It was another monumental week on the China front.
On Tuesday, the Party released its sprawling 15th Five Year Plan (FYP) Proposals — laying out the sheer scale of Xi Jinping’s policy ambitions over the next half-decade
Then on Thursday, Xi and US President Donald Trump got together in South Korea — their first meeting in six years – and agreed to a year-long ceasefire in the trade war
In this week’s Trivium China podcast, host Andrew Polk is joined by colleagues Kendra Schaefer and Dinny McMahon to break it all down.
That’s right folks, this episode is a two-fer.
Andrew and Kendra start off by discussing:
The details of the trade agreement, as we know them
What China thinks it got out of the deal
The pros and cons of the one-year timeframe
Future tripwires that could set things back on an escalatory spiral
Kendra then touches on her key takeaways from the 15th FYP Proposals, when it comes to China’s tech ambitions, before Dinny joins the pod to walk through:
The headline macro takeaways from the FYP Proposals
Chinese leaders’ sense of urgency over the next five years
How policymakers are thinking about consumption’s role in the economy
China’s more assertive position on the world stage
It’s another solid episode, folks, so enjoy!
Transcript:
Andrew Polk:
Hi, everybody, and welcome to the latest Trivium China Podcast, a proud member of the Sinica Podcast Network. I’m your host, Trivium co-founder Andrew Polk, and I am joined today once again by Trivium’s Head of Tech Policy Research, Kendra Schaffer. Kendra, how are you doing?
Kendra Schaefer:
Good. Good to be here.
Andrew:
Yeah. Great to have you on. We are going to talk about the news of the day, which is the big agreement between Xi Jinping and Donald Trump that they shook hands on in South Korea overnight. So, we are recording this podcast at just about 5:00 Eastern Time in the U.S. on October 30th. October 30th Asia Time is when they agreed to this trade framework. So, we’ll talk through that. We will talk about the details in the deal and sort of where that puts us. And then we’ll talk about what the U.S. got, what China got, focusing primarily on sort of how China might be viewing this deal. Then we will pivot quickly to get Kendra’s take on the tech aspects of the 15th Five-Year plan proposal.
I’m going to speak to Dinny McMahon on the second half of the pod, about sort of the higher-level macroeconomic and sort of economic development aspects of that plan, but I just want to get Kendra’s take quickly on the tech self-sufficiency piece while I’ve got you. You’re making a face like you’re not prepared, but I’m sure you will be well prepared. I was going to refer to Dinny as like the pod listeners’ favorite guests, but I think you and Dinny kind of go back and forth, so we’ll see kind of who’s more popular after this episode.
Kendra:
We’re going to do a Trivium hot or not?
Andrew:
Yes, that’ll definitely be in the show notes. So, I’ll put a link to some kind of survey in there. But before we kind of get into everything, as usual, we have to start with the customary vibe check. Kendra, how’s your vibe?
Kendra:
I’m really amped up. This week has been crazy. We had the fourth plenum. The communique came out. We got a bunch of press briefings from officials on the back of that. We had the proposals on the 15th Five-Year plan on the back of that, and as soon as I had caught my breath, Xi and Trump sat down to ink this deal. So, it’s been a week.
Andrew:
I would say it’s been a month. I mean, really, it was three weeks ago today that China dropped their rare earth export control expansion, right?
Kendra:
Three weeks going on a year.
Andrew:
I know. Exactly. So, the first eight days of the month were a holiday in China for the Golden Week Holiday. And then as soon as Chinese officials came back to work, it’s been a sprint ever since. I mean, we had the huge escalation from the rare earth export controls, back and forth negotiations, feverish phone calls, the meeting in Malaysia. Then, just as that’s happening, China’s leaders take a break to go do the 4th plenum, which is a huge deal. There were a bunch of personnel moves in that that were not even related to Xi’s remaking of the Chinese military. We’re not even going to get into any of that. And then, as you just said, they published the proposals for the 15th Five-Year plan, which were huge and meaty and pretty extraordinary, and we’ll get into that stuff today. And then we get the trade framework deal a day later.
So, my vibes exhausted but also amped up like it’s also pretty energizing to be going through all this and analyzing it, working with our clients on it. So, I’m glad to have you here today to talk about it.
Kendra:
Yeah, absolutely.
Andrew:
Great. Well, before we get into the meat of the actual topics at hand, we, of course, also have to go through the usual housekeeping, first, a quick reminder that we’re not just podcast here. Trivium China is a strategic advisory firm that helps businesses and investors navigate the China policy landscape. That, of course, includes domestic policy and things like the 15th Five-Year plan, which we’ll be talking a lot about today. But it also includes policy towards China out of D.C., London, Brussels, and other Western capitals, which we will also be talking about today. So, if you need a more bespoke help on that front, please reach out to us. We’d love to have a conversation about how we can support your business or your fund. You can reach us at hq@triviumchina.com by email to start a conversation.
Otherwise, you can go to our website, again, triviumchina.com to check out all of our subscription content. You will definitely find the China Policy Intel option that you need on our website. We’ve got a bunch of subscriptions around different sort of issue areas — tech, markets, business environment. We’ve got free and paid subscriptions. So, check those out. And finally, please do tell your friends and colleagues about Trivium and about the podcast so that we can grow our listenership and grow our business. We really appreciate those word-of-mouth recommendations. So, all right, Kendra, are you ready to go through this?
Kendra:
Yeah, absolutely. Why don’t you start by outlining what got agreed to.
Andrew:
All right. Will do. So, 90-minute meeting starting on the morning of October 30th in South Korea between Xi Jinping and Donald Trump. They come to a framework agreement. There are basically six aspects of the framework agreement. First of all, there’s cooperation on fentanyl. So, that’s number one. Related to that issue, may not seem related, but it is related through the tariff piece, which I talked to Sean Stein about last week, is purchases of soybeans by the U.S. was agreed to. So, fentanyl, soybeans, broader tariff pause. So, basically, anything that it’s been put on since Liberation Day, including the Liberation Day tariffs, those have all been paused.
We have an agreement on export controls where China will generally look to delay implementation of its most recent export control expansion for a year. From its side, the U.S. will similarly agree to delay implementation of the BIS 50% rule, which we talked about again last week with Sean Stein, for a year as well. Then both sides are looking at pausing port fees for shipping containers to each other’s countries. That was a big one. And then, finally, there was some loose language around companies. The language from the Chinese side was we will talk about individual companies. We assume that to mean TikTok, but they didn’t explicitly talk about TikTok as far as we know. Now, I’m going to get into a little bit more detail on each one of those quickly before I throw to you, Kendra, but I think it’s important to note that, just at the outset, everything I just said comes mostly from a statement from the Chinese Ministry of Commerce, some general comments from Donald Trump on Air Force One on the way back to Washington, and other reporting.
There’s really a lot of detail that is still yet to come. Like, the working-level folks are going to have to figure all this stuff out. So, like, this is the information that we have as we understand it currently. But I think that is subject to change in the days ahead. So, it’s important for people to remember that. So, quickly, I’m going to run down a little bit more of the specifics and then bring you in. So, first, U.S. agreed to remove 10% tariffs on Chinese goods that were had originally been imposed due to China’s alleged failure to stop fentanyl precursor chemicals from entering the United States. Second, the U.S. would continue to suspend its Liberation Day tariffs of 24% for another year, while China would also suspend its 24% retaliatory tariffs on goods for the same period.
