Thread by @RnaudBertrand

This is one of the best talks I've heard in a while on China's economy, by Eric Li, a famous Chinese VC and political scientist.


I summarize the main points in a short 🧵

First of all, he argues there was a fundamental misunderstanding of China by the US. The US convinced itself China would stay in the "peripheral" forever 👇 whilst China's objective was always to move up and be part of the "core".

This is how he describes the "first phase of China's globalization", with the "3 pillars" of its market economy being real estate, consumer internet and industrial capacity & global supply chain (on top of infrastructure building handled by the state).

However by 2020 these 3 pillars had "run out of steam" and created a bunch of problems in the Chinese economy. For instance some of the consumer internet firms had become monopolies or monopsonies (only one buyer), and the pillars didn't stimulate actual technological innovation.

This led to the Chinese economy not "improving on productivity, just growing in size", since approximately 2010.

As a result China needs to find new pillars. So far it had stayed at the bottom of the "smile curve", focusing on manufacturing/assembling/distribution, growing in size there, but to keep developing it needs to move upper left: more R&D & design, and capturing more value add.

Eric Li argues that this plan to move upper left the smile curve "is the primary driver of this looming, existential struggle between the US and China, because the United States cannot tolerate this movement".

Why? Because China capturing more value-add (China currently captures 12% and sees the upside potential at 30-40%) means they'll take it from the US & its allies' companies.

He gives the example of the iPhone: in 2009 China was capturing 3.6%, by 2018 it had increased to 25.4%.

So China needs to gain 20-30% in value add (moving from from 12 to 30-40%) and - this blew my mind - he reckons "8 or 9% of this [nearly half] is semiconductors"

In fact today China imports in value more chips than it does crude oil and iron ore (to make steel) combined!

This goes a long way to explain why chips are so essential to preventing China from moving upper left on the smile curve. From a US standpoint, if you prevent China from becoming a major chips player, it already prevents half their journey to capturing their value add potential!

All in all, he describes the shift to a new economic model as "a wholesale structural change" and "a shock therapy". Especially since "market forces could not be relied upon to engineer this transition" so the gvt had to initiate "a top down supply-side restructuring" themselves.

He says this restructuring by the gvt is "by necessity extremely painful, to redirect capital away from the old pillars to the new pillars. It leads to a lot of losers and the winners are not here yet. So we're in this vacuum which will continue for a couple of years at least."

This is an extremely good point. He said that "when Adam Smith talked about economics, it was political economy. And at some point along the way, the 'political' got dropped, it's now only economics. Why? I'm guessing because the winners already did their politics."

The argument there is of course that the West, through politics (and war, politics by other means), put themselves at an economic advantage and everyone else at a disadvantage.

So, Eric Li argues, "they're saying 'don't do politics, just do economics', stay in the peripheral".

China, who don't want to stay in the peripheral, therefore need to be doing political economy - this top down restructuring and moving upper-left the smile curve - and "the powers that be hate it, they want to stop it."

He concludes by looking at the future of globalization. He differentiate between "small yard countries" ("the British empire and its 4 grandsons", Western Europe and Japan), that is currently trying to protect itself with a "high fence", and the global South.

He notes that whilst the global South accounts for 40% of global GDP (to "small yard" countries' 50%), it generates 60% of the world's economic growth.

As a result he says the key question wrt globalization is: "Can China drive a new round of globalization outside the fence?"

This would result in what he calls "small yard, big world".

The end!

Watch the whole video here: