China's Tech Sector - The Pendulum Swings Back

From crackdown to collaboration—how government support for Chinese tech giants could unlock new growth and investment opportunities

Introduction:

Last week, I shared a simple mental model I use to quickly assess certain Chinese policies (you can find it [here]). This time, I want to expand on the pendulum swing analogy. The key point of this model is that what happened in the past doesn’t necessarily predict what will happen in the future—in fact, it often suggests the opposite. Changes can be rapid and dramatic. To illustrate this, I’ll use the Chinese tech sector as an example. Two or three years ago, investing in this sector was a poor choice (you don’t invest when the pendulum is swinging against you), but today, the landscape has shifted entirely. In this article, I will explain why.

Last week’s article was written in the spirit of how Charlie Munger discusses mental models—focusing on distilling the core idea rather than exploring the deeper reasoning behind it. I only hinted at why this model works, without going into much detail. Initially, I considered writing a follow-up to expand on these ideas. However, Robert Wu has since written an article that explains the topic far better than I could. So, instead of a follow-up, I highly recommend reading his piece.

Tech Company Regulations - A Brief Review:

I’m going to briefly review the increased regulations on Chinese tech companies, often referred to as the “tech crackdown.” While I don’t particularly like the term, it has become widely used, so let’s go with it for now.

Chinese tech companies operated with minimal oversight for years, especially in how they handled consumer data—something unimaginable for their Western counterparts. Chinese consumers, eager for small discounts, often handed over sensitive personal information for as little as one or two RMB off a meal—a practice I’ve witnessed many times and found unsettling. The government allowed this free rein for years, and tech companies largely went unchecked, leading to what could be seen as an extreme.

However, government concerns began to grow. Data security became a key issue, particularly with companies listing abroad and potentially exposing sensitive information. Monopolistic practices and their impact on competition and consumers also raised alarms. In addition, social issues like gaming addiction and the influence of social media were becoming worrisome. Lastly, as tech giants expanded into sectors traditionally controlled by the state—such as finance—the government moved to reassert its authority and ensure alignment with national interests.

The tipping point, or the reversal of the pendulum, came with Jack Ma’s now-famous speech at the Bund Finance Summit in Lujiazui, Shanghai, on October 24, 2020. In this speech, Ma sharply criticized China’s financial regulations, calling them outdated and rooted in a “pawnshop mentality.” His comments, combined with his political ambitions, marked the end of this lenient regulatory era. The pendulum had swung too far, and the crackdown marked the correction.

Alibaba was hit with a record $2.8 billion antitrust fine, and its affiliate Ant Group had its IPO suspended just days before its scheduled listing. The IPO was expected to be the largest in history, and its sudden halt sent shockwaves through financial markets. Tencent, known for its WeChat app and dominance in gaming, faced new regulations limiting the time minors could spend on online games. The company was also scrutinized for its music streaming business, leading to the unwinding of exclusive licensing deals.

Other companies didn’t escape either. Ride-hailing giant Didi Global was investigated for data security breaches shortly after its U.S. IPO. Education technology firms were forced to restructure their entire business models. The list goes on, but I’ll stop here.

Returning to the pendulum analogy: when the pendulum was swinging in the right direction, and the government remained hands-off, investing in these tech companies made perfect sense. They thrived in an environment of minimal regulation, benefiting from unprecedented access to consumer data and market freedom. However, the moment the pendulum began to swing back—with the government imposing stricter regulations—those investments became far riskier. When the regulatory hammer falls, you’d better run for cover, as the once favorable conditions for growth can rapidly reverse.

Does the Chinese Government Hate Tech Companies?

A friend once asked me if the Chinese government hates tech companies. I think this view is flawed. The reality is that the Chinese government is indifferent to these companies; their stance is far more opportunistic. When tech companies align with their broader goals, the government can be their strongest ally. However, when these companies overstep—whether by displaying political ambitions, facing public backlash, or simply falling out of favor—the government can swiftly become their adversary.

A prime example of this opportunism can be seen in the crackdown on the housing, healthcare, and education sectors. These industries were not targeted out of animosity but because they were directly linked to a larger governmental goal: increasing birth rates. The government determined that the high financial burden of housing, healthcare, and education was discouraging families from having more children. By targeting these industries, they aimed to reduce this financial pressure and encourage larger families. This demonstrates how the government’s actions often serve strategic objectives rather than stemming from hostility toward any particular company or industry.

