1. Causes
2. Context
3. Coping mechanisms

With respect to causes, Western investors especially need to come to terms with the fact that… well, they’re not exactly in Kansas anymore and this time, it goes the other way around compared to the iconic movie we’ve borrowed the expression from. A lot of the privileges Westerners take for granted represent nothing more than a dream in certain parts of China and one of the consequences revolves around the fact that yes, competence tends to be harder to come by than in a more established jurisdiction.

Just a few examples of causes include:

1. A sub-optimal education system, with even basic literacy being anything but a given in certain situations, for example rural regions. While a lot can be said about Western education system and not necessarily 100% positive aspects, the fact remains that while the West has its share of problems, catering to the basics (illiteracy, for example) isn’t one of them. For more information on China’s education system, we would strongly recommend reading the article we have dedicated to this topic by clicking HERE
2. Let’s call them cultural issues such as corruption (covered through a dedicated article HERE), nepotism (covered through another dedicated article HERE) or, generally speaking, the fact that meritocracy isn’t put on a pedestal to enough of a degree (with us, yet again, covering meritocracy as well HERE)… all of this inevitably leads to jobs oftentimes being handed out based on criteria more in the realm of more or less petty interests than competence, a state of affairs that reverberates throughout China
3. The political dimension, one we cannot possibly hide from, with even key positions very frequently awarded in a non-meritocratic manner but this time, not as a result of corruption and/or nepotism but rather due to the sometimes excessive politicization of the administrative apparatus and other key sectors
4. Insufficient experience, with it being important to understand that China didn’t exactly flourish overnight after Deng Xiaoping’s famous Four Modernizations. It took not just years upon years but downright decades upon decades of efforts for China to end up where it is today, the world’s #2 nation by nominal GDP. Some things just take time and despite many shortcomings, one can analyze sector after sector in China (we do just that) and safely conclude that pretty much always, remarkable progress has been made compared to how things used to stand. It is equally safe to conclude that just like China is light years away from the West in terms of GDP per capita despite its impressive nominal GDP, it is also light years away in terms of competence in many respects but again, these things take time

To be a bit colloquial: know your turf.

Those who start businesses in China expecting sunshine and rainbows, with administrative processes at Western standards and high returns at Chinese standards, will be disappointed upon facing the realization that there is no such thing as a free lunch in the world of business and the same principle is valid for investors.

The West has had a decade and even century-long tradition of specialization and meritocracy. Therefore, even if not perfect, the various system and the people they consist of tend to seem… let’s say fine-tuned compared to their Chinese counterparts.

If you as an entrepreneur or investor end up bitterly disappointed by the fact that China tends to sometimes be rough around the edges when it comes to competence, a valid case could be made that you are more so to blame than China itself.

Why?

Simply because for decades, China has been chugging along nicely, what more could you ask of a country than decades upon decades where double-digit GDP growth was considered normal? Investors without a relatively firm grasp on economic history oftentimes fail to realize just how weak China actually was prior to the materialization of Deng Xiaoping’s reforms and just how much catching up was necessary.

To put it differently, it is anything but reasonable to judge a country that has experienced multiple streaks of double-digit GDP growth for not catching up to the West fast enough and therein lies the key to understanding the main message we are trying to get across when it comes to incompetence: yes, it can be aggravating and yes, it would have been ideal if China would have already been at parity with the West from this perspective.

However, this perspective is anything but realistic.

And in the spirit of just that, there is a reason why the ChinaFund.com team mentions time and time again how important it is to approach this jurisdiction with realistic expectations rather than projecting your ideal image of a country you’d like to invest in onto China and then being disappointed that in the real world, countries fail at living up to such exaggerated expectations.

We firmly believe that in the long run, investors who have the wisdom it takes to set realistic expectations and the patience required to see things through properly will be more than generously rewarded. Those who fail to do that will likely give up and blame a jurisdiction for their own shortcomings, which is anything but a healthy scenario. Needless to say, ChinaFund.com is at the disposal of those who want to pick our brains so as to embrace a realistic perspective on… all things China.

1. How is Iran likely to retaliate?
2. Will this retaliation be a calculated, tactical one, or something asymmetrical?
3. How will the most vulnerable markets in this context react, for example the oil market?
4. What about the other markets and bigger picture, does this situation risk bringing about something similar to the stagflation which was experienced in the past over in the US (for a China-oriented article about stagflation, albeit a speculative one, click HERE)?

These are just four examples and, again, it’s perfectly natural to be asking yourself such questions as an investor. In fact, it would be less than wise NOT to ask them and this article revolves around one potential answer to multiple questions: the Strait of Hormuz.

Why is the Strait of Hormuz a potential answer to many Iran-related questions in this context?

Let’s just say that in terms of sheer economic might, Iran is no match for the United States and its allies, with a GDP barely 100 billion dollars greater than that of Pakistan and a little over half that of Turkey. As such, Iran lacks the leverage a country such as China can put on the table, with its impressive US dollar reserves that it can (among other things) simply “dump” on the market so as to cause a chain reaction with results that are pretty much impossible to quantify.

