China’s Tech Sector Is in Trouble

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China’s Tech Sector Is in Trouble

Chinese tech workers are stuck in the cold as relations with the US freeze.

China’s Tech Sector Is in Trouble

Workers use their laptops near a display showing sales data at the command center at the headquarters of e-commerce retailer JD.com in Beijing, Nov. 11, 2018.

Credit: AP Photo/Mark Schiefelbein

Perched precariously atop electric motorbikes, swarms of e-commerce couriers zip through China’s cities. For upwards of 10 hours each day, they race to deliver packages and hot meals. In high-rise office buildings, tech-company programmers are toiling just as hard. Coding frantically to meet a deadline, they hunch over keyboards well into the night.

Although they pull long hours, these workers are the lucky ones. At least they have jobs. Amid a protracted slump in China’s once white-hot tech sector, tech firms are resorting to layoffs and hiring freezes. Many thousands of young college graduates and blue-collar workers, who used to count on tech-sector employment, are now scrambling to find work.

Just two years ago, the rise of China’s tech sector (often termed its “new economy”) looked unstoppable. Between 2014 and 2017, Chinese telecommunications giant Huawei doubled its revenue, and a whopping 34 Chinese tech startups topped $1 billion valuations. By one forecast, the new economy was on track to create over 1 million jobs annually. But today, the once-prolific sector has reversed course: startups and tech giants alike have been reeling the past year. In the last quarter of 2018, WeChat owner Tencent saw net income fall by a third, and e-commerce giant JD.com lost $700 million. Alibaba forecasts that, this year, its sales will drop over 20 percent. And across publicly listed technology, media, and telecommunications (TMT) companies, last year’s earnings dropped 140 percent from 2017 — a larger plunge than any other Chinese sector.

What is going wrong? Since 2017, a volatile blend of political, economic, and social pressures have plagued new economy firms—and, therefore, new economy workers. However, one major driving force of China’s tech-sector turmoil, which has compounded these other headwinds, is the past year of conflict in the U.S.-China relationship. In particular, the ongoing trade war and disputes over data security and intellectual property have slashed profits, scared off investors, and created new operational risks for Chinese tech firms.

The faltering of China’s new economy also carries significant social consequences: worker suffering, simmering social unrest, and crackdowns on dissent from Beijing. Looking at this broader picture, it becomes clear that recent U.S. policies have done more to China than threaten Huawei’s bottom line. They are fanning the flames of broader social pressures — which, in turn, push Beijing to take steps that widen the growing rift between the U.S. and Chinese tech spaces.

International Disputes With Domestic Consequences

Had U.S. relations not come under strain, China’s new economy might still be slumping. Lately, new policies from Beijing have cooled the sector, including private sector subsidy cuts, crackdowns on risky lending, and increased regulation. Company-specific scandals have also impaired several firms. Yet doubtless, the latest developments in U.S.-China relations have made the trouble facing Chinese tech far graver.

So far, the biggest headwind has been the U.S.-China trade war. Tariffs have weighed on Chinese tech through a few different channels — each of which has affected new economy firms disproportionately among Chinese companies. First, tariffs slow exports to America, eating into firms’ revenues. Many new economy firms are particularly vulnerable to falling U.S. sales — for Chinese companies on the MSCI stock index, the information-technology sector derives a higher percentage of revenue from the United States than any other sector. Second, China’s retaliatory tariffs cause the new economy outsize pain. Sourcing many technology inputs from outside the U.S. is difficult — as telecommunications giant ZTE learned when a U.S. export ban forced it to shut down last year — so tech firms using U.S. components have seen costs skyrocket.

