Dwarkesh Podcast - Why China's manufacturing economy is dominating — Arthur Kroeber

Episode Date: June 19, 2025

Arthur Kroeber is a leading researcher on Chinese tech and macro, a founding partner at Gavekal Dragonomics, and author of "China's Economy: What Everyone Needs to Know." It's the most useful, detailed resource I've found of how China actually works.On this episode, we discuss how China achieved high-tech manufacturing dominance, and where they'll go from here. By Arthur’s account, the Chinese government is like a giant VC fund: they decide on key priorities and then spend hundreds of billions of dollars subsidizing ruthless competition at the local level. They are willing to lose huge amounts of money for a few of their bets to pay off: at China’s scale, effectiveness matters more than efficiency.There's also a growing bipartisan consensus that we need to combat China's rise. This doesn’t make much sense to me. China is a big, powerful country at the frontier in many fields, and its economy is intricately tied in with our own. Being instinctively adversarial is both unsustainable and risky. Arthur and I discuss how we can create a productive, mutually beneficial version of this relationship.Watch on YouTube; listen on Apple Podcasts or Spotify.Sponsors* Scale is building the infrastructure for smarter, safer AI. In addition to their Data Foundry, they recently released Scale Evaluation, a tool that diagnoses model limitations. Learn how Scale can help you push the frontier at scale.com/dwarkesh.* WorkOS Radar ensures your product’s free trials go to actual users. Radar uses 80+ signals to distinguish malicious bots from real people, eliminating costly free-tier abuse. See why companies like Cursor, Perplexity, and OpenAI use Radar by visiting workos.com/radar.* Lighthouse is THE fastest immigration solution for the technology industry. They help you understand your options and navigate applications for expert visas like the O-1A and EB-1A. Explore which visa is right for you at https://www.lighthousehq.com/ref/Dwarkesh.To sponsor a future episode, visit dwarkesh.com/advertise.Timestamps(00:00:00) – We should reconcile with China(00:21:21) – BYD, Tesla, & Chinese EV industry(00:36:05) – Will China have a Japan-style financial crisis?(00:44:39) – Local debt situation is manageable(00:57:28) – If CCP is so competent, why isn’t China richer?(01:05:08) – How China keeps tech under control(01:33:45) – Does China win AI?(01:43:34) – Communication with China key for AI safety(02:10:08) – What foreigners get wrong about China(02:17:32) – China-US relationship future Get full access to Dwarkesh Podcast at www.dwarkesh.com/subscribe

Today I'm interviewing Arthur Kroger, who is the founder of Gavkal Dragonomics, which is a research consultancy focused on China and author of China's economy, what everybody needs to know. A friend while I was in China recommended it to me. And it's been the most valuable and useful resource that you can get today on how China works. So, Arthur, thanks for coming on the podcast and taking a time of chat with me. It's great to be here. Thanks. First question, what really is the problem if China becomes a lot? as wealthy, or if its economy grows as big as America, or grows even bigger. I know maybe it's not your perspective to be a China Hawk, but I've never really understood why this is a problem in the

first place. Yeah, it's a very good question. It's a very good question. There's a lot of criticism of China from the standpoint of, okay, you're trying to get rich. That's fine. Okay. But you're basically trying to get rich on the backs of everyone else in the world by running this gigantic manufacturing export machine, where it seems like the Chinese ambition is to produce all the manufactured goods in the world for everyone, run in enormous trade surplus, which means that they are depending on other people's buying power to support them, and that this is basically not fair, not sustainable, not a stable way to participate in the global economy. So that's more of a question, not of if China does get rid of,

but how does it get rich? Does it get rich by essentially operating on the same rules as everyone else and having a market that other people can participate in? Or does it grow rich by essentially making it impossible for anyone else in the world to have the kind of production structure that they want to have and relying entirely on these ever-growing trade surpluses? In general, in principle, from a welfare standpoint, it would be great if China got to be, you know, as rich as everywhere else in the world, even as rich as America. But that is likely to have some pretty difficult and destabilizing political consequences because of the vast differences between the Chinese political system and the U.S. political system and the political systems of all the other major industrialized

countries. I mean, the trade surplus point, to the extent that it is made possible by the government involvement in industry, which is actually not even clear to me that that's the case. I mean, just like if you have high savings and not enough investment domestically, just like the accounting identities are just that you will have a trade surplus. Right. But suppose that's even the case. On paper, it just seems like what is happening? The Chinese taxpayer, the Chinese saver is like subsidizing foreign importers.

So on paper, it just seems like we're getting a good deal. I'm sure some people are upset about this, specifically people who manufacture outside of China. But it's certainly not like something obviously insidious. Right. And so it seems like if it wasn't for this, there would be some other reason that, you know, China can't grow as wealthy as us. And I am playing a little bit devil's advocate here. But I just like, I don't really understand why this is like such a big issue that there needs to be a great power competition about it. I think there are a couple of things beneath that.

One is the systemic difference politically is really important, right? So the U.S. self-identity is of the leader of democracies around the world. And we are very invested, at least for now, in our democratic system. We'll see how that evolves over the next two or three years. There's some question marks around that. But historically, that's been a really huge part of the U.S. identity. And basically, the morality play of World War II and the Cold War, which has really been the crucible in which U.S. foreign policy has been formed, is that you had an alliance of democracies that fought back first against fascism, then against communism.

They won. And the result was that you created a world where, you know, most major countries were democratic. They operated on market economic systems, and we were heading towards sort of a world of convergence of systems where everyone's essentially playing by the same rules. And China really gets in the way of that narrative because it is an incredibly successful authoritarian system where the ruling party still calls it self-concern. communist, U.S. elites have never, to this day, really gotten comfortable with the idea that the Chinese political system is legitimate, right? And as long as you have that kind of underlying problem, I think it's going to be very difficult to erase these difficulties. And then on the economic side, I think it is a problem, the way that China has chosen to organize its economy. Yeah, in a strictly financial sense, if you will, The rest of the world comes out ahead in the sense that China is willing to subsidize a lot of low-cost production. So the rest of the world gets a lot of cheap goods and the overall welfare of the world improves a lot. I think that's clearly true.

But I think if you look at what has happened to the U.S. politically over the last 20 years, there are a lot of flies in that ointment. And the fly is that it is important for large countries to be able to maintain a diversified production structure and maintain kind of social cohesion. And if you lose the capacity to run a manufacturing economy that employs large numbers of people, there's a lot of disruptions that come as a result of that. and the purely financialized economy that we had grew up in the United States in the early 2000s as a result of this bargain with China wound up being pretty bad for the social compact. So I think there is a legitimate question about how do you integrate China's growing power, wealth, industrial might into a world in a way that societies around the world can tolerate. And it's a legitimately difficult problem.

And I think a lot of the problems have to do not with China but with U.S. domestic policy. So I think a lot of what's going on right now is scapegoating of China as a way of diverting attention from decisions that need to be made domestically about income redistribution and macroeconomic policy and so forth. But there is also, I think, a legitimate question to be made about China now accounts for 20% of the global economy probably will be larger in future. a third of the global manufacturing economy, there has to be an agreed set of rules about how interacts with the rest of the world so that everyone feels that they are benefiting, not just in financial terms.

And we don't really have that agreement now. Okay, so two points. On the political system, I wonder if we've learned a bad example from World War II and the Cold War, which is that the way in which great power conflict culminates is that the other person totally collapses. Right. I think that was actually necessary, obviously, for Hitler and even for, you know, the Soviet Union.

I think they were evil regimes. I think China today is an evil regime in a way, but it's just not in the same order as Stalin or Hitler. And so the end state for any great power competition for America, you know, history is long, right? So there will be more than just these in the X-3 decades. Cannot be that if there's a different political system, that it has to collapse the way that the Soviet Union collapsed or that Hitler collapsed. And then there's a question about regardless of their political system, there's this economic dislocation. Right. I mean, the first thing to note there is this could be true of any country.

So I think people can play these two arguments, whereas it's worth noticing that if Australia was like producing everything the world consumed and had an economy the size of America is these arguments should apply to them as well. well. And I don't think people have this sense of, well, if Australia has produced a bunch of stuff for us, we need to form a coalition against them and have this adversarial attitude. But suppose we did. I think there's a question of, okay, how could you prevent this dislocation and is their Australia's fault? The analogy is breaking down. So let me just go back to China. So there's low value-ad manufacturing where labor cost is a big fraction of cost. And that's that kind of stuff was shipped off to China. But if it wasn't for China, there's many other countries in the world that have much lower labor costs than the U.S. So if it wasn't for China, it'd be in like

Vietnam or Bangladesh or something. And then there's a high-tech manufacturing. But there, I haven't crunched the numbers. But if I, I don't know, if I already guess, I don't think TSM's leading edge, like what it costs to make a five nanometer wafer. I'm guessing very little of that is like the process engineers themselves. And that is just like, can your country produce it? Yeah. Well, there's a few different questions in there. So let me break that down. So first, I think the first thing that you alluded to there is essentially is a Cold War the right framing for whatever this conflict is that we have with China. And my answer to that is absolutely not. And you can address that question both empirically and conceptually. So empirically,

if you just look at patterns of trade and investment during the Cold War, the actual Cold War with Russia, the Soviet Union. The Soviet Union never accounted for more than about 1% of U.S. trade and investment flows were basically non-existent. China at its peak, about 10 years ago, accounted for 17% of U.S. trade, which is about the same amount as Japan did in the late 80s and early 90s. And that number has come down a little bit on the surface, but when you take account of stuff from China coming in through third countries and so forth, basically that remains the same. So it's just, and then if you talk about investment flows, there's $600 billion or more of U.S. corporate investment in China, which generates huge amounts of

sales, much larger than U.S. exports to China. So the integration of the two economies is just extraordinary. There's basically no precedent for it at any point in economic history, and it is just a completely different order of magnitude to what was going on during the Cold War. So, you know, one question would be is like, okay, if you really want a Cold War, does that mean that what you want to do is you want to reduce those trade and investment flows back down to essentially zero? And if so, how do you do that, right? So that's a very difficult problem.

But I think you got at sort of the more core conceptual issue, which is how does this end? This does not end by China going away. or turning into something completely different. It's too big. It is too successful. The economic model is successful on its own terms. It has a lot of problems, but it's fundamentally successful, and it is deeply integrated with the entire global economy in ways that are beneficial for China and beneficial for most of the other countries in the world. So everyone has some sort of a stake in China continuing to succeed. And so this is just not going to go away. And the other way, The other sense in which it's not going to go away is let's say you could wave a magic wand

and make the Communist Party of China disappear tomorrow and replace it with something else. What would that something else look like? Well, if that's something else were to be successful at governing China, it would almost certainly share many of the characteristics of the Chinese Communist Party. It would have a strong determination for China to be an independent geopolitical actor, taking care of its own security with very strong military so that it could defend itself against all of its real and perceived security threats. It would be committed, as every Chinese government since the mid-19th century has been,

to maximizing the rate of technological progress and making sure that as much as possible of China's core technology needs were met by domestic production rather than imports, it would be very, very similar to what we have today. So it's a fantasy to think that what we have a problem here is just this particular regime. And you could just like get them to change their minds. No, the sort of Chinese approach on this has been, is very deeply rooted in both the institutional cultural history of China itself and its position, its geographical, and geopolitical position in the world.

And so it's going to have interests that create a lot of friction and conflict with the perceived interest of the United States under any government. And it's probably going to be quite successful at managing its economy because they've been very successful for many, many decades. When I was in China, I asked somebody I met, what would happen if there's an election in China tomorrow? And his answer was that it's possible that the median voter in China is much more. reactionary than the government, right? Yes, yes. In fact, this might be much more liberal than the regime you would get out of a sort of Democratic election.

Yeah, we don't know for sure because there really isn't reliable public polling. But a lot of people say that. And my perception is that that could well be true. Right. That there is a lot. And all you have to do is look at, you know, the Chinese internet, the blogosphere. They don't have Twitter, but they have local equivalents. There is a lot of unfettered nationalist, highly militaristic thinking there that the government

spends most of its time keeping in check. Every so often they sort of unleash it because they're in a spat with Japan or whoever and they need to in a popular opinion. But mostly they try and tamp that down. Yeah. So a fully, you know, a Chinese system that was fully representative of actual, you know, popular views, we don't know exactly what that might be, but it could be very, very difficult to deal with. Going back to this discussion about, well, what should the grand bargain between the rest of the world and China be? I live in Silicon Valley, and as you know, a big topic of conversation is AI, in particular the race between China and U.S. on AI.

