The Taiwan Banker

Beijing has gone too far in its crackdown on private enterprise, auguring poorly for the country’s ability to cultivate competitive companies Just two years ago, China’s leading internet companies seemed unassailable. Dominant in China and flush with cash, they were busy expanding regionally. Ant Group, the financial technology subsidiary of Alibaba, applied for a digital bank license in Singapore. With its many investments in e-wallets across the region, Ant was poised to develop a regional digital payments ecosystem. Not anymore. Ant won the license, but is mired in political trouble back home in China. As Beijing reasserts the ruling Communist Party’s paramountcy in the private sector, it is determined to humble the country’s most audacious entrepreneur, Alibaba founder Jack Ma. Whether the company can recover is uncertain. Over the past year, Alibaba has lost 53% of its market capitalization while Ant is being forced to restructure in manner that will reduce its profitability. The pressure has not let up on Ant. In a January report, The Financial Times noted that a recent documentary on state-run China Central Television alleged that private firms made “unreasonably high payments” to the brother of the former party secretary of Hangzhou, where Ant is headquartered. In exchange, the local government offered policy incentives and helped the companies buy real estate, the documentary said. Citing public records, the FT said that an Ant unit in 2019 bought two plots of discounted land in Hangzhou after purchasing stakes in two mobile payment companies that the party chief’s younger brother owned. Though the documentary did not explicitly name Ant, it was the only corporate investor in one of the payments businesses. Dogged by murky political travails, Ant will struggle to compete in an international financial center like Singapore. A stunt like the abrupt nixing of Ant’s IPO for political reasons – reportedly personally ordered by Chinese leader Xi Jinping – would never happen in the city-state, which thrives on its rule-of-law tradition. With an overall score of 85, Singapore is ranked as the least corrupt country in Asia and fourth least in the world by the global anti-graft movement Transparency International. In contrast, China receives a score of just 45. In its latest annual report, Transparency International notes that Xi has carried on a high-profile anti-corruption campaign over the past decade. “However, new forms of corruption have started to emerge, including collusion, where high-level officials use their powers to redistribute formerly state-owned assets to themselves and politically-connected firms. Furthermore, China’s anti-corruption strategy is inherently limited by the country’s disregard for human rights and fundamental freedoms,” the report says. A widening crackdown More than 16 months after Ant’s IPO was put on ice, China’s crackdown on Big Tech has transformed into a full-on assault on the country’s dynamic private sector. Ant’s monopolistic practices and the outspoken nature of Jack Ma made the company an easy target for disgruntled regulators eager to implement Xi Jinping’s agenda. Similarly, ride-hailing giant Didi Chuxing’s decision to list on the New York Stock Exchange (NYSE) against regulators’ wishes invited retribution. Yet more recent crackdown victims were not obvious targets. Rather, they were in the wrong place at the wrong time. The private tutoring sector is a case in point. These businesses thrived because of strong market demand. China’s is a culture that prizes education. As of mid-2021, about 90% of Chinese families paid for after-school tutoring. The industry was estimated to be worth US$150 billion. In July 2021, China’s state council announced new rules banning for-profit companies from tutoring in core curriculum subjects, and foreign investment in such companies. Under the new regulations, no new licenses will be issued and all existing organizations must register as non-profits. The Chinese Communist Party’s reasons for the crackdown are not fully clear. On the one hand, the party claims to want to alleviate stress on students and create a more egalitarian learning environment. On the other, the private tutoring industry had perhaps grown too powerful for Beijing’s liking. The harsh new regulations have taken a heavy toll on the industry. For instance, New Oriental, China’s largest tutoring company, saw its operating income fall by 80% after the new rules came into effect. To survive, New Oriental had to lay off 60,000 employees. It spent US$3 billion in cash to cover payments to the personnel it let go, refund tuitions and cancel teaching center leases. The company also had to shut down K-9 business to comply with the rules. That business accounted for about 50%-60% of New Oriental’s revenue. Other companies lacking New Oriental’s resources went out of business. According to Chinese research firm 100EC, 25 large online