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Original illustration for Echowall by Tse Yuet Ching. 

08:09 am | 22. October 2019

Boxing In China's Innovators

Top technology firms in China now account for almost half of the top-20 global firms. But as these companies seek to develop globally, their close association with the Chinese government is a force that both pushes them forward and holds them back.

By Wen Kejian

On September 20, 2019, the city government in Hangzhou, a coastal city in southeastern China, announced it would dispatch “government affairs representatives” to 100 key enterprises. Government officials claimed this was an “innovative measure” in “new manufacturing industry planning,” designed to provide full support to companies in dealing with a range of administrative affairs, including policy communication and project implementation. Hangzhou is one of China’s key national centers for technology companies, home to tech giants like Alibaba and Hikvision.

At a time when China’s government is strengthening its hold over all aspects of Chinese society, the announcement in Hangzhou was interpreted by many people as an intensification of controls on enterprises. Some speculated that this might be a replay of the so-called “public-private partnerships” of the 1950s, a widespread process of collectivization by which the Chinese Communist Party stripped private companies of their ownership.

Facing a climate of growing concern, the Hangzhou government later replied that the public was over-reacting, and that these so-called government affairs representatives would not affect business decisions. While it is difficult to tell how the situation in Hangzhou might unfold, the case reflects the tangled relationship between the Chinese government and important and influential companies. 

Co-Dependent Giants

The rapid rise over the past decade of Chinese tech giants like Alibaba, Tencent and Huawei has been eye-popping. They have gone from being virtual unknowns to being global giants both in terms of scale and market value. 

According to data from the World Economic Forum, of the world’s top 20 companies in terms of market value as of May 2018, 11 are from the United States and 9 are from China. In this respect, Europe has been entirely left behind. China’s tech champions operate around the world, providing competitive products and services. 

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No European companies appear on the roster of the world's top 20 tech firms by market capitalization. SOURCE: Kleiner Perkins Internet Trends Report 2018, Forbes, Company Reports.

As China’s most valued internet companies, Alibaba and Tencent are still heavily reliant on the domestic market as the base of their businesses and their primary source of profit, even though their businesses have expanded across the world. This is the chief reason why these companies must continue to bow at the feet of the Chinese government. 

Further complicating the relationship, the Chinese government regularly extends special privileges to these giants, as when Alibaba’s Alipay and Tencent’s WeChat entered the sector of payment services and received preferential treatment from Chinese monetary authorities. Mybank and Webank, the banks established by Alibaba and Tencent respectively, benefit from various policy preferences as well. 

As these companies compete with transnational giants from the United States, they can trust that the Chinese government is on their side. In 2010, for example, Google was driven out of China, and the search engine giant Baidu as a result gained a virtual monopoly in the field of search engine services – a benefit unimaginable without the government assistance.

As these companies compete with transnational giants from the United States, they can trust that the Chinese government is on their side

 

Similarly, Tencent’s WeChat dominates the domestic market and can explore global business opportunities even as Facebook remains banned in mainland China. Similarly, Alibaba’s various businesses benefit across the board from administrative barriers and government support. In a normal market, these companies would instead face anti-monopoly actions. 

As China seeks to “innovate” social and political controls through AI and surveillance, governments at every level in China are also important clients of domestic tech companies. One of many examples is iFlytek, China’s leading AI company, which relies heavily on government orders and subsidies, not least to support “smart city” initiatives, which have essentially created an industry out of China’s monitoring of its own citizens. 

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Video cameras like this one in an alley in the city of Qingdao are now virtually everywhere in today's China. Images by Gauthier Delacroix available at Flickr.com under CC license

Innovating Social Controls

Domestic media reports in China have referred to smart cities as a “new wind gap” – an area, in other words, of red-hot investment. By the end of 2017, over 500 cities had either begun smart city development or had announced their intention to become smart cities. It is estimated that by 2021, the scale of this market in China will reach 240 billion euros (260 billion dollars). This will involve the building of more than 5,600 data centers, consuming 120 billion kilowatt-hours of electricity per year. This is more than current annual electricity consumption in Beijing and equal to the annual output generated by the Three Gorges Dam. 

This massive market, chiefly the result of government financing, has attracted an influx of private companies hoping to profit from urban security and surveillance. The four most competitive companies in the field at present are Ping’an, Alibaba, Tencent and Huawei, referred to lately as “PATH.” Other players include JD, ZTE, Baidu, and iFlytek. 

