On this week’s Trivium China Podcast, your loyal Trivium team digs into China’s key domestic and regional developments from the past few days.
First, Trivium Co-founders Andrew Polk and Trey McArver discuss:
The Party’s latest conference on law-based governance – and what it tells about how Xi Jinping views China’s legal and regulatory systems
Xi’s motivations in refreshing and solidifying the various rules that govern Party and government behavior
China’s related efforts to build out its foreign-facing legal toolkit
The gents then move on to examine the intensifying diplomatic row between China and Japan – and why both sides are unlikely to climb down.
Then, in the second half of the pod, Andrew is joined by Trivium’s lead macro-econ analyst Joe Peissel to discuss:
The recent, and curious, drop-off in fixed asset investment (FAI) in China, why it’s happening, and what it means for the wider macro-economic growth trajectory heading into 2026
Fair warning: This one gets pretty wonky!
Transcript below:
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 my business partner and Trivium Co-Founder, Trey McArver. Trey, how are you doing, man?
Trey McArver:
Yeah. Doing good.
Andrew:
Good to have you on, as usual. Good to have you in D.C. as well. We have all four of the Trivium partners in D.C. for our annual strategy session, so it’s been great hanging out. But I wanted to have you on specifically, Trey, to talk about a couple of things. It’s been a quieter week in China, which is good. So, we can actually focus on some key domestic things that have happened. So, we’re first going to talk about the Central Work Conference on Comprehensive Law-based Governance, which sounds like a snooze fest. And in many ways it was. But it really is an important thing in terms of understanding some of the governance goals China is trying to achieve.
So, we’re going to touch on that quickly. Then we’ll touch on the growing diplomatic spat between China and Japan that’s been happening over the past few weeks, and kind of get into what the details are of that, what we think the implications are. And then after my conversation with Trey, listeners should stick around because in the second half of the pod, I speak with Joe Peissel, Trivium’s Head of Macro Research, and we dig into what I mentioned last week on the pod — falling investment rates in China.
And Joe really has a good read on what’s happening in the data, why it’s happening, what the policy drivers are of it, and kind of what the outlook is, and how it all relates to macro-economic growth. So, we really get a little weedy, but it’s a great discussion. So stick around for that. But before, of course, we get into the meat of the discussion, we have to start with the customary vibe check. Trey, how’s your vibe, man?
Trey:
Tired. I think, for listeners of the pod, whenever I’m on, it means that Andrew didn’t really prepare the pod, and then he calls me like two hours before and says, “Hey, can you do a pod?” So, we’re kind of winging it here today, but I’m excited to wing it.
Andrew:
We’re keeping it loose. We’re keeping it loose. So, this is what the people want.
Trey:
Yeah. Let’s go.
Andrew:
Awesome. Well, I already pretty much gave my vibe check, which is really thrilled to have all the traveling partners in town. It’s a rare occurrence. We’re a small company spread out over several different countries — pretty much fully remote. So, coordination, especially among the leadership team, is pretty difficult. So, we’ve had a great week, and glad to cap it off with this pod. Just to timestamp things, it’s not quite the end of the week. It’s 3:00 P.M. in Eastern Time on Thursday, November 20th. So, that’s where we are in terms of the information we’re working with. And now we’ll get into, of course, the specifics of the topics that we want to get into, but of course, have to do a little bit of housekeeping as well.
The first thing this week, just a note to listeners, we are not going to have a pod next week. The U.S. team of Trivium will be off for Thanksgiving, so we’ll be back in your feeds on the first week of December. But otherwise, the second thing is, as always, 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, which includes policy towards China, D.C., London vessels, and other Western capitals. 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. I’m going to do an abbreviated version of the housekeeping today. The only other thing to say is, tell your friends and colleagues about us. Tell them about the pod. Tell them about our work helps us grow the business and grow our listenership.
All right. So, we are going to start today with the second Central Work Conference on comprehensive law-based governance — the place where everyone wants to start. The sexiest topic we could come up with.
Trey:
Yeah, we just lost half our listenership.
Andrew:
Before we do that, I will say I think most listeners know this, but we decided when we started this company eight years ago that if we’re going to be digging into Chinese policy documents and Chinese party speak all day, every day, we’re going to have to have a little bit of fun with it. So, that is the vibe we try to bring. But we do think this stuff is important. And so, it can be very dry, but we try to dig into it and try to, I don’t know if humanize it’s the right word, but kind of do it with a little bit of levity. So, just quick a couple of quick details. The conference started on November 18th. Zhao Leji, the party’s third-ranked official, presided over the work conference.
And this is kind of important because the first comprehensive law-based governance conference that took place five years ago was led by Xi Jinping. So, we’ll kind of get into if there’s any meaning there. But talk to us about what this is and why people should care about it, Trey.
Trey:
Yeah. Well, I think the first thing to note about this is that this is the second instance of this conference. And this governing by law or rule by law is an initiative that Xi Jinping has been pushing since he came into power in late 2012. He originally set up a leading small group focused on governing by law, that then became a Central Party Commission in 2018, that then, you know, led to this national conference. And so I think it’s important to realize that that Central Commission exists because that means that there is a dedicated body with a secretariat that is working on rule by law on a daily basis, and then these now quinquennial conferences or the forums in which that work is kind of reviewed and the priorities for the five years ahead are set out.
