#136 Xi Is Unfriending Big Tech

Matsyanyaaya: The Rational Actor Trap

Big fish eating small fish = Foreign Policy in action

— Pranay Kotasthane

Nothing succeeds like success. Once you are perceived as being successful, new narratives emerge that trace a neat path explaining how success was attained through grit, foresight, and determination. The role of chance fades in the background. All stories show how the hero withstood the odds, took the right decisions, and defeated a world that was stacked against it.

Sometimes, nation-states craft stories with such narrative arcs.

The State as the all-knowing decision-maker is imagined as a consistent, value-maximising agent, which chooses each policy as a calculated solution to a strategic problem. This model is what Graham Allison and Philip Zellikow call the rational actor model of decision-making in their classic Essence of Decision: Explaining the Cuban Missile Crisis.

The book goes on to show the inadequacy of the rational actor model in explaining foreign policy decisions. It proposes two other decision-making models that take into account bureaucratic resistance, individual initiative, turf battles, and a struggle for power, to better explain government decisions.

The key takeaway is that when we don’t understand the internal politics of a nation-state, we instinctively assume it as a black box that churns out decisions based on well-defined goals, well-understood alternatives, and well-projected calculations of costs and benefits of all the available alternatives.

Precisely this is how the thinking about China is today on the streets and WhatsApp groups of New York, Delhi, or Lagos. Every act by China is imagined as a calculated move made with a larger long-term goal in mind; a juggernaut that makes no mistakes; an Arjuna that never misses the fish’s eye.

A common way in which this narrative commonly plays out is as follows: someone will quote a Chinese leader in the past to show how prudent and far-sighted he was. Virtually, no discussion on China goes by without quotes such as “Cross the river by feeling the stones” or “The supreme art of war is to subdue the enemy without fighting” being used to conjure the image of China as a successful rational actor. So much so that some of these quotes weren’t even said by Chinese leaders and yet continue to circulate in opinion pieces, textbooks, and seminars.

Take this quote attributed to Zhou Enlai for example. The story goes that he was asked by French visitors in 1972 about the impact of the French Revolution of 1789, and he sagely replied “It’s too early to say”. This is often cited to prove how the Chinese political system produces master strategists who take the long view. Turns out, he was only talking about the French student protests of 1968 which continued for many years thereafter. And yet, this story has endured.

Another quote ninja is Deng Xiaoping, of course. His famous words “to get rich is glorious” is cited in support of how quickly the Chinese leadership was able to adroitly put behind the socialist excesses of the Mao era. The only problem is that it’s not known whether Deng ever said so. In fact, this phrase comes from Oliver Schell’s 1984 book by the same title on Deng era reforms. Then on, this quote has assumed a life of its own.

These misattributed quotes are not mere trivia but symptomatic of a larger problem — our inability to deeply understand China. Because we don’t know what’s inside the box, we assume the Chinese system as a rational actor that succeeds because of the foresight of its leaders alone.

This view, of course, is incorrect. In edition #44, I discussed four myths emanating from this line of thinking that the party-state is always efficient, always meritocratic, always a military aggressor, and always a sound strategist.

To counter the China challenge, a superficial rational-actor model understanding of China is not just insufficient but harmful. It makes the adversary seem far more powerful than it is in reality. We need better models to understand our adversary.

If the content in this newsletter interests you, consider taking up the Takshashila GCPP. The certificate course is customised for working professionals. Intake for the 30th cohort ends on 22nd August. 

Global Policy Watch: China’s Big Tech Crackdown  

Bringing an Indian perspective to burning global issues

- RSJ

We often write here about how regulating big tech will need a different framework from the typical antitrust lens that's been used in the past to protect consumers from predatory business practices. The big tech companies pose risk to consumers not through predatory pricing or restriction of choices because of their marketshare. Instead, they abuse their market power in new and different ways.

They track usage data without consent in deeply intrusive ways that should spook the average consumer. Their platforms often enable spread of disinformation and creation of echo chambers by directing consumers to content based on algorithms that optimise for engagement. Engagement is different from enlightenment. Never was this more clear in our lives as we see fake news, unscientific notions and rumours scourge our societies. Big tech poses social and political risks that are beyond the ambit of any competition laws. You cannot solve new problems with old solutions.