And one idea I've heard is that what we should do is give them free rein on solar and electric vehicles, batteries, all this other like real world heavy manufacturing, that they seem more, they seem to have greater personal. for anyways that they consider more real. Right. And then say on AI and semiconductor as well, look, this we want to dominate. Everything else will import. Is this a plausible deal worth making?

Because I think if you take AI very seriously, this might be just like an amazing bargain. Yeah. I mean, I think the question is like you can say what you want in your sort of ideal state of things. But then how do you get there? Because, you know, there are a lot of people in China who would say, well, no, we want it all. and we can, so why should we make that deal with you?

Yeah. So if I take this down basically to the level on which the United States and China are now starting to negotiate, right? My personal view on this would be that it would make a lot of sense for the U.S. to be much, much more open to a direct investment by Chinese companies in manufacturing in the United States. And I'm thinking, you know, particularly things like electric vehicles, that whole supply chain, green energy, industrial automation, all of those things. Why do I think that? Well, first of all, I think if the U.S. is serious about revitalizing its industrial base, and I think there's a good case for trying to do that selectively, it is not going to happen unless you invite in the world's leading place. and have them compete. That is how China industrialized.

You know, 45 years ago, they were an industrial basket case, basically. They said, we want to get industrially strong. How do we do that? We get all the leading companies in the world to invest here, and we will learn from them. And that's how you do it. So if we're serious about that, we should be serious about figuring out ways that we can bring Chinese industrial investment into the United States. And that, to me, would be a win-win because Chinese companies,

at an individual level would love that. They see the U.S. is a huge market. They can't get into it right now. They would love the opportunity to tap into it more. We could learn from them. And if you did that, basically, you would be saying whatever we're in with China, it's not a cold war because we are willing to have high levels of direct investment by both sides. And you might want to put protections around that, all kinds of rules of the road. But in an ideal world, I think we would have a lot more of that. Now, first question is like, why is that so difficult? Why do you essentially have a consensus in Washington that not only do we have to prevent the export of U.S. technology goods to China, but we also have to prevent Chinese companies from investing in the U.S. This is basically agreed on in Washington. And the reason is data. Fundamentally, there is a view that any manufacturing process today,

is also a data creation machine, and where does that data go and who benefits from that data? And the other thing is that it used to be back 30 or 40 years ago, you could divide the world into most technologies, which were essentially for civilian use, a few technologies that were military, and then a very, very small proportion of technologies, dual-use technologies that could go either way. and it was those dual-use technologies that had to be controlled very carefully. Now, basically, everything is dual-use. Any technology that you can imagine can be put to some kind of military use. So it becomes much more risky to have these patterns of investment, particularly when you don't know where the data is flowing and how that will feed into someone else's defense production base.

And I think that is a legitimate concern. And so in my ideal world, you would have a lot more Chinese investment in the United States, but it would be very carefully regulated. In the same way, the China very carefully regulates the direct investments by foreign companies. In its economy, they have very strict rules about data localization, et cetera, et cetera. So I think that could be achieved. I think it will be very, very difficult in the current political environment. And then just in terms of the sort of the grand bargain that you suggest is, you know, China is very interested in not being pigeonholed.

They didn't want to be pigeonholed in low value-added manufacturing. They want to do the high-tech stuff. Now they're doing that. They don't want to be pigeonholed in manufacturing. They want all of technology, including AI. So I don't think that any strategy, which is premised on the idea that China should accept arbitrary limits of what it can do is viable. Because would we accept that?

Absolutely not. And so why should we expect them to accept something that we would be? we would consider an absurd and completely unreasonable infringement on our sovereignty. It just doesn't work that way. Publicly available data is running out. So major AI labs like meta, Google DeepMind, and OpenAI all partner with Scale to push the boundaries of what's possible. Through Skills Data Foundry, major labs get access to high-quality data to fuel post-training,

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to improve the reasoning capabilities of their best models. If you're an AI researcher or engineer, and you want to learn more about how Scales data foundry and research lab can help you go beyond the current frontier of capabilities, go to scale.com slash thwar cash. It's funny because one of the main arguments that China Hawks will make or one of the big parts of the worldview is that China really cheated us by our companies would invest in China,

build up factories in China, the technology would get transferred there. And this was like a huge arbitrage that China was able to pull. And so if you actually believe that, it should just make the reverse of that incredibly compelling. Yes. Because you get a chance to do that again. Yes, right. Do you want to tell the story of B.D and Tesla in 2018 and 2019?

Because I think this really illustrates the point or what could be done in a reverse very well. So if you go back to the early 1990s, China recognized that pretty much every other country that gotten rich, had done so in large part by building up an automotive industry that then served as a mechanism for creating innovations in other sectors. You look at the U.S., you look at Germany, you look at Japan, you look even at Korea, which is very successful. So they said, okay, we have to have a big auto industry. This is one of the key industries that we have to support. So starting the early 1990s, they had this strategy of, of bringing in foreign companies, making them do joint ventures on a 50-50 basis with Chinese auto

companies. And the theory was that eventually the Chinese companies would learn and then you would be able to develop your own national champion auto companies and, you know, kick the foreigners out, right? And basically, this failed. It failed massively. over the next 25 years foreign companies came in, General Motors, VW, Toyota, Honda, and so forth. And they did very, very well. And the joint venture partners in China basically just sat around and clipped coupons from the dividends that these companies, that these joint ventures were producing.

All of the technological inputs continuously came from the foreign partners, all of the design ideas. that the local partners were never able to succeed. And in volume terms, you had a lot of smaller scale locally sponsored vehicle companies in China, building kind of low-end vehicles. So a lot of the cars that wound up getting made in China were made by local firms. But if you look at the share of profits and total value in the system, it was dominated by these joint ventures, which were in turn dominated by the foreign partners. So China, you know, circa 2010, 2015 had been doing this for 25 years, and they were basically no closer to having globally competitive conventional carmakers than they had been 25 years before. So in the late 2000s, so 2005, 2010, they started thinking, well, this and other related kind of industrial policies are not working very well. We are not generating the national champions that we thought. we were going to do. So what do we do about this? And their answer was leapfrog. Let's try and

figure out what is the next stage of technological development that people really aren't working on yet. Let's work on that. And then maybe we can get in on the ground floor. And so what they came up with in large measure was a renewable energy, specifically electric vehicles. So they started having a pretty comprehensive set of subsidies and other kinds of industrial support for companies like BID to produce electric vehicles. BID is basically a private company. This worked okay for 10 or 12 years, and BID got pretty good. And particularly what they started to figure out was the supply chain, so they got very good at making the batteries. But still, when you got to 2018, 2019, BYD was still not that exciting a company.

Most people in China really didn't want to buy electric vehicles. They seemed really inconvenient. The sexy cars were like the big SUVs that the joint ventures were putting out and so forth. And then in 2018, Chinese government made the decision that they would allow Tesla to come in and build a wholly owned gigafactory in Shanghai. They had never approved a wholly owned automotive company before. They started cranking out cars in 2019. which became immensely popular. And it seems like one of the things that happened was that the Chinese companies by 2019

had gotten pretty good at the underlying technology of electric cars, specifically the batteries and then the software systems that governed the cars. But they were terrible at consumer design. They had not figured out how to make these appealing products. that people would want to buy. And Tesla did have appealing products that people wanted to buy. They were big status symbols.

So BYD and its competitors said, okay, this is the part we have to figure out. How do we achieve this? And basically, they recognized that they had to up their design game. They, among other things, went to Germany and loaded up. on a lot of German car designers that were able to transform their kind of technology base into much more appealing packages.

And then by 2022 or so, they were, you know, able to compete with Tesla both on price and on quality. So, you know, I think what that shows you is that, number one, the Chinese government made a pretty good bet on this kind of leapfrogging idea that there are technologies at the future. We need to get in early subsidize the heck out of them. Some of the estimates that have been made about the level of subsidies given to the EV industry and related supply chains, it's two or three hundred billion dollars, huge, huge amounts of money that did not generate that much of a return, financial return for a really long time.

But they stuck at it. And then the thing that finally flipped. the switch was this catalytic foreign investment that showed the Chinese companies what they needed to do to actually compete in the consumer market. And then they got very good at that very quickly. How much was the $200,300 billion actually relevant, given the fact that BID, as you mentioned, is a private company? Yeah. Was that all, like how much of that was actually necessary or counterfactually important to creating this outcome? You know, I think the thing is, it's like the old slogan about advertising.

half if it works, but you don't know which half. Yeah, did China need to spend that much in subsidies? Probably not, right? But had they spent less, would they have had the same effect? Maybe, maybe not. They, you know, they tried various different types of subsidies. So initially, they were producer subsidies to just like get companies to produce more. Then they had a lot of buyer subsidies. So at the individual level, but also the city government level to promote, you know, things like electric buses. And so I think all of that played a role. And I think what was important was that the government set a very clear direction. And they said, we want this to happen. And we really want it. And we don't know how long it's going to take. And we're just going to keep trying different things until it works. Because the goal of creating this electric vehicle sector and the whole supply chain for it, that's what we want at the end.

And why are they able to identify these kinds of sectors in advance? Because, I don't know, central planning isn't supposed to work, right? Right. Yeah. So, and there's in many cases of countries which have tried to do this. Germany, Germany, Japan, many other countries missed out on the Internet because there was a centrally directed effort towards these heavy industries or manufacturing, which actually turned out not to be relevant in the 21st century. Yeah. No, it's definitely perilous.

So if you look at China has a list of key industries. It's called the strategic emerging industries. They came up with it basically in 2010. It built on previous iterations of industrial policy. Most of it is not really an effort to predict with high degree of specificity what comes next. They're mostly pretty obvious things like semiconductors, industrial automation, new materials, all this kind of stuff that I think would be on anyone's list if you were just sort of running a VC fund. and saying what are the sectors that we think are... But most VC funds are, like, losing money.

And so, like, actually, like, maybe, like, a couple of firms in the world, which are able to make this prediction correctly. Yeah. So it's, like, a couple firms in the world plus the Ministry of Information, Technology, and China are the only people who can predict the future. No, no, no. I mean, I think basically the analogy with the VC fund is a pretty good one. I've made it many times.

Think of China as, like, a giant VC fund that is just willing to lose huge amounts of money for a really long time. on the assumption that a few of the bets will pan out, right? And so China as a state, as a government, is uniquely able to throw a lot of money at things for a really long time, not care about what the returns are and say, we're going to identify this universe of potential winners. We're going to promote all of them, basically. And some of them may work and some of them may not. And the successes will pay for the failures. I guess I'm still countries on why. Many other countries have tried similar things.

Like, Nidi was a Japanese version of this, right? Yeah. I look at their economy now and their high-tech sector. So a couple things. So first of all, I would say that even if you go back to like 2005, 2006, when they started thinking about this, saying that green energy was going to be an important industry in the future, everyone was saying that, right? You had the Kleiner Perkins guy, John Doer, right?

John Doer was the big VC who said, circa 2007, I'm going to put all of my bets. on green energy because this is the future, right? He turned out to be wrong from the standpoint of his investment returns, but he turned out to be, I think, totally correct in terms of saying this is a really big thing. So it was just not that wild a bet to say that green energy is going to be really important, and so we should place a lot of bets on that. But why does this work and why is this different from a central planning thing, right? I think that's a really important point.

So a couple things. So first of all, the Chinese system like the systems that preceded it in East Asia, Japan, Korea, Taiwan, and so forth, has always put a lot of emphasis on being good at exporting. So there are a lot of pressures within the system to create industries that can export, right? The reason this is important is if you have a totally closed system, which frankly is what I think, Donald Trump is trying to create in the United States, and people are just producing essentially for domestic consumption, there's no incentive to keep up with global technology developments. So if you have this constant export focus, essentially what everyone is trying to do, if you're a closed domestic market, you can rig the domestic market and buy off your connections

in government to make sure that you as a company have your market share. So there are a lot of ways to win that do not involve technological upgrading. And that is what dooms all import substitution regimes. If you have an export-driven economy, you can't rig the global economy. Ultimately, you have to compete, right? And you can't compete just on price. You have to compete on raising your game. And Japan did this successfully.