So, I think the thing that’s most interesting about this, to me, is what it tells us about Xi Jinping. And what it tells us about Xi Jinping is dude is obsessed with rules. And I think that is kind of counterintuitive or goes against some common perceptions of China more generally, and Xi Jinping specifically, because Xi Jinping has changed a lot of the rules of Chinese politics, I think most notably with his decision to stay on for a third term and probably a fourth term, and maybe the fifth term, which was a major departure from his predecessors as general secretary. But I think even that which is often kind of people’s number one piece of evidence about how Xi Jinping doesn’t follow the rules or makes his own rules, I think what’s really interesting about him staying on for a third term is that he went through an elaborate process to actually change the law to make it legal for him to stay on for a third term as president.
So, he may be changing the rules, but he is still following rules. I think that is the most interesting aspect just of this conference is the fact that it exists, and that it tells us that Xi Jinping, the way that he focuses on governing and what he is focused on is creating rules. And those can be laws, those can be regulations. He’s rewritten the entire internal party rulebook. And so, I think that just kind of a bigger point is one that’s really important. And it’s really for us, the work that we do at Trivium, it’s really helpful because what we help our clients to do is to understand what the rules are. And because of the way the system works with regular conferences like this, you can actually see what rules are coming down the pike.
And so, this has been particularly relevant for us when working with foreign businesses because all of the things that you’re talking about on the pod every week — export controls — that is very much an outgrowth of this focus on building out a system of laws, rules, regulations to govern how the party, how the government works.
Andrew:
Yeah, thanks for laying that out. I think those are excellent high-level thoughts. And I think from my perspective it is interesting, I’m trying to think through in real time here what kind of message it sends through the rest of the system. I think Xi Jinping is saying, “Hey, we are going by the book. Now, I have the power to change what the book says, but I’m still going to go by the book.” So, if you have the power to change how the book worked, then you could do it, but you’d still go by the book. But he’s saying, in a way, setting an example all the way down the system to say, “We are playing by the rules. Now, I happen to have the power to change the rules, but that’s what we’re doing here.”
And I think people throughout the system have cottoned on to that. And obviously, like that layers in the whole corruption thing. But maybe you can speak to this, it gets to the heart of, you’ve said it actually a couple times already, rule by law, not rule of law. And that small change from rule by law, or to rule by law, from rule of law, is a critical difference about how we think about rules and laws, definitely the U.S., but in the West generally. Can you speak to that issue?
Trey:
Well, I think it’s pretty simple, which is that, ultimately, Xi Jinping himself and the party more general are above the law. So, they use the law as a tool to govern as opposed to being governed by the law itself, which is how we understand rule of law. But I do think that does, I think, discount a little bit the fact that rule by law does mean that laws play an important, you know, for everybody but Xi Jinping, for most people, except for certain people at certain institutions, it does function very similar to a rule of law system.
And again, I think it’s very telling, to me, the focus on rules is very telling about Xi’s psychology and about how he saw the country and the party when he took power. So, I think if you’re trying to understand what motivates Xi Jinping, I think fundamentally it’s about taking control, imposing control, imposing order because he saw the country and the party as kind of spinning out of control in the years before he took over. It was a time, at least in his view, I think, when officials could do whatever they wanted, there was no kind of unity among the central leadership. There was no control by the former general secretary over other senior officials. It was a time when tycoons and the wealthy could do whatever they wanted.
And so I think if you look at what Xi Jinping’s been doing over the past 13 years, a lot of it has been trying to actually regain control over the party, over society, over the country, and create order where I think before he saw the country kind of sliding into chaos.
Andrew:
Yeah, I think that’s well-put. And I don’t think we need to belabor that point anymore. Yeah, the party is above the law, so it’s not rule of law. That’s the idea of rule of law. Right? Is no one’s above the law in the U.S., but it’s ruled by law. So, they’re using it as a tool to govern. So, beyond that, we’ll just be honest with the people, there was not a lot of interesting developments at this work conference. Just the fact that it happened is important. Save one, which was that Zhao Leji pulled out this idea when he gave his big speech at the plenary session of the conference, saying that the party needs to focus on the need to “strengthen the foreign related legal system and capacity building.”
Now, that is in comparison to five years ago, when Xi Jinping said that the priority was “to coordinate the advancement of domestic rule of law and foreign related rule of law.” So, very much focused on domestic, but also thinking about how it links to China’s relationships with foreign legal systems and foreign countries. But this year, 2025, Zhao says, “We’re strengthening foreign related legal system and capacity building.” Talked to us about why that’s so important, Trey.
Trey:
It’s because, basically, you can understand a lot of this, a lot of China’s creation of what in this readout was called foreign related rule of law, what we often talk about, we call it China’s foreign law toolkit, is very much a response to tensions with the U.S. It’s very much a response to measures put in by the first Trump administration that followed up in the Biden administration’s economic restrictions on China, where basically the big ones would be export controls on key technologies for China. And China in the wake of that, and it was a real wake up call, and the call came out said, “Oh, you know what? We need to have similar tools.” And so over the past few years, we’ve had is this build out of what we call the foreign legal toolkit. So, you have the anti-foreign sanctions law, you have MOFCOM’s blocking rules, you have the creation of the unreliable entity list.
