Talk about bad timing. I was planning to write to you from Shanghai and Fujian province in China this week. But the train I needed to take sold out far earlier than usual, spoiling my plans.
Since I was already in Hong Kong with my Chinese visa arranged, I decided to pop over the border for a few days instead, and see what was going on in the neighbouring province of Guangdong.
Unfortunately, I forgot that China is hosting the Asian Games this month. The police are taking no chances at all. Every single bag taken into the metro has to go through an x-ray baggage scanner. Meanwhile the entrance to my hotel was closed off, and I had to explain what I was doing each time I wanted to go through.
For those of us living in London, it was an unpleasant sign of what the 2012 Olympics might be like. It definitely wasn’t one of my more relaxing trips. But it still gave me a useful glimpse at what was going on in a city I rarely visit – as well as some investment ideas.
The cradle of Chinese capitalism
Unless you do business in China, you may well know very little about Guangzhou. It doesn’t have much to offer the casual visitor, other than some justly famous cooking. But within China, Guangzhou matters a lot. It’s arguably the nation’s third city after Beijing and Shanghai, and certainly one of the top five, along with Tianjin and Chongqing.
That’s all down to commerce. Guangzhou is the capital of Guangdong, the centre of the China’s export revolution. This has always been a highly trade-orientated part of China. Its distance from Beijing meant that it was one of the places where underground capitalism survived best during the communist era.
So when China’s politics changed, Guangdong was where the first ‘special economic zones’ were set up, and Hong Kong and Taiwanese firms moved in to take advantage. Today, it’s one of the wealthiest parts of the country, as the chart below suggests.
Like many of China’s coastal provinces, it’s approaching middle-income status. That’s certainly evident in the shopping streets of booming Guangzhou, although the gap between cities like this and poorer rural areas remains high.
The bad news is that most of Guangzhou’s success is based on manufacturing. That means it’s not the sort of place you’d want to live. The smog was very bad this time, particularly when the train was going through the nearby factory city of Dongguan, where many of China’s exports originate.
As most people know by now, environmental problems are one of China’s biggest issues for the years ahead. So far I see little evidence of any progress.
A vast building site in east Guangzhou
So what was I looking for in Guangzhou? Well, you may already have seen this video from hedge fund manager Hugh Hendry, which he filmed during a trip to the city last year. In it, he visits the central business district and is alarmed by the number of empty or unfinished office buildings. He clearly views the project as a giant white elephant.
I was keen to go there in person and form my own view, having never seen these developments before. That’s partly because I don’t know Guangzhou especially well and have only visited briefly. But it’s also because of something that’s not really made clear in the video: this is not Guangzhou’s current central business district. Instead, it’s an area known as Pearl River (or Zhu Jiang) New Town that’s being developed to the east of the old city centre.
Having gone around the site, occupancy is still pretty light, although a number of banks and financial institutions now have their names up on some of the towers. But to put it in context, this area is very much still under development. The flagship International Financial Centre tower that you can see under construction in the video is still being fitted out. As the picture below shows, it was construction workers’ bicycles, not bankers’ BMWs, parked on the road outside.
It was hard to get a full impression, especially as access was restricted for Asian Games preparations, but I’d say the majority of buildings were still unfinished. The same goes for the supporting infrastructure. The metro stations for the district are open, but the pedestrian subways and shopping malls under the area are still not finished.
So I don’t find it terribly surprising that relatively few firms have moved into the district yet (and I’m viewing it a year on – I imagine this was even less advanced when the video was shot). Judging it a failure already seems like walking around London’s Canary Wharf development in 1990 and saying that it was doomed.
If you build it, will they come?
In fact, I’d guess that comparison might turn out to be rather accurate. Once the development is complete there will be a large supply of new office space coming on to the market in Guangzhou (as is the case in many Chinese cities).
I certainly wouldn’t invest in Chinese office space. The people putting up these buildings may well lose money – just as happened with Canary Wharf.
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But in the end, Canary Wharf was no white elephant. Today, it’s a critical part of London. And to take a similar example from China itself, the Shanghai Pudong new financial district was also seen as surplus to requirements a decade ago, but it’s hard to imagine doing without it now.
I suspect the same will be true in Guangzhou. From my visit, this is a substantial, well-designed business district in a good location with solid transport links. It’s three stops on the metro from the station where the Hong Kong train arrives, for example. And I’d guess that in a decade, the city will look smart for having developed it in the way it has.
Development doesn’t always bring profit
I think this will prove true of much of China’s recent investment. It’s a common criticism that the country has invested too much for too long. The chart below is a popular one among bearish analysts, showing how the size and duration of China’s investment boom has been greater than that of other Asian countries as they industrialised.
It’s a dramatic comparison. But it misses a crucial point. China is a vast country with a huge population that started from a very low level of development not that long ago. To put some crude numbers on the difference, it has a population of 1.3 billion spread over 9.6 million square kilometres. In 1998, its GDP per head in purchasing power parity terms (ie adjusting for the difference in cost of goods and services between countries) was around $1,900, when its investment boom began. (on this chart). For comparison, Malaysia has a population of 28 million, an area of 330,000 square kilometres and already had a PPP GDP per head of around $4,500 in 1990.
Clearly their needs were very different and China had huge investment requirements if it was to catch up. And as a command economy, that’s been the goal. Maximising the immediate return on each investment often comes second behind speeding up the development of the country.
Don’t invest in the infrastructure, but in what benefits from the infrastructure
This is an important distinction. When a country is pushing investment as hard as China has, supply will often run ahead of demand. As long as the investments aren’t completely misguided – although some undoubtedly will be – they will eventually fill up.
Indeed, better infrastructure and lack of bottlenecks should make development faster overall. That’s why the government is especially keen to build up the poorer parts of the country. But investors who initially put their money into investment projects may well be disappointed – especially in cyclical sectors such as commercial real estate. As ever in investing, the best returns come from something that has scarcity rather than abundance.
And in China, that’s not physical infrastructure. Rather, it’s in areas such as services where the country is still lagging. Let’s go back to the reason why I spent the week in Guangzhou rather than Shanghai. China is developing an impressive national rail network. I should have been able to take a sleeper train north in relative comfort. But when it comes to services such as ticketing, it’s a different story.
It may sound ludicrous, but there’s no central system for booking tickets. Instead, you need to buy them through the relevant station, through travel agencies or hotels. So I had no easy way of keeping an eye on when tickets were available and ended up missing out. It’s things like this that are still badly underdeveloped in China – and that’s where the better opportunities will be.
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