A framework for everything: Common Prosperity is where China is headed
Largely unheard of just a year ago, “common prosperity” is the 2021 buzzword for China markets. The term was mentioned by over 70 major Chinese companies in their latest earnings announcements and by President Xi Jinping in over 60 speeches in the year to date, up from 30 in 2020 and just six in 2019.
Common prosperity and stock market performance
Common prosperity is the latest of a series of political priorities articulated by President Xi – dual circulation, environmental protection and family values among others – driving major shifts in Chinese markets. But the market is having trouble digesting this latest priority, which is contributing to a deep lull in performance.
In stark contrast to 2020, HK and mainland-listed Chinese equities have clearly underperformed their US counterparts. As we approach the end of Q3, Chinese equities are lagging US markets by around 40%1. The divergence is now wider than the one seen during the taper tantrum in 2013 and the bursting of the Chinese equity bubble in 2015. Even continental European indexes have fared far better than Chinese equities in 2021.
Earlier this year, underperformance was largely attributable to China’s slowing economy; more recently, investors are blaming stricter regulatory oversight on certain for-profit sectors. It has been a struggle to find a reliable framework to understand and predict these latest regulatory moves – now, common prosperity looks like the best conceptual lens through which to understand policy direction.
“Common prosperity” is not a new concept
We should remember that “common prosperity” is not a new concept for modern China. The term came up in the Mao era and was repurposed by Deng Xiaoping 40 years ago, who famously proposed to let “some people to get rich first” while also asserting that “to get rich in a socialist society means prosperity for the entire people.”
Deng’s policy pivot towards decentralization and privatization allowed Chinese household wealth to grow astonishingly over the past few decades – with China’s GDP per capita2 rapidly converging towards advanced economy levels3.
Over the years, policymakers have prioritized growth at any cost with the belief that a rising tide lifts all boats, which is why China’s breakneck growth has been so lopsided. Today, the urban household income is 2.5x greater than rural household income, and the country’s Gini coefficient – a measure of income inequality – puts China among the most unequal major economies in the world.
In hindsight, China scholars would argue that common prosperity’s return to the top of the Chinese Communist Party’s (CCP) political agenda was only a matter of time, especially with policymakers loathe to allow inequality and the cost of living to become such serious social issues as they have in developed markets. Even in China’s modern market economy, the socialist spirit remains foundational to the whole of the political system.
Broad redistribution implications
President Xi unveiled what is undoubtably his most ambitious campaign to promulgate traditional socialist values at the CCP’s centenary celebration earlier this year, where he proclaimed the country’s success in ending ‘absolute poverty’ while outlining an all-encompassing effort to redistribute extreme wealth and reduce inequalities through a repackaged common prosperity slogan. While light on the details, the new policy has broad redistribution implications.
Already, Zhejiang province – where China’s largest internet platform is headquartered - has been selected as the demonstration zone for common prosperity4. Highly profitable technology companies could feel as though this policy is directed at them though officials have been adamant that the new policy isn’t designed to penalize private businesses nor high-flying entrepreneurs.
In mid-August, President Xi chaired a meeting dedicated to common prosperity which called to “reasonably adjust excessively high incomes and encourage high-income groups and companies to give back more to society”5. Shortly thereafter, many technology companies and billionaires boosted their charitable donations6.
Policymakers have maintained that the policy’s intent is to help close the income gap by lifting those at the lower end of the income spectrum through enhancing healthcare and education services, and strengthening the pensions system and other social safety nets.
Looking ahead, it’s even possible that personal income, consumption and property taxes could be reformed, though these changes would most likely be modest and take some time to implement.
The economic impact and investment implications
In all, this policy seeks to recalibrate the economy to help those that are less well-off and protect small businesses while the wealthy are not only expected but even required to contribute more to society, all the while powerful businesses are more tightly regulated.
The policy’s net effect could boost the country’s overall domestic consumption especially from lower-middle income groups. It should also drive even more capital to “policy friendly” sectors of the economy that were already receiving strong support in the form of tax subsidies and easy access to capital, such as high-tech manufacturing, EVs, 5G, and alternative energy.
On the flipside, as policymakers try to narrow income inequality, sectors such as residential real estate development, internet platforms, for-profit education could face continued regulatory headwinds.
Other private companies providing what are considered public services, such as health, housing and assisted elderly care, could be the next to face political scrutiny.
Sectors viewed as exacerbating or highlighting China’s wealth gap, such as recreation services companies, could face increasing price-control regulation and limits on commercial activity. Most at risk are media and entertainment companies, especially those in gaming and live streaming.
In order to survive, the onus will be on them to prove to the government that they are contributing to Chinese people’s common prosperity.
As China continues to battle what seems to be a never-ending pandemic and economic growth falters, the promise of a more equal and fair society could win a domestic audience and popular support. For now, the common prosperity campaign appears far-reaching - potentially affecting all businesses and society as a whole - and most importantly, here to stay.
Investment risks
The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.
When investing in less developed countries, you should be prepared to accept significantly large fluctuations in value.
Investment in certain securities listed in China can involve significant regulatory constraints that may affect liquidity and/or investment performance.
^1 MSCI China
^2 Purchasing Power Parity basis
^3 Between 1993 to 2019, China’s GDP per capita (PPP) has grown from 5% to over 30% of an advanced economy’s GDP per capita (PPP)
^4 http://www.gov.cn/zhengce/2021-06/10/content_5616833.htm
^5 http://www.gov.cn/xinwen/2021-08/17/content_5631780.htm
^6 https://fortune.com/2021/08/06/china-big-tech-crackdown-billionaires-philanthropy-giving-donations/
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