China’s sudden regulatory action against Didi, the newly-listed ride-hailing company, is the latest in a series of increasingly stringent measures taken against the country’s flourishing technology sector. Even if these steps have some justification on security and anti-monopoly grounds, they will likely diminish the appetite of overseas investors for Chinese startups and deter the Chinese diaspora from starting new ventures in mainland China.  

In turn, such outcomes will undermine the “community of common destiny” that has propelled China’s technology sector into its leading position globally. 

For two decades, beginning in the late 1990s, China seemed to have stumbled on the perfect formula for nurturing some of the world’s most successful internet companies. The government spent billions of dollars modernizing the country’s telecommunications infrastructure. Meanwhile, technically and culturally savvy entrepreneurs — both at home and among the Chinese diaspora — adapted successful Western online models for the China market. Chinese internet entrepreneurs, in time, invented new applications for internet services, in the process revolutionizing entire industries, such as digital payments.

For the first decade of internet entrepreneurship in China, the government largely left these fledgling companies and their domestic and foreign investors alone. Today’s internet giants, such as Tencent, Baidu and Alibaba, all set down their roots during this period of benign tolerance. Following this near-decade of unfettered development, subversive political comment and critical remarks on Chinese social media elicited a government crackdown, with new requirements imposed on companies to carry out internal censorship. Still, from a business perspective, the requirement to censor content amounted to little more than a tax for most of these platforms. The ways in which tech entrepreneurs raised money, recruited talent, and developed their technologies were not fundamentally hampered by government intervention.

This has all changed in recent months. First, the government put a stop to Ant Financial’s planned IPO in New York last November, and demanded a fundamental revision of the company’s business model, requiring it to become, in effect, a heavily regulated bank instead of a nimble technology company. Next, various regulators “requested meetings” with major e-commerce platforms such as Alibaba, Tencent and Pinduoduo, accused them of monopolistic behavior and imposed fines. Of course, companies can face antitrust litigation in the U.S. too, but well-funded tech giants there usually show up with an army of lawyers to fight such charges, often successfully. In China, even the biggest tech companies have little legal recourse against the regulators.

The latest government salvos against the tech sector have seen the Cyberspace Administration of China, a subsidiary of a powerful leading group chaired by President Xi Jinping himself, forcefully take down Didi’s app from all of the country’s app stores, effectively preventing new users from registering for its services while the regulator carries out a potentially lengthy “internet security audit.” All internet companies hosting private user data in China will be required to undergo such audits from now on, especially those companies — like Didi — that are aiming for overseas listings. 

By undermining this international community of investors and entrepreneurs, the Chinese government is moving the country ever closer toward the reality of an economic decoupling from the rest of the world.

The CAC’s as-yet uncertain security demands may well clash with the disclosure requirements placed on companies by the U.S. Securities and Exchange Commission, as well as those of financial regulators in the U.K. and Singapore, making future overseas listings of Chinese tech companies far more difficult. Even companies already listed overseas may be forced to delist in jurisdictions where compliance with the CAC’s new demands is tricky.

The medium-term consequences of this series of events will be two-fold, with neither good for China’s tech industry. First, global venture capital firms will be discouraged from investing in Chinese startups, given the diminished prospect of an eventual U.S. or U.K. listing for the company as a way for them to exit from some or all of their investment. Sure, such companies could list in China itself but markets there still struggle to provide the degree of transparency and liquidity such investors usually require. Even the prospect of a listing in Hong Kong is becoming less attractive because those listings can now be delayed or canceled by mainland regulators, while disclosures to investors will be uneven depending on the cybersecurity demands of CAC and other Chinese agencies.   

The diminished prospect of an overseas listing would also weaken the incentive for entrepreneurs from the Chinese diaspora, or even those at home, to start businesses in China. For decades, China’s growing internet user base, rapidly improving infrastructure and the government’s previously benign tolerance and willingness to provide subsidies gave such entrepreneurs strong reasons to found their companies in China. 

But today, user base growth is already limited and could start to decline as China’s broader population decreases, while the country’s telecommunications infrastructure is already well advanced, leaving little room for vast improvement. With various authorities now imposing onerous regulation on firms, often in a seemingly arbitrary manner, the value proposition for internet entrepreneurship is under further threat. The most talented engineers in China have the alternative option of starting their businesses in places like the U.S. or Singapore. Some, like Eric Yuan of Zoom, have achieved phenomenal success without relying on the China market at all. The latest crackdown will encourage more to follow in his footsteps.   

China’s central government has often emphasized the importance of creating a “community of common destiny” with other nations. In a sense, China had already successfully created such a community in the technology sector, especially on the software side. Eager investors from around the world have jostled to identify the next unicorn in China, founded by the strongest engineers and savviest businesspeople in China and in the Chinese diaspora. 

This community of transnational investors and entrepreneurs has shared the risks of failed ventures as well as the rewards of successful ones which go on to list on major global exchanges. Because of the transnational nature of the community, its members have had strong incentives to support relatively free commercial and financial exchange between China and the rest of the world. They also want cutting edge technologies to emerge in China, sharing the goals of the Chinese government. 

By undermining this international community of investors and entrepreneurs, the Chinese government is now moving the country ever closer toward the reality of an economic decoupling from the rest of the world.

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