China’s Attacks on Tech Are a Losing
Strategy in Cold War II
Forcing DiDi and Alibaba to toe the Communist Party line may
help Xi build a police state but will stall the nation’s dynamic industry.
By Niall Ferguson
July 11, 2021, 8:00 AM GMT+1
Niall Ferguson is the Milbank Family Senior Fellow at the
Hoover Institution at Stanford University and a Bloomberg Opinion columnist. He
was previously a professor of history at Harvard, New York University and
Oxford. He is the founder and managing director of Greenmantle LLC, a New
York-based advisory firm. His latest book is "Doom: The Politics of
Catastrophe."
“Investors have to rethink the entire China structure,”
David Kotok of Cumberland Advisers
said last week. For Hong Kong, the One
Country, Two Systems principle was “dead.”
As for the crackdown on some of the nation’s tech giants, the Beijing
government’s treatment of Alibaba “is not a one-off. Neither is DiDi. Everything China touches must be viewed
with suspicion.”
Wait, you’re saying that investing in the other side in the
early phase of Cold War II might have been a bad idea? You’re telling me that “long totalitarianism” was not a smart trade?
For the past three years, I have been trying to persuade
anyone who would listen that “Chimerica”
— the symbiotic economic relationship between the People’s Republic of China
and the United States of America, which I first wrote about in 2007 — is
dead. The experience has taught me how hard it can be for an author to kill
one of his own ideas and replace it with a new one. The facts change, but
people’s minds — not so much.
Chimerica was the dominant feature of the global economic
landscape from China’s access to the World Trade Organization in 2001 to the
global financial crisis that began in 2008. (I never expected the relationship
to last, which was why I and my co-author Moritz Schularick came up with the
word: Chimerica was a pun on “chimera.”)
At some point after that, as I have argued in Bloomberg Opinion
previously, Cold War II began.
Unlike with a “hot” war, it is hard to say exactly when a
cold war breaks out. But I think Cold War II was already underway — at least
as far as the Chinese leader Xi Jinping was concerned — even before former
President Donald Trump started imposing tariffs on Chinese imports in 2018. By
the end of that year, the U.S. and China were butting heads over so many issues
that cold war began to look like a relatively good outcome, if the most likely
alternative was hot war.
Ideological division?
Check, as Xi Jinping explicitly prohibited Western ideas in Chinese
education and reasserted the relevance of Marxism-Leninism. Economic
competition? Check, as China’s high growth rate continued to narrow the gap
between Chinese and U.S. gross domestic product. A technological race? Check, as China
systematically purloined intellectual property to challenge the U.S. in
strategic areas such as artificial intelligence. Geopolitical rivalry?
Check, as China brazenly built airbases and other military infrastructure in
the South China Sea. Rewriting history? Check, as the new Chinese Academy of
History ensures that the party’s official narrative appears everywhere from
textbooks to museums to social media. Espionage? Check. Propaganda?
Check. Arms race? Check.
A classic expression of the cold war atmosphere was provided
on July 1 by Xi’s speech to mark the centenary of the Chinese Communist Party:
The Chinese people “will never allow any foreign force to bully, oppress, or
enslave us,” he told a large crowd in Beijing’s Tiananmen Square. “Anyone who
tries to do so shall be battered and bloodied from colliding with a great wall
of steel forged by more than 1.4 billion Chinese people using flesh and blood.”
This is language the like of which we haven’t heard from a Chinese leader since
Mao Zedong.
Most Americans could see this — public sentiment turned
sharply negative, with three quarters of people expressing an unfavorable view
of China in recent surveys. Many politicians saw it — containing China became
just about the only bipartisan issue in Washington, with candidate Joe Biden
seeking to present himself to voters as tougher on China than Trump. Yet
somehow the very obvious trend toward cold war was ignored in the place that
had most to lose from myopia. I am talking about Wall Street. Even as China was ground zero for a global pandemic,
crushed political freedom in Hong Kong and incarcerated hundreds of thousands
of its own citizens in Xinjiang, the money kept flowing from New York to
Beijing, Hangzhou, Shanghai and Shenzhen.
