Martin Chorzempa on China’s Cashless Revolution and the Rise of Super Apps

Martin Chorzempa is a senior fellow with the Peterson Institute for International Economics and is the author of a new book titled, *The Cashless Revolution: China’s Reinvention of Money and the End of America’s Domination of Finance and Technology.* Martin joins Macro Musings to talk about this book as well as the history of Chinese fintech development, the basics of super apps in China, challenges to the Chinese fintech revolution, and more.

Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].

David Beckworth: Martin, welcome to the show.

Martin Chorzempa: Thanks for having me.

Beckworth: Well, it's great to have you on. This was an interesting book, a really eye-opening book. I did not know about super apps until I read your book, and was really shocked to see that we're actually lagging behind China when it comes to these super apps. And yes, super apps bring a lot of neat innovation. They've really put FinTech on the frontier. They also come with some risk, which we'll talk about as well. But part of writing this book was an interesting journey you went on. You went over there to learn the language, to get involved in finance. Maybe walk us through your journey into this book.

Martin’s Trek into the Chinese FinTech Landscape

Chorzempa: Sure. I moved to China in mid-2013, on what's called a Luce Scholarship, which is one of the coolest things I think anyone can ever do. Because they will find you a job in Asia, and give you the language training and pay you. And at the time I was living in Berlin as a Fulbright scholar, and I really thought the future of the world financial system is really going to depend more on what China does than what Europe does. And I really wanted to challenge myself, and learn a new language and culture. So I went over there, and then without realizing it kind of stumbled upon this FinTech revolution. I moved there in June, 2013, and that was just the time that this tech company, Alibaba and its payments affiliate had launched a money market fund, which completely disrupted the whole model of financial repression and state control in the financial sector. And there was this political battle going on behind the scenes, that I at the time had no idea about.

Chorzempa: But then as I lived in China, I just watched how technology completely changed the way not only people did financial transactions, but lived their whole daily lives. And what initially looked like a very backward place to me, coming from the US where we have credit cards and Venmo and all this, actually looked more advanced than the United States in many ways. When I went back to the US and had to dust off my checkbook, and mail paper checks in, and pull out plastic again, in China, people don't even carry wallets anymore. So watching this transformation on the ground, and talking to the people who were making it happen, the people who were in government trying to think about how to respond to this, was just something I thought had to be told to a Western audience.

I just watched how technology completely changed the way not only people did financial transactions, but lived their whole daily lives. And what initially looked like a very backward place to me, coming from the US where we have credit cards and Venmo and all this, actually looked more advanced than the United States in many ways.

Beckworth: And it was very interesting to read that this transformation that you cover over two years, so from 2013 to 2015 you're there, and I know you go back and you visit regularly, but those two years you were there, they actually leaped ahead of the United States. So you come in and you mentioned in the book, you get there, we have Venmo in the US, and they have this really state-run static, lethargic banking system where people are suffering from financial repression. The only way you can save is to put your money in one of these local state run banks, where you get interest rates that are less than inflation. So you're actually losing value, losing real purchasing power. And then Alibaba, Jack Ma and competitors, they undermined that.

Beckworth: We'll get to that story, but it's just shocking, I guess, such a quick transformation. And I guess that's part of your story, too, in this book, is they're able to take risks and do things that we can't do. And in fact, just in general, looking back at China, they really transformed their country really quickly. Remember when COVID started, they built entire facilities in a few weeks. They can tear up a countryside quickly and build facilities. So I guess maybe we shouldn't be too surprised they can radically transform, if the authorities are behind it or at least allowing it to occur, is what goes on in your book. In writing this book, two more questions. One, you had to really learn the language I guess to really get into the sources and to know what was going on. So, what was it like learning Mandarin? Is that what you learned?

Chorzempa: Yes. I liken it to building a nuclear power plant. Because the upfront investment is just so massively high, but then once you've gotten it all the way up and running, it creates these really awesome returns for you in the future. It's really made my career. It's just really hard. You have to learn all these characters, you learn the components of the characters, you have to pronounce the tones correctly and listen to them. I think the State Department estimates it's about 10 times more time to learn Chinese than it is to learn Spanish, because they have to teach the foreign service officers all these languages.

Chorzempa: But my mentality was I'm in Beijing, I need to learn as much as I can at the very beginning. Because then I can use it to really have this deep experience. In writing this book, I had to not only read a lot of Chinese government documents to understand what their plans were, what their regulations were, but to understand what they might mean, you had to have conversations with people. Because often the gap between what's on paper as a goal or as a policy is completely different than on the ground reality, which is often very messy. And when Chinese government departments don't agree with each other, they don't write anything.

Chorzempa: You don't see the leaks in the papers like here, where everybody tells you what the spats are between the Treasury Department and the Commerce Department. All of that is hidden, and it's only accessible if you know people on the ground. And if you're limited to the people who only speak English, you're going to miss a lot of it. And people are a lot less forthcoming if you don't have the time to hang out, and have a few drinks, and many loads of spicy food and all this, that's really crucial to understanding the place. And it was wonderful.

Beckworth: So you have got to wine and dine your sources and get to know them, speak their native tongue. And I'm sure some might say, well, how do you know what you're getting from them is the real deal? These are the Communist party leaders, or at least they're connected, they want to stay in good favor with them. I guess part of it is that you did get to know them, you did wine and dine them, you spoke their language. But how do you respond to that question?

Chorzempa: Yeah, China is just this really fascinating, complicated, opaque place. And some of what you have to do is triangulation. If you only have a one source, you rely too much on that one source. But if a bunch of people, especially in different departments who might have different incentives, then you can get both sides of the story. And if you know the documents, then which questions to ask. And then you just have to think, what's this person's incentive? Do they want to spin me on this issue? And I think what I've found is that people in China are often, at least when I was there up until 2019, are often very forthcoming about these things, at least in private discussions. If you go to a public round table where there's media, you're going to get very little useful information. But these people, they want to tell their story, they want to mention… if they're an under-resourced local government, they want to complain to you. And they're going to tell you exactly what the government is doing wrong to put them in this really frustrating position. And you don't have to try to fool them, or treat them to something. It's more just like you build a relationship of trust with these people. And there's a reason that a lot of the people I talk to don't have their names in my acknowledgements, because you want to make sure you protect your sources as well.

