For decades, China’s economy was driven by debt-fueled construction of housing and infrastructure.
But once the housing market collapsed in 2021, China needed to find a new growth model.
The key parts of that new model are well known:
Industrial upgrading
Aggressive export growth
Technological innovation
What’s less well understood is how these parts fit together, and how the new model might transform China in the coming decade – assuming it all works.
For the past 18 months, Trivium Co-founder Andrew Polk and Dinny McMahon, Head of Markets Research, have been working on a research project focused on understanding what type of economy Beijing is trying to build over the next decade, and how those efforts will be shaped by the challenges of high debt levels, a souring demographic profile, and the shifting forces of deglobalization.
CSIS published that report – China’s Economic Transition: Debt, Demography, Deglobalization, and Scenarios for 2035 – at the beginning of September.
In this podcast, the gents draw upon that research to explain what Beijing wants from its new growth model, how it’s supposed to work, and how we might be able to tell if it’s working.
Transcript below:
Andrew Polk:
Hi, everybody, and welcome to the latest edition of the Trivium China Podcast, a proud member of the Sinica Podcast Network. I’m your host, Trivium Cofounder – Andrew Polk. And I am joined once again today, two weeks in a row, by Trivium’s Head of China Markets Research, Dinny McMahon. Dinny, good to see you again, brother. How are you doing, man?
Dinny McMahon:
Good, mate. But you’re going to be getting sick of me.
Andrew:
Oh, I think everybody’s long sick of you. So, that ship has sailed. I was just saying to Dinny, recording earlier today, that I keep getting a bunch of feedback on the podcast, which we really appreciate, so please keep it coming, but it’s all about Dinny — “We love Dinny. Give us more Dinny.” And so this is apparently what the people want, man. So, here we are. We’re keeping it loose today. He’s embarrassed. He doesn’t know how to take it. That’s okay.
Dinny:
I know. I mean, I think we set the bar a little bit too high for today’s podcast.
Andrew:
Yeah. Well, the reason I have Denny here today is we are going to take a step back and talk kind of high level about China’s evolving economic sort of development model, the kind of growth model it’s looking to pursue, which has really been in flux in the past few years. And I think there’s a lot of confusion outside of China around what’s happening, what the Chinese are trying to do. We have spent the past year and a half researching this exact idea on the model Beijing’s trying to pursue, what they want the next ten years of growth to look like in an ideal world, and kind of the scenarios, as we see it, around whether or not they will achieve this new growth model. We put that out as a big report through CSIS — a think tank that we’re affiliated with — just a few weeks ago.
We’ll be doing a podcast with them soon. But we wanted to take a dedicated pod and talk through some of that research. Dinny’s really been driving that for us. So, today, we are going to get into that evolving economic model that Beijing is trying to pursue. But before we do, of course, I think everybody can already tell our vibe is pretty loose today. But Dinny, customary vibe check — how’s your vibe today?
Dinny:
I’m doing good, mate. I mean, we’re having a bit of an Indian summer here in Chicago, so I think you get to this time of year in Chicago and you almost appreciate the weather more than you do even at the beginning of summer because you know we don’t have that much more left of it. So, every warm day beyond the end of August is a blessing.
Andrew:
Yeah. Well, I am coming to this with some good energy as well. I’m heading off to Texas tomorrow morning to see the old college pals going. Just going to go out to the lake for a few days and just hang out and relax. So, looking forward to getting that going. I guess summer is pretty much officially over, but I guess not in Texas. It’s still very warm in Texas. So, this is kind of the last trip for a while before I settle in for the fall. And so, hopefully, we’ll come back from that relaxed and refreshed and ready to talk more about China’s economy and Chinese policy and all that stuff. So, that’s the vibe for today. Hopefully, people are ready for that relaxed vibe to talk about China’s new economic development model. But before we get into the meat, of course, we also have to go through the housekeeping up top. First thing, quick reminder, we are not just a podcast here. Trivium China is a strategic advisory firm that helps businesses and investors navigate the China policy landscape.
That, of course, includes domestic policy around a range of industries and issue areas, net zero transition out of sector, tech sector, arterials and commodities, and things like that, but also includes policy towards China out of Western capitals like D.C., London, Brussels, and others. So, if you need any help on any of that, please reach out to us at hq@triviumchina.com. That’s hq@triviumchina.com. We’d love to have a conversation about how we can support your business or your fund. Otherwise, as always, if you’re interested in more Trivium content, check out our website, triviumchina.com, where we’ve got a bunch of various subscription options for your China policy intelligence needs. We got free stuff. We got paid stuff. Stuff for investors, institutional investors, people who need to stay on top of the tech policy landscape. Check that out. You’ll definitely find what you need.
And then, finally, again, the reminder that I’ve been increasingly trying to make a point of please tell friends and colleagues about Trivium, both about the business and the podcast. Want to continue growing our reach here and growing the business so that we can continue to bring you some great free content. All right. Dinny, with that, let’s go ahead and get into it, man. We’ve talked a lot on the podcast about how and why China isn’t pursuing consumption-led growth. We’ve had several podcasts on that over the past few months. But what we haven’t really discussed is this other idea of what Beijing really is trying to do with its economic model. China obviously needs a new growth model. The old debt-fueled housing construction model died in 2021 when the housing market topped out and the realignment of the housing market began.
