China’s digital economy is unique: characterized by size and hyper-growth, it is also chaotic and often incomprehensible to outsiders.

Digital developments are happening at great pace, across every sector from retail and finance to energy and logistics, but are they a triumph of hype over substance?

First, let us deal with the hype. Record breaking valuations, built on questionable business models, exude all the signs of a bubble. Valuation inflation is rampant and almost always driven by scale metrics, not operating performance. High valuations are driven by the rush of capital into the sector.

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Claims about traffic, views, hits, conversions and transactions are provided by the companies themselves and not independently corroborated so they have to be treated with caution. Macro data don’t support the claims being made – for example, about 80% of shopping is still offline; parcel volumes don’t support the notion of strong nationwide ecommerce demand, with 82% of packages being delivered to the east of the country and marginal penetration in the west.

However, there is substance too and China’s unique innovation environment means that future breakthroughs could be transformational. Much of the creative destruction is happening in “white space” legacy commerce silos, such as banking and postal services, where the incumbents are state-owned enterprises that have abandoned consumers to service purgatory for decades. The alignment of government policy with fast moving capital and market scale enable rapidity not seen in other economies.

It is important to remember that unlike in the west, where the digital economy is decentralized and pluralized, in China it is centralized and controlled. Faith in technology as a means of achieving macro-economic goals runs deep. “Big Data will make it possible to plan and predict market forces so as to allow us to finally achieve a planned economy,” Jack Ma, co-founder of Alibaba Group, said in 2017. Consumer data is perceived as a means of optimizing commercial and political outcomes, not meeting customer needs.

China is sometimes described as a 5,000-year-old country with a 40-year history – most of its new consumer class, the ‘Connected Spenders’, have entered the market via digital channels and they have embraced online shopping because it offers an improved customer experience, especially around pricing transparency and product comparisons. Conversely, there is little regulation to protect consumers, minimizing the risk of failure for operators. China’s Connected Spenders are projected to grow by 200m to 590m by 2025, making up 41% of the population and accounting for 60% of consumption, according to The Conference Board China Center.

However, the size of the potential market is no guarantee of commercial success. The market is full of entrepreneurs and financiers looking to re-invent arcane structures, but it all about scale, with huge upfront spending on customer acquisition. This can quickly become a race to the bottom, with cut-throat pricing and bubble-economy consumer incentives – price competition is the typical reaction to falling behind and short-term thinking often trumps long-term strategy when the next funding round is coming up.

The ‘New Economy’ is seen as mission critical by the Xi administration – critical to State security, economic and national security and as a driver of positive investor sentiment. However, Chinese technological innovation has traditionally been weak in areas of core science, such as chips, sensors and operating systems. Disruptive industrial technology is more visible in areas where private sector investors can see large-scale opportunities, such as genomics and robotics.

China is cataloguing genes at a rate and cost that is unmatched globally, developing new technologies to ensure rapid progress. The China National Gene Bank was set up in 2016 and in January 2018 a lab in Shanghai cloned baby macaques, reporting two live births from 79 attempts. The key is driving towards commoditized commercial models; BGI, formerly the Beijing Genomics institute, is sequencing the DNA of 1m people, 1m micro-organisms and 1m plants and animals. There is potential to develop genetic therapies and personalized medicine.

China’s robotics market is the largest and fastest growing in the world, with a 30% global share, and more than 800 robotics start-ups innovating in automotive, logistics and household appliances. The economies of scale achievable in robotics applications have significant implications for manufacturing.

So, as well as the hype, there are potentially transformative opportunities. Whilst financial investors initially targeted the B2C market, seeing the chance to dominate large, homogenous market segments, they have since turned to disruptive industrial technologies.

China’s investment spree has come with a low cost of capital as investors chased growth, funded by an easy money environment. In the five years to 2017, the wide measure of money M3 nearly doubled in China. In the eight years to 2017 it nearly tripled. However, the generosity of monetary policy is not indefinite and China has already turned the corner into a much tighter credit environment. According to Dow Jones Chines venture capital is in a deep ‘Capital Winter’, with Q2 2019 funding down 70% year on year. We have yet to see how the technology industry in China will weather that. 

Leo Austin is a UK-based businessman. He is Senior Advisor to The Conference Board China Center for Economics and Business. He can be reached at leoaustin@gmail.com.