Taiwan did this successfully. Korea did this successfully. China's done that successfully. So that's answer one is that you had this underlying system, which was heavily incentivized in technological upgrading across the board. So that's what you were sitting on top of. And it was completely different than the old central planning regime, which was autarkic and inward looking. Second, you had this domestic competition environment, which was really cutthroat, and which involved a lot of international companies.

And this is a little bit of a difference to Japan, which always kept the foreign companies out of its domestic market. Their companies operated globally, you know, very, very well, but the domestic market was very protected. China's domestic market was not that protected. And so they were always willing to bring in companies that they thought would be able to spark some technological change. And again, you can say, so what this did is it created a field in which maybe the government has the right ideas, maybe they don't, but you have a crucible in which their ideas can be tested. you know, very competitive domestic market where you have a lot of the big international players doing their own thing as well

and so that the things that work get some validation and you can keep building on those successes. So I think that's a really important and then just the sheer scale at which they were able and willing to support you know, what appeared to be losing bets for a long time

does matter, right? And you could contrast their view, for example, in solar energy, where they said, look, we want to be big in solar energy. And again, they started thinking about this in 2005. What do we need to do? So they identified the whole supply chain from the raw silicon inputs through all of the modules into the finished panels. And they said, we want to be in every stage of that. So they had a pretty deliberate strategy of trying to create people at every point in the supply chain. and they were willing to go through cycles of people not making any money.

Comparison, obviously, in the United States is the U.S. government gives one loan to one company, Cylendra, it goes bad, and everyone says, this is proof that industrial policy does not work, right? And I think China actually has the right answer to that question, and we had the wrong answer to that question. You have to be willing to accept some failures and some loss of, you know, government money along the way if you want to get, to the end. But I really stress the ecosystem because a lot of this would not have worked, just by the government saying, oh, we want to do solar. It would not have worked unless you had this broader ecosystem of export-driven manufacturing, high competition and international participation across many, many, many, many, many sectors of the economy. They all converged to create a successful result. I want to put some of these bureaucrats in a factorial speed run and see how they do. LLM tokens are expensive. So if you're building an AI tool, free trials of your product cost you real money.

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Radar blocks free trial abuse by distinguishing between real prospective users and malicious bots so that you can keep offering free trials without wasting a bunch of money in the process. Cursor recently turned on radar to make sure that their free trial. weren't being used to generate random fanfic. Radar currently runs millions of checks for them every single week. You can learn more at WorkOS.com slash radar. All right, back to Arthur. I just interviewed Ken Rogoff, so Japan's top of mind for me.

That's really interesting that even though Japan had this export discipline, maybe the reason that the growth couldn't continue after the 80s is because you had this, was it the convoy system where... banks were incentivized to lend to people they knew in these conglomerates, and these conglomerates had been around for decades, even before World War II. Right. Now, a question I have about China is, now that you do have these companies which have become national champions, and are conglomerates, right?

The same company is producing a phone and a car and everything in between. And, you know, given this sort of like intrinsic nature. of maybe authoritarian systems or systems with financial repression and will we again will we return to or I don't know if returns the right word will we go to a system that is closer to what Japan had in the 80s where okay now you're going to give money to Huawei because Huawei is the per how are the people or VYD are the people or will it remain dynamic especially in the sectors which are coming up over the next few decades no it's it's a good question I guess I would start by emphasizing the ways in which China is very, very different than Japan.

The sort of central thing that is really different that lies at the root of a lot of this is that China is an independent geopolitical actor in Japan was not. Japan, at the end of the day, they could rely on the U.S. for security. They were demilitarized. China basically is on its own. They're in a very dangerous neighborhood. They have 14 land neighbors that they share borders with. they have names like North Korea, Russia, Pakistan, Afghanistan, a lot of dangerous actors. Several of them have nuclear weapons, North Korea, Russia, Pakistan, and India.

So China, just in a very narrow sense, lives in a very dangerous neighborhood. And so they quite legitimately have, I think, some pretty significant national security needs. And they also have aspirations to be great power and they want to do it on their own. So the incentive to get things right is much more existential in China than it was in Japan. Japan essentially could take the choice to sort of say, oh, well, we're going to have a stagnant economy and that's bad and whatever. But actually, we'll be fine, right? And for China, it's not fine, right? So there is underlying it, I think there's a spur that increases the chances.

that the Chinese leaders will do the things that they need to do to keep the system more dynamic. It's not a guarantee, but it's a pretty strong incentive. But then if you look at some of the specifics, so the big difference between the way that China and Japan are economically organized is essentially the relationship between the financial and the corporate sector. So Japan had the system where banks owned equity in these giant industrial companies, and in the trading companies, and vice versa. There were these cross shareholdings, which meant that it was essentially the entire economy of Japan, the entire corporate and financial sector, had one big balance sheet. And all of that balance sheet rested by the late 1980s on land values that had just gotten

completely detached from any form of reality. There was an investment thesis among investors who were, you know, playing the Japanese stock market in the late 80s that you did not. look at the earnings of the Japanese companies, those were irrelevant, what you looked at was the value of the land that they controlled. So it was essentially a capital ratio where you assumed that this, the value of their underlying land capital was a permanent contribution to their wealth and prosperity. And so the valuations of these stocks, which got, again, crazy, you couldn't justify them

by earnings. They said, well, it doesn't matter because the land that they're sitting on is so valued. Then the land values collapsed by 80%. The stock values had to collapse by a similar amount, 80%. And everyone was holding shares in one another. So the banks, their capital got eroded because a lot of their capital was tied up in the land and in the stocks, which were collateralized by land. And so they were unable to lend.

They just had to de-leverage as fast as possible. The companies had to de-leverage as possible, fast as possible. And so the entire economy got engulfed by this phenomenon of debt deflation, which basically means that in the act of paying down the debt, because you're doing fire sales of assets, you're reducing the prices of those assets, introducing deflation. So the real value of your debt continues to grow even as you are supposedly reducing it because it's a deflationary. In fact, it was very, very difficult to get out. China does not have this problem at all because they looked at the problems that Japan got into. They looked at similar problems that Korea had in the late 1990s, and they said, we will never allow this kind of cross-shareholding between financial companies and corporations. This is way too dangerous.

So they have kept the two quarantined. It is illegal for industrial companies to own a bank. They are allowed, the bigger ones are allowed to have internal financing subsidies. but they can only sort of manage financing flows within the group. And it is also illegal for banks to load up on shares of industrial companies. So you have a distinct financial system and industrial system, which means that the particular type of macro problem that Japan got into is very, very unlikely to occur in China today. So you have huge debt problem. You have huge debt problems, right? So the property developer is very over leveraged, huge problem. You've had a

massive property crash in China for the last five years. That is a big, big problem. You have local governments that borrowed a lot of money, invested in infrastructure, which is now delivering very low returns. They have a big debt problem. So you have very substantial debt problems in China that have significant negative macro consequences, but they're all isolated. They can be dealt with in sort of one by one. If you look at the industrial sector, it's not very highly leveraged. Debt levels, in fact, are not high. Most private companies in China have learned for many years they couldn't get access to bank credit

because the banks only wanted to lend to state-owned enterprises, which were a secure, they had physical collateral and they had a state guarantee. Private companies for years have learned to make due basically financing their investments, out of retained earnings, and their leverage ratios are not that high. They're creeping up now over the last few years because of the big industrial policy push. But fundamentally, they're in a very different position than the Japanese companies were. I mean, this is just stuff from your book that I'm citing back to you, but you talk about these local government financing vehicles, which are backed.

So the local government takes out a lot of loans in order to build this infrastructure. And that is backed by the presumed up precepting. of the land which should go up as this infrastructure goes up. Right. And that sounds actually very similar to the problem you were describing. Right. With Japan. And while you say, look, this is debt that's on the local government's balance sheets.

Right. But, I mean, fundamentally, I don't know, it's like one country. And especially if you have this system of, you know, the government can just like hand the debt to somebody. So how immune is the private economy really from like, will it just take down the local government? and then nobody will make a fuss and these other companies will just never have to hear about it again? I guess my view on this is that this local government land-based financing model was actually a pretty smart thing to do initially. And for a decade or so, it worked quite well. Local governments were sitting on a lot of these land assets.

It was perfectly, the land assets originally were undervalued quite substantially. And so it made sense for the local governments essentially to try and capitalize some of the future value of these things and use them to finance infrastructure development. And it actually, this was not sort of a rogue policy that local governments came up with on their own. It was actually sponsored by the central government and the China Development Bank back in the early 2000s, which was grappling with the problem. that China at that point had a severe shortage of housing and infrastructure of all kinds, including urban infrastructure. And the question was like, we need a lot more of this stuff. How do we build it? How do we finance it? And they realized, oh, actually, as we build this stuff out, the values of this land are going to skyrocket. So let's, you know, essentially take some

financing against that future land price appreciation and use that to build the infrastructure that makes everything possible. And if you look at the first few cases of where this was done in the early 2000s, they had these estimates of what the land would ultimately be worth that seemed ridiculous and astronomical at the time. They were in fact way too low. They were way, way conservative on what the actual land price appreciation would be. So you had a period of about eight or nine years where essentially the development banks, the state-run development banks, were doing this in a fairly controlled way. very, very successfully. And then what happened was that after the 2008 financial crisis, the government said, oh, we just have to spend a lot of money to gin up growth because there's been this global economic catastrophe. And so they did a massive cash infusion into the banks and to the state-owned enterprise that said, spend, spend, spend. And basically, all infrastructure is good infrastructure, just like build whatever you want. And so what happened at that point was that all of the commercial banks got into this business of lending money to local governments for these infrastructure

projects. And their underwriting standards were much less robust than the China Development banks had been. And so the local governments just, you know, it was free money to them. So they just like took all the money and they ran with it. And then that created this kind of of Frankenstein's monster. Even so, I think you had quite a lot of that money in the first two years went into, you know, probably generated a pretty good return because China was still underbuilt relative to what it needed to be. But after that had run for three or four years, it became clear that a lot of this was going into wasteful projects and it didn't deliver good return. And now they've been struggling for the last decade for how to unwind that. But I think it's important to

to understand that the underlying model was actually an okay model. It just wound up being done in a way that was completely uncoordinated and excessive and led to a lot of, and you didn't have incentive structures that enable local governments to, you know, rein it in when they needed to, right? So I still think that that is fundamentally, that is a local government fiscal problem, which ultimately is a central government fiscal problem. if you look at the consolidated balance sheet of the central and local governments put them all together. China's a government debt is still probably less as a share of GDP than U.S. federal government debt, right?

The U.S. is over 100%. China is probably under 100%. So my previous guest, Victor Shee, I think, estimated that the local government debt alone is somewhere between 100 and 150 percent of GDP. Yeah. And you add up to the central government debt. And I think he estimated that government debt in China is 200% of GDP. Yeah, I would, yeah, I would respectfully disagree with Victor on that. I mean, it's impossible to know for sure. And the problem is that you have the problem of formal debt. Yeah. Which is debt issued by, you know, government entities. And then you have contingent debt, which is debt issued by corporations. that may or may not essentially be fronts or windows for local governments, right? There is also a very significant problem of double counting, which is hard to resolve,

where debt gets counted at different levels in the system. It's one piece of debt, but depending on how long the chain is, it gets counted in various different places. And I've long had the view that many of these much larger estimates, of debt don't fully account for the double counting problem. So, you know, I think it's quite possible that the true debt level is higher than, you know, what we think it is. It's unlikely, in my opinion, to be as high as Victor says it is.

And it also matters, you know, what the debt goes to and who is actually formally responsible for paying it, you know, and are there like project flows or income flows that can be used to pay for it? So the servicing, just what the structure of the servicing, the debt matters, right? At the end of the day, we do have a pretty good sense from the macro data of how much total debt there is in the economy. It's on the order of 300% of GDP. So if you want to say that government debt is 200% of GDP, then unless you're double counting, you're basically saying that everything else is a lot less than we think it is. Do we know what the total debt private and public is in the U.S.?

