Tired of listening to the same old Trivium voices? Wishing for more variety in your podcast diet? Well, do we have a treat for you!
In this week’s podcast, Trivium Co-founder Andrew Polk and Dinny McMahon, Head of Markets Research, are joined by Gerard DiPippo, associate director at the RAND China Research Center and a senior researcher in RAND’s D.C. office.
Gerard is one of the sharpest minds out there when it comes to the global implications of what’s happening in China’s economy.
The conversation starts with Gerard explaining what he means when he makes the observation that China’s economy is currently “both strong and weak at the same time.”
The gents then discuss Gerard’s recent work assessing where exports previously bound for the US are now heading, and also talk through how falling prices have managed to keep Chinese exports buoyant.
Finally, they get into China’s anti-involution push and where Beijing might be taking it.
Interested in Gerard’s work? We highly suggest you check out his recent piece for the China Leadership monitor, “Changing Course in a Storm: China’s Economy in the Trade War.”
Transcript Follows:
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 Cofounder Andrew Polk. And today I’m joined once again by Trivium’s Head of China Markets Research, Dinny McMahon. Dinny, how are you doing?
Dinny McMahon:
I’m doing great, Andrew. Good to see you.
Andrew:
And it’s extra special today on the Trivium Podcast because we have our second-ever guest from outside Trivium joining us today. We’re really happy to have the one and only Gerard DiPippo joining us today. Gerard is an associate director at the RAND China Research Center and a senior researcher in RAND’s D.C. office. Prior to joining RAND, Gerard was the senior geo-economics analyst at Bloomberg Economics.
He was also, prior to that, in the economics program at the Center for Strategic and International Studies, and he is an 11-year veteran of the U.S. intelligence community, including stints at the CIA, and was the Deputy national Intelligence Officer for economic issues at the National Intelligence Council. Gerard, welcome.
Gerard DiPippo:
Thank you for having me.
Andrew:
Yeah, it’s great to have you on. We’ve got both Dinny and Gerard today to talk about China’s economy once again. Of course, we talk about China’s economy pretty regularly, but we kind of wanted to take a new tack. We’ve been walking through, in past pods, a lot of Dinny’s work in particular on sort of this new economic model that China is trying to achieve. And we wanted to bring Gerard on because he’s got a different perspective, not at odds with Dinny, but kind of comes at this from a different angle, very much a geoeconomic angle rather than a China only angle — although he does a lot of research on China itself — and wanted to get his thoughts on sort of where China is currently economically and where it’s going, kind of what he sees as the new economic model to sort of in part to stress test what we’re thinking.
And, in general, just to have an overarching conversation around where we see things going in the years ahead for China economically and what that means for U.S. policy and for the rest of the global economy. So that’s what’s on tap today. But before we get into all that good stuff, we have to start with the vibe check. We checked with Gerard beforehand to make sure he was cool with joining this part of the pod, and he was a good sport. So, Gerard, the point of this is just to kind of tell people what’s your headspace, what kind of energy are you coming into this conversation with? So, Gerard, customary vibe check, how are you feeling today?
Gerard:
I feel great, I feel honored to be on the Trivium Podcast. So that’s my curtailed answer. But I guess, broadly, I feel more uncertain, not just recently, but really, over the past year, and I think that the world, but maybe particularly the U.S. and Chinese economies are facing more uncertainty part because of the relations with each other, but in part because of the techno, really the AI shock, that is sort of somewhat slowly underway, but is now manifesting itself almost more and more month by month in my life, and then also both sides facing their own versions of macro shocks.
I think China’s macro shock is much bigger, but the U.S. has its own issues, like our CapEx now is skewed heavily towards AI and there’s lot riding on this one sector. So, it feels like things are slowing down otherwise. But in essence, both economies are making very large technological bets.
Andrew:
It’s a great point, and it’s a weird one because you can sort of get lulled into a sense of complacency or a sense of certainty. I think not really seeing great economic reverberations from the trade war and Liberation Day, which we all, as economists, kind of thought would come to fruition by now, but seem to be more of a slow bleed in terms of hitting inflation, hitting the labor market. So, it feels like things should be more uncertain in the short term because of the tariffs, at least in my view. And then you add to that fact that we’re making these big historic technological bets, and there’s sort of this uncertainty. But for me it’s like right below the surface, it seems like maybe it’s hitting you a little bit more in reality day to day. But that’s an unnerving vibe, but I like the take. So, thanks for that. Dinny, how about yourself? How are you doing?
Dinny:
Well, mate, I’m back in D.C. for the first time in years, and I used to live here. And, frankly, I’d forgotten how much I’d like this city. So, just wandering around, beautiful autumn weather. It’s just been a lovely couple of days. So, yeah, my vibe today’s pretty chill. It’s also a bit nostalgic, but overall, dude, I’m feeling pretty good.
Andrew:
Well, that’s great to hear. I also am pumped. Just great to have Gerard on the pod. I’ve been waiting to have you on for a while. And Dinny, great to have you in D.C. So, I’m bringing some good energy here today and excited to get into this with you guys. Now, quickly, we also have to run down a little bit of housekeeping before we get into the meat of things. As usual, 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 includes China policy domestically in various areas, as well as policy towards China out of Washington, D.C., London, Brussels, and other western capitals. So, if you need any help on any of those fronts, 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 need more Trivium content, more China policy intel, check out our website, triviumchina.com. We’ve got a bunch of different subscription options there. You’ll definitely find the China policy Intel you need on our website. And finally, please, as always, tell your friends and colleagues about Trivium and about the podcast so we can grow the business and grow the listenership. All right guys, let’s get into it. Gerard, I want to start with you. You have a piece that I want to highlight — we’ll put this in the show notes — that was published in the excellent China Leadership Monitor recently. We’re going to get into some of the arguments that you make in that piece called Changing Course in a Storm: China’s Economy in the Trade War.
But before we dive into the specifics that you… well, I guess this is related to some of the arguments you make in there, but it’s a point I’ve seen you make, and I’ve heard you make when we’ve been on panels together in D.C. that a lot of people are trying to figure out, where is the trajectory of China’s economy right now? If you dive back a year, everyone thought China was sort of on its knees economically. There was all this conversation about peak China. The Biden administration’s sort of argument was like, or really the argument in Washington, D.C. generally was — this is the time to go after China. They’ll sort of buckle under pressure. The Trump administration obviously thought that as well; that China would really back down in the face of tariffs. That’s not been the case. But you’ve said that China’s economy is currently both strong and weak at the same time. Walk us through exactly what you mean by that.
