China Forces Big Tech to Make a Choice: Play By Beijing’s Rules, or Be Left Out
Editor's Note: This article was updated in December 2018.
Foreign tech companies have been forced into difficult compromises and today find themselves asking whether the financial rewards and access to a massive market justify the work required to stay in Beijing’s good graces—especially given that the risk of failure is rising, illustrated by the recent blocking of WhatsApp in China.
When users of WhatsApp in China started noticing technical problems with the mobile messaging application in September 2017, nothing seemed unusual at first. The slow sending speeds and inability to deliver video and audio files could have easily been due to a spotty internet connection or a bug. Many users in China had experienced such issues before; these were usually limited and localized, and they were resolved in a matter of days.
[ SPECIAL OFFER: Get your FREE copy of our in-depth report on the U.S.-China Rivalry in the Trump Era. ]
But there was also the possibility of government tampering. A few years earlier, in 2014, users of Gmail and other email services in China had reported similar problems, right up until these services were banned outright.
Listen to Zach Montague discuss this article on WPR’s Trend Lines Podcast. His audio starts at 19:17:
As it soon became clear, WhatsApp’s interruptions were part of the same pattern. Unlike the unexplained disruptions that had plagued the app months earlier, WhatsApp’s texting functions went dark across China in September 2017 and the service's availability has been intermittent since then. Two months later, Skype fell as well, vanishing from all the major app stores available in the country.
The shadowy takedown of WhatsApp in China raised a host of questions. Had the company run afoul of Chinese laws? Was the advent of end-to-end encryption, which allows WhatsApp users to send content more securely than on other apps, a nuisance for surveillance agencies? Was the relationship to WhatsApp’s parent company, Facebook—which has been blocked in China since 2009—seen as a problem in Beijing? Or were communications services like WhatsApp and Skype simply competing too closely with Chinese messaging apps?
As many foreign technology companies operating in China have found, such explanations are rarely clear-cut, and the answers often involve several of these factors. The more the Communist Party of China, or CPC, has moved to control the internet and prop up the country’s strongest corporations, the more foreign tech firms have been forced to bend to its will. Drawn by the allure of China’s massive market, foreign firms operate in an uncertain and, at times, hostile landscape, facing harsh government regulations and fierce competition from homegrown Chinese companies. For most, this creates a dilemma: Is it worth playing by China’s rules in pursuit of huge short-term profits? Or is it better to protect long-term interests while missing out on access to some 20 percent of the world’s population?
The Era of China Bulls
In the short period in which China has been economically integrated with the rest of the world, its stance toward foreign businesses has shifted considerably. In general, it has veered away from an atmosphere that was welcoming of foreign companies to one that is once again more closed off and guarded.
Beginning in the late 1990s and early 2000s, coming off Deng Xiaoping’s policy of “reform and opening up,” Beijing initially invited investment. A thirst for foreign capital led CPC leaders to court companies from overseas, offering tax incentives and minimal government oversight. Foreign companies flocked to special economic zones that Deng had originally set up in the 1980s to experiment with free trade and foreign investment in a controlled setting. By the turn of the century, many of these zones, especially in Shenzhen, Shanghai and Tianjin, had become flourishing sites with exploding populations, surging inflows of foreign direct investment and rapid GDP growth.
The gold rush to enter the newly accessible Chinese market brought droves of foreign companies. Even with the challenges posed by corruption, opaque laws and concerns about intellectual property, the benefits for foreign companies were enormous. The climate of buying favor and selectively enforcing laws, which was rampant in China at the time, was not unlike most other developing countries, and the opportunity to gain a foothold in one of the most exciting and rapidly expanding markets in the world far outweighed these drawbacks. Companies worldwide reacted with big bets on China, hoping for a long and lucrative future. Their high expectations were further fueled by wishful neoliberal forecasts that more foreign investment would lead to a further opening of China’s economy, a more earnest commitment to free trade and even democratization.
With the arrival of the internet, the Chinese market looked particularly promising for multinational technology companies. In the early 2000s, internet penetration in China was less than 10 percent of the population, and just over 200 million Chinese citizens were online by 2007. A decade later, that number sits at 750 million, more than the total population of Europe. The rapid development that brought more than 200 million Chinese into the middle class during this period also foreshadowed a growing demand for consumer electronics, such as cellphones, laptops and other devices, inspiring technology companies of all stripes to make early investments in China.
For foreign tech companies, the business environment in China has shifted drastically since the mid-2000s, forcing many into difficult compromises.
