This week on Sinica, a live recording from October 10 in Chicago, Kaiser asks Chang-Tai Hsieh of the Booth School of Business at the University of Chicago, Damien Ma of the Paulson Institute’s think tank MacroPolo, and our own Lizzi Lee, host of The Signal with Lizzi Lee, to right-size the peril that the Chinese economy now faces from slow consumer demand, high youth unemployment, a troubled real estate sector, and high levels of local government debt. This event was co-sponsored by the University of Chicago’s Becker-Friedman Institute, the Paulson Institute, and The China Project.
06:32 – What is the current state of the Chinese economy?
11:14 – The origins of China’s crisis in comparison with crises from 1990 in Japan and 2008 in the U.S.
14:25 – The real estate sector’s role in the crisis and possible solutions.
22:51 – The significance of able management during times of crisis. Is this a crisis of confidence or expectations?
29:34 – The question of the general direction of the Chinese economy.
43:33 – What does an actual debt crisis look like in China?
48:00 – The right U.S. policy toward China in light of current affairs.
Transcript
Kaiser Kuo: Welcome to this special live recording of the Sinica Podcast here in Chicago, Illinois. Hello, Chicago. I am Kaiser Kuo, and we are here tonight with this terrific and very handsome and well-appointed crowd from Chicago at an event put on by the University of Chicago’s Becker Friedman Institute for Economics, a program that pulls together folks from Chicago’s Booth School of Business with its Kenneth G. Griffin Department of Economics, its Harris School of Public Policy, and its law school. Becker Friedman has partnered with the Paulson Institute, and its in-house think tank MacroPolo — still, the cleverest name ever given to an organization dedicated to research on China, MacroPolo. Let that sink in for a little while. It’s amazing. And with The China Project, of which this podcast is a proud part. We are all joining together to bring you tonight’s program — “Decoding China: China’s economic miracle interrupted?”
A huge thank-you to our friends at the Becker Friedman Institute and at the Paulson Institute for making this happen in this magical spot. The sun’s coming down, and you look at the beauty of just the amazing Chicago skyline, what a view. If I am, sort of, not listening and wandering off, distracted, you’ll know exactly why. There’s so much to talk about, so let’s jump in. All summer long, we have heard deep pessimism about the state of the Chinese economy. There is a long litany of woes that have been repeated and amplified to the extent that I’ve gotten, frankly, kind of suspicious. Flagging consumer demand. We all know the stubbornly high savings rate accompanying that, the obvious problems faced now by major residential realty developers like Evergrande and Country Garden, high levels of youth unemployment, and, of course, enormous local government debt.
Now, none of my guests today are the economists that American presidents and CEOs have often wished they had at hand. That is, economists with only one hand, and they don’t always say, “On the one hand, and, on the other hand.” As for me, I don’t mind hearing or engaging a little, on the one hand, myself. So, on the one hand, ordinarily, when I do hear this level of hyper-pessimism, this sheer volume of doomsaying, much of it built on, frankly, motivated reasoning, my instinct is to be very skeptical. China, after all, has defeated, has defied predictions of doom many a time, including in the Asian financial crisis of 1997 and in the great recession after 2008, the crisis of 2015 when the Chinese stock market plummeted. It seems like it’s always able to muddle through.
On the other hand, as a growing number of people whose views I very much trust have come back from trips to China recently, it’s clear to me that the pessimism isn’t by any means limited just to these distant economists or reporters writing about China from the outside. When we hear about the PTSD, the shell shock caused in places like Shanghai by the lockdowns and by the chaotic, confusing end to the COVID restrictions, coupled with this kind of flagging exports, weak signals from the manufacturing sector, unemployment, and, of course, confusion in policy direction overall, I do worry. I take the bears a little more seriously.
Yet, back to that other hand, an economist whom I greatly respect, Arthur Kroeber from Gavekal Dragonomics, gave a very good talk at Harvard recently. He said that this bad news has been enlisted by some in claiming that their grand narratives, going back decades, were correct all along [cough], Gordon Chang. A relatively small amount of data, he notes, is being made to do an awful lot of work. That’s true. Today is really all about right-sizing the problem where the negativity might perhaps be warranted, and where it certainly is not, as well as identifying problems that perhaps aren’t being given sufficient attention in the reportage that we’re all reading. We’ll talk about the nature of the crisis and the nature of the state response, such as it is. Joining me to attack this important question with both hands, as it were, and to try to get this right is Chang-Tai Hsieh, who is the Phyllis and Irwin Winkelried Distinguished Service Professor of Economics at the Booth School, who specializes in development and growth in the developing world. He’s an elected member of the Academia Sinica, I like that name, and a two-time recipient of the Sun Ye-Fang Prize. Chang-Tai, welcome to Sinica, again.
Chang-Tai Hsieh: Thank you. Great to be here.