Yeah, I don't have it off the top of my head. The federal government debt, I think, is around 110% of GDP, something like that. Total gross debt of all sectors, government corporations, households, I think would be on the order of around 300% of GDP. In Japan, it's substantially higher. You can get into an endless debate on these things where it becomes kind of a numbers game. But I have a pretty high conviction that China has a, they have a significant macro leverage issue. So if you look, if you take my numbers and say, well, gross debt to GDP, which by the way are the official numbers of the Chinese government and, you know, largely accepted, you know, with some structural modifications by the IMF and so forth, 300% of GDP.

That is in the ballpark for highly developed economies, right? it is extremely high for middle income economy. So if you look at China as a economy that has an average per capita income, that's kind of like Brazil or one of these countries, China is way more leveraged than any other country of its level of income. And that is potentially a problem. So I don't want to make light of the problem because I think it is quite serious and it's an important constraint on policy and it is an important constraint on growth at the moment. I don't think that it leads to a financial collapse situation because the system is contained and all the debt is denominated in local currencies. But it imposes a tax on

growth and it is one of the things that makes China's growth more sluggish now than it probably could be. Why is it the case that middle-lun countries are especially in a bad position with having a high debt to GDP ratio because you would think naively that they're in a position to have higher growth over coming years. And so it makes sense for them to take more debt so they can use that to finance the greater growth that will come, at least theoretically, assuming they use it to invest in high return things, as opposed to the U.S. or Japan where you're just going to be stuck with this debt load for a long time. Yeah. I think one of the things that you could say about debt historically in China was

that it, you know, it tended in general to finance productive assets. So whether it was industrial production or infrastructure, for many, many years, China was a very infrastructure short country relative to its, you know, its needs. And so you could justify, you know, quite substantial debt-financed infrastructure investments on the basis that these would deliver, you know, good economic returns for many decades into the future. The case for that is a lot weaker now than it was before. The problem is, you know, how do you essentially retire this enormous stock of very low productivity infrastructure investments, debt financed, and how do you, sort of move on and have a more productive return on capital in future? And there are ways from

solving that problem. To me, the fundamental issue is they have too much of a supply side strategy, not enough of the demand side strategy. It's really a macroeconomic issue that if they had stronger domestic demand, that would generate more profits for companies. They would be able to more pricing power for companies. You would get a little bit of inflation. So you would have more cash flows within the economies that would enable people to, in local governments, to pay down debt. You know, a little bit of inflation would erode the real value of the debt. And that's essentially how they got out of their last debt problem in the late 1990s. They had gigantic bad debts in the banking system, essentially representing legacy loans to state-owned enterprises.

They had no way of paying them back. And they had a very, very growth-friendly program that generated a lot of growth, a lot of inflation, and that basically strength the debt problem. And what they need now is a kind of a revamped, updated version of that strategy where they do a lot more to promote domestic demand to get more profits, more cash flows, and a little bit more inflation into the system. And that would probably solve the debt problem over, you know, a decade or two. All right. Look at this. This is just part of an 01 visa application.

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like AI, robotics, synthetic biology, I guess podcasts, there is a way. Lighthouse only needs your resume or even just your LinkedIn to tell you your options. And they respond to every single person who fills out their contact form. I really encourage you to reach out. You may be more eligible for a visa than you realize. Go to Lighthousehq.com slash get started. to learn more. All right, back to Arthur. I want to keep asking you more questions about the needy-agrity of this situation. But before we keep deep diving, I want to step back and ask this

question. I think the valence of things you've said so far has been, look, they've been remarkably competent, even at the things which economists criticize them most for, for the majority of the period of these schemes, they've actually worked out quite well. For example, this local government financing through land sales on estimated future income and so forth. And then obviously we were talking about Chinese industry and how that's been successful in many key sectors. So I guess the big picture question I have is if that's true, look, I mean, there's still at like a fifth of American national income per capita, a third of similar countries in East Asia, like Japan, Taiwan, and South Korea. So how do we explain the relative poverty on a per capita basis is that

in China, how do we explain obviously bad decisions like zero COVID? Right. Yeah, I guess I'm having trouble squaring the circle of like, you know, if they're making all these great calls. Yes. Why isn't China more successful? They're not successful enough. I thought one of the problems in the world that we're facing today is that they're too

successful at too many things and that this is creating difficulties for other people. So, yeah, that has come up, you know, from time to time. And during the period in the 90s and 2000s, where they're growing it. 10% a year, which is the fastest growth rate recorded by any economy in the history of mankind. And they were doing it just not for one or two years, but for 20 years in a row. People often say, well, there's all this waste and there's too much state on enterprises. And they could grow much faster if they were just more efficient. And it's like, really?

Could they? They're already growing faster than anyone has grown before. Is it really the case that they could have grown a lot faster than they have? maybe, but I doubt it. I doubt it. And the reason is I think there's what I would call kind of an efficiency fallacy, which is that economists who, remember, have all been basically, all global economists, macroeconomists have been trained in the United States, you know, since the end of World War II and

particularly since, you know, the 1990s, right? And so they view sort of the U.S. in its developed state as the norm rather than as the result of other processes. So it's like the way we operate now is the way we got here. And actually, that's not quite the case, right? The reason China was able to grow so fast for so long was that they were able to mobilize these huge swathes of resources, domestic savings, and throw them in a kind of uncons. of uncoordinated way at a lot of problems. And there was a lot of waste along the way. That was part of the equation. So if they had tried to be maximally efficient and said, no, no, no, we're not going to allow banks to lend unless they can prove that this project is definitely going to have

an ROI of X. They would have lent it a lot less. And they would probably have had a lot less growth because they were not willing simply to create that wall of money that would create broad-based growth. And they might, in fact, have had substantially more inequality than they did because this wasteful method allowed them to spread out investment in a lot of areas which were geographically disadvantaged, which might not have done so well in a purely efficiency-driven system. So I think we need to be careful about assuming that inefficiency is bad. I think inefficiency sometimes can be, as long as it is a basically the result of a desire to be effective, that can be sort of a byproduct of a successful growth story.

And I think that's basically my account of China. Is it your quote in the book something like at a country of China scale, what matters not as efficiency of using the resources, but effectiveness of achieving outcomes? Basically, that's my basic thesis. And, you know, I think they've shown that this works quite well. And I think that's also part of the answer to why, well, why aren't they richer on a per capita basis? Well, there are 1.4 billion people. It is just gigantic. If you just think about the scale problem, right, Taiwan, Korea, South Korea, they got to whatever they are relative to U.S. per capita GDP, 60, 70%, something like that, within a generation or two.

because Taiwan they had 20 million people, South Korea, they had 40, 45 million people to move that number of people and get them all working in high-wage, industrial or service jobs in urban areas. You can do that in the course of a generation, right, 20, 25 years. I just think it's physically impossible to achieve that on the scale of that China's been operating of 1.4 billion people. look at the urban migration that they've done, it is completely unprecedented in the history of humanity, the speed at which they have converted people from rural residents into urban residents. From many, many years, they were urbanizing the rate of 20 million people a year, added to the urban population. I forget the precise calculation that I made, but in terms of, you know, they were effectively,

in terms of housing and urban infrastructure, they were building, the equivalent of, I think, I calculated New York plus Philadelphia plus San Francisco every single year for 20 years, right? No one has ever done anything like this before. And so I think what this tells you, the lesson of this is that there's an arithmetic problem there, that even if you do this on this unprecedented scale and do it faster and bigger than anyone has done it before, if you're trying to move one point. 0.4 billion people into an income of United States level, it just takes a really, really long time.

Yeah. Right. And now, of course, what's happened is because they have, I think, gone too far off the deep end of industrial policy and the supply side will solve all of our problems. Growth has slowed down quite a bit in the last few years. It's probably well below potential. I don't think that there's a lot of evidence that China's growth was below potential from, you know, from 2000 until 2020 on average. I think there's a lot of evidence that it's below potential now. And so they are sacrificing the ability of the average Chinese person to do more rapid catch-up with living standards of the West in order to achieve these industrial policy technology goals. I have a question about it. Just to react really fast to some of the things you said. Obviously, there's places in China like Shanghai or Guangdong, which I have per capita incomes.

Yes. Approaching these East Asian neighbors that are really rich. And to the extent that that's possible through this high-tech manufacturing, and to the extent that it's already a problem that other countries are complaining that China is doing too much high-tech manufacturing. I guess it makes sense then, like, well, how could you have literally 10x as many people? Yes. Right. Doing the same thing. I was going to ask, you said, the government has decided to prioritize this high-tech development rather than the growth rate. And you said it as if there's a trade-off. But naively, it seems like

isn't high-tech supposed to lead to growth, right? Like, why is the, why are we on this Pareto frontier with technological development and growth? Yeah. Well, and here you get to, I would say, a conceptual sort of fork in the road. I would say that in many respects the communist leaders in China have a lot in common conceptually with the techno-oponists of Silicon Valley in their what I would call sort of technological fetishism. So let me see if I can break that down. The Chinese leadership throughout the last 40 years, but even going back further, has had this notion that technological upgrading is the key to wealth and power. Right. And the fundamental idea here goes back to the 1840s when you had this great Chinese empire that had been sitting around for a thousand years, doing great. They thought they were the best in the world. And then these upstarts from England come and crush them repeatedly, militarily, and impose this, you know, very humiliating political settlement on them through the opium wars. And so the basic analysis among the Chinese elites was, oh, okay, we fell behind technologically. And so therefore we must.

catch up technologically. This is the central thing that we need to do. And this was kind of recognized, you know, among some elites, but it ran into a lot of encrusted political pressure in the late imperial Chinese regime. They didn't get very far. After the empire fell in 1911, you had a Republican government that basically, if you look back at the things that they were saying and doing, they're pretty similar to what the Chinese Communist Party, has been doing, saying and doing. They just did them somewhat less effectively. They were dealing with civil wars and various other problems. But the basic insight was remain the same, that we need to catch up with the West technologically. This is the fundamental thing. It's just a question of how

do we do this. And so what the current regime in China has been able to do is to take that basic idea and actualize it. They have been successful at this task of technological upgrading and catch up and so forth. So this is really central to the conception of Chinese elite thinking that the number one job of the government is to figure out how to mobilize the resources of Chinese society so as to maximize technology acquisition, creation, and upgrading. starting in the 1980s, you know, that was a big part of the philosophy. But the other part of the philosophy is we just have to grow as fast as possible.

And we are fairly agnostic as to where the growth comes from. And we realize that there are many different sources of growth, you know, foreign investment, exports, construction, infrastructure. We're going to do all of these things. And basically, the incentive structure that we will set up is just to tell local officials, your job is to maximize GDP growth, right? And that will make all of these other things happen. If we tell local government officials, your job is to maximize technology development, they'll do a lot of dumb stuff and waste a lot of money. That's not the right way to do it. Let's just GDP as the KPI, the end, right? And that turned out to be incredibly successful. Then Xi Jinping comes along in 2012, 2013, and says, well,

okay, the problem with this is that it's now gone too far. It's led to a lot of corruption. It's led to a lot of inequality. It's led to a lot of local governments doing wasteful and duplicative things. And now we need to like hunker down and focus a little bit more on the really central task, which is this technology task. So less of growth at all costs. Basically, the implicit idea there is we've got this figure out. Growth will take care of itself. We have a growth machine in China. the resources of government now need to be focused on specifically the technology question. So everything that he has done, particularly since about 2015, 2016, when you really started to see this come into focus, has been, let's worry less about the growth target and more about the technology targets. And particularly after Trump launched his trade war, and the Biden administration followed that up with a lot of controls on exports of, technology to China, I think the focus got intense because they were saying, oh, the U.S. really wants to prohibit, constrain our technological rise. They kind of have the ability to do so. And so, therefore, we have to double down on efforts to replicate all of these core technologies so that we're not reliant on the U.S. or its allies anymore. And we just have to go full tilt on

technology at all costs, right? So that was kind of an accelerant of this tendency. But then there is also, there is kind of a macroeconomic theory. So if you go back and read some of the statements that they put out in the late 20 teens about their vision of the future, basically they said all of these technological developments, by which they meant investments in, they didn't mean Alibaba and Tencent and all of these great Internet companies. they meant physical technology, semiconductors, new material, green energy, industrial robots, all this kind of stuff. Essentially, their view is this is going to be the productivity engine of the future. And so growth and, you know, growth in the overall economy and incomes, it's all going to be driven by these technological investments.