As such, it is likely to choose carefully-calculated options, not necessarily because it wants to but more likely because there aren’t all that many choices on the table, calculated options such as:

1. Leveraging its network in countries such as Lebanon and Iraq in an effort to cause damage to US interests there
2. Putting its foot on the table with respect to its nuclear program, a dangerous decision which would risk generating sanctions across the board and isolating Iran internationally (even as it is and despite Donald Trump’s oftentimes less than diplomatic attitude toward allies, the US has quite a bit of them and Iran… well, doesn’t)
3. “Choking” trade in areas it controls, especially the (in)famous Strait of Hormuz

Geographically speaking, we aren’t necessarily dealing with anything all that impressive, with the Strait of Hormuz simply connecting the Persian Gulf to the Gulf of Oman, enabling ships to gain access to the ocean from the Persian Gulf. The strait itself is less than 200 km long and in its most widest area, we are looking at slightly less than 100 (more specifically, from almost 40 km to slightly less than 100 km).

Again, on the surface (pun intended), nothing seems spectacular.

Economic data however speaks for itself, with ¼ of the worldwide oil trade passing through the Strait of Hormuz and approximately 1/3 of the world’s (liquefied) natural gas trade. In other words, the Strait of Hormuz is a key trade variable with respect to the energy dimension and returning to geography, it should be fairly easy to understand why it represents something one can consider a choking point.

As such, some of the textbook examples of Iranian leverage involve the Strait of Hormuz and it wouldn’t be the least bit a stretch to call the potential effects of it being rendered unusable by Iran devastating.

If no other solution that is deemed superior by their experts will be found, “choking” the Strait of Hormuz seems like one of the most obvious approaches. However, it is worth noting that from a game theory perspective, anything that hinders economic activity in one way or another tends to be quite problematic to implement in our deeply economically interconnected world.

Why?

Simply because oftentimes, implementing “sanctions” which limit trade results in you as the initiating entity essentially shooting yourself in the foot economically.

But isn’t Iran one of the most economically isolated nations?

It is… but an autarky, Iran is not, with (at best) North Korea representing the only modern-day example to that effect, a country analyzed from the perspective with its ties to China through an article which can be accessed by clicking HERE.

While Iran is more economically isolated than other nations, its relatively few allies are not and measures taken by Iran such as examples pertaining to the Strait of Hormuz risk affecting them negatively… allies including, of course, China. And speaking of China, the position it finds itself in at this point in time as far as the Strait of Hormuz in particular and the Iran situation more broadly speaking are concerned can be best described as conflicting.

On the one hand, China believes this situation and other examples contribute to the deterioration of the US worldwide position diplomatically speaking, especially in light of many of Donald Trump’s statements which include potential measures such as attacking cultural sites (something considered a war crime by current standards), even if many of them have been disavowed by high-ranking military officials.

On the one hand, China has economic challenges of its own to deal with (for example the decelerating economic growth rate and its consequences, moving toward an economic model which revolves around increased domestic consumption, etc.) and knows all too well that if things degenerate, the various economic bubbles which have been shaping up in the aftermath of the 2007-2008 Great Recession risk being pricked. Should that happen, for reasons which have been outlined in several past ChinaFund articles, China risks being affected more so than the United States and as such… let’s just say China isn’t exactly the #1 fan of volatility-inducing circumstances and decisions which risk bringing about economic calamities.

In light of how important China is in the Iranian equation, it would be fair to state that there are disincentives coming from the direction of China with respect to retaliation on Iran’s part which takes things so far that global economic turbulence scenarios become a threat. While nothing is certain and it remains to be seen whether or not unforeseen factors will pop up which change the equation, a straightforward preliminary conclusion would be this: as long as things are not taken too far escalation-wise, China stands to gain from Strait of Hormuz-related turbulence. However, as of a certain point, escalation risks tilting the balance in a manner China has issues with and as such, the message(s) from Beijing will most likely revolve around the two parties acting in a manner which at least maintains global economic stability.

Politically speaking, however, there aren’t nearly as many question marks.

As unpleasant as it may be for some economic actors to admit this, yes, (neo)authoritarianism is the status quo in China and while we are not dealing with a level of authoritarian terror that matches let’s say that experienced during the 1966 Cultural Revolution days (arguably the height of Mao Zedong’s authoritarianism and for more information about Mao’s activity, please read our dedicated article which can be accessed by clicking HERE), there is no denying that China is under a clear authoritarian rule.

The ChinaFund.com team believes in being upfront about the pleasant as well as unpleasant realities associated with China, for reasons which range from ethics to pragmatism. Referring strictly to the latter, it is important to understand the proverbial rules of the game you are about to play as someone who is interested in gaining exposure to Chinese assets. Here are just a few examples which should make it clear why:

1. Entire industries can literally evaporate on a whim but the same way, the Chinese authorities frequently change their minds on a whim as well. Perhaps a textbook example to this effect is represented by the cryptocurrency industry. China has been notorious for banning and then unbanning various sectors of the cryptocurrency space. From banning exchanges to regulating them. From including cryptocurrency mining in a list of activities that are to be discouraged from eliminating it from said list. From warning market participants against blockchain technology to embracing/encouraging certain applications of blockchain technology… despite this literal craziness, some of the most important actors in the cryptocurrency space (when it comes to anything from top holders to miners) have been and continue to be located in China
2. The political element associated with various sectors tends to be emphasized more so than in other jurisdictions, with “regime-friendly” industries or businesses being encouraged and at the same time, industries/businesses which are perceived as even mildly anti status quo being put under the microscope
3. The Chinese authorities being more willing to step in and take various forms of action (even if it infringes on the independence of a certain business) than the authorities of most Western nations, with the obvious implications thereof

… in other words, the Chinese authorities and their various actions will represent a far greater variable in your business/investment equation over in China than in other jurisdictions.

