Lizzi Lee on Involution, Overcapacity, and China's Economic Model

Summary

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Sinica Podcast Summary

Episode: Lizzi Lee on Involution, Overcapacity, and China's Economic Model
Host: Kaiser Kuo
Guest: Lizzi Lee, Fellow on the Chinese Economy at the Asia Society Policy Institute
Date: November 5, 2025

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Episode Overview

In this incisive episode of Sinica, Kaiser Kuo sits down with distinguished China economist and analyst Lizzi Lee to dissect the evolving contours of China’s economic policy, focusing on themes of involution, overcapacity, and the shifting model of growth and innovation. The conversation spans the recent Fourth Plenary Session of the 20th Party Congress, the underlying debates on domestic demand versus supply, the structural factors that shape China’s economic trajectory, and the implications of these shifts for both China and the global economy. Memorable insights are provided on the complexity beneath catchphrases like "overcapacity" and "involution," critiques of Western interpretations, and some nuanced predictions for US-China relations in the wake of the revived trade war.

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Key Discussion Points & Insights

1. The Fourth Plenum and Policy Signals

Timestamps: [04:06]–[08:53]

• Mainstream Takeaway vs. Nuance: Many Western analysts saw “continuity” and "doubling down" on tech and industrial upgrade, but Lee highlights a new, prominent emphasis on domestic demand and household consumption.
• Quoting Lizzi:

  "It's not a shift in direction … it's a growing awareness that innovation and advanced manufacturing are ecosystem problems." [05:04]

• Perceived Imbalance: China’s classic overinvestment and underconsumption now visibly constrains the sustainability of its tech and manufacturing sectors, especially as export markets close off.
• Domestic Demand as Security: For China to secure its innovation edge amidst global headwinds, fostering robust internal markets is now seen as crucial — “completing the loop” of China’s manufacturing strength.

2. Consumption: Misconceptions and the Real Barriers

Timestamps: [08:53]–[18:46]

• Challenges in Stimulating Demand: Large-item subsidies (e.g., “cash for clunkers”) have diminishing returns; cash transfers run into logistical and cultural barriers, including a high fraction of unbanked populations.
• Service Sector Focus:

  “There are not enough supply ... of the kind of consumption people want to make.” [11:48]
  Opening China's service sector (e.g., high-quality health, cultural, and elderly care) is key, with pilots in Shanghai and Beijing to attract global capital and expertise.

• GDP as a Blunt Tool: Lee and Kuo engage on the difficulties of measuring “real” consumption in a system where many public services are not priced at market value ([15:11]–[18:46]).
• Cross-country Comparisons Mislead:

  "We need to be very careful about drawing those parallels because China's service sector ... is fundamentally structured differently." [16:10]

3. Meta-Messaging: Ideology, Investment, and Internationalization

Timestamps: [18:46]–[24:20]

• Dual Messaging: Leadership projects both confidence and an urgent need for repositioning.

  "You never know which hand is the priority." [20:13]

• GNI vs. GDP: Focus is broadening beyond just China’s domestic economic output to include the global activities of Chinese firms ([20:13]–[24:20]).
• Service Export Strengths:

  “China’s steady ascent along the global service supply chain is something less highlighted in our analysis.” [24:20]

4. Involution and Price Wars: A Systemic Challenge

Timestamps: [24:20]–[32:37]

• People’s Daily Editorial: Unusually candid admission of damaging “involutionary” price wars in sectors like EV and solar, identifying both the urgency and the difficulty of resolving these issues.
• Shifting Landscape: Unlike prior overcapacity “cleanups” in SOE-heavy fields like steel, today’s hot sectors are private-led, complicating coordination.

  “The most competitive firms are private ... how do you actually align the incentives of this whole sector?” [28:31]

5. The Tax and Incentives Problem

Timestamps: [32:37]–[36:13]

• Explains Local Perverse Incentives: VAT is raised at the site of production, so local governments compete (sometimes irrationally) to stack their supply chains, leading to duplicative waste.

  "Local governments basically act like industrial venture capitalists." [31:17]

• Awareness without Easy Fixes: Reforming incentive structures will require gradual, contentious changes; local pilots will precede any national overhaul ([33:07]–[36:13]).

6. "Overcapacity": Loaded Term and Unexpected Upsides

Timestamps: [36:13]–[44:27]

• Lee’s Critique: The term “overcapacity” is vague, ambiguous, and carries a moral charge. She pushes for greater analytical precision and resists framing China as intentionally exporting cheap excess.
• Global Green Transition:

  “The positive externality ... is to drastically speed up the green energy transition and doing so in a very cost-effective way.” [41:45]

• Politics of Overcapacity: Backlash in the West (esp. EU/US) is partly rooted in deindustrialization fears.

7. Realistic Tools for Reform: Structure vs. Moral Suasion

Timestamps: [44:27]–[53:50]

• Patches, not Solutions: Present "fixes" (e.g., exhortations for industry self-discipline, pilot zones) tend to rely on moral persuasion, not structural reform.
• Unified National Market: Ongoing pilots and the new Five-Year Plan call for a more integrated national market to reduce internal “race to the bottom” dynamics.

  “The focus ... is tied to this idea of TFP ... We need efficiency of capital allocation ... stronger IPO channels, stronger exit mechanisms for uncompetitive firms.” [49:29]

• Innovation Shift: Foreign firms now remain in China not just to access the market, but to learn from Chinese innovation.

  “Previously you stay in China because you want the market. Now you stay ... because you want to learn from the best.” [53:28]

8. US-China Relations: Strategic Competition and the Busan Thaw

Timestamps: [54:07]–[68:00]

• Busan “Pause”: Skepticism about durability, but sees new pragmatism and recognition of limits to escalation on both sides.

  “We will see this kind of bouncy equilibrium ... bounded between the upper bound and lower bound ... lots of oscillating back and forth.” [56:17]

• Policy Volatility and Communication Challenges: Disjointed US agencies complicate Chinese policymakers’ ability to interpret US intentions.
• Tech Controls and AI: The future will see continued tech contest—China focusing its AI on empowering the real economy and augmenting labor (rather than replacing it), with unique caution on employment disruption.

9. What Next? Potential Systemic Reforms

Timestamps: [68:00]–[75:21]

• Hard Reforms (Slow): Major structural changes like tax system reform and bureaucratic incentives will be gradual.
• Mid-level Reforms:
  • Capital market reform—moving away from total state bank dominance to more VC/PE and dynamic markets.
  • Welfare and social policy investments—pivot from “things” to “people,” (public health, insurance, fertility support).
• Pilot Initiatives: Expansion of special bonds, health as a security and developmental goal, deeper insurance reform.

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Notable Quotes & Memorable Moments

• China’s systemic challenge:

  “We have not been able to put out a sufficiently nuanced picture about China for the world to understand.” – Lizzi Lee [36:34]

• On involution:

  “The price war is actually a drag on China’s manufacturing innovation going forward ... crowding out R&D.” – Lizzi Lee [26:53]

• On innovation incentives:

  “Most of the firms that are actually innovating, actually helping with China’s ascent along the global value chain ... are private firms.” – Lizzi Lee [52:35]

• On reforming local incentives:

  “Every single government is acting rationally ... but if you look at the system as a whole, it’s irrational and suboptimal.” – Lizzi Lee [32:37]

• On U.S.-China upper and lower bounds:

  “The upper bound ... is always going to be defined by competition over critical resources. The lower bound is deep interdependence ...” – Kaiser Kuo [57:26]

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Timestamps for Key Segments

• Plenum analysis & domestic demand shift: [04:06]–[08:53]
• Challenges of stimulating consumption: [08:53]–[15:11]
• Misleading cross-country GDP comparisons: [15:11]–[18:46]
• Policy message: GNI, global firms: [20:13]–[24:20]
• Involution & price war dynamics: [24:20]–[32:37]
• Tax and local incentives explanation: [32:37]–[36:13]
• Overcapacity debate & global effects: [36:13]–[44:27]
• Reforms: structure vs. moral suasion: [44:27]–[53:50]
• US-China, Busan and tech war: [54:07]–[68:00]
• Systemic fixes & recommendations: [68:00]–[75:21]

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Recommendations Segment

Paying It Forward:

• Lizzi Lee recommends her colleague Paul Triolo for his exceptional, often technical, and sometimes controversial analysis on export controls and tech policy ([75:56]–[77:41]).

Books & Resources:

• Lizzi recommends Choke Points: American Power in the Age of Economic Warfare by Edward Fishman ([78:15]–[79:54]).
• Kaiser recommends the "Morning Coffee" guitar exercise book by Alex Rockwell ([79:54]–[82:25]).

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Episode Tone

The conversation is erudite, candid, and analytical. Both Kaiser and Lizzi offer humility regarding the complexity of the China story, frustration at simplistic Western narratives, and a focus on structural dynamics rather than surface-level headlines. Lizzi in particular combines a data-driven, systems-minded approach with pragmatic policy analysis and clear prose.

