Beijing just released its most detailed rebuttal yet to accusations from the West around industrial overcapacity – and it pointedly avoided using the very word that started the fight in the first place.
There’s a reason for that, and we break it all down in today’s podcast.
On this episode, Andrew Polk sits down with Dinny McMahon (Head of Markets Research) to unpack:
The five core arguments in MOFCOM’s new position paper on overcapacity, examining which ones hold up and which ones stretch too far
Why Beijing dropped the word “overcapacity” for “involution” 18 months ago, and what that rhetorical swap is designed to do
How China frames itself as both free trade’s champion and its victim, and why that framing leaves little room for compromise
Why the US may have the least at stake here economically, and why Europe is where this fight actually gets decided
As always, we hope you enjoy the discussion – reach out and let us know any thoughts or feedback.
Transcript
Andrew Polk: Hi, everybody. Welcome to the latest Trivium China Podcast, a proud member of the Sinica Podcast Network. I’m your host, Trivium Co-Founder, Andrew Polk. And today I’ve got with me Trivium’s Head of Markets Research, Dinny McMahon. Dinny, welcome back to the pod, man. How are you doing?
Dinny McMahon: Thanks, mate. I’m doing well.
Andrew: Good to have you on. I am having Dinny on today because we want to get into MOFCOM, the Ministry of Commerce’s official response to accusations of overcapacity from the West. This is the first time the Chinese government has really come out with a sort of meaty riposte to the idea that they have overcapacity. And specifically, it held a press briefing, released a big comprehensive position paper responding to these accusations about industrial overcapacity that have taken place over the past several years.
Pointedly, the paper was titled, China’s Position on the So-Called Excess Capacity Issue. You can just kind of feel the sass in that. So, we’re going to get into that. We’re going to get Dinny’s reactions to that, specifically as it impacts macroeconomics and trade. But before we do, we got to start with a customary vibe check. Dinny, how’s your vibe today, man?
Dinny: Mate, I’m living life on the edge. I’ve got two kids in the house, and I’m recording this podcast from my living room. So, if we can get through this without sort of a minor catastrophe, I should buy a lottery ticket.
Andrew: Yeah, that really is living life on the edge, man. That’ll keep your, not anxiety, your adrenaline up during the pod. So that’ll keep you focused. That’s good. Yeah, my vibe is chill. I’m about to go on another holiday for a week. Next week, I’m actually going to be down sort of near SU in North Carolina with the family, just chilling out in the mountains. So, ready to get out of D.C. again for a bit. It’s always nice to get out of D.C. But actually, before we do that, really looking forward to this conversation, which we will dive into in a second. But we also have to, of course, do the quick housekeeping.
Just a quick reminder, we’re 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 in China, a longer range of areas, a light range of issues: tech, macro, autos, minerals, you name it. And we’re going to talk about some of those policies, like industrial policy and policies that lead to overcapacity, or not, as the Chinese would say today.
But it also includes policy towards China out of Western capitals like D.C., London, Brussels, and others. So, if you need any help on that front, please reach out to us at hq@triviumchina.com. We’d love to have a conversation about how we can support your business or your fund. Otherwise, if you’re interested in more Trivium content, check out our website. Again, triviumchina.com. We’ve got a bunch of subscription options as well on the site that you can sign up for, again, focused on things like tech, macro, business environment. Check those out. You’ll definitely find the China policy intelligence option you need on our website.
And otherwise, please tell your friends and colleagues about Trivium. We really appreciate those word-of-mouth recommendations. They help us grow the business and grow the listenership. So, please do that. All right, Dinny, let’s get into it. We are going to talk about this MOFCOM Presser and this position paper. I think first, what we should probably do is lay out the key arguments that MOFCOM makes. I will note some of them are somewhat contradictory, shocking. But I’ll go through kind of the key arguments and then you can kind of lay out how you think they stand up.
So first, the paper argues that there’s no such thing as overcapacity, that no one- no economists, not the IMF, not the World Bank- can agree on a definition. I got to say, I have a little bit of sympathy for that. What exactly is overcapacity? You know, you always have a little bit more capacity than you’re going to use. Are you expected to use 100% of your capacity? Should you have zero exports? I don’t know. Okay, so but that’s argument one. Argument two says that these sorts of major shifts in industrial capacity have happened periodically throughout history.