And probably most importantly, and one that’s been used very frequently of late, is you have a build-out of an export control. And I think what’s so interesting about the comment here from Zhao at the most recent meeting is that, you know, in 2020, basically what they said was we need to build out all these tools. Now, what they’re saying is we have these tools we need to get better at using them. And so, I think, again, we look at a lot of what happens in China from the perspective of foreign businesses because we work with a lot of foreign businesses. I think this is worrying for foreign businesses because what it says is all these tools that have been created in recent years that haven’t really been put to much use, that there’s much more willingness to use them going forward. And I think that is a real worry for foreign businesses.
Andrew:
Yeah. And the one thing that you didn’t mention on the U.S. side, you know, you focused on the export controls, but a lot of these efforts really kicked off in response to sanctions by the U.S. government. And sanctions are a little bit less focused on in terms of the U.S. side’s toolkit. But they were very heavily used, sort of the late Trump 1 administration and throughout the Biden administration, and to great effect, right? Specifically on Huawei and ZTE, back 2018, 2019. And so there’s an array of different areas where the U.S. has restricted China, and China is trying to emulate that. Or, well, emulate it, but also fight back against it. And I think a related piece as well is we actually saw this mentioned as well in the 15th Five-Year plan proposals that came out after the fourth plenum a couple of weeks ago, this idea that we are going to increasingly find ways to protect Chinese enterprises interests abroad. And this is very or immediately relevant in the Nexperia case that’s happening with the Dutch takeover of Nexperia and that whole saga. We haven’t gotten into that on the pod, but we’ve written a lot about it. And sort of building out not just kind of coercive capabilities through export controls and things like that, but also the ability to protect the interests of Chinese companies.
And related to that would be long arm or extraterritorial jurisdiction. So, that’s where a lot of this is going. And I think there’s a bunch of momentum here. It wasn’t just mentioned at this conference on governance, but also, it’s tied into the 15th Five-Year plan and all those things as well. Any thoughts on that aspect of it?
Trey:
Well, not really. I mean, I think you’ve summed it up pretty well. I would just underline exactly what you’ve said, right? That this conference certainly did not happen in a vacuum. And I think everything that you’ve just mentioned lays out very well how this is part of a broader trend, and it reflects that trend, and it’s taking place in the context of those broader dynamics with China, the rest of the world, particularly the U.S. long arm jurisdiction, and everything else.
Andrew:
Well, we’ll leave that one there then. But speaking of China’s relations with the rest of the world, another thing we wanted to get into that was of interest this week is specifically China-Japan relations, and there are sort of increasingly intense spat is sort of a, I think, too small of a word, over really action, potential action towards Taiwan. So, what initially happened is that on November 7th, a few weeks ago, the like relatively newly elected Japanese Prime Minister Sanae Takaichi told Japan’s parliament that any attack on Taiwan could constitute “a situation threatening Japan’s survival in.” Now, that phrase matters because it’s not just rhetorical bluster, it’s actually a legal standard that, if met, could authorize Japan to mobilize its security forces.
This also comes, so there’s more context here, like China was already sort of eyeing Takaichi pretty warily since she had come in last month as prime minister because she’s a protege of Prime Minister Shinzo Abe, who is pretty hawkish on China and had repeated Abe’s well-known formulation that “an emergency for Taiwan is an emergency for Japan.” So, China was already kind of not sold on Takeuchi as an interlocutor. And she kind of, I think, basically said the exact thing, things that they were worried she would say. And so here we are. But talk to me about how you’re thinking about this. And if you want to get into the responses from China, you can go ahead and do that. Or I can do that after you kind of lay out your initial thinking.
Trey:
Sure. Well, I think first of all, I’ll just say that I am not an expert on Japan or Japanese politics. So, I have kind of surface-level understanding. But for any of those listeners out there, and I know there are several that do know a lot about Japan, please feel free to get in touch and tell us where we were wrong and correct any things that we’ve mischaracterized here. But I think again, for this one, well, I think it’s actually useful to go ahead and go straight to the Chinese response and kind of understand what has happened in the wake of Takaichi’s statements. So first of all, I my understanding is that Takaichi’s statements were particularly provocative because she did them in Parliament, which means that it was official in a way that statements by prior officials before her, prime ministers had been more in a less formal setting.
And so, that doing this really does in some way move Japan a step closer to creating the actual legal justification for mobilizing its military in the case of any conflict on Taiwan. So, I think my understanding of this is that this is legitimately a kind of escalation on the Japanese side, or something that takes Japan closer than it’s ever been before, to saying that it would intervene in the timeline contingency, which is something that previously Japan, much like the United States, has a policy of strategic ambiguity. This is, I guess, the least ambiguous that the Japanese Prime Minister has ever been. The Chinese, to say the least, were not happy, so I’m not going to get into all of it.
There has been a kind of never-ending screed from all corners of state media talking about how awful this is. You’ve got People’s Daily, you’ve got PLA daily, you’ve got foreign ministry spokespeople, you’ve got the consul general in Osaka all saying this is not okay. But I think the most interesting thing, and what I think is actually going on here, and why I think we are in a very bad place that is not going to be quickly resolved, is that it appears that Xi Jinping himself is really pissed off. And so, we noticed, one thing that has happened is that the Chinese called in the Japanese ambassador to get him a dressing down, so I think the vice foreign minister.
