China’s Tech Crackdown Could Give It an Edge

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China’s Tech Crackdown Could Give It an Edge

Analysts abroad assume China’s new regulations and restrictions on tech giants will destroy the industry. On the contrary, this is achieving several key goals for Beijing.

China’s Tech Crackdown Could Give It an Edge

In this May 14, 2020, file photo, employees wearing protective equipment work at a semiconductor production facility for Renesas Electronics during a government organized tour for journalists in Beijing.

Credit: AP Photo/Mark Schiefelbein, File

The consensus view in the United States is that China is shooting itself in the foot by cracking down on its largest tech companies. From the disappearance of Jack Ma, founder of the retail giant Alibaba, to escalating fines and regulations targeting social media juggernauts Tencent and ByteDance, pundits claim that no company is safe from Xi Jinping’s wrath. This narrative validates the convictions of some who believe that Chinese leader Xi Jinping is a Leninist ideologue who wants nothing more than a reversion to Mao-era state-led socialism. Investors have run for the hills, obliterating $1.5 trillion of value from China’s tech industry.

But a closer look at the policies enacted and the companies targeted during the crackdown reveals that these measures may advance China’s interests as well as Xi’s. Recent Chinese regulations on data protection, cybersecurity, and anti-competitive practices benefit consumers and advantage domestic firms by reducing competition from foreign firms that cannot comply. Curtailing investment in cryptocurrency and EdTech redirects capital into producing microprocessors. Anti-monopoly rules make the Chinese market more difficult for tech giants to dominate, forcing them to expand their footprints abroad. Although these policies have been carried out haphazardly, the idea that the world’s largest economy is self-immolating for no good reason warrants skepticism.

The Beijing Effect

New regulatory regimes in major markets often have spillover effects that influence the behavior of firms in the rest of the world. For example, in what was dubbed “the Brussels Effect,” firms all over the world rushed to comply with the European Union’s General Data Protection Regulation (GDPR) in order to retain access to the European market. Since the adoption of GDPR in 2016, companies have instituted protocols for handling data breaches, designated data protection officers, and established thorough privacy policies. In the United States alone, 80 percent of large companies spent $1 million or more on GDPR compliance.

China, like Europe, is too big of a market for most companies to eschew altogether, meaning they have to play by the government’s rules. Last year, Beijing enacted a wide array of new regulations, including its Personal Information Protection Law, Data Security Law, and anti-monopoly rules targeting tech. Many of the provisions in the Personal Information Protection Law were taken directly from GDPR, though China’s fines for companies are even greater. These new measures have created an analogous “Beijing Effect,” whereby firms change their practices in order to conform with Chinese law.

Significantly, the Personal Information Protection Law resembles GDPR in that it applies extraterritorially, meaning that companies with no presence in China may also have to overhaul their business practices in order to work with Chinese companies. In this way, China has leveraged its tech crackdown to rewrite the global economic rules of the road. These regulations redound to China’s geopolitical benefit as they allow Beijing to demand more data from foreign firms, limit the outflow of data on Chinese citizens, and shape business practices in other countries to Beijing’s liking.

These new laws could give China more leverage to extract concessions from foreign firms. In December 2021, leaked internal Apple documents revealed that CEO Tim Cook signed a 2016 agreement with the Chinese government in which he pledged to increase Apple’s spending in China by $275 billion to avoid regulatory scrutiny. When negotiating future agreements, Beijing’s new privacy and data security laws could give it political cover to coerce foreign firms.

Anti-monopoly rules will likely create a more competitive and innovative Chinese tech ecosystem. Technology giants dominate China’s economy, making up 40 percent of all large companies in China. They acquire competitors, steal intellectual property from vendors, and dominate new sectors like the metaverse with ease. China’s new policies to limit the ability of a few companies to accumulate ever more market share will force incumbents to compete with upstarts by improving their products rather than buying out competitors.

Investors have nevertheless decried China’s excessive enforcement of such rules on certain companies. Firms like food delivery giant Meituan may never fully recover after brutal regulatory enforcement actions caused them to lose more than half their value in a single year. However, foreign investors continue to spend big in China. Foreign venture capital funding soared in 2021, nearing a record set in 2018. When combined with domestic venture capital funding, 2021 was a record year in which Chinese tech companies raised $130 billion from VCs, 50 percent more than the prior year.

Cracking Down on Whom?

Most commentary on Beijing’s tech crackdown emphasizes its unprecedented speed and severity. It is also worth examining which Chinese firms have been targeted and which have not.

The first notable feature of the Chinese firms that have been reprimanded is that they are almost exclusively software companies. Of the major Chinese technology firms that have been penalized in the crackdown, 95 percent are software companies and only 5 percent focus primarily on building hardware.

This is in line with China’s broader strategy to become self-sufficient in strategic technologies. China’s latest five-year economic plan emphasizes “technology self-reliance” with a focus on robotics, semiconductors, and electric vehicles. Xi Jinping articulated the rationale for the plan succinctly: “Our dependence on core technology is the biggest hidden trouble for us… Heavy dependence on imported core technology is like building our house on top of someone else’s walls: No matter how big and how beautiful it is, it won’t remain standing during a storm.”

