In depth analysis of Chinese investment possibilities

1. BlackRock
External Analysis
China as an Emerging
Market
December 2016
Jake Donahue
Contents
Executive Summary 2
PEST: Macro Environment in the United States 3
Analysis of US Economic History 4
PEST: Macro Environment in China 5
Analysis of Chinese Economic History 6
Analyzing Differences between the United States and China 7

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China’s National Business System 8
Lack of Transparency in China 10
Conclusion of Risk Analysis 10
Assumptions
11
Opportunities
11
Exhibits 12
Work Cited 21
Executive Summary
Situation BlackRock is the world’s largest asset management firm, as $5.1 trillion is under their
advisement. BlackRock has been known to generate balanced returns for their investors;
balanced returns have become an expectation that must be met. Due to the building pressure,
BlackRock is constantly searching for new opportunities to maintain their competitive advantage
in the marketplace and service their investors properly. One of the new opportunities under
exploration is investing in emerging markets, specifically China. China is in the midst of
attempting to transition their manufacturing based economy to a services, consumer-driven
economy. At the same time, the nation’s GDP growth is slowing and the government is
implementing an anti-corruption campaign.
Complication China as an opportunity incurs complications across the globe. In the United
States, the 2016 Presidential Election has promoted an isolationist mindset. One of the primary
goals of the President Elect is to bring jobs back to the domestic homefront, which threatens
China’s economic strength as they derive most of their growth from foreign investment.
Investors in the United States have become more risk averse. There is a great amount of
uncertainty that has been building since the election. As emerging markets carry a characteristic
of greater risk, investors’ mindsets and investing in China do not seem to align. Across the
world, China poses many complications. Lack of transparency in China is abundant; economic
and political data is often skewed when published to the world. Additionally, the state owned
enterprises in China defies the common rule that government succeeds in protecting the nation

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and capital controls (i.e., taxes), rather than succeeding in controlling businesses. SOE’s allow
the government’s lack of transparency to trickle down and skew company performance. Lastly,
as China pours money into real estate infrastructure that has created ghost cities, there is a
concern that a bubble is forming within the Chinese economy.
Critical Question and Recommendations The critical question posed to BlackRock while in
search of new opportunities is: Is China a viable investment market? Before moving forward
with the impression that emerging markets will generate great returns, we recommend
understanding the risks of China. There are both known risks and unknown risks in China.
Pursuing the investment requires knowledge of the known risks and acknowledgment of the
unknown risks that exist. Looking back to the narrative of American economic history in
comparison to China d will provide a fuller scope of Chinese economy. Secondly, if BlackRock
does move forward with China, we recommend only investing in alignment with the Chinese
government. As they begin their economic transition, the government has begun to invest in
service industries that they see as transformative for China’s trajectory: energy, healthcare,
technology, and sports.
PEST: The Macro Environment in the United States
Political The 2016 political macro environment in the United States has been surrounded with
great uncertainty. After the election, some US markets have already begun to flourish while
others have begun to struggle; the fate of US industries rests in government policies. An
example of the latter is the biotech industry, which is greatly related to the rest of the world. The
President Elect has been promoting isolationist policies throughout his campaign, which
threatens US stakes in markets abroad. Isolationism also promotes repatriating money and
bringing jobs back to the home front, which has the potential to change the dynamics of the
economy. Additionally, Donald Trump has promoted reforming free trade agreements, which
again threatens US stakes in foreign markets and the relationships the United States retains
with other countries.
Economic There are great synergies between the political macro environment and the
economic macro environment. The strength of the US dollar is becoming more prominent
against other currencies. This makes investment in the US more expensive for foreigners. At the
same time, this makes investment in other countries for US companies/individuals cheaper. As
the country enters the new year, investors are thinking back to January 2015, when oil prices
plummeted. This memory has created a general fear within the market, leading investors to
begin to pull their money out of the market. In addition, there is constant innovation which leads
to economic fluctuations. The echoing question of “what’s the next big thing?” creates an always
vulnerable underpinning of a company’s existence.