According to the Rhodium Group, China’s gross flows of
foreign domestic investment to the U.S. in 2019 totaled $4.8 billion. But gross
U.S. FDI flows to China were $13.3 billion. The pandemic did not stop the
influx of American money into China. Last November, JPMorgan Chase & Co.
spent $1 billion buying full ownership of its Chinese joint venture. Goldman
Sachs Group Inc. and Morgan Stanley became controlling owners of their Chinese
securities ventures. Just about every major name in American finance did
some kind of China deal last year.
And it wasn’t only Wall Street. PepsiCo Inc. spent $705
million on a Chinese snack brand. Tesla Inc. ramped up its Chinese production.
There were also massive flows of U.S. capital into Chinese onshore bonds.
Chinese equities, too, found American buyers. “From an AI chip designer
whose founders worked at the Chinese Academy of Sciences, to Jack Ma’s
fast-growing and highly lucrative fintech unicorn Ant Group and cash cow
mineral-water bottler Nongfu Spring Co., President Xi Jinping’s China has plenty to offer global investors,” my Bloomberg opinion colleague Shuli Ren wrote
last September.
Recent months have brought a painful reality check. On July
2, Chinese regulators announced an investigation into data security concerns at
DiDi Global Inc., a ride-hailing group, just two days after its initial public
offering. DiDi had raised $4.4 billion
in the biggest Chinese IPO in the U.S. since Alibaba Group Holding Ltd.’s in
2014. No sooner had investors snapped up the stock than the Chinese internet
regulator, the Cyberspace Administration of China, said the company was
suspected of “serious violations of laws and regulations in collecting and
using personal information.”
The cyberspace agency then revealed that it was also
investigating two other U.S.-listed Chinese companies: hiring app BossZhipin,
which listed in New York as Kanzhun Ltd. on June 11, and Yunmanman and
Huochebang, two logistics and truck-booking apps run by Full Truck Alliance
Co., which listed on June 22. Inevitably, this nasty news triggered a selloff
in Chinese tech stocks. It also led several other Chinese tech companies
abruptly to abandon their plans for U.S. IPOs, including fitness app Keep,
China’s biggest podcasting platform, Ximalaya, and the medical data company
LinkDoc Technology Ltd.
To add to the maelstrom, on Thursday Senators Bill Hagerty,
a Tennessee Republican, and Chris Van
Hollen, Democrat of Maryland, called on the Securities and Exchange Commission
to investigate whether DiDi had misled U.S. investors ahead of its IPO.
Also last week, U.S. tech companies such as Facebook, Twitter and Google came
under increased pressure from Hong Kong and mainland officials over doxxing,
the practice of publishing private or identifying information about an
individual online.
For several years, I have been told by numerous supposed
experts on U.S.-China relations a) that a cold war is impossible when two
economies are as intertwined as China’s and America’s and b) that decoupling is
not going to happen because it is in nobody’s interest. But strategic decoupling has been China’s official policy for some time
now. Last year’s crackdown on financial technology firms, which led to the
sudden shelving of the Ant Group Co. IPO, was just one of many harbingers of
last week’s carnage.
The proximate consequences are clear. U.S.-listed Chinese
firms will face growing regulatory pressure from Beijing’s new rules on
variable interest entities as well as from U.S. delisting rules.
The VIE structure has long been used by almost all China’s
major tech companies to bypass China’s foreign investment restrictions.
However, on Feb. 7, the State Council’s Anti-Monopoly Committee issued new
guidelines covering variable interest entities for the first time. Recognizing
them as legal entities subject to domestic anti-monopoly laws has allowed
regulators to impose anticompetition penalties on major VIEs, including
Alibaba, Tencent Holdings Ltd. and Meituan. This new framework substantially
increases risks to foreign investors holding American deposit receipts in the
tech companies’ wholly foreign-owned enterprises. For example, Beijing could
conceivably force VIEs to breach their contracts with their foreign-owned
entities. In one scenario, subsidiaries of a Chinese variable interest entity
that are deemed by Beijing to be involved in processing and storing critical
data could be spun out from the VIE — just as Alibaba was reportedly forced to
spin out payments subsidiary Alipay in 2010.
The stakes are high. There are currently 244 U.S.-listed Chinese firms with a total market
capitalization of around $1.8 trillion, equivalent to almost 4% of the
capitalization of the U.S. stock market.
