Is There a Method Behind China’s Tech Crackdown Madness?

From big tech to edtech and fintech, it seems like anything with the word “tech” in it has been getting in trouble in China. The swift regulatory actions in China’s burgeoning tech sector over the last 6-8 months have caught observers and investors off guard. Many explanations have been proffered—from politics entering the 2022 “campaign season” to undermining the private sector—yet much remains murky about the rationale, the timing, and what may come next.

Rather than speculating further on what has transpired this year in the tech sector, we sought data to see whether a method can be divined from the recent madness. It turns out, it can be.

An examination of the 500 most valuable private companies on China’s Hurun list—about half of which are in the tech sector (sample of 238)—has elucidated what companies were targeted and may yield insights on how actions might be shaped going forward.

Our key findings are 1) regulators almost exclusively targeted “bits” (software) companies rather than “atoms” (hardware) companies; 2) regulatory actions taken appear correlated with firm size; 3) these actions were likely less political in nature but were vigorously pursued because of the available window of opportunity.

Virtually All Actions Aimed at “Bits”

Admittedly, “bits vs. atoms” is an imperfect taxonomy, since technology firms are typically diversified, especially when it comes to big tech. Many would consider Huawei a hardware company, even though it has been building out a cloud business in recent years. The same goes for Apple, which does both hardware and software.

But for the purposes of this analysis, the above taxonomy is useful in sorting the top 500 private Chinese firms. The 238 tech firms on the list were categorized into either bits (software) or atoms (hardware), which was determined by each company’s main business line or the largest share of revenue.

Among these 238 tech firms, about one-quarter, or 62 firms, had been subject to regulatory actions during the past year—such as fines, forced restructuring, regulatory mandates, or bans. For ease of reference, we call these actions collectively as “official reprimands” (see Figure 1). Conversely, this also means that 75% of top private tech firms remain unscathed, making this “regulatory storm” more of a summer thunderstorm than anything close to a hurricane.

Figure 1. 95% of “Bit” Companies ReprimandedSource: Hurun China 500 Most Valuable Private Companies 2020; MacroPolo.

The pattern seems clear cut: among the 62 firms that received official reprimands, 95.2% were bits firms. In the atoms category, only three firms got hit by reprimands. Even more striking, the portion of atoms companies that received reprimands relative to the total number of atoms in the sample (145) is just 2%. 

Larger Firms and Platform Companies Bear the Brunt

Among the 59 bits companies that received official reprimands, a whopping 93% were platform companies, such as Didi and Meituan (see Figure 2). The disproportionate targeting of platform companies isn’t particularly surprising—their very business models are optimized for scaling at little marginal cost, and the network effects they generate naturally enable them to establish dominant market positions. 

Figure 2. 93% of Platform Companies ReprimandedSource: Hurun China 500 Most Valuable Private Companies 2020; MacroPolo.

Reinforcing Beijing’s recent emphasis on antimonopoly and fair competition, the data also show a strong correlation between firm size and reprimands (see Figure 3). The portion of tech firms that received reprimands declined as firm size decreased, but the drop was particularly steep for bits and platform companies, which saw hit rates drop by 72 and 74 percentage points, respectively, from the top 100 to bottom 100.

Figure 3. Reprimands Declined Significantly as Firms Got SmallerNote: Platforms are a subset of bits companies. Total number of bits by tier: top 100 = 29; 101-200 = 18; 201-300 = 15; 301-400 = 13; 401-500 = 18; total number of platforms by tier: top 100 = 27; 101-200 = 14; 201-300 = 12; 301-400 = 8; 401-500 = 14.

Source: Hurun China 500 Most Valuable Private Companies 2020; MacroPolo.

Why Now? 

Some have noted that these actions have much to do with the politics of Xi Jinping’s third-term bid in 2022. That is certainly possible, but the “campaign season” technically doesn’t start until after the upcoming sixth plenum, while it appears the current bout of regulatory actions may have peaked.

A more fitting explanation for the timing, based on the findings above and the regulatory environment, seems economic. That is, the Chinese government has been preparing for action in the tech sector for quite some time. But knowing that these regulatory shocks would have economic repercussions, particularly in the stock market, Beijing needed an opportunity.

That window of opportunity presented itself earlier this year as the Chinese economy roared back from the pandemic. There is no optimal timing for such regulatory actions that will cause market gyrations, but 2021 is much safer than mid-pandemic or the upcoming political year of 2022. Had it not been for the US-China trade war and the pandemic injecting considerable economic uncertainty for the better part of two years, these actions likely would have arrived as early as 2019 or 2020.

Now that Beijing is unexpectedly dealing with a fallout in the property sector and an energy crunch, it’s likely that the tech sector will see calmer waters.

But regulating the market and monopolistic behavior is here to stay. Beijing had already set the stage institutionally in 2018 by consolidating three lower-level agencies into the ministerial-level State Administration for Market Regulation (SAMR). Creating a new high-level enforcement agency isn’t a trivial matter and it wasn’t just going to be for show.

In fact, by February 2021 SAMR clearly showed its hand when it released new guidelines that explicitly sought to “stop monopolistic behaviors in the platform economy and protect fair competition in the market.” This was followed by an October report that China plans to elevate the antitrust bureau within SAMR to deputy-ministerial level. If staffing demand is any indication—more than half of SAMR’s job openings in 2022 are for its antimonopoly bureau—Beijing appears quite serious about enforcing antimonopoly rules.

Now What?

The picture that emerges is one that’s basically consistent with the vision for technology outlined in China’s 14th Five-Year Plan. Almost all the “pillar industries” highlighted in it aren’t bits like e-commerce or crypto, but atoms such as new energy, high-end equipment, electric vehicles (EVs), and biotech.

Hardware companies such as Xiaomi have averted the regulatory storm, and the same goes for firms in emerging industries like Li Auto, Xpeng Motors, Mindray Bio-Medical Electronics, and Cambricon. Not only did these private firms see their market capitalization grow by upwards of 100% in 2020, they are in sectors that will likely see continued support.

Even within bits, there’s “selective targeting.” For example, Baidu may be down a bit but it is hardly out. The search company’s platform for autonomous vehicles (AVs), Apollo ACE, has received significant backing from local governments—as of June 2021, 20 Chinese cities have signed major contracts totaling 200 million yuan (~$31 million) to deploy the technology. Like its competitors Alibaba and Huawei, Baidu also runs a considerable cloud computing business that saw 71% revenue growth in 2Q2021.

So far, Beijing appears deliberative in exerting its regulatory muscles, and is careful to not stifle the tech sector writ large. At the same time, Beijing has also shown a strong bias toward certain technologies that it thinks are more integral to China’s future development.

As such, capital markets seem to agree that the storm has passed, as capital is rushing back into China’s tech stocks. But going forward, one potential way to establish some predictability is to consider China’s tech sector as composed of two asset classes: broadly speaking industrial technologies and platform/content technologies (with artificial intelligence a crossover because it has multiple applications). The latter could carry a higher regulatory risk premium as Beijing wants to show its newfangled teeth in regulating markets.

Ruihan Huang is a research associate at MacroPolo. You can find his work on politics, policy, and other topics here.

Joshua Henderson is a student fellow at MacroPolo.