Trending China: On technology, trade and millennials

I have been writing about China's economy for over a decade. A private equity investor I've known for much of this period recently suggested I look up the articles I wrote - some of which included interviews with him - from the mid-2000s. China was plugged into the international trade system, foreign direct investment was abundant, and wealth was being created at an ever-faster pace. But descriptions of the nascent consumer class were caveated with references to possibility and potential. Chinese consumers were regarded as relatively cheap. A few years earlier, when this PE executive abandoned investment banking to launch a start-up predicated on rising demand for mobile phones, many colleagues ridiculed him. No one is joking now. Discretionary spending is well established and increasingly transacted through mobile devices. Children who were in junior school around the time of those mid-2000s conversations about unrealized potential are acknowledged as China's most influential consumers.

KKR's observations about China-led millennial power in Asia are interesting and the numbers cited – China's 330 million millennials allocate three times more of their income to leisure than the country's consumers as a whole – underline the significance of this phenomenon. However, strategies formulated with it in mind are not unprecedented. Over the past couple of years, VC investors have begun to emphasize paid services, leveraging the emergence of a generation of consumers that don't assume everything online should be available for free and the clearer pathway this provides to scale and profitability. More telling is the fact that these trends are increasingly appearing on private equity firms' radar. Access to the modern Chinese consumer doesn't come through traditional channels. Some PE players are actively investing in the agents of disruption and others are not. But all must consider the impact on portfolio companies with exposure to traditional modes of consumer engagement and distribution. KKR's McVey expressed concern about traditional goods, notably food items, offered by many multinationals, which are losing brand appeal while facing higher costs and increased competition.

The biggest damage to private equity from US-China trade tensions would be in the form of supply chain disruption created by tariffs. Giving the Committee on Foreign Investment in the United States (CFIUS) more teeth – by stretching its remit beyond critical infrastructure and technology and allowing it to probe deals that don't involve a change in control – has potentially serious implications for trade sales to Chinese buyers and co-investments with Chinese groups. But the scope and weight of the tariff regime, assuming the US opts for the full $200 billion package, is far greater. China has become such an integral part of so many supply chains that investors across multiple sectors and jurisdictions will have to recalculate the most efficient way of getting components or finished goods to the end user. 

Ever since China joined the WTO in 2001 and tariff barriers receded in many areas, trade tensions with the developed world have always lingered – and at times cascaded into aggressive diplomatic discourse. This time is different, and not just because of the speed of escalation and the numbers being thrown around. China is further up the value chain. Ten years ago, when Beijing was concerned about its dependency on industrial equipment imports, it built up that competency at home. Now it remains to be seen whether the country can pull off a similar trick with semiconductors. But these are individual markers in a broader initiative to reshape an economy that rose to its current position on the back of investment and export-led growth to one that is driven by consumption, services, and technology. Any trade war will take place against the backdrop of an evolving China, and this will change the stakes as well as the tactics employed. The mid-2000s are indeed a long time ago.

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