Odd Lots - How Science Fiction Explains the U.S.-China Trade War

Episode Date: August 5, 2019

It's no secret that a lot of the trade tensions between the U.S. and China have centered on technology, and China has accused the U.S. of trying to stymie its economic development by suppressing its technological advancement. This week's Odd Lots guest argues that, while there are few historical precedents for this sort of technological suppression, there are a lot of them in science fiction. Laban Yu, head of Hong Kong and China research at Jefferies, walks us through the surprising overlap between sci-fi and the trade war.See omnystudio.com/listener for privacy information.

Thanks for listening to Oddlots. Follow the show on Amazon Music for more future episodes or just ask Alexa play the podcast, OddLots on Amazon Music. Hello and welcome to another episode of the Odd Lots podcast. I'm Tracy Alloway. And I'm Joe Wisenthal. Joe, do you like science fiction? You know, it's one of those things where I like it more in theory than in practice. And by that I mean, I like the... What does that mean? By that I mean, I like the idea of being into science fiction. and I try to get into it every once in a while and then I forget about it

and I'm like, oh, I should read more science fiction and it like never seems to happen. So that makes sense? You know, most people don't like the idea of being into science fiction but secretly actually like it and read or watch a lot of science fiction. Yeah.

I didn't know that. You're the opposite. Oh, is that because it's like seen as like dorky or geeky or something like that? Yeah. No, I could see that. Yeah, exactly. No, like I every once in a while I try,

but then I just like forget. Okay, but you know Star Trek, right? Yeah, yeah, I used to watch it pretty regularly. Oh, okay, so then do you remember what the mission or the prime directive of the Star Trek Starfleet was? No? No? No, I don't think so. All right, well, I'm going to read it off Wikipedia.

I don't want people to think that I know this. by memory. So the prime directive is a guiding principle of Starfleet prohibiting its members from interfering with the internal and natural development of alien civilizations. The prime directive applies particularly

to civilizations which are below a certain threshold of technological, scientific, and cultural development. So basically, you know, the more advanced civilization that is Starfleet shouldn't go around bullying or influencing less developed civilizations during their space exploration. So at first I was about to ask what on earth this had anything to do with markets or economics or anything that we normally talk about.

But that last point kind of makes me think that there might be an analogy to some developments that we're seeing today. Yeah, I think you know where we're going to go with this. And that is, of course, the technological war, I guess you could say. between the U.S. and China. Right. And we've talked about this before on the show, but the implications are so massive, these tech fights, the race to control certain important technologies,

so critical that we really probably can't talk about it enough. Yeah, and the person that we're going to speak to on this is, as far as I can tell, a science fiction fan. And I have to say, one of the more unusual usual analysts that I have met in my entire career in financial journalism. Before I came onto the show, I actually just looked up his profile because I wanted to make sure that I got the job title right. And his job description on LinkedIn is galactic energy commodities, space mining, and unobtainium research at Jeffreys. So that's, that gives you some idea.

I can't wait. So who is this we're talking to? such an awesome job title. All right, it's Leban Yu. He is an analyst over at Jeffreys. Actually, an energy analyst, I believe, but writes a lot about broader issues in China. So Leban, it's really good to have you on the show. Yeah, thank you for having me.

Thank you for that introduction. I have to say, that wasn't the only job title on your LinkedIn. I also saw a galley slave at Macquarie and Paduaan. learner at Lehman Brothers. Yes. I guess my LinkedIn profile was a bit of my little joke against LinkedIn for using our content for their profit. So I did have a little laugh at their expense, I guess. So are you a science fiction fan? I have to say I am. I don't think I am a raging science fiction fan, but I do follow it. And, you know, it's important more and more because there's a lot of things in science fiction now that really pertain to what we see happening in the world.

What are the key things that you read and think about in the science fiction realm that you see happening in the world? Obviously, Tracy brought up the Star Trek Prime Directive and the U.S. attempting to interfere with Chinese technological development. What are sort of the big themes in sci-fi that influence your thinking right now on what we see in the world? The one thing is we have to introduce this Chinese science fiction writer. He's probably right now the most popular science fiction writer in China. He wrote a series of books that everybody reads in China as kind of a representative of the cultural, the civilizational clash between the U.S. and China. And in his book, he has one civilization, which is a Tricilorian civilization, and they figured that they're going to take over Earth. And one of the ways they are going to accomplish this is by sabotaging all the scientific progress on Earth.

