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The Economic Consequences of China’s Regulatory Crackdown

Summary

From clamping down on anti-competitive marketing practices to stifling illicit uses of personal data, Beijing’s regulatory crackdown is driven by a desire to curb the “disorderly expansion of capital.” However, these efforts risk going too far and threaten to deal an outsized blow to China’s rapid innovation and growth.

In early 2013, then president-to-be Xi Jinping described his nascent campaign to combat corruption among CCP leadership and local bureaucrats as resolving the “unhealthy tendencies” of both “tigers and flies.” Nearly a decade later, roughly 1.5 million officials have fallen victim to the Party’s efforts to rid itself of corruption, graft, and “moral decay.”

Now, fearing the adverse socioeconomic impact of independent and unregulated big business, Beijing is using the same tactics to blunt the influence of China’s powerful private sector. Xi’s broadside against private business has been multifaceted. From strengthened anti-monopoly regulation on the private sector and mandating Party committees that have significant influence over decision-making within companies to charging and imprisoning outspoken entrepreneurs and business tycoons across industries, the assault has been unyielding. 

Meanwhile, the post-pandemic economic recovery has been kinder to China than most other major countries. The World Bank recently raised its economic forecast for China, citing the nation’s effective suppression of COVID-19. Moreover, the organization expects the Chinese economy to expand by 8.5% in 2021, up from its previous forecast of 8.1%. However, despite the strong outlook, Beijing must still be cautious that its crusade to prioritize public interest over economic growth does not become a Pyrrhic victory.

Thus far, the regulatory reforms have brought a mixed bag. While Beijing has taken steps to address anti-competitive and illegal business practices, tightened restrictions on the private and financial sectors threaten to stifle innovation as firms shift to prioritize compliance with Party objectives over profitability. Specifically, the regulatory crackdown will particularly impact compliance and access to capital within the ‘platform’ economy and other high innovation-dependent industries.

China’s Regulatory Crackdown

When Did China’s Regulatory Crackdown Begin?

Xi Jinping has long had a rather fraught relationship with China’s business community. It comes as no surprise – Xi inherited a corporate system steeped in fraud, plagued by rising debt, and bound by insufficient regulation. Following the success of the anti-corruption campaign’s latest iteration, which concluded with nearly 40,000 supposed criminal cells and corrupt companies busted in 2020, Beijing was prepared to take up arms against another form of inequality — monopolistic business practices. 

Since Ant Group’s suspended IPO over concerns regarding the sustainability of Ant’s lending and business model in November 2020, Beijing has pursued an unprecedented crackdown on big business, with a particular zest for the technology sector. Alibaba was the first victim of China’s antitrust probe when it was fined a record US$2.8 billion on April 10, 2021. Three days later, 34 tech firms were called in by regulators to reform antitrust practices. In the following months, the State Administration for Market Regulation (SAMR) has fined almost all of these companies for failing to disclose mergers, signing exclusivity contracts, and engaging in misleading marketing tactics. Regulators have also gone on to draft revisions for the national Anti-Monopoly Law as well as enact the Data Security Law and Personal Information Protection Law that address market fairness.

Individual entrepreneurs have also been targeted. For instance, the rise of aluminum executive Zhang Zhixiong, who transformed a rural Chinese hamlet into a lucrative mining community, made headlines after he and ten others were abruptly handed prison sentences for allegedly forming a criminal organization and participating in illegal mining activity. In addition, rural tycoon Sun Dawu was sentenced to 18 years in prison after a disagreement over how much land the Dawu Group and a nearby village leased to a state-owned farm. 

Why Is China Suddenly Cracking Down on Business?

The nature of Beijing’s recent crackdown is too complex to trace back to any singular cause. It is in part an attempt to curb big tech’s penchant for abusing its share of the market and engaging in anti-competitive behavior. In a draft regulation published by the State Administration for Market Regulation (SAMR) in August 2021, internet operators “must not implement or assist in the implementation of unfair competition on the Internet, disrupt the order of market competition, affect fair transactions in the market.” Furthermore, Beijing has aimed to reform its financial markets to assure foreign investors of a stable business environment by eliminating systemic risks and restraining financial institutions that become ‘too big to fail.’ All in all, the end goal appears to be creating a more equitable, fair market landscape for consumers and companies, alike. 

Beijing could also be seeking to limit alternative centers of power that threaten national security interests.  For instance, China recently passed the Personal Information Protection Law (PIPL), intended by the CCP to prevent unscrupulous data collection in the commercial sphere through new legal restrictions. The new law, going into effect November 1st, requires app makers to offer users options over how their information is or isn’t used, such as the ability to choose whether to be targeted for marketing purposes or be subjected to ads based on personal characteristics. While the legislation does make progress in the way of consumer data protection, preventing the outflow of data beyond its borders remains consistent with Xi Jinping’s vision that elevates the role of data in national security and social prosperity over unfettered economic growth. 

