We recently had a terrific session of our monthly CHINARoundtable on Zoom with guest expert, Kendra Schaefer, a partner at Trivium China and one of the world's leading experts on China technology.

• Besides her advisory work, Ms. Schaefer also puts out the indispensable 'Trivium Tech Daily.'

In this hour and a half CHINARoundtable session, she gave members insights into:

1. Where China is in the tech ‘crackdown’ (no, it’s not over, but it’s slowing), and
2. China’s new – but largely unnoticed - AI and algorithm law (it will have a big impact on the businesses and profits of companies like Alibaba, TikTok, and Tencent - so beware).

Today, I’m sharing with you a bit of Ms. Schaefer’s analysis of the tech ‘crackdown’ (but not of the AI and algorithm law). She explains why:

• ‘The execution of any of these exceptionally complicated policies, especially when they start to conflict with each other, doesn't always go according to plan.’
• And execution of tech regulation certainly didn’t go according to plan – a fascinating and instructive saga.

Even if you're not following China tech closely, you'll find Ms. Schaefer's comments provide:

• A case study in Chinese bureaucratic infighting - necessary for understanding how policies are made and enforced, and
• A few frameworks to help you think about how China sets and implements big economic objectives.

One framework I found especially valuable is Ms. Schaefer's description of the two opposing camps of regulators:  

• ‘The Economists’ - who manage the macroeconomic big picture issues - and
• ‘The Risk Mitigators' - who work to keep companies from doing bad things and on tightening security.

‘There’s definitely a conflict between those who are focused on trade and the economy, and those who are focused on national security.’

• The two camps, she says, are 'like Xi Jinping’s left brain-right brain problem – the two sides of Xi’s brain arguing with each other.” ’

'Where the two camps agree is that big tech needs stricter regulation.'

• 'Where they disagree is on the timeline and the methodology of how regulation should be carried out.'

Three other important frameworks encompass how Ms. Schaefer ‘conceptualizes China tech regulation':

• 'The Trellis,'  
• the '30-Year Timeline,' and
• 'But What About Next Week?'
• (You will find these right below this intro.)

BTW the CHINARoundtable members convene each month on Zoom for small-group discussions with leading experts on the big China issues.

• Please shoot me an email if you would like to learn more about CHINARoundtable membership options.

Part One | How Beijing Views Tech Regulation

1 | The Trellis

‘Here’s the way I conceptualize China tech regulation,’ says Kendra Schaefer.

• ‘Beijing doesn't want tech companies to grow haphazardly - so it is building a trellis, along which it wants tech companies to grow.’

‘It definitely still wants them to grow.’’

• ‘But it just wants them to grow while considering their obligations to the state, their legal obligations, their obligations to their consumers, and finally their obligations to their shareholders.’
• ‘None of those four things is unimportant.’

‘They want tech companies to have that mentality that:’

• ‘They have to contribute to national strategic goals.’
• ‘They have to be compliant with the law.'
• 'They just can't throw their middle finger at the Party and say, “Well, we don't want to do that, so we're just not going to.” ’

‘To these ends, they've created this trellis for companies to grow on, all while adhering to Beijing's standards and objectives.’

• If they adhere they're okay. If not, well....

‘The question is: How big are the profits they can end up making while they're on the trellis?’

• ‘We don't know.’

2 | The 30-Year Timeline

‘I always have to remind people: China thinks in 30-year timelines; they don't think on investor timelines.’

• ‘They don't care what happens tomorrow.’

‘That's because the aim is to create a socialist market economy timel.'

• With regard to tech, the aims are to set the guardrails for, in their mind, the healthy development of the platform economy; and build a socialist tech sector.’

‘Beijing is still sorting out what all this will look like over a 30-year period. In tech, they don't want Silicon Valley. So they ask:’

• “What do we want? How should our tech sector behave? What do we allow them to do? What should they do under the CCP system? How do they work in this kind of economy?”
• "We have to set the rules down now.”

‘That's the ball their eye is on, and that's the ball their eye was on when they started the tech regulatory “crackdown”:’

• ‘They may have set the rules down too fast. But that's the train they're going on.’

3 | "But What About Next Week?"

'We often talk to investors who ask, “But what about the market next week?” ’

• ‘We tell them China doesn’t care about the market next week, and it certainly doesn't care about foreign investors.’
• ‘China's willing to deal with a little bit of shake in the market next week, providing that means a stable, healthy long-term sustainable growth of an entire industry - along the "30-Year Timeline" '.

‘They did start to care, however, when the Hong Kong indexes crashed – and that's a domestic investor concern – because this added to a weak economy and COVID pressures.'

• ‘Remember: Instability is the number one thing that will make the Chinese government pivot faster than you've ever seen anybody pivot from a hard position - market instability or social instability, either one is just anathema.'

