With the US and China having agreed to a détente over trade, now is a good time to step back from the day-to-day back-and-forth of measures and countermeasures and examine the longer-term implications of China’s new economic model for trade.
In this podcast, Trivium Co-founder Andrew Polk and Dinny McMahon, Head of Markets Research, kick off by discussing China’s surprisingly bleak October economic data, before wading into big picture trade issues.
They discuss:
How China intends to maintain export growth in the face of rising trade tensions
Whether the world is facing a China Shock 2.0, and how it will differ from the first China Shock
And how countries might adapt to expanding exports of Chinese advanced manufactured goods
Transcript:
Andrew Polk:
Hi, everybody, and 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 I’m joined today by Trivium’s Head of Markets Research, Dinny McMahon. Dinny, how are you doing, man?
Dinny McMahon:
Doing good, mate. Good to see you as always.
Andrew:
Yeah. Great to have you on. We are going to get into today the latest macroeconomic data out of China, which really was just released this morning. So, we’re recording on November 14th at 2 p.m. And that data came out sort of overnight on Friday. So, we’ll get into that. We’ll talk about what it sort of tells us about the current state of the Chinese economy. We’ll also look at the big falloff in investment and what policymakers are doing to address that. That’s been sort of several months that investment’s been contracting. So, we’ll touch on that quickly. And then we will also touch on some silver linings in the data, specifically around consumption. But we will mostly focus on exports today and export growth.
And we will not only look at the most recent data, but we will also talk about sort of China’s broader strategy for continuing export growth in a world of high trade tensions and as it sort of doubles down on this new economic model of innovation and industrial upgrading that we’ve been talking about now for several weeks. So, that’ll be the meat of the podcast. But before we get into all of that, we have to start with the customary vibe check. Dinny, how’s your vibe, man?
Dinny:
Now, mate, thank God it’s Friday. It’s felt like it’s been Friday since Wednesday. So, I thank God it’s now finally Friday. I’m just looking forward to a quiet weekend. That’s my vibe, mate. I’m just looking forward to easing into the weekend.
Andrew:
Yeah, we need to get back to recording these on Wednesdays or Thursdays. I feel like the Friday afternoon, it’s harder to get the energy up. That said, you know, it’s been a good week. We had a couple of colleagues in town, a lot of really good, interesting meetings, specifically with Cory Combs on kind of what people are thinking about on the rare earth stuff, the U.S.-China trade deal, and how that’s playing out, and what the US might do to build out its own rare earths supply chains. So, it’s been a really interesting week. And so I want to end on an upbeat note, especially since I had several people reach out to me last week after my vibe check was grumpier than usual. So, I appreciate the love from the listeners. That was very, very kind of you for those who reached out. All right, so that’s the vibe check.
We now have to quickly do some housekeeping before we get into the rest of the discussion. First, as always, 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 in a range of areas technology, climate, autos, consumer goods, you name it, we do it. 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 receiving more Trivium content, check out our website, triviumchina.com, where we’ve got a bunch of different subscription products, both free and paid. You’ll definitely find the China policy Intel that you need on our website. And then, finally, please do tell your friends and colleagues about the podcast so that we can continue to grow our listenership. Leave us a rating. That helps boost our visibility on various platforms, and tell people about Trivium, the company. Tell your colleagues. Tell your friends who may need China policy support. It helps us grow the business, and we really appreciate those word-of-mouth recommendations. All right, Dinny, let’s get into it. You ready?
Dinny:
I’m ready.
Andrew:
All right. So, latest data out of China, the monthly macro data for October, came out today, November 14th. And it was pretty dire pretty much across the board. So, industrial value added, so that’s basically industrial output grew just under 5%. So, 4.9%. That was down from 6.5% in September. And it was particularly bad on the private sector side. So, 2.1% private sector industrial output with 6.7% growth in state-owned enterprises. On a month-on-month basis, output edged up just 0.17% in October. That was the slowest month-on-month growth rate in almost two years. So, the industrial side of China’s economy, industrial manufacturing starting to sputter a little bit towards the end of the yea. We will get into why we don’t think we’re going to see huge stimulus at this point.
Policymakers seem like they’re comfortable they will hit the overall annual GDP growth target for the year, so don’t want to come in too heavy-handed at the year. But it’s not ideal when the main engine of your economy is industry, ad that is starting to slow. And we’re seeing that reflected also in investment rates. And this is the one I really want to get you on, Dinny, which is tax asset investment. So, another slice of the economy fell outright by 12.2% year on year. That’s accelerated from September’s 7% decline and marked the fifth consecutive month of shrinking FAI. we haven’t seen shrinking investment like this since the pandemic. And we’ll talk a little bit about why these numbers seem kind of funky. They may not fully reflect reality, meaning they may be showing a picture that’s worse than actually is happening on the ground.
We’ll talk briefly about that. But the key point is it’s a weak investment environment for sure. And it’s sort of across the board. So manufacturing investment down 6.5% year on year. Infrastructure investment down 8.2% year on year. Real estate investment, of course, ongoing collapse down 23% year on year. So, for a while now, property has been pulling down the overall investment numbers, but it was largely offset to a large extent by manufacturing and infrastructure investment .But that’s not been the case for the past 3 or 4 months. Dinny, what’s going on here? What do you think the story is?
