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Key takeaways from an expert call on implications of ‘common prosperity’ for China's new economy
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We hosted a call with an experienced government relationship practitioner to discuss the long-term implications of China’s increasing focus on “common prosperity” for China’s new economy, including internet. The key takeaway, in our view, is that China’s pursuit of common prosperity will lead to a rebalance between growth and fairness in many sectors and industries over the next 10-15 years. This could lead to many long-term changes in the regulatory environment and business practices in a wide range of sectors. In particular:
·- Sectors where regulators emphasize growth will enjoy regulatory tailwinds. These sectors are usually strategically important to China’s long-term growth, such as semiconductors, smart manufacturing, clean energy, AI, cloud, autonomous driving, 5G and IOT.
·- Sectors where regulators emphasize a balance between growth and fairness will see a tightening of regulations. This includes internet and high-end consumption
·- Sectors where regulators emphasize fairness over growth will see a lot of tightening measures. This includes housing, healthcare, education and transportation.
With regard to impact from measures to rebalance between growth and fairness in China internet, the expert believes both monetization and profitability could be negatively affected.
We view the expert’s comments as generally in line with our view that investors will stay cautious on China internet space in 2H21, and focus on companies with relatively low regulation risk and clear near-term catalysts. Our pecking order is: JD, Netease, Meituan, Tencent, Alibaba, Kingsoft Cloud and Bilibili.
Below are the key takeaways from the call:
Backdrop of “common prosperity”
· “Common prosperity” was proposed as early as in 1950s
As an essential component of socialism, the concept of “common prosperity” was put forward as early as in 1950s. On December 16, 1953, the government passed the "Resolution on the Development of Agricultural Production Cooperatives.", proposing “common prosperity” in the very first article. The first generation leadership emphasized lifting farmers out of poverty through industrialization and agricultural cooperation.
After 1978, the second-generation leadership put forward the development ideas of “allowing some people and some regions to prosper before others, so that they can bring along those left behind through economic development, eventually common prosperity of the nation will be achieved”. At this stage, building a well-off society was the primary goal. The government began to shift its focus to achieving modernization, and for the first time the government formally proposed to eradicate problems such as egalitarianism. Deng Xiaoping said that achieving common prosperity was a slow and gradual process, which should leverage market mechanisms. He advocated that some regions and some people should get rich first, so as to help those left behind, and finally realize common prosperity.
Earlier this year, the Party announced that China had eliminated extreme poverty (disposable income below Rmb4,000 per year) and completed the task of building a well-off society (????). This accomplishment allows the government to prioritize the “common prosperity” objective, under the leadership of Xi Jinping.
In October 2015, during the 5th Plenum of 18th Party Congress, President Xi emphasized that (we) “need to develop effective institutional arrangements to ensure steady progress towards common prosperity”.
The 19th Party Congress report in 2017 specified the long-term target to “initially achieve common prosperity by the middle of this century”.
· Increasing priority with clearly defined milestones and timetable.
The 5th Plenary of the 19th Central Committee was held from October 26 to 29, 2020. The meeting proposed to firmly promote common prosperity.It concluded that by 2035, people would live better, and China would make a more tangible progress on the all-round development and common prosperity of its people.
In November 2020, President Xi’s explanatory note on the 14th Five Year Plan and 2035 long-term objectives emphasized that common prosperity was an intrinsic requirement of socialism, and it was the first time that the Party document specified “common prosperity” as a priority objective.
On May 20, 2021, the government established a demonstration zone for common prosperity: Zhejiang province demonstration zone of high-quality development and common prosperity, which promised that a tangible progress will be made in 2025, and the goal of common prosperity will be achieved in 2035.
During the 10th meeting of the Central Finance and Economics Committee on August 17, senior officials pointed out that common prosperity was the essential requirement of socialism, and it was important to promote common prosperity combined with high-quality development.
Common prosperity is not uniform egalitarianism.
· Many investors are concerned that the concept of common prosperity promoted by China’s government is equivalent to egalitarianism. This view is one-sided. The enforcement of this concept will differ significantly in three types of industries, each with different long-term priorities:
o- For emerging industries of strategic importance, authorities will continue to prioritize efficiency and growth. These industries include semiconductors, smart manufacturing, clean energy, AI, cloud, autonomous driving, 5G and IOT.
o- For mature industries that have enjoyed policy tailwinds in the past, authorities’ focus has shifted from driving growth to rebalancing growth and fairness. Although growth and development of these industries will continue, their monetization and profitability will likely be negatively affected and their business operations will need to be adjusted under the current regulatory framework;
o- For industries concerning people’s livelihood, such as housing, healthcare, education and transportation, the government will focus more on fairness over growth while curbing disorderly capital expansion.
How will the concept be implemented?
· The concept will be carried out from two aspects: 1) adjustment to business operation. Large internet companies will focus more on quality over growth, in order to ensure legal compliance and long-term sustainable growth. For example, e-commerce platforms will be forbidden from adopting illegal tactics such as “pick one from two” or “big data based price discrimination”, and the monetization rate of online ride hailing companies will likely be limited in the future; 2)adjustment to redistribution of income. Large internet companies will focus more on improving the welfare of labor through redistribution of income or even voluntary distribution of income. For example, platforms’ social responsibility to protect flexible employees’ welfare and safety could be a potential risk with rising payout of social security benefits. These measures together will limit the upside of monetization rates and increase the compliance costs, ultimately reducing the margins of overall industry in the long-term.
· Tight regulation applies to everyone equally. Our discussion with the expert suggests that regulators will not only focus on large companies, but also on mid-small size companies. According to “Administrative Punishment Regulations on Illegal Price Activities" drafted by the State Administration of Market Supervision and Administration in July this year, penalties for “big data based price discrimination” were introduced in the document. This implies that the government will take some key concepts in the anti-monopoly law to extend it to the entire industry, as opposed to just those with dominant market share.
Tax benefits for the sector
· Based on our discussions with the expert, changes in the regulatory environment would lead to a loss of Key Software Enterprise tax benefit (10%) for internet operators but the High and New Technology Enterprise tax benefit (15%) will remain. In the long term, it is unlikely to see a drastic shift in tax rate for internet operators due to the complexity of tax policy drafting process. However, the expert expects changes to take place in consumption tax, which currently does not cover many luxury products, like wine and liquor as well as gaming.
How to capture regulatory tailwinds from an investment perspective?
· Focus on industries with clear development milestones and specific timelines outlined by authorities;
· Focus on companies in emerging industries of strategic importance.These industries include semiconductors, smart manufacturing, clean energy, AI, cloud, autonomous driving, 5G and IOT.
· Focus on industries that enrich people’s spiritual lives, such as the sports industry. |
