China Inc.

Posted on October 15, 2007 by David Laidlaw 

China’s economic growth has been viewed as a supernatural event. While we view China’s impact on the global economy as significant due to its industrializing commerce and from the fact that the country is home to about 20% of the world’s population, we do not view the country as an unstoppable juggernaut.

An article in Forbes magazine over the summer analyzed China’s GDP growth rate and posited that the published rate must be overstated.

All modern economies rely on electricity to grow and over the years, the relationship between growth in the use of electricity and growth in domestic product is well established. Gross Domestic Product has been shown to grow at 45-60% of the rate of the growth in electricity usage depending on the efficiency of the economy.

China has reported its economic growth at between 10-11% per year. However, electricity usage has only increased at a rate of 12-14% per annum. This suggests that the country’s underlying economy is growing at a more reasonable rate of 5-8.5% annually.

China ’s corporations are also not capitalist from a Western viewpoint since the government is so intricately involved in the affairs of their corporations.

Given the extraordinary run-up in China’s stock market over the past two years, we researched and shorted one of the country’s airlines, China Southern Airways, in our hedge fund since the fundamentals suggest the company is wildly over-valued.

China Southern is roughly half-owned by the Chinese government. The government is also intimately involved in the airline’s operations. The government leases the terminals and runways to China Southern and provides maintenance to its fleet. The government also cleans the planes and the terminals and provides certain company sponsored retirement benefits.

Unlike overpaid American CEOs, China Southern’s chief only makes $60,000 per year and received a $2,000 bonus for 2006 even though the company has a market capitalization of $7.5 billion. The airline also has a board of directors and supervisors which consists of over 20 individuals, many of whom appear to be communist party members.

During its heyday in the 1980s, Japan and its industrial conglomerates were referred to as Japan, Inc. due to the unstoppable nature of their growth and the state subsidies that they received. China is referenced with the same tone now. China’s growth is impressive and will influence commodity prices for decades to come; however, the growth is slower than advertised and the state sponsorship suggests that resources are not being allocated as efficiently as with a market economy and that the future growth will be bumpy.