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Social Again, the election has created divide. The election has wedged a wider gap between
those on the left and those on the right. The lack of bipartisanship is tangible. The country is
also maintaining a risk averse attitude. The direct cause of the risk aversion is uncertainty. At
the same time, there is a growing entrepreneurial spirit within the country. The US is the 10th
easiest country to start a business, and there has been a greater emphasis on small businesses
as the foundation for the economy. The free flow of information and continuation of stable
institutions has created a population that demands instant news.
Technological The United States is the nexus of innovation. The market is rich with ample
funding; venture capital is only one example of a funding source. Industries undergoing
innovation are healthcare, education, consumer entertainment, and connectivity. There is also a
cycle of disruptive innovation occurring in the technological macro environment, as the next
invention replaces the old, giant industries. Prime examples of disruptive innovation are Netflix
replacing BlockBuster and Amazon replacing physical bookstores (Borders, for example).
Analysis of US Economic History
In order to understand the future of China’s economy and its subsequent stability, the history of
the US economy is crucial to understand first. China is attempting to do in 30 years what the US
did in 100+ years. However, there are great disparities between the US and China that are
important to note.
The Economic Transformation Reference Exhibit 1. The US economic transformation
has occurred over 100 years. In the 1840’s, agriculture drove growth. Over the years,
the domestic agriculture market has lost power it once had, and as of 2010, was
responsible for about 1% of US output. Industry as a driver of growth peaked during the
Industrial Revolution and carried on until it began to decline in the 1960’s. Consequently,
the services sector has replaced industry. This is the crux of the US transformation. The
country’s reliance on industry has transformed into a consumer driven market. Services
accounted for greater than 70% of output in 2010. One of the most important services in
the US economy are data collection and analytics driven by market research firms.
Reference Exhibits 3 and 4. Tertiary markets, or services sectors make up the majority
of US GDP. This transition would not be possible without the institutions that continue to
promote transparency, democracy, and a free market.
Entrepreneurial Growth Reference Exhibit 2. Entrepreneurship in the United States
peaked in the early 2000’s and fell off during the Great Recession. However,

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entrepreneurship is growing once again in the US economy, and is crucial to the
services economy the US now relies on. Examples of this are Uber, Lyft, Netflix, and
Amazon. These booming businesses all started as ideas and are now the center of
growth for the domestic market.
PEST: The Macro Environment in China
Political The communist structure of the Chinese government is an enormous macro
environment factor within China, and because of such, it must be studied before a company
pursues their investment. As the majority of China’s operations are controlled by the state, much
of its operations are kept secret. This creates a substantial lack of transparency of which any
company pursuing investment in China should be very concerned. Conducting business in a
foreign nation that fails to properly disseminate information is the definition of pure risk.
Additionally, many SOEs, which make up some of China’s largest companies, are run by
politicians. As such, a company should be wary of investing in a nation whose economic activity
is controlled by government workers and not by entrepreneurs or businesspeople.
Economic Although China has the second largest economy, its GDP growth has slowed
significantly from 2010 to 2016. Specifically, China’s GDP growth rate decreased by nearly half
from 12% in 2010 to 6.7% in 2016. This decline in growth, coupled with China’s transition from a
manufacturing economy to a services economy, raises concern for a company looking to invest.
The speed with which China is attempting to transition to a services economy is threefold to the
US transition. The result is significant space for error and inefficiency. In a period of roughly
thirty years, it is attempting to perform the same transition that the US completed in one-
hundred years, an ambition that has yet to prove beneficial. In fact, the slowing growth of the
Chinese economy creates a question that perhaps their ambition is harmful to their economic
position in the world. Additionally, although China technically operates as a free market
economy, the government implements substantial controls that manipulate its economy and
contribute to the lack of transparency. Finally, China is taking on more debt. Corporate total debt
to GDP is near 300%. Increasing corporate leverage leads one to question China’s motives.
Social Social inequality is prominent throughout China. It is largely a result of economic
disparity that exists between those living in rural areas and those living in urban areas. Large
metropolitan cities (Beijing, Shanghai) are home to individuals with high wages, elevated living
standards, and abundant job opportunities. China’s metropolis is furnished with well developed
utility systems and efficient transportation networks. However, the majority of the country is
made up of undeveloped rural areas where people lack access to basic utilities, medicare, and
education. Additionally, the lack of transparency that has been discussed throughout this report
explains the limited access that investors have to information. For example, Facebook and
Google are not permitted in China. Immediate news and censored access to sites that promote
free speech put the Chinese population at a disadvantage. Furthermore, many Chinese
companies are focused financially compensating top employees rather than on social
responsibility. As such, in the effort to reduce costs, Chinese companies pay their employees

