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Saturday, February 11, 2023

Why China’s Crackdown Economy Is Counterproductive to Growth and Innovation

China created a crackdown cycle that is undermining entrepreneurship and investment.

Image Credit: Paul Kagame-Flickr | CC BY-NC-ND 2.0

Many weekends during my studies in Changzhou, China, we would go out to have a drink only to realize that our favorite bar was not open that night. In fact, all of the city’s clubs would be closed. The reason? Police decided to crack down on these nightclubs. These would mostly be drug-related crackdowns but other reasons such as prostitution would make the list. They seemed to go in cycles. Once the crackdown happened, things would cool down for a while and then gradually build up again to reach a climax, at which point another crackdown would happen.

Just like the nightclubs in Changzhou, crackdowns are a well-known theme in the Chinese economy.

Nowadays, any search about the Chinese economy would show results that include the word crackdown. There is this pattern that once in a while, the Chinese government will crackdown on one of the big sectors, specific companies, and even individuals. The reasons are different, but the story stays the same. Sometimes a random company is deemed incompliant by some regulatory agency’s decision. Other times, an influential business person becomes too vocal and criticizes the government, while in many cases a scapegoat is needed to bring peace as the government might be coughed up on a crisis of sorts.

The crackdowns come in different shapes. A common one is the implementation of a new set of regulations. Another one is just stricter enforcement of the regulations already in place. Of course, there is also whatever happened to Jack Ma. Every now and then it has suited the country’s leaders to relax their iron grip on the economy and allow a degree of economic liberty. Corruption also plays a big role in these relaxations, because personal interest comes into play. The libertarian in me thinks also that sometimes, it is just government incompetence and inability to enforce regulations on everyone, all the time.

China was once the leading country in crypto mining. In May 2021, the Chinese government vowed to put an end to mining operations and trading in China, which from a regulatory point of view had been illegal since 2019. Soon enough, videos of hundreds of processors being destroyed—some using road rollers—were released. The data from the Bitcoin Electricity Consumption Index that tracks the IP addresses of mining-facility operators that connect to the servers of bitcoin mining “pools” shows that China’s mining operations hash rate went from 75.73 percent on September 19 to 21.11 percent as of January 22. Similar crackdowns have been happening since 2013. The case was made for cryptocurrency as a means of protecting the stability of China’s economic growth, but with the growing state surveillance on transactions, the crackdown seems to be caused by the growing fear of the government and the central bank losing their grip on monetary sovereignty.

It was the first time the central bank and Beijing-based regulators joined forces to explicitly ban all crypto activities. Definitely not a union to mess with. Moreover, with the sovereign digital yuan in the advanced pilot stage, cryptocurrencies would be in direct competition–something not preferred by the government.

DiDi, the Uber-like app, fell under the regulators’ radar when it tried to list its shares at the NYSE and most likely did not have the blessing of Beijing bureaucrats. The app, which had 500 million users at the time (far more than its US equivalent), seems to have upset government officials, who deployed their regulatory force against it. Accusations started to emerge, such as the claim that DiDi had violated personal data rules. These were enough for the app to be banned from all mobile app stores in China. Just as the pattern usually goes, the regulations were well in place for quite some time, and the crackdown happened when it suited the government. It tumbled DiDi stock by more than 20 percent. Listing in America or Hong Kong is a path that almost all of the largest Chinese tech firms followed. And there are hundreds of startups that are yet to follow the steps of the giants by listing their shares on foreign Stock Exchanges, since companies now have to worry about going on the same path as DiDi.

The famous Jack Ma fell down the same path. Once he mildly criticized China’s financial sector, he seems to have lost more than anyone. Ma was a former English teacher who led the tech boom that forever transformed China’s economic sphere and built an incredible empire. The Alibaba Group was initially founded as a B2B marketplace site and later expanded to a wide range of areas. His story inspired a generation of Chinese Entrepreneurs. Alibaba includes e-commerce, technology, and online payment companies, the most important of which is The Ant Group, owning AliPay, the world’s largest payment platform, which serves more than 1.3 billion users and 80 million merchants with total payment volume (TPV) reaching ¥118 trillion RMB in June 2020.

In late 2020, Ma was preparing for Ant Group stock market flotation in a $37 Billion IPO, which would have been the largest ever at the time. But on October 24, 2020, weeks before the listing, Ma gave a now-infamous speech at the Bund Finance Summit in Shanghai in which he compared China’s state-owned banks to pawn shops and blamed Chinese regulators for stifling innovation.

“The game in the future is about innovation, not just regulatory skills,” said Ma, an outspoken critic of government intervention. On November 3, about a week after his speech, Chinese regulators suspended Ant’s IPO. The company was fined $2.78 billion in April 2021 and forced to undergo a systematic restructuring of its business, with Ma stepping down.

We cannot say for sure that all this happened because of the speech. It’s possible the time had simply come for Ma’s ever-growing influence in China to diminish. Yet, what we can say is that the Chinese government will not allow any individual to hold that much power. In the past years, many of China’s top tech chiefs have been stepping down from their leadership roles amid Beijing’s sweeping crackdown on the sector.

The effects of these crackdowns vary from as inconsequential as not being able to access a favorite pub to billions of dollars being wiped out. The most concerning of all is the state of uncertainty surrounding entrepreneurs and the whole private sector in China. The era which Jack Ma led is over, and what is currently happening in China could shut all the doors to innovation. The China question in the West is ever-growing, and it will most likely be the center of all discussions, be they geo-political or economic.

As Peter Robinson puts it in a recent interview with Peter Thiel, America cannot out-manufacture China and it cannot out-spend China anymore. The only way left is to out-innovate it. It is a fair characterization, even though China has four times the population of its main rival and will most likely have the largest GDP soon. Most metrics seem to indicate that China will lead the 21st century. However, for a country to lead the technological era, it needs to actually lead in technological innovation. China has so far been copying the West in every good step they took, while smartly avoiding the bad ones.

What will happen when there is no one to copy? China will stagnate technologically and therefore economically.

With a crackdown cycle in place, the future does not look good for China or Chinese entrepreneurs.

If the Asian giant were to abandon this approach, however, a bounce back has every opportunity to occur. After all, Silicon Valley stands at the center of wokeism, and with all the political failures in California, entrepreneurship seems to shine evergreen.