The U.S. Commerce Department’s Bureau of Industry and Security will delay the implementation of its 50% rule as I said, and China will delay its export controls and rear of and battery tech, again, both for a year. And then, as I said, the two sides agreed to postpone countervailing measures on each other’s maritime, logistics, and shipbuilding industries also for a year.
Kendra:
So, with the exception of China’s agreement on fentanyl precursors, we are back to where we were a year ago.
Andrew:
100%. Yeah. Basically, the agreement is we are dialing back to Liberation Day, April 4th, I think. Right? So, we’re dialing back to April 3rd or whenever the day before Liberation Day…
Kendra:
Is that date not etched on your heart, Andrew. It’s embarrassing.
Andrew:
I know, I know. Well, I feel liberated. But now that we’re back to pre-Liberation Day, I’m not sure if I am liberated.
Kendra:
Yeah. Most of this seems to me like the U.S. backing out of a self-created situation. I mean, fentanyl seems like a win. I don’t know if you agree with that, but fentanyl was always a kind of headline issue. Getting a little movement on that, I suppose, is a win. China was always going to buy soybeans. They were purchasing soybeans every year prior to the Trump administration entering office. So, I don’t know how big of a win that is. And my understanding, correct me if I’m wrong, is that if the soybean purchases follow this framework, they’ll just be back to where they were at…
Andrew:
As of last year. Yeah, basically the same amount of purchases that China bought from the U.S. in terms of soybeans last year. So, again, dialing back to the Liberation Day status quo ex ante. So, very much, very much the case. I think very clear that fentanyl was indeed the low hanging fruit, which USCBC President Sean Stein talked to us again about on last week’s pod. So that was a very prescient conversation that I had with Sean. So, you’re 100% right. I will say, though, that there’s two other things that kind of strike me. One is that even though it’s a dial back and we’re kind of where we were, now, there’s a conversation and a dialog between the two countries in a brand-new context that that now looks to potentially be able to make some positive momentum going forward.
So, the other pieces out of the agreement were that Donald Trump said he’s going to go to China to meet with Xi Jinping in April. And it’s likely that Xi Jinping will go to the U.S. to meet Donald Trump later next year. In fact, the Chinese readout was kind of funny. I think it said Donald Trump expressed his wish to meet Xi Jinping in China, and Donald Trump invited Xi Jinping to meet him in the U.S. So, very carefully worded there from the Chinese side. So that was positive. And then the other thing I think that is important in terms of the framework is the idea that this is just all for a year. There’s two reasons that’s good. I think, one is that it gets us off the 90-day roller coaster, the quarterly roller coaster where we have to basically constantly be negotiating just to make sure that we keep ticking over on the suspension of tariffs every 90 days.
So, it’s longer. But also, you know, our team was talking internally, having it be a year also means that it’s not just open-ended, and so it’s more credible as, “Okay, we can do this for a year. We’ll work towards making sure we maintain some sort of modus vivendi. And then in a year, we’ll sort of refresh the deal.” Whereas if it was open-ended, you know, I think both sides may be over time, more and more willing to cheat, willing to break the deal. So, I kind of see the year-long time frame is quite sensible. I don’t know. Do you have any thoughts on that?
Kendra:
Yeah, I agree with you on the time frame itself. I’m much less optimistic about… I mean, what does the truce mean? Does it mean no other tit for tat retaliation in the next 12 months? Right? Because I’m guessing it absolutely does not mean that. And so, I worry I mean, I’ll talk about it later, I guess, but I worry that within weeks we’ll be back to retaliation flying and tariffs flying. The one-year framework only bounds these specific retaliatory measures and these specific tariffs. I do think it is a positive that Xi and Trump will meet either in China or in Washington or both. But whether or not the U.S. can refrain and China can refrain from ratcheting those tensions up in the interim, I think is a really an open question.
Andrew:
In other ways.
Kendra:
Yeah, exactly, in other ways. Yeah.
Andrew:
Well, again, if they can do it for a year, that’s positive. But I don’t think again, you go back to the idea if it was open-ended, it’s not like they’re never going to not take any actions in the future towards each other, which is why I kind of think the one-year thing is sensible, but I also agree. I don’t even think in a year that either side’s going to take no action whatsoever to basically what it sees as guarding itself against something that the other is doing. The challenge there is that when that happens, whatever it is, if it’s something at a commerce, some kind of secondary sanctions around Russian oil, something that the SEC does on Chinese listed companies to try to improve disclosures, or on the Chinese side, if it’s another tweak to export controls that is really meant not as an economic coercion measure, but as a move to like defend their advantages and certain technologies that they have, both sides are going to see that, whoever moves, the other side is going to see it as an escalation, right?
Kendra:
Yeah, exactly. Trump has shown that these particular tariffs might be in suspension, but that doesn’t mean that other tariffs as the result of other trade measures are necessarily off the table. And so, for me, this misses the point. The point for the U.S. business community is how the hell much is it going to cost me to import shit from China next year? Excuse my French. What is it going to cost me? I am sick of the tariff numbers going up and down. So, in that respect, I agree with everything you say, but I think in that respect, obviously, this doesn’t solve our problems.
Andrew:
Well, that’s a great point and it will get into this bit. But there are a number of 232 tariff investigations, so sort of a separate facility, if you will, that the U.S. government can use to tariff China for other reasons, at least from a legal standpoint. So, it’s likely at the end of those investigations, some different tariffs are put on. And they may be seen by the U.S. side as like actually this is really just to protect this one industry, but China will say, “Well, that’s an abrogation of our agreement.” Right?
Kendra:
Right. Yeah. Exactly.
Andrew:
All right. Well, so I think we’re hot out of the box, saying this isn’t a done deal and there’s a lot that can continue to disrupt the fragile sort of equilibrium. But let me throw to you even sort of to step back a minute, like what is your number one kind of takeaway or framework? I don’t want to get into necessarily winners and losers, but what do you think China sort of got out of this deal?
Andrew:
How do you see it from China’s perspective?
Kendra:
I mean, I think, as it stands, the deal really does favor China in some pretty notable ways. And I think the most notable way is that it’s clear after this deal has concluded, I mean, at least at this juncture, that the U.S. has really lost a notable amount of leverage over China in the last two years. And again, just going back in time, we get so caught up in the up and down and what happened last week and the week before that and yesterday, and who’s retaliating against what that happened last month.
But if you actually move back you know in time two years and kind of take a longer view of where we are, prior to the release of China’s various controls, and not just the immediate controls that the expanded extraterritorial controls they released a couple weeks ago, I’m talking about, prior to imposing any restrictions on gallium, germanium, everything that happened in-
Andrew:
Yeah, which would have been in 2023, right?
Kendra:
2023. Yeah, it was like summer 2023. Prior to that, not a single one of China’s retaliatory tactics, placing U.S. defense firms on the unreliable entity list or targeting individual U.S. companies or withholding approval for international M&As involving American firms, none of that stuff resulted in Washington reversing course or thinking twice about ratcheting up pressure on China. What China was going to do in response wasn’t really a part of the conversation about whether or not Washington should do something two years ago. But the rare earths controls, and more specifically, I think, the Trump admins’ reaction to the rarest controls has really changed the game. This is the only threat from Beijing that has really ever resulted in generating genuine widespread angst in D.C., or that has resulted in actually pressuring Washington to say, “Hey, wait a minute,” and roll back and delay attacks that it had already planned.
And this isn’t the first time that card has worked. I mean, it’s worked multiple times this year, right? In July, the Trump admin sort of rolled back the controls on EDA software, partially in exchange for China promising to sort of approve the earlier rare earths licensing and stuff like that. So, you have a situation now where Xi knows how to make the U.S. take demand seriously for the first time. I would argue that’s for the first time. And so, for China, that’s like a real improvement in the amount of leverage that they had, especially right after the U.S. imposed chip controls in the last few years.