What I've found is that people in China are often...very forthcoming...at least in private discussions. If you go to a public round table where there's media, you're going to get very little useful information. But these people, they want to tell their story.

Beckworth: Sure. And this speaks to a principle that I've always followed when encountering the conspiracy theories, that people are the same no matter where they are in the world. It's really hard to keep secrets, it's really hard to have this coordinated, concerted effort to have one view, one approach. There's always going to be differences. It's what politics is about, differences in views, and so you're just tapping into that. People with different perspectives, frustrations, hopes, aspirations, and it comes out in this book. And it's really interesting, because you highlight some key players. You talk about Jack Ma and his journey with Alibaba, and I guess the finance group's called Ant Group? And they've developed Alipay, which is one of the super apps. The other individual is Pony Ma, Tencent's the company that had the WeChat app. And I guess I'm familiar with the WeChat app, I've heard of that. Is that something we can use in the US, the WeChat app, like at drug stores?

Chorzempa: In some places, you can use WeChat and Alipay to pay in the United States. Drug stores are one example. This is one area where these companies have a no-brainer. You say you're going to get access to all the Chinese tourists, at least before COVID there were a lot of Chinese tourists, a lot of Chinese students going abroad. And you can say all you have to do is accept their preferred payment system and they'll come to you. So it's actually relatively easy for them to get foreign merchants to sign up to accept Chinese super apps, where they can scan a QR code just like they would at home to pay for something, in the same store as we pay with a credit card.

Beckworth: So those are two key players, they're the entrepreneurs. Part of your story is there's a number of entrepreneurs taking big risks, and these are the two key ones. It's `like the Wild West, but they're going out there taking risks. In some ways it's an inspiring story, in fact, I'm going to come back to Jack Ma's story, how he actually opened up in, I think it was 2004 you mentioned he started the app. Was it the app or the company in 2000?

Chorzempa: It wasn't an app yet. This was still a desktop computer, internet kind of website the same way as eBay or PayPal would've been.

Beckworth: Okay, so the early beginnings of this payment system. Another key character in your book is Zhou Xiaochuan.

Chorzempa: Xiaochuan.

Beckworth: Thank you. I'll let you pronounce the name. And he was the governor of the PBoC, the central bank in China. And what was really fascinating about him in the book is that he was open to allowing this innovation. So you needed some key people and key parts of government. Also you had this premier, Wen Jiabao.

Chorzempa: Wen Jiabao. Yeah.

Beckworth: Thank you again for pronouncing correctly… in charge of the economy. He denounced the banks. So you had support from Communist party officials who encouraged innovation. And again, what's remarkable, I guess one of the big takeaways for me is how quickly they went from being laggards to being on the frontier of FinTech. So let's step back. I'm jumping the gun here. So let's step back and let's start with Jack Ma's story. So walk us through Alibaba. Tell us what it is, his story. He has this great ascent and then recently he had a bit of a decline, but walk us through this amazing journey.

The Journey of Jack Ma and Alibaba

Chorzempa: Yeah, so Jack Ma is one of the most fascinating characters, I think, in general. If you think about China or entrepreneurship, he starts off as an English teacher and things. And then he really wants to be an entrepreneur and start his own company. And he sees the internet and sees the potential. But he's one of the only people in China at that point who does see the potential of the internet. So he's trying to convince companies in China to bank a listing on his China Pages website so that China's merchants can be connected to the rest of the world. Or people who are coming to China from the rest of the world as China's just becoming this important space for manufacturing that they would, for example, be able to find a hotel on the internet, but these companies don't even believe that the internet exists. So they think he's trying to sell them some sort of snake oil and it's just fascinating. He even invents quotes from Bill Gates.

Beckworth: Oh really?

Chorzempa: To try and convince people that the internet is this real thing and they should be going. So he has this fascinating, difficult entrepreneurial journey at the beginning. And one of the things he learns is about the state where one of his early companies goes into a partnership with a state company that then ends up eating his lunch, taking over the company. And I think that's created this sense of that he calls, you can be in love with the government but don't marry them. You don't want to get too close. So Jack Ma tries a bunch of things and then he starts to get success with commerce, which is connecting Chinese entrepreneurs with the rest of the world.

Chorzempa: But then when eBay enters the market and PayPal, he begins to think that the consumer-to-consumer space is where he wants to be helping people sell to each other. And at this point, eBay was a giant. And so it's actually fascinatingly to me… the threat of foreign competition from a strong American company leads him to decide to create this company called Taobao, which is the largest e-commerce marketplace in the world. But at the time it was very small and he was doing it to make sure that he could beat eBay before eBay became too big. And he makes it free. And another interesting element of this is he gets the capital for making his new thing free, typical internet entrepreneurial mentality, by raising money from foreigners. He gets money from Goldman Sachs, from Yahoo, he does a partnership with Yahoo. He also gets money from SoftBank.

Chorzempa: And so these foreigners are funding this domestic Chinese company so that it can beat out eBay. But one of the things he struggles with is, how are you going to get payments? Because at the time China's payment system is very backward. You can't just go online, type in your credit card number and make a payment because you don't have a credit card. Chinese people didn't have credit cards and their debit cards didn't have that kind of functionality. So Jack Ma had to think, well maybe we need to create our own payment system so that we can have people pay each other. Otherwise, they're only going to transact in the same city.

Chorzempa: It'll be like Craigslist, you chat online, you meet in person, you make sure the goods exist, you get cash, you make sure it's not counterfeit and then you go your separate ways. But that is such a limited potential for what could be a nationwide or global e-commerce network. You really need electronic payments for that to work. And it was really risky though to do this because there's really only one major payments company in China at the time, that's UnionPay. It's a state owned monopoly. And the question is, is it legal or not to try and compete with these guys? But he decided to go for it.

Beckworth: That was the 2004 moment, right?

Chorzempa: Yes.

Beckworth: Where in your book you talk about, he's at, I believe, the World Economic Forum and middle of the night, he just wakes up with an epiphany, let's do it. And the line that you have in the book is, "Look, if anyone's going to go to prison for doing this, it's me. I'll take the fall." And what's fascinating is, in the story you tell in the book, it's not just that he doesn't know if he'll go to jail, the regulators don't know what's legal. So even the people in charge in the government, they're not sure what's legal because you have the state run payment system, there's this gray area and so you need someone to take the risk, someone to step out and he does. This is so fascinating. Now I'm going to go back to the landscape that was ripe for this.