Gerard:
There’s maybe two frameworks you could use for that. One would be macro versus micro. And I think maybe the more interesting is new economy versus old economy. So, on the macro side, growth in China in nominal terms, which is one I would track is fairly weak by China standards. The macro economy is not doing great. That’s largely because of the property sector and downstream effects of that, but also consumption growth. Well, not low. It’s definitely low by China’s standards. So, the macro variable doesn’t seem great. But then you look at certain industries, at least from a technological perspective, really things like AI is high tech is doing quite well. Now, we could talk about how healthy they are, and I think we’ll get to that later when we’re talking about involution, but that part of the economy is doing well.
I think the other way of breaking down is just simply that new versus old economy. The National Bureau of Statistics helpfully publishes a series annually that will break down components of the economy at a high level that are “new economies.” And it looks at different processes and also more advanced technologies. And by those metrics, in 2024, more than a third of China’s economic growth was from the new economy, which had been a quarter before. So, it was the largest contribution of the new economy as far as the data series goes back, which is not that far. And so, basically, I think what’s happening is it’s a transition that’s under way from call it all sectors like say steel or coal or more heavy industry or maybe internal combustion engines, autos, shifting to more advanced technologies.
And that’s very much in line with what the Chinese government is trying to accomplish. But if you just look at the overall picture, it might give you a confusing view of what’s really happening under the surface. And I mean, I totally agree with your point, Andrew, that about a year ago, there was the sort of peak China argument, and it was really around the time of, I guess, DeepSeek is, I would say, the biggest inflection point where people realized – “Oh, wait, we forgot China actually is very good at innovation, and they’re actually quite competitive in this thing that we were betting trillions of dollars on in the U.S. market.” And I think the vibes have been somewhat steady since then. Another thing is the Chinese government leadership doesn’t seem all that worried about growth, certainly compared to what you would have expected, say, a decade ago.
And I think that has sort of suppressed the emphasis on the macro slowdown and boosted hope in this sort of micro resurgence.
Andrew:
Yeah, you make a ton of great points there. I think I want to pick up on the last one quickly. Just a thought is, you know, we look at what I call the reaction function of the Chinese government. So, you’ve done all this data. Not sure, in many cases, where and when to trust which data. But my kind of general stance is if the economy’s cratering, the Chinese government’s going to react. They’re going to support various sectors. And the fact that they’ve been so chill, basically, in the face of the past few years of geopolitical volatility, the pandemic, I guess you wouldn’t really call their response to the pandemic chill but keep it to the geopolitics.
And then, especially in the face of the trade war, this very patient, deliberate response, I think, at the very least, says a lot about their confidence. Maybe that confidence is misplaced, but their confidence in their ability to manage through. And, secondly, to your point, this idea that, well, you know, actually we’re just more comfortable in a lower growth environment. I guess the question I wanted to pick up on that is kind of a, I don’t know, I feel like an obligatory question is, what’s your take? You started off saying kind of macro versus micro. You said you look at nominal GDP. I do the same because I think it’s actually a pretty good read on the cyclical growth front.
What is your read at this stage? It’s old school conversation, but how much we can trust kind of GDP statistics when thinking about where China is. And I’m sorry, you’re smirking for asking that question, but we got to ask it.
Gerard:
You’re opening a can of worms.
Gerard:
Well, let me first say, with others, I would avoid the conversation because I found that it results in data nihilism, which is that if you say there are issues with the data, people would then will say, “Oh, I can then use it to believe whatever I want or just ignore it.” It’s usually on the downside, but sometimes on the upside, right? And in D.C., people say, “Oh, we don’t trust our data, it’s not growing at all.” I take the data for what it is. I think their data has gotten much better over the past two decades. I think nominal GDP, insofar as how they calculate it in the sectors of surveying, which is a caveat, is fairly accurate, and it does reflect some of the trends.
I think there’s questions about real GDP, which is why I don’t deal with it. Part of the time I deal with the deflator. But I think basically the economy, even if you’re just using official statistics, can tell you a pretty compelling story. And, for some of that, you have to go below just national accounts, things that may be less politically sensitive – looking at PMIs, looking at investment data. And what it shows you is there has been a massive contraction, a world historical contraction in the property sector. And it also shows you that if you look at PMI for employment, just not businesses, which I like because I find it more variable than looking at headline unemployment rates, what it will show you is that China’s employment in manufacturing is down a little bit over the past few years, but it’s not that bad.
Services are down a fair amount actually over the past year or two. And that to me is a big economic story. That’s where people are feeling the job pressure. And then if you look at construction, that is tanking, but that’s what you would expect from the slowdown. But because it’s roughly, 60% or something of employment is in services, that’s what you should really focus on. So, to me, it’s a macro economy that looks fairly resilient on the surface. But if you look at how people’s incomes or their jobs are, it’s not that great. And that was when Jude Blanchette and I were in China two months ago, and we were definitely getting the vibe there that was fairly negative. People felt like there was a lot of the job pressures and young people struggling to find jobs.
Andrew:
That’s the perfect answer, I just want to say, because when anyone, and this is like just a little old man wisdom for the listeners out there, when anyone asks the question about China’s statistics, the answer, only knowledgeable people will be able to answer with, well, here are the statistics I trust and why. I know the methodology. I’ve looked at both of the things I like about it, and maybe the deficiencies of various indicators. I think you make a great point on the calculation of nominal GDP. And then, of course, you went through some of the subcategories, some of the sub industries. And you also made a great point about why nominal GDP basically tells a story that makes sense, and also a good point about why real doesn’t. And people are kind of stuck on this idea that, you know, real GDP is a political target and so it’s untrustworthy. Well, of course, it doesn’t matter. So, let’s just toss that aside. But people use that to say, “Well, you just can’t trust anything. So, I’m going to say whatever I want about China’s economy.” Excellent answer. Excellent answer. I want to pick up on your last point because that kind of dovetails with things Dinny has been saying over the past couple of weeks in some of our research.