So when the U.S. put the export ban on Huawei, that came to mind of a lot of people who have. I've been following the situation. I've been fans of the Utschasing, where, wow, this is actually happening in real life. It's never quite been done. I don't know if there's ever been a historical precedent where one nation tries to hinder the scientific progress of another. It's just kind of new. So therefore, I think as technology developed so quickly, this becomes kind of a different. new way that the conflicting nations will present itself.

So you used the allegory of the Chinese science fiction writer. I think the name of the first book is the three-body problem. Is that right? Yeah, that's correct. You use that as an allegory for the U.S. trying to basically stymie technological progress in China. But I guess my question is, do you think that is ultimately the goal? of the U.S.'s trade policies and what they're doing with things like Huawei. Is it that strategic?

I actually personally don't really think so. I think it's actually just a, you know, panicked anxiety. Let's do something. It's a function of ignorance and anxiety and with some truth all mixed in there. However, there is the Department of Energy's Business Advisory Board. They actually came out with a policy paper that actually tried to think through all of this. And when they thought throughout this, they still advise that the US be very aggressive with export bans to China to stymie Huawei, even if it will ultimately result in the acceleration of technological catch-up of China.

and they still said this is the correct policy to take. So it seems like there are some parts of the American policy apparatus that has thought through this and has made this recommendation. Now, whether it's in everybody's head, it's unclear. Yeah, reading through your notes and you sort of talked about the two prongs of Trump's trade approach, one on the tariff side, you say, you know, that might actually be sort of brilliant and it might actually begin to cause global multinationals to move their supply chains out of China and it might have some effect. Whereas on the other hand, the export ban to Huawei, which as of

right now when we're recording this, which is in early July, has been softened a little bit. as you put it, well, it may have the perverse effect where supply chains move out of the U.S. so that companies can export technology to Huawei and also will have the effect of accelerating China's own efforts to build its homegrown technology. Yeah, so that is where once I saw these policies come through, you scratch your head to think how well thought through a lot of these policies were. because once the export ban was put in place, especially the extraterritorial parts of it, immediately I thought this is exactly the opposite of putting tariffs on Chinese exports. Because now, all of a sudden, anything with U.S. origin in it becomes kind of tainted.

So a lot of the tech development that needs to find a Chinese market, because China's market is now the largest semiconductor market in the world, it will try to move out of the U.S. Either, you know, there are the minimis rules for the products if you're below 25%. So if, for example, some product had 28% U.S. content in there, all kinds of efforts will be made to make that below 25. But in recent weeks, we have heard that a lot of U.S. companies are still supplying Huawei because they are manufacturing outside the U.S. Those kinds of efforts will continue if the export ban remains in place. I think one of the reasons that Donald Trump ultimately relaxed the export ban is because of very heavy lobbying from these American companies trying to explain. this point to him.

Right. So Bloomberg has actually reported that there are companies like Intel who think that they found a legal, I don't want to call it a loophole, but, you know, the legal thing that does allow them to your point to ship to Huawei. Joe just mentioned this, but talk to us about the self-reliance notion when it comes to developing China's own domestic technology capability. Because again, that's where the sci-fi analogy sort of comes in again, and that's where people start talking about the three-body problem and what happened to Earth when basically the alien civilization tried to stop them from developing technology. Right. So right when a civilization is under threat in this way, now developing your own technology isn't just an economic problem, it's a national security problem. China, which had already been throwing all kinds of resources into developing its semiconductor industry, we think right after the Huawei ban, whatever huge amount of resources that are already committed, there is now very likely a multiple on that. I don't know what multiple it is, but the U.S. has pushed China to try to stop China from doing something. It has actually, you know, accelerated that process.

So the long-term likely ramification of the U.S. threatening Huawei with this technology export limitations is China then doubles down or really increases its investment on domestic technology. What about the short-term gains? Because one of the concerns among many people in the U.S. government and industry is just who wins the race to 5G rollout. And there's a perception out there in your own research. Ed Jeffries has talked about this, that there are big gains from the first country that really rolls out 5G wireless technology, all kinds of revenue advantages, the ability to set all kinds of standards and so on. Is there an advantage just in the short term win if the U.S. can slow down Chinese technological dominance right now in this area? I suppose there is some, but the most the U.S. will get out of it is technological catch up on the U.S. side itself. So whereas right now, if things stand as they are, China can't quite do 5G because it needs a lot of the U.S. parts. And the U.S. can't quite do 5G either because it needs a lot of the Huawei technology.