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For Listeners

If you want an in-depth, realistic look beneath the surface of “China’s economic problems”—tailored for analysts, policymakers, or the deeply curious—this episode is a must-listen. The interplay between policy, incentives, and international pressures is dissected with rare clarity, charting both the roadblocks and the paths forward as China seeks to adapt its economic model for a new era.

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Transcript

[A]

These days, there's no shortage of MBA programs. What's harder to find is one that still feels connected to the real world, to people, to place, and to the way business is actually changing. The MBA at the Hong Kong University of Science and Technology has that connection. The campus sits above the South China Sea, and yes, the view really is as good as they say. But what makes it special is the mix of perspectives it brings together. Students come from everywhere, and the faculty don't just teach business models, they push you to question the assumptions behind them. If you want to understand how China's economy works on the ground and how it fits into the larger global picture, HKUST is one of the few programs that can genuinely offer that you'll graduate with more than a credential. You'll have a clearer sense of how to lead in a world that keeps surprising us. Find out more at mba hkust. Edu HK welcome to the Seneca Podcast, weekly discussion of current affairs in China. In this program we'll look at books, ideas, new research, intellectual currents, and cultural trends that can help us better understand what what's happening in China's politics, foreign relations, economics and society. Join me each week for in depth conversations that shed more light and bring less heat to how we think and talk about China. I'm Kaiser Guo, coming to you this week from my home in Chapel Hill, North Carolina. Sinica is supported this year by the center for East Asian Studies at the University of Wisconsin, Madison, a national resource center for the study of East Asia. The cynical podcast will remain free as always, but if you work for an organization that believes in what I'm doing with the show and with the newsletter, please consider lending your support. You can reach [e-mail] and listeners yes, you listeners support my work by becoming a paying [e-mail] you'll enjoy, in addition to the podcast, the complete transcript of the show, essays from me, as well as writings and podcasts from some of your favorite China focused columnists and commentators. And of course you will enjoy the knowledge, the frison of morality knowing that you are helping me do what I honestly believe is very important work. So do check out the page, see all that is on offer and consider helping out. We're a couple of weeks out from the conclusion of the Fourth Plenary Session of the 20th Party Congress where the outlines of China's 15th Five Year Plan, which is set to begin in 2026, were previewed in quite a bit of detail. We will see the actual plan in March. But the contours of it are now fairly clear. There's not likely to be too much change between now and then. And while going through all that would be a plateful already for any conversation, we've also just seen the reignition of the US China trade war, followed of course by a lot of back and forth raises in this now familiar poker game. Threats by Trump to cancel a meeting in South Korea at the APEC meeting in Busan, and then to the great relief of many, the actual meeting which went forward and which Trump and Xi appeared to have. Staunch the bleeding for now with a ceasefire. Oh God. I'm mixing metaphors, but who is better to discuss all of this than my guest today? No one. Lizzy Lee is someone I've long admired and I am always delighted to talk to. Lizzie is a fellow on the Chinese Economy at the Asia Society Policy Institute and of course a former colleague of mine back in the China Project days. She holds a PhD in economics from MIT and for my money she is right up there among the very, very best China analysts working today. Lizzie has been following all of this very closely. She's also the author of a recent piece in Foreign affairs titled China China's Fatal Flaw. Although as we're going to get into later, that title maybe wasn't her first choice and doesn't really capture the nuance of her argument. I've actually given Foreign affairs enough love in recent weeks on recent episodes that I think I can say that and get away with it. Anyway, Lizzy, welcome back to Seneca. Are you ready to nerd out?

[B]

Absolutely ready to go. Thank you so much, Kaiser.

[A]

Yeah, it's great to see you as always. Let's get started with the plenum itself. For many foreign observers the the big takeaway was continuity, another round of high quality growth, modernization, all the familiar formulations. But you've pointed out that this year's communique actually included some important shifts that went largely unnoticed. There are some people who've zeroed in on this, but especially the quite strong emphasis on domestic demand, on household consumption and what you are calling this anti involution push. Can you walk us through what stood out to you in the plenum documents and what you think Western reporting, maybe some of it anyway, missed.

[B]

Yeah, absolutely. You know, as you pointed out, you know, a lot of analysts, their main takeaway is oh, this is just another round of even further industrial and tech upgrade, right? Doubling down advanced and manufacturing, AI, semiconductor, you know, there are six frontier areas that are highlighted and all that and you know that that's not wrong.

[A]

Right.

[B]

But I think what's equally important, I believe is this deeper recalibration in how China thinks about innovation, advanced manufacturing itself. So it's not a shift in direction, I don't think that's happening. But I think it's a growing awareness that innovation, advanced manufacturing, they don't just come from the factory floor, the lab or the supply chain China successfully built out over the past few decades. It's actually an ecosystem problem. And as you know, in, in innovation in high tech manufacturing ecosystem, observe, you know, we call the law of the shortest plank. Right. So you know, if we think of innovation tech as a wooden bucket, what are China's long planks? Well, manufacturing base, robust stem talent, pipeline, engineering scale. Right. The ability to, to, to, to start something and scale it up and do it over time. Well, China is already world class over those areas. But when it comes to short plank, when it comes to its financial system, when it comes to domestic demand, which still does not compare with its investment, its manufacturing prowess, by the way, I find a little misleading to accuse Chinese domestic demand as abnormally low.

[A]

Right, right.

[B]

Well, first, even if you look at the history of development, almost every single other industrialized country, including United States, including European countries, went through a similar path of building up the supply side, the investment side first, before pivoting to demand or consumption at a late, later a more mature state of development. But the fact is China's investment growth was so fast and China is so large, so that kind of made this imbalance more salient.

[A]

Yeah.

[B]

So I think we need to have some perspective on that. But I think equally important, and I think policymakers in China are increasingly aware of the imbalance as a fact, more as a mistake in our self. And currently the lack of robust domestic healthy demand is actually constraining the growth of its tech and manufacturing sector. It's a more binding shortfall. And you know, back to what you just said with external headwinds, right. US market and European markets, those are traditionally high value market, increasingly closing down to Chinese tech exports like EVs, batteries, et cetera, et cetera. China's best way to secure its domestic innovation, to secure the health and sustainability of its manufacturing strength is actually by cultivating nurturing a mature, deep wealth of domestic demand. I think just from a security point of view, that's actually in China's interest and I'm glad to see there is this in, you know, seems to be this awareness. Well, actually starting back in September last year, but I Think it's a more prominent awareness this time around in idea that new demand should be leading. Where supply goes to. It's just strikes me as a more efficient way to recalibrate its current model. It's not about a change in direction or this binary choice between more supply or more demand. It's more about fixing the plumbing so that the supply side strength intact, manufacturing, green energy transition can actually flow through the system and generate durable demand. So it's about completing the loop of China's manufacturing strength, if you will. That's how I, how I read it. Yeah.

[A]

So, yeah, yeah, I think there's a narrative out there that says that China is sort of implacably hostile to doing anything that will juice its, its demand side. But that's, that's obviously not true. You referred to September of last year and September and October. All through the fall we saw all these, these different programs sort of trickled out, you know, a little bit at a time to try to increase consumption, household consumption. One of the things, I mean, I've talked to you about this before and one of the things that you talked about was how difficult it is just to simply do cash transfers. So many of the people who would need it are unbanked. There's just really no easy way to do that. They seem to have already tapped out on the large ticket item consumption boosts like white goods exchanges and automobile cash for clunkers programs and things like that. But, but what's changed now? What do they think they're going to do differently this time? What is the content that you can discern in the communique and in subsequent documents that show sort of how they plan to actually go about increasing household consumption?

[B]

Yeah, absolutely. So the cash and transfer thing, I think, you know, we're seeing from the most recent data as the momentum is kind of already. I kind of.

[A]

Yeah, it's played out.

[B]

Yeah. Well, the fact is, I mean, at least, you know, for, for Chinese consumers and I, you know, upgrade my, my car. Well, I probably do it every say five years. Right. If you ask me to like upgrade my car every three months. Well, that's not really a, you know, just based on the consumption habits of Chinese households, that's not something that will work out in a continuous basis. And when it comes to cash stimulus, know, in addition to all the kind of institutional constraint, including a large fraction of Chinese populations do not have access to bank accounts. So how do you actually hand off a check? Right, right. From small things like that to cultural factors, saving habit, et Cetera, et cetera. It's, it's just not the best strategy from a bang for buck point of view. So definitely, I think, you know, treat in programs, consumption subsidies are going to continue and you know, there will be more rollout on those fronts. But what I also want to highlight are a few other ideas I think I alluded to in my, in my previous writing. First, you know, when it comes to consumption, it's not that Chinese households do not have the money to spend per se. I mean there are wealth effects from property market drag down, job security effects, makes people more precautious when it comes to spending, all that. There's also, you know, low price, right? So when you Compare, compare consumption a $$ term, you sort of underestimate Chinese households, consumption power, all that. But it's also because there are not enough supply when it comes to the kind of consumption people want to make.