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very little. The continued oppression of the working class is the cause of low standards of living
and dangerous pollution.
Technological China’s lack of intellectual property rights creates a macro environment where
many companies replicate existing products that are cheaper and lower-quality without facing
legal consequences. This lack of legislation severely limits innovation and encourages Chinese
companies to imitate the products/concepts of foreign nations rather than innovate. When the
entire marketplace lacks innovation, growth subsides. Furthermore, China still has significant
progress to make to advance various technological aspects of its nation, including
transportation, nuclear power and e-commerce.
Analysis of the Chinese Economy
China has experienced immense growth that began to take shape in 1978, when the first
economic reforms were introduced to the country. Their growth has been heavily reliant on “low
cost exports to drive growth” (World Economic Forum). In sum, foreign investment -- companies
taking advantage of China’s cheap labor -- has been a primary reason for their economic
growth.
Slowing Growth Reference Exhibit 5. China’s GDP growth has been steadily declining
since 2007 - 2008. In 2010, China’s GDP was growing at 12%, but its growth dropped
half in 2016 to 6.7%. That represents the lowest growth in the last 25 years. Decline at
growth directly relates to questioning the country’s economic stability. Potential causes
of the decline are:
● Economic transition that relies on consumers is not faring as well as the Chinese
predicted
○ Wide gap in consumer characteristics
● China has reached its production capacity
● Foreign companies have relocated their manufacturing facilities to other
countries (Thailand, Vietnam, Bangladesh) due to the discovery of lower labor
costs.
Mark of Transition Reference Exhibit 6. As of 2014, services and industry represented
equal components of China’s GDP. This proves that China is in the midst of transitioning
their economy. However, China still remains as a leading global force, and thus has to
meet expectations of growth. To do this, they must place greater emphasis on
expanding their domestic demand (becoming a consumer-driven economy). To succeed
in that front, two changes must happen:
● The release of Chinese consumers’ spending
● A lessening gap between rural and urban populations
Potential Bubble As of 2016, China has total debt outstanding of $28 trillion. This issue
is exemplified in China’s ghost cities. Cities exist all throughout China in which no one
resides. At the same time, Chinese consumers have bought stakes in ghost cities while

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not having the finances to back up their investment. Real estate values in China
continue to rise and yet the lack of residences that are occupied potentially signal that
the rise in value is falsely inflated. The notion of ghost cities paired with greater debt
resemble the US before the 2008 financial crisis.
Analyzing Differences between the United States and China
As China continues to strive towards a consumer driven economy, there must be an emphasis
placed on creating equities within their population.
GDP per Capita Reference Exhibit 7. The US GDP per capita is seven times greater
than that of China’s. This means that on average, the Chinese consumer has seven
times less spending power. In addition, this contributes to the notion that a majority of
the Chinese spending power is pent up in urban cities, rather than the vast population
dispersed in rural areas.
Per Capita Disposable Income Reference Exhibit 8. Again, US per capita disposable
income is greater than that of China’s (in this instance by 13 times). Chinese consumers
have less disposable income per household, which again weakens the notion that a
consumer driven economy will be realized in such a condensed period of time.
Rural versus Urban Reference Exhibit 9. China is not empowering their rural
population, which represents half of their country. The success of their economic
transition is predicated on empowering the pockets (money) and minds (education) of
the individuals that reside rural areas.
China’s National Business Systems
China’s National Business Systems are composed of state owned enterprises (SEO’s), privately
owned enterprises (PIE’s), and foreign invested enterprises (FIE’s).
State Owned Enterprises Reference Exhibit 11. Many of China’s largest companies are
state owned. They generate the largest revenue in China and are tied to the old growth
model of relying on industry and manufacturing. This highlights that China’s economic
growth is directly tied to where the Chinese government chooses to invest/promote.
Changing Composition Reference Exhibit 12. In the spread of one year, foreign
investment in China has decreased and privately owned companies are on the rise. This
supports the notion that China must rely on its domestic market to further its growth in
the coming years.
Lack of Transparency in China

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Lack of transparency in China poses great risk to foreigners looking to invest, as an accurate
analysis of opportunities is impossible without truthful information. Pursuing investment in China
must occur after understanding the extent of transparency issues. Reference Exhibits 13, 14, &
15. The Chinese government has been known to skew data. Additionally, there is little
information published about Chinese consumer trends and preferences, which comes from the
shortage of independent data collectors and market research firms. The state maintains full
agency over that aspect of their economy, limiting an objective view of opportunities as well.
Conclusion of Risk Analysis
Although China as an investment opportunity poses many risks, such as the vulnerability of their
economic trajectory as well as lack of transparency, there are still opportunities that exist within
the market. BlackRock as an investment manager knows best that without risk there is no
return.
Assumptions
As Blackrock moves forward with our recommendations, there are 7 major assumptions that
must be made in order to visualize success.
1. The Chinese government continues to rely upon and encourage foreign
investments.
2. The Chinese government will continue to promote the economic shift from a
manufacturing economy to a services economy.
3. The Chinese government will take steps to empower the rural population.
4. All known and unknown risks are researched and accounted for.
5. Investments aligned with government interests are most likely to succeed.
6. SOE’s will begin to represent the past of China’s economy and PIE’s will
represent the future.
7. Political reforms will begin to take place and transparency will increase.
Opportunities
As we have previously mentioned, governments generally find success with managing militaries
and banks (capital controls). Yet governments fail to find the balance to successfully run,
manage, and maintain profit-seeking enterprises. That being said, the government, as it wishes
to maintain its dominant economic position around the globe, will point Blackrock in the direction
of profits. The Chinese government promotes industries it sees as transformative for their
ambition. These industries are: clean energy, services, e-commerce, and sports. If the
government views companies within these sectors as vital to China’s continued growth, we
believe that the government will create an environment suitable to said company’s success.

