China’s business crackdown threatens growth and innovation

China’s business crackdown threatens growth and innovation

The writer is an independent commercial arbitrator with Arbitration Chambers in Hong Kong

In autumn 2018, an article in Chinese media by a Beijing banker sent shockwaves through the Chinese business community. Its author declared that the historic mission of private enterprise was about to be accomplished and that communist ideology would no longer support its continued expansion. The article was so widely shared and caused such consternation that the Communist party spoke out to calm nerves.

Then, in November 2020, Ant Group’s initial public offering, which was set to raise $37bn, was suspended after an intervention from the Chinese regulator. And in July last year, high-profile entrepreneur Sun Dawu was sentenced to 18 years in prison for, among other offences, “provoking trouble”.

These two notable episodes are part of a broader crackdown on private enterprise in China — one in which Didi Chuxing, the ride-hailing company, announced plans to delist from the New York Stock Exchange after facing increased scrutiny from regulators, and education companies such as New Oriental and Gaotu Techedu saw billions wiped off their share prices when it emerged that the government in Beijing was set to ban academic tutors from making a profit.

The government’s actions undermine what remains of the rule of law in China, since many of the businesses affected are legally established. The speed and ferocity with which it has acted have surprised both domestic and foreign observers. It is estimated that the crackdown has wiped out more than $1tn from the market value of Chinese companies.

It is true that some private companies have conducted their businesses in legal grey areas. A notable example includes use of the variable interest entity structure (VIE) with an offshore shell incorporated in jurisdictions such as the British Virgin Islands or Cayman Islands. This has been employed by companies seeking to overcome government restrictions in sensitive sectors such as value-added telecom services.

For years, the Chinese authorities have turned a blind eye to the practice. But now there are moves to increase transparency in the use of VIEs. It is likely that China will ban companies using them in the future.

The government may say that the crackdown is being conducted in the public interest and favours data privacy, antitrust review and consumer rights. Nevertheless, it should be undertaken with consideration for due process, transparency and the rule of law.

Leading business figures in China have yet to speak out publicly about the crackdown or how it will affect their future investment plans. Most have simply stated that they will follow government orders. This is perhaps not surprising, although there are clear legal remedies available for them to challenge the measures in the courts.

In the decades since former Chinese leader Deng Xiaoping’s Open Door Policy began the extraordinary transformation of the economy, the equal treatment of private and state-owned companies was a much-trumpeted government slogan. However, the recent hardening of the ideological line in Beijing, and current president Xi Jinping’s “common prosperity” push, may quickly render such equal treatment a thing of the past.

It would not be a surprise if China returned to a version of the joint private-state ownership model adopted under the leadership of Mao Zedong in the 1950s. This would amount to a de facto nationalisation of private companies — at least those in sectors such as data collection, national cyber security and financial services.

China’s business landscape is certainly changing. And the prospects for future innovation and economic growth, which in the past four decades have been driven by the private sector, look dimmer as it does.

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