has lowered its one year loan prime rate (LPR) from 4.25% to 4.2% and its five-year LPR from 4.85% to 4.8%, the PBoC will not adopt the US Federal Reserve's policy of cutting lending rates rapidly, which has offered businesses and consumers more than a couple of 25 basis points (0.25%) reductions in loan rates in the last few years. PBoC officials have, of late, repeatedly affirmed their intention to restrict local inflation and maintain current currency exchange rates versus the greenbacks. Most likely, this is a well-thought out move. Economies move in cycles, and at some point in the near future, the current upward economic trend will expire, and it will drag national economies down with it, including China. By limiting loan rate cuts, the PBoC is essentially preserving its firepower for a real economic recession as it has further room to pare loan rates; this will facilitate the PBoC's attempt to restart China's slowing economy when the real recession hits. Thus, as China's central bank adopts a more conservative stance on loan cuts for the current time period, when other central banks across the world are offering businesses and consumers large discounts on loans, it leaves China prowling for alternatives to rekindle its economy; inviting foreign capital and commerce is that alternative. Essentially, if China's economy can attract enough foreign capital and business into its local economy, it can achieve similar effects to that of lowering interest rates, only this time it is at the expense of foreign economies and not China's.

China's moves for opening its markets are clear: to benefit itself. However, China is an extremely profitable market with over 20% of the world's consumers, an offer that is too good to resist. Given this, foreign companies and investors and the Chinese people could be utilizing China's economic liberalizations for a win-win situation. Other large global economies that are comparable in complexity and size to China's economy, such as the US, UK and Germany, are encountering growth and expansion problems; many global businesses and investors present there have already saturated national markets and are unable to achieve their desired levels of growth. Thus, China, a developing economy but one that has proved itself able to sustain large levels of growth for an extended period of time, remains the only logical choice. Yet, as is the case with all developing economies, companies and business must exercise greater levels of caution when they choose to expand their portfolios and presence in the Chinese economy. For businesses, it is remotely possible that the Chinese government could introduce subtle regulations and measures that favor local corporations and grant these corporations the upper hand in the marketplace; additionally, it is imperative that these businesses adopt strict policies regarding intellectual property as foregin businesses have historically lost plenty of revenue to intellectual property theft in China. As for investors, they must familiarize themselves with the Chinese market and certain industries in which they choose to invest their capital.

China's decision to liberalize its economy and open its markets to foreign companies comes off first as sudden jolt, especially considering the Communist Party's actions within the last decade to regulate China's private sector. Yet, historical analysis of China's economic reform implies that China's leaders have tended to prefer an open economy ever since Deng Xiaoping ascended to political authority. Additionally, commerce today is not commerce from a century and globalizing operations, supply chains and production networks has become conventional for businesses and corporations that are looking to expand themselves and guarantee their existence in the future. While China embraced this philosophy in years past, the nation is transitioning itself into a full-blown, global economic powerhouse, and corporations, foreing governments and investors should treat this move in a favorable light. While slightly uncharted waters like the Chinese economy and marketplace might involve added security measures and constantly watching out for traps that threaten to put businesses and investors at a disadvantage, the move of expanding into Chinese economy, on balance, is extremely favourable. Thus, it is time for world leaders and skeptics to change their opinions of this Asian Titan-treat China as a thief and it will harm you but treat it like a business partner, and it could result in a windfall.