Saturday, August 21, 2021

[FNF] More than a Tech Crackdown, It’s Farewell to China’s Economic Reform

It started with China’s Big Tech sector – and continues throughout all other sectors. This crackdown clearly focusses on the private sector, and chimes in the end of Deng Xiao Ping’s Economic Reforms that helped to turn China into the economic powerhouse it is today. The resulting disruption on China’s economy, the nation’s innovative drive and its private firms may become ultimately a price too high to pay analyses Charles Mok for

Less than two months into the crackdown season on China’s tech sector, starting with the sanctions and investigations targeted against Didi Chuxing on July 2, two days after the U.S. initial public offering of its parent Didi Global, the ferocity of the campaign has only intensified, with its scope widened to more and more sectors, with no end in sight.

What was initially perceived by the media and the public as a campaign against Big Tech had turned out to be much more than that. Surely many leading tech companies were involved, going back to the “first blood” with Ant Financial’s forced cancellation of its IPO in Hong Kong in November 2020, to Didi Chuxing, and spreading to other giants like Tencent, then onward to many other sectors, through multiple legal and administrative means.

The crackdown is rolling on, leaving no sector untouched?

Here are some examples of recent actions against a wide range of sectors:

- Social media: The Haidian People’s Procuratorate, in an administrative district in the city of Beijing, filed a public interest lawsuit against Tencent, alleging the “youth mode” of its WeChat social media platform failed to comply with laws to protect minors.

- Online games: Singling out Tencent and its popular online game Honor of Kings, state-owned newspaper Economic Information Daily published an article criticising electronic games as “electronic drugs” and “spiritual opium,” only to remove that article from its website shortly afterwards.

- Online music: Tencent Music Entertainment Group’s plan to for a US$5 billion IPO in 2021 will be halted, even though the plan was for a listing in Hong Kong, not the U.S. This came after its chief Chinese competitor, Netease’s Cloud Village, also decided to delay its Hong Kong IPO for US$1 billion.

- Online streaming: The National Radio and Television Administration, the country’s media regulator, launched a month-long review on online variety shows, cracking down on their “rampant commercialization,” hypes and extreme behaviors from idol-worshipping fans, by targeting online streaming platforms owned by Tencent and iQIYI. Separately but along the same line, the Cyberspace Administration of China removed 150,000 pieces of “harmful online content” and punished more than 4,000 fan club related online accounts, leading to the shutdown of some social media services such as Weibo’s “Star Power Ranking List,” and many fan clubs themselves. In addition, the Ministry of Commerce initiated a consultation on further regulations for the online streaming e-commerce platforms to prevent frauds or inaccurate product claims, so as to better protect consumers.

- Karaoke: The Ministry of Culture and Tourism issued a directive to establish a national karaoke content screening mechanism to censor certain musical content that might be deemed to be against national unity, racial harmony, national religious policies, or concerning other illegal activities. This new system will be effective by October 1 this year.

- Ride-hailing: Didi Chuxing’s troubles in China is far from over, besides the ongoing investigation of its U.S. IPO. It is facing numerous investigations from all government levels, on concerns ranging from the vetting of drivers to vehicle safety and local licensing. The latest order concerning all ride-hailing platforms is a review of the industry’s pricing, commission setting, and employment practices, to better protect the wellbeing of the consumers and the drivers, in a multi-departmental effort led by the Ministry of Transport.

- Education: After the State Council and the Chinese Communist Party issued a statement on July 24 requiring education companies to become nonprofit organizations, forbidding them from raising capitals or going public, it thereby effectively terminated a vibrant business sector that included large enterprises such as TAL Education Group, New Oriental Education & Technology Group, that combined for over US$126 billion in market capitalization on domestic and foreign exchanges. Wall Street English, an Italian company specializing in English training, reportedly would announce the bankruptcy of its Chinese branch, becoming the first casualty of the crackdown on the education sector. Also, the city of Shanghai announced that it would no longer require local primary schools to administer final exams for English from the third to fifth grade, leaving only Chinese and mathematics as compulsory subjects.