Andrew:
Well, and let me pick up on that, which is that actually is one where, you’ve made this point before, but I think where the one year timeframe becomes interesting from China’s perspective because if they can just make it a year without another big blow up, they will have likely advance the ball pretty significantly on technological advancements, specifically with chips, whereas the U.S. will probably make less progress just over the course of one year on the rare earths issue and getting around the rare earths bottleneck. And then if they do that again and again, so if they buy kind of a year at a time for the next three, four years, I think China’s perspective is that the U.S. choke point for semiconductor technology is less potent than both currently and over time than the Chinese choke point on rare earths. So, they think they have an advantage, and buying a little bit of time helps them. Do you agree with that?
Kendra:
Yes, I would agree with that. I mean, China doesn’t strategically lose anything by not instituting. Its expanded export control regime right now. It doesn’t lose anything by saying, “Okay, you know what? Actually, we’re going to wait another year on this one.” But the U.S. delay does leave this big loophole open, which could allow China time to shore up the gap. And it needs a bunch of time. But you’re exactly right. I think what China needs is time. And if it has to by that time on a one-year, one-year, one-year, one-year basis, that’s okay. But it just needs time. And within, I would say, a 2-to-5-year period, the U.S. semiconductor controls will be significantly less powerful than rare earth controls.
Meanwhile, in 2 to 5 years, the U.S. will hopefully take steps to reduce its dependance on Chinese rare earths. But China’s got like a 90% dominance in that sector. Opening up mines and refactoring those supply chains is not going to be a 2-to-5-year process.
Andrew:
Well, it’s something the U.S. can’t really do on its own. It’s going to need allies. You saw the agreement with the Australians on that. So, it’s something the U.S. can’t do on its own. As you know, those investments take years to come to fruition. There’s technological processes that have to be ramped up as well, not let alone like building the factories that would process the materials, like digging the mines, those kinds of things to the extent that needs to happen. So, you know, I think it is a challenge. And I also just wanted to say on that rare earths piece, so I think this is yet another potential area for miscommunication, even on the back of what we currently agreed, which is it’s pretty clear that China’s export control regime has not gone away.
And anything free sort of April of this year remains in place in terms of export controls. And so, if the Trump administration thinks that they’re sort of dismantling the regime, that’s certainly not going to happen. That’s going to lead to potentially another spiral up, escalatory spiral. But also, it leaves China with this very potent weapon that it still has and can basically pull it anytime. Is that right?
Kendra:
Yeah, exactly. I mean, more than that even, I would actually say that the stay on the implementation, for China to agree to delay the implementation of the expanded various controls is actually a big benefit for China in a couple of ways. First of all, MOFCOM, who rolled out the controls, wasn’t actually initially intending to release the expanded controls so soon. We know that they were drafting those for several months to over a year, but the draft was ultimately rushed out the door right after October holiday in response to the 50% rule. We said to clients at that time that we’re not convinced that MOFCOM has the bureaucratic manpower to execute on any of that right now. I mean, MOFCOM can barely keep up with application approvals for a much more narrow subset of rare earth exports.
Right? It’s licensing approvals are backlogged out the wazoo. And so, now they’re going to institute a global regime where they track how every China-produced rare earth is flowing throughout…. No, they’re not. No, they’re not. So, for China, the stay in implementation buys all this time to build up the bureaucratic structures that are necessary to implement those rules if they need to in a year, or in two years, or after Trump’s out of office, or the next time the admin does something egregious. And secondly, as you said, I mean, the Party’s only agreed to delay the implementation of the most recent, at least that’s what I’m reading from the news, right? We don’t have the details yet, but what I understand from what I’m reading is that China’s most recent big extraterritorial expansion on rare earths has been delayed, but that would mean that its previous restrictions on rare earth exports like gallium and germanium and antimony are still in place. And that leaves China a tool by which it can ratchet up and down licensing approvals for.
Andrew:
So, it still has chokepoints that it can press if it needs to.
Kendra:
It still has choke points in rare earths, not even just other choke points. It still has rare earth choke points it can use.
Andrew:
Yeah. Well, and here, and I think Cory Combs would make me want to point out, I don’t think gallium and germanium are rare earths. They’re critical minerals.
Kendra:
Oh yes.
Andrew:
So, like there’s the critical minerals piece, which is the bigger pie of the heavy rare earths. But to your point, those export controls on heavy rare earths are still in place, like companies are still going to have to get the licenses because that was previous to the April stuff, right?
Kendra:
Yes, absolutely. I always use those interchangeably and I shouldn’t. Yes, the critical minerals versus rare earths, but earlier critical mineral controls are still in place...
Andrew:
Yes, absolutely. And so, they do have choke points. And Cory and I have talked a lot about this, and Cory is working closely with companies, just a quick pitch for anybody listening, to understand their specific choke points and their supply chains for these critical minerals and other materials that go into manufacturing processes, and he has developed a very robust kind of model for helping companies think through this. So, if you need help on that front, please reach out to us. So, I had to put in the quick plug. But I want to go back to the point on the BIS stuff, which is what the U.S. gave. How do you think the Chinese think about that aspect of it? Because, effectively, we’re now negotiating with our export control regime. Right? The U.S.’s when I say we.
Kendra:
Yeah, I mean, I have to say that I think the U.S. has eroded its long-term negotiating position by showing an unprecedented willingness to use those tech-related national security rules as bargaining chips in trade negotiations. We saw this coming. We kept saying we don’t think anything is really sacrosanct for the Trump administration, and they’ll be willing to kind of put everything on the table. In some ways, that’s a positive. But the fact is that previous admins have treated China-targeted trade measures and investigations as if they are processes in which the president doesn’t ever meddle, and it’s bad form in U.S. governance for the president to… he appoints these secretaries, and those secretaries are in charge of their departments, and their departments are releasing these investigations.
And that is, you know, he doesn’t micromanage the executive branch in that way. And the Biden administration and previous administrations have sort of refused to negotiate over those issues, of course, on the grounds we’ve heard it 100 time, the grounds that these are national security issues, the U.S. doesn’t negotiate on national security issues. This isn’t up for discussion. But Trump is willing to negotiate with U.S. regulations, apparently. And he has shown that the US can and will bend on those issues if it wants to. And also, that all executive branch actions are within the president’s power to control if he chooses. So, that leaves China thinking, first of all, what else is up for grabs?
What other Rubicons can we cross here? What was off the table for past administrations that’s on the table now? It’ll also leave kind of future administrations, I think, maybe less room to maneuver even. They won’t be able to claim that certain executive branch actions are out of the president’s hands or that they can’t, you know, or argue that administrative decisions aren’t up for negotiation. And then finally, I’ll just say that, like true or not, this is also going to confirm something that China and Xi have long believed, which is that the U.S. uses regulations as political weapons just as China does. They’re speaking the same language now. And that national security is a kind of fig leaf for the U.S. being unwilling to meet China halfway.
I do want to say one other thing about that, actually, which is like, just to be clear, I don’t think the chip controls were ever really effective tools for strengthening U.S. security over the long term. The U.S is very resolute about sticking to its guns on national security, though, and that resoluteness made it difficult for China to kind of gain purchase and figure out ways around those controls or how to get the U.S. to back off so the US wouldn’t even talk about it. I also don’t think the Biden administration’s sort of refusal to discuss this with China ever was the right move. Prior to the Trump admin, China was just increasingly being backed into a corner and backed into a corner and backed into a corner. There was no clear off ramp. There was no carrot.