Kaiser: Good up. Also joining is Lizzi Lee, who’s well known to folks who listen to Sinica or who follow The China project. She is the host of our YouTube show, The Signal With Lizzi Lee, where she does interviews with amazing people. She’s just a really expert interviewer. Lizzi also hosts the Chinese language show, Wall Street TV, Wall Street Today rather, 今日華爾街 [Jīnrì huá’ěrjiē], which is something I highly recommend. It’s about the only non-lunatic Chinese-language programming. I mean, everything else is either like hardcore party line or freaking Falun Gong, or what’s that cook’s name? Guo Wengui, right? And then there’s Lizzi, who’s like an island of sanity on YouTube.
Lizzi Lee: The bar is pretty low.
Kaiser: Anyway, the last time that we were together with Damien was here in Chicago. Our friends at the Chicago Council summoned us to do a sort of roundup of the 20th Party Congress, where some very, very interesting remarks were made. That takes us, of course, to Damien Ma, who is director of MacroPolo, the think tank of the Paulson Institute. Damien is the co-author of a great book, which I’m still constantly recommending to people. It’s really stood the test of time. It’s called In Line Behind a Billion People. It really looks at a lot of issues related to China’s economy and politics through the lens of scarcity. It’s a very, very good book. I highly recommend it. Damien is always one of the people I turn to for the straight dope on what’s happening in the Chinese economy. Damien, great to see you, man.
Damien Ma: Very good to see you.
Kaiser: Lizzi, Chang-Tai, what a great crowd we’ve had. Damien, let me start with you. You were just in China. You got back just a little over a week ago. You had both high-level meetings and some means or boots on the ground, some shoe leather work. Just talking to people who are either decision makers, economic decision makers at the enterprise level or above, and people who are just directly affected by the economy in China, people who’ve experienced the chaotic end of COVID and everything. What’s the skinny? What’s your overall takeaway from talking to people? Are things as bad as they say?
Damien: Well, let me give a sort of two quick, but different observations. I think Kaiser, like you or Lizzi, when we go to China, we tend to not just stay in the hotel. I got there a few days early, so I could, first, walk around, do my own observations. Small things like, are the malls full? Right? Are people buying things? How normal does Beijing look? And caveat that, I mostly interacted with a very small slice of Beijing elites, so they’re not what I would call the true 老百姓 [lǎobǎixìng], right? They are still Beijing elites. So take that with a grain of salt. I talked to Chinese colleagues and talked to the dwindling number of foreign correspondents who are still fighting the good fight in Beijing, just to get a pulse from the people. And had my share of cabby conversations.
Kaiser: Oh, those cabby conversations.
Damien: The reason I wanted to have the cabby conversations, this is probably one interesting tangential observation, is that something like 90% of Beijing cabs are now electric vehicles made by a stand-owned enterprise. This really happened over the last several years. So, if you want to see the transformation in electric vehicles, look no further than Beijing City itself. And this is purely a stay-mandated drive. They basically wanted to help the state-owned enterprise. If you went to China prior to the pandemic, you would’ve probably ridden in a South Korean Hyundai. Those basically do not exist anymore. They’re all-electric vehicles now. So, if you want to get a little small slice of that change, Beijing does give you that little insight. But in terms of the economy, I’ll just say a couple things, and I think they’re the things we’re going to get into quite a bit with the other guests as well.
Talking to people, talking to friends and colleagues, there does seem to be a sense of just things not going that well. People are not seeing the bright light at the end of the tunnel in terms of the economy. In this sense, the Chinese government is probably correct in diagnosing that there is a lack of confidence among households about where the economy is going. The malls were full, but you do not see a lot of purchasing behavior, which I thought was kind of interesting. There was a lot of more window shopping, so to speak, than people actually pulling out their credit cards. Although, I guess not credit card — paying with Alipay or WeChat. Because that’s all you can do these days in Beijing. I think that struggle is real.
At the policy level what’s interesting is I think they understand that this is a problem. But there is, from what I can tell, a very strong debate about really what to do about it because there’s a lot of arguments, and we’re going to get into the different arguments. But I think it’s tough to turn around a consumer and household competence. It takes a while. It takes a combination of policy, it’s a combination of incentives, and also sending very credible consistent signals for a period of time to get people to understand where the economy is going. Part of the problem that the current leadership has is that it’s sending very mixed signals about what’s happening to the economy and what they intend to do about it.
I think that’s injecting more confusion to average Chinese households. It’s a very tough conundrum. And if they don’t turn that around, it’s very, very hard to sustain the growth rate that they want, which is why they may want to stimulate, but stimulus will get you a very short-term bump. That might allow them to meet their 5% target for the year. But what happens in 2024? This is something that they’re truly grappling with, and I really got that sense from talking to average Chinese, Beijingers.