Dinny, what are your thoughts on Gerard’s point about macroeconomically, even though the numbers are soft, you see a pretty resilient economy? But there’s certain pain points, like in the service sector, where it’s really hitting employment and confidence. And so, the economy doesn’t feel good for people. Are you seeing the same thing?
Dinny:
Yeah. I mean, taking what Gerard was saying about their really being to economies at the moment, it’s both strong and weak at the same time. I mean, I thought along the same lines, but again, from a different perspective, but sort of what, again, along the lines of what Gerard was talking about, like specifically from outside of China, regardless of what you think about 5% GDP, whether it’s real or not, from outside of China, it looks like it’s going gangbusters. I mean, this is kind of the first time ever that we’re looking at major new Chinese brands emerge and new industries. I mean, that’s new. For China to come out, we’ve got BYD and bunch of the battery, you know, CATL, the battery companies. I mean, this is kind of new. China’s exports are going gangbusters. It’s dominating new industries.
It looks like it’s going from strength to strength. And yet inside of China, no one’s kind of feeling that. It’s kind of difficult to sort of put your finger exactly on how people are feeling. But people are worried about their job security. Companies aren’t making profits. The government isn’t generating tax revenue, which is mind blowing for, on one hand, for the government to be saying that the GDP, real GDP is growing at five point something percent. And yet the tax roll has been negative for most of the year. I mean, that’s absolutely mind blowing. You’d expect in a recession period, that’s when taxes shrink. But on one hand the government saying, “No, no, everything’s fine. The economy’s going right.” And it probably is because you see all these this incredible export machine, import substitution going on.
So, it is in a really weird situation that, on one hand, it is both strong and weak at the same time, that the sheer output of its industrial machine is going from strength to strength and yet no one’s really reaping the benefits of what you would expect from a strong economy, which is job security, rising incomes, corporate profitability and rising tax roll.
Andrew:
Yeah, I mean, there are contradictions here. And I guess that’s one of the questions is like the growth is happening, but in some ways it’s very unhealthy. We’re not seeing kind of the positive outcomes or benefits of economic growth and economic activity that we’d normally expect. We will get into the challenges that the economy is facing more later. It’s always tempting to start there because they’re so clear and obvious, and that’s sort of where the conversation tends to go. But Gerard, I do want to bring us back to have you dive in a little bit more to what is going well in the economy. You talked a little bit about the New Economy Index and how that’s providing an increasing proportion of growth, which is positive for China’s economic structure. But talk to us about what the other strengths you see in China’s economy right now.
Gerard:
I’d say is broadly two things. It’s technology, which we mentioned, and exports, which is related but is mostly independent of high tech. The positive framing is that China’s export growth and export resiliency has been much greater than most would have expected, particularly coming into the U.S.-China trade war, which was quite severe, you know, circa April and May. The negative framing is that that is really the only part of the economy in a macro sense that is doing well. It’s increasing share of the work in terms of growth. Consumption has been below trend in terms of this growth. And investment, which we’ll get into more, but that might be slowing down even more of late, possibly due to the anti-involution campaign.
And so, it’s becoming more unbalanced in the sense of relying more on external demand and also through cutting prices for exports which you can see in the data. On the other hand, there are Chinese goods like BYDs or DJI drones or robots and other things that are just clearly world class. And it’s misleading to say that that is just a function of excess capacity or subsidies. Like, no, no, no, they’re really good, very competitive products. And those companies are going to remain strong. So, I guess even in the Chinese stock market, they’re having their own boom in recovery of the stock market this year. But a lot of that is driven by tech just like it is on the U.S. side. The Chinese side is more on hard tech, but it’s also AI related. So, it’s, I’d say, a really narrow sliver of the economy is doing well. But on the other hand, that is a sliver of the economy that the Chinese leadership probably cares the most about.
Andrew:
Right. And we’ll get into this in a little bit. The kind of the gamble is buy as much time as you can so that that sliver becomes a bigger and bigger and bigger chunk of the economy while offsetting the old parts of the economy. The point you made about BYD, I love it. I think that’s great. And I have made this point before on our pod, but sometimes I say to people, careful what you wish for in terms of what you’re asking China to do. Like, for years, we said, China needs to move up the value chain.” Now they’re moving up the value chain, and everyone’s like, “Whoa, whoa, whoa, back down, back down.” But if we want them to reduce overcapacity in the NEV| sector and consolidate to, say, three four NEV companies, and it’s BYD, and it’s XPeng, and it’s three amazing car companies that have the best cars in the world.
They’re just going to dominate everyone. And in fact, like maybe the overcapacity requiring BYD to compete on this insanely value distracting or value destroying way domestically is kind of hamstring BYD in a positive way for its external competitors. I don’t know whether you have any thoughts on that observation.
Gerard:
Yeah, to put a fine point on it, just looking at EVs, whatever the outcome of the anti-involution campaign, and assuming there is some consolidation, there probably will be certainly more than three. It could be up to a dozen or whatever of fairly large market concentrated, profitable EV firms. Those are the firms that are already exporting. So, you can say there’s like 100 plus brands of EVs in China. Most of those are not that export competitive or they have very small markets. If you consolidated all of that, they just create only the bigger firms as the last firms standing. Those are already the ones that are the international markets. And what you would have done would have been to boost their margins and make them even more competitive, including having resources for R&D.
So, I think a Chinese industrial sector that is successful in terms of the anti-involution campaign is one that is going to be, certainly in the medium term, more competitive internationally.
Andrew:
Yeah. And so that’s just something that we should keep in mind here in Washington, D.C. as people think about policy towards China while we’re trying to nudge them towards in terms of various policy adjustments. But I do want to go back now to the export piece because you mentioned that is one of the strong, very robust strengths of China’s economy currently. And that’s kind of surprising, right? Because we’re in the middle of this trade war. The U.S. and China have been in a trade war since 2018. And since April of this year, it’s become much more intensified. And kind of I feel like for the past seven years, I’ve been writing a monthly note that sort of like, well, China’s exports have held up, but the shoe’s about to drop. But they kind of keep going from strength to strength on this. And you’ve done a lot of work looking at their ability to shift to new markets in the face of a reduction in exports to the U.S.