Perhaps worse, the trade war has hemorrhaged tech firms’ domestic revenues. Tariffs squeeze the incomes of all Chinese companies and consumers, which has triggered a cycle of falling domestic spending that slows the whole economy. By all indications, this broader downturn is severe. Already, Chinese retail sales growth has plunged to a 16-year low, and the IMF forecasts that, this year, tariffs could slash China’s GDP growth by a staggering 1.6 percentage points. This, too, harms new economy firms disproportionately. E-commerce firms suffer more than most since retail sales closely track the economy’s boom-bust cycle. Furthermore, the new economy’s rapid rise itself leaves it ill equipped for today’s slowdown. In 2017, as investors poured into Chinese tech at breakneck speeds, many companies used new cash to expand operational capacities beyond what they can easily sustain during recession.

But beyond the trade war, other U.S.-China disputes have cast a pall on internet-based firms. Chinese tech leaders today worry that the United States is more willing than ever to retaliate against Chinese companies it considers threatening, economically or politically. Recent events justify these concerns. Last year, in two separate incidents, Washington arranged the arrest of Huawei’s chief financial officer and fined ZTE $1 billion, after each company violated American sanctions on Iran. Even more strikingly, in May, espionage concerns led the United States to place Huawei and a handful of other Chinese tech firms on an export ban list (though it has since relaxed these measures).

Such U.S. retaliation can prove devastating. ZTE was China’s second-least profitable company last year in part because of the $1 billion it paid the United States. And because it relies on U.S. parts, Huawei estimated that a U.S. export ban, if maintained, would cost it $30 billion this year and next. So, while most Chinese internet companies have yet to suffer America’s wrath directly, fears that the scope of U.S. retaliation may broaden have caused many firms to contract. Last summer, Alibaba cited political tensions as a reason for canceling plans to enter the U.S. cloud-data market. More generally, investment bankers in China cite these tensions as factors pushing Chinese tech firms to delay initial public offerings and capital expenditures.

Making things worse, all these developments in U.S.-China relations have caused investors (particularly foreign ones) to pull back. Internet firms, once awash with capital, are seeing funding dry up. Last year, renminbi-denominated private-equity fundraising plummeted to just $11 billion from $31 billion in 2016, and final quarter venture capital deals shrank 25 percent year-over-year. “It’s become very hard to raise money” for startups, as one Beijing-based founder put it. “That’s a fact.”

Investor skittishness may not compromise the operations of China’s largest tech players, but there are signs it is crippling, or killing, smaller firms. Even for startups that do obtain financing, valuations are typically half what they would have been a year ago. Anecdotally, cash-flow problems have caused startups to break leases since last fall. Start-up failures even led Tencent’s investment arm to write down its portfolio’s value by an unprecedented $2.6 billion in March.

Overworked and Unwanted

The implications of these headwinds, however, extend beyond dipping tech revenues. The social consequences, too, have been widespread and acute.

As internet firms feel the chill creep into their bottom lines, corporate leaders are leaving workers out in the cold. Companies like JD.com, Meituan Dianping, and Didi Chuxing are cutting large swathes of their workforces and reneging on contracts for recent graduates. One survey found tech job openings down 51 percent from the year before — compared to an economy-wide decline of 27 percent. And managers across tech firms have circulated memos making clear that, in the face of the ongoing turmoil, they expect longer hours from employees.

Now, simmering tensions are reaching a fever pitch in the new economy. Those who have kept their jobs are overworked and underpaid; those seeking jobs are frustrated and restless. Both groups have had enough.

First, workers are pushing back against managers’ attempts to cut costs and squeeze more out of employees. The clearest example of such pushback is the “anti-996” movement, which protests the 9 a.m.-to-9 p.m., six-days-per-week work schedule that has become the tech-industry standard. Once, the “996” culture symbolized a rite of passage for China’s ambitious young programmers; now, as wages and benefits dwindle, it has now become a rallying point for a restive workforce. Last month, when an anonymous activist launched an anti-996 protest project on Github, it quickly became the site’s most bookmarked project, garnering hundreds of thousands of followers. Prominent companies “blacklisted” for unhealthy cultures and labor law violations include Alibaba, JD.com, Huawei, and Bytedance.