And I think that is essentially what they sincerely believe, right? And I think there are some problems with that, which is that, you know, the vast majority of people in an economy do not work in those sectors, right? So you can get very, very good at making semiconductors and industrial robots and whatnot. And the people who work in those industries do extremely well. But that is a tiny, tiny fraction of the totality of the population. And how do you have spillovers that enable every. everyone in the economy, regardless of how remote they are from this, you know, engine room of the high-tech sector, to enjoy gains to income, right? And the answer in the United States historically has been we're just going to have this great consumer economy, right? We're essentially going to be demand-driven. And so consumers will tell us what they want and companies will arise to, you know, make what they want, which is increasingly not stuff, but services, experiences and so forth. and we will create a financial system that produces very good financial rewards for the

companies, for the people that produce these kinds of services. And then you generate huge amounts of actually very high paid, you know, employment in the services economy. And I think the Achilles heel of any sort of industrial policy-driven growth model like China, but you can see variants of this basically throughout. East Asia is, they're very materialist. They're convinced that it's only really the physical stuff that matters. So you get really good at making the physical stuff. That will somehow magically spill over into the rest of the economy. And I think the evidence that we have is that

that that actually doesn't work that much, that most of the demand in a modern industrial economy, the really high wage, high income economies, comes from intangible services. And so there's a more complicated interaction between this high-tech core and wider economic growth. And I don't see in China how they set up the linkage between all these great high-tech industries that they have and the 90 or so percent of the economy, which is doing something else. I guess I still don't understand. So a point taken that maybe in the short run, these other sectors don't generate as much growth as just building or housing or something. But by that same token, they don't take that much capital in the scheme of a national economy to sustain. So if China wants to do a

$100 billion fund for semiconductors, that shouldn't detract from it. I just don't understand why the macro growth number has to go down for it to be able to do that $100 billion semiconductor fund or something. Well, it doesn't have to, but the way that they have in fact executed this tends to lead in that direction. And so here's why. So at the same time that they have been doubling down on industrial policy, they have also been much more tightly regulating their service sectors. So a few examples. The famous one is that they woke up in November of 2020 realized that Alibaba's financial subsidiary was about to do this gigantic IPO, the premise of which was that China should build a financial system that resembled that. of the United States in 2005 and that this was a really smart idea. And they said, oh, actually, that's a really dumb idea because look what that led to the U.S. We don't want securitization.

We do not want this like financial risk generation that Ant Financial is trying to talk about. We really need to crack down on these guys. So they did. But then they were also simultaneously concerned with a lot of other things that the Internet platforms were up to. And so there was this broad-based regulation of the Internet. sector, which weirdly for about 20 years, had operated in a complete free-for-all land of almost no regulation whatsoever except for political censorship. But pretty much anything else you

wanted to do, you could do it with very little government interference. It was a strange exception to the sort of regulatory norm in China. They finally caught up and said, no, no, no, we have to regulate all these guys. And so they went around to all of the internet companies. companies and basically told them there are things that you can do that are fine and there are things that you cannot do. And there are a lot of business models that you might be interested in doing such as fintech, such as telehealth, such as kind of wider social media applications that you may not do because we think it creates too much financial risk, we think it creates too much social stability

risk, we think it creates too much political risk for us, the Communist Party. And so a lot of the avenues of growth for the internet companies were shut down. So they still did okay. They're still very big companies. I think share prices fell way more than was justified by the actual loss in revenue. That's starting to correct. Alibaba, 10 cent, there's still great companies. They're figuring it out.

But they were severely constrained. They were much, much more tightly regulated. You look at the financial sector generally. was significantly deregulated from about 2008 to about 2017 with some bad consequences, increased financial risk, shadow banking, lots of bad stuff, but also lots of good stuff. Private companies, which were essentially shut out of loan finance, got the ability to finance themselves through debt in the way that they had not been able to previously. you had a lot of new financial services going to households.

And basically the government said, no, this is a little bit too dangerous, so we're going to re-regulate it. And now most financial activity in China has been constricted back into a small number of basically state-owned banks. So it was severe re-regulation of the financial sector. There was a lot of talk about health care sector opening that up to much more to, private entrepreneurship, that again has been reined in. So you can go down the list and there has been a massive re-regulation of the service sector, which limits the opportunities for profitable expansion by companies, limits the opportunities for entrepreneurship and limits the opportunities for employment. But the examples you mentioned all seem like that the potential growth was constrained

and not because it was cutting off against high-tech development and other. more physical fields, but because it was a threat to political power or to perceive social stability. So to the extent that growth has gone down because of all these actions, not to the extent, it has gone down because of these actions. And it doesn't seem like it's happened because they needed that to happen in order to, you know, get smick up to snuff. Right, correct. It just seems like it's because.

No, it's a political choice. It's a political choice. That's right. And I think, you know, just, you know, so this is what happens if you say, technological development, particularly in hardware, will solve all of our problems. It will generate all this growth. And so therefore, we don't need this service sector, right? So we have a real-life experiment. And what happens if you do that? And what happens if you do that is you get a lot of progress in the technological sectors, and you get basically a persistent shortage of aggregate demand,

which means that even the people who are making all this great technology stuff don't have any pricing powers. They have to keep lowering their prices. So you get deflation. When you get deflation and less employment growth, people say at the household level, oh, people aren't hiring. So I guess I need to save more and spend less because my income is not going to go up. And you create the risk of this deflationary spiral, which they're sort of on the edge of right now. And so I think this is something, again, this gets back to the sort of like the techno-optimic techno-optimist view of things is that if you have this very narrow view of the economy as purely the expression of, you know, the emanation from this technological core, you're

missing a lot of stuff. Right. And you will basically take yourself into a blind alley if you think that that is going to solve all your problems. And the Chinese government in the last few months, I think, has begun to recognize this and say, oh, actually, we need to have some kind of a demand strategy. This is very evident in their top-level statements. And the problem is they've been working for 45 years to build this magnificent machine of investment and industry in manufacturing, and they're very, very good at it.

And they have basically devoted no time in the last 45 years to figuring out how to create a demand machine. So they're just at the very early stages of figuring out that part of the problem. And there's another problem with this focus on specific parts of technology development, which is that in any field you understand well enough, you've realized sort of how contingent and random the steps leading up to what we now consider to be this sort of like self-contained high-tech thing is the field I know. better than others is AI. And just there's so many weird things, right,

that like people wanted to play video games. And so we had decades of progress in making these graphics processing units. Right. Which contributed to AI development. Or people were just like posting on Reddit, on Twitter and so forth. And that fossil fuel of data has been powering these AI models.

And so the idea that you could have just like said in 2000, we want to make progress towards AGI. And somehow that would have like led somewhere as opposed to what actually ended up happening. Yeah, I mean, I think you can scale that analogy up to China just its total economy. I mean, a lot of the stuff that I've been talking about about how they got here, I mean, the thing you want to be careful about is it was, this is not the result of some carefully crafted master plan that they knew all along. It was a lot of groping and a lot of random stuff. They did one thing for one reason and another thing for another reason.

And then through this kind of random process, it all sort of coalesced in the end. But that was not, you know, the amount of intelligent design behind that was, I think, actually quite low. They got a few sort of big directional things, I think, correct. And they stuck with them. That's where I would give policy credit. And they were willing to adapt when things were obviously not working and cut things off. and, you know, adjust with pretty high frequency. But a lot of it was essentially a random walk

where a lot of things that were enabled then sort of started to interact with each other in the way that you've talked about AI, and then they create these other results, which, you know, could not have been pre-planned. Another thing to consider when discussing the virtue of such a system is you can't just look at the results

over the course of 20 years or 30 years and say, well, since they were to pick the key technologies over this period, therefore this is no preferable. It's somewhat similar to like looking at one successful dictator and say like, because they made the right calls, dictatorship is the right model.

Right. I mean, there have been many other countries which like, I don't know, I actually don't know that much about like what Japan was doing in the 40s to the 70s, but I assume they like needy or whatever made some right calls about which electronics and cars and so forth are important. But you know, to judge, like, how plausible is it that this level

of competence and foresight and luck or whatever mixture they're in will continue into AI, what happens after that, whatever is required as an input into that? I mean, I guess, speaking of which, let me ask you about that. Well, actually, can I just stop you there? Because there are a couple things that you touched on there that I think are really interesting. That I just like to put on a little bit more. So, you know, past results are no guarantee of future returns, right? So just because you did it before. It doesn't mean you can keep doing it. You know, we're seeing that now in the U.S. A few years ago, I would have said I had very high confidence that the U.S. will be able to retain the basic political system and structure that has had for a really long time. And that's one of

its, you know, enduring strengths that that infrastructure remains. I'm much less confident about that. You know, similarly in China, I think you have this problem that they've had a succession of top leaders since Deng Xiaoping, several, and with very different styles and sort of power bases and so forth, and they've managed to succeed through, you know, a range of these things. So that gives you more confidence that they're probably more likely to do it right in future than not. But, you know, a lot of concerns about that. And Xi Jinping has basically declared himself present for life. We haven't been in that situation in China for a long time. The last time we had that, it did not end well. And the sort of the, there's always been a tradeoff between growth and control in China. This is kind of the

central dilemma that the communist parties had. We want as much growth as possible, but we also want to maintain a pretty high level of control. And that pendulum has swung much more towards the control side of the equation the last few years, and growth is slowing, right? So a lot of problems. However, I would make a couple of points. One is China has been successful in its industrial policy less because they picked the right industries and more because they were very adept at building the right enabling infrastructure. And I would point to two things in particular.

One was a program that they had starting in the 1990s, which in English has the very ungainly name of informatization. So it translates a Chinese term Sinshi Hua, which just means information. formatization, right? Taking information technology is the embedded term here and putting it everywhere in society. So they were early adopters of the IT revolution, including the internet. And if you think back to the discourse around the internet in the late in the 1990s, everyone was saying the internet is the death knell of authoritarian regimes because this empowers everyone to have

information. Information control is no longer possible. Social control is no longer possible. would that that were true, right? The Chinese government very, very early said, no, that is wrong. We think that the Internet can be an instrument that we can use to, number one, promote technological development at a high speed in China, and number two, enhance our control of society. And I think they have been proved absolutely correct to that bet on both counts. Clearly, their drive, to network the entire society, which they started to invest in very, very early. Initially, just through ordinary fixed-line telecoms networks, but then they were very early in mobile and then getting government network systems that communicated across the whole country. They invested huge amounts in that, and it's been, I think, very beneficial to the rise of

all kinds of things. And it's why basically they were able to create an entire Internet of their own. own with its own companies that doesn't have the participation of the U.S. global companies and is on its own terms basically just as successful. But it was also what they recognized is if everyone's on the internet and we have people watching the internet, then we know what everyone is thinking all the time. We can see that. And this is the holy grail of Chinese leadership since the second century BC, right? We sit on top of this vast empire.

It's great. We have all this territory. All of this wealth is flowing in. And we have no idea what people are thinking are doing far away. This is bedeviled every Chinese administration for thousands of years. And even into the 1990s, it was an authoritarian system. It was very, very hard for the central government to really have any idea what was going on. And now we have a penopticon because everyone is online.

And if we control the online universe, then we see everything. And then we're pretty confident that we can keep the discourse under control. And they won that bad, right? So the comparable move that they are making today, which I think is severely underappreciated, is that they believe in the power of electrification. So electricity has been around for a long time. but still in most countries, it only accounts for about 15 to 20 percent of the total final consumption of energy. So it is still actually a minor player in the global energy equation, despite having been around for 150 years and being very critical in a lot of applications.

China very early on recognized that they needed a lot more electric power. The original reason was very prosaic. They had a lot of power shortages in the early 2000s that were making it hard for their factories to run. And they said, oh, we've got to like build a lot more generating capacity. Most of it fueled by coal just so we can keep our factories running. That was the first thing. And then they started to think about it a little bit more. And they started to say, hmm, actually, what do we want?