And you’ve found a lot of this is not just transshipment to the U.S. through other markets, but it’s actually they are opening new markets and selling goods to other places rather than in the U.S. Talk us through some of your observations on that front.
Gerard:
Sure. So, the top line figure that people will talk about is looking at headline GDP. And you can observe that there was a contraction in China’s exports to the U.S., but it was a more than that, expansion in Chinese exports to other markets. But then the question is, okay, how much of that, particularly in Southeast Asia, Europe or elsewhere, is really just demand that is shifting and is actually going to end up back in the United States or is just a temporary fix and it doesn’t actually show resiliency? So, what I try to do, and I did this in that China Leadership Monitor piece, and I updated the data recently, is to look at China’s trade with various regions. But look at it at the HS six trade level, sort of fairly granular level of trade. And, basically, to be a little bit wonky, what I did was from April to July of this year, compare China’s change in exports across all the specific categories to its change with the United States, so seeing where its exports to the U.S. dropped, and then comparing it for the same level with the same categories, where it’s exports in the same things grew to those other areas.
And what you see is basically China, for the specific goods, appears to have essentially replaced about 80% of the demand with alternative markets for the things that lost in the U.S. market. But then the next question is, okay, but let’s just say this now sending more laptops to Vietnam, is that really just going to go to the U.S.? What I do was check the U.S. import statistics to see, is the U.S. importing more of that same good from the region that Chinese exporting more to? To sort of very approximately test for transshipment. And what I found is about 20% of the trade that was being apparently diverted from the U.S. market to these other regions, only about 20% of that is “potential transshipment.”
And I would treat that as an upper limit because this is not super granular. Now, it is true that that number for Southeast Asia is 63%. So certainly the U.S. is justified in looking at Southeast Asia as the primary potential hub for the shifting of trade. And there’s discussion about this and how we’re going to handle our tariffs on Southeast Asia. But by and large, it looks like most of China’s export growth to other markets is not anything like simple transshipment to the U.S. It is finding alternative demand. But the two caveats are is part of that could be inventories that are building. It could be sort of a temporary effect. Every month it goes by, I become less confident. Just a temporary a factor, more confident is resilient. But it’s one thing to keep in mind. And the other is that they’re cutting prices. So, what you can see is just the total goods. But when I don’t see in a trade data is the health of the firm that is doing the exporting. And the Chinese government doesn’t publish statistics, at least that I’m not aware of, that would allow you to aggregate sort of micro level exporter health.
And I suspect those margins are very poor or tight. So, it could be that, yes, they’re finding new markets. But how do you make a market clear if demand goes down? Well, you cut the price, right. And that means your margins go down. So, it’s resilient at least at sort of the macro level. But the micro level was more problematic.
Andrew:
Yeah. Those are great observations. And most of our listeners will know who Gerard DiPippo is. But if you don’t, he’s a great follow on Twitter. You can see he highlights a lot of his work there and the ongoing updates to this export work. So, at the end, we’ll have you throw out your Twitter handle so people know where to find you. Dinny, what are your thoughts on the sustainability of this export machine that we’re seeing out of China? And Gerard makes a great point of, yeah, they’re pivoting amazingly quickly, but it’s also quite value destroying because they are having to absolutely slash prices in order to keep up the momentum.
Dinny:
Yeah. Look, first I just want to say the data work that Gerard did in the China Leadership Monitor piece is excellent. I mean, just to be able to visualize exactly what’s happening with the export prices in the various sectors, just where the trade flows are going post tariffs, it’s a great piece. Yeah, if this is something you’re interested in, it is well worth your while to check out the link in the show notes. The only thing I’d really add to this is, I mean, this is really the way of the future. I mean, the way that I say it is that China’s investment in innovation, it’s expansion of industrial capacity, I mean, this is not slowing down at any point in time. I mean, this is just hard baked into their economic model at this point.
And I think the real challenge is really going to be, not just to the United States, but any country with advanced manufacturing. And the reason I say that is because, I mean, just based on my last experience when I headed home to Australia for a couple of weeks, Australia doesn’t have the same sorts of hang ups about what’s happening in China’s industrial machine as, say, the U.S. does or the EU does, or Japan does. Manufacturing just isn’t as important to the Australian economy as it is to any of those other places. Australia used to have a car manufacturing sector, and I think we kind of hung on to it until, I’m going to say 2017, when the government said, “Look, we’ve been propping this up with subsidies for far too long.” And so, Australia used to produce Fords. It used to produce Holdens under the GM badge, used to have component companies.
It’s got none of that anymore. And so when I go to Australia and I rent a car for a week, about half the options are Chinese vehicles, and no one kind of bat an eyelid because they’re all getting imported anyway. And these are good quality and they’re cheap. And so what does it really matter? And so, you’re kind of seeing exports of Chinese vehicles in Australia rise aggressively. And then you’re seeing same sort of thing in places like Israel and elsewhere in the Middle East. What it comes down to is if you don’t have an advanced manufacturing sector, you’re not going to worry so much about what’s happening in China at the moment because the past wave, when China was a low end manufacturer, I mean, it was competing against Southeast Asia and anywhere else that was kind of wanting to make textiles or clothes or shoes or furniture or whatever.
But now, it is unabashedly moving into the top end. And it’s not just moving into the top end, it is creating the products in the industries of tomorrow. It is moving into industries that don’t even exist at the moment. You read the Chinese press, and it’s all about flying cars and humanoid robots. No one’s buying that stuff anywhere in the world yet, and that China’s trying to position itself to be the world leader in those products. And so for the rest of the world, ex-U.S., ex-EU, ex-South Korea, ex-Japan, the challenge of what China’s presenting doesn’t seem so bad, but what that also means for those countries is up until now, to the extent that you’ve been buying stuff from the EU, Japan, and the United States, increasingly you’re going to be buying Chinese products.
And I think that’s the biggest challenge at the moment for any country with advanced manufacturing. You can defend your own market to a certain extent with tariff barriers, non-tariff barriers, but it’s your market share elsewhere in the world, which I think is just going to get eroded more and more.
