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The Real Losers of Uber’s Exit From China

August 5, 2016, 12:00 AM UTC

Minxin Pei is a professor of government at Claremont McKenna College.

Given the circumstances, Uber Technologies appears to have done the right thing, at least for its investors. After losing $1 billion a year before the deal in a self-destructive price war with its Chinese rival, Didi Chuxing, the U.S. ride-hailing company finally decided to sell itself to the competition. What makes this transaction worth noting is not the business acumen of Uber’s senior management, but the perfect record Beijing has kept so far in preventing leading American technology firms from dominating China’s information sector.

The saddest thing about this abysmal record is not that American firms did not try hard enough. On the contrary, they have done just about everything they were told to do by their advisers to befriend the Chinese government. For example, Facebook CEO Mark Zuckerberg personally led a high-profile campaign to charm senior Chinese officials in an attempt to persuade them to unblock access to Facebook (FB). In December 2014, Zuckerberg even hosted Lu Wei, China’s then Internet censor-in-chief, in his office, where a copy of a collection of speeches by Xi Jinping, the Chinese Communist Party chief, was prominently displayed. Unfortunately, no matter how hard Zuckerberg tried (he even jogged across Tiananmen Square last year amid heavy pollution), the Chinese government would not relent.

What talented senior executives in leading American tech firms such as Zuckerberg have failed to grasp is that the Chinese government has made it a national policy not to allow any foreign tech firm dominate China’s information industry in an effort to build up Chinese companies. For the ruling Communist Party, its foremost concern is regime security. Ceding the control over the flow of information to American tech firms would seriously endanger its survival. Economically, the Chinese government’s mercantilist mindset would not allow American tech firms to dominate – and reap lucrative profits from – China’s fast-growing information sector. Finally, relying on American information technology also undermines Chinese national security because, as shown by the documents leaked by Edward Snowden, the former U.S. National Security Agency contractor, Washington has a backdoor into the systems operated by American tech firms.

Obviously, governments in many other countries share the same concerns as Beijing (especially those over economic benefits and national security). But unlike China, no other country has the advantages of market size, the political will of the government, and the dynamism of private sector tech entrepreneurs to thwart the titans of Silicon Valley. Consequently, only China has succeeded where all other countries have failed: it is the only country where local Internet giants, such as Alibaba, Tencent, Huawei, and Baidu, can rival their American counterparts in scale, market capitalization and, in some instances, even profitability.

While most Chinese industrial policies are abject failures (such as those on semi-conductors, software, automobile, and civil aviation), Beijing has achieved remarkable success in frustrating American tech firms and grooming domestic national champions. Because the information sector is so new and there were no entrenched state-owned enterprises (SOEs) to protect or support, the Chinese government had to rely on private tech start-ups run by dynamic entrepreneurs such as Jack Ma (founder of Alibaba) and Pony Ma (CEO of Tencent). Unlike moribund SOEs, these firms were quick to imitate, improve, and adapt technologies initially invented in the Silicon Valley to the Chinese market. More importantly, Beijing has also erected a wall of regulations to deny deep-pocketed American tech firms access to the Chinese market.

To be sure, this two-pronged strategy has its costs, such as inferior technology and substandard service (for example, Google is a far superior search engine than Baidu, the dominant Chinese search engine). However, such costs are mainly borne by Chinese customers while the benefits flow to the Chinese government (greater regime security) and domestic firms (monopoly profits).

As long as Beijing maintains this policy, even the most competitive American tech firms have only one of three options. The first option, which Google has adopted, is to stick to its principles, exit China, and focus on its core markets. So far it has been a winning strategy, at least for Google (GOOGL). The second option, which Facebook and Twitter have embraced, is to persevere despite repeated setbacks. Given Beijing’s determination to ensure the Communist Party’s regime security, this strategy seems pure wishful thinking.

The third option, pioneered by Yahoo and now adopted by Uber, is to join local rivals if you cannot beat them. Yahoo turned its $1 billion investment in Alibaba into a stake now worth at least $30 billion. Uber could also see its $7 billion stake in Didi Chuxing grow in value if the combined ride-hailing behemoth dominates the Chinese market, as seems likely.

For most American tech firms, the Google approach may be the best – it avoids unnecessary distractions and possible reputational losses. The strategy pursued by Yahoo and Uber may seem attractive, but such firms are minority investors and have no control. Its success is decided by luck, above anything else. But compared with Facebook, Uber seems to have learned its Chinese lesson – cut your losses before it is too late.