Beckworth: I mean, the Chinese allowed this to happen, the government allowed it to happen. But talk about how poor the financial system was, how challenging. I've already alluded to the fact that banks paid interest less than on inflation, but it really was difficult. Jeff Bezos, when he started Amazon, in some ways he had an advantage because we had credit cards. You could set up the webpage. I remember when it was first a book company, I would order books and then it grew into something more. But it was fairly easy to use. But walk us through what it was like to be a Chinese citizen trying to buy things. Talk about for example, the money, the counterfeits, how difficult, or even in a Craigslist scenario, it wasn't exactly easy to do transactions because there's a lot of fraud and counterfeiting going on. Is that right?

The Early Days of Chinese FinTech Development

Chorzempa: Yes, absolutely. So the main way that you would characterize China's financial system is one of financial repression at this time. The financial system played a role helping the state achieve its objectives and one of those objectives was getting low cost of capital from the general population to then give cheap loans to largely state owned companies and other government priorities, buying government bonds at yields that are really low because that helps finance the development of infrastructure and all the other things the government wants. Really building out consumer financial products was not a priority for the banks, which were all, at least the large ones, owned by the government. And the executives were handpicked by the Communist party, which is also the shareholder of the bank. And the executives at the banks, at least the top level executives were also part of the nomenclatura, vice ministerial level officials in the government at the same time as they're supposed to be running these banks, which are called commercial banks.

Consumer financial products was not a priority for the banks, which were all, at least the large ones, owned by the government. And the executives were handpicked by the Communist party.

Chorzempa: And the only payments company is a state-owned company run by former government people. So you don't really have a huge focus on trying to build out credit cards and all of this. And the result is a very backward financial system for regular people. So if they need to get a mortgage for example, that's okay because there's collateral. But the banks have virtually zero capacity to do the kind of credit scoring that we take for granted here because there was so little consumer credit. So it’s a chicken and egg problem; without consumer credit, nobody knows who's credit worthy. If the banks don't know who's credit worthy, they can't give you loan, therefore you have no credit score and it just continues this way and something had to change for it to it to develop. But the cash level was something that really struck me the most when I arrived in China.

Chorzempa: I expected that people probably wouldn't take my visa card very often, but what I was surprised by is how few places would even accept my union pay debit card. Everything was in cash and even the smallest little local neighborhood restaurant would actually run bills that were only a few dollars worth through a special counterfeit checking machine a couple times with every single angle to make sure that we weren't giving these fake bills. And in taxis at nighttime, a driver would often want you to use a really big bill to pay so they could give you lots of change, which might lead you to trip one of those machines the next day when you try to buy your dumplings.

Beckworth: Nice.

Chorzempa: So it was a really backwards system, did not look like the future of finance at all when I first arrived.

Beckworth: And so Jack Ma and Alibaba, as well as Pony Ma and Tencent, they step into this space, they disrupt it. You mentioned Jack Ma's money market fund. Talk about that story. How did that disrupt banks?

Chorzempa: Yeah, so really interestingly, this is a repeat of the United States. In the 1970s, the US government had these controls on interest rates that banks could pay on deposits. They didn't want banks to keep raising their deposit rates really high and compete on that way and then undermine everybody's cost of funding by making it expensive. So they had these low rates and then these smart entrepreneurs figured out that what you can do is buy Treasury bonds, which were only sold then in something like $10,000 increments. You can buy a boatload of these and then sell shares in these Treasury bond funds. And they called it a money market fund. And essentially this is exactly what Jack Ma does in China. For a long time the banks were the only ones who could sell money market funds and so none of them did because it would undermine their cheap cost of funding.

Chorzempa: But Jack Ma gets a license from the government through this really interesting opening up of new competition to use this e-commerce company to market an investment product. And so what he does is when the banks are paying you 0.35% on a demand deposit, really low, he manages to figure out if you can pool people's money together and try to shop it around in the inner bank market, you can get 6%. And he starts paying people 6% on money they could pull out any time. It's way higher than what the government banks were offering. And it absolutely shocks the banks because all this money that would've been demand deposits at 0.35% is now costing them six because Jack Ma has found a way around it. And there was this big debate where these strong state owned incumbents were saying, “we're being undermined here by this upstart and why doesn't the government do something about that and protect us?”

Chorzempa: And the battle then happened be between these reformers who wanted China's system to be more competitive. They wanted the banks to have a kick to become more innovative and more efficient, people like Governor Zhou Xiaochuan, and Jack Ma is able to defend his case for this disruption in the most important newspaper that the party runs saying finance needs disruptors and he wins. The banks are not successful at banning this product. Instead what happens is everybody raises their rates. So not only the people who invested in this product got much better returns, but the people who kept their money in banks benefited too. The whole ecosystem became better for savers as a result of this single product coming out, which then led to dozens and dozens of copycats as every other internet company did the same thing.

Beckworth: And it was key to have that central bank governor supporting him that was a key government official. And then who was this other official, Wen?

Chorzempa: Wen Jiabao.

Beckworth: Yeah. What role did he play in this debate?

Jack Ma is able to defend his case for this disruption in the most important newspaper that the party runs saying finance needs disruptors and he wins. The banks are not successful at banning this product. Instead what happens is everybody raises their rates. So not only the people who invested in this product got much better returns, but the people who kept their money in banks benefited too. The whole ecosystem became better for savers.

Chorzempa: Yeah. So in any system there are going to be losers from innovation and in the financial system as you know very well, it's a very highly regulated space where it's pretty easy to argue that some new innovative thing is going to bring a lot more risks than rewards. So without political backing that can help make sure that the powerful incumbents can't block it, it's hard for innovation to really survive in these kind of highly regulated environments. So Governor Zhou is really important because he for a long time thought that new technology and competition was really the only way that China's system was going to be able to adapt to what it needed in the future, to support innovative small companies, not just these big infrastructure projects which were starting to have diminishing marginal returns. And Premier Wen, he's the top level economic official in the entire country.