Andrew:
Well, I’ll have to put a pause on that, because I don’t want us to get labeled as just too in awe of the Chinese economy. We were talking about the strengths. I think it’s pretty much inarguable that exports and certain areas of new tech, especially green tech, are those strengths. But now we have to also pivot to the very clear and obvious challenges that Gerard kind of laid out at the high level at the beginning to walk through those to see, you know, what China’s challenges are in terms of getting to this new, fully fledged new economic growth model that it wants to achieve.
I mean, the obvious ones are property and just general industrial deflation. Gerard, walk us through any other challenges, you see and then maybe just talk to us about how you think about property. Then we’ll go into deflation and kind of the whole involution thing.
Gerard:
I mean, there are this sort of standard structural 3Ds of deflation, debt, and demographics. We’ll talk about more deflation. Debt you’ve discuss with Dinny. I know you wrote a book on this. I think something that’s may be less appreciated in the discourse is that if the government in China is optimizing for productivity, particularly for industrial productivity, and I think making progress, and they’re also heralding the fact that they have these dark factories and just you can produce things with fewer and fewer people, job growth in China, over the past decade or so, has been mostly in the service sector. Most of the economy is, in fact, the service sector, despite the fact that the 14th five year plan, which is the one we’re wrapping up, said to keep the manufacturing share the economy basically steady. It is down a little bit relative as a share of the economy.
I also think the more efficient China becomes with these technologies and the manufacturing side, the smaller the share of the economy, but certainly of employment of manufacturing is going to be. And that’s in part because as countries get richer, they spend more and more of their consumption model on services. That is already happening in China. So, they are pushing it… they’re sort of optimizing for one sector. But then the one that is actually the biggest part of the economy is one where I think the trouble is going to arise. And so I think over the past decade, the job growth was in services. The fact that the PMIs this year show that the job losses are in services is a problem, particularly when the government is explicitly trying to automate manufacturing.
And yes, they have a demographic problem, but the population in China is not collapsing. And in fact, the population of educated Chinese is growing. So, this is, to me, a both cyclical and structural problem that is probably not getting enough attention.
Andrew:
Well, I want to throw this to delay, and maybe you guys can have a back and forth on this. He’s floated this idea that I think is right, but see if you agree with it, Gerard, and Dinny you can lay it out for us that I think the Chinese approach to growing services is in the wake of manufacturing. It’s like if you get manufacturing right, then what comes along with it? Legal services, sales services, you know, accounting services, all these other services jobs that should flourish in the wake of an ever more profitable manufacturing sector. Dinny, did I get that right? And is that how using China is approaching it?
Dinny:
Yeah, I don’t have anything to add. I think you kind of nailed it.
Andrew:
Oh, well, I stole your thunder. I’m sorry. Okay.
Dinny:
No, it’s okay. I mean, but just to give an example, you look at auto companies, I think in a lot of auto companies, more than half, maybe a bit half than less of the workforce are doing all the things you just talked about, sort of marketing and after sales service and R&D and finance and legal, I think that might be the vision. But, certainly doesn’t feel like we’re there yet, but I think that’s the vision.
Andrew:
Well, NEVs are in large part software that you’re buying, not just hardware. And so there’s a whole software ecosystem around that and maintenance around the software and updates and things like that. But Gerard, react to that. Do you think that characterization of how we think China’s approaching this is correct? And, secondly, is it good or bad or…good or bad is wrong way to put it, but will it work? I guess is the question.
Gerard:
I agree with that. I would also add that their focus on services is often on enhancing the quality of the services. So, it’s the idea that it’s not that people don’t have money to buy services, it’s the services that they want are not sufficiently in the market. So, again, treating this as a supply side problem rather than as a demand side problem. Will it work? It’s going to work in some sense. I mean the system is going to balance. I also try to avoid sounding like a 1A, like, “Oh, where all the jobs in they come from?” They’ll emerge. Markets adjust, including in China. But on the other hand, I just think that they are neglecting the biggest part of the economy and also the most distorted by the state sector.
So, in DC, some people will say, oh, that, you know, China’s markets really protected. Actually, its manufacturing sector is quite open. It’s just the problem is hard to compete with it. It’s the service sector that’s quite protected. And there are things like the financial sector that is largely state owned in China, or health care or education or media, right? Those are things you consume more and more of the richer you become. And those are areas that I think are going to be more unbalanced because of the state ownership role. And just to throw in another curveball, I’d be thinking about this in the context of AI, which is that if AI is as good as the Chinese government hopes it is, and AI boosters want to believe, and I think they’re probably right, at least directionally, the weirdest effects are going to be in services because we’ve already seen automation in the industrial sector in China.
I can sort of just extrapolate what that looks like. But what do you do if you say ICBC, one of the big five banks, is fully automating all their services? But they are also a massive employer that have social stability mandates. Are they fully going to internalize the labor productivity gains? My guess is no. I think they’re actually going to basically install the systems similar to how in Chinese retail banks there’s like an automated thing, but then there’s someone that helps you poke which button to push. So, I think it’s going to be more of imbalanced between sectors that are truly competitive. And those are the ones where you’re seeing a lot of the involution problems, like e-commerce is private sector, right? But it’s also viciously competitive for the margins of razor thin or even negative.
And then there are other parts like health care, like finance, other big parts of the service sector, or even laws, as Dinny mentioned, like those services are regulated in China. So, I think those imbalances that are also sort of political and regulatory are ones that are going to have to be addressed as the shift occurs.
Andrew:
It’s a very good observation, and I’ll just have you maybe follow up on it with, I know you’ve also done work with your colleagues at RAND on China’s industrial policy as it relates to AI. And Kendra and I, another colleague of mine, and I talked a lot on this pod and elsewhere, about how China’s real focus for AI is diffusion into really real economy processes, manufacturing, industrial processes. That’s really where they’re focused. They don’t really seem to have a plan. The discourse in China is not about how all these white collar workers are going to lose entry level jobs like it is in America, right? That all the lawyers are in trouble and, you know, all the consultants are in trouble. This is about how do we get it into manufacturing? And that’s the conversation in China. Is, are they just missing that entirely, you think? And that maybe it comes to bite them later or?