And in the readout of that, it said that the vice minister had called him in ‘under instruction,’ which is a pretty strange turn of phrase and one that we have not seen before. We haven’t systematically gone back and looked at every single statement by the foreign ministry in similar situations in the past, but I think it’s pretty clear who gave the instruction. And I think what you’ve seen is a very coordinated response across all of the party state, including different ministries, including from the state-owned airlines. So, you had travel warnings from the Ministry of Foreign Affairs. You had travel warnings from the Ministry of Culture and Tourism. You had the state-owned airlines saying, “Hey, anybody that wants to cancel their flight to Japan, you get a full refund. No biggie.”
The reason that’s been so coordinated is because this is coming from the very top. And I think the reason is coming from the very top is that, again, the Chinese and Xi Jinping see this as an escalation. But I also have a feeling it’s probably a little bit personal, because a week earlier, the two met in person for the first time. Right? And had relatively cordial relations. Also from the Chinese side, they’ve spent the past, I guess, year trying to rebuild relations with Japan. So, we’ve had a real easing of tensions over the past year. So, again, I actually think that Xi Jinping is just really pissed. And on the other side, again, I’m not an expert in Japanese politics, so what that means is I don’t think China is going to back down.
It’s the type of thing where the only way this really gets resolved is if the Japanese dial it down and say, “Oh, we misspoke,” or do something to try to… the Chinese are not going to give them an off ramp. But I can’t imagine that a brand-new prime minister who I think said this for very political reasons, and to shore up her backing and her standing, I don’t think she can back down. Her first month in office can’t be characterized by a giant climb down to China. So, I think, this reminds me of a few years ago, I think when probably relations go back into the deep freeze. We don’t have any high-level exchanges. I think a bunch of different econ restrictions come back. Already, the Chinese have basically practically banned Japanese seafood imports.
They were in the process of allowing Japanese beef imports, which had been banned in an earlier spat. But I think those don’t happen now. So, we’ll see. But I don’t see much prospect for this getting better in the near-term.
Andrew:
Yeah, and I was just going to point out there has been a lot of rhetoric back and forth, very intense rhetoric, the Chinese consul general, I think, in Osaka saying the dirty neck that sticks itself up should be cut off. The Japanese obviously took exception to that. So, it’s been pretty nasty war of words. But then also it’s being backed with actual action, like you said, re-imposition of export bans on seafood and beef. We’ve seen the Chinese Coast Guard conducting rights enforcement patrols throughout the waters around Japanese-administered and disputed Senkaku and Diaoyu Islands. We’ve seen three PLA Navy warships go through the Ōsumi Strait near Japan’s Kyushu and Ryukyu Islands earlier in the week. So, it’s not just rhetoric.
But the other thing I was going to say is so tensions are high, I was going to say, the one thing I do know about Japanese politics is there’s pretty high turnover for the past 20 years in terms of prime minister. So maybe, you know, that typically that can be an off-ramp, right? When there’s a change of government or even a change, even if at the same party stays in power, if there’s a new prime minister, often China can use that as a chance to reset. So, my point there is saying this could change quickly if there’s a new prime minister on the Japanese side. But I generally agree with you like neither side has an incentive or real opportunity to back off or back down. So, what I really just wanted you to comment on is what does this say more generally about China’s approach to geopolitics, especially in Asia? Because it had really recently been more on a charm offensive. Right?
Trying to warm up ties with Japan, with South Korea, with Southeast Asian nations, you know, especially in the moment where the U.S. is seen as sort of pulling back some. So, is there anything we can read in this instance on China’s broader kind of placement in the region? Does it help their efforts? Does it hurt their efforts? Are they being overconfident? Is this what they have to do? I don’t know, what are just general thoughts there?
Trey:
Yes and no.
Andrew:
Go on.
Trey:
I think that first of all, you shouldn’t read to like extrapolate too much from this in that I think this is a very particular situation. You know, Sino-Japanese ties have a long history, a very particular history. There’s a whole lot of particular issues in that relationship. And this is very much a response to a particular statement by a particular Japanese politician in a particular setting. And so, this tells us a lot about Sino-Japanese relations right now. I’m not sure it tells us very much about China’s approach to the world. That said, the one thing this reminds me of, or the one thing that this does underline for me, or what I thought, I mean, the Chinese have gone hard at this. And I do get the feeling and I think you and I have even talked about this on earlier podcast, I do think China feels pretty confident right now.
I think they feel relatively strong. I think we see this in relations with the United States. I think we really see it in relation with Europe. China is not really in the mood for compromise. It’s in the mood for kind of getting what it wants and being pretty firm. And so I think we see that very much on display here. Now, that said I don’t think that means that they will not, you know, with relations with their other Asian neighbors, including South Korea, Southeast Asia, I think China is going to continue to pursue a kind of constructive diplomacy that seeks to deepen economic and trade, and even to a certain extent, people to people links with all of its Asian neighbors except for Japan. But I also think, should any of those neighbors do anything similar to what Sanae Takaichi has done, I think China will be quick to say that they don’t like it, and perhaps punish that country.
