The Risks of Investing in China

The Risks of Investing in China
(Dennis Kwok and Johnny Patterson, November 22, 2021)

Transcript available below

About the speakers

Dennis Kwok was a founding member of the Civic Party in Hong Kong. Formed in 2006, Civic Party was one of the key political parties in Hong Kong that championed for the protection of the rule of law, greater democracy and human rights.

In 2012, Kwok was elected as the member of the Legislative Council (LegCo) representing the Hong Kong legal profession. The legislature in Hong Kong is divided into geographical seats and functional seats. Each member of the legal profession has one vote and is entitled to elect their representative in LegCo. Kwok succeeded veteran lawmaker Dr. Margaret Ng who held the LegCo legal seat for 16 years. Previous occupant of the legal seat includes Mr. Martin Lee, S.C., father of the democratic movement in Hong Kong. In 2016, Kwok was re-elected for a second four-year term with a 69% majority of votes from the legal profession.

The main policy areas that Kwok has focused on include access to justice, human rights protection and the independence of the judiciary in Hong Kong.  Protecting the independence of the judiciary, as well as its effectiveness and quality, was a priority for Kwok’s work in LegCo. As Deputy Chairman of the LegCo Panel on the Administration of Justice, Kwok oversaw the development of legal policy issues including the independence of prosecution decisions, the development of the legal profession and legal education. He campaigned for the expansion of the legal aid system to provide the Hong Kong population with more access to civil justice, many for whom exorbitant legal costs had been a barrier. He also served on the board of the China Human Rights Lawyers Concern Group, which provided a support network to human rights lawyers in the People’s Republic of China.

Johnny Patterson is the co-founder and Policy Director of Hong Kong Watch. Johnny was the founding Director of the organisation between 2017 and 2020, and is now responsible for overseeing their research and policy work. He has authored a number of Hong Kong Watch’s in-depth reports, including their research on why Hong Kong matters to China as an international financial hub and their report on the abuse of the Public Order Ordinance. He is a regular commentator on Hong Kong in international media, and has been published in The Spectator, The Independent, TIME, The Financial Times and South China Morning Post. Johnny finds that the most inspiring aspect of the job is working with Hong Kongers who have the courage to take a stand for what they believe in.



Robert R. Reilly:

Hello and welcome to the Westminster Institute. I am Robert Reilly, its director. Today we have two guests, the first of whom is Dennis Kwok. A barrister by profession, he is widely known as an advocate for democracy, human rights, and the rule of law in Hong Kong. He was a founding member of the Civic Party and a member of the Legislative Council (LegCo) from 2012 to 2020. Mr. Kwok led the campaign in combating international human trafficking and better protection and fairer treatment for refugees in Hong Kong. Among other accomplishments, he co-sponsored a private member’s bill to combat international human trafficking and modern slavery. On November 11, 2020, he was disqualified from the Legislative Council along with three other lawmakers of the pan-Democratic camp by the central government in Beijing at the request of the Hong Kong government. Mr. Kwok is currently a Resident Senior Fellow at the Harvard Kennedy School Ash Center for Democratic Governance and Innovation.

Our second guest is Johnny Patterson in London, who is the co-founder and policy director of Hong Kong Watch. He was the founding director of the organization between 2017 and 2020, and is now responsible for overseeing research and policy work. He has authored a number of Hong Kong Watch’s in-depth reports, including on Why Hong Kong Matters to China as an international financial hub and on The Abuse of the Public Order Ordinance. He is a regular commentator on Hong Kong and international media and has been published in The Spectator, The Independent, Time, The Financial Times, and South China Morning Post. Today the topic is going to be: The Risks of Investing in China. Dennis, why don’t you begin?

Dennis Kwok:

Thank you, Bob, and thank you for the Westminster Institute for hosting this talk. Johnny and I have been writing about this subject for a while and this is the principal area of my research at Harvard, which is looking at the political and legal risks surrounding international companies and NGOs that have investment and operations in China. And I think for companies to understand these issues they need to look at the politics of China, and understand that a lot of the decisions and regulatory policies that are coming out of China are really motivated by politics as much as legal ones.

And as you know, legal developments and politics go hand in hand in China, and also increasingly these days in Hong Kong. And when I look at Wall Street Firms such as BlackRock and UBS and Blackstone and what have you, calling for investors to double down on China because they see that there is a great investment opportunity, the question [that] arises is whether we are really being honest about the risk that is so associated with investment in China because we are looking at the country that is increasingly autocratic, increasingly obsessed with national security.

How China Thinks About National Security

Now, on the point of national security I think those of us in the West need to understand that when the Communists talk about national security, it is not in a traditional sense as we understand it in the West, about military security, about political and territorial security. When they talk about national security in China, they really mean a whole range of issues from key industries, key infrastructure projects, of course, also talking about energy security, but we also talk about data security in China when it comes to national security. And what is data security and also cultural security, you know? A film showing in the cinemas could be regarded as endangering national security or a piece of writing that someone puts out. What we call cultural security can also be part of national security.

So first of all, the first point I want to make, Bob, is that we have got to understand that national security is a broad, broad spectrum of interest, and a financial firm going into China can get entangled with national security without really knowing it because Xi Jinping has said in 2017 that financial security is a key part of national security. So when these Wall Street firms go into China, taking with them U.S. pension funds, they are actually getting into the national security realms of the PRC. So when people ask me, why did they crack down on the Ant Financial IPO, which is one of the largest IPOs in the world, and they pulled a plug on them a week before the launch date of the IPO, which has never happened before, and why do they effectively put Jack Ma under house arrest for a few months and force Alibaba, Tencent to give up almost I think a thousand million, a hundred billion renminbi in ‘donation,’ quote, and then, quote, to ‘the state,’ and forces the CEOs of Bytedance and Pinduoduo to step down.

Now, [for] all these there are multiple factors behind it, but one one of them is that these firms are growing too big and hard to control from the eyes of the Party, but also it is because financial security is an important part of national security, and for them Tencent and Alibaba with their financial payment services, such as Alipay and WeChat Pay, are growing way too big and out of the control of the state that they want to bring them into control.