Dinny:
I don’t know, I think you nailed it. I think properties just going from bad to worse. The anti-involution efforts are probably part of this as well. Beijing has clearly made it a high priority to sort of deal with overcapacity issues in various industries. So there’s probably a little bit of political pressure at a local level to pare back the amount of money going into certain industries. As you were saying, maybe that is happening, maybe it isn’t, but it’s certainly in their interest to show in the official numbers that it’s sort of being paid back a little bit.
Yeah. I think, after years of incredibly high paced investment in industry and manufacturing, you do kind of get to a point where we are at the moment where the economy is dealing with overcapacity, and this is a bit of a course correction.
Andrew:
Yeah. And so, the point that we’ve seen several analysts make, we haven’t dug into this in depth ourselves. We’re kind of in the middle of that is that numbers this deep headline 12% contraction in overall investment would typically sort of be an economy in freefall. And that doesn’t really align with many of the other indicators that we look at. It doesn’t really align with still 5% growth in industrial output, for example. And just as in line with what we see from businesses on the ground, and it doesn’t align with the quarterly numbers that show that overall investment is driving some level of actual growth. And so, we’re not sure why the discrepancy is happening. We’ve seen some people point out the idea that this is a political economy thing, and local government officials are now under pressure to deal with involution.
And so maybe they’re actually tweaking the numbers downward to show that they’re doing what the government wants in terms of short term efforts to deal with overcapacity and anti-involution or involutionary pressures. So, we can’t count that out. But it’s unclear. But either way, this is, like I said, like clearly the economy is undergoing a broad-based cyclical deceleration. The investment environment is very weak. You see that also in the credit data, which was very weak in October as well. And if companies aren’t borrowing, it’s because they’re not investing. So that aligns.
Although we just think maybe the 12% might be sort of skewed further to the downside than it should be. But Dinny, talk to us about what policymakers have been doing to not really stimulate, but to sort of support investment, kind of as we close out the year in the latter half of November and December and then likely into Q1 as well.
Dinny:
Yeah, right. Well, I think the key thing to keep in mind is you see data like this, and the question is always, what’s the government going to do about it? When are they going to stimulate? How are they going to stimulate? I think, frankly, they’ve already done what they’re going to do. I mean, sure October is bad, but September wasn’t that great either. And so we’ve seen two things happen over the last month and a half. First was at the end of September, China’s three policy banks, so China Development Bank, Export-Import Bank, and China Agricultural Development Bank got cleared to inject ¥500 billion in base worth of capital into infrastructure projects. So, the way that infrastructure projects work in China is before they can get off the ground, before they can start borrowing, they have to be capitalized.
Usually about they have to raise something like 20% of the overall value of the eventual value of the project. And they already have to have 20% of that in capital to kind of get going. And that money usually comes from local governments. But again, society and local governments are financially overstretched. And so, sometimes it becomes incredibly difficult for them to put up the money that’s necessary to get infrastructure projects going. And we saw this a couple of years ago. The government did exactly the same thing. They got the policy banks to put up the capital instead of the local governments. And so this time around, the policy banks mobilized ¥500 billion, and they shoveled it out the door incredibly quickly. I mean, they got going, I think, on the 29th of September, and that money was allocated in its entirety by the end of October.
So that’s great. But I don’t think we’ve seen the impact of that money really feeding through into the economy yet. Right? Because that money is just for capitalization. After the projects have that money, then they can kind of go out to the banks and start borrowing. And then after that they can kind of stick shovels in the ground and the real investment will start then. So, I think that’s the first thing to keep in mind. That money that got allocated in October, we’re going to see the impact of that on the economy over the next few months. And the thing to keep in mind as well, that 500 billion is leveraging a significantly larger amount of actual investment. So, at the end of the day, we’re looking at sort of 2, 3 trillion renminbi’s worth of infrastructure projects.
That money isn’t going to be spent in a month. It’ll be sort of spread over a couple of years. But it kind of gives you a sense that, okay, we’re going to see more infrastructure come online in the next couple of months. And then the other thing they did in the middle of October is that the Ministry of Finance approved local governments to issue an additional ¥500 billion government bonds. It’s done this trick a number of times before. Towards the end of the year, if the economy needs a bit of a pick up, and they kind of think, okay, overall, local government’s going to need to do more investment than we’d originally anticipated, they allow local governments to issue bonds from previous unused quotas.
So, the local governments, they get a quota of special-purpose and general-purpose bonds they can issue each year. When they get to the end of the year in the past, they haven’t necessarily always used those quotas in their entirety. And so they accumulate. And, every now and then, the Ministry of Finance turns around and says, “Okay, you can now use those unused quotas.” And so, the Ministry of Finance cleared local governments to issue 500 billion renminbi’s worth of that. Now, in the past, I would have said when it’s pulled this trick, all of that money has invariably gone into infrastructure and public works.
