Twenty-five years ago, America’s tech companies took risks and disrupted established business models. Today they are the new utilities, earning monopoly rents by controlling markets. Microsoft chased its challengers out of personal computer software; Amazon crushed most of its Internet retailing rivals; Apple created a duopoly of hardware and services with its rival Samsung; Google destroyed the commercial prospects of competing search engines; and Facebook, through targeted investments and acquisitions, dominates social media.
China wants to avoid the American trap. That’s why Chinese regulators warned the country’s Internet giants that they could not maintain a monopolistic hold on the mass of personal data that drives their businesses, stifling competition from new market entrants. A consultation paper issued this week by the State Council’s regulatory body warned of anti-trust measures directed against “oligarchic firms and their platforms,” as Frank Chen reported Nov. 11. A memorandum sent to provincial governments and viewed by Asia Times warned against the monopoly use of data to stifle competition, among other abuses. A week earlier, Chinese bank regulators forced a postponement of Ant Financial’s imminent IPO, pending improvements in risk controls and capital ratios.
The stock prices of China’s Internet giants dropped on Wednesday after the State Council’s paper was made public, but recovered the losses in the next two trading sessions.
The United States should have done the same thing a decade ago. By allowing its tech companies to turn into monopolistic unregulated utilities, it has high stock prices – for a handful of stocks – and low productivity. US tech companies still innovate, but only where it suits them. Their monopolies for the most part arise from the logic of the marketplace, rather than nefarious practices, but still do damage. Seventy percent of all digital advertising revenue, for example, goes to Facebook and Google, crippling America’s independent media, which can’t compete for ad revenue.
China already has installed 700,000 5G base stations – more than the rest of the world combined – but plans to wire the whole country with 10 million base stations at a cost of $280 billion. The chief technology officer of Hong Kong’s leading mobile broadband provider PCCW, Paul Berriman, told an Asia Times webinar Nov. 12 that the broader benefits of the new technology require the full buildout of the network. That means in the case of PCCW expanding the present 4 million broad connections to 40 million. Most of these will be Internet of Things connections rather than individual smartphone accounts. That’s what will make possible autonomous vehicles, augmented reality classrooms, telemedicine, smart cities, and a host of other applications.
That means that China is betting its future on innovation. China’s government is already holding competitions for the best 5G applications, inviting entrepreneurs to find ways of harvesting the potential of ultra-fast, low-latency broadband. China views 5G not as a consumer technology but rather as the launching-pad for the Fourth Industrial Revolution, as I reported in my 2020 book You Will Be Assimilated: China’s Plan to Sino-Form the World (Bombardier). China’s tech giants, including Alibaba, Huawei and Tencent, will have to do a great deal of the heavy lifting, providing the artificial intelligence (AI) engines, data collection capacity, and cloud computing to make this possible. But there also is a risk that China’s Internet giants might abuse their control of data to shut new entrants out of the market. And as Frank Chen reported, there are credible allegations that Alibaba and Tencent have already done so.
With its enormous national commitment to 5G, China’s government believes that if you build it, they will come – but not if they face a minefield of monopolistic barriers. China’s 5G network will reach a critical mass of installations by 2022, and its regulators want to ensure that new market entrants have access to the resources they need to turn potential into productivity.
America’s experience with tech monopolies is a horrible example of what other countries should not do. The weight of the big tech companies in capital markets is overwhelming. In 2010 the five biggest tech companies accounted for just 11% of the market capitalization of the S&P 500; by September 2020 their share of the index had doubled to 22%. Just 10 companies in the S&P 500 hold two-fifths of all the cash balances of index members, and all but one is a tech giant.
Twenty years ago, the risk that investors assigned to the tech-dominated NASDAQ index was double that of the overall S&P 500 Index, as measured by the implied volatility of index options. The still-innovative tech sector still took risks, and the options market provides a fair gauge of perceived risk. By the late 2010’s the volatiity of the NASDAQ Index and the S&P 500 converged, which is no surprise, given that the big tech companies accounted for most of the growth in S&P market capitalization.
The top three cash holders – Microsoft, Apple and Google – hold a fifth of all cash of index companies. Apple is so cash rich that it has bought back $327 billion of its stock since 2012. That explains why its stock price has risen by 82% in the past six years although its operating income has barely changed.
