We know how to run our Internet, thank you very much, and we don't need lessons from you.

That was the message Chinese authorities sent Saturday in response to U.S. Secretary of State Hillary Clinton's harsh criticism of the regime's Internet censorship and repressive human rights policies. A representative of the Communist government said Clinton was being "disrespectful" when she urged U.S. companies to stand up to Internet censorship in authoritarian countries like China."On the Internet question, China doesn't need any lessons from the United States on what to do or how," said Min Dahong, Chairman of the Beijing Association of Online Media. Min's statement was published Saturday in Xinhuanet.com, the state-run website of China's official propaganda arm. It came one day after China's foreign minister said Clinton's statement was "harmful to Sino-American relations."

Growing Tension

The verbal sniping is the latest fallout from Google's (GOOG) decision to challenge China over Web censorship and cyber-attacks. A single incendiary blog post by Google -- in which the U.S. Web giant declared it would no longer censor its Chinese search engine -- has now led to what one geopolitical expert called the biggest U.S.-China rift in a decade. The widening spat has cast a light on the difficulties U.S. Internet companies face in China.

Min's tone reflected the growing tension between the two countries. "How China's Internet develops and how it is managed are Chinese people's own affairs," Min said. "Hillary's speech on Jan. 21 insinuating that China lacks freedom of information and speech is in fact disrespectful and doesn't stand up."

In a speech Thursday, Clinton urged American media and Internet companies to follow Google's lead. "American companies need to take a proactive role in challenging censorship. They need to consider what's right, not simply what makes a quick profit."

"For companies, this is about more than claiming the moral high ground, it's about the trust between firms and their customers," Clinton added. "Those companies that lose the confidence of their customers will eventually lose customers."

China has insisted that its Internet is "open" and said that foreign companies doing business in China must follow the law and respect local customs. For Internet companies, that means abiding by strict government restrictions on information.

China: Where U.S. Web Firms Go to Die

This presents a fundamental problem for Internet companies and suggests what Google may have belatedly come to realize: American media companies cannot succeed in China under the current circumstances. And make no mistake, Google, Yahoo (YHOO), Facebook and Twitter are all media companies insofar as they facilitate information exchange. For a Chinese government terrified of domestic unrest, a free and open media is simply out of the question.

For companies in the information business, operating in a totalitarian state that strictly censors free speech and spies on foreign companies significantly undercuts their entire enterprise. They are finding that the Chinese government is simply too involved in the the traffic of information to allow a foreign, let alone American, company to fully operate its business, let alone really thrive.

Chinese domestic giants know the language, they know the culture, and they have the connections to local regulators and business partners. In short, the deck is stacked against U.S. web firms. What China's really saying is, "Come, American companies. We welcome you. We welcome you to be beaten by our domestic companies which we favor and which operate with competitive advantages that you will never be able to attain..."

It's clear that U.S. Internet companies, most notably Google, were naive about China. For the last 10 years, when they thought about the Middle Kingdom, they saw dollar signs, spurred on by China's supposed "opening up" to global markets and trade. The early success of Internet search advertising made Web executives drool when they thought of China's billion citizens. In hindsight, the optimism about China's Internet market was reminiscent of "irrational exuberance" of the Internet bubble.

What Google and other companies are finding out is that China is not the pot of gold they thought it would be -- at least not under these conditions. For all the controversy about Google in China, the company's operation there accounts for less than 2% of its overall revenue.

Just Not Worth It

From a business point of view, how can you operate a search engine, a messaging service or a social network in competition with state-favored domestic industries under the conditions of information censorship and state surveillance? No major American Internet company has yet figured it out.

Yahoo, eBay (EBAY) and AOL (AOL), which owns DailyFinance, basically gave up on operating seriously in China, and just when Google was beginning to make some progress, having captured 30% of the market, it was the target of a massive China-based cyber-attack. Facebook and Twitter are routinely banned.

Here's the bottom line: The dramatic rise of U.S. Internet giants, from Google and Yahoo to Facebook and Twitter has been driven by innovation that can only occur if the Web is free, open and unfettered. As long as China keeps its Internet on lockdown, favors domestic firms and spies on foreign competitors, U.S. Internet companies will find it very difficult to operate there. And in the short term, as Google found out, it just may not be worth it.

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