This time it seems that money is going to be spread around a little bit more. Only 200 billion will go into infrastructure and so many things, probably a bunch of it will go towards paying arrears to contractors and suppliers. Maybe some of the money will be used for sort of dealing with other debt problems, but regardless of how it’s used in its entirety, at least an additional 200 billion renminbi’s worth investment is going to go into infrastructure at a local government level by the end of this year. So, I think that’s the “stimulus.” I don’t think Beijing’s going to feel compelled to really do anything in addition to that off the back of the October data. It already recognized there was a problem, and it’s already mobilized the resources it thought was necessary.
Andrew:
Yeah. And that’s what I always tell people, and it’s what we do in Trivium — watch the reaction function of the Chinese government. This is why we think maybe there’s something wonky with the data right now, because if overall investment was cratering, the government would be stepping in to make sure that it was supporting investment much more forcefully. And so the actions that are being taken, sure, are supportive, but they’re not that major of moves, and they’re definitely not panic mode. And so, yes, of course, Chinese policymakers can be reading the signals wrong or getting bad information. But for the most part, if we don’t see policy, the policy apparatus really taking strong moves or reacting aggressively to bad data, then that shows us that they’re at least comfortable with the situation.
And my assumption would be that if they’re overall comfortable with where the economy is on a cyclical basis, that the economy is not in freefall, and having this huge contraction that might be suggestive of a headline 12% contraction in investment. So, it’s a little bit hard to read it.
Dinny:
Andrew, I was just going to say as well, I mean, you’d think if things were as bad as those numbers suggest, that at the very least, the central bank would be making noises about interest rate cuts or reserve requirement cuts or additional lending policies or re-lending facilities or something like that, kind of suggesting that monetary policy is going to get a bit of a boost, even if they weren’t willing to deploy more money on a fiscal level. And everything the PBoC said in the last few weeks has been an absolute snooze fest. It has been, if anything, it’s like nothing to see here, folks. We’re just going to go along a merry way. Everything’s fine. We never expected there to be additional rate cuts by the end of this year. I mean, we thought that was pretty clear a quarter ago, but we’ve been seeing banks sort of change their perspective.
It’s like, “Oh no, there’s not going to be rate cuts now before the end of the year.” I mean, that kind of gives you a sense of just how boring the central bank has been despite this data.
Andrew:
I want to now look a little bit at the consumption picture, and then we’ll really get into the exports piece. So, on the consumption side, also pretty weak data. So, October overall retail sales of consumer goods, which is the main thing that people tend to look at to gauge consumption in China, grew just 2.9% year over year. That’s very low and down from the September’s numbers. And that’s the fifth consecutive month of slowing growth in consumption. But we actually think there are a couple of bright spots if you look under the hood. First, the deceleration in headline consumption of goods was driven by a sort of shock drop of 6.6% year on year in auto sales.
So, you take out the auto sales and overall consumer goods purchases grew by 4%, which would be X autos, the strongest growth rate in three months. So, consumers are spending on goods, just not autos. And obviously autos is a big portion of the consumption basket for a household in a given year. If you’re going to end the year at least that you buy a car. Purchases of autos are obviously a significant driver of overall demand. So, it’s not like you can say, “Oh, well, just autos don’t count.” But it does help explain why things are sort of being dragged down. And, obviously, or maybe not obviously, but also people have been pulling forward their purchases of new cars due to the consumer goods trade-in program, which we sort of have been saying, actually, for months, would run its course in September, and then we’d start to see some numbers softening.
And so it’s not really that surprising to see the headline number softening or the autos number softening, but to see that outside of autos consumption on goods is holding up okay. It’s actually pretty encouraging. And then even more encouraging is that service sector resales were up 6.1% year on year in October, the fastest growth rate we’ve actually seen all year. And we’re doing more and more work to cover this services sales piece because a lot of people don’t really look at that closely in China because the data is a very good. So Joe Peissel, who was on a few weeks ago talking about the economy, and who we’ll have on again soon to talk through some of this stuff, is very closely following the services piece. And we’re just seeing a pretty significant migration from goods to services in terms of how the average household spends its money.
And that’s natural, right? As your wealth increases and your quality of life goes up, you’re buying less things and you’re spending more on sort of experiences — travel, leisure, sports, going out to eat more, and that kind of thing. So, I think this is an underappreciated part of the consumption story because everyone sort of looks at the consumer goods piece and says, “Oh my gosh, China has this massive consumption problem.” But there’s more and more sort of money going into the services piece. There’s a survey from, I believe, the NBS, and the latest quarterly survey shows that year to date, households have spent 46.6% of their expenditure on services. That’s the highest rate on record. So, we’re seeing it very clearly a structural shift more and more towards services. We see household spending on things like travel up 8.3%, culture and entertainment up 10.3%, both in Q3.
So very significant growth in the services piece. And along with that, we’re also seeing some improvements in consumer sentiment. So, for about the past 2 or 3 quarters, consumer sentiment from a very low level has been improving as well. And that may not be as reflected in the goods purchases, but it’s certainly being reflected in more and more spending on services. So, that’s an important part of the story. We’re going to dig into that more in coming podcasts and in coming work that we’re doing. But it’s just something we want to put a flag on because I think often the consumption story is very focused on goods, mostly because of the structure of the data. Dinny, just any thoughts on the consumption piece?