So, you know, the bulk of industrial capacity moved from the UK to the US to Japan over time. And then that this shift now is part of a natural part of the global economic order. These shifts over time are part of that natural global economic order. Third, it spends most of the time rebutting the criticisms, of course, that have been against it, like that industrial subsidies, especially, have led to overcapacity. And it argues that everybody uses subsidies and that subsidies are WTO-compliant. So, you know, that it’s operating within the rules.
Fourth, it argues that, you know, other countries should stop griping about trade surpluses so much because many countries, it points to Germany, Japan, and the U.S. have historically run large surpluses without being accused of overcapacity. Of course, the U.S. doesn’t run a large surplus now, but historically it did. And then it also argues that the trade surplus is a result of U.S. debt in the EU underinvestment, not weak Chinese demand, which the paper says has been growing strongly, which is true- not as strong as in the past, but it is still growing at a decent clip- and that Chinese demand is an anchor of Chinese growth.
Again, I will say I have a little bit of sympathy for this as well. There are flip sides of the Chinese trade surplus, which is that many countries run deficits, most notably the U.S. Of course, I acknowledge that these are arguments that are defending the Chinese position. And they’re made partly disingenuously and partly out of legitimate analysis of how China fits in the global economy. But we’ll get into all this. And finally, the last piece, the fifth piece, there’s an argument that industrial growth has been driven by innovation and that China’s competitiveness stems from genuine technological progress.
This is not a subsidy story. This is not a margin story. This is not a scale story. This is a technological progression story. So those are the five major arguments, Dinny. What do you think about all of them? Just give us your broad thinking as to how these stand up.
Dinny: Yeah, well, on one level, it’d be easy for us to sort of sit here and go through each of those arguments and debate the merits or the economic rounding of them one by one. But that would kind of defeat the point because although this is framed as an economic rebuttal, at the end of the day, this is a political document. This exists because China is trying to do two things. One, it is trying to frame itself as a champion of free trade.
I mean, in this article, when it’s not defending itself against overcapacity criticisms, it’s talking about how it wants to see further trade liberalization, further liberalization of cross-border investment. It wants what it calls an open ecosystem of innovation. So, it sets itself up as both a champion of the prevailing global free trade regime, not just the status quo, but as the one who wants to push it further. So, that’s the first thing.
It’s setting itself up as the champion for the regime that we all say has benefited humanity incredibly over the last 50 years. And the other thing it’s saying, it’s trying to do, is frame itself as the victim. Because, even as it is the one that is steadfastly defending this system, it is the one that is sort of suffering the slings and arrows of the U.S. and the EU unilaterally imposing protectionism and putting up trade barriers.
And so, that ultimately is kind of what China is trying to achieve here. This is a framing for the current trade wars and the trade wars to come that try to position China as both champion and victim at the same time. And this is kind of something we’ve talked about before on the podcast, just how the West, sort of the broadly, the U.S., EU, maybe sort of the ecosystem nations around them, and China see free trade differently.
So, the West broadly sees free trade as a principle, and then they kind of built this sort of edifice of first GATT in the World Trade Organization, sort of edifice of rules around it to try and codify that principle into kind of some sort of working arrangement, imperfect as it may be. China, on the other hand, sees free trade as a set of rules. It came to the free trade world late, got accepted into WTO in the year 2000. And so, it sees the free trade as being the set of rules that exists to maintain this free trade regime.
And so, that’s a really big distinction because as far as the Chinese are concerned, compliance with those rules makes you pro-free trade, makes you a champion of free trade, makes you a party which is preserving the free trade regime. Whereas in the US and the EU, it’s a completely different outlook because you can kind of be adhering to those rules, but if those principles have kind of broken down, then, well, we don’t have free trade anymore.
Now, of course, when we’re talking about principle, the West has never been entirely pure in its commitment or even its defense of free trade. I mean, countries have run large, persistent trade surpluses for a long time. I mean, most notably Japan and Germany. Countries have used subsidies liberally. They’ve defended, they’ve pursued carve-outs for certain industries that are politically sensitive in their own economies.
Even when it comes to the principle, the free trade regime as it’s been built has never been kind of this, you know, pure thing. It’s been a real, just an effort to kind of build a scaffold around the principle. And so now China is-
Andrew: Yeah, let me just make a quick point there before you move on. Well, I’ll make the point that you made a great point, which is I think you’re fundamentally right that China does see these as rules to be followed, right? It doesn’t care about the principle of free trade so much. It’s like, hey, we’re operating within the system that you built. But I will say no one’s blameless here.