While the west is figuring out the way ahead and making unusual executive choices, China in the past few months seems to be keen to show the world its own way of dealing with big tech. Like many regulations in the past, these are meant to reinforce the only truth in the Chinese policy sphere - the party is the boss. It can do and will do as it pleases. You may call it antitrust regulations with Chinese characteristics. This op-ed in the Chinese state run daily the Global Times gives a view on the line of thinking:

“More importantly, the government will not allow internet giants to become rules-makers of data collection and usage. The standards must be in the hands of the government to ensure that giant companies are restrained when they collect personal data and stick to the principle of minimization. No internet giant is allowed to become a super data base that has more personal data about the Chinese people than the country does, not to mention using the data at its own will.For companies like Didi which have gotten listed in the US market and whose largest and second-largest shareholders are foreign companies, China should more strictly supervise their information security to protect both personal data security and national security.”

I will let the irony of the Chinese state talking about privacy and on the principle of minimization when it comes to personal data of its citizens wash over all of us for a bit.

Over the years there was a ‘nudge and wink’ approach between Chinese regulators and its domestic digital champions on many vexing regulatory issues. None more than the variable interest entity arrangement to list overseas that was a well established way to circumvent Chinese laws. All that is history now.

The Story So Far

Anyway, a quick recap of the steps China has taken in the past year or so will be helpful to set the context here.

* In Sep 2020, China issued a new set of rules for regulating financial holding companies with a view to regulate the enormous clout and reach of the shadow banking sector that could threaten the stability of the financial system if left unchecked. On cue, in October 2020, the Financial Stability and Development Committee headed by the Vice Premier raised concerns about the growth of fintechs and their microlending practices.

* In Nov 2020, Chinese regulators suspended the much anticipated $34 billion IPO of the Ant Financial Group. A record fine and the ‘disappearance’ of its founder, Jack Ma, followed.

* In the first quarter of 2021, Meituan (the Amazon of services in China) was fined by multiple municipal regulators and it shut down its health insurance service after facing regulatory scrutiny. Its founder, Wang Xing, a classical literature enthusiast, posted a few verses from an ancient Chinese poem about an arrogant emperor and his misguided attempts at stifling dissent. He later deleted the post. I’m not sure if there is an ancient Chinese parable about a dog with its tail between its legs that he knew.

* Last week, ByteDance (the owner of TikTok) postponed its US listing plans after meeting the Chinese cyberspace regulators. The official line was that ByteDance will take some more time to comply with the new regulations proposed by the Cyber Security Review Office (CSRO).

* ByteDance didn’t have much of a choice really. Didi, the world’s largest ride-hailing firm with about 500 million users across 15 countries, went public with $4 billion IPO on NYSE on June 30. This despite some public reservations from the CSRO on its data security practices. Didi thought it was still the old world and ignored it. The stock soared on debut and Didi’s valuation rose to $80 billion within a day. Two days later the Chinese state cracked down. It barred it from adding any new users. A few days later it found serious violations in the collection and usage of personal information of its users and ordered all app stores to remove Didi’s main app and its 25 linked apps.

* By the end of the last week, the cyber security regulator had announced probe into two other US listed Chinese companies - Full Track Alliance and Kanzhun. In the same week, the cyber security regulations were tightened, the overseas listings process was made tougher and variable interest entity arrangement loophole plugged. The world for Chinese digital companies had changed in a matter of weeks.

There are two things that interest me in this sequence of events. What’s driving this big tech crackdown in China? And what does it mean for the world and India? I will put my initial thoughts here and I will welcome views from readers with greater knowledge of the subject.

This Far And No Further

There are two lens to use on the reasons for the crackdown.

Domestic

The CPC (Communist Party of China) created the ‘walled’ digital ecosystem that didn’t permit US tech giants to enter China. This led to the emergence of the home-grown champions across sectors that copied business models from the Silicon Valley and supplanted them in China. Over the years these champions built large businesses, innovated on the back of strong technology capabilities and laissez-faire regulations on privacy and data usage and expanded to foreign markets to create virtual monopolies in China. This has meant multi-billion dollar valuations and enormous rise in personal wealth of founders and the management teams.

The CPC is now sending out a reminder to these firms on who enabled their rise. This is driven by three fears.