Gerard:
That is a great question, and I’ve been wondering about. In fact, I am going to launch a project on that in RAND, which is doesn’t exist yet, but I want to look at the discourse and just sort of objective analysis about potential AI labor displacement effects, or just effects in general, maybe negative in China versus the U.S. because the discourse is quite different. So, the big thing I think ism at least sort of the policy intellectual level in the U.S., I think Kendra probably said this, but the U.S. has a pretty large contingent of this, AGI built. I don’t think the CCP is a AGI built. They’re just sort of like, well, we’re all about incremental technological improvement. We love technology as a matter of development policy.
This is just the next thing, but it’s also general purpose technology. As such, we’re going to treat it as something we want it diffused throughout the economy, across all industries. We set targets for diffusion, which is what the AI Plus point has. There is one line in the AI Plus point update from a month and a half ago that mentions labor and wanting to study more. But it has not being a focus of the discourse because I think they’re so focused on production and productivity. It’s also a more optimistic view. I think in general, there’s more pessimism and just pulling it back to stop in the U.S. because… It could’ve just been, somewhat, the effects of censorship in China. But also I think that Chinese people have seen development in technology as being a clearly good thing over the past 30 years, whereas the U.S. are like we’ve lost some manufacturing jobs, and some things are not so great.
So, it’s a different mentality. I think they probably are missing part of the equation, and they’re going to have to respond to it in a way that is probably not currently in the plan, so to speak.
Andrew:
Yeah, we’ll look forward to that work that you set up. Yeah, that seems like a big hole to be filled. And I haven’t really seen anyone talking about that kind of conversation as it relates to China. So, we’ll look forward to that. You mentioned, well, we’ve mentioned it a few times, involution. Great point that you made on involution really being this price competition, which is basically what they mean by involution, is not just in NEVs, it’s not just in batteries. It is also in the food delivery market and things like that in the services sector. Dinny, a little bit of a curveball, but can you set the stage for us on kind of the conversation around involution in China? What generally do we think the government means by that and what they’re trying to achieve in their anti-involution push?
Dinny:
Sorry, that one’s for me? [laughs]. What they’re trying to achieve is, you know, I think the problem is, well, the thing that concerned about is the way that we kind of say it is that in some ways you can divide the problem into various different sectors. You’ve kind of got the sunset industries, you know, industries that have been disproportionately hit by the property sector, like steel, aluminum, glass, construction machinery, even household appliances. They’re dealing with problems whereby domestic demand is unlikely to ever come back to what it used to be. So, you kind of have to deal with the capacity issues there. You’ve got the sunrise industries where you have EVs, batteries, any sort of new technologies where local governments have perhaps been overenthusiastic with their support policies, which is kind of driven a overexpansion or overinvestment in capacity.
And then you kind of have it sort of popping up in a bunch of services as well, whether it be the courier sector or the food delivery sector, or even look at airlines at the moment. I mean, airlines apparently flights are full, but none of the airlines making any profits because they’ve invested in planes. Som it really it’s kind of all throughout the economy. So, ultimately, what they want is they want to be able to get to a point where everyone’s making profits again, but they want to do it with a minimum of economic disruption. And so, that’s what they’re trying to work through at the moment. How do you do it without closing a minimum of factories? Yeah, I mean, that’s really what it comes down to. How do you do it-
Andrew:
Basically, without boosting unemployment significantly. Exactly right. Yeah, okay. Well thanks for that and sorry for putting you on the spot there. But I think you laid it out well. I think the interesting piece here, especially we work with a lot of investors, and they’re trying to figure out like what is the policy plan here? And the question is, is the anti-evolution push, or the push to basically return large swaths of various parts of the economy to profitability and to reduce what I’d say is value destroying competition in various industries, how much is that reminiscent of, say, the last time China went through extended deflationary cycle that ended in 2015, 2016, which was really more purely about classic overcapacity?
So, is this an overcapacity story or is this something else? I’ll ask you, Gerard, where do you come down on that question? And then, secondly, the question everyone’s asking is how serious are they about addressing this issue? There’s a lot of talk at the highest level of the policy apparatus, but not a ton of policy action, although at least in my view, we’re starting to see the early stages of it. So, where do you come on the first question of value destruction versus overcapacity? And then, secondly, how serious are they about addressing the issue overall.
Gerard:
Whether the anti-involution campaign is the same as excess capacity reduction efforts in the past is a contentious question. I think the answer depends largely on what sector you’re talking about. I think there’s a Venn diagram. There are some sectors where I think it’s pretty clear, reducing competition means reducing the number of firms and therefore reducing capacity. And, therefore, there is a sense which it is overcapacity, but it’s not exactly the same because it’s not just about quotas on production. And there are others like, say, e-commerce, where I think thinking about overcapacity is probably the wrong framework. It is just there’s too many firms because it is a service, right? So, part of what’s different is that ten years ago when they had the supply side structural reforms and there were excess capacity reduction efforts concentrated in steel, aluminum and coal, those were heavy upstream industries. Right?
That is still happening, actually. I mean, you guys just wrote about how there’s the non-ferrous metals plan that came out, I guess, yesterday, but there’s also a large service sector side to this. And even in the manufacturing goods sector, it’s more about final differentiable goods with branded capacity. So, it’s a different beast. So, I would say it’s related to overcapacity. The Chinese government is trying to avoid saying overcapacity because I think that feeds into Western narratives. But there is some overlap there. I think it’s also worth keeping in mind that the previous cycles of overcapacity, say, from 15 to 16 were addressed, I think, more from the demand side than from the supply side. It was that there was a recovery, particularly in the property sector, that pushed prices back up.
They don’t seem to have a plan to do that this time. And so if you really are going to treat it as a pure supply side problem, the supply side solutions have to be more severe. The industry consolidations have to be more severe, all sequel. Are they serious? Well, if you’re serious, then it depends on a sector. You have to be serious about consolidation. You can’t just tell everyone boost your margins. It has to be, well, some of these firms have to die. And some of the ways you’re going to die would be you improve bankruptcy law, which has gotten better in China. You improve M&A, which is not anywhere like it is in the U.S., but it’s still getting better in China.
