The China Syndrome
Jack Ma was the man. Until he wasn’t. In China, you live by the sword, you die by the sword.
After he couldn’t get a job (even working in a KFC restaurant), he started his first company, China Pages. It did web design for business customers, taking advantage of the newfound comity between the Chinese Communists and private sector entrepreneurs. This was a fickle relationship as the FT explains:
“But the relationship was fragile and China continued to favour state-owned companies with access to loans and licences. Ma saw that first-hand when a local champion in Hangzhou replicated China Pages’ business, leaving him with little choice but to sell to this big, state-backed incomer. Ultimately, he found himself powerless and left.”
The experience scarred Ma, making him forever skeptical of the power of the state. But sometimes, when bad things happen, anti-fragility kicks in. Ma started up Alibaba, a company that would come to dominate Chinese commerce.
Unfortunately for Ma, venture capitalists diluted him and his fellow founders to a miniscule percentage stake. The Faustian pact he made to ensure his resurrection threatened to take away the benefit of everything he had created.
For all its moving parts, value at Alibaba resided in three bits: Alibaba.com (a B2B marketplace with global reach), Taobao (like Chinese eBay), and Alipay (a payments processing firm that allows businesses to accept payments, including mobile payments, from customers).
Having failed to browbeat Alibaba’s investors from Goldman Sachs, Yahoo, and Softbank to volunteer to restore the founders’ equity to something he deemed more reasonable, Ma pushed the button. He seized Alipay.
“First, in May 2009, Alibaba began to restructure how it held Alipay, with Ma’s right-hand man Joe Tsai helping to shift it from a direct subsidiary of Alibaba to a domestic Chinese company majority-owned by Ma personally. Because Ma simultaneously entered into a series of contracts with Alibaba, it continued to treat Alipay as a subsidiary. This seemingly unusual contractual arrangement between parent and subsidiary (called a variable interest entity, or VIE) in fact underpins China’s entire tech ecosystem.”
(Aside: Here’s a decent definition of VIEs. Alibaba ceased to have direct equity ownership but was deemed to have control because of these contracts. I think. Another benefit of the VIE structure was that it was a form of regulatory arbitrage for Chinese companies that wanted to partner with foreigners. Ownership could remain Chinese on paper, even as control was in the hands of the firangi.)
Ironically, in China, a tissue of trust holds the corporate fabric of companies and government together. In the second stage of his scheme, Ma decided to exploit this. Again, from the FT, “Without Alibaba’s board approval, he cancelled the legal contracts that made Alipay a subsidiary of Alibaba, bringing it under his personal control.”
If anything, the fact that he was screwing over foreign shareholders with this transaction earned Ma the favor of the nationalistic Chinese authorities. He got away with it, exploiting what the FT describes as a backdrop of “regulatory uncertainty.”
The final stage of this coup, set up by Ma’s pre-positioning antics, was a subsequent negotiated arrangement in which Alibaba would share in Alipay’s profits. Ma had obtained the leverage to bargain for a good deal and certainty. Years later, Alibaba took that right and exchanged it for a one-third stake. Keep in mind, he was still at Alibaba while this was going on.
Alibaba went public in 2014 on the NYSE. Investors didn’t seem to mind the risks of the VIE structure. Of course, they didn’t seem to mind when Enron used these structures, until that company blew itself up.
As the years went on, Ma’s rising star did not escape notice. The first shots across the bow came in 2015.
“However, on the very same day, a hapless mid-level official at China’s business regulator decided to take aim at Ma’s domestic influence once again. When the regulator’s report suggested roughly two-thirds of the goods sold on Alibaba’s Taobao platform were counterfeit, Alibaba fired back directly at the person behind the report. “Director Liu Hongliang! You’re breaking the rules, stop being a crooked referee!” tweeted Taobao’s account on Weibo, attributing the statement to one of its merchants.
“The business regulator responded with a white paper bashing Alibaba. But then Ma flew to Beijing and met with Liu’s boss, Zhang Mao. The two men agreed that Alibaba would work on stamping out counterfeits and Zhang commended the company’s efforts to safeguard consumer interests. The white paper was withdrawn and the issue melted away. Though public opinion had been largely in the tech tycoon’s corner, the sight of Ma daring to take on the country’s regulators was not to everyone’s taste. “This public challenge was not a step forward for the rule of law,” says Song, the economist. “Actually, it was a demonstration of arrogant capital secure in its backing.””
Ma put himself forward more and more as the face, not only of Alibaba’s growth, but of China’s growing commercial clout.
“But for leaders sitting in Beijing it was uncomfortable: a private businessman was speaking to the world on their behalf — in perfect English to boot. “Gonggao gaizhu — a subject’s achievements make the king feel uneasy,” says a collaborator of Ma’s on international projects. “They don’t like him representing China on the world stage.””
Ma’s set up was really like a Faustian pact of a Faustian pact. He had managed to beat the foreign devil by sneaking Alipay out of the building. But he still had the original sin in place: the relationship of Chinese business to the whims of the Chinese Communist Party. The Party was only growing more powerful once Xi ascended to office. Ma seemed to forget this central arrangement.