But also I think the politics of it is important because when people ask me, Xi Jinping’s anti-corruption campaign was it about anti-corruption? Yes. Was it about taking out his political rivals? Yes. The lesson to be learned is that when they pursue a policy, it is never just about one policy goal, it is always multifaceted. And I use the case of Ant Financial, and Alibaba, and Tencent to illustrate that for them it is about financial security, yes, it is about national security and bringing these companies under control, yes.

Xi’s Populism

It is also about Xi Jinping’s personal political capital, that for him to do these policies in China is actually very popular, it is a very populist move on the part of Xi Jinping because we have got to understand that he has alienated a lot of the party elites in China by the anti-corruption campaign and also the total consolidation of power and prestige on himself becoming lifetime president. He needs the support of the masses. He needs the support of the 600 million people in China who are currently living under ¥1000 renminbi (RMB) per month.

Now, for him to take down Jack Ma and force these people to hand out billions to the state, imagine yourself as someone who is living in the rural parts of China or on the third or fourth line city in China, you know, struggling to pay the tuition fees and the hospital fees of your parents and your kids, and looking at Xi Jinping taking billions of dollars away from the richest man in China and giving out out to the masses, and telling them that I will take care of your problems, it is actually quite understandable and also quite a smart way of looking at it from the political point of view.

And Xi Jinping’s number one consideration right now and the only consideration for him is how to secure his lifetime presidency and to bring everything under control and to have people like Jack Ma hand out billions of dollars will endear him, I would argue, to a lot of people in China and the same goes down to why he wants to crack down on the private education sector because, again, imagine if you are someone who is struggling to get your [son] into the private tutoring schools to learn English in order to get him into a good college, and you are struggling with that. Xi Jinping took care of that problem for you by cracking down on private education so that everyone is equal or in a more equal setting.

So again, bringing these education and private companies down has a political aspect to it and what is next is what a lot of people are thinking because when you invest in China, you are looking at an environment where next week when the Party decides that healthcare is another problem they want to tackle, all your investment in private healthcare companies and hospital could go down the drain. Within a week we have seen how billions of dollars of the investment have been wiped off the capital markets just on the basis of a decision within a few days implemented by the Party.

And a lot of people – I am a lawyer by background, Bob, as you said, a lot of the lawyers in corporate finance have been telling me over the years that, oh, you know the structure that these companies list in New York in London? Yeah, technically speaking, the VIEs, what we call the variable interest entities, are technically illegal in China because in China you cannot have companies that are foreign, effectively foreign-owned and controlled because under Chinese law that is not permitted, but when they go to list in New York, they use BBI companies and enter into a series of agreements that give the shareholders (technically) control over these Chinese companies. Actually, they do not own anything.

Under Chinese law there is no ownership by these foreign shareholders and there is no control, and the corporate finance lawyers will tell me no, but they will not do anything; they being China. The Chinese state will not wipe off billions of the stock market by taking out these VIE structures just because they are illegal under Chinese law. Well, guess what, it happened. And I do not think we can be complacent about the risks, saying that the Chinese government will not do this or that because it hurts their own interests. I think we are looking at a paradigm shift here, Bob. I think the previous generation of Chinese leaders have based their policy decisions on pragmatism, but we are talking about a very new set of thinking under Xi Jinping.

And take Hong Kong as an example. You know, those of us in Hong Kong have been naïve for a very long time in thinking that, oh, the Chinese Communist Party will not rock the boat by destroying one country, two systems because they need Hong Kong as an international financial center, but things have really changed in that, number one, I think Xi Jinping and those in the top leadership believe that they could ride out the storm, that China is now strong enough to take on these risks, that they could do what they did to Hong Kong and ride out the wave, and so far they have been proven quite right because look at all these Wall Street firms and Western companies that are still investing in China and Hong Kong.

And you know, what is the problem? We can ride it out. And also, Chinese state capital or what we call red capital has become so dominated in Hong Kong that they believe even if Morgan Stanley and Goldman Sachs pull out, we have got China red capital in Hong Kong that could continue to sustain the capital markets. So what I am trying to say is that things have changed since the early 2000s when a one country, two systems came into place because back then in 2001 they want to get into the WTO. Of course, they had to honor an international agreement like the Sino-British joint declaration because it is important for them to give the world the credibility they need to say that we are [a] responsible international player, you can trust us, allow us to do the WTO.

But that has changed. They have profited from that deal from long ago, and now they believe they are strong enough to basically ignore international and foreign perception of their policy. And to do that they can just say, you know, we do not really actually care about what you think on the outside as long as domestically the Communist Party is, you know, in a secure place in terms of this power. Foreign perception no longer plays an important role for them.

And so for these foreign firms and investment banks to go into China, you know, investing billions there, can they actually get it out? Is there a really a channel for them to say, look, you know, I invest one billion dollars here in China. In a year’s time I can safely get it out? I do not think anyone who understands the risk involved in investing China could safely say that in one year time my investment will be legally protected and I could remove it from the Chinese market because policy changes can happen so quickly.

And you know one of the points I want to make also is that the most powerful political ideology right now in China is nationalism, aggressive nationalism, and the highest grossing movie right now in the Chinese cinemas is a Chinese movie called The Battle of Changjin Lake, which is about the Korean War and how the Chinese Volunteer Army successfully defeated the US Army in North Korea. Now, of course, a lot of it is fictional, a lot of it is unhistorical and just a propaganda movie, but a lot of Chinese people are going to the cinema to see this movie, and the state is actively pushing for this kind of nationalism in ways that we have not seen for a very long time. And foreign textbooks are banned. English is not encouraged and as if, Bob, I think that they are almost preparing for a rupture or unilateral decoupling with the West.

If you look at the laws they are implementing, the anti-sanctions law, the PRC security law, restricting firms from removing data from China to offshore locations or restricting the transfer of any data from China to a foreign entity, it is as if they are preparing for a lockdown rupture, that something serious will happen whether it is over Taiwan or the South China Sea, that they are preparing themselves for conflict eventually with the Western world and that a rupture will occur, and these laws and decisions of bringing back these companies from overseas to China, and forcing them to give money to the state, and having them effectively segregated from the rest of the world is, I think, a very clear and worrying sign about where the country is going.