The fastest growing areas within the push for smart cities have been “smart surveillance” (智慧安防), “smart traffic” (智慧交通) and “smart communities” (智慧社区). The government pays for these programs, while the police monitor society and control the data generated in the process. Consider that officials in Shanghai, one region leading the smart city push, have said that the development of “smart police should come before smart city [development],” and that the emphasis “must be on constant vigilance, with prevention [of problems] being of foremost importance.”  

According to one domestic study, the principle and most crucial aspect of the “smart city” concept is security, the so-called “safe city.” The concept of the “safe city” has developed in a number of phases in China.

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2003 to 2006: The introduction of the Golden Shield Project (金盾工程), a project to digitalize the public security bureau and build local area networks completely isolated from the public internet.

2005: The start of Project 3111 (3111工程, an engineering project organized by the Ministry of Public Security to advance construction of urban security surveillance. 

2007: The beginning of SkyNet (天网工程), a digitalization project consisting of GIS (Geographic Information Systems) mapping, the development of software and related equipment to capture, transfer, display and control images that enable monitoring and recording of specified areas, particularly urban areas. This project was initiated by Central Political and Legal Affairs Commission (the CCP’s political and legal affairs office), and implemented by the Ministry of Public Security and the Ministry of Information Industry. 

2016: The introduction of “Project Dazzling Snow” (雪亮工程), also known in English as the “Sharp Eyes Project.” This is a national public security surveillance system focusing on the countryside in China, with command centers at the county, town and village levels to be connected to digital surveillance networks under a grid management system.

China has already become a surveillance state, with big data and AI technology integrated into a comprehensive surveillance system.

 
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Bing Xu, a co-founder of the Chinese tech firm SenseTime, boasts at a 2018 conference in Las Vegas that his company powers  'the world’s largest surveillance network." Images by Steve Jurvetson available at Flickr.com under CC license. 

These initiatives, which are being backed with massive technological support, aim to construct an omnipresent, seamless and controllable surveillance system. Today, all of China’s major cities have camera surveillance systems in place. It is estimated that by 2022, less than three years from now, the number of surveillance cameras in China will further increase by 213 percent, reaching roughly 626 million surveillance cameras in operation – meaning one camera for every two Chinese people. 

China has already become a surveillance state, with big data and AI technology integrated into a comprehensive surveillance system. In the process, giant tech companies like Huawei, Hikvision, Alibaba and Tencent have each become important technology providers.

Aside from real-time surveillance of its citizens, China is pushing ahead with the establishment of its so-called “enterprise social credit system.” The government’s ultimate goal is to build a central database that can be used to track, record, publicize and share credit ratings and credit records of Chinese companies, the database serving as a risk prediction and warning mechanism to prevent corporate misconduct. Companies with low credit ratings would be subject to various forms of penalty. 

Official statements have sought to explain that while credit agencies in the West publicize corporate financial information and leave it to the market to  deal with companies, “China’s social credit system is a tool used [by the state] to govern the economy and the society.” Some legal professionals in China have criticized the government’s overarching role in this process of penalization, arguing that in this case administrative policies are upstaging the law. But the “enterprise social credit system” has already the final key stage of its development. By September this year, it had encompassed 33 million companies, with its sights on comprehensive coverage of all private companies in China. 

All companies operating in China must take this grading system seriously and abide by it, lest they be expelled from the market. Just as with the systems monitoring China’s citizens, major tech firms like Huawei, Alibaba and Tencent are heavily invested in this grand project to collect extensive data on private companies. 

Monitoring the Surveillance Companies

Naturally, those companies applying their innovation capabilities to help the government achieve its goal of comprehensive surveillance cannot themselves escape the government’s watch list. 

Aside from the so-called “government affairs representatives” mentioned at the outset of this article, the CCP has pushed the establishment of party organs in both private companies and foreign-owned companies. CCP organizations exist in nearly every private company of a sufficient scale in China. In the private sector, internet companies and tech companies are more likely than companies in other sectors to have CCP party branches. Alibaba has around 200 party branches nationwide. Tencent has 89. 