There was no, you know, “Hey, listen, China, if you do X, Y, Z, we will do X, Y, Z.” There was none of that. So, a larger blowup in that context with no off ramp was pretty much just, and ratcheting up, ratcheting up was just a matter of time. That said, this approach ain’t it. This is not put the U.S. on a stronger footing than we were previously on, particularly, I think, for future negotiations.
Andrew:
Well, I agree with you. I think we’re still thinking this through in real time. That strikes me as the right take. And there are a lot of people, you know, the “China hawks” in Washington, D.C. are not happy about this, right?
Kendra:
Yeah.
Andrew:
I have always sort of wanted to have the discussion of how appropriate or how effective our export controls, but in D.C. it was mostly just like taken as gospel that export controls are effective and are the right thing to do. And so, I think for the most part, there are few people question that, but for the most part, everyone kind of agrees like we’re now negotiating with national security, and that is a Rubicon that has been crossed that a lot of people do not like in this town.
And so that kind of brings up a couple of things. One is like, is there something that the Congress can do to kind of force Trump’s hand on something? We won’t get into U.S. politics, but probably unlikely while the Republicans are in charge of both the House and the Senate, that they try to force down Trump’s hand on something on China or anything else, I guess, for that matter. But possibility, right? That Congress could mandate certain export controls go into effect or have to be reviewed, and that the administration has to explain why it’s going to roll them back or why it’s not putting them on X, Y, Z. So, that’s one. Maybe just to throw out there as another piece of this puzzle to think about over time.
But the other thing that could come in and upend everything we’re talking about, which you mentioned, is other investigations that are going on on the tariff side. Talk to me about sort of the main things you’re thinking about on that side of things.
Kendra:
I mean, I think the underlying question there is, is this truce going to hold or not? And so, kind of what we were talking about at the beginning, it’s like, is this truce going to hold? And, of course, I think any temporary truce between the U.S. and China was going to be extremely fragile. But I think the fact that national security and U.S. regulations and all of that are A, up for grabs, and B, clearly under the president’s authority to control, really makes the truce potentially even more fragile in some ways. That’s because, so let’s say that U.S. executive branch agencies now move forward with any of these other outstanding investigations, right? The section 232 investigation and 301 investigations on semiconductors and pharmaceuticals are obviously top of mind, but there are several other measures being discussed by other departments that we have heard are under consideration.
And if the executive branch moves forward with any of those, China is going to be more likely to interpret that as an intentional bad-faith violation of this agreement, particularly if it comes out like next week. Oh, God. Right? Right after the agreement, right after the meeting, U.S. like hits China with something else. And those investigations have the potential to result, as you mentioned, in additional tariffs. So, they come to an agreement, everything looks hunky dory for a couple of days, and then bam, a new set of tariffs comes out. China will interpret that as bad faith. And so, I’m just not sure that Washington understands the fundamental reason behind why China retaliated so strongly, why it released these expanded rare earth controls so early. It’s not because U.S. actions like the 50% rule or the through one investigation on shipping, were so terrifying in and of themselves that China felt the need to respond strongly.
What was happening is China was protesting the fact that the U.S. has consistently rolled out new restrictive measures against China, or against Chinese firms right after each round of trade talks has concluded for the past year, within a month. And so, that’s what upsets Beijing, that the U.S. does not seem to be engaging in these talks in good faith. And what Beijing actually wants to see, however unrealistic, right? Beijing’s unicorn outcome here would be for the U.S. to pause most or all of these executive branch actions while the U.S. and China sort of step up to more trust and a lasting truce and maybe some major deals in the Xi-Trump meeting, etc. But it is very difficult to imagine that Washington’s going to hold off on those actions for any length of time.
And so, if it doesn’t get, as we mentioned in the beginning, if next week there’s a big new measure that comes out or a big new tariff, we could be back to tit for tat in five minutes.
Andrew:
Well, I want to talk a little bit about what I think are some of the longer term implications of that reality, which is, and we touched on this a bit, which is the idea that if China isn’t sure that the U.S. is going to stick to the deal in any fundamental way, they hope they can get through a year, but what are they going to do in the meantime? Every year that they buy, they’re going to invest more and more heavily, push on the accelerator more and more aggressively to lessen the U.S. choke points in technology, and specifically to achieve technological self-sufficiency. And this is where, I hope it’s not too hard of a pivot, I just want to get your take quickly before we wrap up on the 15th Five-Year plan proposals on technology.
So, I’m writing about this now. I’ll release this, I think, on Friday or Saturday. My weekly piece, which is, as I read, the 15th Five-Year plan proposals, and I talk a little bit about this with Dinny, there was just a sense of urgency in them that I have not seen in previous five-year plans. It was kind of like we’ve got big things to get done and we got to do it now, right? And the clearest one, the clearest area where there was urgency was on the need to pursue technological self-sufficiency. So, I’ll just read a little bit of what we wrote about this — “So, the proposals adopt unusually strong language regarding the need to strengthen China’s tech self-sufficiency and develop “independent and controllable” innovation and technologies. Overall, they signal that Beijing sees the next five years as a make-or-break period for achieving technological independence as a path to economic upgrading, and to escape U.S.-led pressure on China’s tech sector.”
Exactly what we’re talking about. And this is where it gets really, rubber meets the road — “Most notably, the proposals commit to adopting ‘extraordinary measures’ to strengthen original innovation capabilities and strategic technological research.” We don’t know what extraordinary measures are.
Kendra:
No, we don’t know what extraordinary measures…
Andrew:
But that jumped off the page at us. Talk to me about what you think China means by all this. There’s the context of the trade war. But then there’s also China’s efforts at home to make sure that their vulnerability in a trade war over time is less and less and less.
Kendra:
I mean, you could say that since 2018, which I think we’ve said on the pod before, was this kind of big watershed moment for China, the 2018/2019 Huawei-ZTE controls, which really kind of woke Chinese regulators up to the possibility of sort of U.S. tech suppression as they would see it. It has been a nonstop push domestically to shore up and securitized domestic supply chains. We haven’t seen language as strong as the language that’s in the 15th FYP about this now or the 15th FYP proposals that’s about this now. But the other interesting thing to note here, so we don’t know if extraordinary measures means we’re going to do something new and exciting, or we’re really reading a lot into a couple of words.
This is a 49 paged document, and this is like three words in the 49 paged document. But on important three words, we don’t know whether that means something new or if it means pouring additional resources into what Beijing thinks is already working and which is already working, which is across the board total refactor of its scientific and innovation ecosystem, doing things like strengthening the access to project based funding for researchers, totally refactoring the education system with a greater focus on STEM, trying to galvanize and incentivize private companies to spend more on basic research and invest more in R&D. Those efforts are starting to work. Interestingly, the proposals do say they’re going to be upping the tax breaks for companies that do R&D. There’s a bunch of different tax breaks for companies to do R&D.
They’re pretty sweet. Well, one of them is a tax break of 120%. You can take a pretax deduction of 120% of R&D expenses. So, like if you spend 10 million renminbi on R&D, you can deduct 12 million renminbi. That’s specifically for semiconductor companies. So, if they want to take extraordinary measures, they could bump that to 200. It’s hard to say obviously, without more details what an extraordinary measure means. But I can say that for the rest of the policy or for the rest of the proposals, mostly what they’re calling to do is really twist the screws and double down on what they’re already doing, what we talk about on Trivium tech all the time, all this kind of innovation, funding, research, VC, you know, funding channels, subsidies, the entire fiscal package of policy package and intended packages sort of pushed to China’s tech sector.
