China Ascendant: A Guide for Investors

Beijing central business district A COUNTRY OF EPIC PROPORTIONS

With a population of almost 1.4 billion, China is the world’s most populous country. It also has the fourth‐largest landmass, with a coastline stretching more than 9,000 miles. And with a GDP of over $12 trillion, China is the second‐most productive economy in the world. Percent of World GDP

nChina nIndia nJapan nUnited States nFrance nGermany nItaly nBritain China has long been prominent in the world’s commercial and 80 geopolitical landscape. With a recorded history dating back several millennia, the nation has been a leading locus of trade, science, technology and art. China historically accounted for the 70 greatest share of the world’s GDP, as recently as the early 1800s. 60 However, China lost its primacy on the world stage as the economic center of gravity shifted to the West during the Industrial Revolution. An industrially and militarily empowered 50 Britain waged the First Opium War against China in 1840 to secure Britain’s mercantile interests in the region. This and 40 subsequent conflagrations involving Western imperial powers left China politically and economically diminished. With the emergence of the United States as an economic superpower in 30 the 20th century, China’s relative global importance declined further. 20

Through much of the 19th and 20th centuries, China attempted 10 to respond to the changing geopolitical calculus by modifying its own economic and social systems. However, most of these efforts were ineffective, and China remained in a diminished 0 0001 1000 1500 1600 1700 1820 1870 1900 1913 1940 1970 2008 state until the late 1970s. It was only with the installation of Year leader Deng Xiaoping that the country’s potential finally began to be realized after 150 years of dormancy.

2 INVESTMENT GUIDE TO CHINA SOURCE: Angus Maddison, Emeritus Professor of Economics at the University of Groningen, the Netherlands; and Bloomberg. China‘s 1940 GDP percentage is an estimate. THE LONG MARCH TO ECONOMIC REVITALIZATION

The People’s Republic of China, as it is known today, was proclaimed in 1949 by Mao Zedong after almost a quarter‐century of civil war, a period also marred by World War II and the Second Sino‐Japanese War (1937-1945). China convulsed for another 30 years with the imposition of Communism and collectivization across the Chinese mainland, which led to great social upheaval and tens of millions of civilian deaths.

Deng Xiaoping came to power in 1978 upon Mao’s demise. Under Deng, China finally began to get things right economically, and the nation embarked upon the period known as the Opening of China. The country slowly began to move from a state‐controlled collectivist economy to one with more individual freedoms and private participation. Due to the agrarian and rural nature of the previous Maoist period, and because a large swath of the population was living in poverty, China’s focus was to achieve widespread and rapid improvement in living standards. This required industrialization at the grassroots level, particularly in sectors that were labor‐intensive and provided employment for the masses.

After two decades of fundamental economic reform under Deng, China was ready for tighter integration into the world economy, and it became a member of the World Trade Organization (WTO) in 2001. China today is the world’s largest exporter, with an estimated $2.2 trillion of exports in 2017, handily surpassing the United States, which exported $1.6 trillion that year.

The social impact of China’s economic boom is historically significant. According to the World Bank, “real per‐capita incomes increased 16 times over 1978 to 2014, which lifted more than 850 million Chinese people out of poverty. China’s poverty rate [based on a poverty line of $1.90 per day per person] fell from 88.3 percent in 1981 to 1.9 percent in 2013, an achievement that is unprecedented in scope and scale.” Electric vehicles in the parking lot, Liuzhou

3 INVESTMENT GUIDE TO CHINA ASCENDING THE GLOBAL ECONOMIC LADDER

To achieve its next stage of growth, China needs to transition from Industrial & Commercial a low‐value‐added, labor‐intensive manufacturing economy to one Bank of China grounded in entrepreneurship, services and consumerism. China $302 China will also need to further liberalize state ownership of assets, a Construction prerequisite to greater private innovation. Bank Agricultural Bank of $228 PetroChina The 10 Largest China $206 Companies in China $198 Bank of At the initiation of economic reforms in 1978, state‐owned China enterprises (SOEs) accounted for 95 percent of employment and (by market cap in $billions) $163 Alibaba $477 80 percent of investment. While the government’s participation in the economy has been significantly reduced, China still has more than 155,000 SOEs that account for over 40 percent of industrial assets, 30 percent of revenues and 15 percent of employment. In comparison, SOEs typically comprise less than 15 percent of the economy in most other developing countries. Beijing Nevertheless, China’s capacity for innovation has been increasing. The Global Innovation Index, compiled by INSEAD and the World Kweichow Intellectual Property Organization (WIPO), shows that China Maoutai improved from 29th globally in 2011 to 22nd in 2017. Importantly, $143 China has made a strong effort to increase research and Tencent development spending and it is now a world leader, second only to $439 the United States; China spent more than 2 percent of its GDP on R&D in 2015, which accounted for more than 14 percent of total global R&D expenditure. The country has developed a deep pool of science and engineering talent, and had more than 3.5 million Zunyi researchers in these fields in 2014, more than the United States and European Union combined. According to WIPO, since 2011, Hangzhou China has filed the most patent applications of any nation. Ping An Insurance Given its commitment of financial resources and policy, it is likely, $196 though far from guaranteed, that China will ultimately make the China Merchants leap to a high‐income country. Already more than 100 Chinese Bank companies are on the Fortune Global 500 list, including tech $120 heavyweights like Alibaba and Tencent and financial firms such as China Construction Bank and Ping An Insurance.