In a list of top 100 distinguished contributors during the reform period in China, published in the Party’s official People’s Daily newspaper, Alibaba founder Jack Ma was introduced as a Party member. This was the first time this information about Ma had been released, and the story became international news. It is by no means a secret, however, that many of China’s well-known entrepreneurs are members of the Party, including SANY Group founder Liang Wengen, Dalian Wanda’s Wang Jianlin, Evergrande Group’s Xu Jiayin, Lenovo’s Liu Chuanzhi and Huawei’s Ren Zhengfei. 

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Alibaba founder Jack Ma is all smiles at the 20th Anniversary Schwab Foundation Gala Dinner on September 23, 2018. Ma resigned as executive chairman of Alibaba in September 2019. Image by World Economic Forum Foundations available at Flickr.com under CC license

The establishment of Party branches in private companies and the enlistment of founders and managers as Party members is more than just symbolic. It can have a huge influence. While the function of Party committees can vary from company to company, depending on their internal processes, the committees generally have broad authority, enabling them to intervene in major decisions and policies – including the appointment and removal of important officials, decisions on major investments, and approval of large-scale expenditures. All of this happens in the name of “maintaining national security” and “defending state property and profit.” 

According to recent unverified reports that have been widely discussed in China, an independent non-executive director at Tencent who now serves on the corporate governance committee was an appointment made directly by the Organization Department of the CCP Central Committee, the same body deciding on the appointment of Party officials. At the very least, such appointments guarantee a company’s loyalty so that it can be expected to pose no challenge to the existing political system. 

At the very least, such appointments guarantee a company’s loyalty so that it can be expected to pose no challenge to the existing political system. 

 

Beyond the exercise of control through management and Party affiliation, another play the government can use is direct investment in tech giants. State-owned investment funds like CIC Huijin already hold stakes in Alibaba and Tencent, and there has been talk of plans by the government to take one percent “special shares” in major tech companies like Tencent, Weibo, and the video hosting services Youku and Tudou. While the percentage of shareholding is low, these shares were rumored to come with the right to take part in corporate decision-making as well as veto powers. 

These plans drew concerned reactions from Chinese society, and since seem to have been shelved. But there are other ways that state capital is already closely enmeshed with Alibaba and Tencent, for example, through participation in the government’s re-development initiative in northeastern China. Not long ago, both of these companies signed strategic agreements with provincial governments in Heilongjiang and Liaoning to develop smart cities, e-government and the industrial internet. 

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Huawei President Ren Zhengfei has insisted his company's equipment will never be used for surveillance. Image by celianr available at Wikimedia Commons under CC license

Laws in China on national security and cybersecurity are further checks on the country’s tech giants. Implemented in 2015, the National Security Law stipulates that companies and citizens “have a responsibility and duty to defend national security.” The National Intelligence Law, enacted in 2017, stipulates that Chinese companies must “support, aid and coordinate with” China’s intelligence agencies. Under these vague regulations, these companies naturally tend in their operations and data maintenance toward accommodating the goals government supervision. The more than 100 million users of WeChat who are living overseas, for example, frequently endure censorship in various forms at Tencent accommodates the demands of China’s government. 

Huawei, the world’s largest seller of telecommunications equipment and second-largest smartphone manufacturer – of crucial importance in 5G network infrastructure in China and beyond – has been notoriously ambiguous when it comes to the company’s relationship with the government. Although Huawei is nominally a private company fully owned by its employees, the company’s actual ownership structure is still uncertain.  

From its earliest stages of development, Huawei enjoyed the backing of lucrative contracts from both the Chinese military and the government, and nearly boundless access to financing.

In many developing countries, Huawei’s surge in sales is backed by loans from the state-owned Export-Import Bank of China, support that goes back to at least the late 1990s. A 2003 report in the industry journal Telecommunications World (通讯世界) noted that Huawei had received 600 million US dollars in export buyer credits – loans to assist recipient countries in purchasing Huawei's products and services – "in order to raise the competitive positions of our country's telecommunications industry internationally." These export buyer credits have been repeatedly criticized by the United States and other trade partners over the past decade. A 2011 report from the European Parliament noted that China's export finance activities through export buyer credits, concessional loans, and other types of loans and credit lines, had created "an unfair advantage for Chinese exporters." The issue was also addressed in detail in a 2012 report to the U.S. Congress. 

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Screenshot of coverage 2003 coverage in the journal Telecommunications World reporting on Chinese state support for Huawei and ZTE. 