And the pressure on them is coming from the American
regulators, too. The Holding Foreign
Companies Accountable Act passed last December empowers the SEC to require
foreign companies to disclose shareholder information and auditing records to
the Public Company Accounting Oversight Board. Three consecutive years of
noncompliance will force a delisting. The SEC’s new regulations went into
effect in April, so the earliest delisting could be in 2024. But the requirements extend to revealing information about
companies’ boards of directors and their affiliations with the Chinese
Communist Party, as well as about the extent to which Chinese companies are owned
or controlled by “a government entity.”
This is in direct
conflict with Article 177 of the revised China Securities Law, which
“prohibits foreign regulators from directly conducting investigations and
collecting evidence” in China, and restricts Chinese firms from releasing
documents related to their securities outside of China without approval from
the China Securities Regulatory Commission. The combination of new regulatory
pressure from both Beijing and Washington seems likely to force a significant
number of Chinese companies to delist from U.S. exchanges over the next decade.
Indeed, Washington has already delisted China’s three big telecommunications
companies, China Telecom Corp., China Unicom and China Mobile Ltd., on the
ground that they have Chinese military ties.
The fight over U.S.-listed Chinese firms has coincided with
another sign of impending decoupling. Tesla’s
love affair with China appears to heading for a rocky end. There has
been a marked increase in criticism of the U.S. electric vehicle company, both
in mainland newspapers and on social media, focusing on concerns about Tesla’s
safety standards. In February, Chinese agencies, including the State
Administration for Market Regulation, China’s most important market watchdog,
summoned Tesla executives to discuss what they said were quality and safety issues in their vehicles. In March, the
government was reported to have banned employees of state-owned enterprises
and military personnel from using Tesla vehicles.
There has also been speculation in Chinese media that Teslas
may be prohibited from entering certain “sensitive” areas. And last month, the
Chinese government ordered a recall of almost all the cars Tesla has sold in
China — more than 285,000 in all — to address an alleged software flaw.
According to the China Automotive Technology and Research Center, Tesla’s share
of the Chinese market for battery electric vehicles fell from 23% in the first
quarter of 2020 to 11% in the second quarter of 2021.
To Wall Street’s way of thinking, China’s behavior makes no
sense, especially in the context of a potential check to China’s economic
recovery. Expansion in manufacturing slowed in June, as export demand weakened
and supply bottlenecks held back production, according to official statistics
released last week. China’s services
sector, which has lagged behind manufacturing since the pandemic began,
also showed signs of renewed weakness, partly because of recent outbreaks of
Covid-19 in Guangdong and elsewhere.
Moreover, these short-run wobbles are trivial compared with
the much bigger economic problems that
American China-watchers detect. In a new piece for Foreign Affairs, the
Rhodium Group’s Daniel H. Rosen paints a dark picture:
Since Xi took control, total debt has risen from 225 percent
of GDP to at least 276 percent. In 2012, it took six yuan of new credit to
generate one yuan of growth; in 2020, it took almost ten. GDP growth slowed
from around 9.6 percent in the pre-Xi years to below six percent in the months
before the pandemic began. Wage growth and household income growth have also
slowed. And whereas productivity growth
… accounted for as much as half of China’s economic expansion in the 1990s and
one-third in the following decade, today it is estimated to contribute just one
percent of China’s six percent growth, or, by some calculations, nothing at
all.
The standard view, to which I also subscribe, is that the combination of accumulating
private-sector debt and demographic decline — a trend made significantly
worse by the pandemic — condemns China
to significantly lower growth in the coming years. So why, burnt investors
ask, jeopardize China’s access to Western capital, not to mention the access to
Western technology that comes with large-scale U.S. foreign investment in
China?
The answer has to do with the political calculations of the Chinese Communist Party, a way of
thinking that could hardly be more foreign to the wolves of Wall Street.
As one hugely successful Chinese tech investor put it to me
on a visit to Beijing in September 2018, there are three Chinas: the “New New China” of
the dynamic technology sector; the “New Old
China” of the most profitable state-owned enterprises, such as
banks and telecoms; and the “Old Old China” of
the heavy industrial, rust belt state-owned enterprises.
“We are New New China,” he told me. “We have U.S. passports,
we cross the Pacific often, we are in California a third or half of the year.”
In short, the Chimericans. But “New Old China” is the Communist Party
elite — the “princelings” descended from the senior party figures who
survived the madness of Mao, and their children, whose wealth comes from the
state-owned cash cows. “Old Old China” is everyone else, whether in the
miserable rust belts or the impoverished countryside.