This viewpoint also illustrates Beijing’s calculus when imposing burdensome regulations that alarm foreign firms. If firms exit the Chinese market because of the risk of being singled out, that void can be filled by a domestic supplier backed by state-owned lenders.

Manufacturing advanced technological hardware like cutting-edge semiconductors requires tens of billions of dollars of investment, years of construction, and recruiting some of the world’s brightest scientists. Building a single factory to fabricate advanced semiconductors costs $20 billion, 50 percent more than the most expensive aircraft carrier. By comparison, creating a leading software company is relatively cheap. Chinese software companies can use cutting edge machine learning models that scientists around the world have developed and made open source. When combined with China’s vast stores of detailed data on its citizens, these models can quickly be trained to create novel applications.

China is still far behind the U.S. and other countries in semiconductors, aerospace, and life sciences, motivating Beijing to pursue breakthroughs in hardware rather than growing its world-class software firms. Investment in private Chinese startups reached an all-time high in 2021, driven by increased funding for firms that build semiconductors and biotechnology; conversely, funding for EdTech fell threefold year-over-year. Venture funding for biotechnology in China has increased tenfold in the last five years, whereas investment in Chinese e-commerce firms has fallen 40 percent from its peak in 2014.

The U.S. business community has taken notice. In February 2022, the U.S. Chamber of Commerce argued that China’s regulatory crackdown gives it an economic advantage over the United States by “reorienting capital and talent away from consumer-oriented, social media and digital-economy technology companies to strategic technology industries such as semiconductors, electronics, technology, batteries, biotechnology, and telecommunications infrastructure.”

It is also worth noting that small- and medium-sized companies have largely been exempt from China’s tech crackdown. Of the major hardware companies that have been sanctioned, 93 percent operate platforms that provide them with enormous scale. Additionally, Beijing has increased its financial support for small firms. In 2018, the Ministry of Industry and Information Technology set a goal of creating 600 “Little Giants” – state-backed startups focused on strategic technologies such as advanced machinery, electrical equipment, and computing. Today, China has backed 4,500 such companies and aims to create another 5,000 in the next three years.

A Slight Dip in an Exponential Curve

These tectonic policy shifts have not been carried out seamlessly or innocently. The crackdown has been heavy handed, as evidenced by a record-breaking $2.8 billion fine on Alibaba for anti-competitive behavior. This has sparked rebukes from senior CCP officials such as Vice Premier Liu He, China’s top economic policymaker, who recently called on regulators to be “standardized, transparent and predictable,” to complete major enforcement actions “as soon as possible,” and to “release policies favorable to markets.”

By contrast, regulatory agencies such as the Cyberspace Administration of China and the State Administration for Market Regulation have leapt at the opportunity to seize political power by pummeling Big Tech. In doing so, they have furthered some of the government’s wider goals: By reducing the power of technology giants, the Chinese government kneecaps nonstate centers of power.

Regulators have not doomed Chinese firms to bankruptcy, however. For example, Beijing has pushed its technology giants to grow overseas rather than overabsorbing capital at home. In January 2022, the National Development and Reform Commission released new guidance compelling regulators to encourage platform-based companies to “promote digital products and services to ‘go global,’ enhance their international development capabilities, and enhance their international competitiveness.”

The campaign to internationalize Chinese firms appears to have succeeded. In 2021, Tencent went on a “shopping spree” in Europe to avoid scrutiny from U.S. and Chinese regulators. Ride hailing giant DiDi is successfully competing with Uber in 9 countries across Latin America as well as in South Africa and Nigeria. Although ByteDance has been penalized at home, TikTok surpassed Google as the world’s most visited site last year.

Domestically, China’s new regulations will have tangible economic benefits in the near term. Requiring firms to report data breaches will improve Chinese cybersecurity and protect intellectual property. Rules outlawing scams, false advertising, and misleading promotions have helped prevent cybercrime against Chinese consumers. According to Ranking Digital Rights, these changes have put Alibaba and Baidu among the major tech companies that have most improved their protection of digital rights in recent years.

It is also wrong to suggest that U.S. sanctions are on track to sink China’s tech sector. The Trump administration’s efforts to “kill Huawei” have not changed the fact that it supplies nearly twice as much of the world’s telecommunications infrastructure as its nearest competitor. While U.S. President Joe Biden has focused on hamstringing China’s semiconductor sector, Yangtze Memory Technologies developed a memory chip in 2021 that outperforms industry leaders Intel and Samsung, marking the first time that a Chinese chipmaker pulled ahead in the semiconductor race. The Biden administration recently launched a probe into Alibaba’s prized cloud unit, but U.S. regulatory scrutiny cannot stop the company from innovating. OceanBase – Alibaba’s database provider that was started with funding from the company – supplies the fastest databases in the world, twice as fast as second-place Oracle.

Despite China’s tech crackdown, China’s technology ecosystem is still on firm footing. Though China faces economic headwinds, its GDP has grown 15-fold since 2000 and continues to grow twice as fast as U.S. GDP. In 2000, China spent nine times less than the U.S. on R&D. Today, China spends $70 billion more than the U.S. each year to turn scientific discoveries into commercial products. And by 2030, China will spend significantly more than the U.S. on R&D. In the meantime, China’s tech crackdown will likely make its companies more innovative, its consumers safer, and its global influence broader.