Hello, and welcome to another episode of the Odd Lots Podcast. I'm Joel and I'm Tracy Alloway. So, Tracy, I think, um, you know, we're obviously in the midst of this ongoing trade dispute between US and China. Lots of big questions about what's going to happen there. We talked with Brad Setser a few weeks ago about this topic, but it's such a big topic. I feel like there's a lot more to cover. Yeah, I I totally agree with you.
I remember when we spoke to Brad, there was one section in particular of US China trade relations that you were quite interested in, which was the intellectual property proportion. And the US is always accusing China of trying to steal its technological expertise or it's intellectual property. Meanwhile, China is always saying that it's trying to cultivate its own
home grown expertise. Yeah, and I think that this trade dispute is probably one of the first times that the American public, to the extent that the American public is paying attention to trade disputes, is really learning about the full extent of China's ambitions to be a real global leader in many high tech industries, and that there is a very extensive plan in place to really get ahead
from at least where they are right now. Well, I guess, to be fair, you wouldn't expect much else from a centrally planned economy, right, I mean, people talk about China liberalizing, but at its heart it's still very much a sort of command economy with a huge degree of power coming from the ruling class. I guess, yeah, And I think that's exactly right. And of course there're gonna be a lot of people who question whether a centrally planned economy
really can be an innovative leader. I think in technologies we often sort of I think we sort of associate innovation with free market capitalism quite a bit, and China is perhaps trying to show that there is another model for how you can get there, well, not just free
market capitalism. You think of technological innovation, you think sort of the Silicon Valley model, right, A bunch of guys sort of sat in a garage somewhere coming up with brilliant ideas, and because of the way our economy is structured, they're allowed to act on those ideas and eventually build successful businesses. So it's almost a cultural difference. I guess yeah.
I think that's well put. So anyway, today we're going to be talking to someone who is actually one of the first people to introduce me to this idea, and so I'm very excited to talk to him. He's Dan Wong. He is a analyst at gav quel Dragon Omics. He's a technology analyst based in Hong Kong there and he has been following China's ambitions to really grow its own homegrown technology sector for a while and he joined us. Now, hey, damn, thanks for joining us. Hey guys, thanks for having me on.
So let's start with the big picture. What is the Made in China initiatives? Sure thing so Made in China is a comprehensive industrial upgrading plan that the government unfailed three years ago. Its targets about twenty different technologies for broad technological leadership. These include things like semiconductors, telecom equipment, robotics, electric vehicles, medical devices and pharmaceuticals, aviation equipment, and a
whole bunch of other things. To make it happen, that the Chinese government is offering an enormous amount of credit, subsidies and policy support to make it all work. So, just to be clear, we think of a lot of high tech manufacturing already happening in China. US tech giants like Apple obviously work with big Chinese tech companies to
assemble their iPhones. But I guess the idea is that a lot of that is sort of still pretty low on the value chain labor type stuff, and that the real innovative stuff on things like semiconductors that you mentioned, that's still not really happening in China. Yeah, that's right. So basically, the further downstream you go, the more that China looks pretty innovative. So Chinese companies have become pretty good at making consumer goods and offering fun our retail experiences.
China is also the only country aside from the US to have built big internet companies, namely ten Cent and Ali Baba. I used to work in Silicon Valley, and the level of dynamism I observed in the tech scenes of Beijing and Shinjen our justice and pressive as what I saw when I worked in California. But basically, if you look a little bit more upstream at what the at the more upstream segments of China's technology foundations, it's
really quite weak. So China is pretty heavily dependent on other countries for semiconductors, airplanes, machinery goods, and many other things. So I'm glad you brought up the iPhone. So the full value of an iPhone is booked as a Chinese export, but only about ten percent of the value added was actually generated in China. So that means it's the value of the labor used in assembling the phone and a few of the components. But the most important technologies are
not actually Chinese. The processor for the phone is coming from Taiwan, the memory chips are coming from Korea, the screen from Korea, and so on. So China would be much happier if the value added generated in the country actually approaches little closer to the full value of the
iPhone export. And so I think that's a good way of seeing what is about So jan why are they focused on these particular technologies, because I guess the law of comparative advantage in economics would suggest that they should keep doing what they've been doing, what they're good at um and instead they're they're clearly trying to branch out into things that they haven't done before, So why is that sure? So I think there are three big reasons
that China is trying to do made in China. First of all, the GDP per capita is now close to about ten thousand dollars and at that level it's close
to middle income status defined by the World Bank. And the World Bank has also come up with this concept called the middle income trap, which is a fairly common term that you can see in the domestic media, and the middle income trap in the original World Bank formulation outlines the problem in industrializing country faces when it gets squeezed tween poorer countries which have cheap labor and richer
countries which have advanced technologies. So only a small handful of countries have managed to pull out of the middle income trap, and China is really obsessed with leaving it. Japan, South Korea, and Taiwan each managed to escape the middle income trap by climbing various technological pinnacles, almost always with the help of the state, and is the Chinese government's plan to climb a bunch of related or different technological pinnacles. So that's one reason that China wants to do this.