Kind of just like the U.S. and other Western countries, or at least used to, talk about free trade as a good in and of itself, but didn’t always adhere to the rules, China also understands that they’re not adhering to the spirit of free trade often, and so makes an argument that, while I think you’re right, that they fundamentally, they’re like, “Well, we truly are following the rules,” but they know that they’re following them while also bending them and not adhering to the spirit of the design.
And so, all that is to say everyone here is making arguments that are fully in their self-interest, and we’re aware of that, but we’re just going to kind of deconstruct what we think the merits are and I guess the non-merits, where these arguments fall flat. So, that may be a bit of a framing piece, but anyway, go on.
Dinny: Yeah, well, I mean, it’s a good point you make because I think just going back to what I was saying about subsidies and carve-outs and whatnot, China kind of pushes, sort of points to areas in the West, you know, where the Western nations haven’t kind of adhered to the principle and kind of go, “Look, you guys have never lived up to your own principles. Why are you pointing the finger at us?” And in the MOFCOM essay, they talk specifically about, look, you know, big Western countries have run persistent trade deficits. And I think here, there’s certainly a degree of cynicism involved in MOFCOM’s essay, because one of the examples they give is that, look, the United States in 1953 accounted for 44% of global manufacturing output.
And its point is like, look, we’re not even at that level. Although the United Nations, I think it was the UNIDO, has a well-published sized estimate or forecast that by 2030, if things continue the way they are, China will account for 45% of global manufacturing output. So, it’s interesting. Oh, that is the track that we’re on. MOFCOM saying, hey, the United States was in exactly the same position in 1953. Of course, the difference is the U.S. was in that position because we just had a world war which had completely destroyed the industrial stock of both Europe and East Asia.
And so, I mean, for China to kind of go, “Hey, we’ve been here before, you did it, why not us?” I mean, it is a little bit cynical. And there’s also an element of false equivalency as well in the way that the MOFCOM essay talks about subsidies as well. It’s the same argument. “Hey, look, you guys use subsidies all the time. We’re using subsidies. We’re compliant with the rules. Sort of back off.” But of course, the OECD recently published a report which said that China’s industrial subsidies are anywhere between three and eight times the level of any other country in the OECD.
So, yes, China does it. Yes, everybody does it. But China is doing it to a degree of magnitude far beyond what anybody else is pursuing. And I think that kind of comes back to sort of the principles of free trade again. It’s like, sure, Western countries have never purely adhered to the principles of free trade. But in some ways, there was kind of a dance or, you know, there were certain acceptable levels that everyone kind of sort of were willing to live within. And China, with the scale of its trade surplus and the scale of its subsidies, seem to have blown past those informal limits and is now going, “But there were never any limits. You do it. We’re doing it. What’s wrong with what we’re doing?” That’s why I kind of feel the essay is perhaps a little bit cynical.
Andrew: Yeah. I mean, it’s definitely very cynical. Both things can be true at the same time, but it makes some good points and is very cynical. It’s like having a political argument with someone on the other side. The points they may be making may be generally true, but they’re usually taken to such an extreme, no matter which side you’re on, that they become sort of cynical. I don’t what the right word is. They just become kind of disingenuous at a point. But anyway, so I think that’s what’s happening here.
But what the next question for you is, you’ve laid out kind of what the arguments are, what you think about them. You made the point that China is trying to play the victim. Why is it doing that?
Dinny: Yeah, I think it’s laying the groundwork for a protracted trade war. I think it’s trying to establish a theoretical foundation and justification for pushing the back against the EU and the United States. And I think it’s trying to frame it in a way whereby it can say it has the moral high ground and that it will champion a global free trade order and that gives it legitimacy for why it will not back down in the face of U.S., EU, anybody else’s efforts to try and reduce China’s trade surplus, to try and rebalance the imbalances.
Andrew: Well, that’s somewhat daunting and are definitely kind of pessimistic, but I think you’re probably right there. Let’s talk about some of the specific arguments. So, let’s start with the title itself. It’s about “so-called excess capacity.” First of all, there’s the ‘so-called.’ Secondly, it says ‘excess’ instead of overcapacity. That word choice is very specific to say, kind of, to reframe the argument and to basically say we don’t accept basically the overall framing that the West is using. So, sort of that whole, again, back to the political argument, you know, I disagree with the premise of your question, sir, kind of thing.