[A]

Right? And this has always been the theory, right? The supply side approach to it. If we make better, more attractive goods, then that's the way to stimulate demand, right? I mean that's always been the, the Chinese case, right?

[B]

And actually I think you see data on this especially when it comes to service, right? Well, I mean a lot. Well, you know, this, you know, just returned from, from, from China. The Chinese people, they have demands for rich, diverse cultural products, right? Whether it's sporting events, entertainment, cultural events, et cetera, et cetera. But to be quite honest, I mean the supply that the premier services products are not quite there. So I think this is why you see very interesting local pilots in Shanghai and you know, earlier on in Beijing on service industry opening up, right? Attracting global premier events sooners. So the idea is you don't really know where the demands are until you open up the supply. And I think this is, this is also very important for global investors and also global business stakeholders, right? I think we're going to see more opening up, not more closing down when it comes to attracting global capital, global expertise to opening up domestic service sector and not just in travel, not just in cultural events, but also in things like pension fund wealth management, asset management, high quality elderly care, high quality hospice, those kind of service infrastructure which China's domestic economy still, you know, very much lacks, both in supply and also in expertise. And I think that will be really interesting to watch. Including you know, telecom services, which traditionally is a critical sector. It's a strategic sector that's heavily dominated by state owned enterprises and completely dominated.

[A]

Yeah, sure.

[B]

But there might be more opening up.

[A]

I want to ask you about something that I've been, you know, an idea that I've been playing with ever since it was sort of, you know, put put to me. Some months ago I was in Beijing, I was having dinner with a business reporter at Bloomberg who said something I thought was really interesting. He said we were talking about measurements of consumption in GDP accounting. And he said well what if you live in a city that has phenomenally good public transport. It's affordable, it's really world class and around that ecosystem you also have all these private companies providing things like bike share rental. Basically it's de minimis. It's just so inconsequential sum of money that you pay to rent a bike, to ride a couple of kilometers between the subway station and your house. Rideshare services are extremely affordable in China. What is that going to do to your propensity to buy one of the big ticket items that consumers buy in automobile? It's going to suppress it of course. Where does that show up? I mean money is being spent, the money on the subway system, on the buses, on electrification of all the bus routes, all that stuff. I mean paving roads, additional bike and bus lanes, having all the infrastructure in place for the bike share rentals. Where does that all show up? I mean it's obviously just not a simple GDP is just a really blunt instrument. We're all aware of that. But I'm curious what your thoughts are on, on that.

[B]

I think you're absolutely right. A lot of the, the products including education rate, including hospital, they are not market price based. So when you calculate GDP that actually that part is not not price. So I think that's also, you know, that's, that's related to the difference between consumption power and the consumption in dollar term matter that was I think pointed out by CF40 report a while ago. I think when we do cross country comparison versus consumption as a share of gdp we need to be very careful about drawing those parallels because China's service sector is fundamentally, its consumption is fundamentally structured differently. So you know, if say health, right. Public health service now it's market price based, right? Education colleges in China suddenly charge you over 50k US dollars per year. As Kaiser you probably.

[A]

It's a pain point for me. That's what I'm. Yeah, I know it well. I'm paying two of those right now. God damn it.

[B]

Is that a, is that a, is that increasing households utility as consumption seems to measuring or decrease? I think you know the debate is very much out, out there but just compared with China itself, I Think it's fair to say that its domestic demand is still, I would say the critical short plank as as I mentioned. So again, totally agree with. You need to be very careful about drawing those cross country comparisons. And I think one of main takeaways from the CF40 report I mentioned is that, well, you know, once you take into account things like exchange rates. Right. And also basically how things are. Yes, purchasing power. Is China's domestic consumption so low? Yes, it's low, but is abnormally low. No, it's roughly comparable with developing countries during similar stage of development. So that, and also as I mentioned, China's investment growth is simply too stunning to absorb for demand side to absorb. To keep pace. I think we need to have some humility when we come to how we tell China how wrong or right its model is. It's just a totally different and experience it. And relatedly, I think you know, when we talk about China model. Well, this is not directly related to your question, but this is something that been bothering me for a while. I think there's a tendency to do two similar opposite things but I think are equally wrong in some sense. One is to sort of use China as a, as a target rate. This is, this is what's so wrong about China. So the liberal democracy model is still the best alternative. Right? So that's one theory. Another one is, oh, you know what, look at what China is doing. This is why our policymakers suck. So kind of using China as a, a foil. Yeah, as a foil and also kind of as a fable to teach some kind of moral lesson to Western policymakers. And I mean totally different story, totally opposite point of view. And I would say that does not strike me as intellectually honest to reduce the entire Chinese experience to, to a lesson for, for the West. And relatedly, when we talk about this idea of next China, right, India is next China, you know, Indonesia as next China. That strikes me as very disrespectful of India or Indonesia. Those countries are, are different. I mean like what do you mean by, by us being the next China? Like just. I don't, I don't know.

[A]

Yeah, no, Amen. Amen. You're absolutely right. I mean, and it's just, it's just goes to show you, I mean there, it's a complicated thing, you know, I mean somebody listening to the first 30 seconds of our conversation might think, oh, Lizzie's about to make this case why consumption is all important. And then what? You know what? The Chinese government is doubling down on boosting domestic household consumption. But it's complicated. I mean, it's very complicated. It's like why I see yet another guy on Twitter saying, oh look, the rest of the world, the developed world, 68% of GDP is from consumption and China is only 38. Therefore. Yeah, it's complicated. It's much more complicated than that. But I don't have the energy to go into that long conversation with some jerk on Twitter. Anyway, you mentioned how part of the signaling of the communique might have been sort of to the rest of the world. China is a good case for investment. It has a strong ideological charge. There's this whole framing of Chinese style modernization as a political, as a developmental model. So how do you interpret this? Is it primarily about domestic legitimation? Is it also Beijing's way of maybe signaling confidence in its path to the rest of the world? Is it, you know, is any part of this about attracting in investment? What's, what's sort of the, the meta messaging here?

[B]

Yeah, I think you're absolutely right. I, I think, you know, another side of the, the, the, the message is that while we are confident we are doing it right, that's absolutely there. But also, you know, the external environment is, is ever more urgent. That's also part of the message. So I think you see this anxiety and confidence sort of through the document. And the interesting thing about the Chinese policy document is it can be read in so many different ways. And you know, we joke that every sentence comes from, comes with on one hand, on the other hand, you never know which hand is the priority. And I think it's both there. So is there a investment thesis in the, in the document? Absolutely. Is there some signal value to it? Absolutely. But it's the urgency or the need to reposition and rethink itself its role in its global economy important. I think that's also true. And another thing that I mentioned to you is actually the presser from one of the Chinese officials interpreting the company K and he, he pointed out, well, you know, we will focus not just on gdp, but also gni. We will look at not just the Chinese economy, but the Chinese people's economy. I think that's very rich and I, I don't see a lot of media unpacking that. So, you know, what's the difference between GDP and gni? Well, GDP is a kind of a geographic concept, right? What's produced within the border of the country. And GNI accounts for Chinese entities, investment and production abroad. So the key difference here, I think is the awareness that Chinese firms are no Longer Chinese, Chinese firms, they are global firms. Right. And a lot of the strength of Chinese corporate sector actually comes from their global footprint. And as the, you know, the US market, the EU market are closing down to Chinese exports, especially in, you know, new energy sectors, Chinese firms, they're not going to stop going abroad, but they're going to find another way to anchor their ecosystem into the global economy. That could be JVs, that could be FDI, lots of national security scrutiny on those lens. But we're already seeing this playing out, especially in Global South. The idea is to not export our good, but also export the manufacturing ecosystem abroad. And we're, you know, Kaiser, you know, this in, especially in Southeast Asia, in the Middle east and Europe, some part of Europe, you're seeing this playing out. And also if you look at China's export data, I think, you know, many people interpret as, oh, export data, you know, held up strong despite all the trade tensions. But if you look at the, this, the source of the strength of China's export data, a lot of it has to do this stunning growth in high quality service exports. So these are the digital services, you know, cloud platforms. Yeah. So I think, you know, China's steady ascent along the global service supply chain is something that's less highlighted in our analysis. And when it comes to trade data, as you know, you know, month to month trade data is extremely unreliable and highly vulnerable to behaviors like front loading, backloading, you know, sort of a stock buildup. And it's just not, it's not the best way to measure whether the Chinese economy is suffering because of trade tariff pressures. And from, you know, from what I learned, I think the export sector is still under stress. You know, when, when we, especially with all the uncertainties, it's not really about how much terror is actually in place. It's about the, the potential that future growth will be harnessed. That shapes all kinds of behaviors. So. Yeah, but, but service sector, definitely to watch out for.

