Forecast 2018 and China’s Digital Economy: The Shape of Things to Come

This January 30, we convened top China policy experts, analysts, and business leaders to provide members with in-depth briefings on China’s 2018 economic forecast, its current business landscape, and best practices in approaching China trade policy.

Automated government offices like these are just one way that new technologies are being integrated into the Chinese society. It also represents a larger trend in the Chinese economy: the growth of the digital economy.

In 2016, China’s digital economy accounted for 30.3 percent of GDP, an 18.9 percent rise from 2015, according to a China Academy of Information and Communications Technology (CAICT) white paper.

The digital economy is part of the government’s vision of an economy driven by innovation – a key part of their goal of making domestic firms more competitive globally. In recent years, the Chinese government has pushed several national economic initiatives aimed at the development of the digital economy.

These include the 13th Five Year Plan (March 2015), Made in China 2025 (May 2016), the Robotics Industry Development Plan (April 2016), and the Three-year Guidance for Internet Plus Artificial Intelligence Plan (May 2016).

China has shown that it has ambitious plans to upgrade its economy and industrial policy – and these efforts are accelerating going into 2018.

Plans for 2018

On October 11, 2017 the National Development and Reform Commission (NDRC) published the Notice on the Organization and Implementation of the Internet Plus Action, the Creation and Development of Artificial Intelligence and the Major Pilot Projects of Digital Economy in 2018 (“the Notice”).

The Notice clarifies what kinds of projects are eligible to be considered a “major pilot project” and can receive funding and other forms of government support and benefits. Although these areas are not completely distinct from each other and often overlap, they offer varying opportunities for foreign investors.

Internet Plus

Premier Li Keqiang first introduced Internet Plus in a speech in March 2015. The term refers to the use of the Internet and information technologies, such as big data, cloud computing, and the Internet of Things (IoT) in traditional industries. These technologies have the potential to revolutionize almost every sector of the economy and have already shown promise in manufacturing, finance, agriculture, and medicine.

Internet Plus manufacturing, for example, integrates IoT technology, where a network of devices and sensors can record and communicate data such as energy consumption, heat levels, and inventories. This increases efficiency at every stage of the factory line and can even continue to track data as the product moves through the supply chain, largely eliminating human made error.

There is space for foreign investment in Internet Plus sectors not subject to the Negative List and investors should also expect to see exciting opportunities within the newly transformed traditional industries.

Investments into the following project areas are eligible for incentives under the Notice:

• Cloud computing (including next generation cloud computing operating systems), edge computing platforms and applications, and heterogeneous computing platforms and applications;
• Internet of Things (IoT), including the location-based semiconductor industry, autonomous vehicles, drones, and robot sensors; and
• “Internet+” customer service and customization platforms, flexible manufacturing and supply chain management platforms.

AI Initiative

AI refers to intelligence displayed by machines, the ability of computers and systems to think. Applications vary wide from facial recognition and voice recognition systems to machine learning, which enables computers to look at large data sets, search for patterns and make predictions.

As AI continues to improve, new industries and applications will be opened to the AI revolution. In the past few years, the government has prioritized and invested heavily into AI. As a result, China’s AI capability has raced ahead and is expected to surpass the US very soon.

Although, China’s internet sector has been historically off-limits to foreign investment leaving foreign investors with a significant disadvantage, opportunities for joint ventures can offer high rates of return.

Investments into the following project areas are eligible for incentives under the Notice:

• Core technology and application of AI (including deep learning semiconductors), applications, and open-source platforms;
• Public service and infrastructure platform projects (including facial-recognition systems and applications and voice-recognition systems and applications);
• Intelligent unmanned system applications, including drones; and
• Intelligent robotics development and application projects (including high-end service robots).

Digital Economy Initiative

Digital economy is an economy that utilizes digital computing technologies, or more generally, any industry that integrates the internet into their products or services. Major examples include e-commerce, e-business, and telecommunications.

China is already poised to be the world leader in this respect; e-commerce is booming with giants like Alibaba and Tencent. Additionally, more than half of e-commerce transactions in China are made on mobile devices, and companies with existing social media platforms – like WeChat – are leveraging their customer base to enter the e-commerce business.

Foreign investment is welcome in various forms, a subsidiary company, a joint venture and more recently WFOEs. Foreign investors can apply for an internet content provider (ICP) license to conduct e-commerce businesses in FTZs and pilot zone cities.

Investments into the following project areas are eligible for incentives under the Notice:

• • Government information consolidation and sharing application projects;
  • Big data applications in healthcare, transportation, education, finance, logistics, environmental protection, and location information;
  • Digital economy public infrastructure, including e-governance platforms and e-commerce credit systems;
  • China-ASEAN digital hub pilot projects;

• OBOR digital cooperation projects.

Challenges for foreign investors

Although sectors like AI and e-commerce are open to foreign direct investment, foreign AI firms might face trouble with the required national security reviews as these technologies are either dual-use or have implications for Internet security.

Additionally, because the Chinese market is already populated with major players like Alibaba, JD, and Xiaomi that have a monopoly on the existing customer data, the most prudent route would be for foreign investors to seek out joint ventures.

Domestic and foreign investors alike should also pay close attention to China’s new Cybersecurity Law and its potential effects on investments in the Internet Plus, AI, and digital economy fields.

Announced in November 7, 2016, the Cybersecurity Law covers data protection and “cyberspace sovereignty”. Under the law which went into effect on June 1, 2017, “critical information infrastructure” businesses and firms with access to personal information are subject to data localization requirements.

Although the government gave companies a 19-month grace period to comply with parts of the law, the data localization requirements will significantly increase data processing costs for companies, especially for those firms that are leveraging big data.

The law also poses a strange contradiction to the government’s support for a growing role of the digital economy and its use of big data. With the advent of IoT and the various applications of AI, all of which require large collection of data, there’s a potential that the law could touch on a wider variety of products and services than anticipated.

Similarly, Chinese companies can expect some difficulty expanding abroad as several countries have formed their own cybersecurity regulations. For example, the EU’s General Data Protection Regulation (GDPR) establishes specific customer consent practices as well as data localization requirements by certain member countries.

In spite of these difficulties, China’s digital economy does not seem to be slowing down. E-commerce especially has exploded in the last several years, with China taking up 40 percent of the global e-commerce market, and the rapid growth of mobile payment systems has transformed the way people consume. If this trend continues, China watchers should expect continuing innovation and growth in this sector.

 

About the author: This article first appeared in China Briefing by Dezan Shira & Associates, a specialist foreign direct investment practice, providing corporate establishment, business advisory, tax advisory, and compliance, accounting, payroll, due diligence, and financial review services to multinationals investing in China, Hong Kong, India, Vietnam, Singapore and the rest of ASEAN. For further information, please email [email protected] or visit www.dezshira.com.