And in fact, when it did die in 2021, it was already well past its use by date. So, it was time for something new. That said, it’s pretty easy to see some of the constituent parts here of the growth model. That, of course, includes leaning on export growth, fixation with innovation among top Party leaders, and a focus on industrial upgrading. But all of that kind of, when you look at those pieces, feels a bit ad hoc. But all of these things, in our view, tie into what is actually a broader strategy. And as I said, Dinny and I have been working on kind of teasing out the strategy over the past 18 months or so, and we published our report through CSIS.
Again, we’ll put a link in the show notes. And the report in this podcast, we’ll look at what type of economy Beijing is trying to build out to 2035, and the challenges standing in the way of achieving that growth model and building that economy. So, we’re going to talk about all that today using the report as a jumping-off point. And I’m going to just start by throwing it over to you, Dinny. Where should we start when we’re thinking about how the growth model is evolving and what Beijing’s trying to achieve?
Dinny:
Well, before we actually talk about the actual model, we kind of need to understand what Beijing wants out of it, which, in some ways, I mean, it represents a fairly radical shift from Beijing that they have specific aims or specific things they want to achieve from the growth model. Because, traditionally, all that really mattered to China was growth. I mean, growth was what they wanted to deliver. It wasn’t necessarily important how it was delivered — through debt or exports or property or whatever. The goal was to generate initially rapid growth and then moderately rapid growth. You know, 10%, down to 8%, down to 6%. And that was the goal in and of itself. But that’s really changed over the last few years, which is why we have Xi Jinping always talking about the need to deliver high-quality growth, which then begs the question, okay, well, what exactly is high-quality growth?
And that gets us to this question of, okay, what do they want out of a growth model? Because that then can lead us on to understanding why the new model that they’ve settled on kind of looks the way that it does. And I think there’s kind of four key things that they want the new growth model to do. And the first is that they need a model of growth that will allow them to deal with a shrinking and rapidly aging population because that sort of changing demographics means two things. So, firstly, a shrinking population means fewer consumers. So, all things being equal, it means domestic demand is going to decline if it hasn’t already started declining already.
And then secondly, it means, as the population ages, not only will that further contribute to weak demand because retirees just spend less than they do during their peak earning years, but it also means that more retirees, more people over the age of 65, over the age of 70, it means that you’re going to have a greater fiscal burden on the state through both pensions and health care costs. So, up front, China needs a growth model that will allow state tax revenue to rise so that Beijing has the resources to take care of the aging population. But at the same time, what they also need is for household incomes to go up sufficiently so that people are better off, so that they’re able to consume more even though they’re contributing more of their wealth to the state in taxation.
If you kind of get your head around that, they’re both able to spend more, and they’re able to pay the government more in taxation at the same time. So, everyone’s a winner. Households are better off. Plus, the state has the financial resources to take care of an aging population. So, ultimately, that is kind of what they need from a growth model with respect to population. The second thing they’re trying to achieve here, and it kind of gels with the first, is common prosperity. Yeah, common prosperity is still very much a priority of the state. And it’s important to note here that achieving common prosperity has never really been about state-led wealth redistribution, although that’s kind of an aspect of it.
First and foremost, it’s always been about generating higher incomes and non-wage income, and ensuring that that is better distributed through the economy. So, what Beijing wants is a growth model that is capable of generating higher salaries and bonuses, but it’s also capable of delivering corporate dividends and rising stock prices. And yes, there’s an element of welfare here as well. But again, it’s dependent on a tax system being able to pay for it. Then there are two more pieces. I said there’s kind of four components to sort of what they’re aiming to achieve from a growth model. And then the last two pieces are debt and the middle-income trap.
So, the middle-income trap is this economic concept that countries develop up to the level of middle income, which is kind of where China is today, and then the economic trajectory stalls out, and they never make that last leap to being an advanced economy. It was the World Bank that kind of came up with this concept, and they found that since 1960, only about 13 countries, places like, I think, Iceland, South Korea, they managed to make the leap. And China is keenly aware of the trap and genuinely believes that it exists and that they face the risk of falling into it, and they see the solution to avoiding it in changing the structure of their economy. So, their understanding in Beijing is that developing economies produce unsophisticated manufactured goods and usually produce those goods with somebody else’s technology, whereas advanced economies have their own tech, and they produce more technically advanced goods, which then allows them to charge more for what they produce, thereby putting them into a high-income category.
So, that’s the third thing. That’s what they need from a growth model, something that will allow them to avoid the middle-income trap and into the ranks of advanced economies. And then the fourth thing, as I mentioned, was debt. Beijing doesn’t want a debt-led growth model. That’s what it used to have with the debt-fueled housing investment model and infrastructure construction model that they’ve had for the last 20 years. And that’s what they’ve had, and they’ve been left with a mountain of debt that they are going to struggle to pay down. So, what they want is a growth model where the debt is used productively, which effectively means that the debt pays for itself. You invest it, the investment generates the income to repay the interest and perhaps, ultimately, the principal, which is something the infrastructure model really has not done.
