China's new emphasis on 'soft' power of persuasion and influence

Sep 21, 2021

Virginie Maisonneuve
The writer is global CIO equity at Allianz Global Investors

INVESTORS everywhere have been unnerved by a flurry of negative news headlines out of China, but consider these events in a broader context. At the 100th anniversary of the founding of the Chinese Communist Party, China is recommitting itself not just to continued economic success, but to addressing inequality, tackling antitrust issues and curbing challenges to traditional centres of power. These efforts are bound to stir up some volatility, yet they are all part of a new phase in China's evolution as it repositions itself for a new global role.

We consider this to be Phase 3 of China's emergence. It follows Phase 1, when China joined the World Trade Organization and became an essential link in global supply chains, and Phase 2, when a high-tech China overtook Japan as the world's second-largest economy and began integrating its financial markets into the global system. But Phase 3 is arguably the toughest: China must use its economic power to elbow its way to the top ranks while exercising its "soft" powers of attraction and influence.

Geopolitical tensions and fragile global supply chains are making it harder for China to pursue its own path of hybrid development, targeting self-sufficiency while becoming a best-in-class high-tech leader. Consider the state of the semiconductor industry: China consumes 35 per cent of the global supply yet manufactures only 10 per cent. For a country so focused on national security, reducing high-tech vulnerabilities will be a high priority. Investors who recognise this will be well-positioned to use the inevitable market volatility to build strategic positions.


The other component of Phase 3 finds China addressing social issues in ways that align with its Communist system. In recent months, China has tried to "reset" its education sector, attempting to reform a culture that places overwhelming pressure on students to perform while exacerbating social inequality. China has also been reviewing the "rules of the game" in the technology sector, focusing on the strategic importance of data in a world powered by artificial intelligence. The tech sector's success has also created new power bases and many billionaires, which could over time challenge the existing "Chinese way" and its traditional centres of power. It's understandable that these efforts at reform have made markets nervous, but we take comfort in the fact that China will be reluctant to kill the "golden goose" of its financial market success.

More importantly, worrying that the renewed emphasis on social and economic governance will hurt China's growth misses one of the key points. The next phase of China's emergence on the world stage will be as much about its soft power as its economic power - the two are symbiotic - as the country seeks to build a more sustainable path for itself.

There may be no better opportunity than climate change for China to write a positive new chapter in its history. China has set out ambitious decarbonisation goals, and achieving them will be no easy task. But there are also promising signs of international cooperation. In April 2021, US and Chinese officials publicly pledged to work together to strengthen implementation of the Paris Agreement. Perhaps the climate emergency will be the rallying cry that fosters some geopolitical stability and collaboration at a time of momentous global change. Investors seeking to understand current developments in China need to know how China's policy agenda has shifted to new areas, such as promoting high-tech manufacturing, addressing social ills and combatting climate change. This can provide critical insights into the way forward.


Perhaps most importantly, investors need to accept that volatility and the risk of political interventions may always be part of investing in China. This underscores the need to navigate this dynamic market with care, and to consider partnering experts who can take an active approach to security selection, rather than merely mirroring an index. With proper guidance, investors may be able to navigate the inevitable surprises while keeping a clear view of China's long-term vision: to be an essential player on the world's stage.