Andrew:
Yeah. Well, this is one that’s going to definitely have some legs. As you said, when it gets up to the big man desk and he’s personally affronted, I think China is going to keep squeezing and squeezing and squeezing. And, as you said, the Japanese, I think, are going to have a tough time backing off as well. So, we’ll see where this goes. I do want to wrap it up there. I just want to point out quickly to people that in the absence of big U.S.-China moves, this is what Trivium does is talk about what really matters in China. If you’re living in Beijing, the view from Beijing, or the view from Xi Jinping’s desk, right? These two issues, law-based governance, his big conference on that and the boiling tensions with Japan are what matter in China this week in Beijing. And so, Trey, I really appreciate you getting on and kind of diving into these issues with me. Yeah.
Trey:
Yeah, my pleasure.
Andrew:
And for listeners, stick around because we’re going to do in the second part of this conversation with Joe Peissel, going very deep and wonky into China’s investment fall off and what that means for the economy, also very domestically focused. And I think he’s got a really unique and, I think, spot-on analysis of what’s going on. So, you want to stick around for that as well. So, thanks for listening to this part, and enjoy the conversation with Joe Peissel coming up right now.
I’m now joined by Trivium’s Head of China Macroeconomic Research, Joe Peissel, to talk a little bit about the drop off in fixed asset investment that’s been going on in China. Joe, welcome to the pod. How are you doing?
Joe Peissel:
Hey, Andrew. Good to be here, man. My second time on the pod. Very happy to be here.
Andrew:
Yeah. Good to have you back, man. As I said, we’re going to talk a little bit about this fall off and fixed asset investment, what that means, why it’s happening. We highlighted a little bit briefly on last week’s podcast with Dinny and I, but I wanted to bring you on because you actually have been looking into this a little bit more deeply for us and are going to kind of try to explain what’s going on. So, for the listeners, this is going to get pretty wonky pretty quickly, but we think it’s an important issue to kind of dig into this data piece and really understand what’s happening in the near term on China’s macroeconomic trajectory in this very important investment piece. So, Joe, there’s been lots of talk about this drop-off of this fixed asset investment. Can you just give listeners a high-level overview of what it is and what’s been happening?
Joe:
Yeah, sure. So, in terms of what it is, fixed asset investment, well, I actually want to say it’s investment in fixed assets, but that’s a really unhelpful explanation, right? When we talk about fixed asset investment, it’s really the purchase, the investment or the acquisition of long-term physical assets that are used in typically in production or operations. And I mean that in the broadest sense. So, that can be everything from purchasing land, building new factories, laying roads, building bridges, buying capital equipment. It’s really a really broad term that encompasses any sort of long-term physical asset. And I think, as most listeners of the pod will know, China’s relied on investment. China’s had an investment, that growth model. For decades, investment has been a key part of China’s economic growth. And what’s interesting is that since June, fixed asset investment has actually been falling. It’s been in the red.
So, we first picked up on this in June, when fixed asset investment declined by a tiny bit of something like 0.1% or 0.2%. This tiny decline. But it’s accelerated. And by October, the decline in fixed asset investment will hit double digits. So, this is unprecedented in China’s economic history outside of the pandemic, of course.
Andrew:
Yeah. So, very rare for fixed asset investment to contract year on year basis at all, let alone contract by 10% to 12% in a given month. So, what’s driving this contraction?
Joe:
I mean, it’s multifaceted. There’s a bunch of different factors behind this. So, I think broadly there’s 3 or 4 things that are driving this. And I’ll start with the first being real estate. That’s the most obvious. So, China’s had a real estate downturn since 2021. The real estate sector has been shrinking, so for four years now, including real estate investment. And real estate typically encompasses about 20%. It’s about one-fifth of China’s aggregate fixed asset investment. And it has been declining for four consecutive years. But that decline has been accelerating. So, in October, that’s the latest data we have on the real estate sector, real estate investment declined by 23%. That’s an insane decline. And that’s the fastest rate since the downturn began in 2021.
So, as the real estate sector declines, or as real estate investment declines, that drags on aggregate FAI drive because real estate investment is part of AFAI, aggregate fixed asset investment. But we can think of that as a first-order effect. As property developers invest less in real estate, kind of just by mechanical process, China’s aggregate fixed asset investment decreases. But there’s also what we can call or think of as second-order effects. So, as real estate activity declines, this reduces demand for upstream materials, any input that goes into construction. So, think of things like steel, bricks, glass, cement, any of these sort of raw or processed materials, demand for them also reduces. So, we can actually graph this.
It’s pretty interesting. We can look at investment in real estate and investment in these upstream industries. And they correlate really closely. So, what’s happened is as in recent months, the real estate investment decline has accelerated. This has actually led to a reduction in fixed asset investment in all these upstream sectors as well. And these are the second-order effects. So, this is really the first piece of the puzzle, which we can think of as the real estate decline and the subsequent first and second-order effects.
Andrew:
Before you start there, you may not have this answer off your head, but I’m going to ask you anyway. Do you have a sense of how much real estate and sort of related aspects are as a proportion of the overall FAI basket?