One other thing I’ll say that, I don’t know if this counts as an extraordinary measure, but one interesting thing that has changed that was evident in the proposals and that we just actually started to see before the proposals came out, the state, over the last couple of years, has expressed its desire to serve as a connector in China’s innovation ecosystem. That basically means we don’t want to just sit around picking winners. We’re not that great at it. We keep doing it because we don’t know how to pick which companies we should give money to other than by picking winners in a couple of respects. But we understand that that’s an old way to sort of galvanize the innovation ecosystem. And so, we think the state’s role is as a facilitator, as a connector. We want to make sure that smart companies are in the room with funders, are in the room with academia, and researchers have access to each other’s ecosystems or doing projects together. And, more specifically, that they are pointed, that all of this effort that the team China tech effort is focused on breaking through these strategic bottlenecks.
We want these companies not just to compete; they can compete in the market. But when it comes to breaking these strategic bottlenecks, they work together. Now, we’ve seen that kind of language in policy over the last couple of years, so that particular idea isn’t too new. I think they started talking like that in 2022. We started to see that kind of stuff. But now we actually have an example you can sink your teeth into of that happening. And what we’re seeing from the outside is this seeming relationship, if you’re a tech daily reader, you’ve kind of been watching us talk about this a little bit, a relationship between the Huawei and DeepSeek is what it looks like from the outside, where Deep Seek is sort of trying to help Huawei create software and to create chips that let DeepSeek train on its GPUs.
So, that is a critical partnership that the state surely supports that is focused on cracking a strategic bottleneck. And what’s amazing to me about that is that 20 years of Chinese policy failed to get companies to work together, but all of this kind of trade war stuff and U.S. tech restrictions and then Chinese blockages, etc. have sort of… So, I’ve veered a little bit off topic, but…
Andrew:
No, that’s perfect. That’s great.
Kendra:
Yeah, I mean, extraordinary measures. I think most of that will be doubling down on what’s already happening. Maybe we’ll get a couple surprises.
Andrew:
Well, we’ll obviously be tracking it closely. I think, you know, as I read it, and again, we talk about it with Dinny here in a minute, I just got the sense like this period is unlike most five-year periods. There’s a lot of things that we need to do. They specifically talk about this period will connect, allow us to gain the inheritance of the past and achieve the goals of the future, or something like that, like a connection between the past and the future. Very much like a transitionary period that matters. So, I won’t belabor that more because I get into it with Dinny. But I think you made excellent points on the tech piece, and we’ll look forward to talking about this more. Thank you for the time and the thoughts on U.S.-China agreement. And it’s October 30th, tomorrow’s Halloween. So, go trick or treat and we can finally say goodbye to this insane month. How does that sound?
Kendra:
Sounds good. You guys have a good time.
Andrew:
Awesome. Thanks for joining me, Kendra. Everybody stick around for my conversation with Dinny from here.
I’m joined now by Trivium’s Head of Markets Research, Dinny McMahon. Dinny, welcome back to the pod. How are you doing, man?
Dinny McMahon:
I’m doing good, Andrew.
Andrew:
Yeah, and I know you’re especially happy because you’re the second podcast guest today, so you get out of the vibe check. So, congratulations on that.
Dinny:
What are you talking about? It’s a highlight of my week.
Andrew:
Well, I just spoke with Kendra, at the end of our conversation, a little bit about the tech aspects of the 15th Five-Year plan proposals. But I want to talk with you, Dinny, a little bit more, sort of big picture on what we saw, especially in terms of macroeconomic governance, economic development, the plan for all of that stuff. We touched on it briefly last week in our podcast, but now that we have the full proposals out, there’s a lot more to dig into. So, I just wanted to have you start us off by maybe explaining a little bit about what are these proposals. So, it’s a document that comes out at the end of the fourth plenum. It’s not the actual five-year plan, but what is this document? How does it fit into the process here?
Dinny:
Right. So as part of the drafting process, a bunch of the top leaders sort of get together and they survey the various levels of government. So, even this far out from the actual launch of the five-year plan, they already have a pretty good idea of the stuff they want to put in there. And so, this document coming off the back of the plenum, and it’s presented as a list of proposals. And so, it’s all pretty top-level stuff, but it’s kind of like a sweeping view of kind of all aspects of the economy and society and kind of gives a little bit more detail than we’ve had, up until this far, about exactly what sort of stuff we’re going to see in the actual five-year plan.
Andrew:
So, little bit more details on exactly what sort of the strategies and frameworks are on various aspects of sort of economic and social development, but none of the detailed targets that we would actually see in the actual five-year plan when it’s released next March. Is that right?
Dinny:
Yeah, exactly.
Andrew:
All right. Well, thanks for that explanation. Folks are going to understand where we are in this policymaking process, China’s sort of five-year cycle that it goes through. But I thought I’d just start in terms of, you know, we’ve been going through the document in the past few days, I think it’s 20,000 characters or something. There’s a lot in there. And I also want to say for U.S. listeners, or even those who are familiar with U.S., I often kind of think about the five-year plan as sort of a state of the Union address, but sort of on steroids. And for those of you who know how the state of Union works, you know, it’s the president gives a speech to Congress about kind of his policy agenda for the year ahead.
And that is always just kind of a smorgasbord of policy objectives. Everyone in government who kind of has their policies, signature policy, or pet policy that they are pursuing and they try to get it in the State of the Union. So, it’s not necessarily always a hugely strategic, coherent document, but instead kind of looking at the entire waterfront of policy areas that people would like to focus on or that the leadership would like to focus on in the next five years.
That said, though, there are some sort of we can definitely dry out some key themes. So, reading through this thing over the past few days, Dinny, what was your headline takeaway or some of your headline takeaways from the proposals?
Dinny:
So, if we focus on the macroeconomics side of things, as you said, there’s no real specific targets in this thing. But in terms of economic growth, they want to keep it within a reasonable range, whatever that means. I mean, I think at this point, a reasonable range is probably somewhere between 4.5% and 5%. And then they kind of talk about wanting to steadily increase total factor productivity. And that’s kind of important because productivity has sort of dropped off a cliff since the global financial crisis. I mean, the economy was really driven by investment in housing and infrastructure for a long period of time. And so, now they’re trying to improve the productivity of industry, of the workforce. They also want a steadily increased per capita consumption, which seems perfectly reasonable, so that people sort of feel better off because they’re spending more, and also, they want to strengthen domestic demand as sort of the driver of economic growth.
Now, all those things are perfectly reasonable. The question then becomes; do they actually attach real, meaningful targets to this sort of stuff? And kind of at first glance as well, you look at that, and it seems to be a pretty pro consumption sort of agenda. They want per capita consumption going up. They want domestic demand to strengthen. But then if you kind of look at the comments that are talking about consumption, there seems to be a lot less there than meets the eye. I think that’s kind of important because people have been talking about this for ages. They keep talking about consumption. Consumption is important. They need to boost consumption because domestic demand is so weak.
Now, anyone listening to this podcast knows what our position, how we understand Beijing’s commitment to consumption and what it actually means. But I think that kind of looking at the sort of five-year plan proposals, they’re not about to throw down and significantly expand welfare. I mean, again, they said they want to spend more on welfare, but as they keep saying, they’re only going to do it within their means. They’re still very enthusiastic about common prosperity, but there’s no sign that that’s going to trigger some sort of widespread wealth distribution program. You know, the stuff that they are going to do to support consumption, it just kind of looks like more of the same. They talk about the sort of, you know, subsidy programs that they’ve implemented in the past. There’ll sort of be more that sort of stuff.