[A]

Absolutely. So you recently wrote a very long Twitter thread about people's daily editorial. It's actually from a couple of months ago, but it laid out in very frank terms just how damaging China's involutionary price wars have become, especially in things like EVs and PVC, solar. It almost reads like a diagnosis from within the system. What struck you most about that editorial's tone and its substance? Why do you think the leadership is choosing to air these problems quite openly and was doing so just in the months running up to the fourth plenary session, rather than trying to Just frame them as short term growing pains as they usually do. What was the thinking behind that editorial which was front page People's Daily.

[B]

Yeah. So, you know, as you mentioned, I think that that editorial is quite remarkable, you know, in blunt terms, sort of laying out the critical urgency of, of this problem. And you know, I, I think I agree with most of the diagnosis, the diagnosis and also, you know, the urgency of the, of the problem. And the reason I think is this is both both a critical issue for, for China and also a really hard issue for China to solve. So the piece actually, you know, flagged China's auto sector, which, looking from outside, we think is a major success of China's industrial policy. But yeah, if you look at profit margins of the auto sector as a whole, not just the top 20 firms, by the way, among the top 20, you know, EV firms, well, auto firms in the world, I think 16 or 17 of them are from China now. And if you look at the smartphone brands, many people don't realize it. I think among the top 10, five or six, 10 firms, actually eight or nine.

[A]

I think eight or nine if you.

[B]

Look at sort of sales rather than.

[A]

Just Apple and Samsung are on that list.

[B]

Yeah. Which, which is, you know, quite stunning. But the, the piece point out that when you look at the auto sector as a whole, well, BYD is, is doing well, the motors doing well, LI Auto doing well. I mean there are definitely firms that are doing well, are, are turning well, but the entire sector's profits are, are squeezed. And even for the firms that are doing well without a healthy comfortable profit margin, that will ultimately squeeze out their R and D investment. So that, that's, that's very real. And the thing about evolution is that it's actually a drag on China's manufacturing innovation going forward. I think that's, that's because of this.

[A]

Crowding out of R and D. Right?

[B]

Absolutely. And I mean for firm like byd, they are still investing a lot into R and D. But I think we need to focus beyond the top 10% of firms. Right. Majority of the firms. This is eating up their strength to expand, to innovate and they should be the engine of innovation. They are extremely innovative and competitive when it, when it comes to, you know, pure capability. And the piece also discusses the potential problems and actually highlighted some of the issues that I pointed out in the foreign affairs piece, including the financial system, including local government incentives, including its tax system. So I think that the piece is sober yin. It's diagnosed. Right. It knows the problem, it knows the Reasons for the problem. What I find the piece a little unsatisfactory, as I mentioned in my, in my social media post, is that how do you actually, you know, how do you actually tackle this? Well, China has successfully done this before, right. In the 2015-2016 cycle of.

[A]

Sure.

[B]

Addressing oversupply. So what's, what's different this time? Well, if you look at China, steel industry, textile industry, back then, majority of the players in the field are no state owned enterprises. Right. So consolidating those industries, forcing closed downs will definitely have social consequences that need to be dealt with, you know, unemployment, et cetera, et cetera.

[A]

But they could do it with less pain, I mean because they are state, state owned enterprises. I mean it's.

[B]

Yeah, so, so the policy levers are relatively so complete. I would say some pain in the short term but then you know, it's, it's manageable that that transition is manageable. When we look at China's new energy sector, EVs, the solar batteries, the most competitive firms are private firms are all private sectority of the firms here are private sector. So how do you actually align the incentives of this whole sector? That's very problematic. And also when it comes to government incentives. Well, you know, during the property market boom, boom years, remember local finance has another extra lever that's property market land sale, land sales. Right.

[A]

Which is no longer available to it.

[B]

Right. So at least, you know, there's, there's some buffer to local government finance. But now basically, you know, industrial growth is the only remaining lever for local governments to reliably rely on to bring in all the resources. So that relates to the value added tax system I mentioned that basically makes incentives.

[A]

Yeah, yeah. Actually let's get into that because now we're on your former Ferris piece. I mean it stirred up a lot of discussion. One of the big aha moments for me was when you were talking about where taxes are levied, what the difference is between value added tax. I mean what that actually does explain. Walk us through that. I thought that was a really interesting point and it's one that I actually hadn't heard articulated so well.

[B]

Well, that's actually super interesting to me because I'm definitely not the first person who discovered this and I think the best detailed nuanced analysis of this actually came from a Chinese professor, Lan Xiao Huan. So she just a whole book on this issue of local and central government finance and how that, how it is structured in this way mostly due to legacy reasons. This is a kind of a product of the planning period, but how that shaped incentives across the entire bureaucratic system on economic policies and how it played out on the ground is a fantastic book. And I think there's a, there's an English version of it. I've read the Chinese version. I'm not sure if the English version is as good, but highly recommend to people who are interested in local government finance, but noted. Yeah. And just in response to your question. Well, China's single largest tax is, is vat, right. Value added tax in it's collected where goods are produced in, across the entire intermediate good supply chain. So every step of the, the supply chain not where they are consumed. And that, you know, half of the VAT goes to the central government, the other half to the provinces, cities where production actually take place. So if we think about incentives from a local government's point of view, local governments basically act like industrial venture capitalists. Right?

[A]

Right.

[B]

So they want to anchor the entire value chain from upstream raw material to assembly and anchor that in their jurisdiction. That's basically how they can juice up every single step of a tax revenue along the way. And when you have every single government doing that, what you see is this messed up incentive system to attract, to build all supply chains within your jurisdiction. And you know, there are actually interesting stories of local governments kind of know, bribing suppliers in the neighboring province to relocate to their province just so that they can, you know, sort of juice up all, all that, that tax revenue. It was actually flagged, I think by, by to shi or People's Daily as one of the major sort of, you know, misuse of subsidy to try to attract firms from other provinces just to duplicate that similar advantage in your jurisdiction. A flag that's wasteful, inefficient. So that's basically the short answer to the question. And again, you know, what's really interesting is basically all the local governments are doing what's rational from their point of view. But if you look at the system as a whole, it's acting as if the system is irrational in doing so in a very suboptimal way.

[A]

Yeah. I mean, having diagnosed this problem, do you see the central government making that recognition that maybe this is one of the sort of structural flaws that you can address? There's got to be a better way to actually collect tax in places where products are consumed or services are consumed. Services are less of a problem because they're all local. But what's the strategy here? I mean, is this something that they're becoming increasingly aware of?

[B]

I think the Awareness is absolutely there. The political will to tackle this is absolutely there. But the difficulty is at the execution implementation level as you know, you know with the US system any anytime you want to make a change to this tax system, it's going to be a whole mess, right? There are always winners and losers and so political stakeholders and how that's going to receive them played out. If anything it's going to be a very great gradual tweak in the process of, of us baby steps I think. And you know the whole, the, the play out of that will, will not be in next year, right? It will be a decade long project. You ask my prediction of the entire timeline. But there are something that needs to be changed. So for example, right, this allocation of tax revenue and spending between central government and local government actually where the saw some of the policy announcement close to the October plan and the idea is to shifting more spending responsibilities to the center and also you know, sort of extending special bonds to local government just to help them with their, their debt problem which you know, as I mentioned just you know made the problem worse. And also you know when it comes to sort of changing point of collection of tax system, I think there will be some local pilots on changing the point of collection from the site of production to the site of consumption and also pilots on consumption tax. Right. But those would be mini minor baby steps. I think they're going to see how the local pilots play out before doing any kind of national rollout. Just because changing the entire system is a whole different matter. And what's really interesting I think is once you have this focus on you know, doing less of the built, built out, doing more of the consumption, you also see distorted incentives. I think from the latest FA FAI data it's pretty clear that some governments are underreporting their faith, their fixed asset investment. So what's that all about? Well, you know, the guess is. Well because of this anti evolutionary push now they're under pressure to at least you know, make it look on paper that they are not doing the same thing anymore. They are shifting more to other kind of kind of investment. But you know, if you don't solve the local finance problem, that's still going to be the underlying problem is there.

[A]

There's still going to be over reliant on it. Right, right. The incentives are there, the perverse incentives are there still to do massive fixed asset investment and to keep collecting that, that VAT locally. I mentioned that your foreign affairs piece, you suggested that it lost a little bit of nuance on its way to the final version. Particularly your argument about overcapacity. You don't even like that word. I mean, I've heard you rail against the word. And there it was. And it was titled China's Fatal Flaw. Right. Can you give us a better idea what you were trying to convey there and why this whole sort of cheap Chinese exports framing actually misses something really important?

[B]

Yeah, so. So first, I mean, I think foreign affairs editors did a terrific job in sharpening my narratives. I don't want to say, oh, this is all the editor's fault. I think it's ultimately on me to not be able to lay out the nuances in a very concise way, to be.