But it’s also, as Xi Jinping has mentioned, about breaking through provincial protectionism. Because I think a lot of what some of this has to deal with, particularly in strategically prioritized sectors, including the new trio or anything that’s explicitly a national target is most provinces want to get in on the game because that is the priority, right? That’s part of their KPI. But the center doesn’t seem very good at saying — no, no, no semiconductors. Those are definitely a priority. But all of these four provinces should be involved in this. I think with EVs, it’s a much bigger problem because even going back to now third front, like every province had its own auto sector in some capacity. And now they all have their own local EV champions.
That means it’s not just for companies — certain provinces have to lose. And I think the tricky part politically is that the center is going to have to make choices to adjudicate this. And it can’t actually be resolved just by market forces because it wasn’t just market forces that caused it.
Andrew:
Great observations. I’ll throw another wrinkle in there that we haven’t talked about yet. So, you mentioned the sort of growth plan for the non-ferrous metals sector, which was released this week, that’s the 2025/2026 plan, short term plan. Usually, in China, the shortest we see is three years, right? A three-year battle to clean up the blue sky or to clean for blue skies or whatever. Three-year action plan is pretty common. We don’t usually see kind of a 15 month plan. That’s the third growth plan for an industry 2025/2026 that we’ve seen in the last week and a half. The other was, I think, building materials. So, three plans so far, all released pretty quickly. To me, that’s like a sign like, okay, these 2025/2026 growth plans are kind of the way we’re going here.
Interestingly, in those plans, one of the key observations we’ve made, or at least our analysts have made is they’re really not focused on capacity at all. It is kind of about trying to strong-arm these industries to boost their value added to boost profitability. And so, as Gerard just said, it’s easier said than done, but that seems to be the approach for now. And that the wrinkle for me, Gerard, that we haven’t talked about yet is that Dinny has pointed out part of the new economic model is not just dominating new technologies, it’s really improving existing industrial processes and manufacturing industries. So, industrial upgrading of existing processes and industries. Do you agree with that? And, if so, would you agree with the idea that maybe the anti-involution push is going to be an early test of their ability to move to this new economic model that they want to put forth?
Gerard:
Let me test this idea because I’m thinking out loud. The non-ferrous metals action point you mentioned is interesting because in part, as you said, it doesn’t actually say overcapacity, it doesn’t seem to really talk about reducing the supply side. It talks about moving up the innovation chain. It talks about accelerating projects and green transformation. It talks about expanding demand for things like EVs and aerospace, things that are obviously going to provide demand for aluminum or whatever.
In general, with all government plans, including in China, the more targets, sort of the more goals you have, the less credible it is because you’ll sometimes see, like Beijing will put out a plan for like consumption. They’ll have like 27 points. And I’m like, okay, but what’s the actual plan here? What’s the fiscal outlay? These things, particularly if they’re fairly short term, I’m skeptical that there’s actually a lot of policy leverage and sort of like fiscal firepower to make much of a difference. So, to me, it reads as more aspirational. And my idea that I’m floating is, I was thinking aloud, is one interpretation is that this is a refusal to face the tradeoffs, to admit that just pursuing high tech everything, which is, in essence, what this plan is still saying, is causing some of the problems that they’re trying to address.
And it doesn’t seem to be talking about the hard tradeoffs. So, is it going to work? Well, I guess my meta question is what is the mechanism by which it would work? So, when we look back a decade ago when we had targets to reduce steel capacity, if you debate the data, at OECD we talked about this, of how much capacity steel sector really had in China, but I knew what they were trying to do. In this case, it would be hard for me to answer in six months, is it working? Because there’s not clear targets and there’s not clear mechanisms. And that, to me, is probably a reason to be worried. Thoughts on that?
Andrew:
Yeah, I think that’s a great point. Dinny, do you have reactions?
Dinny:
No, no, I think that’s a fantastic answer.
Andrew:
Yeah I think that their not admitting the problem is a good observation. Basically, trying to show like we’re not going to shut capacity, we’re not going to lay people off. Just wave a magic wand and move up the value chain. That’s the plan.
Dinny:
Yeah, we’ll have our cake and eat or two. Thank you very much.
Andrew:
Yeah, yeah. So, well, in that case then I guess the group opinion would basically be this probably isn’t going to work to stop this value-destroying competition.
Gerard:
You have to pick losers. And you also, if again, there’s no demand or no sort of strong fiscal impulse demand side of this, it’s not clear to me how it’s going to work, how you think in 2016/ 2017 with the property sector had not recovered, we would have a more negative view of the supply side structural reforms. And in this case, because the property sector is so important, not just for the sort of related parts, but also for overall business confidence, consumer confidence. They seem to have no plan to address that. And certainly in 15 months, they seem to be… some Chinese economists are talking about it being another five years, or Yao Yang at a piece that came out recently that was in the Sinification Substack that talked about China being in this era that will last through 2035.
That’s like a lost decade, right? Or longer than that. And if that’s going to be how you deal with that kind of deflation is, is a bad deflation. So, deflation can be caused by productivity gains. And just things are getting cheaper because you’re getting better at it. But there’s also a demand side. And I think in the case of China, it’s more that the supply for many things is growing faster than their internal demand, particularly for manufactured goods can sustain. And you to rectify that. You got to pick losers.
Andrew:
So I think the three of us are on record here saying we don’t think the current plan for ending it, involution as currently constituted, is going to work. So, in 15 months when prices are up, consolidation has happened and involution is a thing in the past, everyone can throw this recording back in our faces, but we’ll see. I think we’ve actually diagnosed this one correctly. You’ve been really generous with your time, Gerard, so I don’t want to take up too much more of it, but I do just want to end on this kind of bigger idea of where we go from here. We’ve talked about basically that what China is trying to achieve is to take these really innovative sectors that are a small sliver of the economy and make them bigger, bigger and bigger parts of the economy and then upgrade traditional industries as well, and then rely heavily in some way on exports as part of that process.
I thought you put it really well in your recent paper for the China Leadership Monitor that I mentioned at the top when you said, “China’s strategic patience reveals Beijing’s fundamental gamble, except short term economic pain to build long term technological dominance and self-sufficiency. The leadership believes that the emerging high tech sectors will ultimately replace both lost export markets and the crumbling property engine.” Great. Well stated, and I think aligns very much with our view of kind of what they’re trying to achieve and how much of a gamble it is. But my question for you is, do you think this gamble was going to pay off for them?