Joe:
No, that’s a good question. So, real estate alone is about a fifth of fixed asset investment. It used to be a quarter, but because it’s been declining since 2021, it’s about a fifth. I mean, I don’t a bunch of other fixed asset investment, for all these upstream industries, it’s going to be a really substantial part of China’s aggregate data.
Andrew:
Right. So, if you got a chunk of if I had that big declining in the 20%, it’s really hard for the overall pie to grow at all. Okay. Sorry. Now go on to the next piece that you were going to get into.
Joe:
So, the second part of this puzzle is manufacturing and fixed asset investment. Now, this is pretty interesting. Again, as most listeners of this podcast will know that China’s suffering from overcapacity. Right? There’s too many factories relative to the amount of domestic or even external demand that can consume these goods now in the present moment. And policymakers have referred to this as involution, in Chinese, neijuan, involution, which in Chinese, this literally means to like to curl up into a ball.
This idea that there’s such excessive competition, everyone’s working harder and harder and harder, but because everyone’s working harder to compete with each other, there’s no real progress. And this competition leads to too many factories, too many goods being produced there’s overcapacity. Now, this has been around for several years. In July, China’s most senior economic policymaking body, it’s called the CCFEA. Let’s see if I can remember that stands for. The CCFEA is the-
Andrew:
Central Commission on Financial and Economic Affairs. I got you on that one.
Joe:
Yeah, you’ve got it. Thanks, man. You saved me. I think I would have stumbled on that. Yeah. The CCFEA, the most senior economic policymaking body in China, in July, they made this really public, used this really strong language, and they pledged that they’re going to stamp down on overcapacity. And since then, we’ve seen a flurry of activity from symposiums, industry association meetings, ministerial level meetings, government policymakers and industry consistently meeting and committing to reduce overcapacity. And this is taking place across a range of industries, so everything from electric vehicles to batteries, from chemicals to plastics, from PVs to cement. And what we’ve seen is, since July when the FDA made this commitment to stamp out overcapacity or to stamp out involution, there’s been a dramatic drop off in manufacturing and fixed asset investment. So that’s the second part of the puzzle.
And this is really a policy or politically-led push to reduce the amount of investment across a whole range of manufacturing industries. That’s the second part of the puzzle. We’ve talked about real estate, right? We’ve talked about manufacturing. So, the third part of the puzzle is infrastructure. And this is pretty interesting. Infrastructure investment, which is predominantly led by the state in particular by so I mean by government and in particular by local governments. So, local governments are issued with what are called special-purpose bonds. So, local government debt instruments, they issue these special purpose bonds to raise capital to then invest in infrastructure projects. And this year, well, actually starting from last year, the Ministry of Finance has allocated a portion of special-purpose bonds, so a portion of local government debt, not to be invested in infrastructure, but instead to be used to pay off hidden debt.
So, this is off-balance sheet local government debt. I mean, it’s related to infrastructure, but it’s a total different pool of SPB, special purpose bonds. So local governments have their SPBs for infrastructure spending. And starting from last year they’ve got their SPB quota for paying off hidden debt. And this is ¥800 billion every year. But we’ve scrolled through, or we searched through all local government bond issuance data, and we calculate that so far this year, local governments have actually issued in the region of 1.3 trillion RMB to pay down hidden debt. So, they could be given an 800 billion quota, but they’ve issued 1.3 trillion to pay down their hidden debt. So, this is 500 billion over their specific quota, right? Are you with me so far?
Andrew:
Yeah.
Joe:
Okay. So, the question is where has this 500 billion above the hidden debt quota come from. And it’s most likely come from their infrastructure quota. So, what we’ve seen is infrastructure funds being diverted towards paying down hidden debt. And we estimate this is in the range of 500 billion. So, that’s a huge chunk of money that was initially earmarked for infrastructure spending instead being spent on other things. Yeah. This is the third part of the puzzle is that infrastructure FAI has reduced as well because of this.
Andrew:
Yeah, that totally makes sense. And it actually aligns with an observation that Dinny makes a lot, which is that this is kind of Chinese-style austerity, especially Chinese-style local government austerity, diverting resources away from what would normally be growth-driving activity, or even productive activity, to fulfill the mandate to pay down debt. And so, this is why we are a little bit more sanguine on China’s overall debt profile is because we do see some real action to try to address some of the near-term most vulnerable areas of debt, which is particularly held by local governments off balance sheet. This hidden debt you’re talking about.
But it very much, you know, is a Chinese-style austerity, fiscal austerity. So, it is really holding back economic growth. And the question that keeps coming up is, why isn’t the central government doing more to fill this gap? What are your thoughts on that, Joe?
Joe:
Yeah. Well, I mean, on the surface, they are. So, the central government, starting from 2023, they committed to funding a portion of infrastructure spending as well. And they do this through, primarily through what are called special treasury bonds. So this is another type of debt instrument. It’s a central government debt instrument. And it’s a form of off balance sheet debt. So, when Beijing issued a special Treasury bond, it doesn’t count towards their typical fiscal deficit. It’s an off balance sheet type of debt. Now, this year, Beijing’s issued 1.3 trillion in the first three quarters of this year. So, up to Q3, they’ve issued 1.3 trillion RMD of special Treasury bonds. And most of this is used to fund infrastructure.