‘So when the Hong Kong indexes crashed, they went:’

• “Whoa, whoa, whoa! We can't add to this stress right now. We can't add to the problem."
• ‘They saw markets start to wobble dangerously about a month ago - and they went, “No, everybody stop.”

‘That’s how the government course-corrects most of the time - they definitely course-correct quickly if they see things start to wobble.’

• ‘Nonetheless, every signal we get indicates that Beijing is not rethinking what they have done in regulating the tech sector.’

Part Two | Is the “Crackdown Over”?

1 | Is the "Crackdown" Over?

‘Is the “crackdown” of the internet platform companies over?’

• ‘The quick answer is that no: Tech regulation is not over – and is not going away.’

‘Several of the regulatory campaigns we saw start last year have gained so much momentum that there's a 0% chance they get put back in the box.’

• ‘But regulation will almost certainly will slow down some.’

‘There are very interesting domestic politics that will determine:’

• ‘How much it slows down, and’
• ‘What happens going forward.’

2 | ‘A Giant Wave’

‘At the end of 2020, Chinese regulators kicked off this massive series of regulatory actions against Chinese big tech companies.’

• ‘The press has made it sound like this was a single, sudden, collective push that was ordered by Beijing's top leaders.’
• ‘But it's pretty clear that’s not what happened.’

‘Instead, you had multiple regulatory agencies that over the past two to seven years, depending on the agency, had been independently gearing up to tackle certain aspects of a very unregulated tech sector.’

• ‘All of these pushes coalesced into this kind of giant wave, which crashed down on the tech sector all at the same time.’

3 | SAMR versus CAC

‘The most impactful of those pushes, and the ones that got the most headlines were:’

• ‘The anti-monopoly push driven by the State Administration for Market Regulation (SAMR), trying to crack down on monopolistic behavior by tech companies, and’
• ‘The data security push by the cyberspace regulator, the Cyberspace Administration of China (CAC), trying to secure tech companies massive data troves.’

‘And these two regulators are at odds with each other about what needs to be done.’

4 | ‘The Economists’ versus the ‘Risk Mitigators’

‘When it comes to regulating big tech, over the last couple of years we've noticed an interesting bifurcation into two big schools of thought in Chinese tech policy circles - two opposing regulatory camps:

• “The Economists” and “The Risk Mitigators.”

‘The Economists.’ ‘The first camp we call “The Economists.” These are the guys who are looking at the macroeconomic big picture.’

• ‘These are government entities, like the Financial Stability and Development Committee (FSDC).’
• ‘They're represented by macro economists like Vice Premier Liu He, as well as financial and securities regulators like the China Securities Regulatory Commission (CSRC).’

‘These are the people whose Key Performance Indicators (KPIs) center around ensuring market stability and economic growth; increasing foreign direct investment in China; making sure Chinese companies can go abroad and list overseas; and increasing cross-border trade. That's what they care about.’

• ‘And they're focused on making policy decisions that buoy capital markets.’

‘The Risk Mitigators.’ ‘The second camp we call “The Risk Mitigators.” ’

• ‘These are regulators like China cyberspace watchdog, the Cyberspace Administration of China (CAC), and the market regulator, the State Administration for Market Regulation (SAMR).'

‘Their KPIs are not about the economy at all.’

• ‘Their KPIs center around stopping companies from doing bad things, like abusing personal information, engaging in anti-competitive practices, leaking sensitive data overseas.’
• ‘They're primarily focused on both protecting national security and also ensuring corporate compliance and advocating for citizens and consumers domestically to a certain extent.’
  

‘There’s definitely a conflict between those who are focused on trade and the economy, and those who are focused on national security.’

• ‘My business partner said to me, “This is like Xi Jinping’s left brain-right brain problem – the two sides of Xi’s brain arguing with each other.”’

5 | Where the Two Camps Agree

‘The objectives of the two camps are very different - but here's the kicker:’

• ‘Neither camp disagrees that big tech needs stricter regulation.’

‘We're not hearing any voices say that it's okay for tech companies to:'

• 'flout the law as they do very often,'
• 'abuse the personal information of users,'
• 'leak sensitive data abroad, overwork platform employees, '
• 'deny gig workers insurance coverage,'
• 'use algorithms to cheat consumers,'
• 'chase capital at the expense of national strategic objectives, or'
• 'any of the other things that tech companies have come under fire for this year.’

‘Everybody's on the board with tech sector regulation and is pretty much agreed that the tech cannot continue behaving the way that it has.'

• 'Some guardrails need to be put in place.’

6 | Where the Two Camps Disagree

‘Where the two camps do disagree is on the timeline and methodology of how that regulation should be carried out.’

• ‘When "The Economists," like Vice Premier Liu He, say they want to see tech rectification wrapped up, they're essentially taking issue with the fact that the Cyberspace Administration of China (CAC), the State Administration for Market Regulation (SAMR), and other agencies have basically just given everyone - companies and investors - whiplash.’

