China’s Internet boom appears to have far more significant economic, social, and business implications than the US Internet bubble of the late 1990s . Hardly a day goes by without surprising news on disruptive Internet applications, large investments, and mergers and acquisitions in the sector.
China now has more than one-fifth of world Internet users and its penetration ratio has surpassed the global average by almost by 20%. McKinsey suggests that productivity and economic growth through Internet technologies will expand China’s GDP by up to 22% by 2025 . There has been a massive inflow of global venture capitals into Chinese Internet businesses . The Chinese government is also a strong advocate of “Internet plus” strategy to maximize the Internet potential.
But can China enjoy the full benefit of Internet technologies in the years ahead ? Can it sustain the same level of fast growth in the sector we have seen in recent years? Alibaba’s highly hailed IPO further ignited the great hope of Internet applications in China. However, its share price dropped almost one-third from its post-IPO high and there has been increased scrutiny by investors and US regulators since the Chinese government’s surprising revelation that, ahead of the IPO, it had raised the issue of fake goods being sold on Alibaba’s platforms. These are all signals of the potential barriers China’s Internet businesses will face through its continuous growth. There are many areas of concern, e.g., talent shortage, regulations, threat to traditional jobs, and so on, but we think the fundamental problem is the nature of China’s governance environment.
We believe China cannot fully realize the potential of Internet technologies without overcoming the obstacles inherent in its governance environment – the political, economic, and social institutions (e.g., laws, policies, and culture) that facilitate or constrain people’s choices in managing social and economic transactions (see our piece from April 8). In a rule-based society, people predominantly rely on public means (e.g., lawyers, police, or courts). But they would resolve disputes through private hands in a relation-based society where the rule of law is weak and ineffective. A rule-based environment requires a huge set-up cost to establish an impartial and efficient legal system, along with a public information infrastructure, but a minimal marginal cost to apply it to additional transactions. A relation-based environment works well only when transactions are limited to family, friends, or immediate local markets, but it becomes highly expensive and ineffective when strangers participate in the market.
Internet applications, by their own nature, are similar to a rule-based environment: it is costly to develop the basic system but costless to serve additional transactions on the system. Once a search engine becomes available, the cost of maintaining it would not be much different for the first user or the millionth user. There are three additional features of the Internet that makes it similar to a rule-based environment. First, the Internet environment is decentralized and non-hierarchical, where all servers are equal and linked: that is, an ordinary person’s server enjoys the same right as Google’s to be linked, recognized, and visited. Second, its lifeblood is the free flow of information that is accessible to everyone around the world. As more people and information become available in the system, there is a positive network effect that further enhances the value of the Internet environment. Lastly, its value and efficiency depends on the quality of data, which in turn is closely tied to the level of public trust. If online information and data lose their credibility, users would not waste their time going online.
The salient features of relation-based societies and organizations are opposite to these characteristics of the Internet environment. First, they tend to be highly centralized, with power consolidated at the top, leaving little discretion to rank-and-file employees. Communication and information flow in an organization tend to be more top-down than the other way. Second, they rely on family and friends to conduct business and avoid outsiders at all costs, which thus engenders weak public trust. People rely on private information and have little faith in public information such as accounting data, company reports, or even official government statistics. Third, the government or the leader controls much of the critical information and data that are often treated as state or corporate secrets in relation-based societies and organizations. This then results in many restrictions on whom and what can be online.
These features of relation-based societies make them run counter to those that define the Internet and are essential to making it powerful and realizing its full potential for the society. Empirical evidence shows that the use of Internet or information and communication technology (ICT) is still generally used for commerce-based transactions (e.g., processing paychecks) and limited in relation-based societies and firms. However, rumors (e.g., hearsays about unlawful individual behaviors that often turn out to be true), unquantifiable observations (the boss’s mood and who is seen playing golf with whom) and other subtle signs that cannot be freely and publicly distributed online are a vital part of the decision-making in a relation-based environment.
The rule-based environment, on the other hand, is inherently far more congruent to achieving the full economic and social potential of the Internet. How close China can get to achieving an additional RMB14 trillion in GDP growth (based on the 22% referred to earlier in McKinsey’s estimates) depends largely on the governance environment . Alibaba’s recent troubles in the stock market are due to possible concealment of (private) information and the sale of fake products on its websites, which are often common practices in a relation-based environment but detrimental to its long-term success.
To sum up, if there is no progress in the governance environment, China will have an even bigger gap between the adoption and use of new Internet technologies. This, in turn, may put more pressure on the society for the transition from a relation-based to a rule-based environment so that it can reap the full benefit of Internet technologies and achieve the national goal of “Internet plus.”
Seung Ho Park is Parkland Chair Professor of Strategy at CEIBS, Shaomin Li is Eminent Scholar and Professor of International Business at Old Dominion University Strome College of Business.
This article was written by China Europe International Business School from Forbes and was legally licensed through the NewsCred publisher network.