Dinny:
Yeah, the government’s really been flagging this since the beginning of the year, that services is more important, becoming more important part of the economy. That in terms of providing consumption support, they’re going to try and do more for services. There’s been a real rhetorical shift since the beginning of the year from the government, which is really quite interesting. However, the other thing to keep in mind, and this is my attempt at a segue into the rest of our podcast, is that this sort of rebalancing of consumption trends in favor of services and slower consumption of retail goods is coming at the very time that China’s doubling down on industry and manufacturing. So, we’ve talked about this ad nauseam that the new growth model, it’s all about productivity network in the manufacturing sector, enabled by innovation in by industrial upgrading.
And what that means is that just China is manufacturing more and more stuff. That’s the model. That’s how they think they’re going to build a more wealthy, affluent society. But they’re doing that at the very time that there’s kind of a structural shift in the consumption habits of the Chinese people in favor of services, and a lesser role for perhaps the stuff, the physical goods. And so that really means that this additional, not that there was any doubt to start with, but this additional manufacturing cannot be absorbed domestically. It has to be absorbed by rising exports. And that’s going to create a whole lot of challenges for everybody.
Andrew:
Well, and speaking of that, we’ll first talk about the short-term kind of developments on the export side. Like I said, the economy saw a very broad-based slowdown in October, and that was even reflected in exports. And so, exports fell, in October, 1.1% year over year. That was compared to 8.3% growth in September. Now, we should be clear that it’s always been true that monthly export data out of China is pretty noisy, pretty volatile, and so one down month doesn’t mean that the export machine is grinding to a halt.
In fact, part of that drop was base effect. So, in October 2024, there was a big jump in exports, where shipments surged 12.2% in 2024. So, that’s going to obviously depress the year on year growth rate. If you compare October 2025 to 2023, exports still grew 11% over two years ago. So, that takes out some of the noise from the bump last year, some of the base effects, and still tells us that overall exports are doing okay. But it is something you watch because, you know, you start to see one bad month of data, then two bad months of data, three bad months of data, then you can tell that the tide is starting to turn. We don’t necessarily think that that moment has come right now, but what do you make of those short-term export numbers from October, Dinny?
Dinny:
Yeah, I don’t have a good read. I mean, it does come off the back of an incredibly robust year for Chinese exports, which has completely defied everybody’s expectations. Given U.S. tariffs, fentanyl tariffs, Liberation Day tariffs, everyone kind of assumed that this would be incredibly damaging to China’s export machine. And certainly, specific firms in China are struggling. But even though exports to the U.S. have fallen, export growth has been remarkably robust as China’s exports have grown aggressively in other markets, particularly in Africa, Latin America, ASEAN, and the EU.
And so, yeah, I think one down month, yeah, it could be a result of… I don’t think we should read too much into it just yet. And for me, the key thing is, as I said, this new approach to economic growth, the new model relies so heavily on exports that I just kind of assume that over the medium and the long term, by hook or by crook, they will find a way to kind of keep increasing the volume of what they expect them to see.
Andrew:
Well, let’s get into that piece of it. I mean, we have talked a lot about the new economic growth model, so we won’t go over that specifically. We’ve touched a little bit on exports over the past few pods that we’ve focused on the economy. We talked a little bit with Gerard DiPippo about that. He’s done a lot of good work on the data on that. But we haven’t really dove into sort of the policymaking view around supporting exports. And that’s definitely an omission. So, we’re going to try to address that now. I mean, even though the model is all about delivering productivity gains in the manufacturing sector via innovation and industrial upgrading, this is not possible without export growth. And so, there has to be a plan to make sure that that can continue. Now, I will say at the outset of this part of the discussion, there is a limit, right?
You can’t just keep growing your exports forever and ever and ever. There are going to be bumps in the road. And so, we’re not necessarily saying that China is going to be 100% successful at this, but they’re going to have to figure it out if they want this new model to work. I mean, already a third of what China currently manufactures by value is being exported. So, that’s very export-dependent model. And it’s difficult to ramp that up further and at a time when we already talked about the Chinese public isn’t absorbing more of those goods and spending more and more on services instead of consumer goods. So, Dinny, just talk to us about what we should expect from China’s quest to sort of double down on this export-led growth model?
Dinny:
Yeah, I think there’s a few things to keep in mind. And the first is that over the last few years, they’ve been trying to insulate their economy as much as possible from pushback from developed economies. And the way they’ve done that is by moving very aggressively into producing intermediate goods. And this was something that Xi Jinping identified specifically back in 2019. He was saying that China should strive to make its self-kind of indispensable to global supply chains. And the thing about intermediate goods, so we’re talking about components and chemicals and the stuff that goes into making finished products, the thing about that sort of stuff is that once you’re kind of really embedded in the supply chain and you kind of become the supplier of choice because what you’re doing is cheap and high quality and well made, it becomes increasingly difficult for foreign companies or foreign nations to extricate China from the supply chain.