- Food Delivery: The Administration for Market Regulation (SAMR), the country’s anti-trust regulator, is said to be ready to impose a US$1 billion fine on Meituan, an online marketplace for restaurants and the largest food-delivery provider, for abuse of its dominant market position.

- Property: The SAMR initiated a review of a general offer by Blackstone Group, a U.S. private equity firm, for the control of SOHO China, China’s largest prime office property developer — a deal worth over US$3 billion. Although this review is a necessary legal step in the takeover process, the market is mindful of the effect of the SMAR’s strict enforcement of the anti-trust law on its decision in this case, at this point in time.

Insurance: The China Banking and Insurance Regulatory Commission (CBIRC) issued instructions to order insurance companies to review any of its “improper marketing and pricing practices” as well as its customer privacy protection, or risk facing “serious punishment.”

- From all these examples, it can be observed that despite the picture being painted by the media and the public of a “tech crackdown” — due to the high-profiled attention on the cases involving Ant Financial and Didi Chuxing — it is indeed much more than that. The commonalties among those sectors being targeted appear to be, first, those which may gather substantial customer data; second, those with an ideological influence on the public, especially the younger generation, and their values; and, third, those that are prone to be dominated by a small number of influential market players.

No part of government wants to be left behind

These regulatory actions will certainly continue in the near future and even escalate in their force and expand in their scope. The State Council along with the Chinese Communist Party’s Central Committee just jointly published a blueprint document to call on the government at all levels to “improve and enhance anti-monopoly law enforcement” in its upcoming Five Years Plan for 2021 to 2025. The SAMR also issued a set of draft regulations on August 17 for consultation that would further strengthen rules against unfair competition, illicit trade practices, and restricting misuse of customer data.

In additional to the Data Security Law (DSL), which will go into effect by September, a new Personal Information Protection Law (PIPL), now in the third review stage at the Legislative Affairs Commission of the People’s National Congress Standing Committee, is expected to be launched in China in 2021. Provisions will be included to halt practices such as mobile apps that collect excessive personal data, algorithmic discrimination that involves differential and unfair pricing, and so on.

Not to be outdone, in addition to the cross-sectoral regulators on competition, securities, online services, data and privacy, many other government agencies are getting in the act. In addition to those mentioned above, such as the media regulator and the ministry for culture, transport, commerce, etc., the Ministry of Industry and Information Technology (MIIT) also announced a six-month probe to gather violations over “improper antitrust and consumer protection practices.” As part of that effort, the MIIT just announced a directive ordering 43 mobile apps, including Tencent’s WeChat and video app, iQIYI’s streaming app, Ctrip’s travel booking app etc., to rectify their illegal use of users’ phone book and locational data, as well as the use of pop-up windows that caused user annoyance. Such micro-managing of apps and services from a wide range of sectors, based on relatively broad but vaguely defined principles with tough enforcement power vested to the authorities, is increasingly the norm in China. 

Such a pervasive campaign will be difficult to coordinate. Overlapping investigations and enforcements with unclear demarcation of jurisdiction will result in unintended and undesirable consequences, adding to the overall market confusion. Other potential pitfalls may also include higher than necessary costs of compliance by firms, thereby undermining their competitiveness and innovativeness, with potentially irreversible consequences.

Ideological control is paramount

Let’s go back to the most basic question: why do the Chinese government and the Chinese Communist Party have to do all this now?

To be fair, many of these big tech titans do have a lot of problems with their trade practices, monopolistic behaviors, unchecked use of customer data and so on. However, part of that comes from a lack of clearly defined regulations to follow, and a general atmosphere of “experiment first, regulate later” which was arguably condoned and even encouraged by the authorities and regulators themselves. Indeed, it was not too long ago when the unbridled use of data in China by online firms was celebrated as a competitive advantage in developing artificial intelligence applications and data science over the west, where the use of such data had been regulated more stridently.