So, how significant do you think it is that Beijing is explicitly rejecting the framing outright rather than sort of just contesting the specifics?
Dinny: Well, at this point, I don’t think we should be surprised because Beijing does not talk about overcapacity, and it hasn’t for about 18 months. It talks about involution. Now, if I remember the milestones properly, it was in December 2024, that in the Central Economic Work Conference readout, the big end of the year to get together of all of China’s top economic policymakers. In the readout of that meeting, we saw mention of overcapacity.
One of the big challenges in the year ahead was we return to industrial overcapacity. And this was something that we hadn’t seen in government documents for at least a few years. I mean, overcapacity is a recurring theme in China’s economy. It goes in waves. It pops up. Beijing spends years dealing with it. You have a lull for a while, and then it comes back. And so, you know, end of December, all of a sudden it was back on the agenda. And that was kind of the first and the last we saw of it. And then in the new year, after a few months, it was replaced by this word, involution.
And I think that was a deliberate political choice, largely because when they used the word involution in December of 2024, the U.S., the EU, they all jumped on it. They were like, “See, see, you have overcapacity. We want to work with you to get rid of your overcapacity.” And Beijing was having none of that, and so it reframed the issue. Involution isn’t just another word for overcapacity. It reflects a very fundamental difference in understanding of what the problem is. So, overcapacity is used by the U.S. and EU to kind of look at Chinese industry and say, look, you’ve overbuilt. You have too many factories. You’re driving prices down. You’re driving out competition.
Our firm should be competitive, but because you have massively over-invested, we can’t compete on what should be a fair market basis. So, you need to close down your factories. So, China’s approach, though, is that the issue isn’t that there’s too much installed capacity, that the issue is one of pricing. The issue is of excess competition. And so, whereas foreigners talk about overcapacity as a way to get China to close down capacity, China talks about involution as a way to get Chinese firms to stop running each other into the ground, stop competing each other, stop their race to the bottom.
And so, it’s about stopping Chinese firms overly aggressively driving prices down. It’s about ultimately trying to restore Chinese firms to profitability by stopping them from cutting prices overly aggressively. And so that’s what involution is about. It’s about what they see as being excessive and detrimental and damaging competition. And they don’t see the root cause as being overinvestment really in anything. And so, of course, when you frame it like that, the solutions are different and the ultimate beneficiaries of success of policies to deal with those problems are different as well.
If China successfully deals with overcapacity, then the EU and the U.S. should expect to come out in front in some way. Where, if China can successfully deal with involution, then the winners here are Chinese firms that will see their profits rise and the Chinese state that will see an increase in tax revenue.
Andrew: This one isn’t on our list, but we find it at the top. So, I’ll just throw it in here. What do you think make of the argument about our trade surplus is just driven by the competitiveness of our firms, right? That we’re just better than yours. Because I feel like this an argument they’re making more and more directly that I’m hearing to European officials in particular, to a lot of companies even, to other officials. We heard it sort of at the CDF, the China Development Forum in the spring. You know, it’s another one where, like I said, I have a little bit of sympathy.
I actually do think the Chinese companies are really good, and the products are really good, especially when you think of the big core exports that are growing quickly, the renewable energy stuff, the clean tech stuff, the AI link stuff. These companies are good. Yeah. And the products are cheap. They’re cheap, but good. I talked with Cory yesterday about the battery tech, for example, is like world leading and will continue to be, and that pod will come out next week. And it’s the cheapest in the world. So, I don’t know. What do you think about that part of their argument?
Dinny: It’s complicated because it’s not just the quality of their innovation and the technology. I mean, the crucible that is competition in these cutting-edge industries in China at the moment is like nowhere else on earth. I mean, the sheer intensity of the competition is crazy. And yet, part of the problem here is that we all kind of pretend that we’re all operating or running on the same economic model. China is doing something completely different. I mean, we assume that when firms compete, they’re competing for profit. They’re competing to maximize returns to their shareholders.
Chinese firms might get to that point eventually, but at the startup stage, it’s all about competing for market share. I mean, that’s not unusual. You’ll see the same in Silicon Valley as well. It’s just that the ability of Chinese firms to survive far beyond when market forces should dictate that they collapse is something that’s fairly unique to the Chinese system. That’s why you had hundreds of auto companies, electric vehicle companies. That’s why you still have about 80 of them; that they managed to compete far beyond what their sales and their profit margins would typically allow them to do because they’re getting support from all sorts of different corners of the economy.
