China's Great Firewall blocks innovation and commerce
Howard Chao says Beijing should weigh the cost of maintaining its internet firewall; not only does it hurt consumers but, with the rise of cloud computing, it also blocks commerce
The digital divide between China and the West is growing. The internet world has developed into two distinct and formidable camps - the US internet giants, who are the global market leaders, and the Chinese domestic champions, protected by China's internet firewall and regulatory barriers.
This Great Firewall of China will not last forever and is already porous. But as long as it stands, it will hold back full integration of the global internet market and will hurt innovation in China. With the rise of cloud computing, these consequences will be even more significant.
For the past several years, the Great Firewall has blocked access from within mainland China to many of the leading global websites, including those for social media and video- and photo-sharing, as well as certain news sites. Because of hacking incidents, reportedly by Chinese actors, Google moved its search business offshore to Hong Kong, resulting in intermittent access to its services from the mainland and the blocking of others.
Thousands of Chinese internet censors also monitor offshore websites for sensitive keywords, and selectively block access to sites that use them. Chinese who use a proxy or VPN service can still access all offshore sites, but the government now has more sophisticated means to combat these tools.
China also restricts foreigners from investing in the domestic internet sector. In theory, under the law, Chinese internet companies are categorised as a type of telecoms company and foreign investors can only hold up to half their stock. In reality, Beijing has tacitly permitted Chinese internet companies to be de facto controlled and owned by offshore companies through "captive company" arrangements, using friendly Chinese citizens to hold legal title in the operating company.
However, this is a risky structure and has given rise to many disputes because the "friendly" owners sometimes become unfriendly. Using this structure, many major Chinese internet companies have listed in the US and Hong Kong. In reality, Beijing strongly prefers that these offshore parent internet companies be majority controlled by Chinese rather than big foreign multinationals.
As a result of these restrictions, an entire pantheon of domestic companies have flourished and now dominate China's internet market without much competition from international players. Tencent's QQ IM and WeChat have 800 million and 400 million users, respectively, Baidu now has 70 per cent of the domestic search market, Weibo has 215 million active followers.
However, the Great Firewall has a decidedly negative impact on China's innovation culture. A whole generation of youth has grown up without direct access to some of the leading international internet companies and knowledge of how they work. They hear about them from friends who have spent time abroad, but their access to the newest internet technology is usually through the copycat offerings of the Chinese domestic competitors.
Because Chinese young people do not know these international companies, they cannot tell their parents (including Chinese executives and policymakers) about them. When an entire market segment is protected from both international competitive pressures and technological know-how, it cannot be a good thing for domestic innovation.
The rise of cloud computing models will only accentuate these trends. Cloud computing companies offer customers the ability to access computer services through the internet, so that much less capital investment and fewer in-house IT staff are required.
Customers can sign up online and use the service without human intervention. The customer's usage can be scaled up or down very quickly depending on need. If the broadband connection is good, cloud services can be very fast and reliable.
Cloud computing requires massive server farms to house customer data and run software. International firms offering cloud computing services have such facilities in many places around the world, but because of regulatory and other restrictions, in general they have not set up servers in China. But because of the Great Firewall, internet access to offshore sites is slow and unreliable, and many offshore cloud services are simply off limits to domestic users.
Thus, it appears that major cloud computing firms do not attempt to sell their services to purely domestic customers. Their main Chinese client base appears to be Chinese subsidiaries of multinationals which have global contracts with them, and which can use their own internal corporate VPN lines to access offshore data. For some, this will not be satisfactory, because Chinese regulations require certain types of businesses to keep their data and servers in China.
This state of affairs again favours the development of Chinese domestic champions in the industry who will serve the domestic market. But it does not bode well for the long-term advancement of the Chinese cloud industry. Up to now, the main commercial impact of the Great Firewall has been to hold back Chinese consumers' international internet access, but with the rise of cloud computing services, Chinese businesses will also be hurt.
Increasingly, enterprises outside China share documents and resources through cloud services that are not available to Chinese businesspeople. For example, many share larger documents and data files using services such as Dropbox, but businesspeople in China are being left behind.
SAP and Oracle, the leading traditional enterprise software companies, recently announced they will move much more of their systems into the cloud. Will Chinese companies have access to these and other world-class enterprise software services?
Perhaps Beijing understands all this, since it seems to be trying to promote a domestic cloud industry. But ultimately what the international business community really wants, and what is best for China's companies and innovation culture, is an easing of the Great Firewall.
Although the cloud is one of the fastest-developing sectors of the internet, leading international competitors are largely staying out of the China market, Chinese consumers and enterprises will not have access to the best cloud services, and Chinese innovation culture will suffer.
There are no technical barriers to dismantling the wall. The real challenge is political - overcoming the fear of what a free flow of data across China's borders on the internet will do to China.
Howard Chao is a partner at O'Melveny & Myers LLP, an international law firm