Special Report from The Conversation
by Guido Cozzi, The Conversation
Chinese tech companies are the hottest thing in the corporate world right now. Last month Alibaba – the country’s largest e-commerce group – filed an application for what promises to be an unprecedentedly massive IPO on the US stock market. Now it is the turn of JD.com – the Amazon to Alibaba’s eBay. Its IPO this week raised US$1.78 billion and was 15 times oversubscribed.
Such stock market coronations are the culmination of nearly two decades of strong modernisation efforts by China, as its government sought to integrate its economy into global trade. In fact, the success of Alibaba and JD.com is emblematic, as they reflect almost each step of this process.
More money, more consumption
These firms are seeing the benefits of China’s massive advances in tertiary education – including the build-up of large numbers of highly skilled software engineers. Adding to this are huge investments in transport and telecommunications (including broadband internet) as well as in research and development (R&D). The government has also implemented important reforms to strengthen the intellectual property rights of domestic innovators and multinationals who bring their technology to China.
Competition law has been reformed, as has the real estate market. The effects of these policies characterised China’s economy in the late 1990s and 2000s and led directly to today’s e-commerce boom.
Domestic consumption – and thus e-commerce – in China has expanded hand-in-hand with a rising and increasingly sophisticated middle class. Just a few days before Alibaba’s IPO application, the World Bank forecast that, in real terms (adjusted for the purchasing power of each currency) China’s GDP would overtake the US by 2015. In other words, by next year Chinese people could in total buy more stuff than Americans.
Strong consumption will be the next stage of development in China. Growth led by investments and exports has usually been the country’s longer-term priority. Consumption as a proportion of the overall economy is still far lower in China (about 35%) than in advanced countries such as the US (about 69%) and UK (66%) . This is also due to a highly unequal income and wealth distribution, and to the absence of a reliable and comprehensive social security system.
Trading places
But, in becoming the world’s largest exporter, elements within the Chinese private sector became well prepared to take advantage of the consumption boom, when it did come. In fact, Alibaba started up in 1999 by connecting trade between Chinese firms and foreign buyers. It then expanded, growing alongside the domestic online market whose rapid increase in size has transformed it into a giant that can boast a turnover greater than Amazon and eBay combined.
It may seem surprising to see a relatively new sector, online commerce, becoming so strong in an emerging economy. In this case, China’s “advantage of backwardness” opens the door to frontier technology as it leapfrogs some of the more mature sectors lagging too far behind. In fact, the relative backwardness of bricks-and-mortar trade, with its poor and fragmented logistics, exacerbates the advantages of the rampant internet-based trade networks. As more and more Chinese go online, these advantages are magnified.
Despite a global recession, China’s GDP growth has remained above 7% until now. As such, the gap in per-capita incomes between China and the West will narrow in the medium term, even assuming growth will slow down to US or EU rates as the country catches up. Meanwhile, Chinese consumer spending will grow massively, to the benefit of companies that are able to maintain their competitive edge.
The new challenge for online commerce is mobile commerce, which is a natural consequence of the number of mobile internet users in China reaching half a billion in 2013. In this sector Alibaba is also currently world leader, but it has to face tough domestic competitors of the calibre of Tencent and Baidu, assuming no foreign entrant arrives. This is competition from all angles, stretching from research and development, patenting, to regulation and political connections.
But don’t forget the bigger picture
While the merits of Alibaba and JD.com’s business models are undeniable, investors would be wise to remember the world economy is still in a precarious place, and things can suddenly change.
American investors may be licking their lips over the prospects of a healthy dividend, but uncertainty over interest rates in the US justify some caution. The Fed’s expected “tapering” may have a depressing effect on the US stock market. Gloomy scenarios related to the Chinese house pricing bubble, which according to many analysts may soon crash, raise some fears of a potential economic downturn. This would have consequences on consumer spending and therefore business-to-business and retail trade. Basically: if the Chinese economy tanks, it will probably take its e-commerce giants down with it.
Alibaba’s choice to raise capital in the US stock market could help it diversify away from the potentially fragile Chinese market. But, on the other hand, a temporary decline in the estate market could reduce warehouse costs. This could end up working in the e-commerce industry’s favour.
Finally, since the World Bank estimates each dollar spent in China buys the same goods as approximately three dollars spent in the US, there must be room for the Remnibi to increase its value. This probably explains the reluctance of the Chinese authorities to openly accept purchasing-power-parity based statistics. A longer-term revaluation of the Renminbi would raise the dollar value of Chinese shares. It will also stimulate domestic consumption, especially if coupled with more income and wealth redistribution in favour of the most disadvantaged social groups.
Guido Cozzi does not work for, consult to, own shares in or receive funding from any company or organisation that would benefit from this article, and has no relevant affiliations.
This article was originally published on The Conversation. Read the original article.