They might be getting explicit subsidies, cash subsidies, sure. They might be operating on cheap, free, or subsidized land. They might have their utilities subsidized. They might be getting direct capital injection from a local government. The local government may have secured for them contracts. For example, if you’re making cars locally for me in this area, then all taxis in this area have to be that brand of car. Local governments can put up trade barriers between other cities and other provinces.
There’s just all these mechanisms which allow Chinese firms, both at the cutting edge and even in traditional industries, whether it be steel or aluminum or whatever, to survive on non-market terms for far longer than would ever be possible elsewhere, which allows them to drive prices into the ground, which allows them to drive out other Chinese competitors. But once they go overseas, also allows them to sort of drive out foreign competitors as well.
So yeah, Chinese firms are innovative. Yes, the crucible of competition in China at the moment is second to none. Chinese efficiencies in the factory floor are fantastic. But the fact that it’s running a trillion-dollar annual trade surplus isn’t necessarily indicative of all of that. And putting aside everything I just said, and this kind of brings us, leading to the next issue I wanted to talk to you about — The other question then becomes, why is China incapable of producing so little of what it produces. And understandably, it doesn’t have to consume everything it makes.
That’s what exports are for. But even if it’s not consuming what it makes, why is it so incapable of importing from the rest of the world, to a comparable degree, the volume of what it’s exporting? And that’s kind of the issue here. It’s not about the quality or the innovation of what China produces. It is about why the domestic economy is so incapable of consuming far more than it actually does, such that you end up with this earth-shattering global economy redefining trade surplus.
Andrew: Yeah, that’s a good point, really good point, which we’ll pick up in a sec. Also a good point about all the companies. I just had a buddy who was down with his family in Costa Rica was telling me about all the Chinese EVs he saw there, and they were super cheap and pretty good. They weren’t always the high end, but he said a bunch of brands he’d never even heard of. And this guy follows this stuff pretty closely. And so, I do wonder what element of it is because of just the sheer number of companies and their ability to kind of compete on cost. It’s one I’ll have to think through.
I’m just thinking through it in real time. Because what I always say is like, actually, the worst thing in the world would be if like there were only two very dominant Chinese companies because they would just like run everyone else globally into the ground. So, maybe it’s actually good, like careful what you wish for kind of thing in terms of like saying, oh, you need to consolidate. Then you have two super profitable, super healthy companies and they just dominate. But that could be one problem. But then I also wonder how the number of companies plays into it.
Which one of those is worse? Which one would drive more of a surplus? Anyway, just kind of thinking out loud on that. But let’s get back to the consumption piece because the interesting part of that is, of course, this is something that the white paper that MOFCOM puts out, basically doesn’t even engage with this issue. And you kind of highlighted that when you wrote about this in our daily note. And this is the idea that relative to the size of the economy, Chinese households consume less than basically anyone else on earth, right?
And so, they talk about Chinese consumption growing quickly, which is also true, right? The economists talk about the consumption paradox. It’s so low as a percentage of GDP, but it’s also growing quite quickly at the same time. So, that’s a little bit of a paradox. But again, the paper doesn’t even really engage with that much at all. So, talk to us about what you mean by this. You know, just expound a little bit more on what you were just talking about in terms of weak consumption, the inability of the Chinese economy to absorb imports at all, etc.
Dinny: Yeah, so it’s interesting because, as you said, this MOFCOM essay was like, look, you know, Chinese households are spending more and more. It’s becoming a bigger share of our economy. Clearly, weak domestic demand isn’t contributing to overcapacity, which that is not the argument anybody’s making. The problem, the reason China’s trade surplus kind of exists is because Chinese households consume so much, not in absolute terms, because it’s the second biggest economy in the world.
China’s households are becoming more affluent, you know, compared to almost anywhere else in the world other than really the United States. Yeah, as a group, the Chinese consumer population consumes a huge amount, but that doesn’t matter when we’re talking about what that population is also producing. What matters is how much they are consuming relative to the size of their economy. Chinese households, in terms of end consumption, they consume far less than perhaps any other economy in the world. I think as a percentage of GDP, it’s about 45%, and most other countries, use about 65%, 70%.