So, that’s all the more important because of the aging population. Regardless of the growth model, at some point in the not-so-distant future, Beijing is really going to have to borrow more to take care of its aging population. That’s all but unavoidable. But when it does that, it would like to be able to do so without already sort of pushing up against the limits of how much debt the economy can sustain. And so, ideally, it wants to be able to reduce the current debt burden, to create some space for when that debt level will inevitably have to rise again. And that again comes down to the debt model. They want a model that A, any deployment of debt will effectively pay for itself. And secondly, it will generate sufficient growth such that the debt-to-GDP ratio will gradually come down.
Andrew:
Thanks for laying all that out. That all makes sense. Just a couple of reactions quickly, and then we’ll get to my next question. But I just want to sort of emphasize one thing that you said, which is this idea that more advanced economies have stronger technologies. And I’ve said this on the pod, I say it all the time, but I think it’s really a point that is fundamental to Xi Jinping’s thinking about economic growth and economic development in particular, is he has said explicitly the strongest economies are not the ones that grow the fastest. They’re the ones with the best technology. I think the reason I keep coming back to that point is I think it is fundamental in understanding how Xi Jinping is sort of trying to reorganize things and what his priorities are.
And so this kind of pursuit of cutting-edge technologies being sort of the top priority can help us understand the types of policy decisions that are often made in Beijing. And that’s very different than how things were in the past. You talked a little bit about how they moved from this growth model that was simply about getting as much growth you could, the highest growth rate you possibly could. A rising tide lifts all boats kind of mentality to, okay, now it really matters how you grow, and technology should be at the center of that. So, that’s just one kind of thing I was thinking as you were laying this out. The other thing that I just wanted to point out, which is something that we use as a departure sort of framework in the report, and you touched on different elements of this, but we’ve used the framework of the 3Ds, which are debt, demographics, and deglobalization.
And I think another reason, maybe, to kind of focus on those is each one of those drivers is going to require resources, right? Dealing with legacy debt requires resources. Dealing with the demographic slowdown is going to require resources. And dealing with a more complicated world that’s more technologically deglobalized is also going to require resources. Also, another reason that the growth model needs to change is China is at this place where they are resource-constrained, and they’re going to have to decide which of those 3D’s at any given time are going to garner or receive the most state resources. Right? And so a lot of this is about, you know, when we get to the points about what they’re trying to do and whether or not they’re being successful, a lot of this comes down to policy choices and resource constraints around those 3Ds. So, that’s just kind of a little bit more context to hopefully add to that framework that you laid out.
But whether it’s the threads or the four elements of the types of growth that they’re trying to pursue that you just laid out, I mean, these are big, complicated wish lists, and many of them seem unrelated. So, can you give us a little bit more sort of concrete thinking around how all these disparate elements, especially the four things you laid out, come together in a coherent growth model, at least in the minds of Chinese policymakers?
Dinny:
Yeah, absolutely. Well, the starting point of the new growth model, the absolute non-negotiable which they need, is that they need a growth model that can do two things — can generate higher-paying jobs and it can create an economy capable of generating significant higher levels of taxation. But when we say higher wages, this isn’t just a case of getting state-owned enterprises to increase salaries, right? Because that isn’t a growth model. That’s just like a one-off transfer of wealth. And the same thing goes for Texas. For sure, you can say Beijing needs more tax revenue, and we talked about this in great detail just last week on the podcast. Beijing needs more tax revenue? Great, just raise taxes, raise the VAT rate, raise the threshold for income tax.
That’s not really the point here. Again, that’s just a one-off transfer. What they need is a growth model that can allow wages to rise consistently for tax revenue to expand consistently without being an additional burden on the economy. And in a way, particularly when it comes to wages, in a way, that household wealth will expand. And it’s not just about expanding to keep up with prices. The only way, only real mechanism that’s going to allow that to happen is by raising productivity. And that’s what China did with urbanization, right? That’s kind of what drove the economy for years because you had this mass migration of people moving from the agricultural sector into factory jobs. But, of course, those old factory jobs, they’re just not as price-competitive in China anymore.
If you’re just relying on cheap labor, it makes far more sense to make clothes and toys and all those products that once kind of dominated the majority of manufacturing in China makes far more sense to move them to Vietnam or Bangladesh or other developing countries. So, we’re now at a position where the old kind of way that China drove productivity, just purely by urbanization, moving people from the countryside to the cities, that’s no longer feasible. So, you need something else that does it. Now, I don’t want to get bogged down into definitions of productivity because economists tend to be quite precise in the way that they define it and it can get a little bit complicated.
But the key point here is less about what it is, and it’s more about what higher productivity can do for a firm or do for an economy. And, specifically, what China is trying to achieve here is by generating the productivity gains, it wants to be able to either reduce firms’ costs or allow firms to charge more than their competitors. Either way, it’s creating companies that are capable of paying higher wages, either because their costs have gone down or their revenues have gone up. And, ultimately, the goal here is to create more profitable companies that can ultimately then pay more out in taxes. And that’s ultimately the promised land here, right? That’s how they deal with an aging population, and that’s how they deliver common prosperity.