[A]

Ah, come on.

[B]

No, no, seriously. No, like, I know how it goes.

[A]

I know how it goes.

[B]

You know, foreign affairs, to be quite honest, I, I have. I have real respect for them. From what I heard. I think they're expanding their China expertise.

[A]

Absolutely. I mean, I don't know if you heard. Well, actually, yeah, the show that. It just dropped an interview with Daniel Kurtz Phelan. He talks quite a bit about that. They are really, really leaning in on China.

[B]

So lots of respect for that. I think we need more thinking on China. Well, a lot of the other media are cutting their China reporting team. So just on that, I mean, kudos to front affairs and. Yeah. And to be honest, I think when I say that editors don't seem to value nuances about China as much as I do. I think it's a. It's a judgment on us as China as China analysts. Like, we. We have not been able to put out a sufficiently nuanced picture about China for the world to understand. So even the best editors with China expertise in the world, I don't think it's important to make the distinction between, say, crackdown on China's private economy or overzealous regulation that was executed too fast. I think that's a judgment on us, not the editor. We just, we just have not.

[A]

I appreciate the modesty here. I appreciate that. But, but come on, there's. There's a resistance to that kind of subtlety, Right? There's. I mean, it's, It's. It's not just our fault. I mean, look, we have a very complicated story we were trying to tell. Well, I mean, I mean, it's not an easy one to tell at all. I mean, there is on the other side, this sort of stubborn resistance to complexity, this kind of insistence on flattening it into a binary, into a dyad. And. Yeah, I Mean that. Yeah, but this is a philosophical argument. But yeah, let's go on. Let's talk actually about over convertible. Yeah. I mean, you've talked about it in sectors like EVs, solar and batteries. But you know, you've also talked about its unintended upside. I mean, how it's accelerating the global green transition, it's driving costs down, it's expanding access. That didn't make it into your piece so much. I would love to see that but. Well, expand on that.

[B]

Yeah. I mean, first over capacity. I mean, I think my objection to it is mostly from a nerd's point of view. It's never been defined. Like what is, what do you mean by over capacity? Is it supply growing faster than demand? Well, China is not the, the only country that suffers from this problem. Is it something wrong is a feature of the system. It's just never been defined and it carries with it kind of that moral judgment on it, which.

[A]

Yeah, yeah, no, it's a very loaded word.

[B]

But I mean, so, but even, you know, people's, People's Daily piece, I, I talked about, I talk about oversupply and use the, the word overcapacity. So the idea of there's imbalance between the speed of growth versus the speed of, of demand, I think that's real. And the other thing I don't like about overcapacity is when we talk about overcapacity, we think of it as a deliberate policy choice. The idea of China is, you know, using subsidy, all kinds of unfair trade tools to deliberately export cheap goods, to distort the global market carries with the kind of the intention piece. Well, to be fair, when it comes to unfair trade practice, there, there are definitely issues, lots of issues. Not just complaints from US and eu, but also from global trading partners of China, from Global South. Things are improving on the margin, I think, but definitely issues there. Yeah, but is China deliberately exporting cheap stuff just to screw up everyone else? Absolutely no. And I think we just need to be more careful when we use that word and also the intonation that comes from it. And to your point, the surprising upside of China's overcapacity model. One thing that I find really interesting is after the picture, I think I got a lot of positive feedback and that actually really just pat my, my own, my own shoulder that a lot of the most encouraging thoughts actually comes from Chinese academics and Chinese economists. They're like, oh, you know, these are the problems that we think are the problems that really matter, but we don't really get the platform to, to bring this to, to, to people's attention. But you know, your piece of, is actually a great tool for us, you know, sort of using your narrative, but to, to, to, to highlight our point, so to speak. So, so that's very gratifying. The, the most I, I would say, you know, when it comes to, to critiques, they're the ones that make sense, they're the ones that don't really make much sense, but I think some of the most helpful feedback I receive are from energy analysts, people working on clean energy sector. Sector. And you know, they're, they are less concerned about China's domestic economy, what it means for China's economy per se. They're very rightfully concerned about what China's.

[A]

Model means for, for decarbonization.

[B]

Decarbonization. And their critique is that you, you did not highlight this enough. I, I want to say. Well, I did mention that, but it was not part of the narratives that got cut out. But I think that's absolutely true. The positive externality of this model with all its problem is to drastically speed up the green energy transition and doing so in a very cost effective way. I think it's a massively understated positive upside of China's model. And another positive upside to China itself, which I did not mention in my original draft, is a lot of the clean energy innovations are actually portable or the infrastructure and tech expertise build up. I mean they are not the most efficient way, but they are portable to other sectors like drones, right. Low altitude robotics and also the entire electrification infrastructure that's going to have other positive spillovers. So what's interesting, I think is how over capacity, quote unquote in one sector can be rotated into other emerging sectors and becoming kind of becoming a, a compounding effect on, on other innovations. But already you are seeing this, you know, evolution dynamics playing out in the humanoid robotics sector as well. So, so, so, so the just, just the pure brutalness of private competition for Chinese innovators and enterprises to compete fast and scale fast is still there.

[A]

I remember, I think it was at Davos there was a former Chinese central banker who made a comment to the effect that look, it's funny, I hear this word overcapacity from two places from two specific geographies. I hear it from Western Europe and I hear it from North America and the rest of the world. You don't hear that because they're very, very happy. They think it's under capacity. We want more EVs, we want more solar panels, we want More wind turbines. You know, that's, that's, that's a fair point, but I think it gets to something. The fact that you do hear it so often from these two specific geographies and the reason why over capacity is a sort of morally valence word, it's, you know, very loaded word as we suggested, is because there is this tie into, this fear of deindustrialization and job loss at home. Do you think that Beijing underestimates how politically potent that fear is in Washington and in Brussels, or is it simply pricing that in, as sort of an unavoidable cost of its, its own development trajectory?

[B]

Well, that's a great question. To be honest, I don't really have a answer to that. But I do think just from a pure reality point of view, I think the global backlash, if you will, of China's green sector manufacturing strength and the implication on domestic manufacturing, I think it's, it's going to stay for a while and that's going to create all kinds of tensions, tariffs, trade protectionist, et cetera, et cetera. To be quite honest, I think, you know, very debatable, as we mentioned, if it's China's fault, right, or our lack of, of political urgency to speed up our own green energy transition. But the, the fact is the global backlash is still going to create, you know, key pain points for China's economy and that actually related to the GDP versus GNP GNI distinction I mentioned. I think it's also a opportunity, if you will, for Chinese firms to rethink their engagement with the globe. From what we heard because of this push to go abroad and because of the tariff backlash, they're actually more willingness to work with say, US firms to bring minority JVs to, to, to US territory, right. And more willingness to give some tech transfers to say, European firms as part of the deal to allow Chinese firms to invest abroad and sell abroad. And from the US and EU's point of view, I think that's an opportunity to leverage Chinese technology, Chinese innovation, cost effective ones to speed up the, the re industrialization process. I mean, there are definitely security guardrails, concerns, whatever, but I, I would say there are safe zones to be carved out for something like hydrogen. Right? Security risk relatively low for consumer product relatively low when it comes to critical resource rare earth, I think there's a, there's a authentic and genuine concern, there's validity to security concerns when it comes to, you know, having the, the critical resource chokeholds in the, in a foreign country. So again, I think it's, it's more a design problem. Right. Kind of need to design those mechanisms well enough so it addresses the security concerns what. While leveraging Chinese tech to speed up clean energy transition. So yeah, so, so I think we need to be more pragmatic and I think the, if the, the upshot of, of all the Trump sea meeting, the deal, all the, the, the, the engagement, et cetera, et cetera, I think there is a turn for pragmaticism. We also see, you know, renewed engagement between Canada and China playing out in very interesting ways. I mean first meeting between the Prime Minister.

[A]

Well, I mean that, that's also a collateral damage or you know, it's a benefit.

[B]

Absolutely.

[A]

But we'll get into that in a bit. But I want to stick here very quickly. You know, with, with still with, you know, the anti evolution, you know you mentioned in that Twitter thread you quoted passages from the Daily, you know, the People's Daily piece. You know they, they are aware consuming resources, suppressing innovation, undermining confidence to invest. These are very candid admissions. Beijing clearly sees this price war involution as a macro level threat. It's not just in a few sectors like EVs or solar. There's also kind of maybe a more conceptual issue here. I mean I think a lot of this recognition that China's state directed model inevitably will lead to certain levels of inefficiency and waste, I think. But when you talk about what tools they actually have available to them, the proposed solutions, it strikes me. You talk about industry, self discipline, you talk about pilot zones for fair competition, you talk about these exhortations to local governments. They all kind of rely, as you point out, on good behavior rather than just on structural reforms. Is that a realistic expectation? Do you think that moral suasion is going to do the trick? That they get these at a firm level to behave better and that that's going to fix this.

