Why China’s Cybersecurity Law Threatens International Businesses and Innovation

In addition to creating barriers for international business in China, this kind of legislative move goes completely against innovation. It could well be considered to be part of what is called “indigenous innovation” in China.

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Why China’s Cybersecurity Law Threatens International Businesses and Innovation

China has the world’s largest market for digital shopping, mobile payments and Internet-enabled financial services. Close to 400 mln people in China conduct most of their payments using their smartphones. China’s overall business in information technology is a market of well above $300 bln, and it is estimated that more than 700 mln Chinese have access to the Internet. So any law impacting the online space - cybersecurity included - will make ripples in the way China does business.   

That’s why its new cybersecurity law - due to take effect in June of next year - is particularly alarming. It is part of an ongoing government program to reinforce China’s cybersecurity, and arguably targets non-Chinese hackers.

But it comes amidst continuous tensions between the U.S. and China, not just in terms of cybersecurity - each country has accused the other of hacking - but with trade, the economy and, of course, the U.S. election, which will inevitably change how business is done between the two nations. The law appears to be counterproductive in several ways.

Chinese firms benefit

First, as the law sets forward, important network equipment and software will have to receive government certifications. This means that specific pieces of intellectual property or technical features will have to be divulged, which could easily be passed on to Chinese companies by the regulators behind cybersecurity.

It shouldn’t be forgotten that the Chinese state has tremendous power and plays a critical role in economic plans. Government interference is much more prevalent than in Western nations. Under the veil of cybersecurity, regulators will have access to proprietary information that could benefit Chinese firms at the expense of foreign companies.   

The type of businesses most at risk will be those with special hardware and systems for network management. But it could even include data from ATMs. New generation ATMs have a much higher level of connectivity with mobile integration and face recognition. This makes them more vulnerable to hacking and means confidential devices and information will have to be used for protection, and under this law, that creates a big entry place for government snooping.

Critical areas

This law is also counterproductive because companies gathering data, in so-called “critical areas,” will have to store that data inside China.

At this stage, the definition of “critical” is worryingly broad. Complying with this requirement will force international firms to make expensive investments to build duplicate facilities within China. This is in total contradiction with the free flow of data, expected to swell in 2020 after the introduction of 5G.

International companies will have to weigh this risk against the opportunity to conduct business in China. China has had a long reputation for ‘copying’ without getting insider access, and this law will only strengthen the ease in which China’s business sector can review competition.

For international companies there is no easy way forward, as the choice is black or white. Either foreign companies will comply, knowing China has a way to peek into what previously was private, or they will choose to stand by principles of privacy at the risk of being excluded from the Chinese market.

Despite the challenging dilemma, companies are likely to comply and give in to China’s demands. The market is too huge and far too ripe for future growth, especially when compared to more stagnant outlooks in Europe and the U.S.

Non-tariff barriers

In addition to creating barriers for international business in China, this kind of legislative move goes completely against innovation. It could well be considered to be part of what is called “indigenous innovation” in China.

This consists of favoring Chinese firms by establishing non-tariff barriers, such as specific standards or regulations on products, in order to prevent non-Chinese firms from accessing China’s large and dynamic market. The impact would be wide-ranging, from consumer electronics to products such as equipment to produce renewable energy, including windmills and solar panels.

Innovation involves a complex process, but it requires a society to be as open as possible and to allow vibrant exchanges between people.

Grip of government

While cybersecurity is important, this law will wrap around the free market as it grips security. Within China, entrepreneurs are, by and large, not bothered by their government’s management of the Internet, called the “great firewall.”

However, this law is a new step to tighten the government’s grip on the Internet. Furthermore, far from favoring China’s champions in this very dynamic area, such as Huawei, Lenovo, or Tencent, this law will handicap them in the long term. Maybe the hope is that these companies themselves will fight to alter the law and mitigate the negative implications for China’s Internet landscape.  

U.S. companies have already began to strongly lobby against the law, as well as China’s position that the Internet must be managed by authorities. But despite the efforts of any company, Chinese or other, the cybersecurity law is just a piece in a larger ongoing political puzzle that companies will have to deal with. Trump’s stance on trade is equally, if not more, alarming for businesses. In the end, agility will be key for companies to succeed in the tense political environment.

- By Georges Haour

The author, IMD Professor Georges Haour is a Professor of Technology and Innovation Management at IMD business school and co-author of the new book - Created in China: How China is Becoming a Global Innovator (Bloomsbury, London, 2016).

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