And so that’s kind of been an approach China’s been making for years. But I think it kind of became an explicit strategy in about 2019. I think, at around the turn of the century, about 30% of what China was producing was intermediate goods. And then I think about a year ago, were up to kind of 46%. There was a researcher who did some work from Brookings, a guy called Richard Baldwin, who’s done a lot of work at just how just the degree to which Chinese intermediate goods have kind of permeated global supply chains. And he calls China the OPEC of intermediate goods, because, really, it has become such a central player in global supply chain. So, I think that’s the first thing China did. You know, that doesn’t kind of help them counter or push back against rising trade barriers from the EU or the U.S. But it does kind of provide a certain degree of a buffer about a certain degree of insurance against those sorts of measures, the impact that they might otherwise have on the Chinese economy.
But I think the other thing to look for is, well, what they can do and what they have done to a certain extent over recent years is cut prices of exports. I mean, we saw this to a certain degree when China’s housing market after it peaked, industries in China that had depended for years of growth on the housing market, things like steel, obviously, but also things like white goods, air conditioners, dishwashers, and also excavators, construction machinery, they all started to pivot to export markets more. And we sort of saw that they sort of traded price for volume. That they were happy to cut prices of exports just in return for being able to ship more stuff. And then more recently, we’ve seen the renminbi being relatively weak on a trade weighted basis.
We’ve also seen particularly this year, sort of dealing with Trump tariffs and Liberation Day that the overall price index of China’s exports has kind of been negative. So, prices for the most part have been falling. That’s always an option. But it’s kind of not really the solution. Because, as we’ve talked about before, ultimately, what China needs is profits from their new industries. If you keep cutting prices just to make sure that you can sell enough stuff overseas, it’s not really a long-term strategy. So, I think the other thing is we’re going to see a lot more of, I mean, we’ve certainly been saying it over the last couple of years, but I think we’re only in early days, so we’re going to see a lot more Chinese firms going abroad and building factories to be closer to end users and really to be getting around tariff walls and other protectionist measures.
And of course, the thing about factories that often gets overlooked is when you building a factory overseas, more often than not, you’re still relying heavily on components from China that then gets shipped to that overseas factory and then put together. A lot of car factories around the world are knockdown factories. So, all the components sort of come from somewhere else and then they’re sort of put together into a car in the overseas factory. You get that with a lot of electronic goods as well. And so, I think we’re going to see a lot of that. Chinese firms go overseas, set up factories, and that will allow them to continue exporting the components, intermediate goods from China into their overseas facilities.
And I think the last thing that we’ll probably see more and more of is China sort of pushing hard for more free trade agreements. So, as some barriers go up in the EU and the U.S., it’s going to do whatever I can to bring some barriers down elsewhere. I mean, it’s already negotiated with ASEAN, I think the third iteration of the free trade agreement it has with ASEAN. I think it’s talking to the Gulf countries about putting something in place with them. I think it’s really going to be a full-court press. China is going to try and bring barriers down wherever it can to kind of offset the closing of markets elsewhere in the world.
Andrew:
Yeah, that’s an interesting one. I kind of want to dive into that concept just a little bit to kind of take us off our roadmap here just to see what you think. You know, we’ve talked before about the notion off the pod that like when China thinks about China, like when a Chinese company or a policymaker even thinks about capacity, they often don’t think about just like Chinese capacity. Right? Like Chinese demand. Sorry. Put it that way. Like how much can we make to meet the domestic demand? They’re often thinking, especially in these newer technologies, about global demand — If the entire world’s going to electrify, if the entire world’s going to need batteries, how much can we produce to serve that demand? And then if we can sort of unlock that demand externally by investing in other countries that want to electrify, or building factories in other countries.
So they’re getting some GDP growth out of it, but they’re still buying a lot of things from China. They can actually, in a way, help to enable their own export demand by investing overseas. I think it’s a totally sort of different way about thinking about the capacity that you’re building because you’re not just thinking about what you need to supply your own economy, but you’re thinking more broadly about global demand. It’s a nascent idea. I’m not saying it super articulately, but what do you think about that idea generally?
Dinny:
Yeah, I think certainly when China thinks about issues of overcapacity, they never look at their own market. The idea is about global supply, and particularly when it comes to things that are relating to renewables, green transition, energy efficiency, it’s all often sort of couched in terms of this is something the world needs. It’s not any individual country’s responsibility. We have the capacity to meet the world’s needs. And therefore, why should we do it? And often I’ve seen, I think it was the Development Research Council, which is the State Council’s internal think tank, sort of, I’ll give an example of, say, I think it was the South Korean electronics companies, LG and Samsung as well, who invested heavily in LCD screens when the technology was relatively new.
And it made the point, for a couple of years, it looked like they had massive overcapacity and they overinvested, and it’s like, but the point was that ultimately global demand caught up to how they invested. And over time, even more investment was needed. And their argument was, well, that’s kind of what China’s doing at the moment yet some people see overcapacity in a lot of these industries. But the reality is the way things are going, demand will just increase globally exponentially over the next few years. And we’ve kind of put ourselves in a position to meet that demand. Now, of course, maybe that’s a little bit self-serving in some ways. But yeah, it’s certainly echoing what you were saying. I mean, they certainly see industrial demand in global terms, and very much not just in terms of what the Chinese economy needs.