And it is also true that the big tech companies in China, with their rapid and unrestrained growth toward domination in the last couple of decades, have come to develop the kind of corporate cultures that can only be described as arrogant and misogynist, and the work ethics demanded of their employees is increasingly seen as unconscionably excessive. In recent years, public sentiments quickly turned against these tech billionaires, many of whom were admired as idols of success even up to a couple of years ago. This change in the mass mentality in China is especially evident under the unpredictable economic outlook in China now, due to slowing growth and the uncertainties and changes brought on by COVID-19.

It is therefore not surprising that Chinese President Xi Jinping has found this populist cause to “rein in the big tech” as both timely and right on the spot. With the relentless campaign to right the wrongs of the private industry, in order to protect the interests of the consumers, the welfare of the workers, the wellbeing of the children (against the exam cram culture and excessive online gaming), all the right chords are struck for the paternal state, allowing the Party a chance to impose further ideological control by rectifying education in a outwardly most benevolent manner, and to regain the economic control over its richest private firms and individuals after a couple of decades of runaway “get rich” capitalism.

Unexpected allies for Xi -but for how long?

And it is here where Xi seems to have also found an unexpected ally in the Chinese youth: In a period of slower economic growth, social uncertainty and more global isolation for China, the public and especially the young are increasingly frustrated with issues such as workers’ rights as well as educational and economic inequities. So when the government comes in to “get tough on the businesses,” it becomes music to the ears of the people. However, for such populist campaigns to be sustainable and not just a diversion of attention, the economic and social issues must be handled with positive results. More opportunities and jobs must be created, which may be an even bigger challenge now that the private sector is under strict scrutiny and may not be as entrepreneurial and risk-taking as before. Consequentially, hirings will slow.

Likewise, it is equally doubtful how sustainable the young people’s support for the authorities’ control over online game content and playing time, as another example, would also be in the long run quite doubtful, to say the least. While many parents may dislike the cram exam culture, it is also many of these and other parents who send their children to tutoring in order to score well in public exams in order to get into one of the top universities. In the end, it is the government itself that runs the public examinations and controls all the universities, and ultimately, builds the economy that may create the good jobs. Blaming the current problems on the cram schools can only go so far.

Most recently, Xi even started to openly advocate for “common prosperity,” seen as a call to return to the communist philosophy for a redistribution of wealth in Chinese society, when he spoke at the 10th meeting of the Central Committee for Financial and Economic Affairs, a top-level strategy body that he chaired. Calling for the need to “strengthen the regulation and adjustment of high income, protect legal income, reasonably adjust excessive income, and encourage high-income groups and enterprises to give back to society more,” Xi did insist that this was not “equal distribution.” As populist and attractive as it may sound to the masses, it is still uncertain how such a strategy will be welcomed by the people who have had a taste of capitalism in the last several decades. Beyond the populism and nationalist zeal, it will be a great challenge for Xi’s regime to sustain China’s success in continuously improving the economic wellbeing of all levels of society, especially the new middle class.

Under Xi Jinping, the slogan and gradual revision toward 國進民退 (“the state enterprises advance, the private sectors retreat”) has gained huge ground over the previous reformist emphases on market liberalization and entrepreneurship.

Economic control on capital with central planning and digital service restructuring

Besides ideology, the current campaign also serves to allow authorities to regain the total control of the economic structure of the country. In many ways, it symbolizes a reversal of the “capitalism with communist characteristics” formula and economic reform strategy of the past more than forty years, brought forward by the late Deng Xiaoping. Under Xi Jinping, the slogan and gradual revision toward 國進民退 (“the state enterprises advance, the private sectors retreat”) has gained huge ground over the previous reformist emphases on market liberalization and entrepreneurship.

Critical to Xi’s economic philosophy is the central economic planning for all key sectors in China. Thereby, the government is taking back control from the rich and influential tycoons and their webs of connections and circles of influence developed in the last several decades. This particularly relates to those making their fortunes from the Internet and technology sector mostly through domestic and international public listings. Coupled with the trend in the U.S. to adopt securities and other legislations to enforce financial and customer data disclosure over foreign companies listed in the U.S., the Chinese government is understandably increasingly wary of such foreign investments and listings. The central government’s narrative to “contain disorderly expansion of capital” since late 2020, later documented into a policy goal in early 2021, is evidently a move to limit China’s perceived exposure from such capital exercises undertaken by the red hot China tech sector with great speed and scale.