Well, we know we're failing, as we talked about earlier, we know we're failing in this drive to make cars with industrial capacity. And it looks like we're never going to be able to crack that nut and have our own Toyota or General Motors. But no one's making electric cars. Maybe we can be the first to do electric cars, right? So they said, we've got to do that. Then they said, oh, we need to enhance our domestic transport infrastructure. Wouldn't it be great if we had a giant high-speed rail network, just like Japan, except, you know, we're 20 times larger than Japan, so it has to be 20 times as big. So let's do that.

And by the way, this is all going to be electrified. So they created a couple of core hub industries. The premise for which was you need gigantic quantities of electricity to get these things working, right? If everyone has an electric car and everyone's charging their battery, huge draw. If everyone is riding on electric trains instead of on planes, huge draw on electricity. So we need to have a much more comprehensive idea about what our electricity grid is going to look like to support these industries that we want for other reasons. And then, well, where do we want this electricity come from? Well, coal, yeah, we have a lot of coal, but it's really dirty.

It's a climate problem. It's a very severe domestic air pollution problem. This is really dirty. So from an energy security and pollution standpoint, we're probably better off doing renewables because any other source of, of fuel for thermal power plants, we're going to have to import. We don't have enough natural gas, right? We can build nuclear, but that's hard to scale, and we don't have enough uranium. If we build a renewable-powered domestic electricity grid, we are self-sufficient forever because you don't have to import the sun or the wind. It's just there. And so you can see how these things begin to build on one another. It was not, again, it was not that they had the intelligent design plan in the U.S. or 2000, it's just sort of all these things came together. And the result is, today, China has generating capacity that is double, more than doubled out of the United States. Their renewables generation capacity alone is as big as the entire generation capacity of the United States.

Electricity as a whole is now about 30 percent of China's total energy consumption. It's going up like this. It's rising very rapidly. Everyone else is increasing their electricity. Everyone else is increasing their electricity consumption very, very marginally. And now you see in things like AI, what is one of the big constraints on AI development at scale? It is essentially the power that you need to power these data centers. Who is best placed in the world to do this at home, China, right? And they have also concluded that, you know, AI aside, that having cheap, abundant electricity is really central to all of the major growth industries of the 21st century. So they are now determined, I think, on a strategic basis, to have an electricity system

that just produces as much power as humanly possible from whatever fuel source you can find to interconnect this via grid as efficiently as you can. So they're leaders in ultra-high voltage distribution technology. and we will be able to keep our electricity prices so low that that will make it very difficult for anyone anywhere else in the world to compete with our manufacturing, with our AI, with our whatever, anything that electricity goes into, we will have this competitive advantage.

And so they've been very, and I think they're basically right about that. And the point here is that if you're able to get a few of these sort of enabling all-purpose technology decisions right earlier and then scale them up, then a lot of good things can happen as a result of that, regardless of how effective you are at picking winners, sector-by-sector and industrial policy. Yeah, that's interesting. What is the story in which China doesn't win AI? Because in terms of talent of AI researchers themselves, it's a big country with lots of smart

people, that will be there. We've already seen examples with High Flyer and Deep Seek, where they can come close to the frontier. In terms of chips, eventually Smick will be able to produce the kinds of H-100 equivalents that 5-90metre process at TNC can produce. I don't know how many years away it is. And, you know, expert controls might have still been net good. But this is not something that will not happen within the next five, 10 years. And then it's a matter of scaling, scaling production of the chips, scaling energy, scaling maybe people and data collection. And what is China good at? It's scaling, right? And I think the numbers on energy production are just like absolutely staggering.

Yes. What is the time interval in which China adds a America-sized amount of power generation? It's like... Well, they add basically a France or UK on average every year. Extrapolate that forward. And why that's important is so far we've been focused especially on training of AI models. Right. When these models start becoming super economically productive, basically by the point at which they are at human level. Right. The more important question will be how many can you deploy, right? Right. Why is the reason is America is a powerful country? A big part of the reason is we just have more people. Yes. That's why China could take over Taiwan. It's just like it has a billion people in Taiwan has on the order of what, 20 million? 20, 23 million or so, yeah. Right. So now you just have like more AI's, right? More

AI people if you have more power, which is ultimately what's upstream of. Yeah. Yeah. Okay, anyways, those all just preface for asking in 2035, what is this story? of how Shinaid doesn't absolutely dominate AI? It's a good question, and we're verging a little bit beyond my sort of realm of competence here, because I don't pretend to understand AI very well. I'm still very unclear as to economically where all the benefit accrues, right? And so I guess my theory, if I abstract away from AI and just think about this, okay, this is a situation where you've got a new technology, it's, you know, entering society.

what is like the innovation cycle that's going to drive it? So I'm pretty partial to theories of innovation like the one that was propounded by a guy called Amar Boudet at, I think it's at Michigan State, who wrote a book a number of years ago called the Venturesome Economy. And what he stresses there is sort of like the feedback loop between consumer demand and what producers. are doing. And his view is that we focus a lot too much, we focused too much on what the producers are doing and not enough on what the consumers are driving. And I think that's a pretty good insight generally. I think it helps explain a lot of why the U.S. has maintained its position such a dynamic economy, even though we've sort of abandoned a lot of the physical processes

that underlie it. And so my question is, okay, economically, when we say, say AI, what's the most important part of it? Is it the large language models? I think the consensus is no. That's just like the substrate. And what really matters is the application, specific applications that get built on top of that. And that's where most of the economic benefit is going to accrue. If that idea is correct, then the question you want to ask yourself is, what economic system offers the most fertile ground for people figuring out how to use AI in specific zones. And there I would give the U.S. a fairly strong edge over China because China has become more self-enclosed. They have become more obsessed with self-sufficiency. They've made it, you know,

very, very difficult for other people to operate in China. And it's creating some difficulties and people operating outside of China. So they have this walled garden of Chinese people and whatever they do that creates applications. But whoever the big U.S. or Western AI operators have, they have the entire rest of the world to play with. And that's a much bigger universe where I would sort of rate the likelihood

that you get interesting applications higher outside the Chinese walled garden. That would be my, so if you want the case for why does China not dominate, I think that would, something like that would be the reason why. A previous guest I just had on, Victor Shee, said that the Chinese government, I'd be reluctant to let AI development go full speed because of the destabilizing effects it might have on the political system or the inability potentially to control it. What's your sense on what will happen as AI becomes more economically valuable?

a focal point in discussions about technological development and so forth. I have a lot of respect for Victor, and he, I think, has a very good grasp of the Chinese sort of bureaucratic mindset and how political calculations get manning, and that's his territory more than mine. So I'm very respectful of that view. I would, however, tend to think that actually the Chinese are going to be pretty in favor of high-speed AI. development. And the reason is essentially the same reason that I was talking about earlier about informatization and electrification. This is essentially a basic enabling technology that is useful for all of the things that can flow from it. And I guess my hunch would be that they

would make the same bet with AI that they made with the Internet back in the 90s. And the Internet, they said, Yeah, this technology could be dangerous. It could be out of our control. But we think actually it's going to be really beneficial and that we can control it. And that bet paid off for them very, very well. And I think my hunch is that they will look at AI as a similar sort of thing. Yes, it's possible that this could sort of get out of our control. But we think on balance, this is really important technology.

It's going to enable a lot of other things. and we'll probably be able to figure out how to control it because our control systems are so good. It is interesting because if you look at the big development in Chinese AI recently was Deepseek, right? Deep Seek was not the result of some, you know, state program. It was the result of basically a quant hedge fund guy in Hong Jo sitting around and saying, oh, I could actually build a pretty good, you know, LLM model, you know, flowing out of my, you know, quant activities. let's give it a go, see, see how it happens. And it worked great for him. And the reports that I have seen suggest that this created a certain amount of disquiet in Beijing. They said, well, where did

this guy come from? And why is he not coming out of the official plan? So there is some risk, I think, that they would be a little bit nervous about freelancing on this. But on the whole, I think they'll see this as another basic enabling technology that they should promote and figure out how to control over time. Ironically, this is the one place, I mean, to this thing, the China's advantages lie in its ability, like, in situations where centralization is important, they can do it. Ironically, this might be a case where centralization might be helpful and they might not do it because there are these tremendous economies of scale in AI training and you know you have to keep increasing the training cost. by, you know, 4X every single year. Right. And especially given that the availability of these advanced chips is lower in China,

it would be even more helpful to have one person who can use them all for training. Yeah. This might be the situation where it would make more sense for the government to say, Huawei and Biden's, you had to give all your chips to high fire. And I think we can say with high confidence that that's not going to happen, that they're just like, as powerful as the Chinese government is, they do not have the ability to force everyone into one room for this, right? So Huawei's got its own thing going.

Bite Dance is going to have its own thing going. Xiaomi is going to have its own thing going. Alibaba is going to have its own thing going. All of these have sufficiently large revenue streams and access to capital that they can move independently. And we'll be able to leverage their, you know, their connections within the system, the central level and the local government level where they get a lot of their support to do their own thing. So, yeah, it will be, yeah, you will not have a national monopoly solution to this. That almost never occurs in China. Interesting. That actually, that's a, that's a significant statement

and maybe updates me downwards on the probability of China winning an AI. I think one of their key advantages would have been. Because you think the fragmentation becomes an obstacle. Yeah, Especially given the availability of compute in China. Right. So the ability to concentrate your limited compute resources in one thing instead of you're scattered around. Yeah, no, I think that's a fair point. Right. And then, so that then comes back to how fast can they solve the chip problem domestically.

Yeah. Because if they can solve that really fast, then that constraint goes away. I think one thing that will be important as this AI stuff is happening is to have something that is equivalent to the right telephone. Right. I do buy some of the crazy or scary stories about what could happen with the AI. And not necessarily because, like, you know, God takes over, but more so just like, it's happened many times in human history that some more coordinated group has it managed to do some sort of coup or slowly takeover control. So the kind of thing Cortez did or bizarro did. And I think a key way that can be prevented or you can reduce the risk of that is different human groups should be.

in like tight contact with each other. Right. And have the same kind of mechanism that the vaccination creates with diseases. So the key advantage that the Spanish had over the New World Empires was that the Spanish

knew how each previous conquest had gone. Right. But the Incas and the Aztecs didn't know about, you know, what strategies are used, how horses work, how steel works. So how that it translates here

is I think there might be some crazy things these AI tried, especially if you have these, like, bifurcated world, which I think is actually very valuable from an alignment and safety perspective because you have this independent experiment. Right. Or independent lineage. If their AI tries to do something crazy, I think it's very important that they feel that they can tell us and we do the exact opposite.

Long preamble to ask a question of how do we set up that kind of high trust or prerequisite understanding on these kinds of issues such that this kind of... That is a terrific question. I think that really gets to the heart of a lot of stuff. And I don't have a great answer to that, right? Because fundamentally, what you're saying is that there needs to be, you know, a communication system, a network of interactions between two highly competitive zones, the U.S. and China, basically. where, you know, they have to, you know, be able to operate with some degree of trust, right? And I think the problem that we face in trying to analyze this is a lot of the analogies that you might reach for, you know, break down at some point.

So you brought up the red telephone, which basically is a reference to the line of communication with the U.S. and Soviet Union had during the Cold War where the threat that you were trying to avert was nuclear holocaust, basically. You know, and in some ways, I think that's an apt analogy and we kind of need to think broadly along those terms. But the specific problem that we were dealing with there were these very self-contained systems that were clearly under highly centralized control by a couple of people. And so having that one-to-one line of communication was an effective response to that particular problem. With AI, it's much more diffuse, much more decentralized, much more unpredictable what the problems could be. And, you know, it's kind of easy, I think, to create easy. We say in retrospect, it was hard at the time. But it was a sort of, if you will, maybe a two or three-dimensional process to come up with game theory to enable us to manage

the nuclear balance of terror, right? So I don't want to minimize Thomas Schelling's achievement. It was great. But it was like a two or three-dimensional problem, right? I think with AI, you have more like a more than three-dimensional problem. So it is consequently more difficult to figure out how do you create a game theory solution to this that is kind of stable, right? I think what you can say at a minimum right now is there are ways in which the U.S.-China relationship today resembles that of the United States and the Soviet Union in the 1950s, i.e. before the Cuban missile crisis, right? And I don't want to exaggerate this too much, but the sort of diminution in exchange in communication over the last six or seven years is really alarming. So give a simple example on this. When Trump came into office the first time of 2017,

he inherited structure where there were approximately 100 working level dialogues between U.S. government and Chinese government officials, plus all of this investment in private sector stuff that was going on. But just at the formal level, there were over 100 dialogues. He got rid of all of them, 100%. And he then replaced them with one, which was the trade talks that he had in his first term. That was the only basically mechanism we had of communication. Did this create a specific problem?