They’ll increase the intensity of preferential policies that directly reach consumers. I mean, all this stuff sounds like what they’ve been doing for the past year or so. You know, they rolled out, a few months ago, interest rate subsidies for consumer loans. You know, for the past 18 months, we’ve had subsidies for the purchase of big-ticket consumer items like cars and furniture and electronic goods. I mean, it just really sounds like more of that. So, on the macroeconomic side of things, I think the real takeaway is they probably aiming for growth at a similar pace as we’ve seen over the last couple of years. They want more consumption, but they’re not going to do anything radically different from what we’ve seen in the last couple of years.
And ultimately, they want stronger domestic demand, which is something they keep saying. But it’s not going to be this sort of like demand-driven economic stimulus that people outside of China, or at least just keep hoping we’re eventually going to say. So, yeah, I think the real value or the really interesting stuff of this particular document isn’t really on the sort of conventional macro consumption growth side of things, but it’s more of industrial policy.
Andrew:
Yeah, we’ll get into the industrial policy in a minute. And I also want to talk again, even though I mentioned it briefly last week about how I think this document really kind of validates your view on what the new economic growth model looks like. But you mentioned kind of our view on consumption, and I think it’s worth probably revisiting that. I mean, we definitely have some new listeners from over the past few weeks. And so, probably not everybody who’s listening to this actually does know kind of how we think consumption fits into the picture. And, you know, don’t want to rehash too much old things that we’ve talked about before for listeners, longtime listeners of the pod, but still worth kind of just the thumbnail. What is our, or your in particular, but Trivium’s is kind of house view on where consumption fits in here?
Dinny:
Yeah. Okay. So firstly, China is not pursuing a consumption-led economic growth model. To be able to ramp up consumption on a meaningful scale in a relatively short period of time would require some state led wealth redistribution program. And at its heart, that would be a welfare program. Beijing isn’t against expanding welfare. In fact, the Party talks about it at every opportunity — they want to spend more on pensions, and they want to spend more on health care. They want to spend more on supporting poor communities. It’s just they’re not willing to do it if it’s not within their means. So, they’re only willing to spend to the extent that the economy, and specifically the tax base can support it. And, at the moment, I mean, tax revenue is miserable.
So, they’re not going to borrow just to expand welfare because they see that as kind of the road to economic ruin. So, that’s kind of the first reason for why they do it. And the second reason is that they say wealth redistribution is, well, exactly what it is, it’s redistributing existing wealth. And they are razor focused on an economic model that creates wealth, a model that will allow them to raise the living standards of the Chinese public, particularly in the face of a declining and aging population, something that it will allow over the long term Chinese living standards to continue converging with those of the U.S. and the EU.
So, it’s really those two reasons. One, they don’t want to fund wealth-free distribution with debt. And secondly, they don’t see it as a long-term solution to the sort of China they’re trying to create, which is one that is far richer and better off than it is today.
Andrew:
Thanks for that. And you mentioned earlier that the focus really is less on these macro issues, right? Like traditional like we need to be growing X amount. What our fiscal and monetary policy look like. We will talk a little bit about fiscal policy, but a little bit less focus on what I’d say is traditional macroeconomic thinking maybe, or traditional macroeconomic policy. And, as you said, it’s all about industry. And again, at the risk of repeating ourselves a little bit, I do just want to say again that you called this. You’ve called this in your report that was launched in in March, right? That this is all about, or I guess we’ve officially published in September, but it was basically written as of March. But saying like the new economic growth model is about winning industries of the future, innovating in those places, and upgrading traditional industries. And that’s exactly what they said in this thing at length.
Talk to us a little bit about your views on that and, A, how you thought this validated your views, but then B, any additional color from these proposals that kind of further strengthen your conviction around what they are trying to achieve.
Dinny:
Yeah. Well, the idea is, I said, this is all about wealth creation, and the idea is that they want to raise productivity because ultimately that creates wealth. And it’s such a wonky idea. I don’t really want to get into the details of productivity, but the idea is that they can deliver productivity by innovating aggressively and commercializing innovative new ideas, and also by upgrading existing industries and making them less labor dependent, cutting costs, rising profit margins. That’s kind of the whole vision of this productivity innovation, industrial upgrading. It is about either moving into new industries or upgrading existing industries such that either profit margins expand, or that these companies can pay significantly higher salaries and wages to their staff and/or as well, that they can support a higher tax burden that the central government can then extract.
So, it’s all about this is kind of comes back to this idea of creating wealth. It’s a machine for creating wealth for either firms, for households, or for the government itself, which can then be spent on welfare and sort of other priorities. This document is all about that. It is about talking about the next industries after the EVs and batteries and solar components to the next wave of industries coming through, sort of the next wave of successful new industries. It’s about trying to provide further support for industrial upgrading. It’s about providing further research support for the next generation of industries beyond next wave that’s about to be commercialized. It is about winning the future really. Really feels like an explicit commitment to doubling down on this economic model which is all about generating wealth by lifting productivity in manufacturing and industry.
Andrew:
And in the Chinese speaking or the Party speak, I guess I would say, basically they characterize that as modernizing the industrial system. And so that speaks to, you know, you want to modernize traditional industries by upgrading them, and then you want to be modern as well, or modernize by innovating at the cutting edge. And they are actually, even in this proposal, listed out some very specific things. And we’ll look at the actual five-year plan when it comes out to see if there’s more detail on how exactly they’re going to support these industries. But they are not shy about saying what they’re going after. I mean, almost in a shocking way, you know, people often say, well, you don’t know… You know, the Chinese system’s hard to… it’s a black box, you know, it’s opaque, all this stuff.
And that is true to an extent. But I mean, in these proposals, they list out the emerging industries that they are going to support. Those include new energy, new materials, aerospace and the low altitude economy. So, there are four big ones right there where there’s going to be money support, policy support, lots of efforts to build the future industry, or future industries in those areas then, or in emerging industries, as they call them. Then they also identify very specific future industries for support, and that includes quantum technology, biomanufacturing, hydrogen energy and nuclear fusion energy, brain computer interfaces, embodied intelligence, and sixth generation mobile communications. So, 6G. They’ve laid it all out.
I mean, I think we all know that at this point, they’re not going to make the mistake again of putting out a Made in China 2035 blueprint or roadmap because they put out the Made in China 2025, told everybody what they were doing. The Western business community and governments got quite upset about it. Then they kind of downplayed it. But you fast forward from 2015 when they released that report or that roadmap to 2025, and now they have all these studies about how they were basically successful, like 80% successful in a lot of those areas. So, it’s going to be a little bit harder to piece the roadmap together because they’re not going to be quite, as I think, explicit about it, so that they don’t get in the same situation where western trading partners in Western governments are both complaining about the areas they’re trying to dominate, and also then know the areas that they could try to trip China up in.
But we can put the roadmap generally together, and this is a big piece of it. Do you have any thoughts on those industries specifically, or kind of how China might try to… how explicit they’re going to be with their roadmap this time around?
Dinny:
No, not really. I mean, it’s interesting that the sort of the list of emerging industries, because, I mean, you read the Chinese press, and they are always talking about the low altitude economy, which really, I mean, it’s code for drones and flying cars. There is so much enthusiasm about the potential just in the popular imagination at the moment. It’s kind of interesting to say that it’s not just the press, right? This is also the government going right. This is the next cab off the rank. And it’s also interesting because just watching a space like that and I’m like; this is not really my area. I’m just kind of keeping one eye on it because I grew up watching The Jetsons.
