Google and China’s Changing Economic Paradigm

Following two months of tussling with the Chinese government—much of it under the glare of intense media coverage—Google Inc. (GOOG) abandoned its core business in the world’s most populous nation. Specifically, on March 22, the Mountain View-based company announced it had stopped censoring search results in the world’s most populous state. Users, the company posted on its official blog, were being redirected to one of its Chinese-language sites in the Hong Kong SAR (Googleblogspot, March 22).

Analysts wondered whether other foreign businesses would follow Google’s affront to Beijing’s heavy-handed tactics and pull out of China. On March 24, Go Daddy, the world’s largest internet domain name registration company, announced that it would no longer register web addresses in China due to tough new personal-identification requirements (Al Jazeera, March 25). Network Solutions—Go Daddy’s competitor—had stopped accepting China’s business in December 2009 for the same reason.

These incidents beg the question: has Beijing pushed foreign business too far? Google provides a fascinating case study by itself: ‘World’s biggest search engine forced out of country with most internet users’. Yet there are broader forces at play. While Beijing is developing a new model for economic development, foreign businesses are reassessing the planet’s most enticing consumer market and rethinking China’s potential.
 
The results of late Chinese-patriarch Deng Xiaoping’s economic policies, encapsulated in the official-mantra gaige kaifang (reform and opening up), were extraordinary. Mao’s successor began by first dismantling the Maoist command economy and then opening China’s markets to foreign competitors. During the period known as the “reform era”—generally considered to have begun in December 1978 and continuing through today—gross domestic product increased at an average annual rate of 9.9 percent according to official statistics, which may understate the extent of the expansion due to undercounting of the most vibrant part of the economy, the private sector.  

Yet the name given to this period can be misleading. The Party did not so much as reform China as ratify changes already implemented by hundreds of millions of peasants, factory workers and entrepreneurs who, disillusioned by Mao’s great experiments, had abandoned Maoist notions and were determined to do things their own way. Deng, when it came to domestic matters, deserves credit for the good sense to step aside and let the Chinese people transform their own society. Similarly, Deng knew that China needed foreign capital, technology and expertise, and paved the way for their entry by authorizing a tentative opening. Once the first foreigners were in, however, he gradually—and wisely—allowed barriers to fall as tens of thousands of managers and executives pushed to relax rules constraining them.   

The same dynamic of change existed during the tenure of Deng’s successor, Jiang Zemin, and Jiang’s tough-minded premier, Zhu Rongji. Yet "reform" began to stagnate and then went into reverse during the years of the Fourth Generation leadership, led by Hu Jintao and Wen Jiabao. The pair has, since their elevation in November 2002, pursued two broad initiatives that have turned back the hand on Deng’s reform and opening-up.  

First, they have sought to renationalize the economy. In the second half of this decade, Beijing began to use national-level instrumentalities—such as the National Social Security Fund and China Investment Corporation (sovereign wealth fund)— to buy shares of partially privatized state enterprises and banks. The effect of this maneuver was to increase the percentage of state ownership.

Renationalization gained momentum after the announcement of the State Council’s $586 billion stimulus plan in November 2008. In 2009, the first full year of the plan, Beijing poured, either directly or indirectly through state banks, about $1.1 trillion into the economy according to the author’s calculations.

Inevitably, Beijing’s fiscal stimulus program resulted in a bigger state economy and a smaller private one; about 95 percent of recent growth has been attributable to investment, almost all of it from state sources (Xinhua News Agency, November 5, 2009). Moreover, state investment went into the state sector, of course. The state’s stimulus plan favored large state enterprises over small and medium-sized private firms, and state financial institutions diverted credit to state-sponsored infrastructure.  As they say, “the Party is now the economy.” Stimulus, which appears to be reduced this year, is continuing to build up the already-dominant state sector (South China Morning Post, March 5).

This ongoing transformation not only undermines domestic private enterprises, but also prejudices foreign businesses, shrinking opportunities. Yet renationalization is by no means the major obstacle for non-Chinese competitors.  The second initiative of Hu and Wen is to use the rule book to shut them out of the domestic market.  Since the middle of 2006, Beijing, by issuing a flurry of decrees and orders, adopted a decidedly hostile posture toward foreign multinationals.  Of special relevance are regulations, released August of that year, permitting the Chinese Ministry of Commerce to block foreign takeovers [1]. Beijing, worried about the “loss of economic sovereignty,” which in its view included the loss of control of large enterprises, was not hesitant to challenge takeovers by multinationals. At the end of 2007, for instance, Microsoft was not permitted to buy a stake in Sichuan Changhong Electric, a television manufacturer, ostensibly because of concerns in Beijing that the sales price was too low.

Two Goldman Sachs deals in 2007 were also blocked by central authorities. The investment concern was thought to have negotiated too good a deal to buy stakes in Midea Electric Appliances and Fuyao Group (South China Morning Post, November 6, 2007).  

Carlyle, the American investment group, originally agreed to buy 85 percent of state-owned Xugong Construction Machinery. The proposed stake was then reduced to 50 percent and then 45. The deal, originally signed in 2005, was eventually killed by the Ministry of Commerce through, among other tactics, inaction and delay (China Daily, July 24, 2008).  Carlyle gave up in 2008.

