China's interventions in the tech industry: The dark side of state capitalism

Bad state or good state? The traditional answer in the free-market West is simple: The state should set frameworks and rules, ensure internal and external security, protect property rights, provide public infrastructure, but not intervene. In short, the state should enable competition.

However, the state should not presume to know more than the economic players, who are constantly competing to find ways to improve and are thus the driving force behind innovation and economic prosperity. This basic understanding is put to the test by China and its state capitalism.

Besides the traditional perspective of free-market thinking, there is an alternative that seems incompatible with the first: the special role of the Chinese state, which catalyzed the breathtaking growth process and is its guarantor. According to Deng Xiaoping's famous bon mot, "It doesn't matter if the cat is black or white, as long as it catches mice".

There is plenty of evidence of the economic success of China's politically controlled market economy, especially in the area of infrastructure. Whereas it took Berlin more than ten years to get a new airport ready and operational, China is churning out such airports at record speed. The rapid commissioning of the new airport in Beijing, for example, led not just Chinese media to conclude that Berlin could learn from Beijing.

In the same way, the West looks in astonishment to disbelief at China's rapidly progressing flagship project “New Silk Road,” not least because of the geopolitical consequences. But the economic successes go far beyond the realm of infrastructure. Consider China's catching up and, in some cases, overtaking in key areas of research and development. Beijing's ambition to be the economically strongest country in the world by the 100th anniversary of the People's Republic in 2049 is not seen as fundamentally unrealistic, even by the West.

Politics increases pressure on the economy

However, in recent weeks and months, the view of the “beneficial” role of the Chinese state has changed: The Chinese leadership is clearly increasing the political pressure on technology companies. For a long time, these companies were seen as a splendid counterpart to large US technology corporations and an expression of Chinese innovative ability, but China's high-tech sector is now increasingly finding itself in troubled waters. Dark clouds are gathering over China's economy.

The number of state interventions in individual industries, companies, and business models is too high to be described as isolated incidents. Interventions are now hitting the financial industry, driving service providers, delivery services, online games, and private education providers. In addition, the justifications for the respective state interventions are too varied to be carefully thought-out and implemented steering.

The justifications range from maintaining social stability to safeguarding the financial economy to data protection. No one can fundamentally question the sense of such goals, but the seemingly sudden interventions do not reveal an overall concept. Instead, one is left with the impression that China's leadership is not primarily concerned with its proclaimed goals.

China increasingly needs its own know-how

Many are now questioning their entire stance on the Chinese market. The loss of assets by recently celebrated Chinese companies was correspondingly large. Within a few days, some of them had to accept losses in the billions – a development that cannot be good for them or for the Chinese state.

This is because the losses are occurring at a critical point in the development of the Chinese economy. It is true that China's gross domestic product, adjusted for purchasing power, has now surpassed that of the US and Europe. Accordingly, the People's Republic is the world's largest economy. However, the per capita figures offer the more relevant comparison: Here, the People's Republic has reached just approximately 30 percent of the German level. The catching-up process is therefore in full swing and will be increasingly characterized by the need for comprehensive innovations.

In the early stages of this process, low production costs played a particularly important role. If it was cheaper for internationally active companies to produce in China rather than in their home countries, they often did so with an eye to the developing large market. It was also worthwhile for Chinese companies to copy successful products and processes from other countries and offer them in their own market.

Now, the political leadership wants to put companies in their place because they have become too powerful. The reactions of the capital side to these interventions speak a clear language: Chinese stock markets collapsed, especially in the technology sector – with repercussions especially for the US. Worse still, market participants are increasingly asking themselves how safe existing and future investments in Chinese companies actually still are.

But this early phase of the catch-up process is now slowly coming to an end or has already ended in various areas. The next stage of development will be much more challenging for China's economy: Increasingly, it now depends on its own know-how to trigger the next spurts of innovation and growth. New, knowledge-driven products and processes, however, require massive investment in research and development.

What does this mean for the West?

The state will not always be best placed to predict which investments will achieve the greatest market success. China, therefore, needs large private investments – but these will only come about if investors can assume that the framework conditions will not change overnight and that the state will not suddenly change the distribution of potential profits in its favor. The latest interventions may thus prove to be a disservice to China.

What does all this mean for the West? The Chinese example shows that it is possible to complete large infrastructure projects more quickly. This should also be possible while preserving democratic rights. At the same time, the Western division of labor between the state and the economy is premature.

The reactions to the massive Chinese interventions of late raise an important question for Chinese economic development: Is China's economy actually successful because of politics or in spite of them? The answer has far-reaching consequences, also for Western self-image.

This article was originally published in German by Handelsblatt on August 17, 2021; republished in English with permission.