Kaiser: Excellent. Now, not surprisingly, there are two other historical financial crises that the current situation is often compared to. One of them, of course, is the 2008 financial crisis that started in the U.S. retail housing market, but also the malaise that beset Japan beginning right around 1990. That one is brought up an awful lot. Lizzi, I know you have some thoughts on this. I’m wondering whether you think that China is also about to enter a long period of stagnation and painfully slow growth. Are there meaningful ways in which China right now is comparable to Japan then?
Lizzi: In general, I’m always against making those quick and dirty historical analogies because I think they usually are more misleading than educational. In terms of Japan, my argument is that Japan’s problem is not really an asset market problem. It’s a structural problem in the sense that the Japanese economy has its interlinked financial sector and corporate sector, all collateralized by its lent value. If a piece of asset prices goes down, the entire system goes down with it. It reminds me of Charleston, those historical buildings in Charleston. If there were a sparkle fire, the entire city would burn down. The problem is not the fire, the problem is how the city is structured. In China, the system is much more fragmented, actually intentionally so. There’s not much financial linkage between China’s corporate sector and its financial sector. China’s problems are much more fragmented pockets of problems.
You have cysts and tumors in local governments, in rural banks, but those problems tend to be separate from each other. The potential of a horizontal, like all-out contagion, I would say is low. People talk about whether China is going to lose in their 20 years and their 30 years like Japan. The fundamental problem is quite different. The similarity is only on the surface. That’s Japan. For the 2008 analogy, I would actually argue that the property market in China now is less like the pre-2008 United States than a few years ago, say 2015. And that’s a deliberate policy choice. China has been aggressively reducing its corporate sector’s exposure to property market loans for the past few years. I mean, yes, property market loans are still a substantial part of commercial banks’ assets, but those are individual house mortgages quite unlike the United States.
And we know Chinese households pay hefty, hefty down payments, and those loans are recourse loans. So, banks can claim alternate assets if they default. It was said to be like a safe net for banks. Commercial banks, if you look at their balance sheet, they’re actually quite solid. That’s very different from pre-2008 in the United States. So, just make those two.
Kaiser: Yeah. Let me turn to Chang-Tai and ask you about the 2008 comparisons that are so often made. Let’s start by looking at the amount of leverage in the system. That’s one thing. We all probably are aware of the very high percentage of the cost of a home that you have to put down, whether you’re a first timer or a multiple-time home buyer in China, and the amount actually of equity that people have in their homes right now. But the other thing that seems to be missing is we don’t have mortgage-backed securities in China. We don’t have collateralized debt obligations and credit default swaps that we’re betting against those CDOs, right? Is China less vulnerable in that regard?
Chang-Tai: Let me just say three things. First, let me just repeat what Lizzi said, that it is always dangerous, but it’s very easy to draw analogies, right? But most of the time, the world is complicated, and they can be very misleading. If I think about two views that I see, it is that China needs a stimulus, and then China has a confidence problem. That is a misleading way to think about what’s going on now. Really, the way I think about what China is going through now, it’s a combination of two things. First, specifically, on Kaiser’s question, I think about the first issue. And I like to think about that as a reallocation problem. I think that there’s no question that there has been over-expansion in the housing sector in China.
What does that mean? It means that because of the housing price bubble and because of other factors, too much resources have been dedicated to the real estate sector, say, in the last 15 or so years. Right? What do you do about that? Well, exactly the wrong thing to be doing is to double up. That’s exactly what you don’t want to do because that’s going to make the reallocation problem down the line even worse.
Kaiser: What would constitute doubling down on this right now? You mean stimulating?
Chang-Tai: Yeah. Either some form of stimulus that supports the real estate sector. Part of the problem is that there’s always going to be short-run pain whenever there is an adjustment process. Let me just say some of that has already taken place. The beginning of this process was really starting in 2018 when you started to see the crackdown of some of the largest Chinese conglomerates, the crackdown on arm bound, the crackdown on the…
Kaiser: The gray rhinos.
Chang-Tai: Right, the gray rhinos. Actually, since we’re here, for those of you who can look across the street, if you see those three towers right across the street, that was initially a Wanda project.
Kaiser: Dalian Wanda.
Chang-Tai: The three towers that you see just across the river, 200 yards from where we are. One of the consequences of the crackdown on the Wanda Group starting in 2018, was that they were forced to sell off those three towers. It’s now called Vista Towers, right? Vista Towers, and the new owners got it on the cheap because the Wanda group was forced to sell that, not just that property, but lots of the other stuff. Now, there’s still a lot left to be done. I’m not privy to the internal discussions of the Party on how they’re planning to deal with this. But let me just give you what I think is the right historical analogy to think about this issue, which is that it’s really not 2008, but it’s 1998.
If you think about what happened in 1998, China put in place this program. I don’t know whether this was the official name of the program, but this is what people started to call it, which is ‘grasp the large, let go the small.’ It was essentially a program put in place by Premier Zhu Rongji to deal with another big reallocation problem.
Kaiser: Bloated state-owned enterprise.