Is this good or bad?

Opinions about this matter abound.

Some economic actors believe this level of interference cannot be anything other than bad, with many refusing to do business in China precisely because it lacks the sort of transparent and predictable playing field many have come to expect in the West. Others, however, embrace the exact opposite view point and try to turn this situation into something that gives them an edge (for example, by meaningfully understanding how things work in China and doing their best to anticipate the actions of the authorities so as to position themselves accordingly). Finally, there are of course players who consider the situation for the most part benign, neither inherently good nor inherently bad.

The ChinaFund.com experts have been around the proverbial block over in China enough (for over 13 years) to state that as strange as it may seem, what some consider volatility to the point of insanity from a legislative perspective can most definitely be turned into an edge by savvy market participants. Needless to say, a superficial understanding of “all things China” is most definitely not enough and there is a reason why we tend to be so thorough on this website. Why we publish posts about anything from specific economic indicators to Confucianism.

We don’t do it so as to show off our knowledge and/or try to impress potential clients, we do it because there is literally no other way. Time and time again, ambitious players approach this jurisdiction with very aggressive dreams but unfortunately for them, they prove to be delusional when it comes to assessing the amount of work involved to actually have staying power in China. They read a few articles, believe they have it all figured out, perhaps even get lucky once or twice. In the long run, the market is anything but generous with the unprepared, however, and the same players for the most part end up leaving with various conspiracy theories in their mind as to why they failed.

Hint: don’t be quick to blame potential conspiracies when incompetence represents a possible explanation. And to come even remotely close to considering yourself competent as an investor in this jurisdiction, it is paramount to roll up your sleeves and put in the work. Unless, of course, you choose to outsource this process to a third party such as ChinaFund.com. However, be warned: the market is full of unethical consultants who talk the talk but fail to deliver, so always proceed with caution and take things one step at a time.

We do not shy away from advising potential clients against jumping into a large-scale relationship with us because that is simply not prudent. Instead, we only ask for the opportunity to prove ourselves and gradually establish trust. Other entities do the exact opposite and try to lure Western investor in with tempting promises but as always, keep one of the top axioms of the investment world in mind: if it sounds too good to be true, run like the wind.

Is discrimination a systemic issue?

Yes, for many reasons such as:

1. Throughout the history of the People’s Republic of China, “us vs. them” rhetoric which tends to be quite conducive to discrimination has been prevalent. Whether we are referring to the disastrous Cultural Revolution of 1966 (more information about it can be found in our article about Mao Zedong, which can be accessed by clicking HERE) or China’s economic as well as cultural isolationist tendencies of the past, case studies abound
2. The political status quo not exactly considering the issue of tacking discrimination a priority. On the contrary, a valid case could be made that the very existence (and especially future dominance) of the Communist Party of China depends on “fostering” precisely the type of climate that leads to discrimination
3. The fact that despite China’s tremendous economic growth, inequality looms and the systemic effects are not difficult to quantify. Even back in the days of Jiang Zemin, many Chinese citizens have criticized what they perceived to be China’s policies which revolved around securing economic growth at all costs and to this day, this represents a hot topic. While the Hu Jintao and subsequently Xi Jinping administrations have arguably done more than past administrations to tackle this issue, it still lingers

What about discrimination on a more granular level, discrimination when it comes to the average Chinese citizen… is that a problem?

Once again, the answer is unfortunately affirmative, for reasons such as:

1. Systemic mega-trends which inevitably end up impacting the average individual on a granular level. Stories about totalitarian regimes that nurture a climate of discrimination but average individuals who resist and embrace tolerance and oftentimes just stories. In the real world, “trickle down discrimination” is a more than observable phenomenon, with many average individuals ultimately ending up even embracing the Zeitgeist
2. The fact that a significant percentage of China’s population is still vastly under-educated. Understanding the many facets of discrimination and seeing fellow human beings as complex entities sounds easy enough in theory but let’s juts say that in the real world where functional illiteracy abounds, it would be a Herculean task to generate meaningful change even if the authorities wanted to. And as mentioned rather bluntly previously, they do not
3. Cultural opacity in some instances because, as mentioned previously, China has not decades or centuries but downright millennia of self-imposed isolationism (well before the Communist Party of China was even a concept) under its belt. As mentioned when referring to reason #1, this inevitably trickles down and generates significant effects on a granular level

When it comes to both instances (the systemic as well as granular dimension), the answer to the question which constitutes the title of this article is a resounding yes.

Can this change?

Of course.

Will it?

This tends to be a far trickier question because on the one hand, there are forces that are pushing China toward let’s say modernization when it comes to the issue of discrimination. For example, increased pressures from the international community, in some cases even associated with negative consequences that can be political and/or economic in nature.

