China’s great internet stand off

It is hard to see any room for compromise now that Google has staked out a firm position against censorship. There is no history of Chinese officials conceding on a matter that could lead to a loss of face.

Unlike many foreign companies, Google is not competing for government contracts or craving favour. It has been able to put the government in the unfamiliar position of losing out, whatever happens.

If the Chinese authorities back down, Google has called their bluff. If Google pulls out, it shows that a big company can walk away from China.

Indeed, Google's share price quickly recovered from an initial drop on the news and the company, often a target of criticism, found itself basking in unaccustomed praise.

In China, ordinary people came to leave bouquets of flowers at its offices and 80% of 14,000 internet users surveyed by the website china163.com hoped it would not leave.

With one deft move, Google may have changed the political calculus for other companies engaged with Beijing. For decades, foreign businesses have accepted the doctrine that the potential rewards of the Chinese market make it worthwhile putting up with almost anything - arbitrary rules, bribes, counterfeiting, poor enforcement of contracts and a legal system controlled by the Communist party.

Yahoo has already sparked a fresh row by coming to Google's defence. Its comments were described as "reckless" by Alibaba, the Chinese group Yahoo owns a 40% stake in.

Analysts say Google has accepted a commercial risk greater than the loss of $300m (£184m) or about 2% of global revenues it gained in China last year. JP Morgan estimates Google could lose $600m in revenues. It is also likely to surrender its presence in a growing market of 330m internet users to its Chinese rival, Baidu, and to international competitors such as Microsoft.

That could be painful. Though Google lags behind Baidu in users, surveys show its Chinese customers enjoy higher average incomes and have better educational qualifications - making them the ideal demographic target for a technology company with an eye to the 21st century in China.

Its exit would also cast doubt on Google's ability to sell its Nexus One smartphone to China's 730m mobile users.

So far, it has only been released in Hong Kong and Singapore, but some of the new phones are already on sale in China's street markets. ahead of the official launch.

If Chinese officials pursue a vendetta against the company, Google's relationship with China Mobile, the biggest domestic network, could turn sour.

Google executives have probably calculated that the curbs on it are enough to outweigh the benefits of being in China.

When it opened its Chinese site in 2006 it agreed to censor search results, even though co-founder Sergey Brin admitted it "compromised our principles".

Nonetheless, Google faced a sequence of shutdowns and curbs, usually under the convenient banner of official campaigns against pornography. The company's YouTube and Blogspot sites have been blocked since last year as part of a crackdown that has also shut out Facebook and Twitter.

It has also become embroiled in a legal case over copyright with the little-known All China Writers' Association. "Most Chinese people never heard of this association until Google came along," wrote YHX, a net user.

Yet Google drew a torrent of nationalist online abuse after it emerged that it had scanned 18,000 Chinese-language texts as part of its controversial plan to digitise literature.

Negotiations with the association have broken down, leading industry executives to suspect political motives behind the case.

While commercial calculations undoubtedly played a part, Google executives must have known that in China, politics dictate to business. And under President Hu Jintao, since 2003 China has become more dictatorial and less tolerant of dissent.

The party's liberal faction is in retreat, private businesses are yielding more to the state and the heavy hand of officialdom has reasserted itself.

Since 2003, the government has invested more than £800m in the Golden Shield project, which is now thought to store personal data on 96% of China's 1.3 billion people. The Golden Shield uses foreign-supplied technology to filter the internet and monitor communications.

To Google - which, like other firms before it, argued that its presence might help to liberalise China - the policy was proof that state control of the internet is non-negotiable.

Taking a stand on censorship now, said one Chinese academic, is thus a sign the company has already decided to quit.

Any avenue for compromise is narrowed further because Google has also pulled back the veil of silence over Chinese hacking and cyber-attacks against foreign targets.

The company said its software engineers found that unidentified hackers tried to gain access to its Gmail service to read the electronic mail accounts of Chinese dissidents.

Reports on the Chinese internet yesterday suggested that a Communist party spy inside Google's Shanghai office downloaded key software codes and then vanished.

Since Google's announcement, other hacker targets have emerged including: Northrop Grumman, the US defence contractor; Dow, the chemicals giant; Adobe Systems, the software firm; and an American law firm acting for Cybersitter, a firm pursuing a $2.2 billion lawsuit against China.

Rex Hughes, an associate fellow for cyber security at Chatham House, the foreign affairs thinktank, said that governments spying on each other - from Whitehall to the Pentagon - was "pretty much a wink-wink type of thing". However, throwing a spotlight on the practice, as Google has done, is unlikely to help relations between governments or businesses.

"This is an issue that has been waiting to come to the boil," added Hughes. "For business, this is going to create a lot of uncertainty very quickly."

This could prove to be the most damaging aspect of the affair because it only contributes to an already deteriorating relationship between America and China.

Beneath a veneer of diplomacy, their differences have sharpened since President Barack Obama paid a fruitless visit to China last November. "The personal chemistry was poor and the atmosphere was poisonous," said a foreign diplomat in Beijing, "they were testing him because they thought he was weak."

The US president failed to win ground on exchange-rate policy and the Americans argue that the Chinese currency remains undervalued.

American officials have been saying that "10% unemployment in America and 10% growth in China" was not an acceptable equation.