Geopolitics #1 | What's going on with China and its Tech Companies?

Something very interesting is happening in China. It’s the equivalent of taking a jackhammer to the foundations of a trillion dollar skyscraper.

ANT financial, Tencent, Didi, ByteDance and Meituan are the best known names whose values have collapsed after some surprising moves by the Chinese Government.

Nothing was spared. It’s open season on Fintech, Edtech and IPOs.

What Gives? Why would a country decide to rein in engines of insane value creation?

Is it an antitrust campaign (as advertised), or is it perhaps aimed at eliminating any chance of an alternative political power center emerge (aka Hong Kong) in these big tech companies?

Or perhaps, the government is redefining what Tech means? Huawei still has full support of the Chinese government and the country is still spending like crazy on AI capabilities.

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I think something more interesting is happening and it involves some serious long term considerations. Here’s a view from the political / regulatory lens:

1. Tech platforms are increasingly, a challenge to the traditional concepts of legitimacy of the nation state. They are becoming the gatekeepers to mass access and are effectively arbiters of rules of society. Even closer home, in India, the tussles between the government and twitter underscore a fundamental shift in the role these platforms play in how citizens find and react to information (good, bad or more distressingly, fake or warped).

2. In developing countries (yes, China is a developing country), strong institutions are the exceptions, not the norm. Tech platforms are effectively replacing institutions or are creating them. This is generally a problem for those in power.

3. Historically inaction is a choice. In an environment of high uncertainty, inaction is perhaps a better choice than action. Things can resolve themselves, opportunities or better understanding can manifest as things play out. Intervention that comes too soon likely ends up limiting options or pruning off profitable branches from the graph.

4. No regulation can be better than inept regulation. better to let things mature before regulating.

I would argue, dear reader, that China’s actions are timed with a maturing of the “tech” sector in the country.

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Now, here is a view from an pure economics / capital perspective:

1. Software companies make supernormal profits. Low overheads, network effects and IP allow them to generate high margins. This and fast growth leads to sky high valuations. But is a high valuation actual economic value? Are we conflating value of cash flow with value to economies?

2. What real value economic value is added by Google, Facebook et al? They dont pay taxes. They aren’t really innovating. What seems to be happening is value extraction and exploitation. Increasingly, R&D and IP creation is being replaced with business model innovation and leveraging of network effects.

3. Google’s market cap of 1.8 trillion is more than the market cap of the 10 largest food companies. Guess which one you can live without.

4. Dan Wang¹ writes in his 2020 letter:

   It’s 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, “we must recognize the fundamental importance of the real economy… and never deindustrialize.” 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.

5. So is the Chinese leadership saying that the profits of Alibaba and Tencent are not really results of innovation but rent extraction from gatekeeping or squatting on virgin digital real estate.

Or more importantly, has the Chinese leadership decided that the “real economy” is more important than all this (relatively) newfangled digital stuff?

Let me know.

1. If you don’t read his newsletters, you should. It’s perhaps the best ear to the ground view on what is going on in China and I love his writing.