While let’s say Mao Zedong’s China would have simply openly defied such international pressures because as a nation which wasn’t exactly connected to the worldwide economic system in a manner that can be considered meaningful compared to the West, it didn’t have all that much to lose. The opposite tends to be valid when analyzing today’s China, a country which has been a multi-decade economic growth success story partly or even especially as a result of being one of the let’s say spoiled children of globalization. In light of how important economic interconnectedness is to present-day China, it would be a stretch to state that it doesn’t care about international pressures.

Does it care enough to take action?

In some cases, yes.

Meaningful action?

Not always.

Therein lies the key to understanding the topic of discrimination from the perspective of today’s China. Despite multiple decades of economic growth and “modernizations” across a wide range of sectors since the Deng Xiaoping days, not enough has been done to tackle issues such as discrimination and various human rights-related ones in general.

It remains to be seen to which degree this can change. Perhaps as a result of increasing international pressures, maybe for endogenous reasons or… why not, possibly both. For now, we will limit ourselves to stating that the situation is anything but rosy from the perspective of discrimination for the reasons outlined in this post. It is ultimately up to you to include such variables in your economic equation as someone who is interested in gaining access to Chinese assets or managing a portfolio which includes Chinese assets.

As corny as the statement may be, this is why investing is as much an art form as an exact science. Should you be interested in picking the brains of a team of experts who have been around the proverbial block when it comes to “all things China” (good, bad and yes, even downright ugly), we are at your disposal here at ChinaFund.com and only one message away.

For an extended period of time, the mere discussion of personal freedoms was taboo (to put it mildly), partly because the average Chinese citizen had other priorities which were more in line with subsistence (think of it as a variation of Maslow’s Hierarchy of Needs) and partly because the (geo)political context wasn’t exactly a facilitator of such discussions.

As China’s economy started catching up to that of Western nations, mostly as a result of Deng Xiaoping’s openness policies which would have been considered downright treason during the let’s say Cultural Revolution of 1966, more and more Chinese citizens found themselves able to escape poverty, with the many implications that brought about.

Among other things, these implications also revolved around the privilege of seeing life in a more complex rather than subsistence-oriented manner. The emergence of a strong middle class (more details about just that can be found HERE) brought about novel interests among millions upon millions of individuals, anything from personal development (learning new things, traveling, etc.) to the pursuit of pleasure.

When it comes to the latter, things start getting problematic.

As we all know, Western entertainment in general is quite heavy on let’s call them personal freedoms, in other words seeking pleasure in ways that tend to be perceived as immoral in many cultures. The “rock star lifestyle” frequently preached by let’s say Hollywood inevitably ended up clashing with the cultural values of a China that found renewed interest in currents such as Confucianism, which revolve around being socially conservative, embracing family values and the list could go on and on.

Reconciling these two worlds is, needless to say, a Herculean task.

With new generations of Chinese citizens being more and more eager to experiment with personal freedoms, anything from the products they consume to the sexual choices they make, the Communist Party of China needed to adapt. Unfortunately for it, closing the proverbial informational floodgates is easier said than done, with pretty much any young Chinese with half-decent computer skills being able to easily bypass the Great Firewall of China.

This puts the authorities in a bit of a predicament, because:

1. They had no choice but to realize that censorship can only go so far and, on the contrary, that it may very well backfire, as data pertaining to Prohibition-related alcohol consumption makes clear
2. It is difficult to isolate the many positives associated with embracing economic interconnectedness with the West (export destinations, technology transfers, etc.) from the negatives, as perceived by the authorities (the West’s let’s call them cultural and ideological exports… pop culture, if you will). At the end of the day, it became a matter of coming to terms with the fact that the pros clearly outweigh the cons and the cons are quasi-unavoidable
3. Personal freedoms represent yet another building block of a trend which may risk jeopardizing the very dominance of the Communist Party of China. Let’s just say it is far more difficult to preserve the political status quo for today’s leaders in a China with an increasingly educated and “Westernized” population than it has been for Mao Zedong, for example

Once again, it is abundantly clear that personal freedoms represent one of the most problematic issues the authorities in China find themselves needing to tackle and at the end of the day, a binomial perspective emerges, with there being two broad options:

1. The “controlled demolition” of traditionalism, with the authorities gradually legalizing various personal freedoms, one step at a time, with the main advantage being that the entire process can be controlled rather than potentially violent and unpredictable
2. Enforcing the current traditionalism-oriented status quo, essentially buying the status quo in its current form a bit of time but with significant risks such as those surrounding frustrations that inevitably build up in such cases

If history is to be an indicator, the authorities will most likely choose a slowed-down version of the former. Not because they are thrilled by the thought but rather because they perceive it as the intelligent thing to do from a calculated risk perspective. Just as the authorities ended up accepting the idea of opening up to the West as of the Deng Xiaoping days despite not necessarily being enthusiastic about the many cultural implications, something similar will most likely need to be done when it comes to personal freedoms.

While this doesn’t mean we can expect Beijing to become Amsterdam, it does mean it wouldn’t be a stretch to assume that over a multi-year or even multi-decade period, the authorities will end up allowing Beijing to become meaningfully closer to Amsterdam than it is at this point in time.