China’s gig economy workers are also dissatisfied. Gig economy workers form the backbone of China’s e-commerce and express food delivery industries. However, they lack formal labor contracts, have limited access to basic social insurances, and put in long hours with little pay. (The typical driver for Didi nets only about $17 for 10.5 hours of driving.) In response to lower salaries and increasingly demanding delivery times, couriers and warehouse workers are taking to the streets. According to China Labor Bulletin, about half of all protests in 2019 have occurred in the service, retail, and transportation industries, which are now heavily dominated by internet companies. In some cases, these protests seriously disrupt normal business operations.

Going forward, unemployed tech workers, as well as the jobless populations who used to count on finding tech-sector work, will be another source of social discontent. Recently, for China’s 8 million annual college graduates, programming or tech-firm management jobs were coveted opportunities. The tech sector also represented a new beginning for displaced wage laborers –including 33 million former manufacturing workers who found new economy jobs as couriers, warehouse workers, or security guards since 2015. Today, tech firms can no longer absorb these workers at the same rate.

Carrots and Sticks

Surging unemployment and activism in tech have caught the attention of China’s leadership. In July 2018, China’s Politburo ranked “stabilizing employment” as the primary objective among their six “stabilizing” goals. This May, Premier Li Keqiang demanded that all party cadres make job creation their top priority, particularly for recent college graduates, veterans, and migrant workers — some of those most hurt by the tech slowdown. Government authorities, therefore, are responding to these challenges with a combination of carrots and sticks. On one hand, officials are launching a fierce, systematic crackdown on labor unrest; on the other, they are using financial incentives for workers and companies to alleviate employment pressures.

This year, arrests of workers, students, journalists, and labor rights activists are on the rise. In January, at least five labor rights activists were arrested in Hunan and Guangdong provinces for “disturbing public order.” In March, several employees of a labor rights media site in Guangdong were detained on the same charges. In May, police in Beijing, Guangzhou, and Shenzhen raided migrant labor advocacy NGO offices and arrested at least three more people. All told, in the past year, authorities have jailed or “disappeared” more than 150 people involved in labor activism — a marked increase from years past.

Simultaneously, local and central authorities are fast-tracking financial aid to foundering tech firms and laid-off workers. Last month, President Xi Jinping announced a slew of new subsidies and tax breaks specific to tech companies. Furthermore, compelled by the tech sector’s grim outlook, Beijing recently allocated almost $15 billion to retrain millions of workers and place them in new jobs. The government is also reimbursing half of companies’ required insurance payments if they refrain from jobs cuts this year.

The Way Forward

What lies ahead for China’s new economy? Despite recent movement toward resuming trade talks, the United States and China are far from resolving their disputes in trade or other arenas — a state of affairs that will exacerbate frictions facing Chinese tech. In the short term, this suggests Beijing will continue its carrot-and-stick approach. Authorities will further tighten crackdowns on unrest, while also accelerating “state capitalist” policies, such as subsidy provision and tax incentives, to keep new economy firms afloat.

But the long term may hold farther-reaching consequences. The new economy’s role in absorbing millions of laborers puts pressure on Beijing to safeguard the sector and insulate it from future shocks. For Chinese leadership, this will likely mean expanding government control over the new economy and decreasing its interdependence with the West — so that trade wars or foreign government vindictiveness cannot upend such a socially significant sector.

To be sure, China was working to promote domestic innovation and self-reliance in tech long before Trump launched his trade war or blacklisted Huawei. Xi’s “Made in China 2025” initiative, for instance, touts self-reliance as a critical goal throughout the economy. However, the past year’s developments in the U.S.-China relationship will expedite the decoupling process. Strong social pressures at home, and not just geopolitical ambition, are pushing Beijing to embark on the path to a “tech Cold War.”

Viola Rothschild is a research associate in China studies at the Council on Foreign Relations.

Benjamin Della Rocca is an analyst in Geoeconomic studies at the Council.