Just because the government has penalized these companies in the past doesn’t mean they will continue to do so. In fact, quite the opposite. I would argue that the Chinese government is now becoming increasingly supportive of tech companies. The pendulum is swinging back again. We’ve seen similar things happen in the past. Last week, I discussed the Baijiu industry, the 2013 corruption crackdown, and the subsequent rise in more detail.

So, What Changed?

There are some clear signs that things have shifted. For one, the State Administration for Market Regulation (SAMR) has officially concluded its investigation into Alibaba, signaling the end of a major chapter in regulatory scrutiny. Additionally, if you listen to the earnings calls of the major tech players, you’ll notice that government involvement in the crackdown is rarely mentioned anymore. In fact, some companies are even hinting at more favorable conditions ahead, suggesting that the environment is becoming more supportive.

Real estate, once one of the primary drivers of China’s GDP, is now facing significant challenges. After years of skyrocketing property prices, it’s clear that this growth can’t continue indefinitely. A key factor is demographic: between 1960 and 1970, about 400 million people were born in China, and as this generation now approaches retirement, the population is set to shrink. As the population declines, so will the demand for housing, leaving many buildings potentially unneeded. This is especially true for properties outside key urban centers. With one of the main contributors to GDP growth faltering, the government needs to look elsewhere for economic support. The digital economy, which already accounts for 30-40% of GDP, is the obvious choice. The government has consistently emphasized the importance of digitalizing the economy, particularly the real economy. So, again, we hear signals of support for this sector.

The digital economy not only represents a significant share of China’s GDP but is also a major employer, which is especially critical given China’s high unemployment rate, particularly among youth. This makes it even more likely that the government will continue to support the sector. With the pendulum swinging back, it’s logical for the government to back the digital economy, as long as these companies avoid overstepping their boundaries and treat all parties involved fairly. For more on this, see my articles on Pinduoduo.

While this is quite apparent, I believe there’s another, less-discussed reason why the government is likely to heavily support Chinese tech companies.

National Security

Not long ago, Eric Schmidt, the former CEO of Google, gave a thought-provoking talk at Stanford, where he highlighted the critical role artificial intelligence (AI) now plays in national security. What stood out to me was that Schmidt, who now works with the U.S. Department of Defense, emphasized AI’s growing importance far beyond consumer applications like ChatGPT. He noted that AI is already visible in military conflicts, such as the ongoing war between Russia and Ukraine, underscoring that this technology is increasingly a matter of national defense.

When asked who would lead in the AI race, Schmidt was unequivocal: the future belongs to nations with substantial resources. Building a competitive AI infrastructure requires vast data centers, immense amounts of data, top-tier talent, high energy consumption, and, most importantly, deep financial backing. According to Schmidt, only two nations meet these requirements—the United States and China. Europe, constrained by bureaucratic structures and a lagging tech ecosystem, has already missed the train, much like it did with the rise of the Internet.

The key point for this article is the shift in how the Chinese government views its tech companies. In the past, whether Chinese consumers shopped online or played games wasn’t a major concern for the government; tech companies were primarily there to facilitate transactions, something that could also be done offline in the traditional way. But now, with AI becoming integral to national security, China needs its tech giants more than ever. These companies possess the financial resources, talent, and infrastructure necessary for AI development, positioning them as essential players in securing China’s technological future. Just as the U.S. relies on its tech firms, China will likely provide significant support to its own tech sector, recognizing that AI is now a critical part of national defense.

Conclusion:

Now, both economic growth and national security—two of the Chinese government’s top priorities—depend heavily on the country’s tech companies. These firms are not only crucial for driving GDP through innovation and digital transformation but also play a vital role in safeguarding data and maintaining technological sovereignty. As a result, I expect to see increased protection, support, and collaboration from the government going forward, which contrasts sharply with the regulatory crackdown of a few years ago. The pendulum is now swinging in the opposite direction, toward fostering growth and partnership with the tech sector.

Just as we are free to take advantage of Mr. Market’s mood swings, we are equally free to exploit the shifts of the policy pendulum in the market. When the pendulum swings in our favor, we can capitalize on opportunities, and when it moves against us, we can choose to adapt or wait for the next favorable shift.

Next week, I’ll be writing another article where I’ll elaborate further on recent developments with Chinese tech companies and why I believe even more government support could be in the pipeline. So, stay tuned for more details.