A mega-trend in the making, so to speak. Needless to say, those who position themselves wisely so as to be on the receiving end of the many opportunities pertaining to personal freedoms which will inevitably arise will most likely be in for generation-defining returns. Should you be interested in just that, the ChinaFund.com team is at your disposal, feel free to reach out by sending us a message through the Contact section of our website with what you have in mind and we will happily allow you to pick our brains on this topic and many others.

Perhaps the most textbook example revolves around the morally corrupt bonus mechanism bankers had. On the one hand, their bonuses were directly proportional (enough) to the amount of business they generated for the bank and on the other hand, they weren’t held personally responsible if things went wrong. Therein lies the moral hazard situation: you reap rewards if you are “right” and aren’t in any way punished if not.

This moral hazard situation was exacerbated by the fact that banks engaged in “innovative” banking, with them handing out loans to individuals or businesses, then packaging them as financial instruments (such as the infamous Mortgage-Backed Securities or MBS) and selling them to investors through financial markets. As such, the bank went from “traditional” relationships where a loan was handed out and payments were collected over a period of decades to relationships which involved loans being handed out and passed on as hot potatoes to various investors later on, with the bank washing its hands of them.

Needless to say, incentives to be prudent when handing out loans didn’t exactly abound.

To make matters worse, when things went sour, the banking system in particular and financial system in general had to be bailed out by taxpayers, making the moral hazard dilemma that much worse. From banks to insurance companies such as AIG, examples of moral hazard-facilitated reckless behavior abound.

What about China?

As tends to frequently be the case, it isn’t difficult to find common denominators when comparing China to the proverbial West, even if we do not have perfect symmetry. The incentive structure is different in China, the financial system has its own particularities and so on. But while the “packaging” is indeed different, moral hazard situations aren’t the least bit difficult to come across if we simply… well, follow the money.

It’s ultimately all a matter of asking a few well-placed questions in the right succession:

1. Are there instances in which money can be made in China through methods one can consider reckless? Anything from methods involving excessive debt to methods involving a wide range of externalities?
2. If so, is there a proverbial privileged class that is on the receiving end of the benefits, with an incentive structure (either by design or circumstantial) which enables them to do well when times are good and land on their feet without facing (all that dire) consequences if things end badly?
3. Will the proverbial bill end up having to be covered by third parties that weren’t directly involved in the shenanigans?
4. What about the authorities, are they acknowledging the existence of a problem or minimizing everything, even denying that causes for concern exist?

If the answers to the first three questions are yes when it comes to a certain situation/industry in China, whereas the answer to the last one is negative, we have what can be considered a textbook moral hazard situation on our hands.

Let’s face it:

1. Is it really all that difficult to identify examples of recklessness in China? For example situations involving less than sophisticated entities (individuals, companies, or both) that aren’t exactly experts at juggling debt but were able to receive loans far too easily, loans they once again weren’t that experienced in leveraging? Of course not. The same way, is it that difficult to identify situations in which in the spirit of economic growth (even if at all costs), potentially devastating externalities were overlooked? Once again, no
2. For a nation run by a party with a let’s call it Marxist-Leninist perspective politically-speaking, it sure is easy to come across individuals with quickly-acquired fortunes in China. All it takes is a little bit of digging and in quite a few situations, those gains (perhaps not demonstrably ill-gotten but certainly questionable from a moral hazard perspective) can be traced back to a reckless incentive/disincentive framework
3. While there have been instances in which the Chinese authorities have proven less than willing to bail out an entity, it is for the most part expected that if things truly get dire (especially when, as was the case with the Great Recession, the risk is considered systemically relevant), the Chinese government will act as a creditor of last resort, with the “Who foots the bill?” implications which naturally/logically follow
4. While the authorities have gradually adopted a more vocal stance against anything from corruption to immoral behavior (especially when it comes to the Xi Jinping administration, with the behavior of those with official decision-making privileges being more than obviously in the proverbial spotlight), public discourse is oftentimes little more than hot air. While the occasional head does fall, perhaps in an effort to set an example, let’s just say the journey from official statements to enforcing policy on a local/granular level is more than challenging

As can be seen, moral hazard situations are anything but absent in China, they are simply… as is the case with many other politico-economic aspects, different. Believing that China is somehow immune to basic human folly and that an endogenous Great Recession-type situation cannot possibly occur is an attitude one can consider optimistic at best and reckless at worst. A fairly straightforward conclusion can therefore only be this: while (in our case economic) history doesn’t repeat itself, it most definitely rhymes and common denominators are remarkably easy to identify.

As a bit of anecdotal evidence, we can compare Stalin’s World War II army to that of Germany. While German military leaders for the most part embraced Otto von Bismarck’s meritocracy, Stalin was busy surrounding himself with generals chosen primarily based on loyalty/obedience rather than military qualities. The end result was mostly avoidable decimation on all fronts when it came to the Soviet army.

To close this parenthesis, we can limit ourselves to stating that “meritocracy works” can be considered a quasi-axiomatic statement.

Where does China stand in this equation?

