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Those who pay attention to business news have probably noted an interesting and curious phenomenon over the past few months: China is smashing its internet companies. It started \u2014 or at least, most people in the U.S. started noticing it \u2014 when the government effectively canceled the IPO of Ant Financial<\/a>, then dismantled the company. Jack Ma, the founder of Ant and of e-commerce giant Alibaba, was summoned to a meeting with the government and then disappeared for weeks. The government then levied a multi-billion dollar antitrust fine against Alibaba (which is sometimes compared to Amazon), deleted its popular web browser from app stores, and took a bunch of other actions against it. The value of Ma\u2019s business empire has collapsed<\/a>.<\/p>\n\n\n\n But Ma was only the most prominent target. The government is also going after other fintech companies<\/a>, including those owned by Didi (China\u2019s Uber) and Tencent (China\u2019s biggest social media company). As Didi prepared to IPO in the U.S., Chinese regulators announced they were reviewing the company on \u201cnational security grounds\u201d, and are now levying various penalties<\/a> against it. The government has also embarked on an \u201cantitrust\u201d push, fining Tencent and Baidu<\/a> \u2014 two other top Chinese internet companies \u2014 for various past deals. Leaders of top tech companies (also including ByteDance, the company that owns TikTok) were summoned before regulators and presumably berated. Various Chinese tech companies are now undergoing \u201crectification\u201d<\/a>.<\/p>\n\n\n\n For those outside China\u2019s byzantine, opaque nexus<\/a> of party, government, and big business, it\u2019s very difficult to figure out what\u2019s going on. Just who is ordering these actions is not clear, or what the ultimate result of the crackdown will be. That makes it very hard to figure out why it\u2019s happening. Some observers see this as an antitrust campaign<\/a>, similar to the ones going on in the U.S. or the EU. China\u2019s leaders famously want to prevent the emergence of alternative centers of power, but is the West so different in this regard? One of the driving motivations behind the new antitrust movement<\/a> in the U.S. is to curb the political power<\/a> of Big Tech companies specifically; if you wanted to, you might see the Chinese tech crackdown as simply a Neo-Brandeisian movement on steroids.<\/p>\n\n\n\n But the breadth of the Chinese crackdown suggests a major difference. The U.S. has slapped down a few of its corporate giants before \u2014 Microsoft, AT&T, Standard Oil \u2014 but ultimately it didn\u2019t crush the industries these companies were a part of. We\u2019re unlikely to see major action against all the U.S. internet companies at once, and broad EU action will likely take the form of new rules rather than a sweeping crackdown. China\u2019s attack on its tech companies, in contrast, seems far more comprehensive \u2014 it\u2019s not just attacking the biggest internet companies<\/em>, it\u2019s attacking the entire sector<\/em>. (Update: An important piece of evidence here is that China also appears to be reducing venture funding. If you want more competition you don’t squash new entrants!) For whatever reason, China is suddenly not a fan of the industry we call \u201ctech\u201d.<\/p>\n\n\n\n This is strange because for years, it was conventional wisdom in the Western media that having a \u201ctech\u201d sector was crucial to innovation and growth etc. In fact, for many years American pundits argued<\/a> that China\u2019s economy would be held back by the government\u2019s insistence on control of information, because it would make it impossible for China to build a world-class tech sector! Then China did build a world-class tech sector anyway, and now it\u2019s willfully smashing the world-class tech sector it built. So much for U.S.-style \u201cinnovation\u201d.<\/p>\n\n\n\n But notice that China isn\u2019t cracking down on all of its technology companies. Huawei, for example, still seems to enjoy the government\u2019s full backing<\/a>. The government is going hell-bent-for-leather<\/a> to try to create a world-class domestic semiconductor industry, throwing huge amounts of money at even the most speculative startups. And it\u2019s still spending heavily on A.I.<\/a> It\u2019s not technology that China is smashing \u2014 it\u2019s the consumer-facing internet software companies that Americans tend to label \u201ctech\u201d.<\/p>\n\n\n\n Why do Americans equate \u201ctech\u201d with companies like Google, Amazon, and Facebook, anyway? One reason is that the consumer internet industry is something America is really good<\/em> at \u2014 unlike our electronics hardware industries, consumer software is something that hard-driving Asian competitors haven\u2019t yet been able to beat us at. Another reason is that software companies make a lot of profit<\/a> \u2014 Facebook made over $18 billion in 2020, three times Micron or Honeywell and six times Cisco. With their low overhead, network effects, troves of intellectual property, strong brand value, and differentiated products, successful software companies naturally tend to generate high margins. That\u2019s true for smaller software companies as well as big ones. And since in America we often tend to equate profit with value, this means we think of the consumer-facing software industry as being our industrial champion, generating a huge amount of economic value for our nation.<\/p>\n\n\n\n China may simply see things differently. It\u2019s possible that the Chinese government has decided that the profits of companies like Alibaba and Tencent come more from rents than from actual value added \u2014 that they\u2019re simply squatting on unproductive digital land, by exploiting first-mover advantage to capture strong network effects, or that the IP system is biased to favor these companies, or something like that. There are certainly those in America who believe that Facebook and Google produce little of value relative to the profit they rake in; maybe China\u2019s leaders, for reasons that will remain forever opaque to us, have simply reached the same conclusion<\/a>.