Gerard:
I think you have to ask, what is it they’re trying to achieve to know whether it’s paying off? And I think that there are maybe two primary ways of answering that, which is that the goal is self-reliance or self-sufficiency that is largely driven by national security concerns, including fears of containment from the U.S. and others. And, in that sense, I think it is working. I think they are building up their resilience. So you could debate different areas like lithography, maybe not, dollar reliance, a little bit, but not really. But other things like EVs or a lot of other technologies.
Drones, like, yeah, they’re making a lot of progress there. But the second framing is a more developmental perspective, which is one that goes back a long time for the CCP, which is very non, I think, is use a phrase techno fetish. That they think technology solves all things. And that’s where I have more doubts, and that it may not solve a as a driver for broad-based employment that is satisfactory to a lot of people. It doesn’t overcome things that are being overlooked, like the fact that they launched their three red lines policy on the property sector without having any meaningful plan. As far as I can tell, the deal with the local government financing effects. Like, that is a just languishing part of reform that no amount of techno optimism is going to resolve, even if it means we’ll get better tax collection or whatever.
And so, I think, insofar as they see it as a growth driver, it’s not wrong. But I think it’s sort of missing the broader picture. But I do think from a security perspective and sort of international leverage perspective, yeah, it’s working.
00:51:02:13 - 00:51:27:01
Andrew:
Again, great framework for thinking about this. I want to have Dinny lay out a couple of things in terms of how we’ve been sort of workshopping the metrics that will be watching to see if we think they’re on the right path to achieving this sort of new growth model. Dinny, can you lay those out? And, Gerard, I’ll have you kind of let us know your thoughts on whether those are appropriate, and then we’ll let you have your day back because, again, you’ve given us a lot of time here. So, we appreciate it. So, Dinny, what should we be watching to see which metrics will help us understand where this is going?
Dinny:
Yeah. Well, I’d say that, I mean, for years, we’ve kind of looked at the pace of growth because growth has been the be all and end all in terms of generating employment and sort of meeting the social contract. Yeah, rising tide lifts all boats, that sort of thing. But I think we’re now at a point where the things that really matter in terms of China’s got a rapidly aging population, the burdens on the state are invariably going to rise because of pensions and health care, but with a shrinking workforce, you can’t just arbitrarily raise the tax burden on them. I mean, Xi still kind of holds to his vision of common prosperity. So, you’re trying to create a more affluent nation all around, of soaking in the working age population just to kind of help the aged. So, you kind of have this situation where ultimately the new model of the future economy needs to be able to raise incomes, it needs to be able to expand the government’s ability to tax.
It’s got to be able to raise the nation’s wealth, just generally speaking. And so, the things we’re kind of looking at is less nominal or real GDP. Increasingly, it is the ability of firms to generate profits, because if they’re profitable, then they can pay out more in taxes. And additionally, if they’re profitable, two other things happen as well. They’re able to pay more in salaries and incomes, and they’re able to pay out more in bonuses. And additionally, assuming that they’re listed, their stock prices will rise, they’ll be able to pay out more in dividends. And that will sort of kind of contribute to middle class wealth, and ultimately be able to replace the property sector as the driver of middle-class wealth.
So, what we’re looking at is things like profitability of the corporate sector. We’re looking at tax revenue growth specifically. Is it growing faster than the pace of economic expansion? And we’re also looking at the debt to GDP ratio because I mean that’s something else that the government’s trying to do. I mean, I think it’s sort of aware that in the not-so-distant future, regardless of how successful this economic transition is, at some point in the next few decades, it’s going to have to borrow aggressively to be able to pay pensions and health care and whatnot. And so, to be able to do that in the future, ideally, it would like to be able to reduce the debt to GDP ratio now. And so, those would be the things that we’re kind of looking at. Yeah, profitability, tax revenue, debt to GDP, and ideally as well kind of what’s happening with household incomes. Although I think that’s a little bit more difficult to track. So, that’s where we’re at.
Andrew:
Yeah. Gerard, what do you think about that? Just for listeners to take a concrete, you know, everyone can go home and start tracking these data points each month. Are those the right data points?
Gerard:
Yes. I would also add fixed asset investment has a lot of caveats, but it is very interesting to me that we’re seeing an apparent contraction in manufacturing investment and even in infrastructure investment in China over the past 2 or 3 months. I don’t know if that’s some sort of political signal of localities wanting to signal that they are complying with the entire involution. I don’t know how real it is, but if it is real, that’s a very meaningful trend because that’s the three legs of the stool, being investment, consumption, and exports, that would be removing one of them. Property is the other third. Historically, it had been property, infrastructure, and manufacturing. And property is kind of dead at the moment. Right? So, they’re getting rid of that.
So that’s something else to look at. We are about six months away from seeing, hopefully, the outline of the 15 Five-Year plan. Those indicative targets are certainly meaningful in terms of intention. The three, at least three I would highlight, is the obvious one is always GDP growth. Last time they didn’t have one. It was within a reasonable range, and that was because of COVID. If they stick with something like 5% or 4.5% real GDP target, that, to me, will reflect a sort of unwillingness to reckon with becoming a less capital intensive, service-oriented economy would mean in terms of growth. The second is if they still have a target trying to maintain manufacturing share of GDP, or if they revert to what they had done in previous five-year plan, where they were okay with the service sector expanding. And then finally, household income, it is difficult to track, but they do talk about it as a target. And it had been the case in other plans that they were talking about household income growing faster than national income.
Meaning that households would get a bigger share. The last one was basically growing in line with national income. If you really want to rebalance, I expect them to say that household income should be growing faster than the rest of the economy. And I think, whether it’s going to work or not is debatable. But I think as a as a matter of political signaling, those are three key targets.
Andrew:
Well, that’s a great place to leave it because it gives us something to keep tabs on going forward as we monitor all of these developments over time. I have to say, I think it was an excellent discussion today, gentlemen. Gerard, thanks so much for joining us. It was great to have you here.
Dinny:
Hear, hear.
Gerard:
Thank you for having me.
Andrew:
Dinny, thanks as well as always.
Dinny:
No worries, mate.
Andrew:
And thanks everybody for listening. That’s a wrap. We’ll see you next time. Bye, everybody.