Unfortunately, not as good as the West, for reasons which range from historical to pragmatic ones, for example:

1. The fact that Mao Zedong had quite a few things in common with Stalin when it came to selection criteria, the elimination of potential adversaries or “enemies of the State” and so on
2. The fact that while the Deng Xiaoping and post-Deng Xiaoping era was marked by tremendous growth, this growth was oftentimes chaotic and a generator of inequality, with ample collateral damage brought about by corruption (buying your way toward influence, greasing a few hands so as to make business-related bureaucratic processes more straightforward and so on)
3. Nepotism, in other words promotion based on family ties or anything else of that nature rather than meritocracy, a topic we have dedicated an entire article to (which can be accessed by clicking HERE)
4. Improper education. It is important to state that in affluent Western societies, meritocracy was frequently built upon generational prosperity, generational prosperity that tends to be conducive to better and better education. In China, we are just getting there and as such, once cannot expect proverbial paradigm shifts overnight
5. Cultural and economic confusion. While socialism with Chinese characteristics clearly “worked” (especially compared to the previous model) if we limit ourselves to analyzing metrics such as nominal GDP or GDP growth rates, it is so unique that it brought about amble confusion when it comes to anything from the cultural to the economic dimension. Is China embracing Western values along with Western prosperity or does it frown upon them? Is socialism with Chinese characteristics closer to socialism or capitalism? The list could go on and on. In light of the fact that meritocracy in the absence of clarity is difficult to envision, it should come as no surprise that China is (still) lagging behind
6. Double standards. For example government officials who preach communist values, yet don’t hesitate to shower themselves with privileges. Later administrations and especially the Xi Jinping one have started to tackle this issue head-on but for the most part, it still lingers

As can be seen, it isn’t the least bit difficult to think of a wide range of reasons why meritocracy is not exactly status quo in China at this point in time.

However, in light of the fact that a valid case can be made that the meritocratic framework has been corrupted in the West as well to a meaningful degree (for reasons which range from a corrupt financial system where moral hazard abounds to the sometimes uncontrollable rise of populism), isn’t this entire exercise a case of the kettle calling the pot black?

Perhaps.

But at the end of the day, the fact that meritocracy has arguably been eroded in the West as well doesn’t take away from its… well, merits. Pun intended.

It ultimately remains to be seen which path China will choose.

On the one hand, it might embark on a secular meritocratic trend of its own, perhaps (ironically) right as the West seems to be departing from its secular meritocratic trend. Such cycles are anything but unheard of historically speaking, as nations as well as systems rise and fall.

On the other hand, China might end up doing the opposite and choose to “import” Western moral hazard, financial recklessness and so on. While China has learned from the West tremendously in the most positive manner imaginable over the past decades, it doesn’t mean it didn’t pick up some bad habits along the line. Perhaps we will end up with another one of those bad habits from a meritocratic perspective as well.

While cycles seem obvious in hindsight, human beings are remarkably inapt at predicting the future, so why even bother?

Instead, we will limit ourselves to stating that the ChinaFund.com team sees tremendous value in China embracing meritocracy more so than it has thus far. In China going after its version of the American dream, while (once again, ironically) the American dream is deteriorating right before our eyes. At the end of the day, however, we have no control whatsoever over the path China chooses to embark on.

What we can do, however, is be swift to adapt to whatever it is that reality throws our way. Needless to say, we are always more than eager to also help our clients with just that. Should you be interested in tapping into our expertise, simply visit our Consulting section to find out what we can do for you or if you already have a proposal in mind, send us a message through our Contact section and we will do our best to get back to you in a timely manner.

Who is right?

Both authors, because yes, a country ran by the Communist Party of China can indeed be market-oriented in many instances as well (for more information about socialism with Chinese characteristics, click HERE).

This is just one example (perhaps the most straightforward one) and the bottom line is this: in China, the answer to many questions can be “yes” and “no” at the same time.

The same principle is valid when it comes to the question which constitutes the title of today’s post.

Is China tolerant?

In some cases yes, in others no.

How tolerant is China?

In some cases very, in others not at all.

As confusing as it may seem, things start making sense once we throw some more examples into the mix and we will start with examples of instances in which China can be considered intolerant:

1. Freedom of speech, especially when it comes to opinions which go against the political status quo, with consequences being dire in such instances
2. Freedom of information, with there being a ChinaFund.com article dedicated to the textbook example to that effect, the Great Firewall of China (an article which can be accessed by clicking HERE)
3. Freedom religion in many instances, with minorities oftentimes being persecuted in manners which draw international attention in the most concerning possible manner
4. Freedom of political choice, with China being a multi-party nation technically speaking but in reality, it’s nothing more than a formal status quo, one we have addressed in an article you can read HERE

… the list could go on and on. As can be seen, examples which describe China’s intolerance for the most part revolve around the political status quo and anything that risks threatening it.

