Behind the Brouhaha, China's Struggles to Regulate its Big Businesses Are by No Means Unique By William Bratton August 11, 2020

Post Traders work during Didi Chuxing’s IPO on the New York Stock Exchange on June 30, 2021

 

Regulating new technologies and industries is a challenge facing many countries, including the US. Far from snuffling enterprise, China is responding to the common need to mitigate or prevent the negative consequences of big businesses

To conclude from the disastrous initial public offering that Beijing’s tighter regulation of big businesses equates with an overall negative stance towards private companies is simply wrong. Photo: Reuters

Plummeting stock prices and sensational headlines have led to much excited commentary about the risks of investing in Chinese companies.

Stories of sweeping reforms coming to the music streaming  and  education sectors , coupled with the regulatory response to the disastrous  Didi Chuxing IPO , have also raised questions about the nature of the Chinese government’s relationship with big businesses, particularly those in the private sector; an issue with profound longer-term potential implications for investors in the country.

The underlying and frequently heard presumption is that these recent examples highlight the difficulties China has with reconciling its authoritarian and technocratic style of governance with the more unstructured, unpredictable and dynamic nature of market forces.

The logical extension of this view is that a vibrant private sector – so necessary for sustained long-term economic development – is fundamentally incompatible with China’s style of governance. If this is true, not only will it become a major constraint for the country’s growth outlook, it would also create significant and potentially unprecedented risks for equity investors.

But, as ever when it comes to the financial markets, it is important to step back and take a broader perspective. For while it is easy to frame the recent stories as examples of the Chinese government’s need for control – a desire which runs diametrically opposite to entrepreneurial individualism – this is just too simple an explanation.

There are two related factors which place recent events in context, at least from an investment perspective.

The first is that China’s struggles with the regulation of its big businesses are by no means unique. Most governments have complicated and difficult relationships with big businesses, reflecting the inherent tensions between the benefits they offer and the costs they exact.

On the one hand, for example, larger companies tend to be more efficient than their smaller peers, are typically the focal point for technological innovation, are disproportionately important to a country’s exports and often underpin complex supply chains.

On the other hand, if companies become too large, they can suppress competition, discourage innovation, reduce consumer choice and result in higher prices.

It is no surprise, therefore, that all governments – regardless of their political ideologies – struggle to find the right balance between too little control and too much. It is also why regulatory and policy risks are such an embedded component of any equity valuation across countries, especially as they can change suddenly and without warning.

This is the second factor: the inbuilt dynamism of relationships between governments and big businesses.

This dynamism reflects the need for governments to respond to problems created by new technologies and economic activities, especially when companies are exploiting weak or non-existent regulatory frameworks to suppress competition.

But it is also a function of changing government priorities and ideologies – which happens in all countries – as well as improving regulatory capabilities, especially in terms of surveillance and enforcement.

China is not alone in having to address the economic and social impact of new technologies and industries. For example, the 

regulation of internet-based companies  – and their large-scale accumulation of personal data – is a challenge confronting numerous governments around the world, including in the United States and Europe.

While all eyes are currently on China, it could, conversely, be argued that Western governments have responded so slowly to the issues associated with Big Tech that they have lulled investors into a degree of complacency. It is difficult, as such, to argue that China’s objectives to mitigate or prevent the negative consequences of big businesses, are significantly different than those widely found elsewhere.

Admittedly, the regulatory process itself may appear less transparent than the public processes found in more developed markets, but this reflects the relative youth of the country’s regulatory mechanisms, the extremely rapid pace of change and the linguistic challenges faced by many offshore investors.

Nor do the recent regulatory developments suggest that the Chinese authorities have an inherent bias against the private sector and the emerging entrepreneurial class. Indeed, the data suggests otherwise.

Not only has the country made private-sector development a core policy objective, but entrepreneurship has also flourished over the last decade  with the private sector becoming the driving force for economic growth, employment creation and innovation.

The problem for investors, however, is that listed companies are usually the larger private-sector businesses which, by default, attract the strongest regulatory focus. But any investor must recognise that what is good for specific big businesses may not be good for the broader economy, nor for smaller competitors.

This is why regulatory and policy risks, although often ignored or overlooked, should be embedded components of any equity valuation, regardless of sector and market.

As such, it is simply wrong to equate China’s tighter regulation of big businesses with an overall negative stance towards privately owned companies. China’s private companies remain extremely attractive to investors given their growth potential and diversity of long-term investment options.

Furthermore, recent events do not appear to mark a policy shift against the private sector per se, especially as its travails with the regulation of its big businesses are not particularly unique within a global and historical context.

New regulatory frameworks, in any industry, create market volatility as prices adjust to reflect higher risk premiums and the growth outlook. But this should not come as a surprise to more seasoned investors.

Over time, regulatory risks in China will moderate as the government’s policy objectives become more predictable (partly through established precedents), regulatory processes become more transparent and corporations adjust their behaviours accordingly. Despite all the recent excitement, then, China is still a market that investors cannot ignore. 

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William Bratton is author of “China’s Rise, Asia’s Decline”. He was previously head of equity research, Asia-Pacific, at HSBC.

Behind the brouhaha, China’s struggles to regulate its big businesses are by no means unique | South China Morning Post (scmp.com)

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