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Investments aligned with the interest of the Chinese government have the greatest chance for
balanced returns.
For example, the Chinese government has begun to promote the importance of sports. In a
country where individual rights are limited, sports has become a form of individual expression
and freedom. The governing body of China has realized the importance of sports; most notably
sports’ ability to unite a country and create a sense of nationalism. In the 2008 Beijing Olympics,
China won a combined 51 gold medals compared to 36 won by the US. From an economic
standpoint, the stats are equally as impressive. Reference Exhibit 15. Within the first half of
2016 alone, the total value of investment in sports has increased 300%, from RMB 3.6 billion to
RMB 11 billion. As China pushes for advancements in the “happiness industry”, Chinese
athletic investments will continue to rise. The next Dallas Cowboys (4 billion dollar valuation)
could potentially come from China.
The industry of sports represents only one example of a Chinese investment opportunity that is
consumer driven (representing the goal of the transition), government backed, and realizing
growth. As BlackRock pursues the critical question of China further, more industries alike to
sports will come to the surface.
Exhibits
Exhibit 1 Historical output by sectors in the US from 1840 to 2010
Exhibit 2 American entrepreneurship growth from 1994 to 2015

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Exhibits 3 & 4 United States economic output as a percentage of GDP, both by industry and
sector
Industry Percent of GDP
Primary & Secondary Sector (natural resources)
Agriculture, forestry, and fishing 1
Mining 1.3
Utilities 2.1
Construction 4.6
Durable goods mfg 7.4
Nondurable goods mfg 5.4
Total Primary & Secondary 21.8
Tertiary Sector (service industry)
Wholesale trade 5.9
Retail trade 6.8
Transportation & warehousing 2.9
Information 4.7
Finance & insurance 8.3
Real estate & rental & leasing 12.4

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Professional,scientific,& technical services 6.7
Managementof companies and enterprises 1.8
Administrative & waste management 2.9
Educational services 0.9
Health care & social assistance 6.9
Arts, entertainment,& recreation 1
Accommodation & food services 2.6
Total Tertiary 63.6
Exhibit 5 Chinese GDP growth compared to US GDP growth from 2004 to 2014

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assistance during the completion of this work.
Exhibit 6 Chinese GDP Breakdown by sector as of 2014
Exhibit 7 US GDP per capita compared to China’s GDP per Capita

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assistance during the completion of this work.
Exhibit 8 US per capita disposable income compared to China’s per capita disposable income
Exhibit 9 China’s urban versus rural population

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assistance during the completion of this work.
Exhibit 10 Understanding China’s State Owned Enterprises
Exhibit 11 Understanding China’s National Business Systems

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assistance during the completion of this work.
Exhibits 12, 13, & 14 Excerpts relating to lack of transparency and skewed data in China

16. 15
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Exhibit 15 China’s increasing investment in sports
Works Consulted
Boivin, Jean, Neeraj Seth, Andrew Swan, and Helen Zhu. "Climbing China's Great Wall
of Worry." BlackRock Investment Institute(n.d.): n. pag. BlackRock, June 2015.
Web.

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We pledge our honor that we have neither received nor provided unauthorized
assistance during the completion of this work.
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"Chapter 8 The Structure of the United States Economy." Macroeconomics in Context
(2006): 1-36. Global Development and Environment Institute, Tufts University.
Web. 30 Nov. 2016.
Desjardins, Jeff. "China vs. United States: A Tale of Two Economies." Visual Capitalist.
N.p., 15 Oct. 2015. Web. 04 Dec. 2016.
Hirst, Tomas. "A Brief History of China's Economic Growth." World Economic Forum.
World Economic Forum, 30 July 2015. Web. 30 Nov. 2016.
Johnston, Louis D. "History Lessons: Understanding the Decline in Manufacturing."
MinnPost. N.p., 22 Feb. 2012. Web. 04 Dec. 2016.
Letts, Stephen. "Chinese Banks Sitting on $1.7 Trillion Debt Time Bomb." ABC News.
N.p., 23 May 2016. Web. 04 Dec. 2016.
Reuters. "BlackRock CEO Fink Sees Risks in China, Negative Rates." The Economic
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