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Communism – Good for investors?

By: Sachee Trivedi

Karl Marx wrote the Communist Manifesto in 1848 propounding a new politico-economic system, Communism. 176 years later, we are still talking about it.

Over the years, countless philosophers and historic events tried to dispel the myth of the utopia that Communism promises.

The famous Russian-American author and philosopher, Ayn Rand, extolled the virtues of capitalism in her seminal 1966 book, Capitalism: The Unknown Ideal. She believed that capitalism was not merely an economic framework that maximises common good but also as a “moral social system” and “the only system geared to the life of a rational being”.

For some, reading this book alone made Capitalism the known ideal.

The post-World War II era helped. Amongst the many unintended consequences of the war was the A/B testing of Capitalism vs Communism. A/B testing is a well-known strategy used by marketing professionals – a controlled group of customers is given the product A, and another controlled group of customers is given the product B – then you assess which product is better received. The well-meaning but arbitrary lines drawn on the world map by Allied Forces clerks as the war was coming to an end created the perfect A/B testing environment for Capitalism v Communism – think North Korea vs South Korea, East Germany vs West Germany. We all know how these movies played out.

For the stubborn sceptics amongst us, another legacy of World War II was the Cold War – a period of tense relations between the Communist (erstwhile) Soviet Union and the Capitalist United States of America. No points for guessing which country fared better.

Growing up in India, for me the choice between capitalism and communism has always been obvious. Capitalism wins hands down.

So, it has been intriguing to see the capitalist western investors invest in China.

The euphoria has been renewed in the last couple of weeks. Global investors pulled money out of India, Japan and other countries over the last couple of weeks to invest in China. The investors largely give two reasons for investing in China:

• The valuations of Chinese companies are very low
• The Communist party will be able to revive an ailing real estate sector, a non-performing banking sector and tepid GDP growth by interventionist, pro-market policies

Here’s a thought-provoking statistic – over the last thirty years, where China went from being an insulated eastern economy to becoming a global superpower, the Chinese stock market has returned merely 1.26% on an annualised basis. This return is dwarfed by the 9.25% annualised return of India in the same timeframe.

MSCI China vs MSCI India over the last thirty years

The conundrum

The data above is counterintuitive given that in the last thirty years China’s GDP went from being 1.5 times of India’s GDP to more than 5 times that. What adds to the conundrum is that while we associate communism with bad economic outcomes for the citizens, in case of China, hundreds of millions of people have been lifted out of poverty and lead a modern lifestyle with access to housing, jobs, healthcare and education.

Why then is the experience of investors disconnected from the experience of the citizens?

I believe it has to do with the inherent structure of a communist economy. Communist regimes are hinged upon absolute, centralised control – control of power, control of information and the control of capital. Control and free capital markets cannot co-exist.

I illustrate this point with two bits of anecdotal evidence.

1. Inefficient capital allocation: The largest bank of Luxembourg, the BIL, is majority owned by Lenovo, a PC/laptop maker – what business does a PC-maker have owning a bank thousands of miles away – this government adventurism comes at the expense of shareholders.

The most telltale sign of the structural problems is that the largest Chinese banks trade at less than half their book value – this is evidence that the banks have been lending to unprofitable, unviable businesses that cannot earn their cost of capital.

2. Control, control, control: Govt policies have single-handedly destroyed the stock price performance of Alibaba (Xi had ego issues with Jack Ma and made it a point to teach him who the boss is), and Tencent (since 2017 game launches were stopped, and regulations around gaming have kept changing).

The $100bn edu-tech industry was banned in 2021

To all the investors: Would you invest in China if it was not a part of your benchmark?

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