Tightening Regulation Explained: A Strategic Policy Shift and the Prospects for the Chinese Private Sector
This is an abridged version of an article of the same title by Chi Lo
A change in reform tactics
The economic recovery from the Covid-19 shock has given Chinese leaders the opportunity to tackle structural issues by strengthening regulatory oversight that favors the development of hard tech hardware and components over the expansion of “Soft technologies” (electronic commerce). This marks a shift in Beijing’s approach that had focused on consumer-led growth.
Beijing now wants to increase high-value-added manufacturing to support the development of technology and renewable energy industries in response to the changing domestic and international environment, including the intensification of Sino-US competition.
American national security hawks have successfully hampered the expansion of Chinese businesses through embargoes and supply restrictions. Even the most successful Chinese companies are vulnerable. Their supply chains are too dependent on the United States and its allies, as China lacks the capacity to produce key hardware and technology components. This vulnerability is driving China’s import substitution efforts.
Soft tech, in Beijing’s eyes, has attracted too much investment and only serves consumption and sectors that have little long-term strategic value.
Manufacturing is back
The manufacturing sector has regained favor with politics. This has positive implications for long-term growth.
China’s domestic sector began a structural rebalancing in 2005 with lower costs and improved infrastructure leading to industrialization to poor inland provinces. This resulted in a regional division of labor, with the costly eastern region shifting from manufacturing to high value-added service industries. The cheaper inland regions have resumed low value-added manufacturing.
The process was reversed in 2013 when Beijing made services and consumption the engines of economic progress. The idea was to improve the quality of growth, even if it meant a slower growth rate.
According to the current approach, industrial migration to the interior provinces is expected to resume, with high value-added industries dominating the trend. This will revive the dynamics of GDP growth and increase China’s productivity in the longer term.
The role of the private sector
Beijing attaches great importance to the development of advanced technologies and to reducing the dependence of supply chains on external sources. He sees innovation as a way to achieve common prosperity, digitization being the solution to improve economic efficiency and people’s access to modern services.
While he wants public entities to do the heavy lifting on technology investments, he wants small and medium-sized enterprises and the private sector to drive innovative change and finance the development of hard technologies.
In this context, China announced the establishment of a new stock exchange in Beijing offering SMEs a low-cost financing channel with simple listing procedures. This is a step towards the development of onshore capital markets so that they reallocate capital to the real economy.
It will also go a long way in facilitating common prosperity by redistributing wealth to SMEs and private companies away from the public sector and conglomerates. The new exchange can be seen as a signal that private companies would be encouraged if they helped achieve the country’s strategic goals.
Thus, recent regulatory crackdowns are not intended to hold back the private sector. Rather, they aim to align the interests of the private sector with Beijing’s strategic goals. Those who deviate from public goals risk being sidelined and punished.
This approach underscores our long-held argument that economic reforms were based on the strategic use of markets under the direction of the state, and not on the use of market forces to drive change.
The domestic agenda
Emphasizing this argument further, China is concerned that the media may influence public opinion and government policy, risking potential abuse by serving vested interests, distorting public policy and creating systemic instability. To minimize these risks, the cybersecurity regulator sat on the boards of some of China’s social media platforms in August.
Reducing wealth inequalities is now a top political priority. President Xi sees income and social inequalities as threats to long-term development. Indeed, the common prosperity policy aims to increase labor compensation as a percentage of GDP to help fight inequalities (see Annex 1).
Facing increased scrutiny, many large companies have announced plans to donate funds to the company. However, the good old days of lax oversight and regulatory forbearance are unlikely to return. Enforcement of the regulations will be difficult as Beijing is determined to redistribute income and create high value-added jobs by stimulating innovation and technological advancement.
Implications for consumption
Such policies should increase consumption. Establishing a better social safety net should help reduce household savings and increase consumer confidence. Since the poor have a higher marginal propensity to consume than the rich, the positive impact on consumption of a more equitable distribution of income is expected to be significant.
Expenditure can be expected to be directed to the mass consumption and mid-value sectors. However, a more equitable distribution of wealth between SMEs and the private sector is expected to increase overall income growth, allowing it to continue to stimulate the growth of the luxury goods sector even without policy backing.
All opinions expressed herein are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may have different opinions and make different investment decisions for different clients. The opinions expressed in this podcast do not in any way constitute investment advice.
The value of investments and the income from them may go down as well as up and investors may not get their original stake back. Past performance is no guarantee of future returns.
Investing in emerging markets, or in specialized or small sectors is likely to be subject to above average volatility due to a high degree of concentration, greater uncertainty as less information is available. available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).
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 U.S. foreign policy toward China has shifted from constructive engagement, as pursued by administrations before Donald Trump, to strategic competition. For example, see “Strategy Asia 2020: Competition between the United States and China for global influence», Edited by Ashley J. Tellis, Alison Szalwinski and Michael Willis, The National Bureau of Asian Research, Seattle, Washington DC 2019 https://carnegieendowment.org/files/SA_20_Tellis.pdf
 “Chinese Xi Jinping announces the creation of a Beijing stock exchange for SMEs», CNBC, September 2, 2021 https://www.cnbc.com/2021/09/03/xi-jinping-says-china-to-set-up-beijing-stock-exchange-for-smes.html
 See “Chi on China »Mega Trends of China (6): Evolution of China’s growth model», April 6, 2018.