Can China still lead the world in tech without a new Jack Ma?

A couple of China’s most successful entrepreneurs have quit high-level positions amid the turmoil. Zhang Yiming, the founder of TikTok owner ByteDance, recently announced he would step down as CEO at just 38 years old to take a less prominent role in the company. And Colin Huang, 41, said in March that he would resign as chairman of Pinduoduo (PDD), an upstart e-commerce company that competes with the likes of Alibaba. Meanwhile, Alibaba (BABA) co-founder Jack Ma — China’s most famous tech entrepreneur — has largely dropped out of public view.

“The atmosphere hovering over China’s tech landscape has grown increasingly toxic,” said Alex Capri, a research fellow at Hinrich Foundation and a visiting senior fellow at National University of Singapore. He cited Zhang’s move as “proof that fear trumps ambition if the threat of public humiliation or some worse form of punishment awaits those who challenge the system.”

But challenging the system is essential to the private enterprise that played a key role in China’s transition from a poor country to one of the world’s greatest economic and tech forces over the past few decades. Losing that dynamic would not only risk undermining some of those achievements, it could also make it much harder for China to meet its ambitious goals to lead the world in the technologies of the future.

A state-driven economy

Wary tech executives need look no further than Beijing’s public humiliation of Ma. The flamboyant and outspoken entrepreneur all but disappeared after he criticized China’s state-controlled banking system last fall for having a “pawn shop mentality,” and accused the government of using stodgy and outdated means to regulate a modern financial system.

“Part of the crackdown on internet tech companies is motivated by the desire to reduce financial risk, as in curtailing the lending activities of Ant,” said Nicholas Lardy, a senior fellow at the Peterson Institute for International Economics (PIIE) who studies China’s economy. Ant held about 2.15 trillion yuan ($333 billion) worth of consumer and small business loans this time last year.

But another reason “may be due to Xi’s desire to cut down alternative sources of power that could ultimately challenge the dominance of the [ruling Chinese Communist Party],” Lardy added.

Beijing’s desire to exert heavier control over private enterprise comes from the government’s faith that a state-managed planned economy is more effective than one that relies on a free market approach, and more importantly, more likely to allow the Party to preserve its power.

“The leaders of the tech firms that have become too powerful for the comfort of Xi and the Communist Party are put under pressure, as the monopoly of power across the board by the Party cannot be allowed to be challenged,” said Steve Tsang, director of the SOAS China Institute at SOAS University of London. “Hence, they individually take actions to reassure the Party and Xi that they will not do so, by handing over the corporate leadership to protégés.”

An unstable balance of power

China’s internet companies aren’t necessarily trying to rock the boat. Alibaba has worked extensively with the government on its Rural Taobao initiative, a program aimed at reducing poverty among farmers by helping them sell goods directly to urban consumers online. The company also developed a government-sponsored app — Xuexi Qiangguo — that teaches Xi’s political philosophies.

“All of the big Chinese tech giants — in spite of their private nature — have cultivated a proximity to the government that presumably created the idea of balanced power relations,” said Sonja Opper, a professor at Bocconi University in Italy who studies China’s economy and its institutional transition to the private sector.

“The Party groomed rock-star like celebrities, [and] they were co-opted by making them members of the National People’s Congress,” Opper said, adding that tech entrepreneurs “certainly began to feel safe, because of their economic power and global visibility.”

“They began to raise a critical voice and began to look like people who can challenge current thinking,” she said. “What we see now is how unstable this balance was, and that control remains the government’s key interest.”

A risky strategy

Beijing’s strategy is inherently risky.

Restoring a high degree of state control may curtail the freedom that these private companies have to innovate and keep up with major global competitors.

Investors may lose the incentive to pour money into private Chinese firms if they are worried about “unwanted government interference,” Opper said, especially since some tech projects often take a long time to develop. And there’s evidence that may already be happening.

China’s policymakers don’t want to eliminate the private sector — it contributes nearly two thirds of the country’s GDP and employs 80% of the workers. But it’s very clear that Xi wants the state sector to lead, with private companies playing a supportive role.

“It’s a paradox,” said Lardy from the PIIE. “Xi wants the state to play a greater role. That’s very clear from all the things he said from the last 10 years. He wants the government to play a bigger role to get things going faster.”

“Looking back, there is a reason why China’s tech giants were able to develop,” Opper said. “They had a degree of freedom that allowed [them] to unleash productivity and innovation not seen in any state-owned enterprises in China.”

Overly confident

That doesn’t seem to be a lesson that China’s policymakers want to heed right now.

The Covid-19 pandemic has convinced China that a largely planned economy with strict regulation of many aspects of life is the best approach to running the nation. The country last year implemented some of the strictest measures worldwide to contain the virus. In turn, it emerged as the only major economy to avert recession, outperforming its Western peers.

But skeptics warn Beijing might be overconfident in its top-down economic strategy.

“It is a strategy that prioritizes short-term goals of political control over medium-term growth and development objectives,” Opper said. “State-owned enterprises will not be able to fill the gap given weaker profit incentives and tighter control structures.”

State-owned enterprises, despite being important tools for the Party’s control, are notorious for their inefficiency — both in allocating resources and competing with private firms. They contribute much less to overall employment than private firms, and they account for as much as 70% of the corporate debt in China outside of the financial sector. That poses a threat to financial stability and economic growth.

During a previous crackdown in 2017, this time against high-flying financial tycoons, Xi talked openly about the importance of the Communist Party as the heart of everything in China, including an economic policy focused on advancing the state sector.

“Xi is taking China down a path more risky than the alternative,” said Tsang from SOAS.