Crackdown or Reform? Analyzing the Recent Upheaval in China’s Tech Sector
By Mark Dreyer
In recent months, China has cracked down on several areas of the tech sector, with giants Alibaba, Tencent, and Didi all coming under pressure, plus the online education space getting an overhaul. Companies – both domestic and multinationals alike – have been scrambling to make sense of the drastic policy changes, as well as to figure out what moves might be next. Trivium China’s Kendra Schaefer spoke to the AmCham China Quarterly to share her analysis over what is happening.
Each week, it seems, another sector comes under China’s microscope, as a wide raft of far-reaching changes are announced, often crippling companies overnight. When taken as a whole, it often looks like a coordinated campaign, but it’s not that simple, according to Kendra Schaefer, Partner and Head of Tech Policy Research at Trivium China. “The difficult part here for outside observers is that the tech crackdown really looks like a single crackdown, because there are so many moves coming out against the tech sector. But in fact, you’re looking at different crackdowns being carried out simultaneously, all by different regulators, and to suit different purposes.”
Schaefer breaks them down into the following four categories:
- Regulation on the FinTech sector, focused on unscrupulous lending practices and financial risk, overseen by the People’s Bank of China (PBOC).
- Movement against anti-competitive behavior and antitrust, focused on illegal mergers & acquisitions and improper use of algorithms, overseen by the State Administration for Market Regulation (SAMR).
- Issues with listing and foreign investment, focused on the variable interest entity (VIE) structures, overseen by the China Securities Regulatory Commission (CSRC).
- Data and network security focused on China’s new data laws, overseen by the internet and tech regulators, the Cyberspace Administration of China (CAC) and the Ministry of Industry and Information Technology (MIIT).
Schaefer points out that while the western narrative describes these campaigns as “crackdowns”, China characterizes them as “reforms”. However, she also notes that sporadic social issues temporarily emerge to take precedence over these more long-term goals, such as the crackdowns on the EdTech sector, which included banning private tutoring institutions, and scrutinizing subject matter classes for K-12 students, as well as things like workers’ rights. These, she says, are driven by public outcries such as workers complaining that their jobs at tech companies are too punishing or parents objecting to the high cost of private tutoring. All of this adds up to “a multi-pronged push from different sectors of government with the aim to serve different ends.”
If it feels like this tech crackdown dates back to Ant Financial’s troubles last year, Schaefer says that’s just an illusion. “Almost every thread of those reforms has been bubbling for between five to 15 years, even though these little pieces have all happened to come together at the same time. FinTech regulation really picked up in 2015. Data regulation has been bubbling for two decades. What has happened now is that, for the first time since the emergence of China’s big tech industry, Chinese policymakers have finally coalesced political will around what a modern socialist tech sector looks like. China didn’t want a Silicon Valley. They didn’t want modernization to mean westernization. What a modern tech sector looks like in China has really solidified in the last two years, both in the ideological space – in terms of how companies are expected to behave and comport themselves in the Chinese market, and what kind of attitude they’re supposed to take when doing business – and with this more recent ‘common prosperity’ push as well.”
“Common prosperity” has appeared as China’s latest buzzword or phrase and Schaefer describes it the new reality in which companies should not only be beholden to their investors, but also that their priorities should be equally distributed between the state and their obligations to serving national development by improving people’s livelihoods. “One of the ideas that has emerged on overseas listings in the last year is that it is not okay for companies to be non-compliant with the law in the local market,” Schaefer says. “That’s perceived as being disloyal to China and being loyal to their foreign investors by chasing money overseas – described as ‘backwards priorities’. What companies should be doing is ensuring first that they are compliant locally, and then pursuing overseas listings. Didi is the biggest example of that – and they’re one of the better ones. The compliance rate of their rides is hovering around the 60% mark, meaning that just over half of the rides that that you take are legal, the drivers have a license, the car is supposed to be operating in that space, in that city, and so on. And Didi has been flouting local regulations on ride hailing for years and years, and then they pursued an overseas IPO, so that was one problem.”