Not all of it. Some of it goes into other initiatives, such as the subsidies for the consumer goods trade-in program. But we can say the majority of this 1.3 trillion is going into infrastructure spending. And last year, in the first three quarters of last year, Beijing issued 1 trillion of STBs. So that’s a 0.3 trillion increase. So, on the surface, we could say, well, okay, local governments are diverting some of their funds to pay down hidden debt. But, at the same time, central government is increasing their funding of infrastructure through these STBs. So, what’s going on? Why is infrastructure spending still declining? And that comes down to something that happened in the final quarter of 2023. So, we’re going way back now. Almost two years ago. In Q4 2023, Beijing issued 1 trillion of special treasury bonds and committed to spending half of them, so 0.5 trillion in 2024.
So, what we actually saw in 2024, total infrastructure spending from the central government financed through STBs was 1.5 trillion. And this year it’s only 1.3 trillion. So, we’ve actually seen a decrease in the amount of STB-funded infrastructure from Beijing. So we’ve actually got a decline on both ends. Right? So, it’s kind of like burning the candle at both ends. On the one end, local government is spending less on infrastructure than before because they’re paying down their hidden debt. And this year, Beijing is also spending less on infrastructure than before because last year they spent this huge chunk, this 1.5 trillion of STBs on infrastructure. So, both central and local authority is spending less on infrastructure than last year, and hence infrastructure FAI is declining as well. That’s like the third piece of this puzzle.
Andrew:
So, that all makes sense that you’ve laid it out clearly in terms of, I mean, the three major categories of FAI, property, manufacturing and infrastructure, all clearly down for, I think, reasons that are quite understandable. So, we know what’s happening with the property market. I always say, like, anyone who’s saying that China’s economy is growth model is dead and will never grow in the future, like, we have to wait until the dust settles on the property market realignment because that’s a historical, literally like once in 100 years, if not once in history kind of development.
So, that’s going to take a while to fully sell or shake out. And then the involution piece, obviously holding back manufacturing investment. And you’ve laid it out in terms of less funding for infrastructure spending, why that’s happening at the local government level, and why it’s happening at the central government level. So that all makes sense. And so, I guess there’s sort of two related questions I want to ask to wrap us up. One is so it sounds like, you know, I was saying in the last podcast, like, are these numbers right? And it sounds like you’re saying, yeah, yeah, a 12% decline year on year kind of makes sense when you look at really the big hole in property, as you said, like now that we’re in Q4 especially, we’re going to see probably the biggest part of the contraction on a year on year basis in terms of central government spending and then the anti-involution push.
So, these numbers are showing the real story, right? And then the related piece of that is I also said on last week’s pod, if there’s a 12% year on year decline on FAI, like, how is that not translating into a shrinking overall macro economy? Because overall investment is still a big part of overall macro growth. So how does that align with 4.3% or whatever it is nominal GDP growth that we’re seeing currently? Walk me through those two issues.
Joe:
Yeah. I mean, in terms of the FAI data, yes, it does make sense to me, especially when we break it down over and look, okay, what’s happening to real estate, what’s happening to infrastructure, what’s happening to manufacturing. It makes sense. In terms of why is the economy not in meltdown, and here I think there’s, I guess, there’s two things to say. The first is there’s actually a statistical discrepancy between a fixed asset investment and the investment we think about when calculating GDP. So, this gets a little bit wonky.
Andrew:
No, that’s what we want. That’s what the people are come to us for.
Joe:
All right. Okay. So here we go. So when the Stats Bureau calculates GDP, when they put together the national accounts, they’re interested in what the economy has added, when we think about investment, what the economy has added in terms of new productive assets, and that is called gross capital formation. So, fixed asset investment is not a part of the accounting identity for GDP. What is a part of the accounting identity is gross capital formation which is new productive assets. Now, that is different to the definition of fixed asset investment. So, fixed asset investment is in the broadest terms, the purchase of any long-term asset which is involved in production. But that includes secondhand assets. So we can think of things like secondhand capital equipment or repurchase in a factory.
And it also includes other things which may not necessarily be productive in terms of when we look at does it boost economic growth. So, land sales, for example. If a company or property developer buys a new patch of land, that’s going to cause an increase in fixed asset investment, but it doesn’t change gross capital formation. The same goes, for example, companies spending on mergers and acquisitions. If one company purchases another company, that counts as a form of fixed asset investment. But that doesn’t boost GDP directly, so it’s not considered a form of gross capital formation. So, here we need to distinguish between what is a new productive asset, which goes into our GDP identity is gross capital formation, and what is just general company or local government spending.
Now, there’s a discrepancy between these. Gross capital formation in Q3 actually made a positive contribution to GDP growth. I think it was responsible for 0.9 percentage points of China’s GDP growth. At the same time, over the same quarter, fixed asset investment fell by about 6%. And that discrepancy we can explain between what these two terms capture. So, what has happened over this quarter is land sales have plummeted. So that impacts fixed asset investment. That doesn’t impact GDP. We can imagine that mergers and acquisitions have plummeted. Purchases of secondhand capital equipment or secondhand or used or outdated factories, all this sort of stuff has plummeted. That impacts FAI, that doesn’t impact GDP. So that’s the first thing I want to say. It’s really a statistical discrepancy between what the two terms measure.