Several of Huawei’s projects in Zimbabwe, for example, are financed through Chinese government loans. A 2015 notice posted to the official website of China's Ministry of Commerce noted that "Huawei and NetOne have a long-term cooperative relationship," and that China had provided the cellular network operator with a 218 million US dollar loan for equipment upgrades through the Export-Import Bank of China. A separate report in state media referring to this as a "preferential loan," suggested the decision had been partly political, in order to "finalize the results of last year's visit to China by President Mugabe." 

In talking about state financing, we cannot of course avoid talking about China’s signature “Belt and Road Initiative.” The massive infrastructure investment program involves aid to many countries for the construction of essential infrastructure, including telecommunications. So far, as many as 68 countries are taking part BRI, and this will mean tech companies like Huawei can take advantage of state subsidies for the development of 5G infrastructure in developing countries at low cost. In 2017, Xinhua Agency reported that China will actively push for the application of national standards like 5G, and the development of “smart cities,” in BRI countries

Deep Dilemmas 

China’s tech giants are deeply entangled with the CCP political system, whether this is through government affair representatives, Party branches, investment participation, market dependencies, or through myriad and complex laws and policies. 

As China’s economy staggers into a period of recession, the legitimacy of CCP rule faces ever greater challenges. The Party’s response to this is to strengthen controls on society and thereby dissipate the sense of insecurity. The strengthening of controls on major internet companies like Alibaba, Tencent and Baidu, and utilization of their innovative capacities for censorship and mitigating financial risk, has been an important part of this process. Even branches of these companies operating overseas have felt the pressure to fall in line, so that it is no surprise to see these offshoots essentially mirroring the policy agenda of the Chinese government on priorities such as BRI, becoming ensnared in regional political disputes over China’s role and intentions. 

To put it mildly, the reputation and image of these companies is a matter of some controversy outside China, owing largely to the above-mentioned complex of doubts and questions about their relationship with the government and its priorities. They frequently face accusations running the gamut from plagiarism of business models, to intellectual property theft, unjust government subsidies, commercial bribery, violation of personal data, and lack of respect for human rights.

Just last week, 28 Chinese companies, including iFlytek and Hikvision, were added to the US Entity List of firms with national security implications, meaning any US companies that do business with them must first apply for permission from the Department of Commerce.

Even branches of these companies operating overseas have felt the pressure to fall in line, so that it is no surprise to see these offshoots essentially mirroring the policy agenda of the Chinese government.

 

But when it comes to international controversy, Huawei is the most obvious case in point. The company, which already was added to the Entity List in May 2019, faces a skeptical market and intense scrutiny in the West. Huawei has been a key sore point in the ongoing trade war between the US and China. 

It is safe to assume that these Chinese tech giants do not relish their current status within China‘ s economic and political environment. But given the nature of this environment, they have little other choice. Their immense size and scale does not afford, as some might suppose, any degree of latitude in pushing back against the government, but in fact is a liability that makes compliance and collaboration with the government necessary.  

These companies, therefore, are both accomplices and victims. In the end, they do not bear political missions and serve national agendas out of choice, but because there is no other choice. 

When Huawei became the focus of the US-China trade war, Ren Zhengfei, the company’s founder, made numerous media appearances to hammer home the point that Huawei had always kept its distance from the Chinese Communist Party, and that its equipment had never been used – and never would be used – for surveillance or intelligence activities. This was most definitely a public relations strategy. But it was probably also a reflection of Ren’s real views. Still, it has to be acknowledged that the extent to which this can be true is something almost entirely out of Ren’s hands. 

It is imperative that the world beyond China’s borders understands the very particular policy background and environment facing Chinese tech companies, and the extent to which they have been boxed in even as they are supported and empowered. Having a clearer view of the deeper dilemmas and weaknesses facing these champions, European competitors, decision-makers and society generally might spend less time being envious of their seemingly unassailable positions. Instead, as they work to build up their own innovative potential, they should strengthen oversight and scrutiny of these companies in Europe – ensuring compliance with local laws, respect for ethical standards and international business rules, and avoidance of practices that violate information freedoms and human rights.

In the long run, emphasizing these values as the condition and foundation of tech development will be the greatest boon for innovators. 

 

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Boxing In China's Innovators

22. October 2019
Author
Wen Kejian

Wen Kejian is a Hangzhou-based entrepreneur, independent economic analyst, and columnist for various Chinese media.