Chang-Tai: It was a bloated state-owned enterprise. It was that you had a very large number. I mean, there’s some dispute about what the precise number is, like a very large share of capital, a very large share of the resources of the economy was going to inefficient state-owned firms. I think it’s the same question, which is, what do you do with that? There is going to be short-run pain, companies need to be closed, people are going to lose their jobs. You can postpone the pain by continuing to subsidize these companies by just renewing the loans and just kicking the can down the road. That’s not what China chose to do in 1998. It put this plan in place, which led to a lot of short-run pain. It led to a tremendous amount of short-run pain, but it was the largest closure and privatization program that I’ve ever seen in the world. A large number of firms were closed down. A large number of firms were privatized. There are interesting details about what privatization meant. We can talk about that next, but lots of people lost their jobs.
This was the beginning of the process where it released the resources eventually for the millions of entrepreneurs, private firms to eventually emerge and grow in China. There are lots of details about what happened there. There were these institutions that were built on the financial side. We can talk about the asset management companies that were built in place. There are all kinds of that. It’s not just that program, but it was coupled with lots of other things that were put in place at the same time. Now, I want to say I don’t know whether something like this is in the cards. That really is a short-run issue. The question is whether this short-run issue could eventually become a long-run issue if it’s not resolved.
Kaiser: Actually, since the scale of it is very different, I mean, we’re talking about breaking and resetting a bone, right? It’s not just pulling off a bandaid. We’re talking about something, a major structural readjustment. Let’s look at what happened in ’99 when China was a much smaller portion of the global economy, and already it was incredibly painful. Domestically, I think you could draw a direct line to the Falun Gong, rise of Falun Gong and the sit-ins, or potentially politically destabilizing events in that time, right? Today, much bigger, much more integrated, much more risk of global contagion.
Chang-Tai: In terms of the effect of the world, I think it’s absolutely right. But in terms of the scale of the problem in China, I think it’s much smaller.
Kaiser: Okay.
Chang-Tai: In terms of the scale, now, whether there is, I’m going to say the equivalent of Zhu Rongji and the people that were around him at the time, one of the key people at the time was Wang Qishan. Whether there’s that team now, I don’t know, right? I don’t know. But I’ll just say that when I look at other countries of the world, the vast majority of the countries around the world that face this kind of problem, they never solve it, right? Because it’s painful. And if things are painful, you just don’t do it.
Kaiser: I want to drill down on this a little bit with Lizzi. You know that there’s nothing that shakes confidence in the economy more than uncertainty. And I think what I hear a lot of complaints about are the lack of clear signals and intention to backstop, coming from the leadership. In 1998, to Chang-Tai’s point, we had Zhu Rongji, a fairly firm hand on the tiller. We had Wang Qishan. Today, we’re just coming out of the transition. We have a relatively new premier, Li Qiang, and He Lifeng, just now appointed. Do we have the same sort of caliber of administrative management to the economy?
Lizzi: That’s a really good question. I’ve been pondering this term crisis of confidence, as people talk about it in the media a lot. What do we actually mean by crisis of confidence? Like Damien, I also had the opportunity to interact with a cross-section of Chinese citizens. Some of them are entrepreneurs, some of them are low government officials, some of them are recent college grads. And I do get the sense that there is this general sense of anxiety and unease, which I have not seen before. I mean, we Chinese are a grumpy bunch. We complain about parents, about our kids, about our neighbors, etc. But this time I feel like the grudge is very much pointed toward current policymakers, even to the top leadership. The general sense is that there’s something amiss, and they’re not quite sure the direction this country is heading is what they imagined it to be. So, there’s that real sense of anxiety here.
Kaiser: The product of the COVID closure and the lockdowns.
Lizzi: Yeah, we can definitely talk about that. But my point is, that is actually not consistent with the raw economic data you see. If you look at the data, in the first half of the year, consumption actually went up by more than 8%. Wage and disposable income went up more than 6%. It’s not breakneck pace by any stretch of imagination, but it’s not that bad. I mean, it’s not great by Chinese standards, but it’s not a picture of doom and gloom. So, where does this sense of anxiety, this sense of we are completely in the wrong direction, there’s no hope, there’s no tomorrow coming from? Again, my thinking on this is still very much fluid, but I think it’s not quite a crisis of confidence. It’s more like what happens when there’s this huge gap between your expectation and reality.
If you were born into a middle-class Chinese household, there are certain things that you take to be true, right? Your parents worked really hard, they bought a house, they already paid down the mortgage. You have your family wealth stored in your house, which will appreciate quite a lot, and that’s going to be a decent inheritance to you. And your parents invest really heavily in your education. Most of the college graduates now are from one child household. So, we study really hard. Your parents invest in your education. You go to a really good college, and you expect to be able to get a job in the tech sector, in the financial sector upon graduation, and have a really lucrative career. That’s the expectation that has been building in people’s minds for the past 10 plus years.
