Why Big Tech May Never Recover in China

Even by its own standards, the tech sector has had an extraordinary year. The surges in valuation of firms such as Nvidia, Meta, and Amazon have elevated the tech sector's share within the S&P 500 to an unprecedented 30%. Amid this boom, it’s almost too easy to overlook the challenges faced by tech giants elsewhere, particularly in China.

Leading Chinese tech firms, notably Alibaba and Tencent, have seen their market capitalization plummet up to 75% from their peaks three years ago. A key factor was the sweeping regulatory crackdown initiated by the Chinese government in late 2020, which lasted for an unprecedented 18 months. It wasn’t until a massive sell-off of Chinese stocks in March 2022 which prompted policymakers to reverse course and ease regulations.

During this tumultuous period, Chinese authorities rapidly introduced a series of stringent antitrust, data, and labor regulation, while imposing astronomical fines on companies like Alibaba and Meituan for engaging in monopolistic practices. Simultaneously, Big Tech firms like Tencent, Alibaba, and Ant Group were forced to exit from non-core businesses or undergo significant restructuring to reduce their influence in the tech sector.

Chinese authorities asserted that these hectic actions were aimed to rectify the myriad of regulatory problems caused by years of unchecked growth and disorderly competition among local tech giants. Yet these hectic enforcement actions have also sowed confusion and sparked fears about the capriciousness of China’s regulatory policies.

From 2021 to 2022, the total investment capital in Chinese internet industry plummeted by an astonishing 80%, from $49 billion to a mere $10 billion. Simultaneously, the total market capitalization of Chinese internet companies shrank from $2.5 trillion at its 2020 peak to $1.4 trillion in 2022. As investors retreated from Chinese consumer tech businesses, new market entries into the sector have dwindled.

The crackdown has disproportionately burdened smaller firms, which lack the extensive in-house resources that large firms have at their disposal for handling the costs associated with heightened regulatory compliance. That has inadvertently given larger tech firms a competitive edge, further cementing their dominance in the market.

Even foreign tech firms—ostensibly not the targets of the crackdown—have felt the pains. In 2021, both LinkedIn and Yahoo announced their withdrawal from China, attributing their decisions to escalating compliance costs and an increasingly challenging operating environment.

A major consequence of retreating private investors has been an opening for the state. In the past few years, state-owned entities have aggressively invested in “golden shares” in certain subsidiaries of Chinese social media companies such as ByteDance (the parent company of TikTok), Alibaba, and Tencent. These shares, typically amounting to a nominal 1-2% stake, grant the government power to appoint a representative to the board of directors and exert veto rights over important corporate decisions. Although this scheme has only affected those social media companies, it has made investors vigilant about the Chinese government’s control over its tech firms.

This enhanced state control also raises further suspicion among foreign policymakers toward social media apps owned by Chinese Big Tech. The recent U.S. bill forcing TikTok to divest from its Chinese parent company, ByteDance, or face a national ban exemplifies such a trend.

While the crackdown has eased since early 2022, it has clearly left an indelible mark on Chinese tech regulation and eroded trust in state-business relations. Investors, having endured unexpected and severe crackdowns, are now highly sensitive to even small regulatory changes. A vivid illustration of this occurred last December when China’s gaming regulator announced draft rules to curb excessive gaming. The announcement caused panic among investors, wiping out $80 billion of market value from leading Chinese gaming companies. In a dramatic turn of events, the gaming regulator scrapped the proposed regulation and dismissed the official responsible for it.

Today, the tech sector is still characterized by stricter laws and more powerful regulatory agencies than before the crackdown. And when the next crisis calls for strong state intervention, there is now an even greater likelihood of regulatory overreach. Without strong institutional oversight, there is a risk of over-enforcement and administrative abuse. Worse yet, the crackdown has led to institutional changes that are likely to create more cycles of volatility in the years to come.

The ramifications of all of this extend well beyond economic and financial consequences. The country has been counting on its tech firms to help achieve technological self-sufficiency to catch up with the U.S. But the crackdown has crippled its most competitive tech giants, pushing its goal of achieving technological supremacy even further out of reach.