How Does China’s Regulatory Crackdown Hurt the Economy?

Whether motivated by desires to stamp out “alternative centers of power,” or the need to address predatory corporate practices, the extremity of Beijing’s crackdown on entrepreneurs and their firms could be palpable. The increasing restrictions on private business could lead to slowed innovation and reduced competition, both contributing to broader economic consequences. 

Rewarding Unproductive Investment

The amount of capital input needed to generate one unit of economic growth has nearly doubled since Xi Jinping came into office in early 2013. This is, in part, because China’s state-owned enterprises (SOEs) have been empowered to invest in smaller, private companies. Transactions involving state firms that invested in private enterprises exceeded US$20 billion last year, more than twice the levels seen in 2012, in industries including financial services, pharmaceuticals, and technology, according to disclosures from publicly traded companies. While private tech titans, which are highly efficient engines of growth, are being targeted by regulatory crackdowns, state-owned firms, which are notoriously inefficient at producing economic growth, are being empowered. For example, on grounds of national security concerns, China recently ordered state firms to migrate data to costly government cloud servers, moving them away from clouds hosted by the likes of Alibaba or Tencent. 

Prioritizing Loyalty Over Growth

The punishment of outspoken entrepreneurs signals Beijing’s demands of loyalty from within the private sector. In fact, Xi has already made it clear that he expects unquestionable allegiance to the Party. A 2017 directive called for measures to “strengthen the sense of loyalty” among entrepreneurs and to strengthen the control that Party leadership exerted over them. In July 2020, Xi told a symposium of entrepreneurs that they should follow in the footsteps of “patriotic entrepreneurs” from Chinese history. Another set of directives, released in September 2020, said that “ideological guidance” should be strengthened to “create a core group of private sector leaders who can be relied upon during critical times.” 

Following this, increased party influence in what were once independent, private entities could lead to more bureaucratic red tape, suppressed innovation, and prioritized fealty to the Party over profitability. This is particularly concerning to investors, as Chinese tech giants in large strategic decisions may begin to consider political factors above responsibilities to shareholders.

Limiting Access to Capital

China’s financial reforms that target excessive risk-taking in the financial system, like the crackdown on peer-to-peer (“P2P”) lending, have the potential to be a double-edged sword. All Chinese P2P firms, companies that offer relatively small, unsecured loans via the internet, were ordered to clear outstanding loans in less than one year before switching to small loans, according to a notice issued in November 2019 by China’s Internet Financial Risk Special Rectification Work Leadership Team Office. They were given, at most, two years to make a clear exit from the industry. If these companies wanted to continue operations, they would have to become intermediaries that helped banks find small-business customers, or alternatively transition to providing small cash loans.

Then, following the suspension of the Ant Group’s IPO, Beijing drafted rules to regulate the more than 200 online microlenders. Some proposals included banning lenders from operating outside their provincial base unless given special approval from the Chinese Banking and Insurance Regulatory Commission (CBIRC), others suggested capping loans to individuals at US$45,000, or CN¥300,000. 

The changes are a part of China’s larger efforts to restrain a growing shadow-banking system and secure financial stability. However, the reforms have had their fair share of collateral damage. Executives in the lending industry have asserted that intermediaries are unlikely to be profitable. There is also the question of which firms would be granted that option. According to the Wall Street Journal, a Beijing-based executive of one publicly listed lender said there was a less than 50% chance that regulators would give even reputable platforms the approval needed to keep operating as a P2P lender.

Efforts to secure financial stabilization have thus made it difficult for small business borrowers and consumers to secure financing, which could have downstream implications for domestic entrepreneurship and consumerism. While the crackdown has been effective in addressing systemic financial risks, it has also reversed the benefits of reform, as many low-income consumers now have less access to credit. A curb in the credit-fueled excess over the past decade carries the risk of overcorrection that could stifle innovation in areas that drive financial activity.

Where Does This Leave China’s Tech Giants?

The question remains – ‘what comes next?’ Beijing has shown no signs of letting up in its regulatory crusade; in fact, policymakers released a five-year blueprint calling for greater regulation over significant areas of the economy that would provide a sweeping framework for an even broader crackdown on key industries.

The regulatory onslaught against China’s private sector has been intensifying and has complex motivating factors – among them a well-intentioned effort to curb anti-competitive practices that hurt small businesses and IT upstarts, political anxiety over the growing social influence of companies like Alibaba, and national security concerns over consumer data. Yet, it is still poignant to be cognizant that the “disorderly” expansion of private capital that policymakers aim to curb has produced immense wealth for the country and that a multi-fronted assault on the private sector will introduce its fair share of far-reaching economic risks. 

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