A second element is there's this bit of economic security and its concerns. So a fairly salient data point that shows how dependent China is on foreign technologies is that every year it imports more semiconductors by value than it does crude oil. Now, some countries go to pretty great lens to secure their supply of oil, and China wants to secure its supply of semiconductors by creating strong domestic companies. And third, there's this national security element to it as well.
When I talk to Chinese, a name keeps coming up Snowden. So the Snowden documents revealed that, you know, the US tech companies have been fairly cozy with the US government. Uh, And China's importing hundreds of billions of dollars worth of American semiconductors every year, and it doesn't want to be spied on because it has to import these things. It's funny because obviously a big source of anxiety here these days is the fear of being spied on with goods
that the US imports from China or Russia. So interesting that it the anxiety goes in both directions, though, I guess that's just sort of perhaps to be expected. All right, let's talk about the mechanics that the government is actually using to foster this technological leap forward. How does it allocate resources or know how much to invest and say, semiconductors versus medical equipment versus wide body planes. What does
it do specifically and how does it make those decisions? Sure, so it's trying to catch up to the technological frontier, UH, and to do so, I think you need at least three things. One of that is money, another is I P the technology, and the third is this process knowledge or what we can also call tacit knowledge managerial expertise or no. How So, if we look at each of these segments, we can pretty much assume that money is
not going to be a problem. The state is going to be UH is going to provide a lot of credit subsidies to build up these industries. There's a lot of figures we see floating around, some as high as three hundred billion US dollars that the that the government is willing to spend on this and about hundred thirty billion dollars. So that is e R MAR for semiconductors alone, and that's just from the government. There will be private
funds that will invest too. The second element when you look at technology of China trying to acquire I P. I think the best thing to read on this is the U s TRS Section three or one report. It prepares a pretty comprehensive case of all the ways that China tries to obtain technology UH. These include trying to venture requirements for foreign firms, compulsory licensing schemes, administrative demands for technology transfer, strategic overseas investments, and what the U
s TR calls unauthorized cyber intrusions. And finally, in terms of know how, which is the knowledge that exists in people's heads that are hard to write down and actually give as instructions. China has been fairly active in trying to recruit people from overseas to share expertise. A lot of this involves trying to get overseas Chinese to move to China, but they also try to hire foreigners from
all parts of the world. So is it easier or is it better to be able to sort of buy a tech industry like that or create a tech industry like that with this sort of centralized planning versus what we've seen in Western countries where the tech industry sort of grows up in some cases relatively natural, Like what are the differences between those two industries. So I think the big thing to keep in mind is that China is trying to catch up to the technological frontier for
most of these things. There are a few of its technologies which seem to be at the technological frontier, and so these things would include I would say solar panels, telecom equipment, high speed rail, and wind turbines. China seems to be already fairly advanced in all of these before all the rest things like semiconductors, aviation equipment, pharmaceuticals. China is trying to follow a path that another country or
company has already plazed. So in terms of trying to just basically reach what the what the what the technological front here is today, I think that's that that that is kind of a almost a qualitative difference with UH, this sustained innovation that we see UH in in the US of just incrementally pushing that technological frontier forward. I'm
so curious about the specifics of the resource allocation. So you mentioned a hundred and thirty billion dollars to invest in UH semiconductor development, But who gets the money other startups that apply for grants? Are there existing state owned companies that then launched semiconductor units, how do they actually go and go about allocating it? And then you know, I assume it goes to multiple companies. Who decides who's leading the way and then gets further allocation, and then
who decides you know, you're not cutting it. This project isn't going anywhere because I think in a lot of people's minds, this is where they see the free market doing a good job of, in theory, figuring out the winners and losers and allocating more to the winners. So how does China solve that problem? So pretty much this is um pretty much entirely decided by the state. So
China has a bunch of money available. Some of it it will allocate to some of the existing semiconductor foundries fabs that have already been around, and then some of
it will go towards just totally fresh efforts. So, for example, China basically has not done UH, does not have much of a position in making memory chips at all, and so the government basically decided to put something like UH thirty to forty billion dollars between these UH four different semiconductor fabs in Central China, So these were fresh efforts. The process of which city would get a memory fab
was not entirely transparent. They're dispersed across a couple of big cities in central China, and they were they were given this money from the central government, from the from the local government, from the provincial government, and also from other state owned companies. So these things are not super transparent, and it's probably correct to suspect that a lot of this is driven by political connections. And that's just in