One, the growing wealth inequality in the society because of these firms and the sense of anger at their long and tough working environments (9-9-6 is fetishised among them). Two, the CPC is worried about the enormous power and clout these founders wield which left uncontrolled can be a potential risk in future. Three, the rise of unchecked lending through fintech apps and the almost total control of the consumers’ information and choices by these digital monopolies can create rival power centres for the CPC.

The CPC which had deliberately enabled a loose regulatory ecosystem to facilitate growth of their big tech companies is reining them back now. All the big tech monopoly issues that the US is wrestling with apply to China too. But with the added flavour of a paranoid state apparatus. The state is now wresting control back. And it has a convenient ideological big stick for beating them with. Big tech is threatening one of CPC’s core objectives - building a harmonious society. Expect more of this.

US-China Relations

The Biden administration has repeatedly made the point that America is in competition with China to win the 21st century. And this competition is going to be technology led. In June, President Biden signed an executive order banning investments in 59 Chinese companies that included some of the largest Chinese digital apps and telecom equipment manufacturers. On June 22, the US Senate passed Accelerating Holding Foreign Companies Accountable Act. This Act prohibits foreign companies from listing their securities on any of the U.S. exchanges if the company has failed to comply with the Public Company Accounting Oversight Board’s (PCAOB) audits for two years in a row. Currently, China’s regulators do not allow the PCAOB to inspect audits of companies registered in China and Hong Kong. This act is meant for getting Chinese companies to fall in line.

Simply put, US regulators do not want American investors money to go into Chinese companies whose books they cannot audit. Chinese regulators, on the other hand, are wary of US government agencies seeking access to their homegrown champions who have enormous information about their Chinese customer base. The US regulators have given a timeline for Chinese companies to comply or delist. China went a step further. It asked existing Chinese companies with overseas listing to first undergo a thorough cyber security review with them before complying to any US regulations. This is classic one-upmanship

I wouldn’t go as far as saying this is the start of a decoupling phase between the financial markets of US and China. But the signs are ominous. China wants the domestic companies to go for a Hong Kong listing. This allows them to access foreign capital on their own terms. Plus, it keeps the wheel of finance moving in Hong Kong after the fears of it losing its status as a global financial hub in light of China’s actions there in the past year. China doesn’t want US to dictate terms to it. The recent actions suggest it won’t back down from setting the agenda. US also will not have any more of China using its state capacity to build global companies who then snoop for it. This is a deadlock.

What Does This Mean?

So, what are the implications of these actions? It is a bit early to arrive at any definite conclusions. But if one were to extrapolate and speculate a bit, I will draw a few conclusions.

Firstly, this is trade war by another name. This mutual suspicion of intents, the charade of cyber reviews of its companies by China, the further banning of the apps by the Biden administration and the ‘new cold war’ kind of language suggests we could be in for more tit-for-tat responses between the two countries. There will be slowing down of flow of capital between them and it will have an impact on global capital markets and trade flows.

Secondly, China’s clampdown on its big tech will provide ammunition to those who want to regulate big tech elsewhere in the world in a more direct way. China might not be the best model to emulate on regulations. Agreed. But the other way to frame this is - if the Chinese state is now being paranoid about the power of its big tech, how badly do we need big tech regulations in a democracy?

Thirdly, there will be a slowdown in investments going into Chinese startup and digital ecosystem. Investors don’t like unpredictability and the last year has shown Chinese state can be whimsical in stopping IPOs, slapping fines, changing regulations and clamping down on companies that have huge foreign investments riding on them. This isn’t music for global investors. Expect India and other ‘open’ digital markets to rake in foreign direct investments in their startup ecosystems. Some of this is already seen in India in terms of deal flow in the past two quarters. More will follow.

Lastly, there has been a clamour in India for us to emulate the ‘Chinese model’ of creating domestic champions by restricting US big tech companies to build their base in India. There’s a spectre of ‘digital colonialism’ that’s often raised by the sundry ‘Aatmanirbhar’ advocates, the local startup founders (though they are funded by foreign capital themselves), domestic VCs and others with interests in keeping global competition away. They would would like nothing better than to have a digital ‘Bombay Plan’ for the 21st century.

The crackdown by the Chinese state on its homegrown companies is a useful reminder to all. The state is nobody’s friend. The state has only one interest. To perpetuate its hegemony. Once you invite it to distort the playing field, it settles down there.

