By Len Costa
On the rare occasions when the vice chairman and president of China Investment Corp. speaks on the record, investors listen. But if the audience convened by the Economic Club of New York last Friday in midtown Manhattan expected Gao Xiqing to divulge any of the sovereign wealth fund's investment secrets or telegraph CIC's next move, they were sorely disappointed. Gao prudently limited his comments to his own views and mostly focused on his positive long-term outlook for China's economy, notwithstanding the continued darkening news, including, just yesterday, the World Bank's downgrade of its growth forecast for the world's second largest economy from 8.2% to 7.7% for this year. That's well below the 9.3% growth that China recorded in 2011.
During his talk, Gao leveled two critiques that are of particular interest to those in the West who have grown accustomed to frequent commentary about China's opaque regulatory system and the country's slow pace of financial liberalization. Gao turned the tables, so to speak, by pointing out the shortcomings that he sees in the United States. He said that when CIC seeks to invest in the United States, despite the fact that US infrastructure is in pretty dire straits, he is politely asked to look elsewhere, even when the investment represents only a small stake. The regulatory roadblocks may appear to be technical in nature, he said, but they are in fact political. "It's not serendipity, it's by design," he said.
Gao, who previously served as deputy chairman of China's National Council for the Social Security Fund and deputy chairman of the China Securities Regulatory Commission, also had a few choice words about risk management. He said losses on derivatives at JPMorgan Chase attributed to the so-called "London Whale" were especially telling: Even though he believes in JPMorgan's (NYSE:JPM) risk management, which was designed to prevent just such a debacle from taking place, it happened nonetheless because finance has gotten too complex. "You are creating a system that very few people understand, much less the regulators, because the regulators do not have as much incentive as the bankers to do as good a job," said Gao.
The lesson for China? "As a former regulator," Gao said, "I think we do need to slow down a little bit."
The vice chairman of CIC, which oversees $177 billion in foreign assets and ranks fifth on Institutional Investor magazine's survey of the largest sovereign wealth funds, went on to argue that too many of the smartest engineers have been pulled into finance over the past 20 to 30 years. That has created a "self-fulfilling prophecy" in which the best minds engineer financial products instead of industrial products.
Gao also lamented the lack of real-world experience among the investment practitioners on his team. Although CIC uses financial models, he does not trust them, preferring instead to evaluate investment opportunities firsthand. Gao said he was once a railway construction worker and even worked in an artillery factory, so he knows his way around an assembly line. He said that he has personally visited hundreds of factories and has declined multibillion-dollar investments based on unsatisfactory site visits. However, most of his staff were trained in the United States and Europe, he said, and few have practical training in "actual work," as he put it, meaning in factories or companies that make physical products.
With regard to China's economy, Gao's bullish perspective may come as no surprise given that he and his board report to the State Council of the People's Republic of China, the country's chief administrative authority. Still, Gao's overarching message - which he clarified during a brief Q&A session following his remarks - was not that China would necessarily avoid a so-called hard landing but rather that the probability is not as high as some China watchers have predicted. Gao said he does not believe that the era of high growth is coming to an end. "My personal view is that [the economy] is going to go up," he said, "if not 12%, it's definitely going to be a lot higher than a lot of people expect today." That said, he acknowledged that he could envision a substantial slowdown if China's political situation changes dramatically, an important caveat given the once-a-decade political transition that is looming.
The bulk of Gao's talk was devoted to explaining six reasons why he believes that China's economy is "still on the right track," as highlighted below:
- Urbanization. According to Chinese government statistics, 51% of the population lives in cities and 49% live in the countryside, Gao said, up from a 70/30 split in recent years. Urbanization rates in developed countries are typically in the 70% range - and China's gap of roughly 20 percentage points represents almost the entire population of the United States, he noted. This continued move to the cities will enhance China's economic potential and is the single most important thing for China's economy over the next 10 to 20 years, Gao contended.
- Regional Differences. On China's east coast, cities like Beijing and Shanghai are as modern as any in the West, Gao said, and life expectancy in those cities checks in at 81 years and 83 years, respectively, topping US life expectancy. In China's poorer western provinces life expectancy is still less than 64 years, and people in these areas are aware of the disparity in living standards and are not at all content with the status quo. That is helping to drive growth and explains in part why there is a huge increase in real estate development, which the central government has recently been trying to rein in.
- Industrial Development. China continues to work to attract foreign investment, and the Chinese economy is becoming more diversified. Gao acknowledged the political sensitivity in the United States with regard to sending investment dollars to his country. But he argued that Chinese industry will continue to grow whether or not foreign companies choose to invest there.
- New Infrastructure. China has an opportunity to leapfrog the West as it develops its domestic infrastructure, Gao argued. By way of an example, he said that he was recently on the border with Tibet, and at an elevation of 4,200 meters, he still had good mobile phone service, which continued to function reasonably well at 6,200 meters. In contrast, he said of the United States (only partly joking): "Every time I come here I feel so much pain in my heart. Your cell phone [service] doesn't work!" Gao also mentioned that China has less than 50% of the highway density of the United States, and that his country's rail and subway systems still lag behind those in Japan, Singapore, and Taiwan. China wants to catch up and will require massive investment to do so.
- New Industries. Gao said that China may well surpass the United States in renewable energy. CIC is an investor in one of China's largest solar companies and the country's largest windmill producer. Gao added that China also has strong potential in the life sciences and pharmaceuticals.
- Higher Education. Gao is the product of both a Chinese and a US education - he earned a bachelor's and a master of laws from Beijing's University of International Business and Economics, as well as a law degree from Duke University, where he has served on the board of trustees since 2008. He said that the Chinese government is making a tremendous effort to increase investment in domestic education, and there is still plenty of room for improvement. He noted that China has a nursing shortage but as yet no nursing schools as they exist in the West. He believes there is pent up demand for quality education in China, and said that the Chinese are willing to pay for it.