But now, that equilibrium has been broken, right? First, you have these years of tech crackdowns. All the high-flying tech companies and financial companies are cutting. They’re not recruiting anymore. Those kinds of lucrative jobs are just not there. And then you have three years of lockdowns. And then you have this problem of a market thing where family wealth is now in jeopardy. Basically every single piece of that equation is no longer there. What you take to be 100% certain in the future is just not there. So, I would say it’s not really a crisis of confidence. It’s that gap between reality, between what you currently see and dream. I think that helps explain one puzzling phenomena. If you go to those recruiting fairs in China, they’re all empty, right?
If youth unemployment is at 20%, you would imagine that people are eager to find jobs. They will take whatever is available out there, but why aren’t people not showing up at those recruiting fairs? That’s because those jobs that are offered are not the kind of jobs they want. So, when we talk about Chinese youth unemployment at 20%, which is a historical level for China, I think, by some standard, people should be on the street, right? People should be causing all kinds of social unrest. But that’s not what we see in China. I think people are disillusioned, but it’s not like they cannot find jobs and they have to starve on the street. That’s not what’s really going on. But back to Shanghai’s point, I think what’s really different this time is, when the central leadership, when Xi Jinping and Li Qiang announced this piecemeal measures to stimulate, to remedy the economy, the market doesn’t really take that, which is quite interesting.
There are multiple hypotheses of what’s actually going on. But one thing that I think is quite different from Zhu Rongji’s time and now is that Zhu Rongji is not one single person. Zhu Rongji has a team of capable economic lieutenants who can actually execute his plans, right? Wang Qishan, people like that. Many of those people have been purged by Xi Jinping during past years of anti-corruption campaigns, especially Guang Da Xi (光大系) and 国开行 [the Guangming banking system and the China Development Bank], all those Zhu Rongji lieutenants. They were hit really hard during the anti-corruption campaign. There’s this general sense that the people who can do this are just not there. And I would say the opposite. There are so many people sitting on their hands basically waiting for directions from the very top leadership because they are afraid of the potential retributions.
Like, “What if I do this and something went wrong? I might as well just listen to whatever the top dictates to me.” That kind of inaction, that kind of inertia, is what’s really pragmatic this time. I don’t have a really good solution to that, but this is what I see. And I just wanted to share that with our audience.
Kaiser: Underlying a lot of this is a bigger question of China’s overall economic direction and what it is that Xi Jinping actually wants, the shape of the Chinese economy in his longer-term view. This is something that you’ve talked about a lot, and you actually identified back in 2017. I think you and Evan Feigenbaum wrote a paper that pushed your finger on this, I think proved very prescient. And we’ve seen these ideas echoed out of the 20th Party Congress. This move away from GDP uberalist toward a more sort of qualitative growth. Can you talk a little bit about that idea? And I’d love Chang-Tai to weigh in as well about your thoughts on what it is that Xi and the current Chinese leadership want the Chinese economy to be and to do. We’re no longer talking about KPIs for local officials measured in terms of GDP growth, but rather maybe in nanometers as you once kind of half-jokingly said, but accurately said.
Damien: Right. We published a piece basically with the title — “Nanometers over GDP.” The idea is to capture, crystallize this sense that for 25 years, people were very much accustomed to Chinese introducing growth to meet a certain target, right? There was even this term in markets called the 问价爆破 [wèn jià bàopò]. Every time the economy would tank, they would do countercyclical stimulus because they want to achieve roughly 7% to 8% growth. Because that fixation was really important. But starting the 14th five-year plan it was very clear that the top leadership, in particular Xi Jinping, decided that was not going to be the case anymore. He said, “We’re not going to really have a… We’ll have a range, we’ll still sort of think about growth,” but basically, that target is now no longer valid.
We shouldn’t fixate our entire growth strategy around that. That’s important because the problem is that they didn’t really clarify what the floor is going to be. So, how far can this fall? Are we talking 2%, 3%? What are they satisfied with? This is where I would, I think, agree and also disagree with what Chang-Tai and Lizzi said. I think we can all agree that this is not a 2008 Lehman Brother kind of housing crisis, a problem. And this is not what Lizzi says, sort of a Japanese-style balance sheet recession, which is, I think, Richard Koo branded that. The analogy with the late ’90s holds, it is a sort of debt problem. But last time there was debt on the balance sheet of state-owned enterprises. This time the debt is primarily on local government, right?
Kaiser: But that $5 trillion that-
Damien: Right. We can get to that number, but the main thing is that if you think about it, the macro conditions, though, are quite different now than it was in the late 1990s. Let’s recount what happened. China was about to enter the World Trade Organization, right? Right at the end in the 1990s. That really gave it a big lift in growth. And then China in ’96, ’97, had just privatized the property sector. That was a big growth driver. Now you have just the opposite. The property sector is declining, and they’re not really trying to save it as much as we think. There is no WTO, there’s nothing coming that way. So, I guess the question is, de-leveraging might be the right call, but to do it in a low-growth environment when it’s not clear what the future growth drivers are going to be, is that too risky of a gamble to execute right now when the entire system is saying, “We don’t care that much about GDP growth anymore,” right?