So both sides have kind of hobbled each other. I guess if this was the U.S. strategy from being well ahead of the pack, then now the race is kind of even, if you will. So the short term, there might be some benefit in one very specific industry. I think the problem with all this is that in the longer term, the trust that technology developed, in the U.S. will have a global market has been damaged. So in the longer term, all kinds of R&D that would have been carried out in the U.S. might now have to be either relocated from the U.S. or replicated elsewhere. It's hugely inefficient, and it's damaging to everybody, but mostly damages actually the U.S. if that happens.

a long term. So speaking of inefficiencies and just going back to the notion of China accelerating its own technological progress because of what the U.S. is doing, I mean, we've seen China try to develop its own semiconductor industry before and they haven't been that successful. So what are the chances that they're successful in doing this now? And what are the chances that they avoid, you know, ramping up technological capacity to the point of ridiculousness or mass inefficiency. China has taken multiple staffs at developing its semiconductor industry and has never done a very good job. In the late 90s, at an effort and in the early 2000s, it had an effort. There's two major reasons why it did not succeed in the past. One of the major reasons is that China

just did not have the human capital at that time. At that time, China had about a third or in the early part of the 2000s, half the number of engineers as the U.S. However, over these years, China's graduates of engineers from the year 2000 on, where they graduated about as many engineers every year as the U.S. to today, China graduates eight times the number of science and engineering students every year. And the researcher, the stock of talent, has now surpassed the U.S. So now there's a lot of human capital in the market that can do this kind of work. So there is the resources to throw at this problem. the other thing is that the thing that held everything up is that there was no real market

for the chips made in China. The chips made in China was subsidized products and they were always somewhat behind what was already available stuff made by Intel or AMD and they were probably more expensive and performed worse. So nobody bought them except for the defense industry in China that was required to buy them. But now that you have a company like Huawei and you have also the threat of further export bans, I read an article a while back that now a lot of companies, they describe suppliers from the U.S. as suppliers of the last resort. I mean, first you buy domestic, then you buy from the U.S. if all else fails. So now, because of the engineers there, and now all of a sudden,

a market has been created so that chips are sold, revenue is generated, and R&D in the semiconductor industry, is just a function of revenue. If a revenue is there, about 20% of your revenue spent on R&D, so that creates a virtuous circle. So there's a much higher chance of success this time around, just because you have two pieces in place now, which is the human capital, and then now, which is a market has been created.

How far behind right now would you say still the Chinese semiconductor industry is? So kind of the thumb in the air is about six years. Now, the six years, you've got to be somewhat careful on that. This assumes a static situation. It assumes that the U.S. stops technological advancing, and then based on prior track record, how long it will take China to catch up in the different generations of chip manufacturing process. However, you can't quite assume that the U.S. will stop advancing, but also something else has changed now. Now,

what we believe is that the higher rates that China was catching up on, on has now been thrown out the window because of all the resources that China will throw at the semiconductor industry. And also, the rate of advance for the U.S. semiconductor industry is a big question mark on that now. Because China is the world's largest market for semiconductors. If that world's largest market has a big question mark whether there will be export bans on it, Will the R&D be done in the U.S. to service that market? So the advance of the U.S. technology could slow down, and the catch-up speed of China's technology could accelerate.

But, you know, in a static environment, it's about six years. But, you know, we think it could be less than that. Let's talk about the pure tariff side of the tensions that are going on right now. And again, we don't know exactly what the final trading relationship is going to look like between the U.S. and China. As of right now, the more stepped up tariffs are on hold. A lot of analysts expect that maybe there will be some deal later in the year. You've written somewhat positively about Trump's tariff strategy. So I'm curious what potential gain you see from it.