I always say to people – people ask me why is that happening to Hong Kong and what happened there? I think that is only a symptom of where the country is going. If you look at Hong Kong, that is one piece of the puzzle, but you have got to look at what is happening in Taiwan, what is happening in South China Sea, in Xinjiang, in Tibet, what they are doing to domestic markets, wolf warrior diplomacy, trade sanctions against Australia, the kidnapping of the two Michaels are all part of the same package, which is where the country is going.

So when foreign firms go into China, they need to really understand where the country is going and have that wider perspective in mind when they make decisions. Otherwise I think they are doing the shareholders and the investors and the U.S. pension a disservice when they go in there. Either they are deliberately blind to the risk or they just want to ignore or pretend that the elephant in the room is not there. So, Bob, I will leave it to Johnny to talk about some of the other risks faced by companies who are investing in China and happy to answer any question.

Robert R. Reilly:

Thank you, Dennis. Johnny Patterson from Hong Kong Watch, please.

Johnny Patterson:

Thank you very much, Bob. Dennis has so eloquently and comprehensively covered so many of the political legal risks that I just want to focus on one more area of risk, and that is reputational risk, the issue of the intersection between business and human rights, and particularly international corporate complicity in the worst human rights abuses taking place in China. And I would be interested to know whether your viewers are aware that most pensions in the U.S., Europe, or the UK are currently invested in Chinese technology firms with ties to the Xinjiang surveillance state responsible for the oppression of the Uyghurs or alternatively into Chinese state-owned banks. I would wager that most will be unaware of this, but billions of pounds of Western pensioners are currently being invested in Chinese firms that have problematic human rights records, and governments and city institutions are yet to act on that. The irony is that corporate virtue signaling is more widespread than it has ever been.

The rise of ethical investing, particularly environmental, social, and governance investing (ESG) in the jargon of the industry, has led to trillions of dollars in assets being placed under management of ESG funds. This is designed to give us all a reassuring sense of security that our pension fund money is being invested in good, sustainable equities that will generate profit for our savings while doing a little bit of good for the world. But considering China, and the way that is invested in China, exposes really the rank hypocrisy of many of the key industry actors, and this is the key point in our new, recent piece of research. The growing presence of Chinese equities and funds run by firms like JP Morgan or BlackRock mean that pretty much every pension fund in the West has serious shares in problematic Chinese equities from CalPERS in California to the UK university’s pension fund the exposure is enormous.

Just to take the UK university’s superannuation scheme as an example. This is the largest private pension scheme in the United Kingdom and it covers all university staff. Of all of the global holdings, including U.S., UK., Tencent is the second largest stock and Alibaba is the fifth largest stock. Given that £25 billion is invested in publicly listed equities, this means that the fund is investing hundreds of millions of pounds in those two firms alone. The fund also has more than £100 million invested in the China Construction Bank (CCB). The same story is true of so many pension funds around the world, both state-held and private in the United States.

There are a number of reasons to be concerned by this. Some of them are the points that Dennis has already made, but on the business and human rights intersection specifically, little attention has been paid to the human rights records of Chinese technology firms, and investments in Tencent and Alibaba are problematic because Chinese technology companies of their size cannot divorce themselves from the Chinese state, which is increasingly using a mixture of surveillance and technology to oppress and target minorities within its borders.

Alibaba has produced facial recognition software that specifically targets Uyghurs and has helped construct the surveillance state in which over a million Uyghurs are currently being detained. WeChat, which is owned by Tencent, by contrast has been accused by Human Rights Watch of censoring and putting its users under surveillance on behalf of the Chinese state. Other technology firms like iFlytek, Hikvision, Dahua Technology, and China Mobile raise similar alarm bells. Meanwhile, Chinese state-owned banks are the largest bankroller of Chinese state-owned enterprises, who in turn spent the last decade buying a substantial amount of strategic infrastructure in the West, as well as being the largest lenders to the Belt and Road Initiative, which has been accused of exploiting developing nations and being used as a tool for debt diplomacy.

I am happy to discuss this more, but just wanted to think briefly about what this means for us. And I think the first point to say is that human rights have very often been the neglected part of ESG. International human rights norms, particularly the UN guiding principles on business and human rights, have meant that investors do have a responsibility to protect human rights, but conversations we have had with city insiders and even with people in the industry who are involved in these questions show that very little has meaningfully been done to protect human rights, particularly in contexts like China where there is so much to be gained from engagement for firms like BlackRock, so there needs to be regulation to counter this.

The second question that is really important is what does it look like to inform the public and educate the public about where their money is being invested? I think if the average person in the United States or the United Kingdom knew that tech firms with ties to the Xinjiang surveillance state were investing their money, taking money from us, everyone would be outraged, but people do not know that. How can we educate them? Finally, I think there are technical questions about what it looks like to effectively use capital markets to incentivize and shape behavior in the context of gross rights violations, and that is a much more tricky question and one that I think would be interesting to think about deeper going forwards. Thank you.

Robert R. Reilly:

Thank you, Johnny. I would like to ask you both; there was for a long speculation that China would not suppress Hong Kong, that it would keep its agreement with Great Britain because it would not want to kill the goose that laid the golden egg. They are well along in the process of of killing that goose, but do they still have the golden egg? I mean it was the principal venue through which Western capital came to China, but from what you were saying, Dennis, it appears that they have not paid any penalty for this. Is that correct?

Dennis Kwok:

Yeah, I think they did essentially a risk calculation that we needed to honor Sino-British joint declaration and keep Hong Kong in the early 2000s, following the Hand Over because first of all, back then the Chinese capital markets have not been so sophisticated yet, it was still at the early stage of development. They had just gotten into the WTO. They wanted to get into the WTO and that is why they needed to honor the Sino-British joint declaration. They needed to portray an image that [China was] an international responsible player, that people, including Western companies can trust and invest in, and that is what they did very successfully for 15 to 20 years.

And the Hong Kong financial markets have really changed in its color in that the red capital, what we call Chinese capital, has now dominated Hong Kong markets, and if you look at the major listed firms in the Hong Kong stock exchange, most of them are Chinese companies, and also the Shanghai and Shenzhen stock market has been increasingly strong in terms of helping companies to attract capital, and in fact, they do not want Chinese companies to go to New York and list there. They want them to come back to list in Shenzhen, and Shanghai, and Hong Kong because as you said, Bob, that these Wall Street firms are going directly into China and they are letting Goldman Sachs and BlackRock to set up majority owned companies in China.

