Earlier this week, while on a flight from Seattle to Tokyo, I was catching up on some reading for future columns at . As part of this, I went over a on China’s State Owned Enterprises (SOEs). One of the Congressional committees followed for the last five years has been the (USSC). Depending on whom you talk to, Congressional committees like this one tend to get lumped into one of two categories: wastes of money with little political influence, versus wastes of money with a lot to say about the ecosystem in Washington DC. That is not to say they are necessarily influential in every case, but that when you look at the questions these committees are asking, the sorts of witnesses they are calling for testimony, and the tone of their reports back to Congress, you can get a pretty good sense of where Congress is leaning on the particular set of issues the committee in question is being tasked to analyze.
The larger question the USCC was asking was what sort of influence China’s ostensibly “Communist” government has on . Should SOEs be thought of as essentially government actors, or should they be given some latitude as remnants of China’s transition from socialism to capitalism (or, as has been suggested, a combination of the two that has uniquely “”). Given the central role China’s SOE sector plays in furthering the government’s domestic and international strategies (both economic and political), the USCC wants to understand the relative scope and power of the Party in guiding decisions made by these business, decisions many outsiders mistakenly believe are driven primarily by business objectives.
Once a key sector of the Chinese economy has been identified by Beijing (which healthcare already has been), typically in the form of one of their , Western investors have come to understand several things are likely to follow. Some should be understood as opportunities, but some are risks. The opportunities undoubtedly are that once China makes the decision that it wants a particular area of the national economy to become a priority (), the government will align resources with a single-minded pursuit of this strategy, which will create all sorts of opportunities for new ventures to be formed and new technologies to be developed within the country. If you are in the clean-tech space as an entrepreneur or private equity player in North America, . Why? Because you can raise more capital faster, with fewer strings attached, and get to scale more quickly in China than anywhere else in the world. Period.
However, this same state-sponsorship and alignment of resources also means that certain risks need to be understood by outside investors. Most important of these risks is that China’s elevation of a particular nascent industry, no matter how legitimate the need may be, has within it certain political risks that cannot be overlooked. As we are seeing in the clean-tech space, China’s prioritization on developing this industry has meant its strategy has subtly shifted from one of relative openness to one very explicitly structuring the domestic Chinese market in such a way as to force the transfer of technology from western companies who want to work in China to domestic Chinese partners. China’s strategy did not necessarily start out with this transition as part of the calculus western companies understood they were going to be forced to grapple with; rather, as the industry evolved more onerous expectations in the realm of technology transfer came forward.
The USCC report noted “… the current economic direction of China is ‘commanding heights’ state capitalism, with the Chinese government picking the winning industries of tomorrow and developing state‐owned national champions that are prominent at home and abroad. The private sector and foreign companies will remain important actors China’s economy, especially if they facilitate the government goals”. The report also stated that “Although market mechanisms have played an important role in this restructuring, there is no indication that the CCP was, or is, aiming to turn China into a bastion of free market capitalism dominated by privately‐owned entrepreneurial firms responding to market incentives. The CCP continues to prefer a strong state sector.”
What does all this mean to healthcare investors contemplating China as a source of new markets? Understand the potential rewards, but also the inherent risks that come with being a national priority for the country. Yes, China desperately needs outside technology and know-how in order to address the country’s deeply troubling healthcare problems. But much, much, much more than clean-tech, China’s healthcare space has deep political risks inherent within it. Few things could potentially destabilize China’s path forward more than if the disparities of social services, most notably healthcare, continue to go unaddressed in China.
This is why Beijing is so adamant that it needs investments in these areas; however, if China were to face future instabilities which it believed were related to unequal access to healthcare, outsiders need to be aware that the country’s impulses will be in the direction of nationalization and exclusion, or at the least, such preferential treatment of domestic providers that outsiders no longer find the China space an attractive market to play within. It is worth noting that l passed on making an investment in private hospitals in China, instead choosing to invest in the elder-care space precisely because of the influence of the Chinese government in the hospital market segment.
Healthcare investments in China face one of the more challenging environments because their success is deemed so critical to the country’s stability and future prosperity. But if the USCC report is any indication, the trajectory of the country’s economic reform process suggests that Beijing will subtly move over time to change the rules of the game and structure the domestic market in a way that fundamentally adjusts the return on investment outsiders were anticipating. None of this is to suggest China is the wrong market to be playing in as healthcare providers, simply that the role of the government in Beijing is one with manifestly more political risk than in most other governments in the world. For American entrepreneurs and investors who think “ObamaCare” up-ended the rules of the game in the United States, I would be willing to submit that you haven’t seen anything yet based on what China is likely to do in the mid-term.
The question begs to be asked: how can investors best manage the risk of governmental interference in their China investments? More on that topic soon, but for now, what do you think best practices are for investors looking to participate in the Chinese healthcare market with respect to anticipating and managing this sort of risk?
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[...] (who, among his other activities is pursuing his JD at the University of Michigan). This week my blog post was on the question of what, if anything, American and European investors in the healthcare space [...]