Commentary on Political Economy

Thursday 23 September 2021

 Xi Jinping Makes China a Dangerous Place for Investment

What the state wants, the state gets. That makes the business climate unstable and ethically risky.

By Dennis Kwok and Johnny Patterson

Sept. 22, 2021 6:15 pm ET

China's President Xi Jinping remotely addresses the 76th session of the United Nations General Assembly, Sept. 21. PHOTO: BEBETO MATTHEWS/ASSOCIATED PRESS

Despite the growing tensions between China and the West, the ties between China and Wall Street have grown exponentially in recent years. BlackRock, JP Morgan, Goldman Sachs, HSBC, Vanguard and Schroders are all rushing into the Chinese financial markets. BlackRock called last month for investors to consider tripling their allocation to Chinese equities.

Yet China’s increasingly unstable business environment looks likely to leave these financiers looking foolish or reckless. Beijing’s crackdown on private businesses has wiped out hundreds of billions of dollars in market value in the past two months. Under the policies of “advancement of the state, and retreat of private enterprises” and “common prosperity,” the state’s tightening of control will increase. Beijing’s obsession with national security puts key economic sectors, including finance, firmly within the state’s purview.

In a study session for members of the Politburo in 2017, Xi Jinping emphasized that financial security is an important part of national security. The Chinese Communist Party’s concept of national security is far-reaching. Bullish investors who believe China will open up its financial markets without conditions should think again.

The latest crackdown on private businesses primarily is aimed at placating the domestic audience and shoring up Mr. Xi’s image at home. It is a strategic move before the March 2022 National People’s Congress, where Mr. Xi is widely expected to be confirmed as lifetime chairman. Having alienated many party elites, he needs the support of the masses. For the 600 million or so Chinese with a monthly income of $160 or less, Mr. Xi wishes to be seen as the strong leader who can bring down billionaires and force them to share their spoils. Glamorous movie icons and heavily indebted property developers—like those at Evergrande—make easy targets.

Meanwhile, Beijing assails “foreign forces” for seeking to curb China’s rise as a great nation. That refrain is constantly pushed by state media and diplomats, as it was in the cases of Hong Kong and Xinjiang. Given the constant political need for enemies to purge, the risks for foreign financial firms are clear.

China’s anti-foreign-sanctions law, enacted in June, should ring alarm bells. A failure to comply could land any foreign company in legal problems leading to the confiscation of assets by the state. Investors and shareholders of Wall Street firms must understand that there has been a paradigm shift in Mr. Xi’s China. Long gone are the days of pragmatism. What the Chinese state wants, the Chinese state gets.

The drive to increase investment in China also is at odds with the other big trend in finance: “environmental, social and governance” investing. By the end of last year, the total assets in sustainable funds hit a record of almost $1.7 trillion. Every major financial firm has sustainability statements touting their ethical credentials. Most have signed on to the U.N. Guiding Principles on Business and Human Rights. Can the commitment to ESG be squared with growing investment in China? No. If average Americans realized it was likely that their pension-fund managers were investing billions in Chinese technology firms with close ties to the state, they would have objections. But financial services are complex and opaque, and few are aware of these trends.

A new Hong Kong Watch report on institutional investment around the world has implications for U.S. retirement investors. Consider one example: Vanguard manages academic and staff retirement funds for several elite U.S. institutions, including Princeton and Columbia. Between 22% and 35% of each retirement fund is allocated to the Vanguard Total International Stock Index Fund, depending on the retirement date of pensioners. As of July 31, this fund, which isn’t ESG-driven, held $4.4 billion in Alibaba, $4.6 billion in Tencent, $17.3 million in Iflytek, $7.6 million in Dahua Technology, $23 million in the Aviation Industry Corp. of China, and nearly $2 billion in China’s top four state-run banks.

The ethical issues are clear. Iflytek and Dahua Technology have faced U.S. sanctions for their complicity in building the Xinjiang surveillance state. AVIC has been deemed a national-security threat by the U.S. government and faces an investment ban under an executive order issued by President Biden. China’s state-run banks bankroll the country’s state-owned enterprises. Alibaba has produced facial-recognition software that targets Uyghurs. WeChat, owned by Tencent, has been accused by Human Rights Watch of censoring and putting its users under surveillance on behalf of the Chinese state. Uyghurs and Tibetans have been imprisoned for using WeChat to share religious materials. Vanguard didn’t respond to requests to comment.

Vanguard’s portfolio is no anomaly. Most pension funds operate with very little scrutiny. But the systemic funding of firms with ties to the Chinese Communist Party carries ethical implications and any firm that claims to be serious about ESG must start having these conversations.

We are entering an era of one globe, two systems. The recent Hong Kong experience taught us that the old days of playing both sides are over. One can operate either within China’s orbit or outside it. For Western firms, straddling both sides will become unsustainable.

Mr. Kwok served as a member of Hong Kong’s Legislative Council, 2012-20. He is a senior fellow at the Harvard Kennedy School’s Ash Center for Democratic Governance and Innovation. Mr. Patterson is a co-founder and policy director of Hong Kong Watch.

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