So the need for Hong Kong is gone, and the need to placate to foreign perception and foreign government’s trust is no longer needed, so they feel like they are strong enough to ride out the storm which they have created, and so far they have been proven right because the Western actors are willing to play along with this, and the so-called sanctions are imposed by the U.S. government is I do not think generating any impact at all. You know it is not going to shift policy directions and it is not even going to give Xi Jinping a second thought because for him this all plays to a very attractive narrative, which I alluded to in my opening remarks, which is aggressive nationalism, nationalism being the most powerful ideology in China right now.

And the Hong Kong narrative from the state media point of view – and actually, unfortunately, a lot of mainland China people believe it, it is that the Hong Kong unrest was instigated by the Americans, by Western forces, by Western government, you know, it was the CIA that got the millions of Hong Kong people who took to the streets. I always say that if the CIA is really that efficient and effective, you would have solved a lot of problems in your country as well. So you know I think it is sad that this propaganda is being believed and held up as the truth and that the Hong Kong unrest was instigated by foreign government and Xi Jinping under his leadership has managed to contain this development and resolved the problem and arrested all the political actors and activists who were controlled by foreign governments and instigated unrest.

So this is the narrative that which they play out in the domestic audience and it is being absorbed as as the truth, and that is why I think to understand the decisions coming out of China you need to look at it from Xi Jinping and the Communist Party’s perspective and what works for them. It may seem irrational for you and me to say, oh you, why are you killing the golden goose? But from their point of view they have their own logic and it is something that you need to understand in order to understand some of the considerations underlying those policy decisions.

Robert R. Reilly:

On a personal level. Does this mean you cannot return to Hong Kong now?

Dennis Kwok:

Well, you know, I think anyone who has said anything or done anything that is not in line with what the Chinese Communist Party wants is at risk, and myself included. I would not say, you know, you cannot ever go back, I would not put it as high as that, but I think for a lot of even China experts in the West, those who have studied Chinese issues, those who have commented on Chinese affairs, a lot of them tell me that they will not go to China these days because of the risk. They look at what happened to the two Michaels, the two Canadians, they are thinking this could be me.

I am sure the two Michaels did not think or did not ever imagine that they would be arrested and held in prison for so long over Meng Wanzhou, but the fact [is] that it happened. And the lesson again, I think, Bob, you have raised a very good point. The lesson I think we have learned from the Meng Wanzhou incident is that it was held up as a domestic victory for Xi Jinping in China. You know when Meng Wanzhou landed in the Shenzan Airport, she gave a speech, thanking Xi Jinping, saying, you know, ‘how grateful I am, just a private citizen, I am nobody, but the state went out of this way to secure my release.’ You know the two planes with the one carrying Michaels and the one carrying Meng Wanzhou effectively took off at the same time?

So in the past when they did this kind of business, they would at least put out some legal procedure, you know, make up some excuses and say that oh, the two Michaels have been released because of some blah blah blah reason, but these days they do not even pretend, and the reason why they do not pretend is because hostage diplomacy works for the domestic audience, that the fact that they grab the two Canadians and secure the release of Meng Wanzhou for them is fair game. It is what we do because we are strong now. And they do not even hide the fact that it is hostage diplomacy, and I think they have learned the wrong lesson in that they believe that hostage diplomacy really works. Next time they will not only grab two Canadians, next time they will grab ten because it worked and that is the lesson I am afraid they have taken out from the Meng Wanzhou incident.

Johnny Patterson:

Just to come back to the question earlier about the golden goose. I think the other thing that is interesting or another dimension of what is interesting about the rise of red capital and Chinese money being really dominant in Hong Kong’s economy is it weakens the leverage of international businesses there. So for a lot of these businesses Hong Kong still remains the most reliable place to raise money and to access China because Hong Kong’s legal system is still better, but they are much weaker in terms of the amount of power they have in the city than they used to be, but so you see that play out if you compare the protest in 2003 when the China tried to push through a national security law in Hong Kong and the business community and the democratic movement kind of stood together in to block it and the Hong Kong government eventually backed down, with the protest in 2019 when again the business community were very much opposed to the extradition bill, but their views were ignored and red capital got behind the government, and that meant that eventually what we have seen is all of the businesses have eventually kowtowed to Beijing because ultimately their access to China is the thing that they prioritize more than anything else.

And so then you have in 2020 HSBC, Standard-Chartered, lots of the big firms in Hong Kong, lining up to endorse the national security law, and that is a sign of their weakness, really. I think what we have seen is that Hong Kong still matters to those firms quite a lot because it is much, much safer. Still, it may not be forever, but right now it is than some of the other places, but what we have seen is their power in comparison to which means Beijing has more power.

Dennis Kwok:


Robert R. Reilly:

Dennis, you are a barrister so you can speak to this. As these Western firms are going into China proper now to set up businesses which they own, what kind of contract law exists there that gives them any protection for their ownership and their investment?

Dennis Kwok:

Now, for a while, I am talking about the early 2000s and up till 2010, I was invited to go to Beijing University and Wuhan University to talk about the rule of law because there was a genuine desire (I feel at least back then) that they wanted to improve their legal system in order to give confidence to the outside world that the Chinese legal system is something that you could depend upon, and the development of the civil courts have been happening for a while at least back then.

I could feel that they were genuine in the sense that they wanted to develop a more sophisticated legal system, but under the leadership of Xi Jinping we see a lot of reversals. First of all, you cannot even talk about the independence of courts and judiciary. That is a banned term in China. And the rule of law as we understand it in the West is definitely not happening in China, where rule of law concepts and human rights and due process are not allowed to be discussed in universities, and will not be practiced in the courts. So when companies sign contracts, a lot of them know that there are problems with Chinese law and Chinese courts, and especially if you are up against a major state-owned company or a PRC conglomerate like Huawei, and you enter into contract with them, how confident are you in the judicial process in the mainland?