Chorzempa: So when he makes a statement, he's balancing all these interests who want the state's development interests, but also these innovative companies to succeed. He then is an important high level official to make the commitment that then enables all the lower level officials to say we support breaking up the bank's monopoly. And that's what he says. He says, "The banks make too much profit serving too few people and we need to change that and bring private capital," he says, "into the financial system to allow the country to grow in the future."

Beckworth: And what was a little bit surprising to me is that the Communist party, now you mentioned Premier Wen, he led the way, but the party fell behind him, they supported his decision. So at this stage at least, they were reformers. They were open to this. Should I be surprised by this or was this just the nature of the party at the time?

Chorzempa: Well, I think that there's a view in Washington now that there's no debate in China. That there's one leader, he makes the decisions, there's one party and that's the image that they like to project to the outside world. But everywhere that I've looked in depth, you find an incredible amount of pluralism. You find these differences of opinion about what should be done, what is necessary to adapt the system for future needs. Mao Zedong said whatever in the fifties, sixties, seventies, but how relevant is that to the decisions about these new technologies which he never possibly dreamed of? And you find that that there's just really robust debate and the reformers don't always win.

Chorzempa: I think the overall reform story after the early 2000s is pretty poor. But you find that an official like Governor Zhou who's very pro-reform is able to get a lot done and really reshape China in important ways that make it a more marketized, more competitive, more innovation friendly place. And we see this innovation thrive under an authoritarian regime. And I think even now if we look at the COVID policy, we see that there were people inside the system who were pushing for moving away from these draconian crushing of civil liberties through all these quarantines. And once the politics work the right way, they can take the day.

Beckworth: I guess it was important then that these transformations happen really quickly because you never know who's going to be in power. So this 2013 and 2015 period, rapid change… Xi Jinping, when was he the leader? When did he become the leader in China?

Even now if we look at the COVID policy, we see that there were people inside the system who were pushing for moving away from these draconian crushing of civil liberties through all these quarantines. And once the politics work the right way, they can take the day.

Chorzempa: Depending on whether you take the party or government post, it's 2012 to 2013. So the really interesting thing is that he comes to power right at about the time this FinTech revolution is about to begin. But none of it is really on his radar initially, the FinTech specifically.

Beckworth: Okay.

Chorzempa: Technology, though, is, so we think of him now as being this super pro party classic communist kind of leader. But when he was selected as the new leader in China, the first thing he did was go to Shenzhen, which is a hub of innovation. And he went to Tencent, this social media company, and he said, "You all are doing really important work and we can learn all sorts of things from the data that you have about public opinion and things." So you see that he's immediately projecting an image of someone who is pro-innovation and wants technology to work with the party. He's not hostile to innovation and that's a positive signal for the people who are making these important decisions, and the regulators, they're going to follow the leader. And the signals he was sending were very positive for technology at the very beginning.

Beckworth: That's so interesting because my impression of him is maybe based on the past few years where he's come down hard on real estate, tech firms, the zero-COVID policy, this seems like not a very thoughtful approach, at least from where I'm sitting, but we'll talk about this later. But now he does seem to show some flexibility and he's relaxing the zero-COVID policy. But maybe you're saying it's not just him though, there's this broader debate going on. But before we get to that moment, I want to go back to this period of innovation. So we've touched on Jack Ma and his company and the transformation that took place and there's some more to his story before we get to the rest of his story, let's talk a little bit about Pony Ma and Tencent. So first off, they're not related even though they have the same surname?

The Story of Pony Ma and Tencent

Chorzempa: Correct. There's a relatively short list of surnames in China. There's actually relatively far less sounds in Chinese versus others. That's one reason they need the tones. But you can often have… there are probably tens of thousands of Wang Jingweis in China for example. And that can often make it hard to figure out who you're referring to.

Beckworth: So they're not related, but they have the same last name. But tell us about his experience, Pony Ma and Tencent. Because it's important in terms of creating competition, it forces Jack Ma to innovate and in turn forces Pony Ma to innovate, Tencent and Alibaba. Having competition was good for them.

Chorzempa: Yes. So Pony Ma is, dispositionally, the complete opposite of Jack Ma, despite them both playing a similar role. Pony Ma is this very quiet engineer who tries to stay out of the limelight and not cause problems. He quietly gets things done behind the scenes and he starts off doing a lot of copycatting. Their first product was actually called OICQ, which was a copy of ICQ, a company that I believe AOL bought. And they lost a copyright suit. So he's actually once said that imitation is the most dependable form of innovation. So China's known often as a copycat place and at the very beginning that's absolutely what was happening. But as time goes on, they become a really innovative social media and gaming company in China. And starting around 2013, when they launch this WeChat product, they start to build something that no longer looks like a copycat of anything that exists in the West, but instead combines all sorts of different elements they've learned from around the world and puts it into this one super app.

Chorzempa: And the really interesting thing here comes around the lunar new year of 2014. It's when one of China's most important holidays and at this time, Jack Ma… it's an e-commerce company, Alibaba and Alipay. And he's absolutely dominating online payments in China, monopolistic almost level of positioning, like the US dollar in international currency markets. And it looks like this social media company… why should you give your payments data to one of them? It's obvious you hand your payment data when you're buying something but chatting with your friends, not clear. And they take this holiday where people send money to each other and say, "Hey, we have your social network, why don't you send a digital red envelope to your friends?" And it's a gaming company. So they gamify it, they make it really fun. You can send, say, $20 bucks to a group of your friends and the first person to click on it gets a good amount of money, someone else gets less, someone else gets less.

Beckworth: Oh, cool.

Chorzempa: Or it can be randomized.

Beckworth: Right.

Chorzempa: So they make it really fun. And in one fell swoop, Alipay goes from the dominant player in online payments to a duopoly and it creates this arms race between these two companies. One has its stronghold in e-commerce, the other in social media and gaming. But from that they recognize that there's going to be this bundle going on where you try to add as many functions as possible into your app, so it can do things that your competitor cannot do. And this competition more than anything else is what brings this incredibly rapid revolution in China because each of these tech companies knows that whoever dominates payments is going to dominate the future of commerce in China's massive market. So they want to get there first. They want their QR code standard to be used, they want to build in hailing taxis in their app and this just gets the flywheel going. And these private companies in something like a year or two just completely remake the way that people pay. And then as a result, getting scooters, getting a car becomes easier, getting a train becomes easier, waiting at the hospital becomes easier because you don't have a separate payment window anymore. It all goes into this one incredibly powerful platform that then competes with another incredibly powerful platform.