When you grow, even if you take on debt, you can actually inflate away that debt if you have inflation. Actually, debt just becomes a smaller portion of GDP over time. That’s essentially what happened since the late 1990s.
Kaiser: But unpack this a little bit. Tell us, what’s the positive vision? What do they hope to achieve? When they talk about qualitative growth, what does he really need?
Damien: Well, this is my own interpretation, my view is that China wants to become the Amazon of countries. Amazon is the everything store. China wants to be the make-everything country, essentially. If you think about the 1990s, what was the main moniker attached to China? Factory of the world?
Kaiser: Of world.
Damien: 2023, what is China set to do? Also, factory of the world. Just those factories have changed from socks and Nike shoes to batteries and low-end chips, and all those technology products. I think China really feels it’s got a strong competitive advantage in all these mid-range tech supply chains, manufacturing. Obviously I’m exaggerating to say make everything, but I think the strategy is can we attract a global supply chain ecosystem to China, make it there, and export it around the world that might offset some of the other growth drivers that are slowing down?
Kaiser: Lizzi, you had an interesting way of talking about it. You used a martial arts metaphor. You said it’s 练内功 [liàn nèigōng]. I don’t know how to translate that, sort of like your internal, like cultivating internal…
Lizzi: Right. Yeah, I agree with Damien’s framing, but I would use a slightly different word. I think China’s really focusing on the resilience of its system. Here in the United States, we tend to focus on the final product. When we want to develop the EV industry, we focus on consumers, cars, right? We focus on subsidies and policies, policymakers, energy, and so on. In China, they take a much more holistic view on what EV means. They started from rare minerals down to infrastructure, down to batteries, down to the cocktail of government subsidies, tech breaks, and consumer tax credits to the final product itself. That’s a much more vertical way of thinking about what a product actually means.
By the way, that ensures that the whole system has enough flexibility. So, if you want to attack a single part of that system, we want to make sure that there’s enough fluidity in the system itself for the system to heal itself. So, a single act of sanction won’t break the entire system. I think that’s what I mean by 内功 [nèigōng]. It’s the chi, the circulation that matters.
Damien: Also because the external environment is just not as conducive to China’s products.
Lizzi: Yes, absolutely. One thing that I noticed is that there’s a lot of focus on how to adapt to hostile external environments as they speak of, as we can see from the case on Huawei, right? I think they expect that to happen in the future. They sort of preempt future sanctions and restrictions by making sure there’s enough leeway in the system to have at least three or five years of buffer to sustain that attack. Huawei did not survive by making trailblazing breakthroughs in 5G in chips. Huawei literally found a get-around, Huawei developed a software system to get around hardware restrictions. Huawei developed those chiplets quite literally by stacking inferior chips together to achieve roughly the same thing as those high-speed chips can do. I think that’s what China has gotten really good at. For most of the business and industrial organizations, top technology is actually not necessary. You just need to find something that works and execute that really well. I think that’s what China’s focusing on.
Kaiser: Chang-Tai, how would you describe it? You talked about this period of readjustment that we’re in right now. What’s the end goal of that readjustment? What is the imagined end state post-readjustment?
Chang-Tai: I’m going to get to your question, but let me just say that I think there’s something else there. And I was asked this question, but I’m going to ask the question to the other people on the panel because I don’t have an answer. There also just seems to be something more than resilience. I don’t know what it is about this view that certain things, that certain products or certain technologies are the ones that are valid, and other things are invalid. Maybe a example is that there is that semiconductor chips are a real thing, and it’s something that China needs to be, and it’d be great if China were good at making semiconductor chips, but coming up with a software, the very best software in the world to design semiconductor chips, that’s not a real thing.
Kaiser: I’m not sure that they would classify that as not a real thing. The things that they think are not real things are creating complex financial, derivative-based products, doing social media. They don’t want their best and brightest being steered into, like in the United States, they want their physicists to graduate from Tsinghua and freaking do physics. They don’t want them to go work for a social media company or go work for a bank to design speculative products.
Chang-Tai: I mean, for some products, you can say that they’re negative externalities, right? They’re negative. But why is a chip company or the revenues from a chip company more valid than the revenue of Alibaba right? But there’s a very clear sense in which one company is really valuable and the other company is less so.
Kaiser: Because they want to be Germany.
Chang-Tai: But why?
Kaiser: Because they really, honestly believe, and this is something…
Chang-Tai: No, no, no, but I-
Kaiser: I get into this in this documentary.
Damien: Because software platforms, social media has social political ramifications, ultimately.
Kaiser: That’s only part-
Damien: I mean, that’s one factor. A chip is a chip. It doesn’t have that baggage.
Chang-Tai: No, but maybe, but even something like food delivery, software for food delivery, that has no political ramifications. But my sense is that if you ask them, they’re like, “Who cares if you come up with a better food delivery software?”
