“Americans Don’t Know How Capitalist China Is”

Weijian Shan understands the delicate U.S.-China dynamic as well as anyone. He was born in China, and his life was upended during the Cultural Revolution, when he was sent off to do farm labor in the Gobi Desert. Eventually he came to the United States, where he earned a master’s and a PhD at UC Berkeley, worked for the World Bank and J.P. Morgan, and taught at the Wharton School. A candid observer of Asian society and business, Shan is the author of Out of the Gobi: My Story of China and America and the newly published Money Games: The Inside Story of How American Dealmakers Saved Korea’s Most Iconic Bank. Now CEO of the Hong Kong–based $40 billion private-equity firm PAG, Shan spoke with HBR Editor in Chief Adi Ignatius about the economic prospects for China and the United States. HBR: China’s economy seems to be the healthiest in the world at the moment. Does that create new investment opportunities? Shan: Despite initial blunders, China has handled the coronavirus pandemic well through strict lockdowns and mass testing. Its GDP dropped 6.8% in the first quarter of 2020, but resumed growth from the second quarter onward. China has been shifting away from an investment-driven growth model to one led by private consumption. A decade ago its retail-goods market was about $1.8 trillion—less than half that of the United States. In 2019 that market reached $6 trillion, surpassing the U.S. level of $5.5 trillion. Even now China’s private consumption represents only about 39% of its GDP—way below the U.S. level of 68% and the world average of 63%. That leaves much room for growth and many opportunities for investors, particularly in businesses that cater to consumers. Investors have always been enticed by China’s vast market. How accessible is it these days? Our firm, PAG, invests throughout Asia and occasionally beyond. China’s is the only major economy that requires no special approval for foreign direct investments, although some sectors, such as Lived Change media and the internet, are on a “negative list” that restricts them. However, there are usually lawful ways to get around that. PAG invested about $100 million in a digital music business in China a few years back which subsequently merged with a similar business and changed its name to Tencent Music Entertainment. Today it’s traded on the New York Stock Exchange with a market cap of about $45 billion and has more than 800 million unique active users. The name of the game in China is scale. If a business is successful, it’s usually open to taking outside capital so that it can quickly expand nationwide. That’s why China is the most active private-equity market in Asia. Trade wars, nationalism, and the pandemic have led many companies to question their supply chain strategy—in particular basing manufacturing in China, thousands of miles from their markets. Are you seeing a significant shift in supply chains out of China? Some manufacturing has been relocated away from China since the trade war with the U.S. began in 2018, but that hasn’t made a dent in either China’s exports or America’s trade deficit. In fact, the pandemic has made the world more dependent on Chinese exports, which grew 21% in November over the previous year. The point is that a China-based supply chain has proved a blessing, not a curse, in this pandemic. Any shift in supply chains will be gradual and partial, because it’s very costly to move from the most efficient supplier to the second or third best. American companies will do so only if U.S. tariffs become more penalizing than moving would be. Also, while it’s relatively easy to shift the sourcing of a low-value-added product from China to Vietnam or Mexico, how can you move an entire supply chain with many indigenous players? And what if the market itself is in China? GM sells more cars in China than in the U.S., Canada, and Mexico combined. Where can it move its production if the target market is China? China is also Apple’s biggest market for iPhones: It has about twice as many iPhone users as the United States does. The U.S. continues to vilify China, and China does itself no favors with its poor policy on human rights. How can outside investors ensure that they don’t become collateral damage in a bigger political and economic war? Both countries have human rights issues, although in different forms. Investors anywhere should invest in a socially responsible way to advance human rights, adhering to a high standard for labor practices, gender equality, investment in human capital, and charitable contributions. Wherever PAG operates, we adhere to the same environmental, social, and governance policies. The Trump administration was determined to damage China’s economy and businesses. Does the U.S. even have the power to hurt China economically? Here and there, yes, but not in a meaningful way in general, and not without harm to itself. Trump’s trade war was an abject failure. Its stated purpose was to reduce America’s trade deficit. In November 2020 China’s trade surplus with the U.S. was 70% greater than it had been in January 2017, when Donald Trump took office. Meanwhile, American consumers have paid for the higher tariffs, because the average prices of Chinese exports haven’t decreased. China’s GDP is forecast to grow 7% to 8% this year. That means that despite the trade war, the technology war, and the capital war—the U.S. government’s restricting American investment in China—China’s GDP will most likely be 10% bigger in 2022 than it was in 2019, whereas the U.S. economy probably will only recover to 2019 levels by 2022, according to the International Monetary Fund. It seems