This competition more than anything else is what brings this incredibly rapid revolution in China because each of these tech companies knows that whoever dominates payments is going to dominate the future of commerce in China's massive market. So they want to get there first.

Beckworth: So this is a perfect storm of everything coming together. You have a window when communist officials are open and they actually want some innovation in the payment and banking system. But more importantly, you actually have two players that come on. If you just had Jack Ma, maybe a little less innovation, but because of the competition, they both innovate and we end up with Alipay and WeChat. So maybe walk us through a super app. How is it different than what we have here in the US or in Europe and what are we lacking? What are we missing in our world compared to these super apps?

The Basics of Super Apps in China

Chorzempa: Yeah, the best way to think about it, I think, is an alternative operating system for your phone. So within iOS on your Apple device you have the ability to make payments with Apple Pay, you have an app store which controls who's going to be able to do things on your phone. You have all sorts of settings and then you have all these different functionalities. You're going to do your social media on Twitter and Facebook messaging. You're going to have your banking app, Venmo, Uber, United app maybe to take a flight.

Beckworth: Right.

Chorzempa: All of these things, instead of being something that someone downloads in China necessarily from Apple, they're going to download it from Alipay or WeChat Pay. So it really starts with a foundation of payments, which then allows you to move money and have a service with clients. And so a super app then becomes… they call them mini apps. You can build an app within an app, but these are much smaller than big apps. So a restaurant will have a mini app that allows you to order, for example. You don't have to scan a QR code and go to their website anymore.

Beckworth: Okay.

Chorzempa: It'll pull up this little thing and you can click, "I want to order these things," and the payment will go through automatically. When you go to park somewhere, Aaron Klein always gives this example because he went to China and explored this too, you come in, you scan a code, and then when you come out you scan the code and the payment just goes through like that because there are no multiple parties anymore. It's not like a credit card where you have multiple banks and then a credit network and a POS provider and all of this. It's all on one closed loop ecosystem, which allows it to be incredibly efficient and you can do everything that you would do in all those apps I mentioned before within this one place. So in China the question is not iOS or Android, it's WeChat or Alipay. And you can do just about anything you'd want to use an app for in your daily life in this one place. Which also means that this one place has all of the data on you.

Beckworth: Yeah, that's the ominous side of this. Before we get into that though, so this would be like if in the US we only had one payment app, say it's just Apple Pay and every other app functioned through Apple Pay. So my American Airlines app, it was tied or tethered to… everything was tethered to Apple Pay. And that was… that's the idea here, right?

Chorzempa: Exactly.

Beckworth: Which is great for efficiency, interoperability. Here in the US we're now just working on completing a real-time payment system. There's the private sector version, real-time payments from The Clearing House which started before the Fed. Now the Fed's doing FedNow. And it's this awkward moment where, will they actually be interoperable? And the question… well maybe not. And which banks? Where do you go? This one or that one? So we don't have a good real-time payment system, pervasive real-time payment system. But this is something that exists in China effectively through these apps already, right?

Chorzempa: Yes, but they're not interoperable. At least until very recently they were completely separate. So you'd arrive at a merchant and they want to accept all of these. So imagine you had to have a separate POS machine to accept, say one for Visa, one for MasterCard, one for Amex, one for Venmo. You would see just these multiple QR codes already. You scan a different one for each app. So there's all this in one, but then they want to keep all of your activity on their ecosystem. They don't want it going in or out.

Beckworth: I see.

Chorzempa: And they don't want to involve the banks. They would rather have you transfer your money into their closed loop and then do all of your transactions in there. Imagine you're a business, you get money, you get revenue from Alipay when people pay, you might be able to pay your employees with Alipay. You can buy all your raw materials you need. Say you're a restaurant, you need to buy peppers, very common in China, you can probably order those through Alibaba platforms and you never really need to leave. It's like what do you even need a bank account for except for the initial linking with Alipay and getting your money into that ecosystem? And this is something that the government really had concerns about because they're saying it's not interoperable. This is potentially this crazy oligopoly where there's really no ability to transact between platforms and the platform has so much incentive to keep you on that it really becomes closed.

Beckworth: So, Martin, these rapid developments in China, this advance in China is why Mark Zuckerberg got excited about the Libra stablecoin for Facebook. Because when it came out, I'm like, "What does he care?" And I did think, "Well it does make sense, he's everywhere." He has this network set up across the globe. I could see network effects being established, that'd be very useful. And I can also see why that freaked a bunch of monetary authorities around the world out. But why do this now? But in your book you say he's responding to what he sees in China, right?

This is something that the government really had concerns about because they're saying it's not interoperable. This is potentially this crazy oligopoly where there's really no ability to transact between platforms and the platform has so much incentive to keep you on that it really becomes closed.

Chorzempa: Absolutely. So essentially I see the Libra idea as an attempt to take what WeChat did in China and take it to the entire world because if you are a Silicon Valley entrepreneur for a really long time, China is a place that's behind. We need to look there to see what ideas of ours they are ripping off. And then by the time that the Libra is coming out, it's actually we're looking to China to see what really interesting business models we might be able to apply here. You see that the flow of ideas reverses.

Beckworth: So fascinating.

Chorzempa: And it's actually a scary thing for the United States actually, that a lot of this innovation doesn't occur in the same way. And I think what Zuckerberg saw was that the connection between social and the economy and e-commerce wasn't really that strong and still is not that strong in the US. And he saw how WeChat was able to capitalize on its social media advantage to then create this incredible business that then ran payments and investment and everything else and said, "Why don't we do this same thing in the United States and the world?" Because the main difference between the two in terms of network is WeChat is so much thicker as a network within China in terms of the breadth of services it offers. But it does very little outside of China. They haven't been very successful at eating into Facebook or WhatsApp's market share around the world. But then Facebook with that incredible advantage of a global network, but far less breadth of products that it can offer says, "Why don't we do the same thing?"

