The Chinese crackdown on tech companies

-Penned by Jeevan Joseph and Varnika Gupta

Investors across the globe panicked as the Chinese government and its regulators pushed various tech companies from their enviable heights. Did Communist China finally start living up to its name and initiate a purge against the biggest enemy of communism, the capitalist? Or is there another power struggle that we are missing? This Macroscan explores the impact and motive of Chinese crackdown on tech companies.

THE ROAD TO CAPITALISM

In the early years of the People’s Republic of China(P.R.C.), it never once attempted to challenge the views of its most revered leader, Mao Zedong. Mao was convinced that capitalists and their ideals, if allowed to proliferate in China, would result in a’ restoration of capitalism’. This was the communist party’s primary argument against the adoption of any capitalist policies. Another factor that contributed to P.R.C. closing off many aspects of its trade to the outside world was its reluctance to play to the tune of the arguably capitalist west. The west wasn’t very welcoming either, with many countries recognising the P.R.C. only in the late 1970s.

Enter Deng Xiaoping who was able to give new life to the political and economic philosophy of the communist party. His thought process was radically different from Mao’s entrenched stance against capitalism in all of its forms. Deng was drawn to certain aspects of capitalism like the ‘theory of self interest’ as a tool to motivate the workers. Deng thought that growth could only be attained by adopting such changes. He gave more control to farmers over the plots of land and even allowed them to keep a share of the produce. Policy experts believe that these reforms eventually helped increase productivity and competitiveness of the Chinese economy to a large extent.

The other major area of policy interest for Deng was the industrial and manufacturing sector of China. Earlier, the central government would set the production targets for firms, Deng liberated these firms from the clasp of the central planners in Beijing. Instead, he let the workers and the factory leadership set their targets and rewarded the best performers through central and local schemes. Deng also played an instrumental role in establishing SEZs (Special Economic Zones) that were pivotal in bringing western investment into China. These zones were largely reformed to include free market policies acceptable to the foreign investors. Paired with this initiative was the development of coastal regions, which would become China’s hubs of foreign interaction and investment.

Ever since the Deng Xiaoping era, China has embraced property rights, profits and free market competition. China has recently gone full throttle to ensure that it is no longer seen as a hub for low-cost and low-tech manufacturing. Great emphasis has been put on increasing innovation and becoming a technology leader. China’s tremendously fast pace in catching up with global innovation standards has been truly impressive. The country has increased its research and development spending by roughly 10% each year since 2000.

RECENT INCIDENTS

With so much pro-innovation and capitalist clamour emerging from China, the last thing that one would expect is a crackdown on some of its largest emerging players in the domain of technology. Yet that is exactly what has happened. The first in line to suffer the unexplained wrath of the Chinese government was Alibaba. Its subsidiary, the Ant group, was all set to raise funds to the tune of $34 billion from its highly anticipated initial public offering (IPO). What would have been the world’s most valued IPO didn’t materialize. Jack Ma, a name once synonymous with China’s love for promotion of capitalist enterprises, disappeared from public view following a spat with the country’s regulatory bodies. The company lost an antitrust lawsuit filed by the regulators and had to pay fines amounting to $2.8 billion. The negative clout took Alibaba shares on the New York stock exchange for spin. While it had a pre-controversy share price of $320, the company shares have nearly halved in value to around $180 per share.

Next to suffer a similar fate was Didi Chuxing, a very popular ride hailing Chinese company. Given the nature of its business, Didi had access to a treasure trove of Chinese user data. Chinese regulators did not take kindly to the fact that disclosure requirements of the NYSE would require the company to divulge some of this ‘sensitive data’ with US regulators. Right after it successfully raised $4.4 billion from its NYSE IPO, the company was removed from all Chinese app stores and barred from registering any new users. The charge against Didi was that they were under investigation for “serious violation of rules and regulations in collecting and using personal information.”

Meituan, the Chinese version of Zomato, was a highly successful food delivery app. While Zomato had a fairytale finish to its oversubscribed IPO, Meituan had to suffer a loss of about $40 billion in value. The Chinese State Administration for Market Regulation (SAMR) launched an investigation of suspected monopolistic practice against Meituan. SAMR cited that it was investigating the company’s alleged practice of forcing restaurants to choose its platform over rivals and penalizing those that didn’t list exclusively on Meituan.