So, it is a massive, massive shortfall. And this is where we kind of get into the territory of Michael Pettis’s arguments, and he probably explains it far better than I ever will. But he’s also not the only person who makes it as well. I mean, inside China as well, academics like Liu Shijin make this exact same argument that Chinese households do not consume anywhere near as much as anyone else does. And ultimately, they need to consume more to be able to create a sustainable source of demand. So, the issue here is that if the nation isn’t consuming, if households aren’t consuming, what it effectively means is that the national wealth isn’t going to households.
It’s being distributed in some other way. And that other way really is that the wealth is pooling in the hands of firms. Now, of course, firms can generate wealth, but then distribute it back to households, either as wages or bonuses or as dividends or even as taxes, which then get redistributed to households, right? But in China’s system, the national wealth disproportionately avoids household and pools with firms. And what has happened is that China has one of the highest savings rates in the world, something like I think 55% of GDP is saved, or maybe it’s 50% relative… I think the global average is something closer to 25%.
So, all those national savings, about half are being saved by households and the other half is being saved by companies, by corporations. So, what it means is when you’re saving, you’re not spending. And when you’re saving, savings, by definition, are being used for investment. So, the system by definition has been set up to provide a self-replenishing, cheap source of funds for firms to invest because the cheapest source of funds is retained profits for firms, right? They don’t have to go out and borrow. They don’t have to issue shares.
And so, having this system which kind of recycles money back into the firms, it creates all these resources that have to be invested. And, of course, you know, what are these mechanisms? Look, you look at the state sector, which accounts for a significant portion of economic activity. Sure, they pay dividends, but they pay dividends to the government. And in most cases, they then get handed straight back to the state sector as capital injections and as subsidies. You look at the Hukou system. The Hukou system is effectively the household registration system whereby people who move from the countryside to the cities, because they’re legally not really supposed to be there, it means that employers can pay them less.
It means employers avoid making their social security contributions because they don’t really have any political connections, political protections. And so, you’ve got a system, again, whereby the labor system is effectively set up in a way to provide an implicit subsidy to employers. The property system, although we look at it as a mechanism, as an engine for generating wealth for China’s middle class, that wealth was never realized. They were all paper gains. The property system was also a massive tool for extracting wealth from households by local governments through inflated land prices that then recycled the money back into construction companies for infrastructure investment.
I mean, it’s almost every layer of Chinese economy in some way or the other was tooled to either minimize the degree to which wealth was flowing into households or, in some ways, extracting wealth from households to support the corporate sector. And what that’s resulted in is these huge pools of savings, which, by definition, end up in investment. And those investments then result in greater industrial output, and somebody has to buy that output. But because Chinese households aren’t spending, because they get such a relatively small share of the national wealth, well, that output has to go somewhere else.
And it turns into exports. And so, this is kind of the recurring problem of China’s economy. All these arguments in the MOFCOM essay, so many of them are like, this is just the way things are. We have the great surplus…
Andrew: This is the way of the world.
Dinny: Exactly. This is the way of the world, right? It’s like other countries have big surpluses. Where now this is a period of technological innovation. Every industrial and technological revolution results in overcapacity because old plant gets superseded by new machines. We can get used to it. This is just the water we swim in. This is how the economy works. Whereas the reality is China runs such a big trade surplus because of this savings and consumption imbalance, and that’s a political decision.
That is a decision China made, really 40 years ago, and it was a decision made by so many other developing countries, particularly in East Asia, as a way to generate wealth, to supercharge domestic development. But we’re now at a stage where that sort of economy works really well when the sheer needs of the domestic economy demand large-scale investment. So, China needed that when the housing stock was absolutely lousy, which it was at the end of the 1990s.
And you need it when the population is rapidly expanding or migrating to the cities because they need housing, and they need infrastructure. And you need it when your economy is advancing because you need to upgrade infrastructure. There is legitimate reasons for a domestic economy to need to shortchange households in the interests of investment because everyone’s better off. But China’s not there anymore. China has a surfeit of housing. It doesn’t need to invest in infrastructure the way that it used to.
And yes, it has all these savings and an under-consuming household sector. So, you have this massive imbalance that’s getting worse and worse, and the adjustment costs are being forced on the rest of the world.