[B]

I think you absolutely just nailed the problem with the current solutions. Those are all.

[A]

Well, you nailed it. I'm just repeating your words.

[B]

Those are kind of all patches, right? Not kind of fundamental ways to fix the really hard to fix system. But I think the direction of the pilots are also interesting. Right. So Guangdong had a fair competition zone and Zhejiang is experimenting with regional integration. I think what will be really interesting to, to, to see during the next five year, during this 15th five year plan is national unified market, right Highlighted as policy buzzword. The idea you did.

[A]

Yeah, that was very, really interesting. I mean right when the, the communique came out you, you pointed that right away.

[B]

I think we see more detailed about that had in the recommendations drafted by the central Committee that was, you know, issued days after the, the plenum. The focus. So unified national market is tied to this idea of tfp, right. Total factor productivity. And the recommendation was actually very clear about what needs, what kind of efficiency we need. We need efficiency of capital allocations. Right. Where the, the capital market is running in an efficient way. It's not. And you know, stronger IPO channels, stronger exit mechanisms for uncompetitive firms. So that's part of the TFP narrative and you know, building a unified national market, reducing regional protections, expanding national level fair competition law, reducing competition over price, you know, cutting each other down to the bone just to survive, just, you know, running faster just to stay in place. So definitely a lot of the focus is on, on this and the local pilots are interesting. But currently I, the push on that you as I mentioned is going to face a lot of institutional constraints. And, but you know, and also, you know, when we talk about voluntary restraints. Right. So what's really interesting, remember I think a few, a few months ago there was this regulation on basically banging firms from delaying payments to their suppliers more than 60 days. You see how prevalent it is for downstream firms to delay payments of suppliers just to cut down their cost. Right. What's really interesting is for byd, from what I heard, because BYD is so dominant in this, this build. Well, they actually use that as a leverage to negotiate for lower prices with suppliers. The idea is that we'll pay you.

[A]

On time, but we have to pay you less.

[B]

Right. And you know, so, so it's really interesting on one hand you have this over competition, if you will, on you also have a few dominant firms with outsized negotiating powers.

[A]

Yeah.

[B]

So again, I think, you know, when we think about the evolutionary price war and the, the effect has on China's economy, I think we need to go beyond the firms that are doing well, the BYDs and CATL. So they are probably going to be fine. Right. Anyway, and they're, they're going to keep invading and they're, they're still going to lead the world. And actually, you know, CATL is charging ahead on solid state batteries, very much the next frontier. So they are fine.

[A]

Yeah, there's a sodium, the new sodium battery.

[B]

But if you, if you look at the entire supply chain, imagine how screwed up the suppliers to BYDs are. So when we, I think, you know, from a policy point maker's point of view, their concern really is about the, the health of the entire sector. And I think the people's data is really aware of, of how this evolutionary price war is currently a major constraint for the health of the entire corporate structure. And back to the point of demand, the thing is the, you know, the firms that are actually innovating, actually hoping with China's charge ascent along the global value chain, most of them are private firms.

[A]

Yeah.

[B]

You know, these are not the, it's not that the policy dictate them to do well. It's under the direction of the policy that under the incentives created by the policy, these firms are innovating like crazy. And Chinese firms are some of the most innovative, most resourceful firms. Chinese entrepreneurs are the most hardworking. And you know, quite honestly, you know, Chinese R and D, Chinese scientists are the best in the world. I think there's a slow recognition from global MNCs. And you know, as, as one executive recently pointed to me, pointed out to me, well, you know, we used to think of China as a, the market. Right. As an innovation sink. Nothing innovative will come out of China. It's just a market where we can sell our innovations. But now China is increasingly treated as an innovation center.

[A]

Right, Right.

[B]

Chinese R&D's are the best R&D's. So how, how do you actually stay in China? Well, previously you stay in China because you want the market. Now you stay in China because you want to learn from the best. And I think, you know, in their exact word, if you cannot compete with Chinese firms in the Chinese market, you cannot compete with them in a global stage.

[A]

Global market. Yeah, yeah.

[B]

And also if you don't stay in China, you miss out on the innovations. You don't know what's, what's happening. You don't know what's the next frontier. They're actually actively trying to learn from Chinese innovation. That's also something that I think is really fascinating to watch.

[A]

Yeah, it's a massive sea change. It's absolutely transformative. And let's talk about the United States and its efforts to compete with China. And the Trump sea meeting in Busan earlier this month was the first face to face since the US rolled out the affiliate role at the end of September and China returned retaliated with these sweeping export restrictions on rare earth elements and other key materials. It's really strange how so much of the press coverage in the United States completely failed to mention the 50% affiliate rule September 29, as though the REE restrictions came out of absolutely nowhere. Anyway, let's just cut straight to Busan what was the real story here from your vantage point? Was this a genuine thaw? Was it just a tactical pause? What, what do you think is, is going on?

[B]

So I think that's a absolutely great question and to be honest, I, I want to temper my optimism a little bit just because all the, all, all the flip flops, you know, all the previous truth thought and escalation after the Madrid talks, escalation after that. I can never predict what's going to happen in three months or, or, or tomorrow, next week. Yeah. But I do think the tone is something noteworthy and the, the thing that both sides are willing to pause a little bit and to prevent this escalatory spiral from going out of control. I think it's a maturity from both sides and frankly a pragmatic, I think recalibration from both sides. So I think the thing is US China as a, as a regular, the, the competing nature of the, of the economy and the strategic competition. I hate that word, but let me just use that. The systemic competition between the two countries is going to be the theme of US China competition. Increasingly over tech, increasingly over critical resources and critical technologies that are so valuable to both countries. And that's going to define what I call the upper bound of US China relations. So is it going to be a G2 literal sense of the world? Never.

[A]

Right.

[B]

It's going to, going to be engagement. The engagement model will never. But so that's sort of the upper limit. But the lower bound of China US China relationship I think is the deep interdependence of the two system and the deep complementarity and also symmetry in many interesting ways ways it just not make any economic sense for the two economies to self inflict any more pain, if you will. So I think, you know, if, if I have to make a prediction, I think we will see this kind of bouncy equilibrium, right. Kind of bounded between the upper bound and the, the lower bound I mentioned. But there will be lots of, you know, oscillating back and forth, back and forth. But I, I do think there's a pragmatic recognition of the limit of Eastside's leverage and also the leverage from the other side on it. And ultimately I think stability is, is critical, if not just for US China, but also for the global economy. Because you know, I, I think as one Southeast Asia leader pointed out, when the elephants fight the grass, the really.

[A]

The grass is trampled. Right, right, right. You know, the upper bound, I would agree, you know, is very much determined by this competition for strategic Resources and for technology and what have you. But weirdly, the Trump administration seems to be trying to push that upper bound higher. I don't know if you saw Pete Hegseth's tweet, the Secretary of War. In case listeners haven't seen it, I just pulled it up. I'm going to read it here. He wrote, I just spoke to President Trump and we agree the relationship between the United States and China has never been better. Following President Trump's historic meeting with Chairman Xi in South Korea, I had an equally positive meeting with my counterpart, China's Minister for National Defense, Admiral Dong Jun in Malaysia. And we spoke again last night. The Admiral and I agree that peace, stability and good relations are the best path for our two great and strong countries. Countries. As President Trump said, his historic G2 meeting. So he uses that word. I mean, Trump uses it. We say that it's never going to be the case, but his historic G2 meeting set the tone for everlasting peace and success for the US And China. The Department of War will do the same. Peace through strength, mutual respect and positive relations. Admiral Dong and I also agreed that we should set up military to military channels to deconflict and de, escalate any problems that, that arise. We have more meetings on that coming soon. God bless both China and the usa. I thought it was remarkable, I mean, just crazy, but that this could come from our Secretary of War.

[B]

Yeah. So Kaiser, I have no knowledge of how US Policy makers think or Chinese policy makers think, but my sense of not to read too much in that same, it's the fact that, you know, repeating word for word G2 and God bless China strikes me as a way to signal alignment to the Supreme Leader of, of, of the United States rather than some genuine policy, policy change.

[A]

Right. It's just sort of a declaration of fealty. Right.

[B]

Yeah, just, you know, falling in line as fast as you can. But, but I, I don't know, like what's, what's the, the, the deeper message behind it. But you know, I, so, so the one thing that I, I, I think I agree with President Trump is that I think Beijing knows the consequences of taking Taiwan by force. And I, I don't think that's, that's something that Beijing's actively planning. But again, I'm no expert on this.