Three years ago, my friend correctly predicted growing
pressure on New New China from the Communist Party, which had begun to regard
the big tech companies as so large and powerful as to pose a political threat.
Jack Ma’s decline and fall — from an Elon Musk level of stardom in China to
near invisibility — has proved that prediction right. It was Ma’s blunt and
public criticism of the Chinese financial regulators last year that led to the
cancellation of the Ant Group IPO and his eclipse as a public figure.
If you thought the CCP’s top priority was global economic
dominance, cancelling Ant’s IPO made no sense. Ant had the potential to become
the most powerful financial services platform in the world, its artificial
intelligence technology honed on the vast trove of Chinese data harvested by
the Alipay app, its game plan simple but brilliant, as its chief executive Eric
Jing once explained to me over dinner in Hangzhou: to make Ant the default
online market for all financial products throughout the world’s emerging
markets.
So why did Beijing decide to abort this potentially
world-beating mission? The answer is that the Communist Party’s top priority is domestic: specifically, the
preservation of its own power.
The CCP did not plan for China to become home to the only
tech companies in the world big enough to compete with Silicon Valley’s. It
just happened because there was enough freedom from regulation for Ma to
create, with breathtaking speed, “Amazon with Chinese characteristics.”
Such are the consequences of allowing a free-market system to flourish even
as you retain control of state-owned enterprises that you assumed would always
be the economy’s commanding heights. Already in 2018, however, it was
becoming clear to Xi and his fellow princelings that Jack Ma and his arriviste
counterparts at the other big tech companies were getting too big for their
boots. And the crux of the matter was their ownership of all that data
generated by their Chinese users.
Significantly, China’s new data-security law, which was
completed in June, gives the government greater power to get private-sector
firms to share data collected from social media, e-commerce, lending and other
businesses by classifying such data as a national asset. That ended the
ambiguity that had led some big tech representatives to suggest that users’
data might not be available on demand to the government.
A similar logic explains Beijing’s sudden iciness toward
Tesla. According to Article 36 of the Data
Security Law, data stored in China cannot be transferred to foreign
law-enforcement authorities or judicial bodies without prior Chinese government
approval. “Provisions on the Management of Automobile Data Security,” released
in May, specifically targeted automobile data storage and processing. The new
rules state that geographic and mapping data collected by smart cars could
constitute critical infrastructure information — again a matter of national
security.
A cynic would say that Tesla is merely receiving the
treatment previously meted out to many other Western companies. It has been welcomed
into China just long enough for homegrown companies to copy its technology;
now the future will belong to the likes of BYD Auto Co. Yet this is to
understate how seriously the government takes the data issue. If you are intent
on building a new kind of surveillance state, applying the power of artificial
intelligence to all the data you can harvest from your citizen-helots, it makes
perfect sense to ensure that the Communist
Party has complete control over the data. And if you believe you are in the
early phase of Cold War II, it makes perfect sense to ensure that companies
based in the other superpower are cut off from the data.
Like the Soviet Union in Cold War I, China believes that the
U.S. will behave the same way it does. Maybe it’s true —maybe Tesla would make
data gathered by its Chinese vehicles available to the U.S. National Security
Agency. But you can be absolutely certain BYD would make U.S. data available to
the NSA’s equivalent in Beijing if they had sold a lot of Chinese electric
vehicles to Americans.
Xu Zhangrun, who was a professor of jurisprudence and
constitutional law at Tsinghua University until he was fired last year,
believes that Xi has restored tyranny in
China, by removing the constraints on his power — such as informal
term-limits — that his predecessors had imposed after Mao’s death. “Tyranny ultimately corrupts the
structure of governance as a whole,” Xu has written, “and it is undermining
a technocratic system that has taken decades to build.” That may well prove
to be true.
In the short run, however, the big losers from Xi’s tyranny
and the Cold War that he is waging will be those Western investors who
foolishly believed that Chimerica could survive not only a global financial
crisis made in America, but also a global health crisis made in China.
This column does not necessarily reflect the opinion of the
editorial board or Bloomberg LP and its owners.
To contact the author of this story:
Niall Ferguson at nferguson23@bloomberg.net
To contact the editor responsible for this story:
Tobin Harshaw at tharshaw@bloomberg.net
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