Kaiser: Well, I mean, you’re the one who introduced this phrase earlier in the conversation — grasp the heavy, let go of the light. This is exactly what they believe they’re doing right now. That’s what they believe in themselves. What was the phrase, though? Arthur Kroeber, a great talk, you should check out. He says, “China wants to be a Leninist Germany.”
Lizzi: Leninistic Germany.
Chang-Tai: I think that’s exactly the right phrase, but let me just ask the question is that… Let me just pull two companies. Nvidia is one, right? That is one. It’s the leading…
Kaiser: GPU maker, yeah.
Chang-Tai: Chip company in the U.S. For those of you who know Nvidia, Nvidia makes nothing, right? It just designs chips. It’s just incredibly good at chip design. They also are really good at doing the software for AI, but it makes nothing. So, think about Nvidia versus Taiwan semiconductors. Which Taiwan semiconductor, what they know how to do really well is to actually make it, right? I guess for my vantage point, as an economist, I think both of these things are incredibly valuable. How valuable they are, well, it’s what people are willing to pay for these sorts of things. But the leaders of the Party, I think they think about it differently and I don’t fully understand why.
Let me just say that there’s one thing there, right? There’s one thing, or like, so say, software to tutor kids, clearly, that’s of no value, but why not, right? I mean, kids learn and…
Kaiser: Well, in this case, they believe clearly that this creates social problems by inequity just by the inequality of opportunity, right? That’s in this case, I don’t think that they would look at one part of the value chain and another part of the value chain in something like semiconductors and say, “This part isn’t important and this part is.” I think that when it comes to semiconductors, though, they do believe that the manufacturing process is absolutely vital and that they should focus on never stopping manufacturing because they really buy into this idea that process knowledge, that the actual innovative advantage conferred by continuing to manufacture is very real.
Damien: I think another fact is just China has basically converged with the West on software on the app economy. I mean, China frankly makes some of the best apps in the world already, right? So, the gaps where they feel they’re still deficient are in a lot of these hardware segments.
Kaiser: We could go on with this one for a while, but I want to get back into a really cheery topic, which is local debt. Damien, MacroPolo recently put out an estimate that there’s about $5 trillion of local debt that’s at risk in the next three, oh, default in the next three years.
Damien: Potentially, yes.
Kaiser: Let’s just put that in perspective. What was 2023? The projected GDP is $19.4 trillion. So, we’re talking about north of 20%, of 25%.
Damien: Well, but remember, but the debt to GDP ratio, it’s always higher, right?
Kaiser: It’s always higher. Right.
But I want to ask Chang-Tai, what does an actual debt crisis look like in China? What are the ramifications? What are the spillovers? I mean, if you are a money manager and you’re looking at China, where do you steer away from? Where do you think you want to limit your exposure in China where we start seeing massive default of local government debt?
Chang-Tai: Let me just firstly give a direct answer to, it’s clearly the property sector. But in the property sector, there could be some part of the financial institutions. If you think where a lot of the action is taking place, it’s really in the combination of these local financing vehicles and shadow banking. Some of these, we have data, a lot of these we don’t. So, there’s a bunch of it. But let me just push back on that. I don’t think that really is the biggest issue. I think the biggest issue is what Lizzi was talking about, which is this view that things have changed in China. And I want to hone in on one thing, so let me put it this way. One way I have thought about China for a long time is that despite the fact that there are no formal property rights, there was this very clear sense about what the rules of the game were.
That is, if I’m an entrepreneur, I don’t engage in politics. If they want to make me a member of the local National Party’s Congress, I will do it, of course. But if I don’t engage in politics, I will be left alone. Although there’s nothing formal about it. My property rights are going to be protected. I can grow, I can make money, I can accumulate my wealth. I think of it almost like this marriage. If I think about what a good marriage is, it’s about, there are clear expectations on both sides about what proper behaviors — Nothing is written down, right? There’s no prenup. After the fact, I think what happened last year may have shattered that contract.
Things that I thought only happened to dissidents, things that only happened to somebody like Jack Ma, I didn’t think about it then, but maybe this sense of what happened in 2022 is that, hey, the Party can actually be really crazy, the Party can actually do really crazy stuff. And this crazy stuff can happen to me, even if I’ve done nothing. That may be part of it. I don’t quite know how to quantify it. I’m curious to know your views on how much is going on, but I think of it as the breakdown of a marriage – ‘These were the things that I believed about you, and now I don’t believe in it’.
Kaiser: You and Lizzi are apparently on the same wavelength because recently she was on our sister podcast, The China Global South Podcast, talking about this, the same sort of breakdown of the informal, the contract.
Chang-Tai: The contract. Right.