that the only country that can stifle China’s growth is China itself—if it makes major policy mistakes. And only the U.S. can threaten America’s economic supremacy—by underinvesting in its own infrastructure and by limiting trade. What are the dangers in America’s continued demonization of China? Much of Donald Trump’s rhetoric and his actions on China were meant to deflect attention from his leadership failures at home, such as neglecting his duty to protect the public from the coronavirus. With less than a quarter of China’s population, America has a death toll about 100 times China’s and counting. Some real differences between the two countries do exist, but they have historically managed them without escalating tensions. The United States had maintained a fairly consistent foreign policy until Trump. The Biden administration is expected to restore that policy and to work within the rules of international institutions, which I expect will defuse tensions. When Nixon first visited China, in 1972, the differences between the two countries were vast, in political and economic systems and of course in ideology. Yet they found common ground to work in mutually beneficial ways. Today the differences are arguably a lot smaller, and there are many areas in which the two can benefit from cooperation. After all, each is the other’s largest trading partner, and China has lent more than $1 trillion to the U.S. government by holding U.S. Treasury bills. Let’s be honest: A rising China may be a threat to America’s economic and technological supremacy, but not to its national security, because China doesn’t export its ideology or political system and doesn’t seek regime change anywhere in the world. But it won’t back off from its territorial claims, all of which predate the People’s Republic of China. The real danger is the Taiwan issue. If the U.S. abandons the one-China policy and supports Taiwan’s independence, conflict will be inevitable, with unimaginable consequences for the world market. Is a China-U.S. decoupling a real possibility? Not completely and not without very high costs. The technology war waged by the Trump administration forced China to develop critical technologies, such as semiconductor chips, for which it has relied on U.S. suppliers. It will take years if not decades for China to catch up in some areas, at great cost. But the technology war also hurts U.S. suppliers. The top 10 American semiconductor chip makers sell about three times as much in China as in the United States. Losing the China market will be costly for American tech companies and deprive them of funds for further R&D. What are the biggest risks for China’s economy in the coming years? The economy has grown 36-fold over the past three decades, chiefly because of market-oriented reforms that have created a vibrant private sector, which now accounts for about two-thirds of China’s GDP. But the state-owned sector remains too big and inefficient. Great challenges lie ahead. China’s saving rate will drop significantly as its population ages, and investment will slow. The country will need to continue to reform and privatize its state-owned firms—and shift from investment to private consumption—or it will not be able to sustain its growth. Are you concerned about China’s debt? I see no systemic risk either in China’s banking system or in its economy. Pundits tend to be alarmed by a default here and there. But defaults and bankruptcies are common in a market economy. Only a sudden surge of such events would herald an economic crisis. In 2020, a year of severe difficulties all over the world, there was no significant increase in Chinese corporate defaults. In fact, China is the only G20 country to have posted positive growth. Its monetary policy is reasonably tight, with the yield on government bonds about 3.5 times that on U.S. Treasuries. Its currency appreciated 6% against the dollar last year. All these testify to the strength of the Chinese economy. What is it that Americans don’t understand about China? They don’t know how capitalist China is. China’s rapid economic growth is the result of its embrace of a market economy and private enterprise. China is among the most open markets in the world: It is the largest trading nation and also the largest recipient of foreign direct investment, surpassing the United States in 2020. The major focus of government expenditure is domestic infrastructure. China now has better highways, rail systems, bridges, and airports than the United States does. For example, over the past 15 years it has built the longest high-speed rail system in the world. At 22,000 miles, it is twice as long as the rest of the world’s combined. China’s high-speed rail could cover the distance between Boston and Chicago in about four hours, whereas Amtrak’s fastest service takes 22 hours. One reason China can spend so much on infrastructure is that its defense budget, after years of increases, is still only about a quarter that of the United States. And what is it that the Chinese don’t understand about the United States? They don’t know how socialist it is, with its Social Security system and its policies to tax the rich by collecting capital gains taxes. China is still in the process of building a social safety net that is largely undefined and underfunded, and it has no tax on personal capital gains. In 2020 China had more billionaires than the U.S. did, and it outpaces the U.S. three to one in minting them. Consequently, inequality is greater in China than in the United States, measured by the Gini coefficient.

“Americans Don’t Know How Capitalist China Is”

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