[A]

But yeah, I mean that's, that's a huge can of worms and we won't go into that here. But I do want to ask you because you've always been somebody who I think has a very good Read on how Chinese leaders react to different circumstances. I think that you have that ability to channel them. And so I want to ask you how you think China's leadership now views Trump personally versus how they view the US System as a whole. I mean, has he become paradoxically a more predictable counterpart in their eyes, somebody who's transactional approach they really feel like they can manage? Or does this whole renewed tariff spiral convince them that Washington's hostility is baked in regardless of who's in office? I think they believe that, but also that Trump is just. There's one thing that's predictable about him and that is that he's still totally unpredictable. Where do you think they land now on him? Well, transactional, reliably transactional, or utterly unpredictable?

[B]

Well, again, like, I have no idea of how they actually view President Trump, but from what I see and read from some of the policy advisors and academics within the Chinese policymaking ecosystem, I think there are a few things. First, Trump is very much viewed as some, someone who's less rigid about ideology, as something that's more workable, focusing on making a deal, focusing on making tangible progress rather than sticking to values and, you know, system. So I think that's a, A plus, if you will, from Chinese side volatility. Definitely something that's a huge negative and a huge, I think, risk, including a lack of coordinations among the various agencies. I mean, so from what we heard before the rare earth mechanism that was in the expansion of the rare earth exponential was pulled out, there were actually technical level communications on some of the contours of those policies, not just with the United States, but also with Europeans, with Asian countries. Actually. There are public information on bilateral export control negotiation, communication channels, especially between China and Japan, China and Korea. But for some reason, that message did not get across the top level decision makers or something strikes me as some kind of a miscoordination among US Agencies and how this administration actually coordinates. Right. Is the message that we sent to one department, you know, reflected in policy thinking? I think that's also a puzzle that China is finding very hard to, to navigate. Like who actually calls a shot. Right. So that's another part of the risk, I think, Lizzie.

[A]

I mean, I don't want you to betray any confidences, but you know, before Busan, we were talking, you hinted that there's, there was a pragmatic off ramp that was being quietly discussed, something that, you know, you caught wind of that you thought might be able to stabilize the relationship even amid this ongoing trade war. It turns out that yeah, it exceeded my wildest expectations in terms of off ramp, in terms of the optics and everything. It was a 12 out of 10 I hear. Obviously you've got some good sources. What did that look like in practice? What was hinted to you and was that reflected in what you actually saw transpire at Busan here?

[B]

I have to give a huge credit to my colleague Paul Triolo who runs a fantastic newsletter. I think, you know, everyone interested in.

[A]

This issue should read it. I've been on show about a million times.

[B]

Yeah, and, and Paul, we all know him well, Paul actually laid this out very clearly of what he thinks is the best path forward. And I think the, the final version kind of, you know, reflects at least the, the first few steps reflects 100% of what Paul laid out in that strategy. The idea is first there needs to be some kind of a pulse. Right, right pulse of this spiral and then review and revision and that's going to be a back and forth process, right. For both sides to take the temperature down and to see what's actually pragmatic, what's not, what are the real concerns and then consider sort of further, I would say retooling of the expert control system from the US side and also from the Chinese side, frankly I think are more powerful than both sides can, can handle and not meant to be used in practice. But I think that's the, the way forward and this is going to be the most challenging part before the US to fundamentally rethink its approach on export control and tech competition with, with China. I mean previously we talked about small yard. Right. High fence. Now it's the yard is, is larger and the, the target of national security seems to be a, a moving target. We never really know what is it. And the bite of export control is, is loosening over time because China's domestic ecosystem is quickly catching up. Are there still chokeholds? Absolutely. Right. Especially when it comes to, you know, Nvidia's software ecosystem, some of the design tools upstream and also when it comes to.

[A]

Although I got to think that that's something that China could overcome fairly quickly if it threw effort into it. I mean it's. Well, I mean, I think software seriously, I mean China is pretty good.

[B]

Well, I mean if you think about the CUDA system, it took millions of global talented software engineers over two decades to build it. Right. China is a formidable force of innovation, but I think the software side is still kind of the, the weakness of the hardware side on the other hand, quickly catching up, not just by sort of computing Raw compute level, but by finding smart engineering solutions to solve the problem. And you know, remember China's AI strategy is not to compete with the US and frontier models. Right. China is never going to spend billions of dollars on building expensive data center to, you know, charge ahead on AGI.

[A]

Well, yeah, they're leaning into open weight models, open source, they're leaning into diffusion, they're wanting to make it available to other nations, the global South.

[B]

And also I think if you look at China's AI strategy for the 15 five year plans laid out pretty clearly it's going to focus on real economy, so how technology is going to serve the real economy. And relatedly, I think China is hyper aware of the employment implications of AI, the disruptive effect of AI on employment. So if you look at China's priority areas for AI development, a lot of this what I call labor augmenting. So the idea is to not replace jobs but to make working more efficient if you will. And for labor replacing technology, I think China's gonna be much more cautious. So when it comes to things like industrial robots, definitely, you know, developing those to make, you know, production more, more, more effective.

[A]

But those are TFP baby.

[B]

Yeah, but those are not meant to replace labor. And I think China is actually quite cautious when it comes to the potential that AI is going to cause a further unemployment problem, which is, which is different, different topic for another day. But I think the tension is very real. And also when young people, when you know, young people with STEM degrees graduating with master's degrees, they're pivoting to jobs like DD delivery drivers when they're pivoting to sales positions. The human capital accumulation implication for China for its long term innovation strength, I think that's a less discussed aspect, but that's a topic for another day.

[A]

Yeah, we've touched on a lot of topics that I wasn't originally planning on. But I do want to come back, back at the very end here to refocus on what you've been working on. You've been very candid about the fact that fixing involution ultimately requires tackling really the political logic of China's growth model. The same forces that have driven its very, very impressive industrial successes have also been part of problem, if you will. If the leadership really wanted to realign incentives to reward innovation over just heedless expansion, what would need to change at a systemic level? We've talked about how the recipe they've put out has a lot of moral suasion components in it, behavioral changes, but it's more systemic that we've talked about. Are we talking about fiscal reforms, about different criteria for evaluating cadres? Or is it something maybe that's just so baked into the party state's DNA that it just resists change? I know, I don't love being asked for solutions either. But I'm going to hold your feet to the fire and ask you for a couple of things that you think that could be feasibly done, that need desperately to be done.

[B]

Yeah, absolutely. So there are the really hard things, right? Tax system reform. Recalibrate the entire bureaucratic culture. So those are the things that are really tough to tackle. And there are the easy things like you know, voluntary industry commitment to, to, to raise price. Right. And there are also the things in between which I would say are challenging are reforms that need to be done. But there is a meaningful way going forward. So I will focus on those. First I think is capital market reform. You know, China's financial industry is still very much bank dominated and banks are risk averse. And Chinese banking system also state dominated. Right. So I think they're rightfully concerned about potential loss for betting on risky innovative project for, for something like biotech. Right.

[A]

Sure.

[B]

Takes 10 plus years. Right. Takes 10 billion like investment and the success rate is less than 10%. So for that kind of risk endeavors, it's a, it's a speculative sector. That's just the nature of the beast, right. How do you actually fund it? Do you want state assets to fund it? Well, under current Chinese laws, laws, you know, lots of state assets is criminally punishable and frankly it should be. Right? It's not, it's not, it's, it's not an, a solution to the problem. So there got to be more private VCs and PEs in this field. There's got to be a more dynamic and mature capital market which is one part of the US experience I think China can learn from, if not US experience, Germany experience or Japanese experience. But the thing is Chinese leadership is hyper aware of the danger of over financialization and rightly so, especially after 2008 financial crisis. So I think that will force a really fundamental rethinking about the role of financial market. There needs to be some recalibration of its approach to the finance industry. By the way, the finance industry is still very much under stress. I mean anti corruption campaign hit this industry the, the hardest and you know, not surprisingly. Yeah. And the morale is extremely low. So there needs to be some, I, I would say recalibration of its, of its Thinking, by the way, you know, when we think about China's strength, I think China is great at accelerating things, starting up, switching up, accelerating, scaling famous.

[A]

Ability to scale and also, you know.

[B]

Cutting it off completely, drastically as we saw from this sweeping, you know, regulatory campaign in the 2020, 2021 and also in the property market, the three red lines and the entire reshape of the sector overnight. China is extremely.

[A]

Calling the red new deal back then.

[B]

Yeah. In terms of China, extremely good at those. But when it comes to decelerating slowly adjusting all the margin, that's not something that Chinese policymakers are great at doing. I think there needs to be something. Is China going to have a full bubbly Wall street style capital market? Probably not. And probably that's not in China's best interest, especially when it's still a developing country. Right.

[A]

But, but it does need to reform its capital markets. We do need to see more private equity, we do need to see more participation of private sector VCs. Yeah, I couldn't argue with you there. Do you have any other big fixes that you want? It's that middle ground between the deep difficult DNA level structural changes and the more cosmetic sort of behavioral fixes. What else do you have in that?