<\/p>\n\n\n\n But in fact I suspect that there is something else going on here. If you\u2019re interested in China and its economy, one analyst you should definitely read is Gave Kal Dragonomics\u2019 Dan Wang<\/a>. And in Dan\u2019s 2019 letter<\/a>, I noticed the following passage I find it bizarre that the world has decided that consumer internet is the highest form of technology. It\u2019s not obvious to me that apps like WeChat, Facebook, or Snap are doing the most important work pushing forward our technologically-accelerating civilization. To me, it\u2019s entirely plausible that Facebook and Tencent might be net-negative for technological developments. The apps they develop offer fun, productivity-dragging distractions; and the companies pull smart kids from R&D-intensive fields like materials science or semiconductor manufacturing, into ad optimization and game development.<\/p>\n\n\n\n The internet companies in San Francisco and Beijing are highly skilled at business model innovation and leveraging network effects, not necessarily R&D and the creation of new IP\u2026.I wish we would drop the notion that China is leading in technology because it has a vibrant consumer internet. A large population of people who play games, buy household goods online, and order food delivery does not make a country a technological or scientific leader\u2026These are fine companies, but in my view, the milestones of our technological civilization ought to be found in scientific and industrial achievements instead.<\/p>\n\n\n\n Dan\u2019s job is to keep his ear to the ground, figure out what the movers and shakers in China think, and relay those thoughts to us. So when he started talking about the idea that consumer internet tech isn\u2019t real \u201ctech\u201d, I immediately wondered if China\u2019s leaders were thinking along the same lines. And then in his 2020 letter<\/a>, Dan wrote:<\/p>\n\n\n\n It\u2019s become apparent in the last few months that the Chinese leadership has moved towards the view that hard tech is more valuable than products that take us more deeply into the digital world. Xi declared this year that while digitization is important, \u201cwe must recognize the fundamental importance of the real economy\u2026 and never deindustrialize.\u201d This expression preceded the passage of securities and antitrust regulations, thus also pummeling finance, which along with tech make up the most glamorous sectors today.<\/p>\n\n\n\n In other words, the crackdown on China\u2019s internet industry seems to be part of the country\u2019s emerging national industrial policy<\/a>. Instead of simply letting local governments throw resources at whatever they think will produce rapid growth (the strategy in the 90s and early 00s), China\u2019s top leaders are now trying to direct the country\u2019s industrial mix toward what they think will serve the nation as a whole.<\/p>\n\n\n\n And what do they think will serve the nation as a whole? My guess is: Power<\/em>. Geopolitical and military power for the People\u2019s Republic of China, relative to its rival nations.<\/p>\n\n\n\n If you\u2019re going to fight a cold war or a hot war against the U.S. or Japan or India or whoever, you need a bunch of military hardware. That means you need materials, engines, fuel, engineering and design, and so on. You also need chips to run that hardware, because military tech is increasingly software-driven. And of course you need firmware as well. You\u2019ll also need surveillance capability, for keeping an eye on your opponents, for any attempts you make to destabilize them, and for maintaining social control in case they try to destabilize you.<\/p>\n\n\n\n It\u2019s easy for Americans to forget this now, but there was a time when \u201cability to win wars\u201d was the driving goal of technological innovation<\/a>. The NDRC<\/a> and the OSRD<\/a> were the driving force behind government sponsorship of research and technology in World War 2, and the NSF and DARPA grew out of this tradition. Defense spending has traditionally been a huge component<\/a> of government research-spending in the U.S., and many of America\u2019s most successful private-sector tech industries are in some way spinoffs of those defense-related efforts.<\/p>\n\n\n\n After the Cold War, our priorities shifted from survival to enjoyment. Technologies like Facebook and Amazon.com, which are fundamentally about leisure and consumption, went from being fun and profitable spinoffs of defense efforts to the center of what Americans thought of as \u201ctech\u201d.<\/p>\n\n\n\n But China never really shifted out of survival mode. Yes, China\u2019s leaders embraced economic growth, but that growth has always been toward the telos of comprehensive national power. China\u2019s young people may be increasingly ready to cash out and have some fun<\/a>, but the leadership is just not there yet. They\u2019ve got bigger fish to fry \u2014 they have to avenge the Century of Humiliation and claim China\u2019s rightful place in the sun and blah blah.<\/p>\n\n\n\n And so when China\u2019s leaders look at what kind of technologies they want the country\u2019s engineers and entrepreneurs to be spending their effort on, they probably don\u2019t want them spending that effort on stuff that\u2019s just for fun and convenience. They probably took a look at their consumer internet sector and decided that the link between that sector and geopolitical power had simply become too tenuous to keep throwing capital and high-skilled labor at it. And so, in classic CCP fashion, it was time to smash.<\/p>\n\n\n\n Excerpted from<\/em> https:\/\/noahpinion.substack.com\/p\/why-is-china-smashing-its-tech-industry<\/em><\/a><\/p>\n","protected":false},"excerpt":{"rendered":"