They create an economy of more profitable companies that are paying higher wages and are paying out more in taxes. And, moreover, they’re also paying out more in dividends. And, ideally, because they’re more profitable, their share prices are going up as well, thereby ideally creating an engine of middle-class wealth that can replace the property sector. And between the taxes, more taxes the state’s bringing in from profitable firms and from taxing more affluent households, the government then has the fiscal resources to spend more on welfare, which, again, in an earlier podcast, we talked about. They’d love to be able to spend more on welfare, but they’re not willing to do it out of debt. They can only do it if they’ve got the fiscal resources to be able to pay for it. And so, all of that, that sort of ideal vision of what the economy looks like, all of that can only come from sustained productivity gains.
Andrew:
Well, and you said, you know, we won’t bother too much with the definition of productivity, but I will spend, as an economist or a recovering economist now, someone who runs a business, but I can’t not touch on it a little bit.
Dinny:
I was actually hoping you’d weigh in on this one because I hate talking about productivity. I think you’re much better at this than I am.
Andrew:
Well, I was actually thinking, it seems like your definition of productivity is sort of the pornography definition of productivity. I don’t know exactly what it is, but I know when I see it. Anyway, I just wanted to touch on it for a second, which is everything you described kind of in economic theory is largely around this idea of catch-up growth, right? When an economy is at a lower level of income, lower level of GDP, it’s easier to grow quickly because there’s sort of some low-hanging fruit. Moving people from agriculture, from rural areas into cities sort of automatically gets you productivity gains because those people are going from relatively low industries like agriculture to, by definition, higher productivity industries like manufacturing and industry.
Also, part of that catch-up growth that is commensurate with sort of the low-hanging fruit productivity gains is bringing technology from abroad, right? Like, moving up what they call the technology frontier, right? Or moving towards the outer edge of the technology frontier, where you engage foreign companies often that have the advanced technology, they bring that technology to their processes in your country, and you very quickly improve whole industries at a time, whether that be overall manufacturing or the auto sector specifically, or steel processing or whatever. You are able to quickly learn from the global best technologies, global best practices, and boost productivity kind of economy-wide that way.
The challenge, once you have realized a lot of this sort of easier productivity gains, and you are closer as an economy to the technology frontier, is that productivity then has to really be focused at a firm level. And this is a lot of work we used to do when I was at The Conference Board. The Conference Board does long-term economic forecasts for global economy, most of the major economies in the world, and very much focused on the productivity piece. Firm level innovation is very difficult because it literally requires individual firms to continually be improving their processes and eking out internal technology gains, efficiency gains that then aggregate up firm by firm into overall productivity improvements for the economy.
And that’s something that an economy like the U.S., for example, has been very good at for many, many years, as U.S. companies are highly productive, highly innovated, continuing to become more and more efficient. Chinese companies are now having to do this in a new way, in a very competitive environment. I think we can see that many Chinese companies, BYD, CATL, many in the solar industries do have some of the best technology and are very competitive and are increasing their own innovation. But this has to be sort of widely spread through a bunch of different companies throughout an entire economy to really aggregate up to ongoing productivity gains in the economy.
So, it really comes down to individual firms, which is kind of what you’re talking about, right? The idea that these firms need to be more innovative, more profitable. So, how does China plan to achieve that type of productivity at the firm level?
Dinny:
Well, firstly, they’ve very much focused on manufacturing, largely for all the reasons you just outlined there. And I mean, it’s far easier to deliver productivity gains consistently in manufacturing than it is in the services sector. And then, beyond that, within manufacturing, Beijing is razor-focused on two things. One on innovation and two on industrial upgrading. Now, this is a bit of a simplification, but the easiest way to think about it is that, on one hand, Beijing wants Chinese firms to become pioneers in new industries, and we’ve been seeing that already with electric vehicles.
We’ve seen it with batteries and the solar sector, which have really been the big three successes over the last few years. But Beijing has a long list of areas that it’s focusing on and has got supportive policies for, and is pumping a huge amount of resources into it for development and research. And there’s already a bunch of new industries which are kind of lining up to come next after the EVs and the batteries is kind of potential industries in which China can kind of become a world leader. And those are things like flying cars, like biotech, like robots.
And the idea being here that China will develop its own proprietary technology, which will allow Chinese firms to become world leaders, and that will put them in a position where they can charge a premium for their products. That they’ll be able to generate profits from these industries that they haven’t traditionally been able to make from their lower-end manufacturing businesses. So, that’s one hand. That’s the innovation side of the equation. On the other hand, it wants to keep old industries. And this is where the industrial upgrading comes in. Now, keeping old industries, I mean, this is in some ways completely at odds with the old model of economic development. Now, I still remember studying the flying geese model at university, whereby countries, as they became more industrial advanced, as they moved up the value-added chain, they’d shed low-end industries.