But secondly, and maybe a more common sense answer to your question is, well, of course, a fall in fixed asset investment is eventually going to drag on the economy. There’s going to be spillover effects on business confidence and on broader economic activity. And it looks like we’re starting to see this. So, in October, industrial output dropped sharply, I mean, industrial output growth dropped sharply. It still grew, it still expanded, but at a much slower rate than in previous months. We’ve seen an uptick in unemployment based on PMI surveys. So, these are business surveys of manufacturing firms. Business confidence is down. It’s distinctly lower than its long-term average. So, we’re starting to see impacts on the economy, which really kind of leads me to conclude this 12 or this double-digit drop in fixed asset investment, it’s not going to cause an economic meltdown, but it is definitely going to cause a drag on China’s economic growth.
Andrew:
Yeah, that totally makes sense. And we’ll see how long this lasts. I mean, the property market correction doesn’t seem to be going anywhere. We’ll see how the anti-involution push evolves. And then, you know, the fiscal austerity, that’s kind of up to Beijing if it wants to fix it or not. Right? With more transfers to local governments or maybe backing off the push to pay down hidden debt, which I think there’s a 2027 deadline for some of that. So, maybe we’re in for this for another year. Seemingly, I guess the next question is what’s your outlook for 2026 macroeconomically? Are we in for another kind of pretty slow growth year because of all that you expect most of these dynamics to continue into next year?
Joe:
I think the downside risks for China’s economy are pretty obvious. So, you’re right. I mean, real estate is going to continue dragging on the economy. This kind of local government austerity, there’s really one of three conditions that has to happen for this to stop. One, Beijing has to reduce the pressure on local governments to pay down hidden debt. But I don’t think that’s going to happen. The second is Beijing reforms its tax system to give local governments more revenue-raising power. But that’s not going to happen over a 12-month period. Or the third thing is that Beijing increases central transfers, which is possible. That’s plausible. So, in terms of like this idea of fiscal austerity going into 2026, I mean, we’ll get more information about that when Beijing releases its spending plans at the two sessions in March.
So, the downside risks are pretty obvious, but I actually think there’s kind of some upside risks, which people don’t focus on so much. And that leave me sort of cautiously optimistic about the outlook for 2026. So, I say the first is exports. Export is just consistently out-beat market expectations. They’ve managed to diversify to new markets. They move up the value chain. And, of course, with this apparent reduction in China-U.S. tensions, it’s also possible that exports to the U.S. start to increase again. Remember, the U.S. is China’s single biggest market in terms of countries. So, a reduction in China-U.S. tensions is really positive for China’s economic outlook.
I think the second area, which is potentially an overlooked upside is consumption. We know that the retail sale of consumer goods sucks. It grew by something like 2.9% in October. It’s like the fifth consecutive month of slowing growth. Consumers are not spending on durables or consumer goods. But what we do see and what is not really talked about is a surge in retail sales of services. So, this is everything from catering sales to domestic tourism to entertainment, going to the cinema. And this is growing consistently by over 5% every month. And in fact, in October it grew by 6%, the fastest growth rate we’ve seen this year. So, when we think about services as well as goods, the consumption outlook is nowhere near as pessimistic or negative as many think. So, kind of to give you a maybe a more direct answer about the outlook for 2026, I’m actually cautiously optimistic. I certainly don’t think the economy is going to have a howler at all. There are obvious downside risks, but there are these overlooked upside risks as well.
Andrew:
Yeah. That’s great. And I mean, we touched on the services piece a little bit last week with Dinny, but largely drawing on your work. And that is something that we are going to be focusing on a lot, I think, next year in terms of digging into that a little bit further, because, you know, if the trends continue, pretty soon services are going to be over 50% of consumer spending, right? And so if that’s growing, that’s going to pull up those consumer numbers sort of just by definition. And then you make a great point on the U.S. piece on exports, which is, you know, yeah, exports are contracting, will continue to contract because of tariff levels for a little while. But eventually, those numbers are going to wash out, you’re going to hit a bottom, and then growth will start happening from a new lower level.
And, again, by definition, will start supporting overall growth in exports by a dint of kind of, again, just sort of mathematically. So that’s also a good point. I have to say, before we wrap up, you know, I’m really impressed. I really appreciate you walking me through all of this, walking the listeners through all of this. There was a time in my career, probably 10, 15 years ago, where I was as deep in the data as you are. And I have to say, I kind of miss it. Like, you let it all out really well. I should know the difference between FAI and gross capital formation, and I’m sure there was a time that I did. It’s embarrassing. You educated me, so I really appreciate that, Joe. That was great.
Joe:
All right, man. It’s my pleasure. I mean, yeah, I enjoy being in the weeds, and I do this every day. And this is the sort of stuff that we update, we share with our subscribers and clients, right? To try and give them an edge over others in their understanding of the Chinese economy.
Andrew:
Love the organic pitch there at the end. Awesome.
Joe:
It was so organic, right?
Andrew:
Yeah. Awesome. Well, thanks so much, Joe. I really appreciate the time.
00:50:31
Joe:
All right. Thanks, man. We’ll speak soon.
00:50:32
Andrew:
And thanks, everybody, for listening. Bye, everybody.