By the end of the boom years of the late 1990s and early 2000s, China had largely solved its capital problem. Flush with cash from foreign investments, and buoyed by its historic export-led development, Beijing began to shift its focus toward bringing the economy to a more mature stage, led by a strong service sector and higher consumption. Through this process, the CPC rolled out new policies aimed at rearing a new, robust generation of Chinese corporations that could not only help boost consumption at home, but also compete on the global stage.
For most multinationals, Beijing’s new priorities had little impact on business. Companies like General Motors, Boeing, Starbucks, Procter & Gamble and Nike grabbed huge shares of the Chinese market, bringing in considerable revenue. And while some have run into problems in recent years, including suspicious fines and controversial antitrust suits from the Chinese government, for most others, China remains an important and lucrative place to do business.
For the many tech companies that bet on China early on, however, the atmosphere since the mid-2000s has shifted drastically. In part because of an aggressive and protectionist economic strategy engineered by the government, and in part because of Beijing’s extremely stringent internet laws, foreign technology companies in China have routinely been forced into difficult compromises. Especially in recent years, many of these uncomfortable bargains have reached a breaking point, causing firms to pull out of China voluntarily or be expelled.
‘Made in China’ Meets Big Tech
The drive to turn China into a global leader in high-tech industries remains a central pillar of Beijing’s economic policy today. This goal is arguably the most important part of the CPC’s official “Made in China 2025” blueprint for revolutionizing the economy and achieving dominance in strategic areas like cloud computing, robotics, aerospace technology and IT.
In this pursuit, Beijing has relied on a number of tactics to acquire advanced technology and help local tech companies succeed—some familiar, and some novel. In general, Chinese companies have always benefited from the same policies other countries have used to support local industries, such as subsidies and cheap loans from state-owned banks. This sort of intervention was one of the main features of the autarkic growth model that helped countries like South Korea and Singapore achieve rapid industrialization and huge economic gains decades ago.
But because of the size of China’s population, Beijing has always had an extra bargaining chip to bring to negotiations with foreign corporations. The sheer value of access to China’s massive market allows the government to push for steep concessions, compelling foreign technology companies to hand over valuable trade secrets that are otherwise jealously guarded.
From the infant years of the internet through the mid-2000s, Beijing rarely used this leverage, because, for the most part, it never had to. Chinese tech companies that sprung up in the late 1990s, such as Tencent, Sina and Alibaba, were so competitive in China that they thoroughly outshined foreign challengers. Especially in the beginning, simple knowledge of Chinese cultural norms and consumption habits allowed these companies to thrive where outsiders foundered. For example, eBay’s auction-style model was notoriously unpopular in China, largely due to the lack of any sort of direct messaging between buyers and sellers that would allow for haggling. In another case, Yahoo failed early on to attract users to its search engine, largely because rivals like Sina and Sohu knew to direct traffic to popular Chinese chat rooms and message boards that Yahoo’s engine glossed over.
Beijing, April 28, 2017 (AP photo by Ng Han Guan).
With the arrival of more sophisticated foreign companies in later years, however, Beijing began making greater demands. This new assertiveness became clear to the world during the high-profile dispute between the Chinese government and Google, which spanned an uneasy four years, from 2006 to 2010. Despite agreeing to censor its search results in accordance with Chinese rules, Google found itself facing a barrage of disruptions. Due to the various layers of internet controls that make up the content control system known as China’s “Great Firewall,” searches on Google were often slowed or blocked, sometimes bringing the entire site down. The company also weathered constant official complaints from Chinese regulators that it was failing to block pornography and other illegal websites, which some saw as an effort by rivals such as Baidu to cripple Google. Cynical onlookers also pointed to similarities between the design and function of Google products and those of its competitors, such as Baidu Maps.
Friction between Google, the CPC and Chinese companies came to a head in 2010, when Google announced that it had suffered a highly sophisticated hack, ostensibly carried out by Chinese agents, in which intellectual property was stolen. In response, Google uncensored its search results across China, and was promptly and permanently blocked. With Google gone, Baidu and other Chinese web services companies have filled the void.
Despite philosophical differences with Beijing over internet freedom that Google considered irreconcilable just years ago, the company has never felt secure being sidelined from China’s market. In August 2018, reports emerged that Google’s top leadership had been secretly exploring avenues to introduce a news and search product in China that would comply with government censors. Even after the research, codenamed “Project Dragonfly,” was revealed as having been concealed from Google’s privacy team, Google CEO Sundar Pichai enthusiastically defended the concept in hearings before Congress. Ultimately, though, misgivings among Google employees about the way the project was carried out proved too toxic, and the plan was scrapped by December 2018.