And those industries would effectively get passed from country to country as a way for countries to kind of get a foothold on the lower rungs of industrialization. And, as they became more advanced, they’d shed it and they’d sort of pass it on to the next nation that was slowly industrializing. Now, what China is effectively saying is that the wild geese model is now dead because China has no interest in shedding low-end industries because it wants to keep all of them. And a really good example of that is the cigarette lighter industry. Now, I forget when people first started making cigarette lighters, but originally that was done in Europe, and then in the 1970s, in the ’60s and ’70s, it moved to Japan and South Korea.
And then, in the ’90s, it moved to Guangdong Province in Zhejiang. And these days it’s centered in Hunan Province, and specifically one town called Shaodong.
And, currently, something like 70% of all lighters manufactured globally are made in that town. That Hunan town of Shaodong. Now, about a decade ago, the Shaodong lighter manufacturers were experiencing all the problems that you would expect of a industry in a place where incomes are rising and industry is moving up the value-added chain. The factories were having trouble finding workers and the salary bill was going up. And under normal circumstances, under the old model, you would expect that either these companies would move further into China’s hinterland, maybe out to the western provinces, or they’d leave China altogether to find somewhere else where labor was even cheaper.
But what happened instead is that China’s lighter manufacturers started upgrading their machinery, and they’ve gone through multiple rounds of industrial upgrading since 2014. So, to give you a sense of what’s actually happened, I think the biggest manufacturer is a company called Dongyi. And in 2014, it was making a million lighters annually with about 200 workers. And now it produces 5 million, with only 30 workers. And so what it did is it used to be a very finicky manufacturing process, where the workers were using pincers and tweezers with very small parts and components. And now, almost the entire process is automated with sensors, and the number of bad lighters or defective products has been reduced incredibly, and the cost of making a lighter has absolutely plunged to, I think, like a 10th of what it was, like 10% of what it was a decade ago.
And that is ultimately what China is trying to do. It’s trying to take old low-end industries and it’s trying to make them effectively high-end. And this, in some ways, this industrial upgrading kind of creates its own virtuous circle as well because, by applying new technologies, manufacturers, they cut their costs and they increase the quality, and they increase their profits. But then with these profits, they can fund another round of upgrading. You know, once upon a time, Chinese firms upgrading their machinery would have bought machines from Germany or from Japan. Increasingly, that machinery, that new iteration of technologies coming from Chinese firms. And so, you create the profits to buy to support more innovation in China and then that creates more profits downstream.
And that’s ultimately what they’re aiming for. And that’s why you’re seeing developments like this across a whole lot of industries. I’m sure everyone’s kind of read stories about the dark factories, particularly in the textile sector in China, you know, yarn-spinning factories, which once used to be a massively labor-intensive industry. Now you have factories that don’t require any lights because there’s nobody in the factory. You’ve got these massive factories where robots not only spin the yarn, but they collect the end product, they clean up any dust from the process. It’s temperature-controlled. And you’ve radically changed the nature of the business by adding technology and taking people away.
And so, those are the kind of the two ends of what China’s trying to do. It’s trying to move into new businesses that barely exist at the moment and kind of establish China as a world leader through its own proprietary technology. And then, at the other end of the scale, it’s trying to maintain and hold on to old industries by making them less labor-intensive and applying new technologies, which further support this drive for an investment in innovation.
Andrew:
Few kind of reactions there. really interesting stuff. The first would be we’ve talked about this in, again, another pod, specifically with Kendra when it comes to the AI race and China’s approach to AI. This older industry industrial upgrading idea is very much a big part of why China is focused on real-world applications of AI, what it calls AI+, whereas the U.S., in cutting edge AI firms in the U.S., are mostly focused on the idea of overall artificial general intelligence and kind of that big sort of moonshot idea that could unlock all kinds of various new technologies and processes. China’s more, at least from a policy standpoint from all the policy documents we read, focused on how can we use AI in the real world now for better efficiency gains in manufacturing and industry?
And so, I think that’s really important in terms of understanding China’s overall approach to AI and how that really differs from the U.S. approach to it. The other thing which we won’t necessarily get into at all today, I don’t think, but just as you’re saying that about how China wants to keep the old industries and make them more efficient and not have them moved to other developing countries, is all of this, if China can pull it off, seems like not necessarily great for manufacturing in the rest of the world, right? For manufacturing industries in other countries. Because China just wants to dominate and go from strength to strength in the legacy industries and in the new manufacturing industry.
So, maybe that’s something we can touch on another pod. But if they’re super successful, what does this mean for the rest of the world? Either way, we can leave that point for now. I want to come back to if they can do all this, the question is, how does all this ultimately lead to wage increases in the aggregate for the population? So, obviously, as companies become more profitable, some people are going to get paid more. For example, like a purple-collar engineer or technician is going to get paid a lot more than a blue-collar production line worker.
But if things work as you described it, we’re going to have a whole lot of blue-collar workers being replaced, by far, fewer, more skilled so-called purple-collar workers. So, that doesn’t necessarily feed into the overall population having wage increases. What’s your take on that sort of dynamic?
Dinny:
No, it’s a good observation, but I think the thing that’s easy to miss is that this doubling down on manufacturing, it isn’t a blue-collar revolution. I mean, it’s going to create a lot of purple-collar jobs, as you pointed out. But even then, that’s not really what is driving wage growth here. At the end of the day, what it should look like, and I think what Beijing is hoping for, is that this is going to create a whole lot of white-collar jobs. And I know that’s not immediately intuitive, but if you look at the low-end manufacturing, it does create a whole lot of supporting service sector jobs. But they typically be sort of things like warehouse jobs or in transport. It doesn’t create a lot of white-collar jobs.
