If you want to know what the future of finance looks like, head east, where it’s already been laid down in China. Digital payments through mobile phones are ubiquitous, and there is incredible innovation around lending, investments and digital currencies that are at the vanguard of global financial innovation.
Take the cover photo of this article: At Alibaba, facial recognition software identifies customers at the employee cafeteria, while visual AI identifies foods on their tray and calculates a total bill — all pretty much instantly.
Given some of the big news stories emanating out of the sector the past two weeks, I wanted to get a deeper view on what’s happening in China’s fintech market and what that portends for the rest of the world moving forward. So I called up Martin Chorzempa, a research fellow at the Peterson Institute for International Economics who is writing a book on the development of China’s fintech sector to get his take on what’s happening and what it all means.
This interview has been condensed and edited for clarity.
TechCrunch: Why don’t we start with the big news from earlier this month about Ant Group and how its world-record shattering IPO was pulled at the last minute by Chinese financial regulators. What was your take and why were so many people trying to pile into the IPO?
Martin Chorzempa: I think there’s been surprise at how much interest there is in the company, and I think that’s just really an indication of the market for fintech in China. It’s certainly the world’s largest market for financial technology, and even though in the payments space things look pretty saturated between Ant and Tencent’s WeChat, there are so many areas that they’re expanding into, like credit and insurance, where there’s still a lot of room to run for these kinds of financial technologies to take over a much larger share of the financial system than they do now.
So even just considering the domestic market, it’s huge and it’s just going to get larger. Then, the big question mark is expanding abroad and whether these companies can become truly global financial technology giants. Today, nobody except Chinese people outside of China uses Alipay or WeChat Pay to pay for anything. So that’s a big unexplored side that I think is going to come into a lot of geopolitical risks.
So on globalization, who do these companies need to globalize? China has 1.3 billion people — isn’t that enough of a market to stay focused on?
Well, I don’t think anything’s ever enough for firms this ambitious. And if you think about it, if you have this really unique experience and data, that has a lot of applicability to other countries. So at the very least, it would be kind of a deadweight loss not to have that technology and experience applied to building out digital financial solutions in other countries.
Prior to the pandemic, Chinese people were going abroad in large numbers. So if you want to keep serving even the domestic market you have to have your payment methods accepted abroad.
Plus, if you want to facilitate and grow with China’s e-commerce businesses and other kinds of international trade, then having networks of merchants abroad and being able to use Alipay, for example, is something that could be really important to future growth. The domestic market is huge, but eventually you do run into diminishing returns if everybody already has your app and they’re already borrowing and investing.
What do you think has been the key to the success of these fintech companies?
I think the key is relentlessly focusing on solving real problems. It’s finding areas where the financial tools available are expensive and low tech or just not working for the new economy, and then plugging those gaps.
A key side note of that as well is a government that has been very much in support of these improving activities, because any one of these could have been blocked at any moment by regulators. The fact that they were not is an indication that there’s a real growth mindset desire to develop the financial system by policymakers and that created the space for these new solutions to be tried, tested and ultimately expanded across the country.
Why do you think the Chinese government was so supportive of innovation in this sector?
I think there was a recognition that the existing system that had served the state really well for a long time was no longer suited to China’s future growth, and that future growth was going to depend on innovative startups and new companies. Just the way the banks were set up is not to lend to those guys, they’re set up to lend to big state-owned companies, so they recognized they had to make some serious changes to the financial system if they wanted to keep growing. We all know that growth is a key underpinning of the legitimacy of the leadership in China so it was kind of a do-or-die scenario.
China’s two largest internet companies own the two largest fintech payments networks. Is there — or was there — an opportunity for other entrants in this market?
Ultimately what it came down to is network effects. I fundamentally think that both from an economic-network-effects perspective and from a political perspective, having the influence you need to take on something like UnionPay requires big, deep-pocketed tech companies with a lot of political support. So I do think only BAT (Baidu, Alibaba and Tencent) really had the chance to build out this kind of market.
Let’s talk about your book project a bit — what are you writing about?
When I was in China, I saw the fintech revolution occurring and saw how China’s financial system went from being really backward to having really cool new convenient tools for investing and paying while supporting an innovative ecosystem in a way that didn’t exist in the United States. I thought that this transformation was one of the coolest things happening in China at the time, and everyone needed to hear about it. But, I just felt like it wasn’t being covered, outside the occasional news story here and there. There just really hasn’t been a deep investigation as to why the government let this happen. Why didn’t it happen earlier? So I kind of just started digging.
I did hundreds of interviews with everyone from high-level Communist Party officials down to the local level and from Ant’s executives all the way down to Ponzi-scheming P2P lenders and really just got a kind of sense of the characters that were making this happen. I then did a lot of deep research to really build a comprehensive history of how on earth this happened — that Silicon Valley startups really haven’t changed the way that people pay very much at all in the United States or invest at any large scale but in China they did.
It’s somewhat counterintuitive — you wouldn’t necessarily expect that an authoritarian government would be more conducive to innovation, and especially in a sensitive sector like finance. In fact, that’s what I’ve found. And the result has been this incredible outpouring of innovation that is beginning to inspire Silicon Valley. Now the flow of ideas is moving in the opposite direction than they used to.
We’ve heard this idea of “leap-frogging” a lot, where a country will skip over a generation or more of technologies to jump to the best-in-class tech. Do you think that theory bears out in China?
I think about this a lot. I do think it’s very applicable because people really went right from using cash for most transactions to using mobile phones for most transactions. The elements of leapfrogging that I think are relevant are sort of skipping intermediate steps if you will.
I don’t necessarily think that we can say that China’s system is say, ahead of the U.S. or superior to the U.S. in a comprehensive kind of way. China took a lot more risks to build out its current system than the U.S. would be willing to take for the level of improvement that it would get. Although it’s much cheaper — about 20 and 30 times cheaper for a merchant in China to accept Alipay or WeChat Pay versus merchants accepting cards in the U.S. — it’s a really complicated system. There are certainly strong advantages to its system, but I do think it’s leapt ahead much more quickly than it would have been able to if it had gone through the same kind of historical path that we had.
We mentioned geopolitics a bit earlier. Obviously, that’s been a huge theme in U.S.-China ties the past few years. What does the future look like on that front?
I think it’s only going to get more intense, and I think that it’s not just going to be Chinese companies in the crosshairs but also the current American incumbents that dominate much of global payments. If you look at India, for example, and its requirements for data localization of financial data, they essentially mean we don’t necessarily trust these companies to be responsible with sensitive data on their citizens abroad.
Call it “balkanization” in terms of sensitive data — countries want to make sure they have much more oversight over the data and national security implications of payment companies in their jurisdiction. For Chinese companies attempting global expansion in fintech, they are going to be really heavily constrained by this trend and it’s not going away.
Any concluding thoughts on the Chinese fintech market?
I think the key is that this is really a window into the future, no matter how wedded Americans are to their credit cards. The economy is moving more digital and if we want to know what that looks like and what that implies for competition, for national security, for privacy and for all of us, I think looking at China just provides a really rich set of lessons for us. It should not be viewed as just some far away place where this totally unique stuff is occurring. I think tech companies are going to go into finance more and more, and we better be ready for it.