Andrew: Yeah, this is definitely the point where they lose me in terms of what I was saying before, you know, some of their arguments are grounded in reality. Some of them are legitimate. They just take them to the extreme. This one, just not engaging with this idea of underconsumption and the need to do some sort of rebalancing and just saying this is kind of the way of the world and how it works. It’s a bridge too far for me. And I think it really kind of undercuts the whole argument. But then, again, this is not really an economic argument they’re trying to win.
It’s more of a political thing, as you said. And so, this kind of brings us back to another one of the off-putting parts of this whole effort, which is this idea of China being a victim. And in particular, a victim, at the same time that is supposedly a champion of the global trade regime. I mean, the question is sort of how is the U.S. or EU even supposed to react to that? It’s not like they’re going to look at themselves and be like, “You know, actually, you’re right. China is playing by the rules that we set up, and we should just accept this and move on. And it is the natural order of things.”
I mean, that is just not happening. So, where does that leave us in terms of any kind of response that the U.S. or EU would make? I guess there’s not going to be a massive feel. They will not feel a need to respond, but also what does that tell us about this whole effort at all?
Dinny: Yeah. Look, the way that I see it is that this sort of framing from MOFCOM doesn’t really set the stage for compromise or for finding mutual ground.
Andrew: You don’t say!
Dinny: I mean, I think, if there was any ambiguity about that, I mean, you look at sort of how China has engaged with the trade wars over the past year, I mean, it’s become pretty clear that it’s built up an arsenal of tools which it can deploy quite successfully against the protectionist measures of other countries. And so, as much as anything, I think this essay signals Beijing will continue to do that. And what it’s signaling is that it has the high moral ground when it does deploy those tools. And so, I mean, as you were just saying, where does this leave everybody else? Because if we go back to first principles, the global free trade regime wasn’t supposed to look like this.
I mean, sure, plenty of countries have abused it over the years with all that stuff we talked about; persistent trade surpluses, subsidies, whatever. But the foundational principles of having a free trade regime in the first place was that everybody would be better off, right? So, sure, countries would see some of their industries suffer because you bring down the trade wars and the tariffs and the trade barriers, and other countries would do certain things better than you did, and so your domestic industries would suffer in some areas. But other domestic industries would do far, far better, and net-net as a nation everybody would be better off.
The idea was that by opening ourselves up to free trade, the benefits net-net would justify any adjustment costs, but that’s a mile away from what’s going on at the moment. And I think Europe is really the canary in all this, because they’re increasingly at a point where they’re going to have to decide whether they are willing to accept the cost of protecting their own domestic industries. And that’s kind of the first step. And then the second question becomes, well, if they do, what comes next? What is the trade regime that replaces what we currently have?
So, at the moment, it kind of feels like the inevitable direction on the path, that sort of feels like the path that we’re on, because China is arguing that the system is currently operating as it should. So, if that’s the case, then it’s no longer really in the interest of many countries to adhere to that system anymore. And the only thing keeping them in line and adhering to, at least paying lip service to the current order is the threat of Chinese repercussions. And I think, increasingly, that’s kind of where we’re at. I mean, I think we’re going to see a lot more deep thinking about what we replace the current water with.
Andrew: Yeah, I think you make a good point about Europe. I’ve always thought it was a little weird that the Americans are making the overcapacity argument or leaning into it because I don’t think Chinese overcapacity really impacts the U.S. economy all that much. It’s in the stuff that we tend to buy from China is a little low-value add. We have decided not to allow Chinese EVs into this country. I talked with Cory on this podcast that we’re going to release next week while on vacation, we talked about the battery sector, and I was just talking about how I don’t think it’s tenable to just shut down our economy, or not shut down our economy, shut out Chinese products from our economy, like with the robotics thing that happened this week and with the EV thing that’s happened before, and which may happen with batteries.
I think U.S. companies understand that this tech is really good and they want to license it. They basically want to work with Chinese companies. So, long term, I don’t think that’s a strategy from the U.S. side. And it doesn’t work long term to just kind of turn towards autarky or cut out China of the global trading system, say, “We’re not going to buy any of your products,” because, as you said, China will retaliate. And we want them to allow our companies to operate there. We do want them to buy some level of our exports. But all of that is to say the overcapacity, excess capacity, whatever, is a moot point, I think, in the U.S.-China relationship for the most part.
