China Bullish Thesis Revisited
Should we really expect above average returns for Chinese investments?
If you are familiar with my writings on Seeking Alpha, you know that I am bullish on major Chinese technology companies — including Tencent, Alibaba and Baidu — and you might also know that I see China as potential candidate for becoming the next global superpower.
Recently, Ian Bremmer published an article titled Has China’s power peaked? and I will take the article as a good basis to question my bullish thesis. In the following article we will look at several statistics to answer the question if China can become the dominant superpower in the 21th century and supersede the United States in the coming year.
Increasing Labor Costs
One rather bearish argument Bremmer brings up in his article are the rising labor costs in China in the last decades. China’s rise over the last few decades was mostly built on cheap labor costs which led many European countries and North American countries (especially the United States and Canada) to outsource production to China.
And it is a typical pattern that countries getting wealthier and economically stronger see increasing labor costs and are therefore less competitive with other countries. When looking at the data, we clearly see China getting more expensive for companies that are outsourcing production. India for example is offering cheaper labor costs, but when comparing it to many countries in Europe, the United States or Australia, production in China is still extremely cheap.
Therefore I don’t know if I would endorse the argument that China is not competitive anymore due to higher labor costs. Especially as China is moving away from low quality products towards rather high-quality technology products and services, I don’t know if we should focus so heavily on labor costs. And Bremmer is pointing out that China is leading in several important fields:
China continues to invest massive state resources in advanced technologies, and it has already achieved parity or surpassed the US in many fields (e.g., voice/facial recognition, smart infrastructure, telecommunications, and electric vehicles). If AI ends up becoming the new commanding height of the global economy (as I think it will), China’s data advantage and strong AI talent pipeline will make it competitive if not dominant.
Soft Power and Trade
Aside from China’s competitive advantage not being cheap labor anymore but rather a leading position in many technology fields, another aspect that should not be ignored is the conecpt often described as “soft power” — the concept to rather co-opt than to coerce (described by Joseph Nye). Apparently, China’s Belt and Road plans are losing momentum, but we have to see what the coming years and decades will bring. Ian Bremmer is writing:
This is embodied by the United States’ explicit policy of containment of China’s tech sector as well as China’s growing strategic encirclement in its own backyard — where Japan and South Korea are increasing their defense spending, Taiwan grows more defiant by the day, and new anti-China alliances like the Quad and AUKUS are blooming like algae. Relations with India, meanwhile, have become more competitive on the back of military clashes on the shared border, causing Delhi to draw closer to Washington.
But we also can’t ignore that China managed to build trade relations with many countries around the world and has become a real competitive threat to the United States over the last few decades. And at least in 2018 (I don’t think the picture changed much in the last five years), for most countries around the world China was the larger trading partner — and not the United States.
Shrinking Population
One of the hardest arguments to invalidate is the shrinking Chinese population. Of course, these numbers are projections but it seems like the Chinese population will shrink drastically in the coming decades.
And a shrinking population will be a massive challenge for a growing economy. Especially as it seems like highly qualified people might leave China due to the heavy interventions of the government (the tech sector has been hit hard several times). High levels of uncertainty and the risk of constant and huge government interventions might not only scare the talent away that China has but also unsettle investors.
We can also see this when looking at companies like Alibaba and Tencent as they are struggling to grow and also seem to try to comply with the Chinese government — which might come at the expense of innovation.
Declining GDP Growth
We can also make — the rather bearish argument — that China’s GDP growth is slowing down. Especially when looking at the data since the Great Financial Crisis in 2008 we see GDP growth constantly slowing down (including projections till 2028).
But I don’t know how solid this bearish argument is. Despite growth slowing down, GDP growth is still projected to be above 5% in 2023 and in the coming years growth is projected to be around 4%. And especially when comparing the growth in China (projected numbers for 2023), basically no developed country can match this growth rate.
Investing in the future
When trying to answer the question if China can become the next superpower, Ray Dalio’s book The changing world order is definitely worth reading. And among the eight determinants Dalio is using in his book to measure the power of an empire (or country), are military spending as well as education. Both are investments in the future and can help a country to rise and gain power.
When looking at the public spending on education (as share of GDP), we can see China constantly increasing its spending over the last decades, but it still doesn’t match the spending of most developed countries (and especially countries like Sweden are way ahead).
And it is interesting to see — and I was very surprised — that China is obviously spending only a fraction of its GDP for its military. China is spending less than the United States, the United Kingdom or France. And what is especially interesting — the spendings of China are nowhere close to the spendings of the United States in the 1950s, 1960s or 1970s. Of course we should not ignore the just ended World War II and starting Cold War, which led countries probably to higher military spendings. Nevertheless, China’s spendings today are nowhere close to the amounts the United States spent in the years when it rose to become the global superpower.
Among the eight determinants are also the share of world trade (which we already mentioned above) as well as inventiveness and technological development (also mentioned above). And based on these metrics we can certainly make the argument for a rising Chinese empire.
Conclusion
If the premise of a rising Chinese empire challenging the superpower United States is correct, the next few years might not become very pleasant. Times of one superpower challenging the other (and it doesn’t matter if it’s successful) are often times of external conflicts (including hot wars) as well as internal conflicts (civil war and political as well as economical turbulent times — especially for the declining superpower).
While we certainly can ask how bullish we should be about China, from an investor’s point of view, China does not have to become the next global superpower for investments in China (and Chinese companies) to be very profitable:
- Countries like Germany, France, Sweden or Switzerland have never been global superpowers. But investing in these countries (and companies) was still extremely profitable in the last decades. Not only investing in the United States was a good idea in the last few decades.
- It also seems likely that GDP growth in China will be higher than GDP growth in most developed countries and investors can profit form these higher growth rates.
- And while growth (or GDP growth of a country) is the decisive factor over the long term (several decades), the valuation of a stock also pays a crucial role in short-to-mid term investing (several years up to one decade). And stocks like Alibaba, Tencent or Baidu are trading for extremely low valuation multiples making them still potentially great investments.
Subscribe to DDIntel Here.
Visit our website here: https://www.datadriveninvestor.com
Join our network here: https://datadriveninvestor.com/collaborate
