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Thread by @kylecyuan: "1/ Many should exercise more caution in predicting China's future. Those overly attribute short-term market opportunity for innovation abili […]" #BAT

25 tweets, 6 min read
1/ Many should exercise more caution in predicting China's future. Those overly attribute short-term market opportunity for innovation ability. They also omit serious macro factors and structural concerns. It's a "treadmill to hell" and "Gravity will not be repealed."
2/ The conventional attitude towards China: invest in the promises of today but ignore the risk. Consumption, global trade, and technological innovation are the promises. Excessive debt, frothy markets, Ponzi-like financial structures, bureaucracy, and opacity are the risks.
3/ Software bends the cost-curve downwards, improving productivity and economic growth. @pmarca brilliantly noted to @karaswisher "slow" (no software) versus "fast" (with software) sectors. The US says "There are no more jobs!" But should be saying: "There are not enough jobs!"
4/ China is focused on economic transition: from exports, forced industry investments, and low-skilled manufacturing, to domestic consumption and "fast sector" production through talent, finance, market conditions, and government support. (cc Schumpeter's Development Theory.)
5/ China's "Made in China 2025":
1. Upgrade industry.
2. Utilize Private Markets: Strengthen IP and position in global markets.
3. Focus on advanced Information Tech (like AI, VR, AV), aerospace, maritime, energy, power, agriculture, materials, and biopharma.
6/ For many in Silicon Valley, "Made in China 2025" is promising. China understands the vision of innovation. The corollary to vision is execution. Are China's prevailing system and institutional framework conducive to innovation?

The answer is more no than an emphatic yes.
7/ Many abstracted from @mattturck AI report—where he noted China AI is "playing at a different level" with financing and data collecting—as China having a "nation edge" with Frontier Tech. State-sponsored capitalism as a catalyst innovation has been mythologized.
8/ Much like "Made in China 2025," China once aimed to be a leader in semiconductor, hardware, and software in the 1980s. However, China is still dependent on IP import and manufacturing export. It's years behind R&D input from Japan and South Korea. Why?
9/ State Control enable market efficiency, but tradeoffs with innovation. China's success in applying software to consumer-driven models is representative of Schumpeter's latecomer advantage in a globalized world. This should not be mistaken for vertical progress.
10/ The logic of state control inherently fosters a culture of top-down optimization, which inhibits bottom-up innovation and serendipity. This creates "arbitrage entrepreneurs," not breakthrough ones. Creating the Chinese Google (Baidu) is not akin to creating the next Google.
11/ China is more capitalist than communist. This does not mean China isn't pervasively authoritarian. Bureaucracy is entrenched in social life, education, and the private sector. China's culture of harmony:

Conform. Not Confront.

When does disruptive innovation conform?
12/ Crypto as the next techno-economic paradigm illustrates the antagonism between Conform vs. Confront.

@katherineykwu recently broke the news of Chinese censorship a vaccination scandal on Ethereum. If new tech produces disharmony, censored. No funding can change this.
13/ Why is China's M&A always hot? China's innovation has been a result of acquisitions. In the 1980s, China M&A'd to enable energy and natural resources. Today, China M&A's for high-tech and brands.

Homogenization creates interdependence, not independence.

Look at #BAT.
14/ China's acquisition dependency won't drive Chinese hegemony in Frontier Tech. With "Made in China 2025," the reality is all breakthrough tech go through long, high beta cycles (cc Carlota Perez).

Cycles invite macro discussion: can China endure for tech cycles to play out?
15/ China's recent claim to open competition and foreign investment show the macro and structure concerns are now more explicit. China has reverted to slow sectors for growth and is a credit economy to boost confidence. China requires CPC influence in all companies in China.
16/ @sama astutely noted: "you can't day trade startups" when discussing private tech markets with @roelofbotha in the US. Given the serious structural issues put forth and further macro consideration, can this be applied to China?
17/ All companies must be harmonious with China. CPC communist representation is required in all companies (especially foreign companies like Google).

E.g., a startup need to downsize to innovate, but this weakens Chinese-set productivity targets, will China let them?
18/ Many highlights China's rising wages, inflation, and low household debt for optimism. Consumers will surpass US retail by 2020! Domestic consumption accounts for 62% of China GDP. This not only skirts structural inquiries but exaggerates outlook on the market opportunity.
19/ There is a distinction between "average" and "median" household incomes. Wealth is concentrated in the CPC, and there is a wealth gap in China. "Averages always lie"- @mattcohler 's view on startups applies here. Excessive leverage also drives the "great" market opportunity.
20/ While Chinese GDP has grown 12x, it's financial leverage has increased 40x. China's GDP-to-total-debt ratio has grown 4x. China's excessive leverage is carcinogenic and only gets worse.

State Control cannot sustainably address this debt.
21/ State Controls cannot at all fix the demographic cliff. Their one-child policy will impair labor productivity in China, but also enhance financial fragility as the population ages, pension costs rise, which mean less capital flexibility than China has enjoyed.
22/China needs to stabilize and increase direct financing. The reality is excessive leverage, the demographic cliff, and air pollution. Liquidity declines to levels China is unfamiliar. Credit diverts from productivity.

The point:

China can run. It cannot hide.
23/ The absolute size and delta to China's credit are terrifying; its concentrated on the balance sheets of corporate sectors. Given these facts and the lack of optionality, China will, not if, share an outcome like Greece (government debt) or the US (housing market debt).
24/ @wolfejosh and @rabois have noted Chinese opacity in accounting. In an environment of centralized power, homogeneity, excessive debt, leverage dependence and political monoculture, the consequences of opacity exacerbate. Can China's use of leverage be worse?
25/ China has not sustained a significant crisis since 1989.

The next crisis is not if, but when.

China has a classic Innovator's Dilemma. What's worked in the past will not work for the future. It needs to cannibalize its strategy and transition.

Can it afford to? Will it?
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