Also, the central government is clearly working toward redefining the Chinese industry through more central planning. The previously heavily promoted strategy initiative of “Made in China 2025,” issued since 2015, unfortunately had to confront a hostile U.S. president Donald Trump from 2016 to 2020 and his “trade war,” ending up largely under-achieving. With the emerging and likely protracted “technology war” between China and the U.S., China can be expected to refocus its effort on high technology manufacturing, especially in the areas of semiconductors, electronics and other key technology components, as well as research and development in critical scientific fields such as advanced artificial intelligence and quantum computing.

One of the possibly welcome side effects of the current campaign may be the redirection of the nation’s collective efforts and manpower toward these critical technology areas and deep sciences, away from the “digital economy” type of service-oriented business models that dominated both investments and manpower consumption in the past twenty years, while creating a host of problems in consumer interests, privacy, and monopolistic trade practices.

Such an industry redirection strategy may be laudable, but its success is not guaranteed. Over the last several decades, the Chinese semiconductor and electronics sector has continued to lag behind competitors from the west as well as Taiwan and Korea in the higher end of the market. Those sectors in China had already been receiving massive state support and subsidies. Yet, they domestically still lagged behind the private digital economy and service sector, led by private companies and entrepreneurs, in terms of investments, financial returns or even the number of jobs created. Most certainly, reining in commercially successfully companies in some sectors will not necessarily make companies in other laggard sectors more likely to succeed because of central planning, which did not work well before anyway.

For those digital economy and service sector companies, which have built some of the most successful and prevalent platforms around the world, such as AliPay and WeChat, in addition to the current regulatory campaigns of which they are the targets, the central government will gradually aim to redefine the marketplace structure to be dictated and led by the government. An example is the central bank digital currency (CBDC) development in China, widely regarded as the global leader, where the commercial e-wallets and payment service providers will be greatly diminished to a secondary and supporting role, as the core transactions and data will be largely controlled by state-owned player, in this case the People’s Bank of China. It is not inconceivable that the central government will try to replicate such marketplace restructuring to maximize its stranglehold on private firms in other digital service verticals.

It’s easy to start a fire, but hard to put one out

Moreover, other administrative measures to ensure further control over private firms are also taking shape. Recent reports indicated that Bytedance, the Chinese owner of TikTok, had sold 1% of its stake to a state-owned firm which is owned by the Cyberspace Administration of China plus two other government agencies, thus allowing the government to effectively appoint a representative on its board. Such tactics are not entirely new, but they are likely to become more common.

So does that mean that the “gold rush” days of China tech investment is over? Very likely: yes. At the very least, things will never be the same again. Since July, global investors have lost billions in stocks from many of these Chinese tech players, from newly-listed Didi Global to those already listed before in the U.S., in Hong Kong, and even domestically in China’s exchanges. Softbank, a leading investor in many Chinese tech players, including Alibaba, Tencent as well as Didi, recently admitted that it would “significantly cut back” its investments in China amidst the current uncertainties. Richard MacGregor, a senior fellow at Lowy Institute in Sydney, even bluntly stated that “Xi has many priorities. Building socialism is at the top of the list. Helping foreign investors is not.”

Finally, the biggest risk factor of all may just be that the current campaign will turn into a runaway train, whose engine is easily revved up but much harder to stop. This risk is exacerbated by the involvement of so many government ministries, regulators and agencies getting in the act and intuitively trying to outdo one another, in addition to the difficulties in coordination and the concerns of unexpected side effects. It’s always much easier to start a fire than to put it out. If that happens, the disruption on China’s economy, the nation’s innovative drive and its private firms may become a price too high to pay.

Published: Friedrich Naumann Foundation, Aug 20 2021 


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