“The other issue is compliance with data regulations,” Schaefer continues. “Companies are not yet compliant with those, because they don’t yet know what to be compliant with or how to be compliant, but they’re still pursuing overseas IPOs. I don’t think the ultimate goal is to force companies to list locally; I think the ultimate goal is to ensure that companies are first operating compliantly in the local market – that they are loyal to their domestic customers and concerns – and then you get a treat, which is that you get to go pursue foreign capital.” Schaefer further describes common prosperity as more of an ethos than a policy. “You should be making money while doing good,” she says. “In the short term, it means downward pressure on profits. It’s unclear what it means in the long term. I think what we’re looking at is Beijing trying to lay out an ideological trellis along which these companies grow.”
Sweeping Education Reforms
One view on China’s recent education sector changes is that is has been done to protect students from too much academic pressure and encourage families to have more children; but another narrative holds that this has been done to stamp out English language teaching and pesky foreign influences. So where does Schaefer stand on that? “I think it’s much more the former than the latter, but I also think there are other threads there. I’ve got a lot of Chinese friends here who are parents, and they’ve complained about education sector issues for quite some time. So, it made sense to me from that perspective.”
The 30,000-foot view is important here, Schaefer says, with China looking at an impending population crisis. By 2040, 35% of the Chinese population is going to be over the age of 65, compared with the current level of around eight to 10%. “This is a massive, massive problem,” she says. “You’re looking at a huge economic slowdown, a huge reduction in work capacity, and increasing pressure on parents. This has incredible implications on almost every aspect of the economy, including food security. There aren’t enough people in the farms. The average age of a Chinese farmer is 60 – that’s the average. So, it’s incredibly important for it to be easier for parents to have more children. China has tried several times to encourage families to have more kids and it hasn’t worked. Food security and economic growth is obviously a much more pressing concern for Chinese regulators, than foreign influence in the classroom.”
Schaefer lists other parental concerns – a trend towards teachers shunting their teaching duties off on after-school classes, increased education inequality, and tutoring institutions poaching the best teachers from public education – as additional reasons behind the moves made in the education sector, but adds, “You can kill the private tutoring sector, but you can’t kill parental ambition. That’s more ingrained than the concern over financing. Everybody wants their kids to go to Harvard or Tsinghua, and so what we saw immediately in the aftermath of the EdTech crackdown was a mad scramble by companies to rebrand themselves or find some other way to deliver private education that flew under the radar.”
“But I don’t think that this solves the problem, because the pressure is coming from the gaokao [China’s college entrance exams] and that has not been reformed or changed. It’s also coming from the fact that there are very few top-level universities in China, and those take several decades to build, which is why they can’t really reform it that way. So, I’m skeptical as to whether or not these moves will spark a baby boom.”
Three-Pronged Approach to Data
If the past few months have already witnessed a surprising amount of upheaval, there is plenty more to come, according to Schaefer. “We’re definitely not done. In fact, I think we’re just getting started. If you look at the crackdown under the framework that I laid out in the beginning – that it’s multiple threads with different objectives by different regulators – you can look at each one of those threads, and see that new regulation is coming down the pike in the case of almost all of them. The one set to get much more stringent and much more prevalent over the next five to 10 years is the data thread.”
China has three foundational data laws – the Cybersecurity Law, which became effective in 2017, the Data Security Law, which passed earlier in 2021, and the Personal Information Protection Law, which goes into effect on November 1, 2021. Didi was investigated by the first of those three laws, but Schaefer notes that it took nearly five years for the law’s mechanisms to take shape and only now are the ramifications of that becoming clear. “Now, with two other hugely impactful laws, we will see the mechanisms to implement those laws start to roll out and you’re looking at five to 10 years of upheaval for companies as they figure out what data they have, how to send their data overseas, how to do a security check, and so on,” she says.
Schaefer offers that China is taking “an economic view on data” by segmenting it into three levels of risk. The first risk area is sensitive data that has low economic value highlights is extremely sensitive data that has very low economic value, such as a social security number, or state secrets. Trading these doesn’t benefit the economy and poses very high risk to national security or individual privacy. At the other end of the spectrum, there is very low risk data, with high benefits to society if it’s traded, such as carbon emissions data. Companies, for example, could use that data to make algorithms that lower carbon emissions and make positive changes to the economy and to the environment. But it’s the data in the middle that is the problem, Schaefer concludes, because that includes data like marketing and purchasing preferences. There’s some personal risk to allowing companies to have access to this, but there’s also considerable potential economic benefit. As a result, she says, China has ordered every regulatory body and state agency to sift through the data in its own sector and sort that data into categories, by appropriate risk level.