I think those who understand it will say that the confidence is very low, so some of them try to breathe out by outsourcing it to private arbitration tribunals that are based in Hong Kong or Singapore. And I would argue, and I have argued in my Harvard paper published a few months ago, that even using Hong Kong legal system will pose a problem for international companies if they are up against a state-owned company or a PRC conglomerate. The reason is even if you assume that the Hong Kong courts are independent, there are now provisions in the national security law that effectively give the Hong Kong government and the PRC government [the ability to] to issue certificates that are binding on the Hong Kong courts.

Now, given how wide and broad national security is, let’s say I have a major investment in a financial firm in China or an ownership in a very sensitive piece of intellectual property in China, and I go to litigation against a state-owned company or PRC conglomerate. They can say that what you are litigating, the subject matter, is a matter of national security. They could get the Hong Kong government to issue a certificate under Article 47 of the national security law to say that this is a matter of national security. That effectively binds the Hong Kong court and takes it out of the hands of the Hong Kong court, so do not tell me how independent Hong Kong courts are when there is a law like that, which effectively imposes the will of the state on the Hong Kong courts in a piece of litigation, then you effectively are left with no protection.

So I am not saying this will happen on a daily basis, but this will be something of concern if you are dealing with a major matter like a major SOE contract concerning energy, financial infrastructure, or something that is very sensitive piece of technology, etc. It is not going to happen on a daily basis, but when you are talking about really big deals, when a lot of things are at stake, the will of the state could be imposed on the courts to bend the law in their favor.

I think what most companies are thinking is that, ‘Look, you know, it happens to the next guy but not me because you know, my deal is small, you know. I do not touch on anyone’s toes. I am just selling toothpaste, kind of thing, that is not going to happen with me.’ And that is how businessmen think, that they weighed risk, you know, the pros and cons. If the risk level is tolerable and there is still money to be made, then these will continue to happen and this is what we are seeing.

Robert R. Reilly:

I am curious as to why now when growth in China has slowed appreciably, when the debt problem is becoming more evident, and when massive losses have been suffered by Western offshore investment in China, that American and other firms are still lining up to go in there and put those investments at risk. It is almost an invitation, kick me again, or am I exaggerating?

Dennis Kwok:

Well, you know, you look at what happened in the 2008 global financial crisis. A lot of people were asked the same question in 2008. Why didn’t we see this coming, how come the guys in Wall Street did not warn us about it? [The reason is] because there is too much vested interest, Bob. If I am trying to sell you a China fund that I am building, that I am trying to raise billions of dollars to go into China, am I going to tell you, look, you know, at the same time you are very, you know, disclaimer that this is very dangerous and you might lose your investment if you invest in this?

No, there you cannot rely on people who have deep, vested interest to be honest about the risk that they are getting into. No, that is the reason why I think regulators and political actors in the West should be looking at tougher laws and regulations to force these firms to disclose the risks that they are actually investing into, and you cannot rely on the companies themselves to do the right thing. That is my experience with dealing with the business sector, that only if you make it a legal requirement and that it will seriously affect their reputation and the bottom line, things will not happen.

Robert R. Reilly:

Can I ask you what the new economic policy announced by Xi called common prosperity means for a restructuring of the Chinese economy that could affect the investment risks?

Dennis Kwok:

Absolutely, the common prosperity is very much what Xi Jinping under the new era, what they call the new era under Xi Jinping’s leadership, [is implementing]. If you look at the recent historic resolution that was passed by the Sixth Plenum a week ago, which is the third of its kind, it has only happened twice before in the history of the Party, [you will see the implementation of common prosperity]. One in 1945 effectively cemented Mao Zedong’s position in the Party and it gave him enormous overriding power over everyone else. That was Mao Zedong’s historic resolution. The second one was in 1981 under Deng Xiaoping, who basically overturned Mao Zedong’s leadership and the problems that he brought over with the Cultural Revolution, and cemented Deng Xiaoping’s thoughts into the Constitution of the CCP, being open in reform, and what we have seen is the 40 years of economic development.

And Xi Jinping, in order to secure his authority as a lifetime president to the same level of Mao Zedong, basically, this guy wants his portrait up on Tiananmen Square, is to have his own kind of footprint or mark on the development of the Party and the country, and this common prosperity is basically taking up what Deng Xiaoping said 40 years ago, let a small group of people become rich first, and he emphasized let a small group become rich first, and then there will be common prosperity later on. So he is effectively taking on what Xiaoping said, bringing it to the next level, which is to restructure the prosperity and the economy, and to spread the wealth in a more equal way.

Now, as I said, this is very popular for a lot of Chinese people because if you are one of the 600 million people who are living under 1000 RMB per month, that is roughly $160 US Dollars per month, you are thinking, you know, these guys they got rich and they are living lives that are unimaginable for average Chinese people. They are flying in their private jets, they are buying chateau in France, they are, you know, dressed down to their underwear is luxury brands and goods. and living this really glamorous life. And you are stuck there, thinking, you know, how come I do not have that opportunity? And for Xi Jinping to now do this it is very popular for a lot of the average Chinese people. Now, some would say that he is going to overplay his hand by pushing for common prosperity, and we are seeing some pushback on his idea that he wants to impose a property tax. It has not really happened on the mass scale yet, but he is definitely talking about that.

And you mentioned one point, Bob, that the GDP growth in China has been roughly around three to four percent, which is quite low for, you know, for Chinese record, and it should worry every Chinese leader that the economy is only growing by three to four percent. If you take away some of the excesses are driven by the property sector, which makes up about 30 to 40 percent of economic activity, the GDP figure is actually I think much lower than three percent, and the Chinese leaders know that and it will mean that jobs will be lost, it will mean that people will earn less money, and how do you resolve that problem?

You have to resolve that by taking money from the rich, from (I would argue) foreign firms when it suits their purpose, and give it to the Chinese people. And to shore up the nationalistic sentiment they could easily target a foreign firm at whatever point they feel is convenient, and then to say that these foreign investments are now confiscated by the state, and then we will hand it back to the Chinese people. You can just see that kind of argument coming out whenever it suits them. So I think common prosperity works on many levels, on the political level for Xi Jinping, on the economic level when it suits them and where there is a need to cure some of the problem that is inevitable for the Chinese economy because of the debt problems that you mentioned because of the slowing GDP growth. They need a new formula in order to keep the masses happy.