It did. So if you look at the early stages of COVID, right? Back when SARS came out in 2003, there were staff members. of the United States Centers for Disease Control embedded in the Chinese Centers for Disease Control or their equivalent organization. And that relationship, in fact, grew significantly

in part because of SARS over subsequent years. And that was a very, very useful channel of getting information out. It was not perfect, had plenty of problems. But the absence of that channel, I think, was really catastrophic in the early days of COVID, where we literally had no way of understanding what was going on within the Chinese system. There was no back channel that enabled us to get even a little bit of a head start on what was going on. And I think that had very, very dire

consequences. You can probably trace many, many, many deaths and a lot of social chaos to the inability of the U.S. and China to communicate at that critical moment, right? So we have essentially dismantled the whole structure of communication. The Biden administration basically took the same view. They introduced a few more things. So there were a few more communication channels that they handed off to Trump that I think have not been made use of. So we're back to essentially zero except for the trade.

And that is a very, very dangerous situation to be in with regard to global public health, any kind of sort of global coordination, whether it be on macroeconomics or climate effort or whatever, and on these issues like AI, right? I think that's a really bad place to be. So we're starting at a, I think, a rather dangerous position. I think it should be a priority to figure out how we can get there. And it's very hard to see how we get there, given the political environment, frankly, in both countries. So in the United States, you have this narrative that China is this bad actor. They have an illegitimate government. They are a systemic rival. We basically have to contain, constrain, control them. And any kind of interaction with them is in and of

itself dangerous. So you have people in Congress saying, I don't want to go to China. There's no point in going to China. A, because I'll pay a political price for it. If I go there, I will be tarred as someone who went to China and therefore is tainted. And what can I possibly learn? I already know what I need to know, right? So you have a deliberate effort, I think, with the United States to reduce the channels of information that we have with China and direct experience, which is very bad. And, you know, I think one of the bad outcomes of COVID in China was that they kind of locked themselves off from the rest of the world for almost three years. They got really obsessed by this self-sufficiency, industrial policy, you know, complex. You know, the Chinese system has always had a lot of difficulty communicating with the rest of the world.

This has been persistent for many decades and centuries. And so this gave them a great excuse to just, like, not do the thing that made them feel very. uncomfortable, which is like engaged in communication with the rest of the world. And they concluded, it's kind of okay. And so they also retreated into a very sort of paranoid narrative about what the U.S. is up to, which is, to a significant degree justified, but not entirely. And I think lost sight of the value of really robust communications. lines with the rest of the world. So both sides are entrenched in very suspicious, self-reinforcing

narratives about the other, which makes it incredibly difficult to forge a better communication system. And I have to say, you know, I'm fairly critical both of the Biden administration and the Trump administration in different ways, how they handle this. I think the Biden administration could have done a lot more, a lot faster. I think they were sort of had the idea that it was good to have more communication, but they waited for two years before they did anything. And then they were very parsimonious about how they did it. And I think they could have been much more aggressive.

They weren't, and that's a problem. And then I think the Trump administration, unfortunately, just doesn't have, doesn't place strong value on having respectful communications with anyone in the world, frankly. And then when you compound this with the people, paranoia about China, then it just creates more, I don't want to say paranoid. That's too loaded term, but the suspicion, the fear, the distrust of China that exists, it's very hard to see how you get that. So I agree with you that we need something like that. I'm kind of pessimistic

that we'll get there anytime soon, unfortunately. The red telephone point you made is actually really interesting. It didn't occur to me before that EIA is such a diffuse thing. It's like saying we're going to have a red telephone out of the Industrial Revolution. Yeah, exactly. Exactly. How do you do that? You can't. But on the point about the ability of both sides to perceive each other,

it is true, as you say, that because maybe China has become more closed off, their perception of what's happening in America has been diminished. I would argue that the opposite is even more true. That's our understanding of China is more limited than theirs. And a big part of this is just that every country in the world has some understanding what's happening in America because of the overwhelming cultural

significance, the charismatic nature of American politics. And everybody knows who the main senators and cabinet people are all around the world. When I visited China six months ago, it was shocking to me that you could go to cities with 20 million people like Chongqing and Chengdu, and you would, I don't think I saw a single white person in Chongqing. Which is insane, right? Just like, you're literally seeing seas of people. And none of them are from the West. And in fact, that was what motivated me that trip to do these kinds of episodes.

I think people are right to say, well, look, fundamentally, I read a book like this, and I'm learning a lot about how China tangibly works. As opposed to, like, I go there, I'm going to chat up taxi drivers. What am I, like, I'm not going to learn about whether they're going to invade Taiwan by chatting of taxi drivers, right? The thing I guess you miss is this more, the kinds of things I guess which should be obvious that probably aren't obvious to these Congress people that are cavalier about what information to get. It certainly wasn't obvious to me, at least on a sort of more subliminal level.

Right, right. Is just how big the country is. I mean, I think people talk about it as if it's like a small thing, like, oh, China's over there and we're going to deal with it, especially when you think about like we're going to change its government. We're going to constrain its global impact. something. It's a real, like, it's big. It is really big. It is really big. It seems like a very banal observation. And yet, I keep coming back to it as one of the fundamental facts that continues

to be underestimated about China, just how big it is in geographically and in terms of population. But yeah, so I mean, the question there is like, okay, so what is the value of these things? Well, okay, so it's a fabulous book. I'm very proud of it. And a few thousand people read it. Right. And at any given moment over the last 15, 20 years, there have been north of 300,000 Chinese students in the United States, right? And so I don't know what the total number is over time, but it is quite a large number, right? So the cumulative effect of personal experiences can be gigantic, right? Particularly if it is like extended over time. It's really, really important. And then the impact of these more structured engagements, right? Yeah, so you go as a tourist, you talk to some taxi drivers, you see this and that. What do you learn? Well, I'll give you a concrete example.

So one of my side gigs is for a number of years I taught a executive MBA course at NYU on China's economic rise and, you know, what that meant for companies and so forth. And usually I have about 20, 25 people in the class. and I taught it for three or four years before COVID, four years, I guess, and then two or three years after COVID started. And in the years that I taught it before COVID, there were always reliably four or five people in the class that had spent some time in China. And many of them had done so just as part of this executive program. Because part of what you got by signing up for this EMBA is that they took you on the, global study tour trips and you would go to this country or that country and you would be there for a couple weeks and you would talk to a few companies and this and that. It's pretty superficial,

right? But what I found was that when I had a class that had a few of these people sprinkled in that had that experience or a little bit of work experience or they'd been, you mean, it's gone as a tourist. It's been had some kind of like a student experience or something. The class discussions were always, much more nuanced and people did not retreat into these sort of cartoon stereotypes of what China was like. Because everyone who had been there could say, well, actually it was a little bit different because here's my personal experience, right? Then the classes that I did after COVID had set in, they weren't doing these study tours. So no one in the class had been to China as part of the program. And kind of luck of the draw, you know, I didn't find any people who had been there, you know, as part of work or what.

whatever, so I had zero direct experience of China in the class for a couple of years. And the baseline view of what China was was, A, way more negative and B, much more stylized and, there I say, cartoonish, that they were essentially getting it, getting their view formed entirely by whatever they were picking up in the media and from their preconceptions. And there was no check on that. And so I saw in just a very, very small, but very concrete way that if you don't have people going back and forth and there aren't some people in the mix who say, wait a second, what you're saying doesn't make any sense because I was there and I saw this and it's totally different, right? That, I'm convinced, has gigantic impact. And I think it's really, really damaging if people in positions of authority in our government and our political system refuse to expose themselves to the actual reality of what China is, which is essentially what they're doing now by making it politically impossible for anyone to go to China and see what's going on there. That is a very, very dangerous place to be.

It's ignorance. And, you know, one of the things that drove me and many sort of China, you know, Western China types crazy about being in China for many, many years is you would go. And frequently you would have this experience you'd be sitting in like in a seminar room or think tank or whatever. And, you know, some Chinese expert would say, you know, we Chinese, we understand America much better than you, you Americans understand China, right? And for years and years, I basically thought this was BS, that most people in China don't travel. They have no idea, right? And even the expert class, they had fairly superficial kind of understandings. And so I always felt pretty confident that I and people in my cohort, we understood China just as well as they understood the U.S.

And their blind spots towards the U.S. system were very, very clear, right? So for years and years, that drove me nuts when people wouldn't say that. Now, I think it's completely true, right? And all you have to do is look at the student numbers. 300,000 Chinese students in the U.S. until their visas get revoked. We're struggling to get to a thousand U.S. students in China. You know, in the U.S., we closed down the Chinese consulate in Houston as part of a trade spat back in 2020, I think.

Chinese responded by closing down our consulate in Chengdu. complete disaster. A whole sort of area of Western China really important that we have no eyes on officially anymore. We decided that they're Shinhua journalists are not really journalists, which is, you know, sort of true. So we forced them to register as government agents. The Chinese responded by kicking out a lot of our journalists, massive own goal for us.

So the types of interactions that U.S. people have with China directly on the ground in China have been massively restricted compared to what they were a decade ago, partly as a result of Chinese government action, partly as a result of really misguided actions on our part, partly because of just like fallout from COVID and, you know, various other things. But where we are is bad, and there is an information asymmetry, which I think operates the disadvantage of the United States right now. I worry that this sort of cycle is an escalation will seem in retrospect to people,

especially if it leads to a hot conflict, as sort of mystifying as World War I seems to us now. Okay, if it's instigated by something in Taiwan, that's a different story. You can just tell a very direct through line. But you look back at World War I, and it's like, why did Germany do what it did about? What was it worried about encirclement?

Why was it worried about encirclement? There's this weird thing with like the Russian, whatever, ambassador didn't. get back in time. It would just be this kind of thing where it's like, why did we have to have this adversarial relationship with China again? And explain it to me when we're 50 years removed and the sort of day-to-day news is a desalient. Yeah, I basically agree with that. I mean, I think there's, you know, we should be spending a lot more time trying to figure out how to make this a workable relationship. There's going to be competition. There's going to be conflict. There are some

conflicts of what we define as core interests on either side, which are tough to resolve. This is not easy. But we basically both have to recognize, and this is more of a problem on the U.S. side. I think the Chinese recognizes the U.S. is not going anywhere, right? There is a little bit of a meme in Chinese foreign affairs circles. Oh, the decline of the U.S., the rise of the east, which is very sort of officially popular. I think most people don't really believe that because they just have too much confidence in the long run resilience of the U.S. system, and I think they're basically right about that. I think we and the U.S. side have to get a little bit more attuned to the idea that this is just like there is no end point to this. This is a relationship which will go on

forever. There's no winning. There's no losing. There's just managing. And we need to do a much, much better job of figuring out how to manage it and keep the conflicts and a friction in a, is contained as own as we can, not easy to do. I think people focus on, there is this interesting volatility in how people think China is doing where some piece of news will come out about electric vehicles and people will be like, China will obviously dominate us. And then maybe some economic data will come out and say, like, oh, China is like collapsing. Right.

And I think people in their own countries have the sense that a lot of things are happening, somethings are going well, somethings are not going well. But in like 20 years, America's not going to collapse. That's right. And it's also not going to like have destroyed every other country, right? It's going to be like... Things are complicated. And it's just like there's like a long run trend. That's right. Right. Whether China has like 1% higher growth rate or 1% lower, right. It's just going to be a powerful nation of the technological frontier. Absolutely. And there's no sort of like very immediate implication of what exact growth trajectory they are on with respects to the most important questions about how we should engage with them.

