Updated: Nov 28, 2020
By 2020, China intends to assign each business entity a “social credit score.” It’s like the American credit score, but it factors in non-financial data such as compliance with environmental regulations, relationships with suppliers and customers, experiences of past and current employees, etc. These scores will be incredibly important to businesses. With a good score, a company will be granted unrestricted access to capital markets, lower interest rates on loans from financial institutions, and lower stated tax rates. Sounds simple enough, right? Keep the rules, enjoy the rewards, make lots of Chinese Yuan (¥). Well, as one might expect, it may be a bit more complicated when put into practice.
Chinese businesses will face two main difficulties: (1) the human component of ratings and (2) the actual adaptation to the government’s mandates.
Although the extent of the impact of personal reviews is unknown, employees’, customers’, and suppliers’ experiences with companies will hold some weight in determining its social score. Clearly, there is substantial room for bias, bribery, and any number of unethical practices to influence scores. And, scores will be vital to a company’s success or ultimate failure. But, proponents of the scoring system might argue that if businesses truly want to be “consumer-centric,” this is the way to do so.
A company’s adaptation to the updated policies could be troublesome as well because some ideas that were previously viewed as preferred practices can now be legally enforced. One glaring example is the government’s emissions policy. The systemic overhaul staunchly penalizes entities that exceed federal emissions targets. This could be critical. In 2017, China’s emissions of CO2 from fossil fuel combustion represented approximately 27 percent of the world’s output—more than the U.S. and Europe combined. What’s more, China plans to use real-time monitoring to track energy consumption and associated emissions. Therefore, according to the Mercator Institute for China Studies (MERICS), punishments could follow within seconds of surpassing the predetermined emissions cut-off.
The Chinese government has established rigid penalties for companies that fail to comply with the new initiative. Similar to the [link to previous Chinese Social Credit article] penalties [/link] that citizens face, businesses can be cut off from benefits that are deemed as “luxuries.” Unsurprisingly, the government considers access to the country’s capital markets to be a privilege. Therefore, upon violation of the rules, businesses can be restricted from issuing bonds and shares (at times even including shares designated for employee incentives). Further, funds obtained from domestic banks will be subject to higher interest rates. Without external sources of financing, the idea that rule-breaking companies are “bad” can become a self-fulfilling prophecy. Conversely, an argument is easily made that old habits die hard—unless an incentive large enough to abruptly change behavior exists.
Perhaps surprisingly, some aspects of the Chinese Social Credit Score are reminiscent of the partnership of the American federal government and the capital markets. For example, policies like subsidies, tariffs, and tax breaks incentivize businesses to behave in a certain way. The government rewards compliant companies for providing a service that it wishes to promote; meanwhile, stringent regulations on undesirable activities can drive other companies out of business. Further, if a government-sanctioned rating company deems a company as “untrustworthy,” the cost of debt financing can rise substantially, taking that option off the table.
The difference, it seems, is that American consumers respond to government policy in the manner they deem fit. In other words, American citizens ultimately decide the fate of businesses, but the government has some influence via economic policy. In China, on the other hand, the government creates the policies and chooses the consequences. So, consumers are essentially coerced to accept the government’s decisions surrounding the economy and the enterprises therein.
Supporters of capital markets likely find this ideology counter-intuitive, but those who prefer an economy guided by government might find it appealing. Looking beyond ideological differences, MERICS summarizes the potential benefits and/or consequences for the Chinese economy as follows:
1) Preventing illegal behavior,
2) helping strengthen companies’ economic trustworthiness,
3) building a new culture of socially and environmentally responsible behavior, and
4) creating a vast number of IT jobs to satisfy the data collection and storage needs.
1) Many failed businesses,
2) errors with serious repercussions for businesses in the program’s beta,
3) loss of data security, and
4) lack of government transparency.
Essentially, the Chinese government is wagering that it can effectively direct its domestic market to success through establishing clear, strict policies in almost all areas surrounding business. Adam Smith’s “invisible hand” framework might still be in play, but the arm that guides the hand will belong to the federal government. As is the case with most macroeconomic strategies, more time is required to observe the efficacy of this new tactic.
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