Shenzhen 4 INVESTMENT GUIDE TO CHINA SOURCE: Bloomberg CHALLENGES IN THE DECADE AHEAD

While China’s economic rise has been meteoric, the road ahead presents some potential speed bumps that could turn into roadblocks if not resolved successfully.

China’s “one child” policy has caused the working‐age population— those between the ages of 15 and 59—to already peak, in 2011. Therefore, population growth is no longer a driver of GDP as it is in most other emerging‐market countries, such as India.

Secondly, an increasingly affluent and educated Chinese populace is more aware of its political rights‐or lack thereof‐than ever before. Under the monolithic rule of the Communist Party of China, citizens’ activities are heavily monitored and rights are only afforded on a selective basis. The state has a great deal of control over public speech; the movement of people and labor within and across Chinese borders; and which websites its citizens can view on the internet.

Thirdly, the Chinese economy has acquired a great deal of financial leverage since the Financial Crisis of 2009. The fiscal stimulus the Chinese government pumped into the market had the desired effect of avoiding a hard landing then, but this now threatens to dampen growth for several years ahead as the economy gradually returns to acceptable levels. While the extent of financial leverage is not precisely known, particularly because lending activity at the local government level is not adequately reported, the IMF estimates that government debt will rise to 90 percent of GDP by 2023.

The net result of all these potential impediments is that GDP growth will likely be slower going forward than it has been in the past decade. The World Bank estimates that Chinese growth could slow to 4.5 percent annually over the next decade if the government fails to adequately reform the country’s economic and political systems.

Bicycle traffic during rush hour, Beijing

5 INVESTMENT GUIDE TO CHINA GEOPOLITICAL AMBITIONS AND THE CHINESE CENTURY

China’s increasing economic clout has brought increased Bloomberg World ($M) Imports geopolitical ambitions not only in the East Asian region, but also Trade Flow: globally. With regard to territorial claims in the South China Sea United States 3 .0 0 M Trading Partner Total Trade and the flow of trade traffic, China is now butting heads with China Jap (US$ Millions) 2. a 00M n

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M M a a i i a a s s l l y y a a

If China can reform adequately and continue its economic growth

trajectory, and also strike an appropriate balance between 44155.65 66233.48 88311.30 individual rights and state stability, then this century might, in fact, be the Chinese century, just as the last was the American century. SOURCE: Bloomberg That certainly is China’s ambition, and it seems to be well on its way to achieving it. DISCLAIMER: This Bloomberg Media Studios Investor’s Guide is derived from selected public sources. Bloomberg Finance L.P. and its affiliates, in providing the service/information, believe that the information it uses comes from reliable sources, but do not guarantee the accuracy or completeness of this information, which is subject to change without notice, and nothing in this document shall be construed as such a guarantee. The statements in this service/document reflect the current judgment of the authors of the relevant articles or features, and do not necessarily reflect the opinion of Bloomberg Finance L.P., Bloomberg L.P. or any of their affiliates (“Bloomberg”). Bloomberg disclaims any liability arising from use of this document, its contents and/or this service. Nothing herein shall constitute or be construed as an offering of financial instruments or as investment advice or recommendations by Bloomberg of an investment or other strategy (e.g., whether or not to “buy,” “sell” or “hold” an investment). The information available through this service is not based on consideration of a subscriber’s individual circumstances and should not be considered as information sufficient upon which to base an investment decision. You should determine on your own whether you agree with the content. This service should not be construed as tax or accounting advice or as a service designed to facilitate any subscriber’s compliance with its tax, accounting or other legal obligations. 6 INVESTMENT GUIDE TO CHINA Employees involved in this service may hold positions in the companies mentioned in the services/information.