Right. And so forth. Yeah. No, that is a really important point. I want to just dwell on that a little bit. The attraction that people have towards extreme narratives about China, total domination or total collapse or so forth, very, very strong. In my view, again, it's a product of ignorance. The less you know about the realities of place, the more you can construct these fictional stories, which take some truth and then absolutize it, right? And the more you know about the reality, it's like, yeah, it's more messy than that. So neither that nor this, right? So that, I think, is just another argument for why you have to have much more deep engagement. So people are engaging with realities rather than fantasies. You can see this, again, in very mundane ways. If you just look at the way that the Trump administration has conducted its trade negotiations with China, it was premised on the notion that China's economy was so weak that you hit them with tariffs and they immediately cabitulate. And that was a ridiculous idea. And it's taken them a couple of rounds to

figure out, oh, maybe that wasn't quite so right. And we have to take this more seriously. So getting away from the extreme narratives is important in general. And then I think also in the U.S. side, also to some case, at some extent in China as well, is a lot of the things in the U.S. political context that are blamed on the rise of China. We have this problem or that problem because of China. They are predominantly exercises in scapegoating, right? So we're talking at the beginning of the conversation about the change in the industrial sector, you know, hollowing out of U.S. manufacturing employment and so forth. If you look at the trend of U.S. manufacturing employment as a share of total employment is a straight line from 1946 today that looks like this.

You cannot find the Cold War. You cannot find the rise of Japan. You cannot find NAFTA. You cannot find China. You cannot find anything. What you find basically, I think, is the march of technological progress. That's basically what that line tells. And so all of these stories about China did this or China did that.

Yeah, there was some impact, but mainly what the United States failed to do as the world was transforming in the late 90s, early 2000s. We failed to take seriously our responsibility to change our systems of redistribution, of helping people out, of social. We failed in the social contract domestically. So there were failures of domestic policy which got then blamed on China, right? And I think similarly, if you look at, you know, scare stories about how China is going to take over the world, you know, okay, B-YD very good company, Huawei, very good company, CATL, very good company. You look at the totality of the corporate universe in the world. It's still pretty big.

U.S. companies are incredibly powerful in depth across many, many, many technological sectors. They are very good at what they do. In many cases, they still have very strong positions in China because they're so much better at what they do than the Chinese competitors. We're dealing with the rise of a new entrant on the global stage, and that's a very uncomfortable and there's some jostling there, but we should also not overstate the degree to which even on a sort of a commercial industrial side that we are sort of existentially threatened by this. There's some real challenges there, but a lot of this notion that we will, you know,

that we will not have an auto industry in five years because of BID. That's, that's, you know, let's get a grip, folks. We could end up there. But if we end up there, it's because we will have made a bunch of really bad policy decisions that got us there, not because this competitive threat exists. So mostly it's on us to figure out how to get things right on our own terms within our own system. And then I think basically we'll be fine. But right now, that isn't kind of where the conversation is particularly. You first went to China in 1980 and you've been living... 85, 85.

And you've been visiting and living there on and off ever since. Right. I mean, we're all aware that obviously China's developed a lot since then and so forth. But like, what are some non-obvious changes you've seen? Or maybe even things that have stayed the same through all this change. Well, I think one of the things, I often describe China as a very turbulent and very deep ocean. So you scheme along the top and you see the huge waves, right? So all the stuff that's been built, all of the cities, the high rises, the industrial parks, the high speed rail, and so forth.

And then you go below that and there's a very deep, still ocean of ideas, concepts, bureaucratic tendencies and so forth that have built up over a century. that in a lot of ways does not change that much. So a simple example on this is how to make that more concrete. If I think about what the United States was like socially in 1985 compared to what it is today in terms of the space for gay and lesbian people, trans people, social acceptance of different. lifestyles, awareness and attention paid to racial issues, all these kinds of things. We were, the changes that have occurred in the United States over the last 40 years, I think, are substantially greater than the changes that have occurred in China over that time period in terms of people's fundamental understandings of how do we interact together in society.

And partly that just reflects that the U.S. is intrinsically a somewhat more complex society than China with all of these layers of races, the whole immigrant experience that, you know, was just in terms of the number of foreign-born people was much lower in 85 than it was today. But socially, we are much more, there's just been a lot more change and a lot more, I would say, evolution of people's basic attitudes towards, you know, what they think about society and how we should interact. China, in that sense, I think, has been more stable. It's more cohesive. It's more attached to rather deep-rooted notions of gender relations, patriarchy, sort of how the society should hang together.

So that, you know, as we think about all of the change that's occurred in China, which is real. And some of it, you know, the changes in social relations that has come with the essentially abolition of the planned economy system and the replacement with this basically capitalist system with a Leninist political carapus. Those are very significant, right? So I don't want to underestimate how much transformation has gone on in China over that period. I think it's been substantial. But in the U.S., it's been, I think, in many ways, even more. There's a kind of intrinsic churning dynamism to the American system that is just always there is often very uncomfortable to live through.

And we're living through, I think, a very particularly uncomfortable moment now. And in China, there is some of that, but there's a lot of, there's a lot of containment and there's a lot of, there's more stasis in a lot of the kind of fundamental, you know, or sort of, social relationships. So I lived in China more or less full time until 2015, and then I started doing half and half after that. Now I principally live in New York. One of the things that always struck me when I would come back from China to the U.S. is just how much grassroots cultural activity you have all over the United States, right? We have a very distributed sort of system of cultural activity here. And in China, you have a few sort of big cultural hotspots where things happen, and then it's all kind of placid, right? So the sort of the variety of experience that you have in the U.S. I think is still unrivaled.

And, you know, I think you were talking earlier about there's still this huge discrepancy between, you know, the average income in China and the average income in the U.S. It's partly a reflection of that, right? It's still, on average, a much poorer society in the U.S. than the U.S. And so the surplus that's available for people to do stuff that's interesting, but not sort of economically productive in a narrow sense. That space is still a lot small. And it's not just political repression that's doing that. It's kind of like it's a combination of the level of income and just like the ingrained social structure. I think the broader point you're making here is important to emphasize in the sense of, I think sometimes in, if people are hawkish on China, they have the sense like they're doing everything wrong, they're this aggressive belligerent power, you know, they're like, this is the new Stalin or Hitler.

But conversely, when people are, say that there should be, I don't know the right word is, there should be a productive relationship. I think then there's also this other attractor state where people are just so uncomfortable with cognitive dissonance that they say like, and you can see how well their system works, central planning works, you know, like authoritarianism works. Yeah, let's not take those lessons. Those are very bad lessons. You just see those two patterns of correlation so often

that it's worth emphasizing that you can think you can have a productive relationship with the country and still think that not only is authoritarianism morally wrong, But it actually has had a bad impact on growth or on the day-to-day life of people and their cultural or whatever else. I think people sometimes have trouble just like holding two thoughts into their head at the same time. Right. And I think there's also a very strong pattern. There's been a few good books written about this about how American attitudes towards China in particular have tended to swing from one extreme to the other.

They are, you know, this great, you know, Americans and Chinese are kind of the same because they're the same. They're both pragmatic. They like money. They like business. If you go to China, it's very easy, in my experience, to sort of like chat with people and get along. So that level connection is fairly easy. And then the other swing of the pendulum is that they're this enormous, amorphous force that is committed to a devilish system that we don't like. and finding the middle ground

and that historically has been very, very difficult for the U.S. to do. Yeah. Yeah. Final question. Right now, obviously the U.S. and China

are engaged in this negotiation to figure out some somewhat stable coming back from a liberation day. What is the most positive, plausible story of what comes out of this? Well, my expectations for this are very low because I think the basic problem here is that we have on the U.S. side, we have a sort of a collection of grievances and complaints that have not coalesced into a very coherent agenda of what we want from ourselves and what we want from China. And if you don't know what you yourself want and you don't know what you want from the other party, it's very hard to engage in a constructive negotiation. So I think that's my fundamental take on where we are right now.

To me, what we should be, so this is a normative statement, what we should be aiming for is trying to figure out what are the terms of coexistence between the U.S. and China in the coming years. and decades. The most desirable outcome would be some kind of an agreement under which we create a broader permission structure for Chinese companies to invest in the United States in a lot of these key industries that we're talking about. I think that's good for the United States because I think it is reasonable for us to try and rebuild certain aspects of our industrial manufacturing system. I think we let those atrophy too much. So, selectively. I think it does make sense for us to try and rebuild that. And rebuilding that, you know, should incorporate the best anywhere in the world. And some of that is now coming from

China. And I also think just in terms of enhancing mutual understanding and getting better communication channels, investment is even more than trade is a very good communication channel because it forces you to go to the other guy's place and put down roots there and figure out how things work and figure out ways to communicate with one another. Now, the obstacles to that are enormous, both because the U.S. narrative that this is intrinsically unsafe and because, you know, I think the Chinese will be very reluctant to allow a lot of their technology high flyers to go and set up in the U.S. and risk having their technology leak way there, too. So I'm not saying that that is easy or achievable.

And certainly not in a few months. This would be over the course of a year or two or three, you might be able to negotiate some terms of engagement there. I mean, the big problem I think that China creates for the world as a whole right now is this fact that they just are unwilling or unable to generate enough domestic demand to keep their own economy running at full steam. That's bad for their own economy. and it creates a lot of friction in the rest of the world because what it then means is that

companies that can't sell in China are forced to export their surplus production and this creates rising trade frictions not just with the United States but with lots and lots of countries. And it does sort of contribute to the narrative that China is not really all that interested in creating a situation where everyone benefits from their growth. It's much more of a, we're in this for ourselves. So I think it would be helpful for the world economy, helpful for the Chinese people, and helpful for general stability if the Chinese could recognize that they need to do a lot more to promote the demand side of their economy. It can't just all be about endless investments in new technologies. And I think they're coming to a point where they may be forced into that because if you look at most metrics that I and my team follow of return on investment in China, they're going down, right?

The number of zombie companies that, you know, still exist, but, you know, don't even generate enough revenue to pay the interest costs in their debt that's going up. there's a lot of pressure that's building within the Chinese system because of this obsessive concern with the supply side of the economy. So they'll continue to do, I think, quite well overall in technology production, but the financial constraints are rising. So they, I think, have some self-interest here in coming up with a more balanced economic model and having some pressure from the outside to get them in that direction. I think that would be good. But I guess the final point I would make on this, though, is on the U.S. side, which is, of course, where I generally said, it really is critical to have a realistic understanding of what's happening in China and how they're

interacting with the rest of the world. So I think one of the big dangers that we have in the current Trump administration strategy in this, which was also to some degree apparent in the Biden administration strategy was there is this belief that China can be contained and that you can essentially construct an alliance of countries that will stand up to China and try to constrain it with you. It's kind of a replay or dusting off of the Cold War playbook where you had Soviet Union and the War Star Pact, you had United States and NATO and all of the informal allies everywhere else and you had the blocks against each other and the bigger and more economically productive block one, right? And that is just not going to work because the Chinese have seen

this coming for a long time. They have long had the view that the U.S. was going to try and constrain them. And they said, well, how do we get around this? And their answer is not you build a block, I'll build a block against that. Their answer is, I will operate so that it is impossible for you to build a block that you want. So you look at China's international engagements. More countries have China as their number one trade partner than any other country in the world, right? 140 countries trade more with China than they do with the United States, which is not true during the Cold War. So if you go to Southeast Asia, you go to Latin America and you say, how would you like to join our anti-China alliance? They will say, no way. This makes no sense for me. I import a lot of my industrial inputs.

from China. A lot of my consumer goods, this is really a critical relationship. I might have some concerns about the trade balance and blah, blah, blah, but I am not going to go up against this country that is now either my number one or my number two economic partner, certainly on the trade side and increasingly on the investment side. So that is a non-viable strategy. It will never work. China has integrated itself into the global economy very successfully. And this is just like a fact that we need to live with. So we need to have a more, a strategy that recognizes this is a reality, that there are a lot of strengths that the U.S. has to bear if it's willing to, you know, play them, and that we have the advantages of a dynamic system and, frankly,

a lot more sort of creativity and flexibility in our financial system than that. the Chinese do. So it's perfectly possible to come up with a coexistence scenario in which we do really well. We have domestic policies that sort out our own imbalances, both economic and social. And we have a significant degree of engagement with China that is competitive, but hopefully can be bounded so that we don't wind up in a hot conflict situation, which would be the worst of all possible worlds. All right, that's a good note to close on. Arthur, thanks so much coming on the podcast.

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