[B]

Yeah, the other thing I mentioned is actually, you know, so the welfare reforms or this whole idea of investing in people. Right. It's interesting and I think it's a very smart rhetorical advice. Meaning we're still going to invest. Right. But we're not just invest in things now, we're going to invest in people. So what that means. Well, basically more wealth security. Right. People have better access to healthcare, people have better access to social services, people have better access and increase, including fertility support. And I think we're going to see more initiatives when it comes to social policies.

[A]

There's a lot of language in the communique and in the following document about this though. So I mean that's, that's encouraging.

[B]

Yeah. And you know, if you look at so just China's National Health Commission director Li Haichao's announcement after the fourth plenum, he actually laid out what he called health first strategy, you know, and the.

[A]

Right, right, right.

[B]

And it's very stunning to integrate health and security. Basically position public health as not just a developmental goal but also a security goal. You know, how to modernize disease control system, how to expand public investment and how to, you know, go from a hospital centric model to a more know, community based model. Basically, you know, by making the population healthier and you know, so, so, you know. Right. The idea of it's health is still a major financial risk is also just.

[A]

Means it's, it's, it's a pain in the ass to go to the hospital.

[B]

Yeah, absolutely. And I think we're going to see more reform on the socioeconomic side and also public health equity, deepen insurance reform, allowing more commercial insurance to play a role and broaden its current national drug procurement list to include more innovative drugs. That's going to have huge implication for the public health, the, the, the, you know, the, the population health of, of China, you know, delivering affordable access across the country, which is still highly uneven. Now I think those are also basically by leveraging its domestic reform to create a healthier, more secure and wealthier population. I think that's also huge for China.

[A]

Yeah. Lucy, it never fails to astonish me, just the level of depth and granularity and insight that you bring in discussing anything related to China, to its economy, to its politics. It's just astonishing. It's such a pleasure always to talk to you. I want to thank you for taking so much time out of your Monday morning to chat with me. Let's move on to our Paying it Forward segment where I ask you to name check a colleague, maybe somebody at the Asia Society Policy Institute who's doing some great work that should be getting more attention. And then we'll go on to recommendations from there. So who do you have for paying it forward?

[B]

Okay, I already mentioned his name. And so I usually, I want to highlight, you know, kind of rising stars, if you will, the young colleagues, especially not from the US policy ecosystem. But here I have to recommend my great senior colleague, Paul Triolo. His newsletter on not just the rare earth issue, but a host of issue on the.

[A]

Oh, I mean, so many. I read it. Every new piece that comes out, I read it instantly. I mean, often it's completely over my head. You know, Paul has, you know, the problem with Paul, of course, is that he knows just too damn much and it's sometimes hard for the same complaint.

[B]

And I, you know, this is a little too technical at some point, but I think when it comes to expert control, to understand what's actually going on within the industry, I think that's, that's hugely beneficial.

[A]

And to be frank, he's hardly a junior, though. He's, he's one of the most senior people who writes on technology. But I'll let all that slide for now.

[B]

Oh, you're still young. I don't mean to say. Well, yeah, but anyways, But I should also mention. So I think the good thing about Paul is that he's deeply knowledgeable, but he's also not afraid of being controversial. Right. There are definitely people who do not agree with what Paul laid out. And I think it's a healthy, it's a healthy debate to have. And I see, you know, I think there are people I respect from both sides and I benefit from both sides of the argument. But I think Paul's point of view, definitely something worth reading, especially because that point of view is kind of, I think, undervalued in our broader general audience media landscape.

[A]

So I will say this for Paul, he used to be even more sharp elbowed. He used to be even more pugilistic out there in social media and so forth. I mean, he really has changed his sort of communications game and he's gotten a lot more collegial in his interactions with people with whom he disagrees. And it's nice to see.

[B]

Got it, got it. Paul has always been a great colleague to me, so I have to.

[A]

Yeah, no, he's great. Yeah, he's absolutely great. All right, Lizzie, what about recommendations? Do you have a book you've been reading or anything that you want to recommend for us?

[B]

Well, yeah, so this is not a new book, but this is something that I've been thinking about how sort of leverages, if you will, over trade talks are increasingly over. Choke points. Right. Not just sort of the, the overall strength of, of economy. And so, you know, there's a book called Choke Points. The full name of the book is American Power in the Age of Economic Warfare. It's a, it's a, it's a book that was published earlier this year by Albert Fishman. You know, so the book describes sort of the geopolitical and also economic choke points emerging in the 21st century, including some, you know, physical, literal choke points like the Strait of Hormus Right.

[A]

Or Malacca.

[B]

Yeah. And also, you know, something less tangible like the dollar based financial system. Right. U.S. maritime Insurance and also, you know, advanced technologies like semiconductor. How those critical choke points actually become the most potent tools of economic warfare, if you will. So this is something that I've been thinking quite a lot about and you know, adding to, to the, the book, which the book does not really get into in depth, China's resource leverage, how those are going to play out. This is an area that I'm actively, you know, trying to think more about. And also China's chokehold on biotech innovations, especially the cost effective one. I think Bloomberg had A new newsletter on how biotech innovations, biotech assets are China's next rare earth. It might be a little too, I don't know, exaggerating it a little bit. But definitely watch this space. I think it's going to be critical for us. China.

[A]

Yeah. This is a book that I bought and I have not gotten to yet, but I'm really, really looking forward to plunging into it. And I'm going to figure out some way to reach out to Edward Fishman and get him on the show because this is a very, very, very important book. So my rec. That's great recommendations and so Choke Points is next on my reading list. I've got a couple more books I'm trying to finish off right now, but then I will absolutely get to that. What I do every morning when I get up before I even, you know, I'm. I brush my teeth and put my contact lenses in. And then assuming my wife's already out of bed because I don't want to bother her, I practice guitar. I've been playing a lot of guitar. I play a few hours every day now, and it's hard to think of what to practice. Sometimes you don't want to just play your old repertoire. You don't want to just noodle over backing tracks. So I found this really great system by this guy named Alex Rockwell. It's just a couple of books called Morning Coffee and then Cream and Sugar. But the Morning Coffee exercises, it takes me about 45 minutes to get through the whole book. And it's, you know, it's what you'd expect a lot of scales and arpeggios, but really, really cleverly put together. So you play all your major scales in the circle of fifths and major arpeggios and then, you know, major pentatonics and all the minor scales. I mean, I kind of pick and choose from among them, but the bulk of it is taken up by two major sets of exercises that I find have really changed the way I approach playing. And I can't recommend or highly. I mean, it's really good for people who like a little bit of structure. I like a little bit of structure. I don't take lessons or anything like that. But this Morning Coffee book, it's just like five bucks for the PDF. You can buy the hard copy, too, but it's really, really cool. Not found anyone else in my circle of friends who's into it, because it would be really fun to just sort of show them. The thing for me is just remembering what it was like Playing some of the more difficult things in the early days. Now I can play, just sort of blow through them really fluently, really quickly. It feels good to just feel like I've got market improvement. Alex Rockwell, Morning Coffee for all you guitar players out there. And I know there are lots of you. You reach out to me once in a while and we talk gear and stuff. So keep that coming. I really appreciate it.

[B]

Thank you. That just flew right over my head. I have no musician but Kaiser. I mean, if you have Good Easy Cookbook for beginners who are looking for ways to try to get started on better food, please send them my way. I mean, critical need.

[A]

You know what's really good for cooking? What I really Enjoy is just TikTok. Just when you start, like, they're really quick, easy recipes. Often they're really good. I've recommended a couple of people from TikTok who I really like. You know, there's one again, it's a pain in the ass because I'm trying to drop weight and I stopped eating carbs. So no pasta, no rice, nothing like that. No bread. The bread is the hardest thing to live without right now. But even with those dietary restrictions right now I'm finding really interesting recipes online constantly.

[B]

I mean, I'm much, much less ambitious than you. I'm mostly just looking for recommendations for a good first food that does not suck. Coming out of microwave them. They're good. Yeah. But anyways.

[A]

All right, Lizzy, what a pleasure. I can't wait to see you again. And we'll get you back on the show. And I swear to God we're going to get our China talking points going again. I'm sort of settled back in now, putting a bunch of shows in the can right now, so. But we, you, me, Eric and Andrew will. Will ride again very soon, right?

[B]

Absolutely. All right.

[A]

All right.

[B]

Well, good to talk to you.

[A]

Nice to talk to you.

[B]

Bye. Take care.

[A]

You've been listening to the Seneca Podcast. The show is produced, recorded, engineered, edited and mastered by me, Kaiser Guo. Support the show through [e-mail], where you will find a growing offering of terrific original China related writing and audio. Email [e-mail] if you've got ideas on how you can help out with the show. Don't forget to leave a review on Apple Podcast podcasts. Enormous gratitude to the University of Wisconsin Madison center for East Asian Studies for supporting the show this year. Huge thanks to my guest, Lizzy Lee, the awesome Lizzy Lee. Thank you for listening and we will see you next week. Take care.

[B]

Sa.