China cracks down on its technology giants

Alibaba, Tencent and their peers grew fast by exploiting gaps in a heavily regulated economy. But with the Chinese government tightening the rules, their prospects are more uncertain. Cris Sholto Heaton looks at the sector and asks if it's worth buying in.

Jack Ma getting a spanking

It is difficult to understand what Jack Ma was hoping to achieve when he spoke at a high-level financial summit in Shanghai on 24 October. The Alibaba founder was just about to preside over the initial public offering (IPO) of Ant, the giant payments, investing, lending and insurance platform that has become the world’s most valuable financial-technology firm. Yet Ma – who has long had a fraught relationship with China’s financial establishment – decided that this was a good time to launch an open attack, suggesting that old-fashioned regulators are stifling innovation and bluntly accusing banks of a “pawnshop mentality” that can’t meet the credit needs of today’s economy. Neither is capable of delivering the financial system that modern China needs – unlike Ant, he implied.

 Whether he’s right or wrong – there was plenty of self-interest at play – it’s a well-argued speech that makes valid points about China’s sclerotic banks. But the consequences were swift. Ma and top executives were summoned to meetings with regulators. Officials published a draft of tougher rules for online microfinance businesses, such as Ant’s lending operation arm. And perhaps most significantly, Ant’s IPO, which was set to raise a record $35bn (£26bn) in a dual listing in Hong Kong and Shanghai, was put on hold. Since this float was set to be a matter of no small prestige for China, it seems certain that Xi Jinping, the Chinese president, will have signed off on the decision, as The Wall Street Journal subsequently reported.

Top Chinese executives are both politically astute and politically vulnerable. Ma himself stood down from the board of Alibaba in 2019, for reasons that are unclear; there has been speculation that he was forced out by a government that is concerned about any individuals whose profile and influence might pose a threat to its authority. That makes it doubly baffling that he would make such a provocative speech – remarks that he was urged to tone down by several people close to him, according to Reuters. One view is that it was simply a moment of hubris; another is that Ma already knew that tighter regulation was on the way and this was a last-gasp effort to set the terms of the debate and head some of it off. Either way, his gamble appears to have failed.

A sector under scrutiny

While Ma and Ant have made all the headlines recently, they aren’t the only part of the tech industry coming under scrutiny. Last week, competition authorities proposed new rules in areas such as below-cost pricing and exclusivity agreements that might curb the ability of Alibaba and other heavyweights to squash smaller rivals before they can pose a threat.

Meanwhile, Caixin, a leading financial magazine, ran a major story claiming that law enforcement is investigating search portals, social media platforms, digital payments systems and ecommerce sites run by the big tech firms for allowing illegal gambling sites to attract users and to disguise betting transactions as online shopping. Caixin has a record of knowing what targets are in the sights of the authorities; the high-profile crackdown on insurance group Anbang in 2017 and the imprisonment of its founder on charges of embezzlement and fraud were preceded by a series of critical articles in the magazine. So the timing of this story may be significant. 

Other than requirements to censor content and the occasional brief regulatory storm (such as accusations in 2018 that Tencent was not doing enough to prevent children being addicted to online games), China’s tech giants have been given considerable latitude to operate in an economy that is otherwise highly regulated in many sectors. That’s one reason why they have grown, expanded and innovated in a way that makes Western tech giants look comparatively stodgy. The picture of a sector being told to fall into line – or else – is becoming increasingly clear. 

Trebling down on state control

This crackdown – if that’s what it proves to be – is the latest of three major developments in China during 2020, all of which need to be viewed together when thinking about what the next few years might bring. The first, of course, was Hong Kong. In dealing with the escalating crisis there, China faced a choice between coercion and persuasion. The most likely path seemed to be a combination of the two: it would be difficult for the government to give way on many of the political issues that were the direct pretext for the protests, but policymakers could readily make concessions on some of the economic grievances that underpin the unrest (eg, the high cost of housing and other basic services that result from well-connected tycoons dominating these sectors).

This was certainly my expectation when I wrote about the outlook for China in MoneyWeek last November. The reality so far has been entirely different: all stick, no carrot. Beijing has made zero effort to buy off protestors with populist economic policies, but has doubled down on security measures. It has imposed new laws on Hong Kong that criminalise dissent and allow mainland security personnel to operate in the region. Leading figures in the anti-government protests are being prosecuted and opposition politicians expelled from the legislature. While the legal and political system in Hong Kong technically remains separate from the rest of China, any meaningful autonomy has been stripped away. The belief that “one country, two systems” would continue to operate in a predictable and reliable way until 2047 has completely ceased to exist. 