On the other end of the spectrum, there are examples of situations in which China can be considered tolerant:

1. Business-related standards and especially their enforcement, anything from worker protection to quality control. Let’s just say the equation based on which businesses decided whether or not to relocate to this jurisdiction pretty much always involved considerably more than simply wage arbitrage
2. Unethical or even downright fraudulent practices, especially practices which revolve around defrauding Western entities. While let’s call it endogenous fraud tends to be more thoroughly enforced, things tend to be multiple orders of magnitude trickier when international fraud is involved
3. Externality-related situations, for example instances pertaining to pollution, situations in which Chinese businesses tend to have a fair bit more wiggle room than their Western counterparts… to put it mildly
4. Barriers to entry for domestic individuals/businesses (most definitely not for foreign entities, however). In fact, many expressions along the lines of “there is more capitalism in China than some European nations” revolve around just that, barriers to entry or the ease of doing business, generally speaking

Once again, the straightforward observation which arises is that as long as we are referring to activities which do not question the political status quo, China oftentimes finds itself on the tolerant end of the spectrum… ironically, more so than even certain Western nations. There is a reason why industries such as bitcoin or cryptocurrency mining have been thriving in China despite the love-hate relationship authorities have with them, with “tolerance” being the operative word.

Simply put, the authorities have been willing to tolerate the sometimes questionable energy contracts mining operations have obtained, the pollution dimension of mining data centers, the lax (by Western standards) security and worker protection protocols and the list could go on and on. The end result is that bitcoin and cryptocurrency mining ended up being dominated by Chinese market participants to such a degree that otherwise decentralized cryptocurrency assets (with decentralization being a key crypto selling point, arguably the number one selling point) can be and are considered dangerously centralized from a mining perspective.

Let’s just say that if you or your organization have business interests in China, wrapping your head around nuances most definitely conducive to long-term survival. Do not make the mistake of expecting a Western-style framework of predictability, as you will be bitterly disappointed. Instead, understand that China is the country where cryptocurrency mining can be hated (it was even included on the list of activities that should be prohibited) yet still thrive. Just as fortunes have been made by cryptocurrency miners, generation-defining wealth can be generated in a wide range of other industries as long as your business model and overall approach are tailored to the particularities of China.

As an entity with an actual brick and mortar business presence in China for over 13 years, the ChinaFund.com team is in a unique position to help with just that. From the economic/investing experience of our managing partner Andrei Polgar to the brick and mortar expertise of Graham Haynes and the multi-jurisdictional accounting know-how of James Macrae, we pride ourselves in having all bases covered. For more information about our team, visit the About Us section of ChinaFund.com, visit our Consulting section to find out what we can do for you or your organization and, finally, simply access the Contact page of our website to send us a message if you have a specific request in mind.

Why not the political one as well?

To put it differently, the average Western observer cannot help but wonder if increased prosperity can or will bring about increased political freedom in China because in the West, it is considered a quasi-axiom that the two go hand in hand.

Do they?

Perhaps.

As pointed out rather frequently here on ChinaFund.com, it isn’t prosperity in and of itself that facilitates cultural changes but rather the consequences of said prosperity. Think of it as Maslow’s Hierarchy of Needs applied to a population of 1.4 billion individuals.

Back in the let’s say Mao Zedong days, the average Chinese citizen was oftentimes struggling with the (very) basics, anything from putting food on the table to basic medical care. While some people did somehow find time for ideological endeavors, let’s just say such individuals represented a minority and that for the most part, people had more “pragmatic” needs that had to be met before bandwidth could be allocated to topics which pertained to more abstract aspects, anything from political freedom to ideology.

However, as time passed and the policies of Deng Xiaoping and his successors brought about increased prosperity, things gradually changed. As more and more Chinese citizens escaped poverty and even ended up having excess capital at their disposal, a chain reaction took place across multiple dimensions over in China:

1. More and more people could afford better and better education for their children, leading to better and better-educated new generations. Young people who oftentimes saw life in a remarkably different light, one based less on subsistence (putting food on the table, having adequate shelter, etc.) and more on the proverbial abstract dimensions of our existence
2. The adults themselves became more and more affluent, leading to an increasingly financially potent middle class. Once again, subsistence was no longer the name of the game as far as this demographic is concerned in light of the fact that China’s growing middle class could afford to aim higher
3. With increased prosperity came increased consumption (as mentioned at the beginning of this article as well), which didn’t revolve exclusively around consumer goods and didn’t revolve exclusively around China-centric products/services either. The average Chinese citizen was able to come into contact more and more frequently with Western products and services, products and services which inevitably carried a cultural component as well. Whether we are referring to Western online publications which can easily be read by Internet-savvy Chinese citizens who know how to bypass the Great Firewall of China or to let’s say Hollywood, it isn’t the least bit exaggerated to state that the West also exports ideas/thought currents to China

… the list could go on and on.

In and of itself, each item is more than capable of altering the let’s call it Chinese Zeitgeist and in aggregate, they are a force to be reckoned with. To put it differently, it is increasingly harder to convince a better and better-educated as well as better and better-informed population to tolerate what is essentially authoritarianism.

While it is true that for the most part, the political status quo has yet to be challenged in a meaningful manner over in China yet and while things may persist in this manner indefinitely (nothing is impossible), let’s just say everything from simple logic to complex game theory indicates that eventually, something will need to change.

Does this mean Western-style democracy will eventually be embraced?

Perhaps, but it is difficult to make such game-changing predictions with a reasonable degree of confidence.