Now it wants to play. And that helps no one.

India Policy Watch: The North vs South Debate Revisited

Insights on burning policy issues in India

- Pranay Kotasthane

Ramachandra Guha, in an important article for The Telegraph, expresses disappointment that South India counts for too little in national politics, a situation he feels will only worsen in the future:

“..for all its social and economic progress in recent decades, in political terms the South continues to count for far too little in the life of the Republic. And it may soon count for even less. On the anvil is a proposal to re-allocate Lok Sabha seats afresh on the basis of population. Were that to happen, the states that serve their citizens moderately well, such as Kerala and Tamil Nadu, will find their negligible influence on the Union government’s policies and priorities declining even further. 

The states that serve their citizens indifferently or abominably, such as Uttar Pradesh and Bihar, will find their already considerable influence on the Union government’s policies and priorities escalating even more. This increasing asymmetry shall place fresh burdens and stresses on the already-fragile state of Indian federalism.” [The Telegraph, 19th June]

This argument adds weight to the common refrain in India’s federal polity and hence I will follow it through. Specifically, I seek answers to these two questions: what does it mean when people say that the South ‘counts too little for national politics’? And if that’s the case, what would giving the South its due look like?

A caveat before we begin this exploration. South and North are completely malleable concepts. Sitting here in Southern India, North is assumed as a short-hand for the economically laggard states in the Indo-Gangetic plain. This conception generally ignores the more prosperous northern states (J&K, Punjab, Haryana, Gujarat, and Maharashtra) or the less populous hilly ones (HP and Uttarakhand). Essentially, the definition of the ‘North’ gets moulded only to focus on the basket cases.

Now, back to the two questions. In my view, there are three dimensions of this detachment.

1. Economic Siphoning

The perception: A common grouse you would have come across often is how the South ‘subsidises’ the North; how the money produced by the sweat and tears of factory workers on the outskirts of Chennai is wasted on farm loan waivers in Lucknow.

The reality: For one, the figures that the South subsidises the North are quite exaggerated. For example, looking at direct tax data shows that Maharashtra alone accounts for 38 percent of collections. Surely, it’s not true that 38 percent of India’s economic activity takes place in Mumbai. In reality, this striking difference is because of a tax accounting design bug — since most companies are headquartered in Mumbai, taxes paid by them get “collected” in Maharashtra even if the economic activity is carried out by their subsidiaries in another state.

That apart, given the shifting economic base since economic liberalisation, it is safe to assume that there is, indeed, some redistribution from the South to the North. More accurately, there is transfer of money from all states that do economically well to states that don’t i.e. even Punjab, Haryana, and Gujarat, apart from most states in the South, would be having net outward flows of government revenue.

And this is unavoidable to some extent. The logic is simple — in order to ensure that at least minimum levels of key public services are achieved across the country, the poorer states would need more help from the Union government than the richer ones. Imagine another communicable disease that has been eradicated in a few rich states but not in the poor ones due to lack of funds. Sure enough, this disease will eventually spread to the richer states as well due to inter-state human movement.

So, some form of redistribution across states is desirable. This is not a problem per se — no federal system in the world balances government money flow at state borders. Perhaps what makes the problem acute in India is that the stark difference in per capita GDP — the richest, Haryana, has a per capita GDP that is nearly five times that of the poorest, Bihar. More on this issue in this twitter thread.

A solution: Given that there are good reasons for why government transfers exist, is there a way out? Indeed, there is. As I have written earlier, focusing on how much money gets transferred from TN to UP is a wrong question to ask. Instead, the focus should be on the government revenue that the union government appropriates from all states as a whole. If the Union is pressured to devolve more money to states via the Finance Commission formula, all states will gain. More on this “monkey and two cats” devolution fable in edition #131.

2. Denial of Political Power

The argument: the South has better socioeconomic indicators and yet its influence on Union government policies will continue to decline because of its lower population growth.

The counter-arguments: The Malthusian idea that there should be a political reward for reduction of population is quite unfair to the average Indian, regardless of where she lives. That’s because in a representative democracy, the key factor that’s equated as far as possible is that my vote has the same electoral value as yours. This core principle means that constituencies across India roughly have the same number of voters. What follows from this ‘republican’ principle is that larger and denser states will definitely have more representatives than the smaller and less-dense ones. To overturn this idea because governance in the North is terrible is to punish the individuals in that state twice.