Andrew:
Well, we’ll keep digging into that concept as all of this plays out. But in the meantime, follow-up question to sort of what you were saying earlier is, is there a cynicism here on China’s part when it’s sort of out there trying to grow these export markets and trying to capture more and more global demand, but presenting itself as the champion of free trade? I mean, the U.S. and the EU are putting up trade barriers in response to huge subsidies and state assistance in China. So, it’s not exactly free trade. Talk me through how you view sort of that dynamic.
Dinny:
Yeah, you’re right. I mean, whenever Chinese officials talk in sort of like the World Economic Forum or some multilateral forum, they always talk about how important globalization is and how anti-free trade is important and putting up barriers doesn’t help anybody, where the reality is the industrial sector is built on huge subsidies and government support. But it really comes down to a difference in how, say, the United States sees free trade and how China sees free trade. Because the U.S. ultimately sees free trade as a principle. And the WTO was an institution that was supposed to sort of formalize those principles on a global level. But ultimately, free trade is a principle that we all are kind of working towards. And if we only buy it, then it’s in everybody’s interests.
Andrew:
Well, so I’ll just say that was true up until recently. I don’t know if you can say that of the U.S. today, but anyway.
Dinny:
Yeah, I mean, this was the starting point. This is why we had a gap. This is why we had a WTO. But China looks at it very differently. It’s not a principle to live by. It is a rules-based order that we have to comply with. And so, I mean, the Chinese will say it. It’s like, “Look, we’re free traders. Look at these WTO rules. We live by these rules. Everything we’ve done is in compliance with these rules.” And maybe not everything. There’s certainly reasons why other countries bring WTO cases against China. But all of its subsidies and government support, for the most part, they’re not in violation of WTO rules, even though they are in violation of what the U.S. would say is the spirit of free trade.
And so that’s kind of why China can present itself as a champion of globalization because it’s like, “Hey, these are the rules we live by.” And I think it still has resonance in a lot of parts of the world because a lot of countries have kind of turned against free trade in the way that, although the free trade regime, in the way that the U.S. and EU have because, I mean, this new economic model of China is the challenge to countries with advanced manufacturing, right?
And that’s a very short list — it’s the U.S., it’s the EU, Japan, Canada, and South Korea. So it’s effectively G7 plus South Korea. If you don’t have advanced manufacturing, then China’s headlong drive into electric vehicles, flying cars, humanoid robots, pharmaceuticals, the shipbuilding industry, it doesn’t really affect you. And to the degree that it does affect you, it’s probably a good thing, right? Because it means we’ll have cheaper cars, we’ll have more renewable and potentially cheaper energy. We might even get factories out of it if we can kind of convince the Chinese to come and set up an NEV factory. So, a lot of the world doesn’t make advanced manufacturing. China has always been a market for commodities, primary goods, maybe tourism.
And so, China’s transition into an economy very much focused on advanced manufacturing isn’t a threat. And so, the promise of free trade with China is still is something that could potentially be a good thing, and certainly not something to turn your back on. And so, I think that’s why China can still and continues to sort of hold itself up as a champion of globalization, because for a lot of countries, there’s real value in having free trade with China.
Andrew:
Well, that though very much hints on why China’s economic transition or the economic transition that China is trying to manifest makes it such a challenge to the U.S. in particular, but other Western economies, as you said, basically any economy with advanced manufacturing, G7 plus South Korea. So let’s dig into that a little bit. There’s an author called David Autor who originally kind of framed this idea that the U.S. industrial sector was upended sort of between the early 2000, between 1999-2007 by the China shock. Right? And he recently wrote that the U.S. is now facing a China shock 2.0. So, here’s what he wrote —
“China shock 2.0, the one that’s fast approaching, is where China goes from underdog to favorite. Today, it is aggressively contesting the innovative sectors where the United States has long been the unquestioned leader — aviation, AI, telecommunications, microprocessors, robotics, nuclear and fusion power, quantum computing, biotech and pharma, solar, batteries. Owning these sectors yields dividends, economic spoils from high profits and high wage jobs, geopolitical heft from shaping the technological frontier, and military prowess from controlling the battlefield. Contrary to a strategy built on cheap labor, China Shock 2.0 lasts for as long as China has the resources, patience, and discipline to compete fiercely.”
What’s your take on that quote from David Autor?
Dinny:
Yeah, it certainly feels as though we’re barreling towards another China shock, but this one differs from the one from earlier in the century for a number of reasons. First, that that first China shock was mostly a U.S. phenomenon, right? Germany really didn’t get affected that much at all by that sort of first shock at the turn of the century, whereas this one is going to affect, or is affecting really any country with advanced manufacturing. Now, the second thing is that that first shock hit traditional industries. So, steel, furniture making, textiles, whereas this one, it’s going to impact advanced manufacturing, advanced value manufacturing, sort of yeah, we’re already seeing it with batteries and solar, and we’re seeing it with automobiles. But it also affects industries that haven’t emerged yet. And that’s really interesting. I mean, this is a fight for the future as much as anything.