I think the flying car, right? Flying cars in our cities I think is going to be amazing. But it’s interesting watching them the way that they go about it because it’s not just about the tech and it’s not just about the commercialization, it is also about the infrastructure and it’s about the regulations. So, there is a real recognition that when you’re moving into new technologies like this, it’s not like back in the 80s when the Japanese were moving into new tech. Right? You didn’t need to redefine how the world worked because Sony had rolled out a Walkman or because Nintendo had rolled out the Gameboy. I mean, these were great. As kids, they made your life so much more exciting. But when you have flying cars, that changes how your cities work, right? Particularly if they’re being charged with batteries and they need places to land and they change the way goods and people move around the city, that requires new regulations.
It requires new infrastructure, both in terms of flying routes and in terms of recharging. And it also requires a whole lot of new jobs, not just making this stuff as well, but designing flying routes and like altitude. It has the potential to change cities in such radically different ways. But to do that, it requires more than just tech and commercialization. It requires sort of these layers of government involvement, such as the infrastructure and regulation. So, I think that’s kind of the thing that I find interesting as much as anything. To make the most of some of these products that are coming down the turnpike, it’s not just enough to have innovative new companies. It’s almost a full court press that requires the state as well.
Andrew:
Yeah, you need an ecosystem around that. And I’m glad that you made that point, that bigger point about how a lot of these new emerging and future technologies have the potential to really change the way cities work, and I guess the way we live, basically. And that actually ties into a couple other big takeaways, at least for me, from reading through the proposals. And there is an amount of urgency in this document that we don’t normally see in a five-year plan or the proposals for a five-year plan. They very clearly see now is a pretty critical moment, one in sort of accelerating the shift to the new growth model away from the old growth model. And secondly, in particular, and we’ll talk more about this in a second, but in achieving kind of fundamental aspects of technological self-sufficiency.
And then you throw into that the idea that a lot of the technologies that are very likely to mature or emerge over the next five years really are world-changing potential technologies, and you can just feel the urgency of them saying, “We have to do this now. Now is a critical period for us to get from where we were previously or where we are now, to the kind of innovative economy, innovative society and economic model we want and the kind of tech self-sufficiency we want.” So, there’s a real urgency there that I thought was just striking, notable from this document. And then the second piece and related to that is there was also a coherence to this document that you don’t normally see in the proposals for the five-year plan or the actual five-year plan itself. I said at the beginning or the beginning of our conversation, this document is often like the state of the Union.
It’s a smorgasbord of different policy ideas, but there really seems to be more of a North Star in this document where everything kind of fits into this changing economic growth model, innovation, and tech self-sufficiency. Those two three things are the North Star they held together, and everything really kind of is in support. To the extent they talked about climate, it’s all about we want to build the technology that will allow us to decarbonize in a way that leads the world, and that we can sell these technologies and invest in them in other countries. So, just a very coherent overall approach that we don’t normally see. And related to that, sorry, third, kind of big high-level takeaway that I want to throw out there is it’s also a very confident and assertive document when it comes to China’s plan to position itself externally, like in the global economy and vis-à-vis other countries, right? Both bilaterally and more multilaterally.
Dinny:
Most definitely.
Andrew:
Yeah. Talk to me a little bit about that assertiveness from your perspective.
Dinny:
Just the whole tone of it, I think you’re a little bit more abreast of the whole implications for foreign firms and international relations side of things. But yeah, tonally, just in terms of the way that it sees the future. Right? It kind of comes down to the coherence of the document because as you said, so often, this is more like a state-of-the-union address. There’s a little bit of here on this issue and a little bit here on this issue. Whereas this time round, if you know how to read it, it comes across as a coherent vision of China’s future. And with that, as part and parcel of that, there is kind of a coherence and confidence that comes with the way that it sees its place in the rest of the world and how it’ll sort of engage with the rest of the world, partly because China is going from, well, at least, yeah, this is the track that it’s on, it’s going from a country that’s been technologically been catching up with the rest of the world in terms of technology.
It’s been trailing, it’s used other countries technology. And all of a sudden, it is leading the world. It leads the world in certain technologies. It sees itself as being a peer with other countries. It’s got a raft of emerging industries which are coming behind which other countries aren’t developing at the same pace. It sees itself as being at the cutting edge and kind of shaping what the world is going to look like. And for a country to be doing that, providing the world with cheap renewable energy, leading the world with batteries and electric cars, leading the world in drones on the cusp of having mass producing, I guess, flying cars, aggressively moving into humanoid robots. I mean, we all kind of feel that over the last 10, 15, 20 years that there’s kind of been a massive technological change in our lives. And to a certain extent that has. But I guess for the most part, that’s sort of revolved around our phones. And the real changes have been kind of software related, whereas all of a sudden, China is bringing this hardware revolution, and no one else seems to be close. And I think it’s kind of realizes that it’s in a unique position of global leadership.
Andrew:
Yeah, those are great points. I wanted to bring in to that your views on how, so there’s kind of a contradiction here at the same time, right? They are a global leader in many hardware areas. And yet at the same time, they’re still very reliant on Western technology, especially based technology. And of course, the number one of which being semiconductor production. And so another really striking feature, and I talked about this a little bit more length with Kendra, but want to get your thoughts on it, is this idea of tech self-sufficiency being hugely important to this five-year plan, to this drive to urgently move China onto a new economic path. And they specifically said they will take “extraordinary measures” to achieve tech self-sufficiency in some very specific areas. How do you read how that fits into all of it?
Dinny:
This is a little bit outside of my wheelhouse. But, I mean, you see that in a document like this, when the Chinese Communist Party starts talking about taking extraordinary measures, I mean, it’s a bit of a thunderbolt. Like for me, I’m like, I’m not even sure what that would look like, but it’s still kind of it pulls you up short because it clearly signals something is coming. And I guess it’s not necessarily one measure. It’s sort of throwing down to say that this is an absolute non-negotiable, and we will do everything in our power to ensure that we can achieve the technological independence that we think is necessary. So, it might be they have a raft of measures ready to go, or this might just be a declaration of intent, that this is a non-negotiable.
But yeah, as I said, this is a bit outside my wheelhouse. But you see something like that in a document like this, and it does, it pulls you up short.
Andrew:
Well, and it’s already starting to filter into the discourse. Because in terms of saying this idea or putting this idea out there about extraordinary measures, we actually saw that even before the full proposals came out in the press conference that the Party had just before the proposals were released, but after the fourth plenum had happened. So, we were already like immediately after the plenum had happened, and they had a press conference and were talking about tech, you could already hear the rhetoric had kind of changed and they were already talking… I’m not sure if they actually said the word extraordinary measures at the press conference, but we were just taken aback by kind of how clearly they were going to up the aggressiveness to achieve tech self-sufficiency, or at least to, as it was characterized in that press conference.
And then a couple of days later, you get the full proposals, and it very clearly lays out, we’re going to take these extraordinary measures. So, I think the system’s really starting to internalize this already very quickly. And so that’s something we’re going to be very much following obviously in the next five years and beyond as all this plays out. Two last quick things that I want to go over with you, Dinny, is well, this is all well and good to say we’re going to innovate, we’ve been all this urgency and we’re going to take extraordinary measures, but we’ve got to fund it somehow. And so, we also kind of looked at what they talked about on the fiscal side, what they’re thinking about in terms of how they’re going to deploy fiscal resources. And they don’t spell out we’re going to put X amount of money behind these projects or this or that. But what did you see on the fiscal side in terms of how they’re trying to support the overall economy in the next five years? And will we see any sort of fiscal reforms to make the fiscal system more stable?
