Capitalism with Chinese Characteristics

 A few years ago, as manager of the graduate economics program at the University of San Francisco, part of my job was to recruit qualified students. Consequently, I read hundreds of transcripts from Chinese students. They all had two classes in common. Some type of military training and a class called, “Socialism with Chinese Characteristics.”

I always wondered about the syllabus for that class. Recent Chinese government actions are making its essential elements come to life.

In October last year, Jack Ma of Alibaba, lashed out at Chinese banks comparing them to “pawn shops.” Almost immediately his $37 billion IPO for the ANT Group, an on-line lender, was cancelled and Mr. Ma vanished from public view for months. At the time, market participants saw this an isolated incident by the Chinese Communist Party (CCP) teaching Mr. Ma a lesson for shooting off about his governmental competitors.

Now we know this was just the beginning of a broad multi-year effort to re-structure the technology sector to ensure it serves the goals of the party. The two vectors leading the effort are Cyberspace Administration of China (CAC), the entity that manages their vast censorship apparatus and State Administration of Market Regulation (SAMR), the anti-trust regulator.

Here are some initial steps according to SupChina:

  • Didi Global (the Chinese version of Uber) launched its $4.4 billion IPO on June 30. Two days later the CAC suspended downloads of their app for violating data security rules. The stock lost $24 billion in value in a few days.
  • The dormant enforcement of anti-trust rules came to an abrupt end as Alibaba was fined $2.8 billion. The SAMR accused 34 other firms of similar violations.
  • Meituan, the food delivery app, received a $1 billion fine for “abusing its market position.”
  • New Oriental Education and several other on-line training companies had their business models re-aligned so that future net profits will not be a number different from zero. New Oriental lost 89% of its value.

As profiled in the Economist, the stated goal of the CCP is an “orderly development of capital” with an emphasis on “social fairness” and “national security.” Thus, reducing the market power of the large tech firms and increasing competition in the sector is the order of the day. As the dust settled on this first round, the Chinese tech sector had lost $1 trillion in market capitalization.

Importantly, the CCP has also defined data as a “factor of production” similar to labor, land, technology and other physical assets. This underlies their desire to have Internet companies share data more readily – especially with the government. It will also give them an easier public explanation when they take control of this “factor of production.” Detailed data on individuals is key to strengthen the party’s authoritarian design.

The negative $1 trillion market impact is simply an accounting of the political risk attached to investing in China. The crackdown has also prompted steep declines in dollar denominated Chinese junk bonds as yields reached 14% a 10-percentage point premium over similar quality U.S. issues. Raising capital in the Chinese tech sector just got a lot more expensive.

Foreign investors are finally recognizing the extreme political risk embedded in any Chinese based entity. In an authoritarian environment where government regulations are inherently politicized and unstable and the legal system is chaotic and unpredictable, every investment necessarily takes on a speculative profile.

The Didi Global IPO has startled even the somnolent SEC to wakefulness. After years of struggling to convince Chinese issuers to comply with U.S. accounting principles they have now added a risk disclosure requirement around potential government intervention in their business.

“Public companies must disclose significant risks which, for China-based issuers, may sometimes involve risks related to the regulatory environment and potential actions by the Chinese government,” declared Allison Lee, acting head of the Commission.

All of this forms a pretty uncomfortable reflection of our own political process and the evident frustration in congress over their inability to control and direct the technology giants. In Senator Warren’s term they should be “accountable capitalists” and align their activities more closely with the government’s objectives.

California’s Proposition 22, was an effort to make app-based gig companies more “accountable.” It would have required Uber and Lyft (the U.S. versions of Didi Global), to hire all of their drivers as employees delivering a rich target for the unions that provide the lifeblood of the Sacramento legislators. In the event, consumers and other voters provided a 16-point margin of victory for the gig-workers.

I recall watching the zoomed-in testimony of Zuckerberg, Dorsey and Pichai to congress on March 25th. Their responses and general demeanor mirrored that of the head of a government agency that was beholden to these politicians for its existence. For their part, the representatives expressed some satisfaction that these tech giants were making efforts to censor posts that did not aligned with their political views but they wanted more robust action on that score in the future.

Finally, we cannot help but wonder whether the SEC will begin requiring more complete political risk disclosures “related to the regulatory environment and potential actions by the [U.S.] government.”

-Jim Anderson

 

 

 

 

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