This is also a defeatist argument. It assumes that the South is destined to play a shrinking role in the Union government.

The solution: The problem on the political front is not with respect to MP, Rajasthan, or Chattisgarh. The real issue is that some of our worst-governed states — UP and Bihar — are also the largest single political entities. They together account for nearly 22 percent of the Lok Sabha seats, making them wield disproportionate influence at the national stage. Splitting a big state such as UP into more manageable parts would negate the advantage it has.

Second, if the South wants to influence the Union government more than it currently does, regional parties from the South must work towards extending their presence in the North. Without broad basing their presence across the country, they will have to play a second-fiddle role at the national level. Regional parties need to think beyond the limited notion of one-state, one-language.

3. Cultural Underrepresentation

The argument: Hindi, Hindu, Hindustan themes crowd out the alternate conceptions about India. I sympathise with this argument.

The solution: These concerns get heightened when a Union government insists on ramming down one religion, and one language across the length and breadth of the country. Letting go of this need to assimilate might at least partially assuage the South. On the other hand, state governments should work with each other such that Kannada can be taught in Ahmedabad schools and Telugu in Lucknow colleges.

In essence, solutions to the disgruntlements in India’s federal polity require imaginative solutions by both the Union and all States together.

Addendum

- RSJ

I agree with Pranay’s counterarguments on the North-South debate. Unfortunately, these are coming up with increasing frequency in the media mostly driven by the contrasting electoral fortunes of BJP in these regions.

I will add a few points that are relevant to this topic.

Firstly, spatial imbalance is an economic feature at every geographical level. It depends on the level of granularity at which you want to do your analysis. So, you could argue South does better than North at pan India level. But within South, maybe the old Mysore belt is better off than northeast Karnataka (the erstwhile Hyderabad-Karnataka). Within the old Mysore region, the western part has better socioeconomic indicators than the north. You can go down to the ward or taluka level of a city or a district with this analysis and you will find spatial imbalances. The reason for this is simple. Economic growth tends to spatially cluster because agglomeration of activities increases efficiency and leads to positive externalities. This sets off a virtuous cycle of more investments in social and physical infrastructure which further attracts investments and so on. This agglomeration has been exacerbated in the knowledge intensive and service industries where even migration of labour that helps in redistribution of wealth through repatriation doesn’t happen as much because of the specialised skills needed. So, this idea of using a geographic lens to assess socioeconomic prosperity and then to link it to greater political representation is illogical. You will set off a demand for such unequal representation down to every ward and taluka in the country. It is dangerous to further this line of argument in a democratic republic.

Secondly, the question really is that of ‘convergence’ of socioeconomic progress between regions and reduction of spatial imbalances. This is a vexing issue for policy makers. The traditional way of looking at this is how to balance efficiency and equity within a region or a country. Continuing to have economic growth clustered in specific regions gives you efficiency but leads to regional inequities. On the other hand, we have seen top-down attempts to push investments into newer regions rarely work because of variety of factors including network effects and lack of positive externalities. In fact, forcing investments into newer regions through tax incentives or any other means leads to suboptimal results at an aggregate level. The traditional economic clusters lose out on efficiency while the newer regions rarely take off. You get neither efficiency nor equity.

This is why like Pranay suggests the solution lies in greater devolution of finances and decision making in our federal structure. The choice or the trade-off is easier to make at a smaller regional unit. Of course, at the national level, the Union must make the investments in developing stronger institutions, spending on public goods and building social infrastructure to improve human development indicators in poorer regions. The answer is obviously not having differential political representation for the better off regions. Like Pranay writes that would be penalising the citizens of poorer states twice over. And if I might add it would be plain stupid.

HomeWork

Reading and listening recommendations on public policy matters

* [Article] “The China Discount Widens” writes Robert Armstrong in the Financial Times

* [Paper] “Amazon’s Antitrust Paradox”, the famous 2017 paper by Lina Khan in the Yale Law Journal. President Biden nominated the 32 year-old Lina Khan as the Chair of the Federal Trade Commission (FTC), the US antitrust watchdog.

* [Book] The Paradox of India’s North–South Divide: Lessons from the States and Regions by Samuel Paul and Kala Sridhar, is an excellent economic exposition of some key differences.

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