The same dilemma that has haunted Google’s executives — whether to make costly compromises on multiple fronts in exchange for access to China’s market or accept lost opportunities and walk away — is one that almost every major technology company has faced.
Foreign Firms on Bended Knee
The storyline of Google in China might suggest that Beijing’s primary interest is controlling access to information, and that if Chinese companies benefit indirectly, this is only an added bonus. But particularly under President Xi Jinping, China has made a policy of squeezing technology companies of all stripes for IP information and other data, and using its sway to help build up its strongest domestic tech players.
Many of the major American tech giants have handed over some amount of intellectual property in order to maintain a presence in China.
The past three years alone have seen an unprecedented transfer of emerging technologies to China at a pace that many worry will springboard the country into a position to rival the U.S. in high-tech manufacturing and military sophistication. Slowly but surely, many of the major American tech giants, including computer chip manufacturers, software companies and network equipment designers, have handed over some amount of intellectual property in order to maintain a presence in China. The list of technology companies that have bowed to pressure from Beijing has grown so long that security and trade agencies in Washington and beyond are sounding alarms. Protectionist practices in China were the subject of a highly critical 2017 report by the U.S. Chamber of Commerce, which echoed similar protests by the European Union. Beijing’s tactics have also been cited as a central motive behind the Trump administration’s ongoing trade war.
In 2017, Qualcomm and AMD, two of the largest chip manufacturers, began working directly with the government of China’s Guizhou province to set up factories that will make critical parts for internet servers. They were following Intel, which cut a similar deal in 2014. Cisco, which makes the networking hardware used in the Great Firewall, agreed to share some of its intellectual property with a Chinese company in 2015 after being blacklisted in the wake of the Edward Snowden scandal, which revealed how Washington used data from American companies and government agencies to spy on other countries. Both IBM and Microsoft have turned over parts of their proprietary source code to ease security concerns from Beijing, and both have recently come under pressure to divulge even more. Dell and Hewlett Packard are also among the big names that have traded IP information for the opportunity to continue selling in China.
For others, the inconvenience and costs imposed by Beijing have proved prohibitive. In early 2017, the hard drive manufacturer Seagate pulled out of China, citing oppressive tax laws and preferential treatment of local companies. The complex web of licensing rules and overlapping local and national laws that foreign companies must navigate also tends to implicitly favor Chinese companies, posing problems for outsiders trying to break into the market. A number of prominent economists have argued that this convoluted regulatory environment was what forced Uber to abandon its business plans in China in 2016 and withdraw entirely.
Abiding the Chinese Internet
A popular view has formed that China is deliberately creating a regulatory minefield for foreign companies in order to help create national “champions” in the tech sector. Cynics have also argued that Beijing disingenuously complains about national security risks as a way to justify extracting trade secrets, like reviewing Microsoft’s source code. But these arguments ignore the very real and significant role that cybersecurity policy has always played in China’s decision-making, even in relation to trade.
The CPC’s desire to control the internet internally and protect itself against foreign espionage isn’t new or unique. Official censorship in China has always been a fundamental challenge for any tech company that deals in information or even connects to outside information networks. And in an era where both the U.S. and China have been exposed carrying out major surveillance operations and hacks, both sides are understandably on alert. For its part, Washington has blacklisted a number of Chinese telecom companies such as Huawei from government contracts in the past, and is now discussing banning Chinese-made drones as well. China similarly barred a range of companies from being awarded official contracts, including Cisco, Citrix, Intel and Apple, in what some speculated was a response to the anti-government protests in Hong Kong in 2014.
during the China Development Forum, Beijing, March 19, 2016 (AP photo by Mark Schiefelbein).
The CPC’s internet control policies have always been so stringent that most foreign social media, messaging and information websites simply haven’t been able to adapt to government requirements. Facebook, Twitter, and YouTube have all been blocked in China for years, followed more recently by Snapchat and Pinterest. In all cases, Chinese companies offering equivalent services have flourished in the absence of any competition. And under WTO rules, Beijing is essentially allowed to bar any outside company it objects to in any way, leaving foreign firms with few remedies.
