There’s been a lot of media coverage about a slowdown in Chinese economic growth. Analysts on television have been endlessly droning on about how China growth will face a “hard landing” which will haunt its economy for the foreseeable future.
What sort of catastrophic numbers are we talking about that will soon bring, what is now the world’s largest economy, to its knees? A 7.4% economic expansion in 2014, and an annualized rate of 7% during the first three months of 2015.
Mind you, this is still the slowest pace since 2009, but that in itself is saying a lot. Many central bankers would kill to have their country’s economy grow by 7% per year.
In fact, China is the second fastest growing economy in the world (after Panama), that isn’t a frontier market. By extension, it is the strongest large economy in the world by far.
Many would argue that while China may enjoy 7% GDP this year, it could be 6% next year, 4% the year after that, and continue into a downward spiral that will eventually force the country into recession, or even worse.
There are several reasons as to why this will not happen. But it’s important to first understand China’s long-term strategy and the cards it has left in its hand.
A Brief History of China Growth
In the 1960s, and after suffering from the disastrous experiment that was the “Great Leap Forward”, the Communist Party sought to mimic the industrial revolution that many western economies had enjoyed centuries earlier.
However, by the late 1980s, the industrial sector took up so many resources and eclipsed the agricultural sector by so much that leaders were warning of widespread famine due to lack of food.
The answer to this problem was modern China’s first instance of privatization. Communes, often as large as tens of thousands of individuals, previous owned all farmland. Productivity and crop yields were increased without having to move workers from factories into the fields once land was privatized.
How? Incentives. When the farmland was owned by communes, everyone in that commune got paid the same amount at the end of the day regardless of how much work they did.
This led to laziness and everyone in the commune taking a “someone else will do it” approach. Once private land ownership was enabled, workers now had an interest in their land’s productivity.
Since then, the Chinese government learned the benefits of capitalism. They allowed privately held companies since then. Afterwards, Beijing allowed foreign owned firms. Even further down the line, state-owned companies started becoming privatized.
China’s government also pays attention to those around them. They have noticed the failures of countries such as India, avoiding the mistakes these nations made in their turn to capitalism.
For these countries, capitalism was not what failed. A policy of “overnight capitalism” which caused a shock to the system is to blame. Their entire government got thrown out and replaced without much warning. Those “in the know” took advantage of their less-informed countrymen, quickly using capitalism to build entire empires where everyone else suffered.
I was fortunate enough to spend two weeks at Peking University last year. It’s the closest thing China has to Harvard. I was there to learn, but not from a textbook.
One of the highlights of the trip was an hour-long lecture by one of the Communist Party’s senior officials. It was incredible learning more about China’s future plans, and the fact that they not only have a plan, but a very sound one.
He went over many problems, along with solutions to them. The answer to most problems often involved continued privatization for businesses and property.
The question is: how does all of this relate to China’s ability to avoid an economic crisis? Privatization of farmland spurred productivity to avoid famine in the 1980s. However, the same concept could also apply to many different things. China is certainly not a free country right now. There’s a lot of barriers left to break down.
By breaking down these barriers in the future, the Chinese government can enable further growth when they need to.
Many state-owned companies have not yet been privatized, real estate investment is a hassle for foreigners, freehold property doesn’t exist, and urbanization (and thus job prospects) is strictly limited.
Getting rid of these barriers is not a foolproof solution. But newly-privatized and more efficient companies could spur China growth. In turn, allowing freehold titles in a country which values home ownership as much as China does could help prevent a property bubble.
China wants to be capitalist. They’re just taking their time with the transition. They know that implementing a new form of government overnight would cause massive economic shock to a nation of 1.3 billion people.
Want to invest in China? Here’s three Chinese stocks which we believe are very undervalued.
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