Imagine going to sleep as a billionaire and waking up as a millionaire. Though it sounds absurd, the owners of Chinese Edtech giants lived through this very experience. The Chinese regulators put into effect a new list of reform-oriented guidelines, which severely impacted the profitability and scope of the Edtech business in China. Even though we have covered many examples, the list is not comprehensive. Interestingly, even the likes of Tencent were fined in excess of $80,000 for its attempt to dominate the music streaming service in China.

These incidents were a response to the recent announcement by the Chinese Government to a 6 month campaign to regulate internet companies that “disrupt market order, damage consumer rights, or threaten data security.” This was in line with vows made by Beijing’s top leaders in December 2020 to prevent “disorderly expansion of capital” and growth at the expense of the public interest. Total 34 homegrown champions from various sectors ranging from fintechs, ecommerce, edtech, ride sharing and social media sectors found themselves in the crosshairs of the Beijing regulators.

IMPACT ON THE FINANCIAL MARKET

The funds raised by the Chinese companies have grown by leaps and bounds over the years, having a total value of more than $ US 2 trillion at present. China’s recent crackdown on the big giants have blindsighted many foreign investors, costing them more than $US 1 trillion of losses this year. In addition, it may have also threatened China’s access to international markets, especially the US. According to Bloomberg Chinese companies have raised nearly $US16 billion of equity in the US so far this year, with another 70 planned IPOs in the pipeline.

This overnight change of the broader picture by the Chinese authorities, with little to no regard for the Chinese companies and the investors, is a cause of concern for the security regulators around the world having Chinese companies listed on their boards. The lack of explicit decrees and framework to assess regulatory changes, have in a way made these companies “uninvestable”. It is predicted that in the future, the variable interest entities(VIE) used by Chinese companies as offshore entities used to get around the foreign investment rules used in China, can also come under the radar of the Sino authorities. The Nasdaq Golden Dragon China Index, which tracks 98 of China’s biggest firms listed in the United States, has plunged about 20 percent over the last week of July, its biggest such drop on record. Except the Edtech sector, whose share rose by at least 10%, all the other sectors were deeply affected. Below is the impact of the recent ongoing actions by the Chinese authorities on the market.

Responding to the intensified crackdown by Beijing, the US Security and Exchange Commission (SEC) has asked the 248 Chinese companies listed in the US markets to provide additional disclosures. This move may hamper China’s attempt to liberalise its financial markets and attract foreign capital and expertise to quite immature markets by cutting off the flow of external capital.

SOME LIKELY EXPLANATIONS

Many believe the crackdown is a way for the CCP to establish itself above the tech giants and reassert its power. However there are many things that seem to be going on beneath the surface. Many analysts including Will Oremus of Washington Post say “China is doing what the US isn’t able to – control its tech giants”. There are many explanations put forth by the analysts to make sense of the sudden intensification of crackdowns.

Li Chen, the chief economist at Soochow Securities, said China’s national policy has “abandoned the American road” in favor of the “German road.” It is reported that the Chinese government wants it to be heavy on manufacturing and hard tech – semiconductor, batteries etc., and light on the consumer internet.

There is also an explanation that Chinese agencies may be engaging in turf wars to expand their influence. Since Xi’s tenure, many agencies have come and gone, depending on their strategic value and through turf wars they try to come in limelight and gain brownie points from President Xi.

Lastly, the government is trying to establish a status quo as Chinese citizens seem to have been disappointed with CCP over the high cost of housing and education. Public discontent is reflected with popular terms like “involution”, referring to life’s meaningless rat race, being used on social media. Responding to the concerns of the public, the Government clamped down on apps like Meituan, Yuanfudao by citing exorbitant education costs and financial risks.

In the end we realise the difference between American and Chinese markets with China much more willing to sacrifice the investor interest to achieve State priority. Future of Chinese tech companies and the impending rules and regulations by Beijing are yet to be seen. But this incident is sure to deter the investors from investing their hard earned money in Chinese firms.

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