Private Equity


China’s Regulatory Gambit Against Private Enterprise

For several months, Didi Chuxing was the ultimate success story: a Chinese ride-hailing startup that beat Uber at its own game and that projected a US$60 billion valuation for its initial public offering on the New York Stock Exchange. Within days after its IPO, the company’s share price plunged and it lost almost US$29 billion in market value after Chinese regulators accused the company of mishandling sensitive data about its users in China.

China’s posture toward Didi is not an isolated incident. During the first half of 2021, Chinese regulators have targeted several large private enterprises, including Full Truck Alliance and the job listing firm, Kanshun, with regulatory actions that catalyzed the loss of more than US$1.2 trillion in market value for those enterprises. Investors are now asking if innovation is now a thing of the past in the world’s second-largest economy.

What is motivating Chinese regulators?

Chinese regulators are not so much rejecting aggressive capitalism as they are seeking to advance corporate growth solely along terms dictated by China’s ruling Communist Party. Under the Party’s control, Beijing has imposed substantial fines on companies like Didi and has banned apps from online marketplaces to force those companies to more closely align their businesses with the Party’s philosophy, which emphasizes the protection of the economy and the country’s citizens from instability. Secondarily, the regulatory actions are aimed at concerns about overwork and employee burnout, data privacy, and inequality in education.

With its actions, the country has demonstrated a willingness to forfeit more than a trillion dollars in corporate valuation in exchange for preventing corporate conduct that might lead to independent and potentially non-conforming business models that threaten the ruling party’s state-centric model.

Is China’s crackdown a recent development?

The Chinese government initiated its recent round of regulatory crackdowns in the technology sector when it suspended the IPO that Alibaba founder and Chinese billionaire, Jack Ma, had scheduled for his payment app company, Ant Group, in November 2020. Regulators forced the company to restructure its operations and to recast itself as a financial holding company. At roughly the same time, regulators imposed a fine of US$2.8 billion against Alibaba after accusing the company of behaving like a monopoly. Regulators also brought monopoly allegations against the social media and gaming giant, Tencent, and the e-commerce platform, Pinduoduo.

Chinese regulators next pursued other US-listed Chinese companies in different industry sectors with allegations of mishandling customer and client data. Most notably, China banned education and private tutoring companies from turning a profit or raising funding on stock markets.

China has demonstrated regulatory zeal previously, but unlike those prior efforts, analysts have characterized the recent crackdown as lasting longer, being more intense, having a broader scope, and reflecting a greater number of actions against companies.

Has China made specific allegations against the companies in its regulatory crosshairs?

Chinese authorities appear to be placing a priority on social welfare and wealth redistribution over capital markets among companies and industries that fall within the ruling Party’s definitions of social necessities and public goods. Some analysts believe that the country is merited in justifying its decision as a necessary public good. Regulators have alleged that Didi and other online platforms, for example, have mishandled sensitive data about their users in China, posing risks to personal privacy and national cybersecurity. There’ are also reports of public complaints about data breaches, abuse of personal information, and corporate surveillance, but the sources of those reports suggest that they may be a pretext for regulatory action.

The ruling Party does have a legitimate issue with Inequalities within education and private learning, which has led to new restrictions on for-profit tutoring. Those restrictions were justified with claims that education has been hijacked and its purpose distorted by private capital. Education in Asian cultures is very competitive and results-oriented with a focus on exam scores. Private tutoring has fed that competitive environment as urban middle-class families have hired private tutors, typically for a premium, to prepare their children for exams.

How has employment contributed to the government’s regulatory efforts?

The government’s focus on inequality reflects broader concerns about disparities in income and education, as well as growing issues over a competitive employment environment. Young workers are increasingly complaining about a crushing culture of overwork, and are rejecting pressures to work hard, get married, have children, or buy property. This is a common complaint among younger workers around the globe, and it is particularly noteworthy in China because young workers there see diminishing rewards as they strive to achieve those goals.

Both private and government sources have criticized Chinese tech companies for forcing young people to work long hours in a culture that glorifies overwork. These issues have accumulated to create significant worries for the ruling Chinese Communist Party, which relies on the creative contribution of a younger generation to contribute to high-quality development. Any labor problems in China will hurt the ruling Party’s long-term economic goals.

How is the world reacting to China’s regulatory push?

The country’s current tactics carry plenty of risk. Along with the US$1.2 trillion in market value that has been wiped off of prominent stocks, analysts are concerned that an aggressive regulatory environment will destroy entrepreneurialism in China’s spirit. New startups, particularly in the technology sector, have fueled the country’s economic liberalization and rapid growth.

From one perspective, new regulations may bring some benefits and more equality to a corporate environment that has been very unregulated. The methods of how new controls have been imposed by the ruling Party, however, sends a strong signal to private entrepreneurs to bring their businesses in line with Party guidelines or leadership. Some observers outside of China have suggested a more measured approach that includes progressive taxation and education support for the poor.

China’s recent regulatory reforms effectively show concerns by the ruling Party that economic inequality could hurt the Party’s legitimacy if left unchecked. Apart from a major change in Party philosophy, it is likely that the Party will continue to increase control over private enterprises such that they continue to serve the people and the Communist Party’s efforts to retain that control.