And similarly, being an original equipment manufacturer, an OEM, which has been a huge part of China’s traditional manufacturing and evolution, where Chinese firms produce manufactured goods on behalf of foreign brands, similarly, that doesn’t create a lot of white-collar jobs because all the white-collar stuff is where the brands are — mostly overseas. But when you produce your own products with your own brand, and particularly when you’re marketing your own technology, you create a need for not only engineers and designers and PhDs to do R&D, but you also need salespeople, you need marketers, you need lawyers to protect your intellectual property and acquire intellectual property. You need finance professionals to help you expand or to acquire other firms.
And then, of course, as you’re getting bigger, you require HR, you invariably end up with more middle managers. I mean, that is kind of what I think the future ultimately looks like in terms of job creation around this model. I just read the other day that you take an auto manufacturer like Volvo, I mean, ultimately, it’s a manufacturer, right? It makes cars, but 40% of its employees are white-collar. So, for China to move into producing a lot more of its own brands, developing a lot more of its technology, not sort of producing stuff either at the low end or on behalf of a foreign firm, it creates a whole lot of opportunities for white-collar professional service jobs. And so, yeah, Chinese companies are going to become a lot more automated, which is going to reduce the number of sort of blue-collar production line workers. But a very large share of their staff will be white-collar professionals. And I think that’s where the higher paying jobs ultimately are going to come from.
And I think, ultimately, that is perhaps the ideal solution for China’s youth unemployment problems as well. I know we’re kind of at a place at the moment where everyone’s like, “Oh, you know, maybe we push Alibaba to hire more young people, or we kind of try and create busywork,” or whatever. But, I mean, none of that’s really a solution. The only real solution is either you push them into, the next wave of university graduates, into job areas where there’s a more pressing job, I mean, already waiting. And there’s a lot of talk at the moment that the Chinese university needs to be churning out more purple-collar technicians and professionals. But assuming this transitional transformation sort of takes place, everything goes according to plan, then you will ultimately create the white collar jobs for China’s unemployed university graduates. Assuming all of this kind of comes together.
Andrew:
Well, so I know you’re talking about sort of how white-collar jobs, or more white-collar jobs, are sort of part of the ultimate outcome of all of this, but it’s still an incredibly manufacturing-centric model, a manufacturing-centric development path that they are trying to pursue. And the challenge, I mean, it kind of goes back to what I just said earlier about what it means kind of for the rest of the world, you’ve got China not only trying to dominate new markets, but trying to keep the old ones and make them more efficient so that those manufacturing industries don’t spread out the rest of the developing world.
The question is, if China’s making all this stuff, who’s going to buy it? I mean, I understand that the idea, to some extent, is that to boost productivity so that people make more money, so incomes go up so that they can spend more. But at China’s current level of development, households typically spend sort of less on physical goods and more and more on services. We’re already even seeing that in China, consumer spending on services is growing about 1.5 percentage points faster than retail spending on goods. So, again, back to the question, who buys all this stuff, Dinny?
Dinny:
Yeah. Well, at the end of the day, for this to work, it needs to be exported, which is kind of wild given that China is already such a monstrously large exporter of manufactured goods. The UNIDO, which is the United Nations Industrial Development Organization, put some numbers around this a few years ago, I think, last year — they calculated that in 2023, China accounted for 27% of all industrial production globally. Now, already at that level, that makes China so dominant that the only other times that any other country has really been sort of in the ballpark was, firstly, the United States immediately after the Second World War, which had a high percentage, and the UK during the 19th century. But UNIDO estimates that, given current trends on the trajectory China currently is on, it could account for 45% of all industrial production globally by 2030.
I mean, that’s almost half of any industrial production produced anywhere would be Chinese within a space of five years. And, as I said, that’s wild. To hit that sort of level, that doesn’t just mean that China is ramping up, but it means that the rest of the world has to acquiesce to making less. Because it’s not just China is going to make more and more, and the rest of us will consume more and more of that. There’s going to be a reallocation or a redistribution of who’s making what. And for China to kind of hit that sort of level, it means that the rest of the world is going to be producing less. That all kind of assumes that we continue on the current trajectory. But as I said, I mean, this whole model is heavily dependent on China being able to produce more and more, and there is no way to make that work without exports rising.
Andrew:
Yeah, that’s an interesting one. I mean, it’s obviously like politically a nonstarter for other countries. There’s the question of, can China achieve this on its own anyway? And then there’s the question of, how are other countries going to react? Are they going to try to stop it? My guess would be yes. There’s already these huge trade tensions between the U.S. and China, and actually between China and a lot of different countries. I actually am willing to have the conversation and debate around how much manufacturing does the rest of the world need and how much manufacture does the U.S. need. It’s now become this like accepted wisdom that the U.S. needs more manufacturing, that we don’t make stuff anymore, and that’s bad.