We touched on it in the beginning and how you see how the Chinese government is going to play its cards in response. I'm not too sure. I'm all that positive on Trump's strategy. What I think is that he is quite innovative in using tariffs. Tariffs have never really been used in this way before. Tariffs historically have been used to protect a domestic industry where, you know, there's a domestic beneficiary when you use this tariff. Domestic consumers are hurt, but you actually have a domestic beneficiary. In Donald Trump's case, he has no domestic beneficiary really in mind. All he has is a foreign businesses that he really wants to cause some pain on.

At the same time, he's causing pain on domestic consumers. However, if this foreign adversary caves, then there is no harm done to domestic consumers because the terrorists will be lifted and then the U.S. will collect the trade concession from whichever foreign adversary caved. And this strategy works extremely well with small economies, South Korea, you know, Mexico, Canada, they all caved. And the U.S. collects its concession, however minor they are, concession, concession, concession. However, if you have an adversary that is not small and that is not caving, then your tariffs are causing harm for your domestic consumers. You may be hurting the suppliers from the foreign country, but your consumers are being hurt. So then I think, me personally,

I think it's the level of pain on both sides is almost symmetric. So then it just becomes a game of who can withstand more pain? So as it's playing out, I think both sides right now think that they can stand more pain than the other. China, I think, believes that the U.S. will cave because special interests will force Donald Trump to throw in the towel, whether it's the farm lobby, the consumer lobby, or whatever. The politician in China believe that the U.S. is controlled by special interests. Donald Trump's strategy is probably betting on their belief that China's economy is pottering because of the huge debt that China's built up in recent years. Without that being true, China will not cave and then it would just be a long, drowned out trade war before someone realizes which side

is suffering more pain. So I've always wondered this, but the Trump administration seems to simultaneously believe that China is on the brink of a massive financial meltdown or economic slowdown of some sort. But at the same time, they seem to be very, very scared of the potential for economic progress and eventually strength in the country.

How did they square those two positions in their minds, do you think? Yeah, from what I see, a lot of commentary out of the U.S. does hold like a schizophrenic view of China. At the same time, they think China is advancing at such a pace that it will dominate everything. And things must be done now. Otherwise, nothing can be done in five, ten years' time when China controls everything. But also, at the same time, they also believe that China's economy so over-leverage. overstretched that it's on the brink of collapse. And those two kind of opinions exist almost simultaneously in the minds of a lot of American policymakers, I think. And I'm not too sure that that is healthy or correct and will lead to any kind of an intelligent strategy. I just want to go back

to what you said about the Chinese perception that the U.S. can't win the trade war because special interests will ultimately force the administration or force the government to relent in some way. I mean, arguably, that view was somewhat vindicated just by the recent actions with Huawei in which chip companies came and urged the administration to relax the export controls. and that's exactly what happened. But more big picture, does this essentially represent a fundamentally pessimistic view on the state of U.S. politics right now that our government, sort of regardless of who is in control, is incapable of doing anything long-term strategic because there will be these powerful special interests that will demand that be undermined for short-term profits?

I think that is the opinion. of the leadership in China. Rightfully or wrongfully, I think that is opinion. There is a man by the name Wang Huning. He just recently ascended to the Standing Committee of the Politburo. These are the seven people who pretty much run China. He has a very interesting background. He was never a politician.

He never ran a province. He never ran an SOE. He never ran an M. ministries, he just extended the bureaucracy from academia and as advisors for the last three presidents from Zhang Zaming to Hu Jing Tao and now Xi Jinping. He is the ideological theorist for China, and he wrote a book about, I don't know, 15, 20 years ago, he spent a number of years in the U.S. studying in universities and researching universities. And he wrote a book titled America Against America, pretty much saying that the U.S.

is controlled by what he calls minority shareholders and special interests control all of U.S. politics. And therefore, it leads to gridlock and nothing that can be done with, you know, where big money control of things. This is not at all a very unique analysis. You have people like Mansor Olson, the U.S. political scientists and Francis Fukuyama, who more or less come up with the same conclusion, where Francis Fukuyama calls it repatrimonialization, which is a long drawn-out phrase that he coined, which is the late-stage democracies. He will develop in such a way that special interests control everything, and that's Mansor Olson's theory as well,

where what he calls distributional coalitions, which is special interests, will dominate the political landscape. And both Mansor Olson and Francis Fukuyama, their conclusion is that once it happens, they can't think of any way that it can be resolved. This is kind of a steady state. I have to ask, who do you think is ultimately going to be able to withstand the most pain when it comes to the trade war? Is it the U.S. with, you know, a fractured political system beholden to lots of interest groups, but that is coming from a position of strength and power to some degree? Or is it China with its command economy able to develop industries very quickly, but coming from a lower base? Which one?

