Why is China destroying its tech companies?

Tuesday, August 31, 2021

/ by mansuralisaha


News Cover: This is the MSCI index of China that comprises several medium and large companies in China. This was the value of the index in February 2021. Look at what happened in five months. Some of the world's largest internet companies incurred losses of billions of dollars. Tencent, best known for WeChat, or you can call Chinese WhatsApp, had to face a loss of USD170 billion. That is nearly the GDP of Greece. And Tencent isn't alone. Many tech companies lost billions of dollars of their market value. This crash resulted due to the crackdown by the Chinese government that targeted the e-commerce, gaming, and education companies. The crackdown didn’t occur overnight but took months. There were three key moments. First, the suspension of Alibaba's parent company Ant Group's IPO in Nov 2020. Second, when Didi, a company like Uber was listed on New York Stock Exchange on June 30 and two days later, the Chinese government put Didi on a cybersecurity review and banned it from accepting any new user. Third, when China initiated strict regulations on China's after-school tutoring or ATS sector. In late July, the Chinese government even banned for-profit tutoring. The rules say that tutoring can only be conducted on a non for profit basis. Try to grasp the gravity of the situation. 

Imagine if the Indian government decides to ban private tuition. How would you react? And the Chinese government didn’t stop here. Earlier this month, a Chinese newspaper affiliated with a state news agency criticized online gaming as “opium for the mind” i.e. online games are the same as drugs. Even though this was only a newspaper article the investor sentiment had become so fragile that it triggered a mass selling of gaming stocks. And the gaming companies incurred a huge loss. On the face of it, this looks so strange. Why would China ban its world-renowned internet companies? It’ll not only damage the companies but also the economy of the country. Consider this for example: In 2020, had Alibaba's IPO been allowed to debut, it would have raised 37 billion dollars from the market, the highest ever in the world. But the answer behind it tells us about the kind of economy the Chinese Communist Party wants to create. Now several theories have emerged on why such a crackdown took place. Let's discuss them in detail. On Didi, the Chinese administration mandated a cybersecurity review because Chinese regulators were concerned that due to stock listings in the US, US data disclosure rules could compromise national security. The crackdown of the education companies is argued that due to the highly competitive schooling system of the country, education companies have flourished. And the companies manipulate parents, using the pretense of the future of their child, into spending exorbitant money on After School Tutoring. This high mental and financial pressure is one reason why Chinese parents aren't keen on raising children, which China is concerned about. 

The other reason cited is that the Chinese Communist Party wants to strengthen its ideological control over the education system. Former education officials argued that the recent crackdown is entirely consistent with Xi Jinping's ideological determination that “government, military, society, and schools — the party is the leader of all”. In Alibaba’s case, Chinese regulators have blamed that Alibaba was abusing its dominant position in the market by punishing those merchants who were selling products to other e-commerce companies. Another reason could be that the Chinese government wanted to send a message to Jack Ma and other similar entrepreneurs because Jack Ma criticized the Chinese financial system. It wanted to convey that no one is bigger than the Communist Party. And the party would only support entrepreneurs who are loyal to it. By blocking Alibaba’s IPO, the Chinese government changed the trajectory of Alibaba, Jack Ma and the Chinese financial system. Countless articles and videos came out that talked about the disappearance of Jack Ma. Jack Ma's fascinating journey can teach us many life lessons. If we discuss the non-controversial part of his life, we can learn how he built a multi-billion dollar company. 

If you’re interested in his journey, I would recommend an audiobook on him that is featured in the KuKu FM app. This show has 32 episodes, which details Jack Ma's life. You can listen to it on the KuKu FM app, which has sponsored this video. This app has many other original podcasts and audiobooks in several languages. This app has many other original podcasts and audiobooks in several languages. And as they’re sponsoring the video, you will get 20% off if you use the coupon MOHAK20. This brings the cost below 1rs a day. So do check out the app. The download link is in the description. Now all these reasons are very logical. They’re not surprising. What I want to tell you about is a different reason, which I feel is the most interesting part of this video. Over 40 years ago, China's Premier was Deng Xiaoping. Deng challenged the existing economic structure of Chinese society which relied heavily on state control of the market, meaning private companies had limited freedom. Deng reduced the influence of the state on the Chinese economy. This helped many private companies. And over time, Chinese products flooded the world market. 