Beckworth: That's such a fascinating turn of events there that initially Alipay and WeChat, they're copying the west, they're copying Venmo, they're trying to incorporate some of this technology. The efficient frontier for payment systems is outside the country. But then by the time we get to 2014, 2015, Mark Zuckerberg was looking into China for the efficient frontier of the payment system. So interesting. And I'll mention an interesting little story you tell that beggars on the street in China have their own QR code, they don't ask for money, which is just mind blowing. With that said, let's move on to some of the challenges. In chapter four and five in your book you get into Ponzi schemes. So I guess part of the process of getting to this efficient frontier, there were some mistakes made and it did help to have the Communist party on your side. They could paper over some of these things, suppress concerns. So there are Ponzi scheme issues. Let's talk about those first before we move to the more Orwellian problems that have emerged with these apps. But what were the challenges that they faced in getting to this efficient frontier?

Challenges to the Chinese FinTech Revolution

Chorzempa: Yeah, the really interesting thing, we referenced it earlier about whether authorities are willing to welcome innovation is that financial innovation is very risky. If a regular company tries to innovate and then goes bust, some of the people who knew they were working at a startup and that was risky, they lose their jobs. That's unfortunate. But then it's mostly rich VC kind of investors who lose money if one of these internet startups goes down. But if a company that was managing people's savings goes down, the impact on regular people is just so much larger. I can understand why most countries are a little reticent to allow these new things. The challenge is that ex ante, it's hard to know what is a useful financial innovation and what is someone that's actually maybe a Ponzi scheme or classic loan shark that's hiding behind claims of innovation that we can't verify to get the benefit of the doubt for a long time by the authorities and by investors.

Chorzempa: And so what we have in China is, again, inspiration from the United States. LendingClub goes public in the US, makes a ton of money. A lot of very smart people said, "This looks like the future of finance." We now have… what do we need banks for? We can say they're just running a credit scoring algorithm anyway. Why don't we create an online platform where people who want to borrow money, meet people who have excess money, they want to invest, and instead of having it go through a bank with all the mess of FDIC insurance and all that, we can just link them directly?

Chorzempa: And if we link them directly, there's a lot less cost to that intermediation and maybe less risk too, because an individual can say, "I'm going to buy a piece of a hundred loans. So if one of those goes bad, I don't really care. That's fine." And an individual can get their loan funded by a bunch of other people. And if the big data that gives us the credit score for that individual is good, then we can have a pretty great outcome. And maybe that's the future of finance. That's how it worked in the United States, at least for a time. Then it turned out that model didn't work as well as we expected. But China looked at that and they had, as I mentioned, so many more problems with consumer credit.

I can understand why most countries are a little reticent to allow these new things. The challenge is that ex ante, it's hard to know what is a useful financial innovation and what is someone that's actually maybe a Ponzi scheme or classic loan shark that's hiding behind claims of innovation that we can't verify to get the benefit of the doubt for a long time by the authorities and by investors.

Chorzempa: There was just so much more demand for consumer credit and for small business credit that had never been met by the financial system, that they rushed into this as a way to help a lot of people. And the challenge was they didn't know how to regulate it. It didn't fit in anybody's jurisdictional bucket. So there was nobody to check under the hood and say, "Are you actually just a platform that matches borrowers and lenders or are you pretending that you're doing that and meanwhile you just operate completely unregulated ... "

Beckworth: You're pocketing the money.

Chorzempa: " ... bank?" Yeah. And that's what a lot of these guys were doing. The incentives were all wrong because in the financial repression world, everything is guaranteed by the state, all your investments. So you just invest in whatever has the highest return and you expect that if something problematic happens, the state's going to bail you out. Now apply that to a completely unregulated space where the people have very limited financial literacy and they're being told, "You can get 12% risk free, 15% risk free. We have all this amazing big data, AI technology, it's going to be great." And the incentive for the platform is to hide the losses. Because if you show people that there are some defaults, they think there's risk, they pull their money out, you go bust.

Beckworth: Right.

Chorzempa: So if you have the losses, you paper them over and you hope that the next batch of loans is going to be better. And essentially what you end up with is a one trillion renminbi size, massive set of Ponzi schemes that are all just waiting to teeter over. And that leads sometimes tens of thousands of people to take to the streets for telling the government, "Hey, you know, you guys were in cahoots with these guys." And in some cases that's true. And in other cases the government says, "This isn't our problem. We didn't regulate this. We didn't tell you this was safe. We didn't say there was a state guarantee." And so you see these growing pains from people who don't really know what to trust, who to trust in an environment where you have more choice. But some of those choices are bad and you don't know, and then you see the potential drawback of a system that allows these new companies to offer financial services without proper regulation.

Beckworth: It brings to mind FTX. But let's move on. So there were some Ponzi schemes along the way by people who also wanted to compete in this space. And unfortunately some Chinese citizens lost their savings. But let's move to probably what people really want to hear about, this new Orwellian side of this. So as most of our listeners know, China had a zero-COVID policy. They had really strict lockdowns and just now, just yesterday, they've changed their policy because of the rioting, the protests. I want to come back to and discuss it with you in a minute, but they've definitely have dialed it back. But what's interesting, you note this in your book, is that part of how they enforced the zero-COVID policy was all this information in these super apps, they could track you. They knew what you were doing, how you were spending, social media, everything about you is in this centralized location. So perfect tool for the government to enforce zero-COVID policy. So this is the Orwellian side to this wonderful innovation.

The Orwellian Side of Super Apps

Chorzempa: Yes, this is essentially a story that I tell in the book of what initially looks to be a tool of financial freedom and freeing people from this repression ends up being the creator of these codes, which if they turn red, because you're the contact of a contact of someone who had COVID, gets your door welded shut. And if there's a fire in your building, you might have the same problem that they had in Urumqi that led to these protests. Building on fire, you can't get out, and it's because your health code turned the wrong color. And so initially when the government is looking at these things, they're looking at it through a financial lens and trying to improve competition and all this. But then Xi Jinping, as he takes power, begins to be more concerned about state surveillance and helping the state sector.

