China Presents Long-Term Prospects

June 18, 2007
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GRAND RAPIDS — China is building an economy that is very different from the U.S. economy; it resembles capitalism in some ways, but in many ways it’s still a system in which the Chinese government maintains heavy-handed control. China calls its economic strategy “socialism with Chinese characteristics.”

Change is very slow in China, but there are enormous opportunities there for American companies, according to Donald Straszheim, vice chairman of Roth Capital Partners and one of the country’s leading experts on investment in China and other emerging Asian markets. Straszheim was in Grand Rapids last week to address the Charted Financial Analysts West Michigan Society as part of a national celebration of the CFA Institute’s 60th anniversary.  

Many people think China’s economy is overheated, but, according to Straszheim, it’s not overheated, it’s a little unbalanced. Overheated means too much money chasing too few goods, which results in shortages, rising prices and longer waits for goods, whereas unbalanced means there’s extreme competition, with companies producing as rapidly as they can and frantically seeking customers. Too, there are all kinds of imbalances in terms of too much investment here and not enough investment there, he said.

“What’s unbalanced is the fact that most of the important decisions are made by the government in the command and control portion of the economy,” Straszheim told the Business Journal. “These are not decisions that are market driven; these are decisions that are driven by a bunch of bureaucrats sitting around a table.” 

Many industry sectors are largely closed to foreign competition. China industries that are seen as “strategically vital” by the government are protected to varying degrees against foreign competition. There are 13 industry sectors over which the government has “absolute control,” including oil and petrochemicals, armaments, coal, shipping, aviation, information technology, telecommunications, non-ferrous metals and machinery. Not surprisingly, most of the companies on the Shenzhen and Shanghai Chinese stock market are state-owned enterprises that don’t pay dividends.

As Straszheim sees it, the environmental protection/remediation sector in China is the best growth sector for American companies in the foreseeable future because it’s the most polluted country in the world. It’s a “nightmare,” he said. Of the 1.3 billion population, 700 million drink water that the World Health Organization says is undrinkable. Sixteen of the top 20 most polluted cities in the world are in China, he pointed out.

What’s most interesting is that there are no environmental and remediation companies in China at all, so there is no need for the government to protect that industry and put it under absolute control.

“So they embrace the new technology from outside; they are happy to have countries come in from all over the world to help them with the environment,” Straszheim stressed. “It’s the best long-running growth story in all of China.”

In America, the economic power resides in Washington, D.C. The economic strength in China resides with the mayors and provincial leaders, who are constantly vying for new production capacity but who allocate capital inefficiently, he said. Municipalities and provinces also make the rules and regulations. 

“China’s economy would work much more efficiently if the government gave more decision-making authority to the invisible hand of the marketplace,” Straszheim said. “When people are accustomed to making the decisions, it’s scary to give up decision-making power to some market force. It’s the No. 1 priority of every leader in the world to stay in power.” 

China’s economy has been growing at a rate of nearly 10 percent a year for 25 years — the fastest economic growth of any country of any size in the history of the world. How fast might it grow if government allocated capital in an efficient way? Clearly, a lot faster, Straszheim said.

Straszheim said China’s financial sector is its weakest link, and the list of weaknesses is long. Commercial banks are still largely “lending arms” of the government. Banks don’t ration capital according to risk and reward principles; the capital gets allocated according to the borrower’s connections, relationships and government ties. Most people pay with cash, not checks or credit cards. So Straszheim sees another long-term prospect for American companies in commercial banking in China. A modern financial sector would be “a huge plus,” he said.

Since China is the world’s No. 2 consumer of oil and other energy, opportunities exist in new energy technology, such as clean coal, nuclear energy and alternative energies such as wind, solar and biomass. Other long-term prospects, according to Straszheim, are in commercial real estate, steel and commodities, transportation, health care and telecommunication, to name a few.

China’s economic reform process began in 1978 and started as kind of a pilot project in the southeastern portion of the country. The people of China associate the rise in their standard of living with the partial transformation to a more market-driven economy that started more than a quarter-century ago.

“The people, not surprisingly, have decided that rich and growing is more fun than poor and stagnant, so they want it to continue,” Straszheim observed. “The government knows that it’s going to be trouble when the growth stops, so they’ll do anything to keep this process going.”

China wants to be regarded as a full-fledged player in the global economic and financial community, but the fundamental dilemma is that government doesn’t want to give up its decision-making power, yet it wants to keep the economy growing. The 60-year-old men who run the Chinese government aren’t inclined to adopt ideas and attitudes from 25-year-olds who just returned from Harvard, Straszheim added. It’s a generational issue that would call for a cultural change, and Straszheim believes it’s going to take a couple of generations for China to get there.   

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