I’m not sure I understand the arguments behind it, but I don’t take it as an article of faith. I wish we would have more of that discussion from a policy standpoint, and I would even go so far as to say, like in theory, it’s fine if China makes half the world’s goods, right? As long as markets are open and we can buy them. And I think where people get nervous about that is the vulnerabilities that are created in case of tensions between China and the rest of the world and in case of global supply shocks like we saw during the pandemic. But in theory, I’d actually also be willing to have that debate or conversation around, so what? Let China make a bunch of that stuff and the rest of the world can also be white-collar workers and help to sell Chinese manufactured goods. Basically, that other countries could continue to focus on services and experiences and travel and that kind of things.
Anyway, I don’t want to digress too far down that path, but it’s obviously bringing up a lot of big questions. But the next question for me now to you is, why are exports so important in terms of China’s approach here? I mean, basically, why is China also wanting to keep these low-end industries as well? Japan and South Korea both escaped the middle-income trap by pretty much doing the same thing that China is doing, focusing highly on manufacturing, moving up the value chain. But then they shed those lower value industries, which, of course, then went to China. And that’s not what China is trying to do. Those other countries obviously had big trade surpluses, but nothing near what we’re seeing in China. Now they’re committed to effectively what seems like ever-growing trade surpluses.
Why take that path? And then we can maybe talk about whether or not it’s going to work or what the rest of the world would do in response. But why is that so central to what Beijing’s trying to do?
Dinny:
Yeah, it’s a good question. I mean, why both move into new industries and keep the low end at the same time, right? I mean, isn’t the whole point of becoming a more advanced economy is like, how everyone else has ever done it, you move into the high end and then you leave the low end for somebody else? And I think it’s because there’s a couple of reasons for it, and I think it’s because China is on the clock. It doesn’t have a lot of time. I mean, there’s been this old adage that China runs the risk of growing old before it grows rich. We’re at that moment at the time. I mean, you look at the experience of South Korea and Japan. I mean, their economic transformations came over the space of a generation. And they came at times where the population was still rising. I mean, I think Japan’s population peaked in 2008. I mean, that was what? 18 years after the bubble burst, right? Japan had become a developed economy a generation earlier. I’m not sure, I think South Korea is already shrinking as well.
If it isn’t already, it’s about to start. It’s got an awful demographic profile as well. But it became a developed economy years ago, whereas China is attempting this transition to kind of move from being middle income to an advanced economy when the population is already shrinking. I mean, it started shrinking in 2022, which means already it’s up against it. It’s already looking at having a shrinking domestic demand. And so, it kind of needs to throw everything at it, at this problem now to become a rich country in time to be able to support the added financial costs that are going to come from having such a large percentage of retirees within, what? 25 years, 30 years? I mean, it’s coming down the turnpike incredibly quickly.
I think that’s it. This should have happened years ago if they were going to do it. And instead, you know, they persisted with the property-led growth model for such a long time. I mean, people have been talking about China growing old before they get rich for years, but now they can’t muddle through anymore. They’ve got to flip the switch if they want to be able to both become rich advanced economies, lift people’s lifestyles, and be able to have the financial resources to deal with a rapidly aging population within a very, very short period of time. So, I think that’s the first issue. And the second issue here is that to be able to deliver productivity gains across the board in such a large economy, well, you really need to be doing it in a whole host of industries.
So, take, for example, a place like Taiwan, which is relatively small, but it’s the global leader in the production of semiconductors. It’s got the global leader, which is supported by, what? Dozens, hundreds of suppliers, all of which they generate profits, they support a whole lot of high-paying technical jobs, creates a lot of tax revenue for the state. I mean, the semiconductor industry plays an outsized role in the Taiwanese economy and makes a huge contribution to the financial well-being of the island. But if you took that away, it’d be devastating. But if you transplanted it, wholesale to China, I mean, sure, one or two provinces would be significantly better off, but the contribution to China as a whole would be far smaller than the impact of that one industry would have to Taiwan as a whole.
Right? So, to put it another way, for China, it’s not enough simply to build a world-leading electric vehicle industry, and it’s not enough to have a world-leading electric vehicle industry and battery industry and solar sector. I mean, those are great, but they’re still not going to deliver the productivity gains that are going to be able to lift wages and generate taxation on the scale that China really needs. So, to transform the economy, you’re also going to need a flying car sector, and you’re going to need to be a world leader in humanoid robots. You see what I’m saying with this? It needs to be able to generate productivity across in so many different areas. And so one of the ways they want to be able to do that is by generating those gains in existing industries.
And I think that’s where they’re coming from. It’s because of the sheer scale of the transformation they’re aiming for, plus the fact they’re trying to achieve that in such a relatively short period of time means that they have to deliver those productivity gains in all the areas that they can feasibly do it. And, of course, that means both new industries and old industries, and hence the sort of the pressure on exports.