“China has this massive strategy for its data economy, but it hasn’t sorted out the details. In the meantime, companies are sitting on piles of data that they need to send somewhere, and they are uncertain whether or not it’s legal to do that. So, what companies need to be paying attention to now is what the regulator in their sector is deciding about the data in their sector,” Schaefer adds.
Connected Vehicles and Cryptocurrency
Schaefer is clearly passionate about China’s tech sector, having studied it for two decades, but still gets excited about certain sectors more than others. One of those is connected and autonomous vehicles, another industry that has been scrutinized of late. “I love the ICV (intelligent connected vehicles) sector,” she says. “It’s so interesting. There are so many elements here, one of which is data. What data does the car collect and what can you do with it? Another element is infrastructure. If the car has to speak to a network many, many times per second, you’ve got to have 5G networks and the infrastructure that allows extremely rapid connectivity from the car to the network. Then you’ve got a hardware issue. You can’t build smart cars without chips. Today’s smart cars have about 1,700 chips in a single car. China is struggling to develop its own chips – that’s probably one of its biggest bottleneck technologies at the moment – and struggling to import them as well.”
Schaefer says that China is well ahead of the rest of the world in terms of development of the infrastructure, and having government support for autonomous vehicles, but is “hopelessly behind” in other areas, such as being able to develop its own high-end chips. Overall, though, she highlights ICV as a sector to watch “because it’s very clear Chinese policymakers have decided that the Internet of vehicles is one of the areas that is within reach for Chinese dominance. They’ve already got the vehicles, and the plans for the networks; they’re already rolling out the data laws, building the roads, and building the 5G towers. The question is whether or not China can effectively bring all that together, given that there are geopolitical issues in the mix as well.”
Cryptocurrency is yet another sector that has been getting plenty of attention in recent months, with stories about crypto being banned in China seemingly appearing every other week. So, what’s the real story here and how does crypto fit in – or not – with China’s own use of its digital currency? “I think one of the critical the most critical issues with crypto is financial risk,” Schaefer says. “Financial regulators in China have been very clear that they do not see crypto, specifically Bitcoin, as a store of value and they’ve taken a very hard-line approach against it. Part of the issue is their inability to regulate it. There is nothing the Party likes less than feeling totally out of control about some major financial movement.” Meanwhile, Schaefer, whose team has been closely tracking China’s digital currency pilot programs, predicts it will be “everywhere” pretty soon. “On a daily basis, there are baby steps being taken in multiple cities across China to slowly roll out digital currency – and we’re likely looking at national adoption within the next five years,” she adds.
Potential Impacts and Implications
It’s clear that the tech industry has faced some dramatic changes in China this year, with plenty more still to come. But once the dust settles, will the sector be in a better place? Schaefer again highlights the need to look at each move in isolation, before drawing some wider conclusions. “In the long term, a better regulated and more compliant tech sector is not necessarily a bad thing. Unfortunately, in the short term, there are many cons. The biggest one, of course, is that all of this creates uncertainty for foreign investors. There’s been significant opacity around what’s coming next and it has the potential to damage Chinese companies’ short-term ability to raise foreign capital. The risk of investing in Chinese tech companies has suddenly become a little bit higher, and it’s unclear what other sweeping regulation is in the pipeline.”
“China’s got some very beautiful strategies here, but it’s uncertain whether or not those strategies – particularly the ones related to data – are going to play out the way that China wants them to play out. They’re doing something very ambitious. The pros and cons play out in implementation, so until we see what those rules look like and how those rules are being enforced, it’s really difficult to speculate whether or not this is a good or bad thing. The optimistic view is that, 10 years from now, you’ve got a much more well-regulated tech sector and the world’s most clearly defined data economy. That’s a massive benefit. The pessimistic view is that, 10 years from now, you would still have rule flouting and non-compliance, but you’d also have a lot of additional rules and hoops to jump through.”