the case of semiconductors. So if in seven years time we wake up and China has built a world class semiconductor industry, is that going to discredit the sort of western um pre economy way of doing things. Does that suggest that maybe the Chinese model is correct. I'm not sure that it does. I think that if China manages to catch up, basically, UH, this be another case of
there is some success of protectionism. Basically, if you look at every country that has industrialized after Britain, did the US, Germany, Meiji, Japan,
uh and UH. More recently, the East Asian countries. They each built their industries with some level of teriff protections, teriff protections, some level of government support, some level of trying to acquire technologies from overseas and plowing state subsidies, especially in more recent times, plowing state subsidies into trying to build to try to catch up to the technological front here. And that's pretty much what China is doing. China has taken a look at basically the memory industry
is pretty interesting. Actually, uh memory was in d RAM was invented by this small American company named Intel. The US got pretty good at making d RAM. Japan took a look at memory, thought that it could do it as well, built up its memory industry, turned out to be pretty successful, mostly drove US players out of business. And then the Koreans did pretty much exactly the same things to Japan, and Taiwan also tried to do this
to Korea. So at least in memory chips, at least we see that there is this progression of leadership helped by different countries. Right now, it's been Korea has continued to be the leader in making memory chips, and China is trying to unseat to Korea as Korea and seated Japan. Yeah. I wanted to follow up a little further and push the question about the U S model. You mentioned you
used to work in Silicon Valley. Is there a myth that we have about Silicon Valley that's incorrect where we imagine all these people toiling away and their garages, raising money from friends and family and then building the next Hewlett Packard or Intel, We're Google, and that we end up downplaying the all that federal subsidies and federal industrial planning or military planning played in the fostering of U S technology. I think that's a great question, and to
some extent, Silicon Valley itself downplaced this story. I think, UH, semiconductors were initially bootstrapped by a lot of government spending, including for for the space program and also for the military. So Silicon Valley, you know, silicon is in the name, comes from semiconductors, and that was significantly bootstrapped by federal
funding UH and UH federal subsidies. UM, if we wanted to think about, you know, what is the opposite model of innovation UH from from Silicon Valley, I would say something like what we see in Germany Germany has basically a pretty strong culture of engineering that it's kept through
many decades, arguably many centuries. And I was in Germany for a research trip a couple of weeks ago and listening to some of them explained basically, the German model of innovation is that they've built these systems of quality improvement to incrementally improve their technologies. UH. They have these systems of corporate encouragement, of vocational training, bridge between academia and companies. UH, this very strong sense that older people
have to transfer their knowledge to the younger people. That is kind of what we see the opposite of what we see in Silicon Valley. Both of these places I think are fairly innovative, but in different ways. So should the world be at all concerned over China's plans? Here? Over the plans, is there any reason to worry if if they're essentially just pursuing protectionist measures that other countries at one time or another seemed to do themselves, I think there is a pretty good reason and to worry.
So Chinese industrial policy has created a lot of overcapacity, for example in UH, in sectors like steel and solar panels, over capacity crushes everyone's profits, so that might reduce aggregate R and D spending and thereby slowing overall innovation around the world. And I think if we take a look a little bit more closely at the experience of high speed rail companies, that's also another cause for concern. So UM.
When China was trying to build its high speed rail network, there were four companies that were around to basically supply it for high speed rail. It was Seamens of Germany, Kawasaki Heavy Industries of Japan, Bombardier of Canada, and Austam of France. UH. They brought their technologies to China, and China basically was in a pretty strong negotiating position at
the time. There weren't that many other countries building high speed rail systems, and so ch ask these companies to transfer their technologies as a condition for accessing the Chinese market, and these four companies basically decided that they had to agree to transfer these technologies to domestic joint venture partners. The domestic joint venture partners digested their technology uh the Chinese term for for absorbing foreign technologies, and then they
out computed these companies in the Chinese domestic market. So these foreign firms gave their technologies to um Chinese firms. Uh, they first lost the China market, and then they had to compete with Chinese companies in the global market. So that's another cautionary tale that makes people nervous about the success of And then there is this other aspect that the US is concerned about. China's doesn't allow much reciprocity.
So China can invest in important companies of other countries, but it doesn't allow foreign companies to really invest in important domestic projects. It's a fairly protectionist place, and it's not a level playing field. You mentioned the overcapacity issue.