Dinny:
Yeah, I think we’re going to see more reforms. They said they’re going to pursue proactive fiscal policies. So, government spending is going to be supportive of the economy. They’ll enhance fiscal sustainability. Now that’s kind of important given that China’s tax to GDP ratio level is really quite low by international standards. And it’s been falling over the last few years. And I think that’s never been a problem in the past because the economy’s been growing so quickly. Therefore, tax revenues have been increasing. And, additionally, local governments have always kind of been able to supplement their funding by selling land, the one-time privatization of a state asset. And that’s not feasible anymore. And so, the state’s ability to fund itself through taxes has become a lot more important.
So, yeah, it’s talking about enhancing fiscal sustainability, which is important. Also, things like improving local fiscal autonomy, saying the central government will strengthen its responsibility and increase the proportion of spending, accelerate mechanisms for dealing with local government debt, I mean, there does seem to be a focus here of like, okay, we’ve got a local government debt problem. The balance of revenue and expenditure responsibilities between the center and the local governments are a bit lopsided. We need more fiscal resources. It’s an acknowledgment of a fundamental problem that everybody knows exists. The thing is, though, I mean, we would have thought we would have seen progress on tax reform well before now. I mean, we’ve been waiting for it for almost a year. They were talking about the reforms that we needed in the tax system in the middle of last year.
This year, we’ve seen a lot of incremental changes to the tax system, but it’s all been about trying to come up with new ways to increase tax revenues in ways that aren’t going to be particularly disruptive to the overall economy. So, it’s kind of a Band-Aid approach to compensate for the fact that tax revenue has been so weak as opposed to any sort of systemic change that will either put local governments on a better financial footing or will be a long-term solution to the government’s funding problems. We just haven’t seen any of that yet. One of the things that got mentioned is that, you know, they’ll optimize the sharing of benefits between production and consumption. One of the things that’s been talked about for a long time is that the China’s value-added tax, the VAT, the way that it’s set up is that it gets collected at the point of production.
And what that does is it creates an incentive for local governments to encourage overcapacity because they get to generate taxes based on pretty much what’s being produced, whereas they need to kind of shift that to the consumption side. So, local governments get to collect the VAT at the point that consumers or the end user actually spends money on it. And that will then perhaps shift from being a local government incentive to encourage production into one that then encourages consumption. Now, of course, they’ve been talking about this for a while, it makes a lot of sense, but the practicalities of imposing that and then working out, how do you balance the tax hole between, you know, the provinces that are producing versus that are consuming? How do you make it work? It’s a headache for everybody involved. But you know, again, that got a shout out in this proposal document. Makes a lot of sense.
Let’s just see if and when it’s going to happen. So, more than anything, it’s seen to be a confirmation that Beijing knows the problems it’s facing. But we didn’t really get a good sense as to what it’s going to do about it. And I really don’t know what that means because, as I said, we’ve been waiting for some sort of meaningful tax reform for over a year now, and it hasn’t materialized. So, just because it’s in the five-year plan, I don’t really know what it means for fixing these problems.
Andrew:
Yeah, well, thanks for that. We’ll see. It is one, like I said before, there’s urgency throughout this document. There seem to be a little less direct, explicit urgency around the fiscal stuff. But I’m going to keep an open mind on that one because the fiscal system… funding everything China wants to do is hugely important. And it fundamentally has to do that through the fiscal system. And so, making those reforms to stabilize how the fiscal system works and the disconnect between local and central governments is crucial, I think, to really landing in this new development pattern, this new economic growth model that they want to achieve. And so, I actually wouldn’t be surprised if we saw a ramp-up in urgency around the fiscal reforms because it really is, it’s central to everything else that they want to do as well.
It’s just a little less sexy, a little bit more technical, and it can be quite hard to do. But all that to say, I will reserve judgment for now. I would not be shocked if they actually really did make some progress because they need to in order to achieve some of these other very urgent aims that they have. I want to end on one last thing which is related to the fiscal system, tax holes, which is poverty. It’s also the thing that they’re trying to move away from. So, this is the last part of the growth model. But it’s also, like I said, related to, you know, how local governments in past years or from past decades primarily funded themselves. So, what did the proposals say about the property sector and how should we think about that in the context of what they’re trying to achieve?
Dinny:
Well, the short answer is that said actually very little. I mean, as you pointed out in past periods, I mean, this is used to be such an important part of the economy. But the thing that we took away from the proposal document is that Beijing no longer really sees real estate as an important engine of economic growth. And so, you know, there was talk about, you know, we need to remove restrictions that are preventing people from buying houses. There’s a lot of talk about the new model of property development, but the focus was more on things like optimizing the supply of affordable housing and promoting urban renewal and things like redeveloping aging, which is really about redeveloping aging neighborhoods and urban villages and just expanding and improving the quality of housing. And I think it was quite telling that all sort of property comments sort of landed in the sort of the quality-of-life section of the report.
It wasn’t part of like the macroeconomic section of the report. So, they see increasingly housing as about an issue of people’s lifestyle or living quality, which is, I think, really probably how it should be. But the upshot of all that is they don’t seem to have a solution, or they’re not sort of looking at a pivot that will do something to either reflate the housing market, stop it from falling, do something to kind of make it again at least a partial sort of smaller scale engine of growth. There was nothing in the document to kind of suggest that it’s going to resume a role as a meaningful economic contributor. It’s as though the party’s attitude has fundamentally shifted. And now housing, it’s all about ensuring better equity, and it is ensuring that the sort of elderly communities are taken care of, and it is about ensuring a more livable urban lifestyle. I think that’s the thing we took away.
Andrew:
Yeah, I think that point about how they didn’t even mention it in the macro section, or the sort of more pure economic sections where it would normally be in the past because it was so fundamental to management of the macroeconomic environment and, of course, driving macro-economic growth. So, I think it’s pretty clear, you put it right, they’re just thinking about it in a totally different way. And I guess the upshot of that is definitely we’re not going to see a revival of the housing market, but it also means that it’s going to continue to be a drag on growth for at least another year. We talk about this on other podcasts all the time, or when we’re talking that more about straight up macro issues, but they’re not backing away from their efforts to find a “new development pattern,” which they also used for property.
So, they want a new equilibrium for property, they want a new development pattern, and one that is fundamentally not about macroeconomic growth, but is more about, like you said, all of these affordability issues, which just strikes me. That’s a little bit more how Western policymakers seem to talk about housing. Right? Affordability, housing shortage, all those things. We don’t talk… Yes, of course, the property sector and construction sector matters to the U.S. economy, but we don’t talk about it as much macroeconomically. It’s more from a policy perspective, usually very much about individuals and livelihoods and affordability and all that kind of stuff. So, just an interesting observation there. I think very much kind of nail in the coffin for the old growth model.
Now the question is, can they get to that new growth model. We’ll see. And we’ll be tracking it all over, well, the coming weeks, but also over the next five years and much beyond that. Dinny, we’ll leave it there for today. Thanks so much for walking me through your high-level views on the 15th Five-Year plan proposals. Really appreciate it, man. Good to see you as always.
Dinny:
Yeah, likewise, mate.
Andrew:
Thanks, everybody, for listening. We’ll see you next time. Bye.