Chorzempa: So a lot of the productive, useful innovations that were disruptive to the traditional banks, they start to become more regulated, more difficult to do. And the financial freedom side begins to erode. And at the same time the government is seeing technology as a way to better manage society. And when you combine all of this into one, it becomes the perfect locus of control. If everyone has the app, if you're able to get the data from those apps, you have the ability to monitor the population in very scary ways. So similarly to this overall story, when COVID hits initially everybody's in lockdown in China. Everyone is locked down, no codes at all. And they're thinking, "How can we have some people be free?" The people who are low risk. And they ask Alipay to be the one to create the algorithm that determines if you have freedom of movement or not.

The government is seeing technology as a way to better manage society. And when you combine all of this into one, it becomes the perfect locus of control. If everyone has the app, if you're able to get the data from those apps, you have the ability to monitor the population in very scary ways.

Chorzempa: They allow a private company that role, which is just absolutely extraordinary. And at the same time, that company says, "Our data's not going into it, although it's in our app." They're tracking your location from you scanning the QR code, which tells the government where you are. And the telcos are telling them which cell towers you've been near. And that's how they know where you've been. We're not giving them that data. So the fascinating thing in this story is that these companies recognize that the data they have on people is something they want to keep private, they don't want to share it with other companies. And generally they don't want to share it with the government, but sometimes they have no choice. And that's really where the current debate becomes so fascinating. How much are they going to be willing to share with the state now that the tides have turned and the tech companies are not as powerful as they used to be because China's system has become much more state dominated? Can they still resist some of these calls from the state to share data? And my sense is it's much harder.

Beckworth: So just to make this concrete, if I'm living in China during the zero-COVID lockdown, which appears as of yesterday and today to be fading, maybe gradually fading, but it's fading. I literally was being tracked. I may have come into a space where someone else had come into maybe same day, same time period who was found to have it. So I may not even be aware that I was in a potentially exposed situation, but they know. And they shut me down. That just very Orwellian. And I suspect some people may not even have understood why they were locked down. Literally, they got welded shut and they may have no idea why they're in this predicament, but maybe people at Alibaba does, the government does, because you happened to be in this space where this exposure took place.

Chorzempa: Algorithms generally tend to be pretty opaque. And in this case, there was an algorithm that took all sorts of data in, and how close did you actually get to the case? Is it based on any epidemiology? Not so clear. I've heard of people who were locked down because they went through a toll booth, two cars ahead of somebody who was related to a COVID case. How on earth are you going to get it from someone two cars back at the toll booth.

Beckworth: Right.

Chorzempa: It's not even the person you talked to, but everywhere you went in China, for much of the zero-COVID time, you had to scan your code. So you had to not only show that you haven't been around anybody with a case, but everywhere you go. You go to the supermarket, you get on public transport, you go to a bar, a restaurant, they're going to scan that code. And the New York Times did a tear-down of the code, the actual coding behind that. And there's a little line in it which says report info and location to police. It's actually named that as a command within the app. So the government knows exactly where you are at all times and can figure out if you're related to COVID. But the scary part of this, now some of this is being dismantled, but the scary part of this still remains, which is when your social media and your finances are tied together in this way and the government will make sure that things are censored that they don't like. So if you write something critical of the government, let's say you shared an image of the recent protests on WeChat, they might lock you out of your account permanently. And if that's the main way that you… say you run a small business, all of your revenue is through WeChat.

Chorzempa: The way that you communicate with your clients is through WeChat. The way that you have your investments, you have your loans, you have everything on this one app, all of your social network, your contacts, your professional relationships are all through this app. You get locked out, it's an end to your life. So are you going to write those things? Are you going to share images of the protests? It underscores the extraordinary bravery of the people who did share these images. But it also tells us maybe we don't want to connect these two things together because it leads to very scary outcomes.

Beckworth: Yes. So it definitely underscores the bravery, the boldness, because the stakes were so high for these folks, their entire life. So, it's so startling. Not only were they being monitored, where they went, who they met, who they unintentionally ran into, but their livelihood with a flick of a switch or a keypad, they could literally shut you down. And that was pretty stark to read in your book that it's another tool of the government. You think with innovation, technology, there's more freedom, but actually it increased the power of the police state, the surveillance state in China. And before we move on from that, I want to just ask about this area because it got a lot of play in the US news. It seemed very terrifying, but this was the talk about the social credit system, and it strikes me that these apps are far more troubling than the social credit system. But talk us through what is the social credit system and what did it do?

The Social Credit System in China

Chorzempa: Yeah. This is probably the number one worst reported on thing in relation to China that I've ever seen. There was this idea from the government, which was mainly driven by a problem I think we could all agree is a problem, which is that Chinese courts were not able to enforce their judgements. They could find some of these Ponzi schemers or someone that defrauded their business partner, ran away with the money and then is living large and the court found against them, but they can't do anything about it. You say, "Isn't China this authoritarian police state? Can't they do it?" But they weren't able to enforce their court judgements. That sounds pretty banal. But that leads them to say, "We need to figure out some joint system of punishments. If somebody breaks the law or serious administrative regulations in China, can we create some negative consequences that doesn't necessarily involve them going to jail?"

Chorzempa: It's not a criminal case or maybe a civil case, but we don't want that person who hasn't fulfilled a court judgment to be able to start a new company or get a loan or become an officer in a securities firm, these kinds of things. It all makes sense. So they created this system and at the same time you had Alibaba with all of their e-commerce data and all of this that was given permission to create a credit system. We all have a FICO score… in China, nothing like that existed. They had a credit bureau with the central bank but didn't have a score which would allow all sorts of lenders to be able to give you consumer credit. Alibaba was like, "We have a lot of data, we can bootstrap this. Even if you don't have a credit history, we'll give you a credit score based on the data we have."

Chorzempa: And then all these media sources took the Alibaba thing and they took the social credit thing and then somehow merged them together as if they're the same thing and said, "The government has a score which we'll give you. It's your citizen score, and if you buy alcohol it's going to go down, and if you buy diapers it goes up." Because actually the Alibaba score says, "If you're buying diapers, you're pretty responsible. We're going to give you a little bit better score." But that score only really matters for access to credit from a limited subset of lenders in China. It's not actually that scary.

Beckworth: It’s two separate-

Chorzempa: Two separate things.

Beckworth: Okay.

