Unintended Chinese Consequences

by Paul Goodwin on July 31, 2014

This is an excerpt from Cabot China & Emerging Markets Report, which seeks to capitalize on the big boom in China and other emerging market countries. Editor Paul Goodwin, Cabot’s international investing guru, provides your passport to profits.


The Law of Unintended Consequences is about as close to humor as economics gets. Economic phenomena are so complex that predicting with any certainty how a particular change will affect an entire economy is just about impossible.

The latest confirmation of The Law is coming from China, where an unusually energetic anti-corruption campaign is being carried out by President Xi Jinping. Xi vowed upon taking office that his war on corruption would be aimed at bringing down tigers (high-net-worth individuals and high-ranking party officials) as well as fleas (small fry of all sorts). The campaign is bagging an unusually high number of both animals, and the consequences are really interesting.

Recent headlines have focused on the announced investigation of Zhou Yongkang, a former member of the Politburo Standing Committee, the key decision-making body of the Communist Party of China (CPC) and former Chinese security czar. Zhou worked his way up in the oil business to become head of China National Petroleum Corporation in 1996, but it looks like he’s in a world of hurt now, as he’s under suspicion of cronyism, hiring family members and sweetheart deals for associates. And the net that caught him also hauled in most of his top aides from his days in the oil business.

Zhou is the highest-ranking target of the campaign, but the campaign has also skewered a former high-ranking officer in the People’s Liberation Army (PLA) who was also a member of the Politburo.

These investigations and prosecutions have uncovered officials with huge fortunes for which they couldn’t account and small-time politicians called “naked officials” whose families were found to be living abroad. In one amusing incident, an online photo of a city official appearing at an accident site was examined by online activists who determined that he was wearing a Rolex that he obviously couldn’t afford on his salary. Goodbye official.

In other words, Xi Jinping isn’t afraid to take down anybody, which makes every government official at any level a potential target. And these people are nervous.

Reports out of China indicate that government officials are reluctant to be seen playing golf, because it’s expensive and might lead to suspicion that they are supplementing their income on the side. The company that exports Remy Martin cognac to China has reported lower sales, and many high-end restaurants that hosted hugely expensive dinners for Party members are said to be in rough financial straits. Imports for certain highly-visible luxury cars have also declined, although Party officials everywhere still enjoy the black Audis that are as much a part of their uniform as their blue suits.

Some more-cynical observers have pointed out that Xi Jinping’s takedown of big names in the Party apparatus and the PLA serves to consolidate his control of the major sources of power in China. And that’s true.

It’s also true that the Communist Party of China is a possible victim of Xi’s zeal. Every successful prosecution (and pretty much every prosecution in China succeeds) is another bit of evidence of the Party’s corruption. Xi will have to find the right balance point, one that will scare many corrupt officials straight, but will also avoid bringing the Party itself into disrepute.

Xi Jinping’s anticorruption campaign has the potential for further unintended consequences, especially if ambitious young Chinese begin to doubt that the CPC is their road to success. If Party membership loses its cachet and its reputation as a road to financial success, the implications for the medium-term future of China could be huge.

For the stocks in our portfolio, the possibilities are many. If a possible government restriction on buying non-Chinese automobiles is actually implemented, it could help BitAuto and other auto stocks, but might hurt Tata Motors, which looks to China as a major market for Jaguars and Land Rovers.

But what’s more likely is that the unintended consequences will come from a direction we can’t anticipate. Economies are too complex to track with straight lines.

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