Most worrisome, Beijing used its Anti-Monopoly Law, effective August 2008, for the first time when it rejected Coca-Cola’s proposed acquisition of China’s leading fruit juice company. The Ministry of Commerce, in March 2009, said the proposed $2.4 billion merger with Huiyuan Juice Group might end up increasing prices and squeezing out smaller producers. The government’s action, hailed as a “landmark,” proved a questionable decision (Wall Street Journal Online, March 18, 2009). Hong Kong-listed Huiyuan controlled only a little more than a tenth of China’s $2 billion juice market and Coke had a 9.7 percent share. In any event, the Ministry of Commerce provided almost nothing in the way of explanation or rationale. Yet, the irony is that Beijing saved Coke from overpaying for Huiyuan. The fact that Chinese officials stopped a takeover of a run-of-the-mill enterprise in a non-sensitive industry by a foreign business despite its willingness to pay a vastly inflated price is also a sign that there has been a fundamental shift of attitude.  

The Chinese government, of course, denies there has been any such change in its policy. Yet it is undeniable that, for the past three decades, Beijing had committed itself to attracting foreign capital, and now it appears to be backtracking. The perception underlining this new attitude is that foreigners have captured “excessive” market shares and own too much technology. There is also a fear of an overreliance on foreign direct investment. Moreover, Chinese ambitions are much bigger these days. Beijing is attempting to build “national champions” and wants 50 of the world’s 500 largest companies to be Chinese within the next decade (Forbes.com, June 2 8, 2006). The Chinese, in short, want to keep their expanding market for themselves.  

That, among other factors, is motivating Hu Jintao’s “indigenous innovation product accreditation” program, which, to obtain accreditation to sell to governments in China, requires the ownership of foreign technology and trademarks by local enterprises. This attempt to obtain intellectual property has naturally sparked controversy and almost universal opposition from foreign businesses and governments (China Daily, December 16, 2009). In this climate, it is no wonder the latest survey from the American Chamber of Commerce in China shows a growing percentage of businesses—now 38 percent—which feel unwelcome in the country (Voice of America, March 22).  

Google certainly felt unwelcome.  It was undoubtedly perceived as too big, too foreign and too successful, and therefore the central authorities felt compelled to undermine its operations. In a January 12 entry on the company’s official blog (Googleblogspot, January 12), it announced it was no longer willing to filter Chinese searches. Yet the dispute, however framed, was more than just a struggle over government censorship. In the statement, the search engine stated that in mid-December it had detected “a highly sophisticated and targeted attack on our [Google] corporate infrastructure originating from China that resulted in the theft of intellectual property from Google.” According to the statement, at least 20 other large companies had been hacked. In Google’s case, the attacks targeted the Gmail accounts of human rights activists in China, the United States and Europe and the company’s source code.

With Google’s source code, cyberintruders could penetrate the search engine with ease.  Due to “the Great Firewall,” another name for Beijing’s tight internet controls, no independent group of hackers could have carried out coordinated attacks without either official support or implied consent. Moreover, no organization in China outside the central government, the Communist Party and the military has the resources to maintain large-scale and concerted efforts.  

Therefore, the inescapable conclusion is that, if the attacks on Google’s network originated in China, the Chinese one-party state had to be behind them. “The fact is that everyone in the U.S. government who looks at these cyberattacks admits privately that they have the evidence: “the attacks are from the Chinese government, and not rouge hei-ke,” says John Tkacik, retired State Department intelligence specialist on China and author of “Trojan Dragons,” a 2008 survey of Chinese cyber spying published by the Heritage Foundation [2]. In fact, VeriSign’s iDefense Labs, an American internet security firm, traced the attacks on Google back to the Chinese government "or its proxies" (Guardian [London], January 14).  

The U.S. government has begun to discuss China’s cyberwarfare campaign in public only because Google forced its hand. Beijing was responsible for a “DNS poisoning” attack that caused Google to crash worldwide last June, and the company was perpetually harassed by Chinese hackers since its arrival in the country in 2006.  That is one of the reasons why Google’s business never took off in China. Its market share in that country was only 36 percent before its withdrawal, far behind local competitor Baidu’s 58 percent at that time. Google may have made missteps entering the Chinese market, but Baidu got to where it is largely because of crucial help from central government authorities.  

Google thinks it can salvage its business there. Beijing, predictably, began to block searches that had been routed to Hong Kong. More ominously, Chinese officials are already pressuring the big state-owned cell phone companies—China Mobile and Unicom (New York Times, March 23), the two largest operators—to break off relations with Google, which wants to launch its Android phone. And the American company has been the object of Cultural Revolution-style attacks in state media that can’t help but talk about America’s “information imperialism,” Google’s “deliberate plot,” and the link between the company and the Opium Wars (China Daily, March 22). “Google is not God and Google is not a ‘value virgin,’” wrote People’s Daily, the Communist Party’s flagship publication, just after the company announced it was shutting down its China search engine (People’s Daily, March 24).  

So far, we are seeing a spiteful response from an angry government. And a government that will go to great lengths to make sure the Chinese market is reserved for Chinese competitors. Google’s recent troubles show us that Beijing has a new economic paradigm, and it is not a good one. 

Notes

1. See Regulations on Acquisition of Domestic Enterprises by Foreign Investors, promulgated on August 8, 2006 and effective September 8, 2006 (issued by the Ministry of Commerce and five other agencies).
2. John Tkacik, e-mail message to author, March 27, 2010.