Europe’s where the rubber meets the road. And the EV thing obviously is the most kind of front and center, hollowing out the German car industry in particular, potentially the broader European auto sector; clean tech’s another area. And so, I do think it’s an interesting idea that China is ramping this up with the Europeans in mind and is ready to really play some hardball. And I think you’re right. The Europeans are going to have to decide. Do they want to take the path of the Americans and say, we’re just shutting this out? I don’t think that’s a viable option. Like I said, for the U.S., it’s more viable. But I don’t think that’s viable for the Europeans for a bunch of reasons, for political reasons, for economic reasons.
So, we’ll see. And then we’ll have to see, do the Europeans have the stomach to fight against China? Because you know that China, once gloves go off, they’re going to be nasty. So, I just don’t think, as I’m just talking this through, I guess somewhat concerning that MOFCOM is putting this out because it may be a sign that this Europe-China fight might get even nastier than it has been.
Dinny: Yeah. I mean, the way I see it is the way Europe works is everyone keeps talking until everyone arrives at a compromise. And I don’t think that can work in China-EU discussions at this point. To the extent that that may have happened in the past, I don’t think it’ll happen this time. And I look at an essay like this, and China is very much nailing its colors to the mast. It’s like, we are the victims here. We have become the champions of the trade regime that you built. It is not us to make compromises, and we will defend our position. That’s what’s… I was going to say, between the lines in this essay, but I’m just…
Andrew: Decide between the lines.
Dinny: It’s all the subtext.
Andrew: Totally. Well, I’ll just say, I’ve said this a few times before on the pod, and elsewhere, I think China’s increasingly saying the quiet part out loud. They’re basically saying, the model is the model, get used to it. We’re better than you because we’re more competitive and more innovative. And if that leads to exports, so be it. So, that to me is the kind of change that we’ve seen since, again, I first started hearing that message back in March this year. And I think that’s pretty telling because once they make it official, so to speak, like that, you know, it’s one thing when they kind of do it subtly and won’t kind of be that blunt about it and won’t negotiate, but then try to change things at the very end.
But they’re just kind of putting it out there and saying, “This is how it is and we’re not backing down.” Now, the whole adding — “Oh, and we’re the victim,” that’s the part of the Chinese system that drives me crazy, or of any authoritarian system where it’s like this brittle, like can’t deal with any criticism. Yeah, it just drives me nuts. So, I could do without that. But I just find this whole get used to it attitude concerning and interesting from an analytical standpoint. What are your thoughts on that?
Dinny: Yeah, I think interesting is the right word because China is in a position at the moment, given how weak domestic demand is, I mean, the economy is exports, right? I mean, their ability to sort of maintain growth, to sort of sustain this massive industrial investment that they’ve been pursuing over the last, what, six, seven years, I mean, it relies on the rest of the world buying more and more Chinese stuff. And so, on one level, that’s quite a vulnerable position to be in. But on another, I think Beijing feels like it holds all the cards.
I mean, you look at how they managed the U.S., sort of pushing back with rare earths and not, I think it feels like it’s an even stronger position in dealing with the Europeans. And so, even on one level, their economy is vulnerable to a decline in exports. I think they think they hold all the cards because no one’s going to sort of push back to a degree that would really result in a significant hit to the export machine.
Andrew: Yeah, that’s interesting. We have not seen China take that approach yet. And by that approach, I mean, if an economy like the U.S. has done restricts imports or tariffs something. So, I guess, obviously China used the rare earths vis-à-vis the U.S. on tariffs. But they haven’t done it specifically to say like if the U.S. or another country says we’re not going to buy X from you, they haven’t said, “Well, if you won’t buy X, then you can’t buy Y. You have to buy both.”
And that would be an interesting development of the Chinese lawfare toolkit, right?
Dinny: Absolutely.
Andrew: Well, on that very happy note, Dinny, it’s definitely depressing. It’ll be interesting, again, from an analytical standpoint. I always try not to use the word interesting because usually we’re talking to clients and they have a problem, I’m like, “Oh, that’s interesting.” And they’re like, “No, it’s a problem.” Anyway, from an analytical standpoint, we’ll be watching how all this plays out. I really appreciate you taking the time to walk through this. Pretty fascinating that they put this out, and I think worth dissecting and kind of going through kind of how they’re trying to frame this up. So, thanks for that, man.
Dinny: Yeah, no worries, mate.
Andrew: And thanks, everybody, for listening. We’ll see you next time. Bye, everybody.