What is likely however is that China will become MORE democratic than in the present rather than meaningfully democratic in the Western sense. Just like the fall of the USSR was followed not directly by Western-style democracy (let’s face it, it’s still not exactly the case in Russia) but by the Perestroika phenomenon, it wouldn’t be a stretch to expect something of this nature in China.

Think of it as a controlled detonation of the political status quo, followed by a gradual transition to a system that is easier to “sell” to an increasingly educated, informed as well as financially potent population. Time and time again, we have stated here on ChinaFund.com that China likes to embrace its own version of anything from political systems to ideological frameworks (socialism with Chinese characteristics representing a relevant example to that effect) and as such, it would be rational to assume that the same will ultimately be valid in one way or another when it comes to the topic of democracy.

In a nutshell:

Can China become a democracy?

Yes, anything is possible.

Will it become a democracy?

This is where things start to get tricky, with the more likely explanation revolving around the fact that even if this is to eventually happen, it will most likely be an excruciatingly drawn-out process, whereby “more democracy” is gradually permitted. While black swan events which could bring about an acceleration of this process cannot be eliminated from the equation completely, it would be quite unrealistic to expect major democratic breakthroughs overnight. Needless to say, keeping your eyes on these developments if you have business interests in China is a must and as always, the ChinaFund.com team is here to assist you with just that.

Indeed, you find many particularities associated with communist regimes of the past in China. As far as the Politburo is concerned (the Central Politburo of the Communist Party of China or to be even more formal, the Political Bureau of the CPC Central Committee), however, it is worth pointing out that power being centralized when it comes to the so-called Politburo Standing Committee represents a particularity.

To keep things (somewhat) simple, the Politburo (for the sake of preserving what little sanity we have left, we will use this one-word term moving forward) consists of 25 individuals, the most influential members of the Communist Party of China. Technically speaking, the Central Committee is the entity which elects Politburo members. In more practical terms, however, the equation seems to be a bit more incestuous, in that members are chosen through deliberations between existing as well as retired members.

What is the Politburo Standing Committee or, to use more pompous terminology, the Standing Committee of the Central Political Bureau of the Communist Party of China (quite a mouthful)? Let’s just say that while the Politburo consists of the elite (25) members of the Communist Party of China, the Politburo Standing Committee consists of the elite among the elite. At this point in time, there are 7 Politburo Standing Committee members, a figure which can fluctuate between 5 and 11.

In terms of subordination… let’s just say things are tricky. Once again, technically speaking, the Politburo Standing Committee is supposed to answer to the Politburo, which itself formally answers to the Central Committee. In practice, however, that is definitely not the case, with the Politburo Standing Committee overshadowing the two other entities in terms of influence.

We need to understand that just like when it comes to many other aspects pertaining to China and how things are handled in China, “indirect” is the operative word. Observers who are expecting the members of the Politburo and/or the Politburo Standing Committee to have clearly-defined let’s say executive responsibilities (in other words, observers who expect the two entities to revolve around directly handling key aspects) end up being surprised when they realize that clarity is… well, lacking.

Many of the internal workings of the two are not exactly known to the public and therefore subject to speculation. Suffice it to say that the power of the two lies in the fact that its members occupy various other positions within the Chinese administrative system. Key positions, of course. Think of them as political gatherings of the CPC elite, which may not be the most precise description out there but is close enough.

Moving on to the present, here are the seven members of China’s 19th Politburo Standing Committee, revealed during the First Plenum of China’s 19th Central Committee back in October of 2017:

• Xi Jinping
• Li Keqiang
• Li Zhanshu
• Wang Yang
• Wang Huning
• Zhao Leji
• Han Zheng

… needless to say, the seven previously-mentioned individuals are also simple Politburo members, with the other Politburo members being:

• Ding Xuexiang
• Wang Chen
• Liu He
• Xu Qiliang
• Sun Chunlan
• Li Xi
• Li Qiang
• Li Hongzhong
• Yang Jiechi
• Yang Xiaodu
• Zhang Youxia
• Chen Xi
• Chen Quanguo
• Chen Min’er
• Hu Chunhua
• Guo Shengkun
• Huang Kunming
• Cai Qi

It is worth noting that at various points throughout the history of the People’s Republic of China, the Politburo and the Politburo Standing Committee had occasional let’s call them hiccups. For example, the Politburo Standing Committee wasn’t anywhere near as influential as today during Mao Zedong’s Cultural Revolution days. The same way, the Politburo was overpowered during the Hu Yaobang days, with the entity overpowering it being the Secretariat of the Communist Party of China Central Committee, a state of affairs that was no longer valid as of 1987.

As complex to the point of unnecessarily complex as it may seem, there is let’s say method behind this madness. To someone who is accustomed to the (more) transparent manner in which policy is shaped in the West, this entire situation may very well seem disheartening. Whether or not you personally agree with the Politburo / Politburo Standing Committee approach, the situation is what it is and as an investor who is interested in gaining exposure to Chinese assets, it is just something you have to deal with.

After conducting business in China for over 13 years, the ChinaFund.com team learned a thing or two about the particularities of the system. If you will, we have so you do not have to, should you choose to hire us as consultants. To find out more about this service, access our Consulting section or to get in touch directly by leaving a message, visit the Contact section of ChinaFund.com.