And so, these are the ones that the G7, under normal circumstances, would expect to dominate. And by dominating, I mean this kind of reflects what David Autor actually said, it’s like by dominating those industries, it allows countries to maintain their affluence, their influence, and their relevance. And so, with this particular shock, China’s potentially leading the technological future and then capturing all those benefits that go with it. And then the third thing, the third reason why this is different is because the G7, the companies from those countries, have built the industrial strength, not just on the demand of the domestic economies, but on global demand. And the challenge or the shock to existing industries this time is going to come from three different directions.
Now, the first is that it’s coming from Chinese firms encroaching on mainland markets, but the second is that it’s also coming from a collapsing demand for Western foreign manufacturing products from overseas. So, China’s just buying this stuff. And then it’s lastly coming from China cannibalizing the market share in the rest of the world. And I think that’s the best way to sort of understand what’s happening and what potentially will happen in other industries is what we’re seeing in the auto sector at the moment. Now, the thing about domestic markets is that they are the easiest ones to protect, right?
So, if you look at the United States, and surely, there are no Chinese peoples on the roads over here. I mean, the U.S. is managed to put up an economic, a trade regime, a political regime whereby there are just no cars, Chinese vehicles on the road. The Japanese have managed to do the same thing except a little bit differently, because the Japanese have managed to keep foreign cars off the road for now, what? Seven years now. So yeah, like 90% of all vehicles sold in Japan are Japanese. And that’s because it’s such a unique market that got such specific specs and specifications that are required for a car to be on the Japanese roads. And there’s other quirks of the Japanese market as well. So, they managed to keep out foreign brands for a very long time.
But even then, I mean, BYD started making cars specifically for the Japanese market that comply with all the specifications. So, we’ll see how things go in the future. I think the EU isn’t doing so well. I mean, the EU has sort of imposed tariffs on Chinese vehicles, but the volume of Chinese cars that are entering the country, I think, growth, I think in the first nine months, it’s what? Almost 6% of all cars sold in Western Europe were Chinese. And that was up from about 3.2% over the first three quarters last year. I mean, Chinese cars are sort of pouring in. But the point is that with the domestic market, you can protect to a certain extent.
But in China, I mean, up until a few years ago, China’s car market was a foreign car market. I mean, yeah, sure, the foreign car companies had to get together into joint ventures with Chinese companies, but there were very few Chinese brands that were making internal combustion engine vehicles that had the confidence to go abroad. They might have a bit of a market share in China, but they weren’t market leaders. I mean, the market was dominated by Japanese and European brands. And certainly, you had American brands in there as well. But it was a foreign market. And then that has just radically changed because the market is no longer a gasoline market. It is an NEV market.
I mean, in any given month, more new energy vehicles or hybrids or electric vehicles are sold in traditional style vehicles. And the companies that are making electric vehicles are Chinese. And so, the whole market has been turned on it’s topsy turvy. And so, you’ve had, over the last few years, these foreign joint ventures, one after the other, they’ve been shutting down their plants. Now, of course, even though these are foreign companies, they’ve got factories in China, almost all the components, all the parts, all these cars are made in China. And so, this isn’t going to be sort of an industrial hollowing out of Europe or Japan. But I mean, it’s certainly, it’s hitting the bottom line of some of these industrial champions, these big car companies of Europe and Japan and the U.S.
And then, of course, the third thing is the rest of the world. Any country that doesn’t have its own indigenous car brand doesn’t really care where they car comes from. They don’t really care if they’re buying a Japanese brand or a Chinese brand or a Korean brand. All they want is for the quality to match the price. The great thing about Chinese vehicles is that they’re innovative, they’ve got design, they’re well-made, and they’re cheap. And so, you’re seeing, yeah, I think in Mexico, Chinese vehicles have 20% of market share. I think it’s something similar in Israel, a little bit lower in Australia. And year on year, just the sales growth is double figures. And so, for every car that gets sold in the rest of the world is a car that a traditional car maker from the G7 is no longer selling.
I mean, this is a big point of concern for the Japanese car makers in Southeast Asia. I think Honda originally thought that its sales in Asia X Japan would fall by about 5000 units this year. At the moment, it’s on track to be down 75,000 units sales in the first nine months of this year. In Indonesia, I think it’s down 16%. In Thailand, it was down 12%. Of course, there are always multiple factors for why sales are up or down, but a big part of it is the degree to which Chinese automakers have really moved aggressively into Southeast Asia. And so, that is the risk. That is what the China shop looks like. It is there’s some potential industrial hollowing out, the industrialization less demand for G7 and Korean products.
And it’s happening most clearly in also, but we’re going to see in a bunch of other industries as well as China moves more aggressively into new products and expands its market share.
Andrew:
Yeah. Well, taking that sort of auto market or new energy vehicle market development as sort of the playbook and expecting that they’re going to try to do this in a range of other industries and technologies. But where does all this leave us as China doubles or transitions to this model where it’s going to try to do this over and over and over? What are the implications globally and how two countries react?