“But he took the fatal step of making the battle public. On stage, Ma challenged the financial norms of the old world, pushing for China to take its own path. “Today’s financial system must be reformed,” he lectured from the podium. “Right now our capacity for ‘control’ grows stronger and stronger, while our capacity to ‘monitor’ is obviously lacking. Innovation doesn’t fear regulation, but it does fear regulation by yesterday’s methods.” Unlike most of his speeches, Ma repeatedly looked down at his notes, suggesting his words were finely calculated. Ma’s personal office is full of former journalists from China’s official news agency Xinhua.
“According to people close to the situation, some top officials in Beijing saw the episode as Ma attempting to win the public over to his side and influence policy. The Alibaba-backed news outlet Huxiu reposted an article defending Ma’s speech.
“But a few weeks later a vice-chair of the party’s propaganda department gave a speech urging Chinese media to resolutely “guard against . . . the risk of capital manipulating public opinion”. Huxiu, which had also published an editorial warning against excessive punishment of China’s tech groups, was ordered to halt its operations for a month.”
Awkward.
“In November, Ma dropped out of judging an African talent show he created. Then the General Association of Zhejiang Entrepreneurs that Ma chairs called off its annual conference, and one member says there was talk of him stepping down from his position. Rumours in China spread that he was under house arrest or had fled to Singapore. A cloud of uncertainty weighed on Alibaba’s share price and a planned bond sale. Then Ma drove into the Chinese countryside and on that cold Sunday in January surprised the teachers at Yuhua elementary school. “He was very satisfied with what he saw here,” says principal Chen.”
[ADDITION: The Alipay (renamed Ant Group) IPO was put on hold in the Fall of 2020. Here again is the FT in April 2021: “Since Chinese President Xi Jinping unexpectedly called off the blockbuster public offering of Ant Group, Ma’s payments and lending business, five months ago, Ma has made a single public appearance. Bloomberg reported that Ma gave up control in January 2024 to pave the way for an IPO. Even after all of it, Ma is still worth $31 billion as at July 2023, per Bloomberg.]
His fall was complete. You’re in the room until you’re out of the room.
I relate this story (relying on the FT’s reporting) to showcase the Chinese approach to regulation.
MIT Tech Review puts it well in an article discussing AI regulation.
“The way China regulates its tech industry can seem highly unpredictable. The government can celebrate the achievements of Chinese tech companies one day and then turn against them the next.
“But there are patterns in how China approaches regulating tech, argues Angela Huyue Zhang, a law professor at Hong Kong University and author of the new book High Wire: How China Regulates Big Tech and Governs Its Economy. The way Chinese policies change almost always follow a three-phase progression: a lax approach where companies are given relative flexibility to expand and compete, sudden harsh crackdowns that slash profits, and eventually a new loosening of restrictions.”
In this sense, the Chinese outsource much of their R&D to the private sector, letting them take the risk and raise the funding. It encourages national champions and global leadership. As long as the private sector understands their place (subservient to the Communist Party), they can operate with commercial independence. Owners benefit financially. But the moment there is any sign of political challenge or they reach a point of sufficient cultural influence, then the Party must come down hard. The marginal cost to stability at some point outweighs the marginal benefit of letting one thousand flowers bloom financially. Once the crackdown is complete and the scales have tipped such that the marginal cost of slower progress exceeds the marginal benefit of Party supremacy, then there is a graduated return to a synthesis in which managerial agents resume their personal enrichment but defer to the state.
AI in China is in its liberal phase. The need for it is too pressing. Authorities there do not see the need to regulate it in the cradle. They are more interested in obtaining its benefits.
“The government’s deeply embedded interest in China’s AI industry means that the industry will stay in that initial phase of lax regulation for a while, Zhang says. And she argues that AI regulations in China today are looser than those in the US and Europe.
…
“But Zhang believes that these regulations are strict only when it comes to freedom of speech and content control, areas in which the Chinese government has been increasingly stringent. Other than that, the recent regulations offer vague principles and few enforceable measures to prevent the AI from causing harm, including harm to Chinese people’s human rights.”
Here is the Wall Street Journal discussing the progress of AI in China:
“With leading generative AI models including OpenAI's ChatGPT, not available in China, domestic tech giants like Baidu are leading the charge. The search giant is reporting that the number of users of its Ernie Bot doubled in recent months to more than 200 million, the WSJ's Tracy Qu reports. It also has more than 85,000 enterprise clients.
“The company also said Ernie Bot’s application programming interface is being used 200 million times each day.”
For all the talk of strategic competition between the West and China, there are two implications, at least. First, the regulatory imperative in the democracies dictates that authorities see control of AI given its potential power as more important than the potential benefits from developing it with maximum effort. Second, if there is going to be some sort of disaster that comes from AI, it is more likely to come from China, given the laissez-faire attitude of Chinese authorities (and the pressure to push hard for global strategic advantage). They would prefer to dominate the West in this new technology, cognizant of their ability to socialize the pain globally, should Doomsday ever arrive. Perhaps, if the worst comes to pass, they will blame some sort of anonymously authored cyber-virus run amok with unanticipated emergent sentience.
May you live in interesting times.