The world is holding its breath since the crash of the Chinese stock market in September 2015. Investors lost billions in the blink of an eye, before being ultimately prevented by the Chinese government from selling their shares, which is unprecedented for the former 10%-growth giant. One can already observe the financial knock-on effects of this catastrophe outside China, the most spectacular example being that of the U.S. stock exchange, which crashed right after. Other exchanges followed the same path. Whereas attention focused mainly on the financial fallouts of this crisis, the goal of this article is to provide an insight from a business perspective. This article first talks about the creation of the Chinese bubble, how it has been fueled by blind faith and fairy tales, before recent statistics eventually led to disillusion and financial collapse. In the second part, the future of business in China and in the rest of the world after this crash will be discussed.
Once upon a time, China
China has a long history of conquests, power and domination in Asia. Coherent with this philosophy is the way it grew over the past few decades. It quickly became the so-called world’s factory, relying on key competitive advantages such as very cheap workforce.
As a result, FDI skyrocketed, especially since the early 1990s. New plants, business centers or even entire cities were built very quickly. The whole world was talking about China, and it came as no surprise that Shanghai, China’s economic heart, became the world’s largest city. Companies, funds, and individuals invested massively in China, either by relocating their production, or by buying shares of promising Chinese companies.
Too good to be true
In the meantime, the real estate market was going through great transformations. Properties appreciated in an unprecedented manner. Many whispered that it was the start of a bubble.
The announced bubble did not burst. Instead, prices eventually stabilized over the last few months. Still, investors cannot stand stable prices. Funds from real estate were massively invested in the stock market, with the promise of generating huge capital gains in a very short period of time. The Chinese government encouraged households to invest their savings in the booming stock market and even pushed them to get indebted in order to be able to invest. This is the very notion of a bubble.
In the same time, despite the impressive recovery of the emerging markets after the Great Recession of 2008, it became more and more obvious that China would not reach the announced ten-percent growth target. But as long as the music is playing, you’ve got to get up and dance. Many tried to ring the alarm, highlighting the fact that data related to the manufacturing sector’s health, such as the PMI (Purchasing Managers’ Indices), or the electricity consumption, were indicating at best a much lower growth (around 1.3%), and at worst a contraction of the economy.
Despite all these signs of a slowing economy, Chinese households massively invested in Chinese stocks. Over the course of the months preceding the crash, the rate of title accounts opening in China was around 100,000 per day and jumped to 500,000 per day shortly before the crash. The bubble surrounding the Chinese market kept growing until it burst in the summer 2015, with spillover effects on the U.S. and European markets. The Chinese government tried to stop the haemorrhage by preventing Chinese stockholders from selling their shares and other measures were taken to get the markets back on track.
Great Collapse or Great Catch up?
There are always two sides to every story. Although one can simply argue that China’s best days are gone, it might be worth considering a more positive explanation. For example, South Korea and Japan both started with a labour-intensive, low tech and export driven economy before gradually increasing the level of value added in their production. South Korea concentrated its resources firstly on the textile industry and reinvested its human and financial capital in sectors with a higher value added such as IT and services.
The Chinese government is arguing today that its country may be following a similar path to that of countries like Japan or South Korea. China would be in fact moving from heavy, low tech industries to IT and services, which could explain the contraction of the manufacturing sector revealed by indicators such as the PMI or the electricity consumption. Even though electricity consumption only grew by 1.3% in the manufacturing sector for the first six months of 2015 (year on year) according to Reuters, an impressive jump of 8.5% in the electricity consumption for IT and services has been noticed over the same period.
Whether this can explain the seven-percent growth of the Chinese economy is hard to establish without more reliable data. The share of the manufacturing sector in China’s economy is still huge compared to that of IT and services, although the latter ones could generate higher value added. In addition, such an evolution could bring the country to the next level of its development. The strategy that the Chinese government is following is thus risky but has also proved to be the natural evolution of most successful emerging economies.
The world is a house of cards
When China sneezes, the world catches the cold. This saying used to apply to the U.S. economy. However, it now describes better than ever the knock-on effects of the Chinese slowdown and stock market plunge on the rest of the world. As the largest emerging market and the second largest economy in the world, China’s role in international business has expanded rapidly. But the transition from a centrally planned economy to a free market one does not happen in a linear way. Relying on its abundant workforce, its low labour costs and its government support, China has become a global sourcing platform with a rising middle class and an economic strategy oriented towards export-driven industrial growth. China’s importance on the international scene has now become unquestionable and the massive global consequences of the Chinese slowdown that we are witnessing today make this situation more vivid than ever.
Picture courtesy: CDC Global