education firms shut down following the announcement of the new regulations. Among them were Juren Education, one of China's oldest tutoring companies, and Wall Street English, a major global English learning center. Next up on the chopping block was live-streaming, a key sales channel for many consumer brands in China, Chinese and foreign alike. In December, Beijing abruptly shut down the e-commerce and social media accounts of Viya, known in China as “the queen of live-streaming” with 100 million followers. She is accused of tax evasion and has been fined US$200 million. The extent of Viya’s alleged tax evasion is unclear. "I'm deeply sorry about my violations of the tax laws and regulations," she said on her Weibo account. "I thoroughly accept the punishment made by the tax authorities." Scoring an own goal The companies and individuals targeted by the Chinese Communist Party in the crackdown have a few things in common. One, they are usually in sectors that have evolved with little involvement by the party. To be sure, anyone who wants to succeed on a large scale in China needs the right government connections, but it was not the state that was responsible for the rise of companies like Alibaba, Didi Chuxing and New Oriental or a live-streaming star like Viya. Rather, they arose in response to market needs. They are, in different ways, representative of China’s diverse and dynamic digital economy. Before the crackdown, they were worth billions of dollars, at the top of their respective fields in China, and influential in Chinese society. In that sense, they represent a threat to the more-assertive Communist Party that Xi Jinping leads. Xi is China’s most powerful leader since Chairman Mao Zedong and is determined to use his vast political capital to strengthen the party’s control of the Chinese economy. Xi does not want to revert to Mao’s command economy but does aim to channel some of the former chairman’s socialist spirit. Xi is a true believer in those leftist ideas and frowns upon the capitalist excess that came to characterize China in the past two decades. Xi’s slogan for this campaign to reduce inequality by humbling the private sector, “common prosperity,” sounds like something Mao might have thought up. Sure enough, the Great Helmsman first mentioned the term in the 1950s. Deng Xiaoping later revived it in the 1980s, though he is much better known for saying, “Let some get rich first.” At the same time, Xi aims to channel more capital into state-led industrial policy initiatives. His idea of a national champion is not an internet company like Alibaba, which he sees as producing nothing of real value, but high-tech manufacturers that can help China become a leader in next-generation industries such as artificial intelligence, quantum computing and new-energy vehicles. Beijing’s massive support for the semiconductor sector since Xi came to power is a case in point. Xi wants China to achieve self-sufficiency in chipmaking and is sparing no expense to turn his turn his vision into reality. China has created two enormous national funds to support its chipmaking ambitions thus far, one in 2014 that raised about US$22 billion and a second in 2019 that attracted US$29 billion. At the local level, 15 local government semiconductor funds have raised an additional US$25 billion. Further, 40 chipmakers are publicly traded on the Shanghai STAR Board, China’s answer to the Nasdaq. During their IPOs, they raised a total of US$25.6 billion. The mammoth investment makes sense given chipmaking’s capital-intensive nature. Yet the results thus far have been mixed at best. Self-sufficiency remains elusive. China spent more importing semiconductors (US$350 billion) than crude oil in 2020. Meanwhile, Tsinghua Unigroup, the most prominent of Beijing’s state-backed chipmakers, defaulted on an RMB 1.3 billion bond in November 2020. By mid-2021 it was facing bankruptcy. Even if the company restructures successfully, it will struggle in the face of U.S. ban on China’s access to advanced semiconductor technology. Whether the failure of Tsinghua Unigroup eventually helps reduce wasteful spending remains to be seen. In 2020 alone, more than 22,800 new semiconductor firms were set up in China, a 195% annual increase over 2019. In the long run, heavy-handed state intervention in China’s economy will likely produce more Tsinghua Unigroups, while discouraging healthy private sector innovation. If the state punishes entrepreneurial activity that falls outside narrow parameters, then it will squander the talents of China’s best and brightest. Ironically, Xi’s draconian controls on China’s private sector will weaken the country in the aggregate. A less-dynamic Chinese private sector will produce fewer firms capable of competing internationally, which will reduce Beijing’s global influence. Over the past century, the Chinese Communist Party has shown time and again that it is its own worst enemy. Some things never change.