Apple laid the blame for its market-mangling earnings miss on China, noting “over 100 percent of our year-over-year worldwide revenue decline occurred in Greater China.” The announcement roiled markets and unleashed the usual hurricane of evergreen opinions about Apple’s premium pricing and perceived pace of innovation, differentiation in the smartphone market, and the wisdom of Trump’s trade war. Equity analysts used the announcement to once again demonstrate their unrivaled ability to forecast the future with absolute confidence right on the heels of explicitly failing to predict the present (with a very few exceptions).
Despite Apple attributing the entirety of the miss to China and highlighting the softening economy there, the desire to relitigate eternal debates about Apple and the smartphone market obscures what I think is a broader and much more important inflection point: the Chinese economic model of the last forty years has BOTH run out of gas AND the Chinese government is now on a very different policy path that might best be characterized as neo-Maoist.
After unprecedented decades of growth that have pulled hundreds of millions of Chinese out of extreme poverty and made China the world’s second largest economy, China’s rate of growth has been slowing, and perhaps dramatically so in the last year or two (official numbers are increasingly suspect). This slowdown predates the arrival of President Trump with his sixteenth century mercantilist mindset, though the trade confrontation is probably exacerbating China’s slowdown and amping uncertainty.
Apple is the most successful Western company in China and it is now paying the price for that success. Some of its China travails are company and market-specific (particularly premium pricing and stronger Chinese competition). “Buy China” sentiment may be a consequence of Trump’s trade war. But Apple fundamentally is still at the mercy of a faltering economy (and, some argue, with a diminished moat in China relative to the rest of the world). The slowdown in Chinese consumption goes beyond just smartphones, and appears to have taken a sharp downward turn in the last months of 2018. Car sales in China, for example, plummeted 16% in November. Others point to a precipitous drop in Chinese luxury tax revenues late in the year.
My thinking about China has been greatly influenced by George Magnus’ Red Flags: Why Xi’s China is in Jeopardy. He lays out why what got China here economically won’t get them to the next level as they struggle with debt, demographics, and despotism under newly-minted President-for-life Xi Jinping (or Xi JinPooh as I like to call him). China’s investment-led and stimulus-happy economy badly requires fundamental rebalancing and reform, but China’s leadership finds itself trapped between conflicting needs to deleverage an excessive debt load, boost productivity to offset the world’s most rapidly ageing workforce, prop up a fixed exchange rate, and reform governance if they want to be an advanced economy. Xi’s orthodox economic instincts only increase the degree of difficulty here.
Magnus also underscores what a break Xi represents from Chinese leaders since Deng Xiaoping. Authoritarian, a Chinese Communist Party superfan, a centralizer of power facing few checks or balances: he’s bringing Maoism back. Domestically, he’s reasserting Party control everywhere while building a cutting-edge police state that melds Facebook-style all-seeing digital eye with old school Maoist re-education camps. Abroad, he’s abandoned Deng’s strategy to keep a low profile and is exercising a much more aggressive, nationalist, and jingoistic foreign policy. His promise to “unify” Taiwan during his reign as emperor might be the foremost threat to global stability today. And as the Chinese economy flags (a problem likely to be aggravated by his policies), the risk increases of doubling down on nationalist distractions.
These economic and political changes fly in the face of the last two decades of conventional wisdom about China. Its future economic trajectory is unlikely to resemble that of the recent past (as Herb Stein says: “If something cannot go on forever, it will stop.”). And China’s quiet rise is being replaced by a much more aggressive and confrontational external posture. The implicit Western assumption of ever greater liberalization accompanying growth has been crushed under Xi’s boot.
The technology industry seems late to recognizing and digesting this inflection point. Even in Washington DC, where bipartisan consensus is rarer than an IBM product living up to its hype, there is broad agreement that China is now a strategic rival. Xi’s commitment to “Make China Great Again” has galvanized America’s political attention. And as is often the case, the populist diagnosis is largely accurate even if they get the prescription wrong. The confrontation with the West is much deeper than trade. Superficial declarations of victory on trifling trade issues after making so much noise (the Trump modus operandi) will not dampen or counter China’s aggressive “Made in China 2025” industrial policy ambitions to seize leadership across a range of high tech industries and desire to become the dominant power in Asia.
Tech needs to set aside the intoxicating dream of selling just one product to each and every person in China and parse the new reality. The Great Firewall of China model of parallel ecosystems may expand to other domains, as today’s deeply intertwined global economy starts to disentangle. Supply chains will have to factor in tariffs and national security concerns. Cross-border flows of capital and acquisitions will flow less freely. Non-tariff barriers and even further technology executive hostage taking may escalate. The prospects for China’s private tech titans (i.e. BAT) are in flux as they find themselves with a Party invitation they can’t refuse.
I don’t believe Mr. Xi’s China’s model will prevail. Despotism undermines itself and it is hard to think of a worse way to build an advanced economy than looking to Mao for guidance. And the Chinese people have seen and tasted too much of the rest of the world to go along with Xi. But the happy path for China’s rise over the last two decades is over and we need to recognize that. It will be bumpy, and not just for Apple.