Dinny:
Yeah, it’s a tough question to answer. I mean, long term, I mean does the U.S. and the EU do, everyone put the barriers up and we end up with like two unique technological ecosystems. People have sort of suggested that that’s a potentiality. If that happens, I think that’s still a long time away. I think in the shorter term, there’s a few things to watch for. So, as I said, I don’t know what’s going to happen, but there’s a few things that are potential options. And one is, you know, this is what David Autor wrote about in his book, the first China shock, and flagged this idea of a China shock 2.0. He’s like, look, what the U.S. should be doing is just opening the door to Chinese investment, I guess, much in the same way as the U.S. kind of insisted on Japanese and South Korean firms coming to the United States, making their cars here rather than sort of the U.S. importing from overseas.
Let the Chinese firms come to U.S., they make things here. And that kind of forces local U.S. opponents to adapt, to become more innovative, to become more nimble. And so, that’s one approach. I mean, politically, that would seem to be a nonstarter at the moment. But these things change. So that’s one potential thing to keep an eye out for. Now, that approach might not work in Europe, largely because, I mean, the Europeans haven’t kind of put up the walls in the same way as the United States has. And so, you have, I mean, Chery is setting up a factory in Spain. BYD and CATL in Hungary. I think there’s other, I think they have battery projects in Finland or certainly in the Scandinavian countries.
I mean, there’s a lot of Chinese investment going in. And then, in addition, you’ve got Chinese investment and a BYD setting up a factory in Turkey. I think there’s battery factories being built in Morocco. The significance of those is they sort of have a free trade agreement with EU. So, anything produced in those countries can kind of cross over without duties. And so, Chinese firms are already setting up shop there. The problem is that’s great for a country like Spain. And in Spain, it has a very explicit strategy to develop the EV, electric vehicle industry. But it’s not right for Hungary, Hungary seems to get more Chinese investment than anywhere else. But it’s not great for Germany and the Central Europe, where the auto sector has been concentrated for years.
I mean, the threat then is that demand for auto and the long supply chain of auto suppliers starts, the demand starts diminishing. And so, what happens there? And so the most interesting suggestion I’ve seen recently is that what the Europeans should do is flip the script on China. And China for years insisted that foreign investors, when they come into China, they enter into joint ventures, that it’s almost not quite a pay for play set up, but the idea being that if you want access to the domestic Chinese market, you have to partner up with a local Chinese company, and that would involve some degree of technology transfer in both management style and in the actual hard technology, and that the EU should do something like that.
If China wants to sell into Europe, then it should have to produce locally and do it with a European partner. And that was advocated most recently by one of the former heads of Airbus. So, who clearly for years had to deal with Chinese joint ventures himself. I’m sure there’s a degree of schadenfreude involved, but that’s something to watch for. And I think the last thing to keep an eye on is that companies and the G7 countries will be looking for ways or looking for areas they can invest or expand into that allows them to use their advanced engineering and manufacturing prowess, but in areas where they’re not in direct competition with China.
And we’re seeing that at the moment with the auto sector in India. As I said, the Japanese carmakers are sort of looking around, and they’re saying that Southeast Asia, which has being their traditional stomping ground, its market share is under threat. And so, they’re investing heavily in India. And the significance of India is that the Indian government has effectively boxed out Chinese vehicles. And so the Chinese aren’t threat. And so, Japan is thinking of that as the next big potential market. And I think the other thing to watch for is defense spending. Because even though China has its own thriving defense export industry, it’s not a global market. The sort of countries that would buy from, say, Germany or Japan, or from the United States aren’t going to buy from China.
And so, there is a real potential there. And I think we’ve seen the South Koreans move into this most aggressively over the last few years. I mean, it’s already been called sort of the new arsenal of democracy, but certainly the Japanese are trying to expand their military industries. And we’re certainly seeing it in Europe as well, although the focus in Europe has been very much about Ukraine. But of course, the upshot is for the European countries to start spending more and more on defense has real benefits for their advanced manufacturing defense industries at the very time that they’re advanced manufacturing private sector firms in the commercial sector are finding it harder to survive. So, I think that’s the other thing to watch for.
Andrew:
Well, you’ve certainly given us a lot of food for thought. I’m not sure that we’re leaving it on an optimistic or pessimistic note. I mean, just the idea that so many more countries are going to have to invest in their defense industrial bases to keep their advanced manufacturing going seems a little bit depressing to me, but we will see how all of this plays out. This conversation is the conversation that is going to really dominate, I think, the global kind of trade policy space and global economic policy space. This is all, at the end of the day, being couched in most countries as economic security. How do we maintain economic security both in terms of getting the critical inputs we need, both for defense manufacturing but also for commercial manufacturing?
But also, how do we protect jobs and our own ability to grow our economies, especially as China goes for this new model of growth that very likely, if they’re in any way successful, will lead to a second China shock? I think everyone now is trying to get out in front of this instead of just being caught with their pants down, which is sort of what happened with the first China shock. But Dinny, thanks for laying out all that stuff. I think we don’t have any answers today, but it will be something where sort of researching, thinking through specifically China’s evolving approach, and sort of thinking through what the likely Western and G7 reaction will be or what the G7 and Western reaction should be. So, thank you very much for walking me through all that today, Dinny, really appreciate it, man?
Dinny:
No worries, mate. It’s a pleasure, as always, to be here.
Andrew:
And thanks, everybody, for listening. We will see you next time. Bye, everybody.