And this model was so successful that in 2010, China took over Japan to become the world's second-largest economy. But in 2013, Xi Jinping came to power. And he had some other ambitions for the country. Xi believed that technology comes in two varieties: one that is "nice to have" and one that you "need to have". And Xi seems to classify WeChat, Alibaba, games by Tencent, Didi as "nice to have" technologies. Xi isn’t the only one with this ideology. Xiaomi founder Lei Jun had famously once said: “Even a pig can fly if it stands at the center of a whirlwind.” It means that any company can do well if it rides the right trend at the right time. And Xi thinks that all these internet companies have done exactly that. The Chinese government seems to think that the profits of companies like Alibaba and Tencent come more from rents than from actual value-added — that they're simply exploiting first-mover advantage to capture strong network effects. And in some ways, this makes sense. 

Facebook and Google are two of the most valuable companies in the world but many can argue that they produce little value relative to the profit they rake in. Dan Wang is a technology expert based in Hong Kong says that "I find it bizarre that the world has decided that consumer internet is the highest form of technology". He says, "The apps they develop offer fun, productivity-dragging distractions; and the companies pull smart kids from fields like materials science or semiconductor manufacturing, into ad optimization and game development". He believes that “If a large population of a country plays games, buys household goods online, and orders food delivery does not make it a technological or scientific leader". 

So if not the consumer technology companies, what does China want to focus on? According to Dan, Xi Jinping believes that China's future lies in the hands of the manufacturing sector. He says that “Companies that produce semiconductors, aircraft, batteries, and telecom equipment will play an important role and not the internet companies.” This is why while the stock of leading internet companies collapsed, that of China's leading semiconductor companies has increased. Let’s try to deconstruct this argument. There are three major sectors in an economy: agriculture, manufacturing, and the service sector. Usually, a society starts focusing on the agriculture sector and then on the manufacturing and service sectors. Countries like the US and the UK have started focusing more on the service sector. 

And China doesn’t want to do this. So why do politicians hate technology companies even though investors seem to love them? First, big tech companies inflict costs on society that aren't reflected in private market values. This is why Chinese state newspapers called games as "opium of the mind". American leaders would agree. They, too, worry that big tech suffocates competition, violates privacy, propagates misinformation, and encourages online addiction. And none of these problems are reflected in their stock values. Second, tech companies disrupt government control of the market. Take for instance Alibaba's sister company Alipay, which heavily disrupted the public banking sector of China. Alipay would give loans to small businesses at cheap rates which the public banks couldn’t do. This decreased the government’s control over the financial system. We discussed the downsides of technology companies on society. Let’s discuss how the manufacturing sector benefits a nation. Manufacturing companies confer social benefits that market values don’t reflect. 

For example, manufacturing companies create jobs, raise productivity, and disseminate essential skills. Innovations in manufacturing can help countries get ahead in geopolitical rivalry and military power. In fact, throughout the era of world war and the cold war, technological advancements benefited the nations. The innovations in the manufacturing sector have several applications. For example, Defense Advanced Research Projects Agency or DARPA is an agency of the US defense department that created technology in the late 1960s, which is used by everyone: the internet. And as military technology is increasingly becoming software-driven, the need for manufacturing technological goods like chips and semiconductors would also become more important. And this need for manufacturing was observed during the recent US-China trade war. The US government cut China's access to biotechnology, nanotechnology, and cloud computing infrastructure. The US government cut China's access to biotechnology, nanotechnology, and cloud computing infrastructure. 

What can India learn from all these? For context, India is one of the few countries that jumped straight from the primary sector (agriculture) to the tertiary sector (service), leaving the manufacturing sector behind. Companies like Infosys benefited from this a lot but local manufacturing companies suffered. But tensions with China on the border and COVID have heightened the importance of local manufacturing. If you study the data, India’s manufacturing has been slowing down for the past several years. In 2019, in fact, the value-added growth of manufacturing was negative. Dependence on countries like Korea and Taiwan for chips has slowed India's manufacturing. While at the same time, many internet companies are seeing a significant rise in valuation. Currently, India has been focusing more on the tech companies, overlooking the manufacturing. That’s why India has little growth in R&D. Only time will tell if India’s current economic model is more efficient than Xi Jinping’s new model.

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