Andrew:
Yeah. I cannot escape, as you’re thinking, just the ongoing thought, man, if they can pull this off, what does it mean for the rest of the world? How does it reshape the global economy? I mean, China’s place in the global economy has evolved so much just in the past 20 years and reshaped global trade and financial flows. And, I mean, this would just do it and at the same magnitude, if not bigger, again over the next ten years. And so, like, yeah, that’s the question I’ll be pondering a lot, and I think one for Western policymakers to think through. The whole point of this conversation is to understand what China wants to do and then, hopefully, then policymakers at least can think, “Okay, well, what does that mean for how we should design U.S. policy, Europe policy, policy throughout Asia, etc.?”
But that will be an ongoing conversation. The question, additionally, that I want to ask now is how do we know, at any point in time, now or in the future, whether or not China’s achieving what it wants to achieve? Is the model working? Are they on the path towards the model? I mean, you just look at the economy now, and half of the economy looks really strong, right? So, export machine is humming along despite U.S. tariffs, and EVs are flying off the shelves. You know, amazing cars are being sold. All throughout the world, people can’t get enough of them. They have a lock on the global supply of rare earths. But then, domestically, you look at the economy, deflation is endemic, the housing market is going from bad to worse, government tax revenues are falling, consumer confidence and business confidence both remain weak. So, how do we judge whether or not Beijing’s pulling this thing off now or in the future?
Dinny:
Yeah, it’s a really good question. And I think the three things to look at are, one, corporate profits, two, tax revenue, and the third one is the debt-to-GDP ratio. And the model is not working at the moment because, despite all the innovation and industrial upgrading that’s been going on, that’s resulted in overcapacity. And the consequences of that are negligible corporate profits. I mean, some of the firms in some of these leading innovative industries aren’t generating profits at all. So, negligible corporate profits, additionally falling tax revenue, which we talked about last week on the podcast. And then, in addition to that, we’ve had rising debt-to-GDP ratio. And that’s largely led at the moment by the government, and that’s partly a consequence of the government needing to borrow more because tax revenue has been so weak.
So, yeah, the question is, can China break this cycle that it’s in at the moment? Can it rise profits, boost taxes, and rein in debt? Can it then engineer stock prices to continue rising as a slow bull? Can it ensure higher wages? Can it engineer a decline in youth unemployment because it creates a whole lot of white-collar jobs? I mean, I think these are the things that we’re going to be talking about for years to come. And I mean, anyone who’s been listening to the podcast knows we’ve been discussing a bunch of these topics already, like tax revenue, the slow bull market, how Beijing supporting exports. I mean, it all ties together. But yeah, the things to watch are corporate profits, tax revenue, and the debt-to-GDP ratio. And you look at those at the moment, and you can see, yeah, the model’s not quite coming together at the moment.
Andrew:
Yeah. The only exception I’d take to that last comment or the idea that it’s not coming together at the moment is I think we are in the early stages of this transition. Right?
Dinny:
Yeah, absolutely.
Andrew:
I mean, we’re not that far away from the peak of the housing market. They’re trying to fundamentally change the drivers of growth away from this, particularly property and debt-fueled infrastructure and property investment. And that’s going to be a messy process. And so far, the economy’s not imploding, as they make what is like an historical economic adjustment. So, I think you could also say, “Well, to some extent it is working because at least the economy’s still like in a pretty decent place in the very early stages of this transition.” Certainly, we’re not anywhere near where they want to be, but the economy could be in much worse shape, given how momentous of changes that we are seeing in terms of the growth model.
Dinny:
Now, it’s a good point, Andrew. I mean, let’s say the housing market bottoms out. Let’s say they manage to really manage to rein in either industrial overcapacity, which, by extension, then stops deflation, and government revenue starts going up. I mean, yeah, you know, if some of those things happen, then this model’s going to start looking a little bit more robust.
Andrew:
Well, and let’s just put a fine point on it. Do you think they can pull this off? Like, you said, “if, if, if,” do you think they can pull it off, and how do you handicap it? What are the key sticking points in your mind that will determine whether or not they’re able to make it happen?
Dinny:
I think the big thing is exports, but I mean, how they maintain exports, who gets screwed over, who is willing to accept more and more Chinese-manufactured goods, I mean, I think we can save that discussion for another time. I think we’ve been hard at this for an hour already. I think the big question is exports. But, I mean, we could do an entirely other podcast on that.
Andrew:
Yeah. Well, if that’s the case, as I’ve just said, like for policymakers in other countries, whether it’s the U.S. or Indonesia, I mean, I think the message is you ain’t seen nothing yet when it comes to the Chinese export machine. And if we have problems with it now, well, those are going away. And, if anything, they’re going to be much more exacerbated. So, thinking through the trade relationship with China, as we’re currently doing, is hugely, hugely important. And we have to get it right. I don’t know what the exact answer is, but it is something, as you say, we’ll be kind of mulling on, debating, discussing for many, many years to come. Thank you, Dinny, for laying all this out. I think it was really important to kind of pull all this together, these various threads we’ve been chasing. I thought that you did a great job of really kind of pulling that all together. And I hope my kind of interjections didn’t detour us too much from coalescing those ideas. I thought you did a great job. So, thanks for that.
Dinny:
Not at all, mate. They were very welcome.
Andrew:
Oh, no, stop it (laughs). All right. Thank you, buddy, and thanks, everybody, for listening. We will see you next time. Bye, everybody.
