The beginning of fall seems to mark a bit of a lull in China’s regulatory crackdown. The focus has shifted back to more traditional areas of concern, such as power shortages, debt reduction, and managing the frothy Chinese real estate sector. Nonetheless, the rapid and wide-ranging regulatory rules issued during the summer of 2021 have changed the narrative on financial markets in China. What was once touted as the financial opportunity of the century is now seen as a highly risky proposition, even “un-investable.”
The regulatory offensive has mainly come at the expense of privately owned technology companies, many of them listed on stock markets abroad. Other sectors, such as steel and real estate, have also landed in regulator’s crosshairs, but market actors have grown especially concerned about the perception of a wider crackdown on private business in China. Regulation has focused on the whole educational technology sector, new fintech ventures such as Ant Financial, large platform companies like Alibaba and Meituan, as well as entertainment and gaming, a staple for mobile-giant Tencent. Ultimately, a who’s who of China’s most successful private technology firms are targets.
Much of the regulations are a matter of catching up to a new reality: large platform companies have carved out monopoly positions with their access to massive amounts of user data. Several of the most significant regulations are actually based on foreign precedents, such as the European Union’s data protection laws, specifically the General Data Protection Regulation. Others are unique to Chinese circumstances, mainly the crackdown on private for-profit technology enhanced tutoring services. Indeed, it was this crackdown that proverbially broke the camel’s back and caused a change in the market narrative on China.
One of the factors driving the change in market perceptions is the speed with which regulations have been issued, and their profound nature. In some cases, such as education technology and fintech, regulations are altering the business models of whole industries in one fell swoop. The regulatory onslaught could thus be considered well-intentioned, yet badly implemented.
Nevertheless, the change in tone on investing in China is rooted in more fundamental concerns. At the extreme, American commentators see this as a return to the practices of the command economy, “a policy of total control.” This is clearly spooking market actors, who fear this crackdown will support the Chinese state sector at the expense of private business.
More seasoned analyses also see an “unsettling” influence of national security concerns on economic policy and efforts to increase control over the Chinese private sector, as a recent report by the European Chamber of Commerce argued. Similarly, The Economist stresses that such crackdowns could create a drag on innovation and efficiency, and thus prove self-defeating for China’s economic development.
At the center of such arguments are fundamental debates in political economy. Since the 1980s, the laissez-faire approach embodied by the Washington Consensus has been globally dominant. However, the European social-democratic model of providing welfare supports with economic coordination as well as Japan’s model of industrial policy intervention continue to provide alternative politico-economic models.
Stephen Roach, a long-time optimist on China’s economy, expresses the central worry of the laissez-faire crowd. The full force of Chinese government regulation could strangle the business models and financing capacity of the economy’s most dynamic sectors. On the other hand, Chinese policy makers and commentators argue that new regulations are necessary to reign in counter-productive forces in the economy, such as monopoly power, over-commercialization, and growing income inequalities. Data security is also cited as a justification, considering its sensitive nature and the potential of Big Data to push artificial intelligence and other innovations.
At this point, it is safe to say that the Xi Jinping administration took advantage of an opportune time to implement policy adjustments that would be immediately damaging. Since late 2020 the Chinese economy has benefited from considerable capital inflows and a large current account surplus due to booming exports. The domestic economy also has been stabilizing after the see-saw created by the COVID-19 pandemic.
Xi might have seen this as a suitable time to launch a long-planned effort to restructure the economy. In part, political calculations could have loomed large, such as buttressing his legitimacy with the upcoming Party Congress in 2022, when he will seek an unprecedented third term as President. Rather than being perceived as “captured by the wealthy,” the Chinese Communist Party leadership is now projecting the image of reigning in China’s super-rich.
There are clear historical parallels to events in Europe and America. The Progressive Era and the New Deal in the United States, as well as various efforts by European states to constrain the powers of capital and establish social democratic models starting in the 1930s represent historical episodes of states aiming to protect societies from the more extreme vagaries of markets and private capital.
Similar to these political economies, China was passing through a Gilded Age as Xi came to power in 2012. While far wealthier than before, China confronted a host of problems connected to its Gilded Age, ranging from extreme corruption to rising inequality and a massive debt overhang.
Xi thus seems determined to stage his own progressive reform push. But this introduces a significant twist. While many of the reforms in Western countries were triggered by popular pressures from the bottom-up, the Communist Party is framing this as a return to its “original mission.” It is staging a revolution from above with limited political consultation, transparency, and debate.
Since timing is of essence, these reforms have been rolled out in an extremely rapid fashion with little recourse for companies, workers, and investors who are hurt. There is a logic to this, since even in Western democracies progressive reforms tend to be the result of politico-economic crises during which opposition is muted or unable to organize.
What we are witnessing therefore is a historically unprecedented effort to progress capitalism through authoritarian command and control to make it more sustainable, beneficial for society, and conducive to economic upgrading. Only Singapore might serve as a historical parallel, but even there, elections and popular pressures, as well as a more institutionalized legislative process created a different policy-making environment.
In the end, the central question of political economy endures: Can the Chinese state put increasing constraints on business activities, even creating or destroying whole industries at will, while keeping entrepreneurship, innovation, and growth humming? Can it successfully steer economic activities away from social media and finance into new industries and manufacturing?
Only time will tell. This great debate of political economy has not yet been resolved, as the global capitalist system has swung from laissez-faire periods to the managed capitalism of Keynes and back again. Developmental states such as Japan have scored great successes, though later succumbed to economic lethargy. And the social democratic models of Germany and Sweden have continued to deliver decent economic growth with fewer social dislocations as in more laissez-faire systems.
The dangers in China are unique, however. No other state undertaking progressive reforms was so powerful with such few constraints on its actions. In fact, each time a state intervenes in the economy there are costs. But the biggest danger is that the state cannot resist continually intervening, creating unpredictability and political risk for capital that saps the economy’s lifeblood over time.