I have to say China, you know, time is on China's side. China's government has a lot more tools that it can use if the economy really were to, you know, enter a really weak patch. They can do a lot of things that the U.S. cannot. They can stimulate their banks. They can cut taxes like they already have. And, you know, kind of the magic thing with China is it still has refurb. in its back pocket.

Can always do reforms. You can privatize its SOEs. There is an effort right now to more or less push toward the privatization of SOEs, which is probably going to force SOEs to pay a lot more dividends, pretty much distributing the capital from the SOE to the larger economy through tax cuts. So there's a lot of tools that China has. China also has the benefit that they more or less control the media. As this trade war is being raised, they have already been preparing the population with propaganda,

linking this to the Korean War, linking the trade war to the long march. Now, in the U.S., there has been very little preparation for the fallout. I guess they're hoping a deal will be cut and there won't be any fallout. But right when prices really start rising for American consumers, right when the farmers really start, you know, losing a lot of sales, these interest groups will, you know, start their lobbying efforts and start pushing back. China's economy is probably could take, you know, the damage to China's economy in the short term could be larger on a percentage basis. It's not about who is damaged more. It's more about who can take more pain. So even if the U.S. economy suffers less,

it's unclear whether they will be able to withstand that amount of suffering. Leibang-U, head of Hong Kong-China Research at Jeffreys. Thank you so much for joining us. Thank you. That was so great. I really enjoyed that. Oh, you're welcome. Thank you for having me. So, Joe, I have a secret confession, which is that I started reading the three body problem after reading one of Laban's notes a few weeks ago. See, remember, I actually started reading that like two years ago.

Now I got to start. Oh, you beat me. No, but I didn't finish it. You'll probably beat me to it. But I do want to restart reading it now. It's good. Although, I mean, Laban has kind of ruined the plot a little bit because now we know that the A-LARL civilization tries to suppress technology on Earth and in doing so, they encourage Earth to

basically ramp up their technological prowess and years and years of intergalactic warfare kind of ensue. So I wonder if that's going to be what happens to the U.S. and China. Wait, aliens are going to come and... No. Oh, no, no, the U.S. are the aliens in this one, right? No, I think if aliens actually came to Earth, I think there's a chance that the U.S. and China might unite, right? Against a common enemy. Oh yeah, so we should root for that outcome and avoid domestic earthbound strife. Yeah, exactly.

All right. On a serious note, though, I really enjoy having Leben come on and talk about this. And I think he does point out some very interesting things, especially when it comes to the differences in the respective political systems of the U.S. and China. Yeah, that was really one of the things that struck me. And now I want to read that guy's book, America versus America. But, you know, it's funny thinking about it from that lens because in a way it suggests that the election of Donald Trump, while we sort of think of it as this major event that sort of changes everything, if you think about it through sort of like stages of democracy and we're at this captured stage in which long-term strategic planning isn't even really something that we don't, we don't really even have the muscle for it anymore. then it makes you sort of wonder whether Trump is just sort of an artifact or just a something along the road of a path that we've already long gone down on. Right.

It also puts me in mind of one of the earliest Oddlots episodes that we ever did, which was with the archaeologist Arthur Demarest where he talked about how or why civilizations are prone to collapse. And he basically argued that it's when they become too complex that things start to go pershade. And you can see that a little bit when we start talking about trade and interest groups and the notion that you're going to have to hire dozens and dozens of lawyers to figure out whether or not you can, you know, sell into China. You can see that complexity really clearly. Yeah, absolutely. We should have him back on soon. That was a really good episode. I love that. That was one of my favorite episodes.

All right. This has been another episode of the Odd Lots podcast. I'm Tracy Alloway. you can follow me on Twitter at Tracy Allaway. And I'm Joe Wisenthall. You can follow me on Twitter at the stalwart. And you should follow our producer on Twitter, Laura Carlson. She's at Laura M. Carlson. And you should follow the head of podcasts at Bloomberg, Francesca Levy, at Francesca Today.

And follow Bloomberg's podcasts overall on Twitter at podcasts. Thanks for listening.