The flip side is that for many of the things that China is building, there could be tremendous benefit to the consumers of those good So one area that comes to mind in recent years is the incredible collapse we've seen in the cost of solar panels all around the world. The estimate for when solar would reach price parity with other energy technologies have all proven to be way too pessimistic, and solar prices continue to plunge much faster than people expect.
And that's a theoretically benefit too many people around the world. And uh sort of Chinese industrial policy has played a big role in that. Yeah, I think that's a pretty good example. If solar panels are really good for the environment, then this could be something that people can be glad about. And I think it's also possible that can be good for the world more broadly because downstream businesses can benefit a little bit. So capital goods industries tend to be
pretty consolidated. If you want to buy memory chips, basically you only have three companies making d ram It's Samsun, SKA, high Nes, Micron, and that's it. So I've spoken to a smart phonemaker who told me that, you know, if the Chinese government is willing to spend billions and subsidies to lift Samsung's thumb from his business, uh, they're not going to complain about that. UM aviation is famously a duopoly between Boeing and Airbus, and many of these capital
goods industries tend to be pretty consolidated. So if Chinese competition comes in and UH introduces a little bit more competition, Uh, that could be good for downstream users of these technologies. I'm curious, so looking at the list of different industries We've talked a lot about semi conductors, but there's obviously
others include a wide body aircraft, advanced medical devices. Is there anything that you've seen so far in how the different industries or the different technologies have progressed that suggests that some of this is working better than others, or that this particular Chinese model of technological innovation might work really well in some areas, but it has more obvious limitations in the development of other areas. Sure, that's a
great question. UM so China has already succeeded in reaching the technological front here in a few industries UH and I cited solar panels, telecom equipment, high speed rail, and wind turbans. And I think a couple of the things that unite UH these together is one is UH the UM nature of the buyers. So for basically all of these midstream products, government is an important procure of these
UH different technology segments. And if government is a big procure, you can basically have UM provinces competing amongst themselves to get the best telecom equipment or solar panel offering from from these different companies, and then UH, basically these companies can get pretty good at making these technologies because there's a lot of government procurement of their products. Another is that these usually tend to have fairly long product cycles.
So the longer the product cycle, the easier it is for Chinese firms to catch up to the frontier before it moves away again. So that's another characteristic of these different technologies. And China has had much less success trying to build through industrial policy more downstream goods, so things like automobiles is something that the leadership concedes has been a fairly big earlier in terms of trying to build homegrown companies that are making really excellent cars that are
exportable as well. So the nature of the buyers, the product cycle, these are all factors that play into how successful industrial policy can be. Dan, that was a fascinating conversation. I feel like this is a going to be well obviously a huge story for the years ahead, and regardless of what happens with the trade talks right now, it just seems inevitable that there's going to be so much more interest in the progression of China on these various
technological fronts in the years ahead. So thank you very much for joining well, thank you back. Thanks for having me on, Tracy. I really like that conversation, and why I liked it so much is the degree of specificity that Dan brought to the table in terms of this stuff. I mean, I think we sort of lots of people maybe understand the sort of real broad strokes here about China trying to acquire its own technology and the complaints that other countries have about how they're forced to hand
over technology in order to compete in the market. But it's interesting to get in the weeds and learn about the specifics of how each industry operates in where they are. Yes, we know all about China's ambitious plans for advanced medical equipment. Now I feel good about that. I think you're right. It's an important conversation. It also throws up a lot of ideological questions around different economic models and also how
they develop, which I find really fascinating. And you know, the notion that China is being criticized for doing something now that a lot of developed economies had done a hundred years ago or so. It's not really new, but you can see it's sort of an ongoing tension in the world economy. Yeah, and it is also a good reminder that, yeah, as you say, it's not really new. Every country has had its own model that is some combination of markets and private enterprise plus state directed R
and D and subsidies. So there is a fair amount of double standard I think in this idea that suddenly China is doing something really terrible or really really flouting the rules of development. Yeah, that's right. But one other good thing about this conversation is it's only seven years until, which is kind of fascinating. So I guess we'll get to see the results of China's initiative here relatively soon.
I'm sure we'll still be doing odd lots in yeah, seven years from now, and so let's schedule one for seven years from now, and then we will will grade them on how they did in each category. All right, I'm putting it in my diary right now, Joe. Okay, this has been another edition of the Odd Thoughts podcast. I'm Tracy Allowaite. You can follow me on Twitter at Tracy Allowhite, and I'm Joe wisn'hal. You can follow me on Twitter at the Stalwart, and you could follow Dan
on Twitter at Dan w Wong. And you should follow our producer top foreheads at for Hest, as well as the bloomberg head of podcast, Francesca Levy at Francesca Today. Thanks for listening.