‘They contend "The Risk Mitigators" have failed to signal major policy decisions before they happen:'

• ‘ “The Risk Mitigators” have released rules without hashing out the details of how those rules are going to be implemented.’
• ‘And they've dog-piled on the tech companies all at once without properly considering the cumulative impacts of regulation for multiple agencies.’

Part Three | Where Regulation Stands Now

1 | Impact

‘The impact on internet companies has been very dramatic.’

• In January 2021, revenue growth was 29% revenue growth; in January 2022, revenue growth in January, 2022 was 5.1%.’

‘Some of that slowdown was the Chinese economy and COVID.’

• ‘But mostly it was death by a thousand regulatory cuts.’
• (Remember also that most of the big techs were hitting a growth ceiling anyway: there are only so many users in China. After a period of just wild growth for five years, a slowdown was expected - regulation or no regulation.)

'And there, of course, have been all these other impacts as well.'

• 'We've seen crashes in Chinese stock prices abroad.'
• 'We've got platform companies like DiDi planning to de-list from the US. and on and on.'  

2 | Enter, Liu He

‘For the last year and a half, investors have been increasingly asking us:'

• “This seems detrimental to Chinese companies. It seems detrimental to capital markets. It seems detrimental to foreign investment. Why are China’s leaders allowing this to go on?”
• “Surely, someone's going to step in and put a stop to this overregulation.”

‘It took a while, but sure enough, recently, China's top economist, Vice Premier Liu He, chaired a very public meeting, very well-reported meeting of the Financial Stability and Development Committee (FSDC).’

• ‘Among other things he said at that meeting, he urged regulators to implement and, I quote, "standardized, transparent and predictable regulation for platform companies." ’
• ‘And he urged them to hurry up and complete any languishing or outstanding regulatory actions against internet companies.’

‘In short, what Liu He and the FSDC are saying is:'  

• 'This lack of circumspection and transparency, and of signaling by these bodies has made domestic and international investors so jumpy that now the smallest policy moves and minor setbacks result in these kinds of wild market swings, everyone's really on edge.’

3 | ‘Okay. So Now Is the “Crackdown” Over?’

After that FSDC meeting, we got just a flood of phone calls from investors and reporters asking:

• “Liu He said the 'crackdown' is over. Does that mean the “crackdown” is over? Are we done?”
• ‘To repeat the short answer: no.’

‘Liu He is not saying that regulation overall is a mistake.’

• ‘What he and “The Economists” are asking is for “The Risk Mitigators” to slow down.’

‘But that doesn’t mean just because Liu He said that he would like regulators to slow down or be more transparent, they will.’

4 | ‘Crickets.’

SAMR. ‘For its part, the State Administration for Market Regulation (SAMR) has totally changed its tone and very differentially bowed to Liu He and Financial Stability and Development Committee (FSDC).’

• ‘SAMR said they are going to keep pursuing anti-monopoly bearing in mind the overall national macroeconomic situation, and we will not destabilize the market anymore.’

‘But the guys handling anti-monopoly at SAMR spent the last half of 2021 beefing up their anti-monopoly bureau.’

• ‘The bureau got a new office, more authority, and more manpower just in the last six months.’

‘We just looked into SAMR's annual budget: They have made a separate line item for anti-monopoly expenditure.’

• ‘If that isn't enough signal that anti-monopoly is not going away in the next year, then I don't know what is.’
• ‘And Xi Jinping himself is repeatedly called for stronger anti-monopoly enforcement.’

CAC. ‘But the Cyberspace Administration of China (CAC) has made no announcement like SAMR's.’

• ‘We have heard nothing from them - crickets.’

‘The CAC has been all geared up for a year now to strictly enforce the new data laws that China released, namely, the Data Security Law and the Personal Information Production Law that came into effect last year.’

• ‘Those laws are not suddenly unimportant.’

‘The CAC has called 2022 “The Year of Data Law Implementation.” ’

• ‘So, the CAC’s coming for companies on data security.’

‘The CAC has also been screaming from the rooftops at every meeting that it's had that it plans to further tighten control on multiple other areas this year from the way tech companies use algorithms in AI – a huge and otherwise unnoticed change - to censor and online content control. Lots of noise around that.’

5 | No About-Face

‘While it remains to be seen if the CAC takes the FSDC's message to heart, overall, we think that tech regulation won't subside.’

• ‘Things like anti-monopoly will go on; data security is still an issue; labor issues and ride-hailing companies and platform economy jobs are definitely still there.

‘Hopefully, at least there's some movement in the direction of clear policy signaling a more measured approach and a little bit of a slowdown.’

• ‘But these announcements don't constitute an about-face on tech regulation.’