Recently the Chinese stock market has been showing the warning signs of an economic slowdown. The Shanghai Composite Index dropped from an earlier rally, closing at 2,180.90 points in December, the lowest level in 33 months.
The public may have a perception that the current weak trading of the stock market is an inconsistent indicator of China’s strong rate of economic growth, which continues to grow roughly 8 percent to 10 percent each year. But China’s biggest underlying problem is a structural one: an over-dependence on export-led growth at a time when its two major customers, the U.S. and Europe, have continual stagnant rates of GDP growth and persistently high rates of unemployment.
Ten years after joining the World Trade Organization, China has become the biggest exporter in the world relying on its advantage of low-cost labor. Exports were equal to 26 percent of the GDP in 2010 and Europe was the biggest market for China. Now China faces the possibility of a long-term decline in its export trading. According to PRC Ministry of Commerce spokesman Shen Danyang, “China likely faces a ‘very severe’ foreign trade situation in the first quarter of 2012.”
With rising costs of labor and land, less preferential tax and incentives policies, combined with the uncertainties of the overseas markets, entrepreneurs in China are finding it increasingly difficult to maintain sustainable profit growth. Concurrently, China’s capital markets are experiencing rapid growth, and many business leaders see the potential to make quick money by becoming full time investors. This stands in stark contrast to the “hard money” business people hope to make when they invest the time and energy to develop a business over the long term.
Backed by growth-driven economic policies, an increasing number of Chinese business executives are deciding to try their hand at full time investing in the capital markets. The number of venture capital firms operating in China has grown rapidly, but as one industry expert noted, “There was a lot of money chasing a limited number of good deals.” People will compete heavily for attractive projects and their investment decisions tend to be made abruptly. Not every investor will be successful in the investment game. Some will lose and some will lose substantially since opportunity and risk go hand-in-hand.
Teng Bingsheng, associate dean and professor of strategic management at CKGSB, pointed out that once business professionals begin investing in companies outside their own industries and fields of expertise, they risk losing their competitive edge. “The potential risks associated with venture capital and private equity investments are of a greater magnitude than those of non-investment related business.”
It needs to be emphasized that most business executives lack formal investment training. However, as Teng stated, “They typically decline to seek help from professional investment analysts. Instead, bolstered by their past successes in business, they tend to conduct due diligence based on gut-level decisions, often based on their impressions of a target company’s founder or management team. Put simply, they believe that as long as the right person is in charge, everything else will take care of itself. Acting on instincts only increases the likelihood of failure.”
There are lessons to be learned from the experience and advice of Zhou Hongyi, the former chief of Yahoo! China’s operations, who stepped down in 2005 to become a partner with the IDG investment house. After a number of failed investments, he developed three ironclad rules. First, don’t invest in industries you don’t understand; it is the equivalent of buying a lottery ticket. Second, do not allow your emotions and friendships to cloud making rational investment decisions. Third, making investments on impulse is equivalent to gambling.
Motivated by the idea of “easy money” made in the short run, an increasing number of executives are becoming investors, turning their backs on the more traditional, long-term approaches to business growth. Teng expressed his concerns with this growing trend. “It presents risks for the nation as a whole. If nobody cares about sustainable business models, and the first priority of Chinese business elites is simply to seek out quick returns on their investments rather than focusing on long-term growth, we will have no chance of realizing our ambitions for developing global brands. China stands to lose potential industry leaders – the Chinese equivalent of a Steve Jobs or Kazuo Inamori.”
There are inherent challenges with trying to balance traditional business practices with the world of high-risk and high-return investments. As Teng points out, “Business and investing can be complementary, as long as business people invest within their areas of expertise. In fact, companies that manage to strike a successful balance between their business operations and their investments are the ones who stand to substantially improve their positioning. ”
Lenovo is a good example of a company that has successfully combined business and investments. It teamed up with the Chinese Academy of Sciences to create “Lenovo Star”, a specialized training course for CEOs. At the same time it established a RMB 400 million angel investment fund. Through these dual initiatives, Lenovo was able to realize its goals of boosting its technology investments.
According to Teng, such integrated models of business and investing offer the ideal solution for business leaders tempted by the potential windfall of a new career in investing. “Rather than exit an industry in which an executive has accumulated decades of expertise, he should consider a new role in which he can give advice regarding investments that will strengthen his company’s industry standing and create a foundation for long-term growth.”
China has roughly 20 percent of the world’s population and is now the second-largest economy. Currently in the United States, 75 percent of the GDP comes from consumer spending. In China, according to Chi Fulin, Deputy Director of the China Institute for Reform and Development, domestic consumption contributes roughly 37 percent to China’s yearly GDP growth. There is clearly room for domestic spending to play a much larger role in helping Chinese businesses maintain a positive profit growth rate.
The uncertainties of the export market heightens the need for China to wean itself off its export-driven, fixed asset-based economic model by encouraging more corporate and consumer spending at home. Meanwhile, more domestic spending might help stimulate Chinese industry to be more innovative and develop new products, rather than focusing on producing high-volume, low-value goods. Only through these reforms can Chinese companies truly compete on a global scale.