Chorzempa: Now, the social credit system overall is a pretty scary idea though, that the government is going to track everybody's demerits and if they create some numerical score for ranking citizens, that's really terrifying. And some local governments who are doing pilot programs under the social credit system, they created actual ranking systems. The challenge is, how much do you rate paying back your loans versus visiting your parents, an actual thing in one of these local government things that determined what your score was, or whether you write something negative about the party or whether you've been named a model worker in your work unit. What kind of numerical thing do you attach to this? And that's actually a hard political question in a place like China.

Chorzempa: I actually anticipate there never ever will be a social credit score. There won't be the one number that rules them all and is exactly what determines your value in China. And I think that, as you say, the real scary things in China are not something that fits our Black Mirror conception of what China might be. It's the daily surveillance, the fact that there are cameras everywhere. The fact that everything you say on these apps is being watched and censored and so they don't need some crazy high tech automated scoring system to try and keep people in line. It's all already there. It's already scary.

I actually anticipate there never ever will be a social credit score. There won't be the one number that rules them all and is exactly what determines your value in China. And I think that, as you say, the real scary things in China are not something that fits our Black Mirror conception of what China might be. It's the daily surveillance, the fact that there are cameras everywhere. The fact that everything you say on these apps is being watched and censored and so they don't need some crazy high tech automated scoring system to try and keep people in line. It's all already there. It's already scary.

Beckworth: You don't need the scary social credit story. Let's come to the present and talk about this pivot in China's zero-COVID policy. So for me, it was surprising. For you, maybe not since you're a China expert, but for me, I had this impression that Xi Jinping couldn't change even if he wanted to. Even though these riots were getting messy, he would lose face, right? He just got elected to his third term, the leader of China, and he's very bold, very aggressive, very nationalistic. And to back down would mean he's not this credible threat. But lo and behold, it happened. And I'm just a little surprised. Were you?

Xi Jinping and Zero-COVID

Chorzempa: I am surprised at how quickly things changed. One of the ways to think about it is the act of removing the zero-COVID restrictions, there really isn't a middle ground with how infectious Omicron is, right? You're either going to have zero or you're going to have a lot. You can't really credibly say we're going to have some relatively low number of infections. So if you're coming up to a party congress, which is supposed to give you this very out of the ordinary anointment as leader for the next potentially as long as you live, you don't want there to be overwhelmed hospitals and lots of deaths going on when one of the things you want to say is that you've managed COVID so much better than the rest of the world. And one of the things we look for in whether China's policy is going to change is, are they going to vaccinate the elderly and are they going to do something like say that COVID is not the same.

Chorzempa: So you don't lose face for the policy you had if you say we're dealing with something different. The conceit here is that omicron, accurately, from a scientific perspective is a lot less lethal and more infectious. So it's harder to control in terms of numbers of cases, but each individual case matters a lot less than under a previous thing. It's very convenient that they don't say that it's been omicron for a long time now. So they could have done this then, but they're saying the disease is different now and that allows them to very creatively sell this and diffuse all of the frustrations at the same time.

Beckworth: Well, do you think it also portends a change in Xi Jinping's approach to the world? Is he going to be more open to engage less war mongering, less rhetoric, harsh rhetoric about invading Taiwan? Do you think this is something… he's turning a new chapter in his leadership?

Chorzempa: I wouldn't bet on that.

Beckworth: Okay.

Chorzempa: But I do think that as many have said, the isolation that China's been under since it closed its borders to the world and made it very difficult for Chinese people to leave because they'd have to quarantine upon return, that has really isolated China and led to a lot of problems. You don't have the same person to person interaction. Chinese officials are not going around the world seeing how China's perceived. I think it'll be very positive for China and very positive for the rest of the world to have China once again, a place that people can visit. Once again, allowing Chinese to leave the country, it'll stop being a hermit place and more interactions with the world. That will be very beneficial.

Beckworth: Absolutely. One last thing before we wrap to show up. We are recording this on December 8th. This show will probably come out early January. So some of this may be dated, but really fascinating article today that related to this zero-COVID change in the Wall Street Journal. And the title of the article is, *Letter From Apple Supplier Foxconn's Founder Prodded China to Ease Zero-COVID Rules.* So the article lays out this claim that Foxconn and Apple basically applied some pressure to the Communist party. And guess what? The Communist party backed down. Now if this is true, this is to me very striking because it's always been the other direction. And this has been the critique. China's this huge market, so all these Western companies are caving. Hollywood will change its movie so they don't offend the Chinese party, or Apple will tweak an app so people can't protest. But here it seems like pressure went the other direction. Am I interpreting this right?

I think it'll be very positive for China and very positive for the rest of the world to have China once again, a place that people can visit. Once again, allowing Chinese to leave the country, it'll stop being a hermit place and more interactions with the world. That will be very beneficial.

Chorzempa: Yeah. So I wouldn't take what I'm about to say too far.

Beckworth: Okay.

Chorzempa: But one of the main lessons from the book is that there's more pluralism in China in terms of views within the system about what should be done than meets the eye. And in this case, if you read the article, it says that there were people who'd long been pushing for there to be a less restrictive COVID policy. And there was some sense that it had to happen at some point, but not sure when. And then this case was something that particularly was something that crystallized to the leadership that China was putting its economic position in the future in jeopardy, and that helped tip the hand of those reformers and come out… We could call them reformers or at least these advocates for a less strict stance and help them come out on top. And I think it's very positive to see. One of the things I always look at in China, is there still some disagreement within the system? Can people still express ideas, within China's constraints, suggestions for the government to do things a little differently? And I think that still exists and thus is a little bit of a positive ray of sunshine in what's otherwise often a very dark place to be looking at.

Beckworth: Totally. And just to be clear for our listeners, what the article argues is that Foxconn and Apple leaders made the case that these policies would undermine China's role as a leading global supply chain provider. And that was huge apparently for Chinese leadership. And given President Biden has started a chip war and all this talk about re-shoring or friend-shoring, I could see everything coming together and they're like, "Yeah, we got to change what we're doing." All right, well our time is up. Our guest today has been Martin Chorzempa. His book is, The Cashless Revolution: China's Reinvention of Money, and the End of America's Domination of Finance and Technology. Check it out. Martin, thank you for coming on the show.

Chorzempa: Thanks for having me.

Photo by Wang HE via Getty Images