They need to have some sort of saying, whether it will work is a different thing, but they need a saying. In Chinese politics it is very important for them to have a saying of what they are going to do, what they need to do in order to keep things going. And I will just add that I think for Xi Jinping I think a common prosperity will be what he will try to make a hallmark of and I think it will affect every aspect of life, including in Hong Kong. You can kind of see a miniature of that development happening in Hong Kong because the housing market in Hong Kong has always been a huge problem, it is one of the most expensive housing markets in the world, and the Communist Party is now putting the blame on the property developers in Hong Kong.

Now, we all know that the property developers hoard a lot of land in Hong Kong. They have grown enormously rich, but that has always been the problem, but the Communist Party is now putting the blame on them for the problem because they no longer feel like they need to partner with the property developers to control Hong Kong. Now that they have secured complete and total control over Hong Kong, they can now go after the next the next guy, which are the property developers, and to accuse them of bearing the responsibility of the problem with housing, which is, of course, much more complex than that, but they are putting the blame on them because this (I argue) is part of the common prosperity theme that is happening with the rest of the country.

And you know the property bubble, the property market troubles that we recently saw with Evergrande and other property developers in China, is actually a result of deliberate policy change because we all know that these property developers in China are highly leveraged, leveraged to the hilt, and the Chinese government knows that but they deliberately changed the debt-to-capital ratio that these companies are allowed to have, and they basically cut off their credit lines so that these companies immediately got themselves into trouble.

Now, you would say, why would they do something like that because they know that housing is a generally very unaffordable for a lot of people. What I predict will happen next is that they will nationalize, effectively nationalize, these companies and hand out these properties to ordinary Chinese people, which, again, is part of common prosperity, and you can just see that happening.

Johnny Patterson:

[I have] one thing to add there. I think what is interesting is the question of whether this will work and whether it will achieve the goals that Xi Jinping has laid out, and my hunch is that it almost certainly will not because he will not be willing to go after the major arena of unproductive investment, which is the state-owned enterprises. And so a huge source of the problems in China’s economy and the fact that there is a potentially massive bubble that could burst is the fact that there are loads and loads of unproductive capital investment and the whole economic model is based on that. And so we are seeing with Evergrande at the moment some of that being undercut, but it is not only private firms where there is a problem, and ultimately there are questions about whether the government can can ever tackle the issue of unproductive state investment, which is a huge problem in the Chinese economy at the moment.

Robert R. Reilly:

That is a very good point because one can see the political attraction that Xi is exercising with that huge audience of the 600 million who are living such poor lives in China, $140 a month or less, in lowering the cost of housing or making housing available to them, but then that danger, Johnny, that you just mentioned, if you do that plus the proposed real estate taxes [will that] lead to a giant devaluation in property prices and the political repercussions that might cause because property is the main vehicle for savings of the Chinese people, and all of a sudden a large portion of those savings will disappear overnight?

Johnny Patterson:

And I think one of the big questions at the moment is can they manage the unrolling of Evergrande, and it is a really big, open question because, yeah, you are right that the biggest place where people save their money is in property at the moment, and so if that were to be devalued, for many people that would be absolutely devastating, and so I think it is a really interesting question. The state is trying to manage this, it is trying to manage it to avoid contagion, and the open question right now is are we going to see like a slow and steady downturn in order to rebalance the economy, which I think is what Xi Jinping wants, or will be watching more of something that gets a little bit outside of their control? And obviously, outsiders may not know whether or not it gets to that point because the state obviously manages the narrative, but I think these are the questions that are most important right now economically. Dennis, what do you think abot that?

Dennis Kwok:

We are talking about economic developments now, which are first of all very hard to predict. I mean experts have been saying all sorts of things, saying that there will be a hard landing, saying that there will be a corporate debt bubble bursting. Of course, the corporate debt levels are very high. I think it is around 300 percent of GDP, which is higher than when the Japanese economy burst in the 1990s. You are looking at a much bigger scale, but also the state has many more levers that they could pull in controlling what is happening, so I am not one of those who say that there will be a hard landing, the corporate debt level will burst, the Chinese economy will come to a halt. I am not one of those who believes that because we have seen how well they managed these crises before by pulling all levers of the state and they actually control a lot of the factors there.

So you know, what I am seeing is why do they do that to property developers like Evergrande, and at the same time, knowing that it is going to cost the middle class a lot of their savings and ownership, what is the calculation there and what is it that they are trying to achieve is something that I have not been able to really work out. And maybe we need to see developments going forward in order to truly understand the picture, but I am sure with everything that is to do with Chinese decisions, political decisions, it is always political calculations from the perspective of the Party, and they rarely take decisions that are purely economical or social, there is always a political aspect to it.

Robert R. Reilly:

In other words political control is more important than economic development.

Dennis Kwok:

Oh, absolutely, absolutely. I think the political control from Xi Jinping’s point of view is paramount from this point onwards until November 2022 when he will be formally confirmed as the lifetime President or get his third term, so to speak. From now until November 2020 I do not expect they will ease the quarantine measures for foreigners because I suspect they know that the healthcare system once they open up the borders again and COVID becomes more infectious in China, I think they know that the health care system cannot handle [it]. They know that the vaccines are probably much less effective than their Western counterpart. They know that COVID will flare up again so that is why they are not opening the quarantine measures anytime until November 2022.

And sadly for Hong Kong that means international travel will continue to be banned to a point where American companies, a lot of them, are saying, look, you know this is killing Hong Kong as an international financial center, we are moving away. But the Hong Kong government these days basically has no choice but to follow the mainland government. So you can see how effectively they have basically taken over Hong Kong, very effectively.

But I think it is important to not lose sight of the bigger picture because I think we alluded to this in the opening, which is you need to look at what is happening in the South China Sea and in Taiwan, and the potential instability that we are talking about is of a geopolitical proportion, that you know you and I were talking about Evergrande and Wall Street firms, but what is at stake is much bigger; 60 percent of the undersea internet cables go through the South China Sea, and so does a lot of international cargo, and also what could potentially flare up in the Taiwan Straits could be, basically, upend the whole of [the] Asia-Pacific security order.