Kaiser: Interesting. We only have a few minutes left. I really want to focus on one final big question. I’ll start with Damien. What should U.S. policy do? We seem to be all indulging in a kind of schadenfreude, looking at China’s travails economically and almost gloating over it. But China is deeply interconnected. It could bring our house down as well. It could impact us negatively. What is wise American policy when it comes to China right now in terms of supporting or helping along its economic troubles? What should we be doing? Should we be rooting for China, or should we be rooting for the forces that reset China?
Damien: Well, look, the U.S. and China are still 40% of the global economy. You look at what’s going on at a macro level, Europe’s not doing so hot. Germany, France, not doing so hot. It could enter a recession. In The United States, that debate is still outstanding, whether in a few quarters, we might still see some recessionary characteristics.
Kaiser: Please not before November.
Damien: And the Chinese, even if they stimulate, they’re probably not going to get too much above 5% this year, which is fine, but not great. So if we’re thinking about global economic stability, there’s no reason why the U.S. and China should think about how to provide the anchor as 40% of the global GDP, which they did try to do back in 2008 and 2009.
Kaiser: That’s right.
Damien: I think this is a time that’s going to be needed more than ever, the geopolitical volatility aside
Kaiser: Can you imagine China having a major financial crisis that threatens to bleed into the global economy and the U.S. stepping up in the way that China did in 2008?
Damien: Well, I don’t think the nature of the crisis is going to be that sort of a global contagion like that because it’s not going to come from the formal financial sector. It’s mostly going to be a domestic debt crisis. But a China that grows below its potential is not a good thing when the world needs growth. And I think markets, investors are going to be looking for growth. And if all the big three pillars, the EU, the United States, and China, their trifecta are all kind of anemic, that’s not a good outcome for the global economy.
Kaiser: Absolutely. Lizzi, what are your thoughts on this? And then I’ll leave for Chang-Tai at the end.
Lizzi: Right. I’m going to answer a slightly different question of what doesn’t work for the United States. I think by making China look bad, by making China do bad, that clearly does nothing for the United States to strengthen itself. And I see a lot of deflections, reflections in the media when it comes to China from policymakers. I do think the United States needs to think harder about what its own strength is and what its own course is. Ultimately, the United States can only become stronger by becoming stronger. It won’t become stronger by making China look like a bully, making China look weak. I don’t want it to go like a full therapist on this, but I think there’s a lot of soul-searching for the United States to do, and it has nothing to do with what China looks like in the future.
Kaiser: Run faster, goddammit, and stop trying to trip the other guy.
Lizzi: Right.
Chang-Tai: I don’t think that’s completely right. Let me try to articulate what I think the U.S. is struggling with for a long time. I think that we have all believed, and it’s true, of course, that everybody gains from trade and investment. If China grows, the U.S. gains. If the U.S. grows, China gains. I don’t think there’s any doubt about that. What the U.S. is struggling with is the question of suppose that, or let me put it this way. I will give an analogy. Suppose that there’s a powerful CEO, right? The owner of a company that you know, or that you believe is a racist. If that person is poor and they’re a racist, it doesn’t matter because they have no money, right? The question is, what if this person is worth a trillion dollars and this person… It’s not a problem if this person just wants to buy a fancy yacht with…
Kaiser: And now we’re talking about Elon Musk.
Chang-Tai: Yeah. No, that’s a question. Suppose that Elon Musk is going to do stuff that you fundamentally disagree with, and he can do it if he has money, right? The question is, what are you going to do? You are going to lose if you don’t buy that Tesla, right? You love that Tesla, but you buy that Tesla, and that person starts to do stuff that you fundamentally disagree with. I think that is the tension. That is what the U.S. is really struggling with. And it’s a spiral that’s going on, which is this fear in the U.S. on what are you going to do with your economic power, right? Then on the other side, on the Chinese side, there’s this widespread belief that the goal of the U.S. is to destroy China, right?
And this speaks to the question about, oh, China faces a hostile environment, so we got to build resilience. You can see how these two views of the world easily reinforce each other. And you could start off with a situation where China has no intention towards the rest of the world. That Elon Musk is really a nice guy, but then you start to do stuff towards him, and Elon Musk feels threatened, then they start to do so. I think that is the spiral that we are on. And that could get both sides to do things that they originally did not want to do. So, what should U.S. policy be? I don’t know. I think that that’s a very dangerous spiral that we are on now.
Damien: Convergence on capabilities, divergence on values.
Kaiser: Yeah. We should all go home tonight and ponder deeply the question of whether China is Elon Musk or Bill Gates, and that will shape our… Or somebody even who’s not George Soros.
Chang-Tai: But it’s endogenous. That’s part of what I’m saying is that whether somebody becomes Elon Musk or Bill Gates is endogenous.
Kaiser: Right. I don’t think it’s entirely. I think that the way that we treat that person also determines how-
Chang-Tai: Of course.
Kaiser: Not entirely an endogenous question. Alright, folks, thank you so much for coming and for joining us in this great conversation. Damien Ma, Chang-Tai Hsieh, and, of course, Lizzi Lee. All right.