In his first five years in power, Xi has presided over a dramatic tightening of internet regulations in ways that further cut Chinese consumers off from foreign companies. After years of disruptions and partial censorship, China blocked all access to Wikipedia in 2015. Work is reportedly underway to replace the website with an official government-backed encyclopedia authored primarily by Chinese scholars. Departing from a longstanding policy of tolerating their existence, Beijing also appears poised to finally shut down operators of virtual private networks, or VPNs, which provided Chinese users with a portal to blocked websites. It is unclear whether foreign companies operating in China will also be forced to do without VPNs, which in some cases are critical for communicating with offices outside the country and accessing censored information.
The vast expansion of the surveillance state under Xi seems likely to give Chinese tech companies an even greater edge and drive Chinese consumers toward domestic brands. In 2017, the CPC also moved aggressively to implement a national “social credit system,” which has stirred considerable unease outside of China. As part of the plan, the government has enlisted Chinese companies to share information about customers, and can use big data analysis to score all citizens on everything from their shopping habits to their behavior on social media, building a nationwide social ranking system in coming years. The algorithm is also expected to take into account the choices and actions of people’s friends, family and others in their social network.
One company vying for a major role in the project is Tencent, which operates the WeChat “super-app” that is ubiquitous in China and provides a variety of services, from texting to mobile payment. Another is the credit scoring giant Sesame Credit, which has teamed up with other companies to collect data, including Didi Chuxing, the ride-hailing app that took over Uber’s operations after its withdrawal. In an environment in which one’s social ranking is based on data collected from Chinese companies, there is a clear incentive to use those platforms above others. Such a system would even give the government the ability to penalize citizens that don’t buy Chinese technology or seek services from foreign companies.
Is China Today a Bridge Too Far?
The biggest problem for foreign technology companies in China is that the tech industry exists at the nexus of security and economic policy, and Beijing takes a wary view of outsiders in both spheres, as the banning of WhatsApp in China demonstrates most of all. From the security side, China’s leaders cut off a provider of encrypted messaging, ending a service that helped citizens skirt surveillance and communicate easily with others abroad. In doing so, they also solidified WeChat’s grasp on the Chinese market, potentially forcing more people outside the country to download the app in order to stay in touch with Chinese mainlanders.
The tech industry exists at the nexus of security and economic policy, and Beijing takes a wary view of outsiders in both spheres, as the banning of WhatsApp in China demonstrates.
The choice to try to break into China is less attractive than it once was for foreign companies. While the financial rewards are enormous for the few that find a way to navigate the Chinese market and stay in Beijing’s good graces, recent years have shown that the risk of failure is rising.
The voices of advocates and critics of working with China are getting louder. In the summer of 2017, the CEO of the Consumer Technology Association encouraged U.S. companies to continue trying to find ways to succeed in China, despite the roadblocks. But political pressure is growing on companies to put U.S. security interests ahead of profits and not turn over critical technologies. Lately more than ever, academic and human rights groups are also speaking out against companies that have agreed to self-censor in compliance with Beijing’s information controls.
Since 2016, the Trump administration has also departed from administrations past in shining a spotlight on these issues and blaming Beijing for what it sees as unfair practices. Like many companies, former U.S. presidents have tended to place a high value on healthy business ties with China, using only rhetoric and soft pressure to discourage exploitation of U.S. firms. This has changed under President Trump, who has surrounded himself with advisors sharing his view that China maliciously manipulates U.S. companies, and has aggressively retaliated with hard policy. Criticizing China’s treatment of U.S. companies has been a common theme throughout Trump’s campaign and presidency, and has informed the harsh terms of the ongoing trade war waged by Trump and his advisors.
By every measure, China has developed into exactly the outsize, up-and-coming market that foreign companies expected it would. But as the Chinese economy has matured, Beijing has never embraced a more even, market-based economy, or warmed to the idea of an open internet. If anything, in the tech space especially, the Communist Party has doubled down on centralized planning and grown far more draconian with its controls over online speech and access to the larger internet. Up until now, many players in the tech industry interested in their bottom lines have at least tried to find a working strategy to unlock China. But with at least five more years left in Xi’s powerful presidency, some of today’s largest companies may choose—or be forced—to watch from the outside as China becomes the world’s leader in technology and innovation, on its own terms.
Zach Montague is a news assistant at The New York Times and a graduate of the China and Asia Pacific Studies program at Cornell. Follow him on Twitter at @zjmontague.
[ SPECIAL OFFER: Get your FREE copy of our in-depth report on the U.S.-China Rivalry in the Trump Era. ]