And you know a lot of my work here is also to do with foreign policy and, you know, predicting what is gonna happen. I have always said that, Bob, when I was in office as a lawmaker, that the international community should care about Hong Kong because after the fall of Hong Kong the next issue on your desk will be Taiwan, and this is exactly what is happening. 150 war planes flew into Taiwanese airspace and, you know, with a lot of rhetoric coming out of Xi Jinping, saying that we cannot leave the Taiwanese question to the next generation.

I think the world needs to understand that for Xi Jinping these are not just rhetorics. I think we need to take him at his word, seriously, and because that is exactly what he said he would do to Hong Kong a couple years back, which is to implement complete control in Hong Kong. I think a few years back a lot of people took it as just, you know, mere rhetoric, but now it has happened. Of course, Hong Kong is a low hanging fruit for them. Taiwan is a very different set of considerations, involving possible military action, but those are the real risks that I see that people are not taking sufficient account of.

Xi’s Risk Calculation

Robert R. Reilly:

I find it very interesting from a foreign policy perspective or from the larger perspective since as you pointed out, both of you have pointed out, Xi considers a comprehensive picture. There is not a political lane and then an economic lane or in the national security lane, they are all of one piece, and everything is put at risk in respect to Taiwan. It is a huge gamble. If they win, they basically win everything. They already have much of the South China Sea. Were they to take Taiwan, either peacefully or through an invasion, Japan knows it would be in an untenable position. The United States would have to retreat further eastward in the Pacific. The repercussions are absolutely massive. It would be a major step in asserting Chinese predominance.

However, were this to be undertaken militarily, even in pieces, take Quemoy and Matsu first or take the Senkaku Islands, how much of a sort of a risk calculation is Xi doing in terms of what that might mean economically for China due to the Western reaction?

Dennis Kwok:

I think what we should not underestimate is the appetite for risk from Xi Jinping’s point of view, that he has a huge appetite for risk, and internally, from some of the internal Party documents that we have managed to see and from some of his speeches he is calling on comrades within the Communist Party to not shy away from struggle, which is a clumsy phrase in English but in Chinese is not shying away from struggles or confrontation. And if that is what he is preaching to his Communist colleagues, comrades, then I think we should expect that he will take the risk necessary in order to achieve the goals of reunification with Taiwan, and on the grander picture they want to push American interests out of Asia Pacific.

Some say that the equivalent of the Monroe Doctrine will be true of Chinese foreign policy, and you come to think of it, you know, Americans they pushed out European influence from the Western hemisphere under the Monroe Doctrine, and a lot of people say it is just natural for China to want to push American interests out of the Asia-Pacific, out of Japan, South Korea, out of Taiwan, out of South China Sea.

But the problem with that is that the geographical calculations and consideration is much more complicated in the Asia-Pacific. Not only do you have Japan, South Korea, Taiwan, Australia to grapple with, you also have a whole bunch of countries around the South China Sea who would take a serious issue with China’s position on the South China Sea, and the Nine Dash Line, and the militarized islands, and also as I said the undersea internet cable that the world depends upon goes through the South China Sea, and also a lot of international cargo. So the freedom of navigation over the South China Sea is an issue that involves every single nation in the world, so for China to want to implement its own version of the Monroe Doctrine, the stakes are high, but the appetite for risk, as I said, in my experience in Hong Kong politics I can tell you the appetite for risk is also very high from this Chinese leadership.

Robert R. Reilly:

Johnny, is that the perspective from Hong Kong, as well?

Johnny Patterson:

All I would add is that I think what cannot be understated is that there is resolve within the American establishment to respond if there were, particularly military intervention in Taiwan, and so for businesses and for others thinking through even let us say a 25 percent risk that some kind of proper confrontation happens, they need to be thinking about what happens in terms of financial and economic decoupling, and what that will mean for their engagement in China, and are they resilient to America using the financial leverage it has, say, in the SWIFT clearing system? Are they resilient to that or would they be absolutely screwed if a confrontation happens and America declares economic and financial warfare on China?

I do not know whether the majority of businesses have even thought about that as a potential scenario, but I do know congressional staffers who have discussed that as one of the levers they would have in that context. It would be interesting to find out whether the risk analysts that are out there in these businesses are thinking about those kind of questions.

Dennis Kwok:

I would just add, Bob, that between full-scale invasion, military invasion, and doing nothing there is a whole lot in between, which they are capable and are actually doing in terms of infiltration of Taiwanese society, breaking Taiwanese society from within, to infiltration that we are seeing in the West in countries like Canada. It is very well documented that Chinese state influence in these countries is happening, so the point I want to make over Taiwan is that I think there is a range of actions which they could take.

To what point will the West say, okay, this is enough, this is something that we cannot tolerate? I think they will keep pushing that line to test the reaction of Western governments on the question of Taiwan, and we expect to see tensions continue to rise. I do not believe that the recent summit between Biden and Xi Jinping will change that course. It may cool down emotions a little bit, but I do not see how that course could be changed by the two leaders just sitting down and talking through Zoom. I am not sure that will change things very much.

Could Sanctions Lead to War?

Robert R. Reilly:

By the way, just as a side note you may have noticed the recent story that China went into Italy and bought locked, stock, and barrel an Italian drone company, and of course, took its technology to China, an action of which the Italian government was completely unaware, just another step in perhaps the kind of economic infiltration that you are speaking of.

This is a really rough analogy but when you think back to World War II, Japan was attempting to create the Greater East Asian Co-Prosperity Sphere and dominating Southeast Asia, and the opposition from the United States was expressed rather late in the game through economic sanctions. And it is when it emplaced steel and oil sanctions against Japan that Japan decided our best risk, the best opportunity is to strike the United States now before these sanctions make us weaker.

If action were to be taken, Johnny, through the SWIFT or other economic measures that would imperil the Chinese economy and thus politically imperil Xi, might they make the same kind of calculation, ‘we are stronger now, better to utilize that strength before before the Western reaction gets stronger and they become more capable of countering us.’ Is that a reasonable expression of the risk?

Johnny Patterson:

I think I am sure all of these conversations are being had amongst strategists in both China and the U.S., and I cannot speak exactly to what they are saying, but I think that sounds very reasonable to me. I do not know, Dennis, if you have any other thoughts on that?

Elites Do Not Understand One Another

Dennis Kwok:

I only speak from my personal experience, that the experts or the elites in the two countries are often out of sync, and also miscalculate the factors and risks involved. I remember vividly that in 2017 I went to Beijing to attend a high-level economic summit between the U.S. and China. I was only a fly on the wall. I was just there to listen in on what the elites in the two countries were thinking. So from China there were all these top professors and officials in Beijing, and then the Americans flew out. I think there was a former the Secretary for Treasury and, you know, some very famous professors and thinkers all came out.

Underestimating Trump

And then what I felt at the time, what I heard at the time is that they think Donald Trump is a joke. They think that Trump is something that they could handle very easily, especially on the Chinese side there was even a sense of elation, thinking that, you know, how can the Americans be so stupid in electing Donald Trump, and that he is so weak, never has America had such a joke as a president.

But what I think was missing from that room was a voice representing the Trump side of the argument, you know, basically, you know, they underestimated the guy, they did not see it coming. This was in 2017 and these is talking about the top thinkers in both countries. They often ignore and miss what is happening, you know, that may be obvious to some people, but because of who they are and they talk among themselves a lot, and what I saw was they completely did not see it coming. And I am just afraid that whether the these people are still miscalculating one another and miscalculating what is happening in the politics of both countries.

Devastating Miscalculations on Taiwan

There is a lot of talk in China amongst top Chinese thinkers, saying that America do not have the will to fight, they are too divided, they are too partisan, look at Fox News every day, you look at CNN every day it is about fighting one another, you know, they will not have the will to fight. You know, if that is the kind of thinking that is fed up to the leadership of the Communist Party, will there come a point where they think you know I think the Americans will not fight back if we do something in Taiwan, they are too busy fighting themselves. And if that is the kind of miscalculation that eventually lead to a decision, that would be devastating because I think they are also missing [that] if they really think that way, then they really do not understand American domestic politics and sentiment as well.

And also the sentiments of people in Japan, and South Korea, and Australia. And there is a recent poll in South Korea showing that 60 percent of South Koreans think that the CCP regime is evil. I spoke to a group of Japanese professors at Tokyo University recently and they told me the sentiment in Japan is the same, that that is really changing, and also I feel that people in America also have a very changed feelings and sentiment, and that will be fed through because as a democracy it will be fed through into the politicians and officials when they make decisions.

A Very Dangerous Situation

But I do not feel that the Chinese thinkers are sufficiently aware that that is happening, and they continue to push for things like wolf warrior diplomacy, continue to act, basically behave badly on the international stage, which will further consolidate this kind of sentiment against China. If they are not sufficiently aware of this, and go ahead and think (or continue to assume) that the American-led international order will not do anything if they take over Taiwan, then there will be a serious miscalculation.

I will just end by saying that from Xi Jinping’s point of view, of course, the best way to do this is not by military invasion, [it] is by a peaceful reunification, but because of what has happened to Hong Kong and that the failure of one country, two systems there is no no longer any doubt that the Taiwanese people will not accept one country, two systems, so everything is coming to a head and Xi Jinping saying that he will not leave it to the next generation, with the Taiwanese people they are saying they will not accept one country, two systems because if you look at Hong Kong, there is no way we are handing ourselves over to you. Then what is the situation we are looking at? A very dangerous one I would say.

Why Xi Can’t Wait to Act

Robert R. Reilly:

Yes, I would agree with you, Dennis, that for the first time in many years there is a bipartisan consensus in foreign policy regarding China. It has really crossed the aisle. Republicans and Democrats are agreeing about the nature of this threat, perhaps not unanimously on what ought to be done in respect to it, but the sense of danger is is very keen.

Let me close by asking this last question or making this remark as I have asked the same thing of other experts on China that we have had on this program: I believe it was Deng Xiaoping who said just develop our strengths and and quietly, do not show your hand until you are strong enough that showing your hand will not have any negative repercussions for you. And I have always thought, why didn’t Xi just wait five, ten more years when there would not have been any prospect of a serious strategic pushback to what he is attempting to achieve?

And the answer I have gotten uniformly is he thinks, well, it is that has already happened, it is too late for America to react, that they are indeed weakening [in] precisely the ways that you have said, Dennis, so that there is no danger for us in showing our strength now. In fact, there is only an advantage to doing it.

Dennis Kwok:

Deng Xiaoping’s foreign policy, I would argue, also is his policy towards Hong Kong and domestic policy; it is one of pragmatism. It was pragmatism, you know, we should be prosperous, we should hide our strength and abide our time. Xi Jinping has effectively pushed back, completely turned the tables on his policy towards Hong Kong and his policy, foreign policy. And the reason why, why didn’t they wait for another 10 years before they show their swords? By then we will be toast to that.

I would say that he does not have that kind of time because his personal political agenda that is that he wants to secure a third and fourth term or a lifetime president, okay? So if he just continued with what Hu Jintao and Jiang Zemin did for another decade, he would be pushed out because he would have no basis to say that give me another term and I will really change policy. He needs to change the policy narrative so that he can say to the Chinese people, ‘Look, 120 years ago we were beaten down by the imperial powers. They came and contained us, took away, and split our country. Now that we are strong, now that we are prosperous, look at these guys again. They are at it and trying to contain us, but don’t you worry, you have a strong leader in me, and I am gonna take care and protect the country,’ and that kind of feeds into the narrative that in into everything that he is doing.

I would say that he knows that foreign relationships with a lot of Western countries will be bad, but he played it in such a way that he is using, invoking memories of the century of shame and humiliation that the Chinese people went through and he is saying, ‘look, they are doing it again but don’t you worry, you have got me,’ and that is why he is taking the position he is taking. It is all through a domestic political calculation.

Robert R. Reilly:

Well, I am afraid we are out of time and I want to thank Dennis Kwok and Johnny Patterson for joining us today to discuss the risks of investing in China. I invite our viewers, by the way, to go to the Westminster Institute website and to our YouTube channel where you will find many other programs on China, Russia, the Middle East, and other topics we cover. Thank you for joining us today. I am Robert Reilly, the director of Westminster Institute.