So much capital is concentrated in so few hands that the management decisions of a dozen companies set the tone for the whole economy. The United States has lost most of its high-tech manufacturing industry, for example, because the tech monopolies decided that their cash was better put to use buying back their own stock than investing in stateside production facilities.
So predictable are the cash flows of the big tech companies that they trade the way utilities used to. After US interests fell sharply with the coronavirus recession earlier this year, tech company stocks rose in lockstep with falling bond yields. That’s what gas and electric utilities used to do. The stocks of regulated utilities were the equity market’s closest equivalent to a bond. In 2020, however, the market treated the big tech companies like utilities. The chart below shows the straight-line relationship between real yields (the yields on Treasury Inflation-Protected Securities) and the tech-heavy NASDAQ Index (the r2 of regression is 73% for NASDAQ, vs. 53% for the S&P 500).
America doesn’t produce any telecommunications equipment because its tech companies think software is more profitable. The marginal cost of adding a software customer is zero; not so the marginal cost of producing a 5G base station. Huawei spent $20 billion in R&D in 2019. That’s not a lot of money by the standards of American Big Tech. Apple alone bought back $73 billion of its outstanding stock in 2018 and another $67 billion in 2019. By contrast, it spent only $18 billion in capital expenditures during those two years, compared to a combined $140 billion in stock buybacks. Apple believes that its stock price will rise faster by levering up the cash flows on existing products than it would by investing in new products.
Earlier this year, Trump Administration officials approached Cisco Systems and suggested that the former top manufacturer of Internet routers buy one of Huawei’s competitors like Ericsson or Nokia, in order to outflank the Chinese market leader. They were told that the company “wasn’t interested in buying into low-margin businesses,” the Wall Street Journal reported. Cisco reported a 30% return on equity in 2019, compared to a 2.6% return on equity for Ericsson.
Asian countries (including China) subsidize capital-intensive manufacturing, and America doesn’t, so the reluctance of American tech companies to commit capital to manufacturing in the face of Asian competition is understandable. Nonetheless, America is behind the curve in the Fourth Industrial Revolution, and in some respects not on the curve to begin with. It barely has begun to build out its 5G network. As of April only 10,000 base stations were installed in the United States, vs. 700,000 in China. China’s newly-constructed cities with their broad internal highways are well suited for autonomous vehicles, while America’s crumbling urban infrastructure makes self-driving cars impractical in most parts of the country. Telemedicine isn’t on the horizon, in part because of legal barriers to digitization of patient records (although blockchain technology could solve the problem).
Financial innovation is a parallel concern. The United States has been the world’s center of financial experimentation, starting with mortgage derivatives in the 1990s and credit derivatives in the 2000s. Wall Street learned to repackage home mortgages into complex securities and sell them at a substantial markup. When the Federal Reserve raised interest rates in 1994 and again in 1998, buyers of these securities realized too late that they owned levered exposure to interest rates. In the 2000s, Wall Street sold derivatives based on low-quality home mortgages as well as corporate debt, and the collapse of this market brought on the World Financial Crisis of 2008.
These market crashes were occasioned by sophisticated risk models produced by the smartest quantitative analysts that Wall Street could hire. As I explained in a 2012 article for the Journal of Applied Corporate Finance, some of the risk models accurately warned of impending trouble, but bank management ignored them in favor of keeping the game of musical chairs going.
China’s Vice-President Wang Qishan was the official responsible for mopping up the mess in 2008, and well understands the risks inherent in financial innovation. He warned last month at the Shanghai Bund Summit that China intended to reduce financial risk. Beijing doesn’t want financial innovation to produce the sort of disasters that it brought to the United States. Jack Ma’s Ant Financial borrows from state banks and relends to consumers (with a US$250 billion book) and small businesses (US$58 billion outstanding). Ant claims that its artificial intelligence analysis of credit quality justifies its privileged position as an intermediary. But other AI practioners in China’s fintech community think that Ant Financial’s claims are exaggerated, and that its loan book is riskier than it admits.
The last-minute decision by China’s regulators to postpone the IPO looked clumsy. It suggests that the regulators aren’t yet ready for prime time, although they have a great deal of company; US regulators ignored the risks of credit derivatives completely in the approach to the 2008 crash, and refused to believe what was happening until the crash was already underway.