China’s Tech Sector Is Too Big To FailThat’s Why Beijing Is Cracking Down on It – Heritage.org

Beijings ongoingtech crackdownsent U.S.-listed Chinese stocks into a tailspin and left investors and analysts wondering what is going on in China.

Does the ruling Chinese Communist Party feel threatened by the size and influence of these firms or the tycoons who run them? Was the action against Didi days after its U.S. IPO aimed at deterring other technology companies from listing in New York?One narrative getting a lot of media traction speculates that Beijing is cutting its internet companies down to size to redirect capital toward higher-priority technologies, such as semiconductors and biotech.

While there is an element of truth to each of these theories, the driving force behind the crackdownlike previous action taken in other sectorsis a regulatory enforcement campaign aimed at cleaning up the tech industry.

The Party has a longstanding distrust of the interneta mass communication tool it cannot fully control. On top of that, Beijing fears the massive size of the digital economy and its rampant shady business practices could result in civil unrest or even economic ruin if left unchecked.

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A recent studyby a Chinese government-affiliated think tank found the digital economy accounted for nearly 40% of the countrys GDP last year. By comparison,in the U.S., this figure was just 9% for 2019, the latest year for which data are available. Even more shocking, over 80% of payments in China are made via mobile apps, and this figure continues to grow. Almost all these transactions are completed through either Tencents super-app WeChat or Ant Groups Alipay. Indeed, the sector has become, as the clich goes, too big to fail.

In the U.S., too big to fail implies a promise of government protection, up to and including an eventual bailout, if needed. In China, however, the concept motivates the government to regulate companies heavily, even excessively, so it doesnt have to bail them out in the future. So, while political motivations are no doubt at play in the current crackdown, there is also an economic motive. The more reliant Chinas economy and society become on a given sector or company, the greater the governments urge to beef up regulation and oversight, even if it means jeopardizing the well-being of key companies.

Weve seen this before, in the 2017 takedowns of some of the countrys largest private-sector conglomerates, like Wanda Group and Anbang Insurance Group. These incidents, possible political motivations aside, were part of a broader crackdown on the irrational overseas investment binge among Chinese companies, which the government viewed as a huge financial risk.

Regulatory crackdowns typically target large, well-known firms, because their massive size and omnipresence make their infractions both easier to spot and potentially more harmful socially or economically. Action against a high-profile company also has a deterrent effect against non-compliant behavior by other businesses. This is important for the Chinese government, which relies on fear as a tool of self-regulation.

Nor did these crackdowns come out of the blue. Since Xi Jinping came to power in 2012, China has tightened regulatory enforcement across the board. The Party often designates priority industries or behaviors for the regulators to focus on, and two prominent themes driving these priorities have been controlling financial risks and cleaning up industries closely connected to quality-of-life issues. The tech companies targeted in the current sweep fit into both categories.

Indeed, the writing was on the wall months before the clampdown intensified in July. In March, Xi instructed Chinas key regulatory bodies to strengthen oversight and scrutiny of the platform economy, specifically prioritizing anti-monopoly and data security. Importantly, Xis stated objective was to promote the healthy and sustainable development of the platform economy, echoing a pledge made in each of Premier Li Keqiangs annual government work reports since 2018. Xi said that, in order to promote the sectors sustainable development, the irregular development and risks of some companies had to be reversed.

If previous well-publicized enforcement actions against platform operators like Tencent and Pinduoduo and last Novembers halting of Ant Financials IPO didnt provide sufficient warning of a looming crackdown, this statement and others like it should have.

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Seen from this perspective, it is little surprise that Didi was targeted after reportedly ignoring regulators request to halt its IPO pending a data security review. The company could not have been ignorant of the trend toward greater scrutiny on these grounds. Just prior to the IPO, China passed a new Data Security Law which, among other things, will require security assessments for data transfers overseas. Didi may have thought it could continue operating in a grey zone, given the law doesnt come into force until September, but the regulatory direction was clear. Didi simply failed to read the signs.

Chinas regulators were actively cleaning up tech companies long before Didis IPO debacle. Ant Financials dual Shanghai-Hong Kong IPO was cancelled last year. Whether or not one buys the official account that this action was due largely to concerns over financial risks rather than a power play against Ant Group founder Jack Ma, enforcement actions since then have carried all the markings of a standard regulatory campaign. On the anti-monopoly front alone, nearly every major Chinese platform company was either punished or admonished during the first half of this year. This doesnt even take into account the punishments dealt out for other issues, such as labor violations and cybersecurity infractions.

Chinas crackdown on big tech is neither surprising nor unprecedented. Regardless of what other motives played a role in this development, the sector has become too big to fail, and it will remain a target until Beijing is satisfied that its most serious risks have been resolved.

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China's Tech Sector Is Too Big To FailThat's Why Beijing Is Cracking Down on It - Heritage.org