The second significant event was Covid-19. When the disease first emerged, it seemed like the government’s response – including early efforts to cover it up – might prove a significant blow to the Chinese Communist Party (CCP). The CCP retains power as a one-party state not purely because it’s good at suppressing dissent and discussion of any alternative political systems – as many people tend to assume – but because the higher tiers of the government are widely trusted to deliver economic development, public safety and international clout for China (even if local-level officials are often mistrusted). A pandemic that swept across China and caused vast amounts of death could well have shaken faith in the government’s ability and undermined its legitimacy.

Yet if anything, the CCP has emerged with its reputation enhanced and its authoritarian approach to civil society and personal freedom validated. After almost a year of this crisis, China is still functioning more normally than most of the rest of the world. Even if one assumes that there could still be wider outbreaks of Covid-19 than are acknowledged, there’s no doubt that most of the economy and society are now open. 

Meanwhile, the rest of the world has rushed to embrace indiscriminate confinement, widespread surveillance, travel restrictions, mass testing, government and media information campaigns so unbalanced that they amount to propaganda, severe criminal penalties on what were once held to be inalienable basic freedoms – exactly the kind of measures that were initially condemned in China. And despite abandoning their principles, most countries have suffered higher infection and death rates combined with worse economic and social outcomes. The idea that Western democracy offers a better model of governance than the CCP now looks laughable within China and perhaps increasingly elsewhere.  

A 21st-century Cold War

Put all this together and you can see that China is confidently continuing down a path of greater state control and narrower scope for disagreement. Of course, this process began quite a while ago. Restrictions on journalism and online freedom of speech, which had been unevenly loosening, began to tighten again early in the past decade. Quite quickly after becoming president in 2013, Xi consolidated power around himself, began to build a cult of personality and abolished term limits that would have forced him to stand down in 2023 – all of which was a retreat from the way that the CCP had steadily tried to embed a collective system of leadership after the death of Mao Zedong. The expectation that prominent individuals and companies must serve the interests of the nation rather than just acquiring wealth or influence for themselves has become increasingly firm. But the events of 2020 may be a turning point.

That’s partly because China’s relations with the West continue to deteriorate, for reasons that can be shared among both sides. Things may improve a bit when Donald Trump is no longer stirring the pot, but a good deal of damage has been done. China and the West will remain tightly connected by trade, but the schism between them in certain areas will continue to grow. Technology is on the frontline of what might turn into a 21st-century Cold War. Western governments are increasingly vexed about the security implications of Chinese firms having access to their infrastructure and data, and about whether China should have access to Western research and technology in areas that are likely to play a key role in future rivalry, such as artificial intelligence (AI).

This may not affect Alibaba and its peers directly, because their area of tech is already divided. Amazon, Google and Facebook operate almost everywhere except in China, while their Chinese equivalents (see below) do little outside their borders. Trump’s attacks on social-media video platform TikTok (owned by China’s ByteDance) in August were an exception; it’s one of few Chinese-owned services with widespread international use. WeChat, which Trump also tried to ban, is used mostly by the Chinese diaspora, while Alibaba’s services are used by international buyers but only to connect with Chinese sellers. 

However, this climate will almost certainly hinder their ability to expand their services abroad over time, as some would clearly like to do (their best remaining option is likely to be southeast Asia, where several already have affiliates and investments). So their future is mostly dependent on the opportunities that China offers. These are currently huge, but tough or capricious regulation might change that. Rules to create more competition might make them slower-growing or less profitable. Restrictions in areas such as financial services – which have offered some of the best opportunities – could make these less attractive. 

To read the whole of this article, subscribe to MoneyWeek magazine

Subscribers can see the whole article in the digital edition available here

Most Popular

The MoneyWeek Podcast: Asia, financial repression and the nature of capitalism

The MoneyWeek Podcast: Asia, financial repression and the nature of capitalism

Russell Napier talks to Merryn about financial repression – or "stealing money from old people slowly" – plus how Asian capitalism is taking over in t…
16 Jul 2021
Three companies that are reaping the rewards of investment
Share tips

Three companies that are reaping the rewards of investment

Professional investor Edward Wielechowski of the Odyssean Investment Trust highlights three stocks that have have invested well – and are able to deal…
19 Jul 2021
The future belongs to emerging markets – three EM stocks to buy now
Share tips

The future belongs to emerging markets – three EM stocks to buy now

Professional investor Carlos von Hardenberg of Mobius Capital Partners picks three of his favourite emerging-market stocks.
5 Jul 2021