China Shock 2.0: State Capitalism at the Frontier | Dinny McMahon

In Episode 451 https://hiddenforces.io/podcasts/china-shock-2-0-state-capitalism-at-the-frontier-dinny-mcmahon of Hidden Forces, Demetri Kofinas speaks with author and long-time China analyst Dinny McMahon about the Chinese leadership's efforts to redesign China's economic model in the face of structural headwinds to growth, mounting trade barriers, and growing concerns in Western capitals about Chinese economic and military domination. The first hour is spent exploring why McMahon believes that China is at a transformational moment. He details the kind of economy that Beijing intends to build by 2035 and the internal debate over whether China should rebalance toward household consumption through welfare and redistribution or double down on its investment-driven growth model as the primary mechanism for raising household living standards. The second hour is devoted to understanding China's evolving industrial strategy that Dinny describes as a potential "China Shock 2.0" driven by legacy industry upgrading, innovation at the technological frontier in sectors like batteries and electric vehicles, flying cars, and humanoid robots, and import substitution in areas like machine tools and semiconductors all while pushing intermediate manufacturing offshore to circumvent Western trade barriers. McMahon lays out his best and worst case scenarios, as well as what China's economy is most likely to look like by the middle of the next decade; he and Demetri examine the risks of further deindustrialization and strategic dependency by the United States and Europe on Chinese manufacturing; and discuss how all of this collides with global climate goals, the energy transition, and a world in which China's state-driven capitalist model is increasingly setting the pace for innovation, growth, and material abundance. Subscribe to our premium content—including our premium feed, episode transcripts, and Intelligence Reports—by visiting HiddenForces.io/subscribe https://hiddenforces.io/subscribe. If you'd like to join the conversation and become a member of the Hidden Forces Genius community—with benefits like Q&A calls with guests, exclusive research and analysis, in-person events, and dinners—you can also sign up on our subscriber page at HiddenForces.io/subscribe https://hiddenforces.io/subscribe. If you enjoyed today's episode of Hidden Forces, please support the show by: Subscribing on Apple Podcasts https://podcasts.apple.com/us/podcast/hidden-forces/id1205359334, YouTube https://www.youtube.com/channel/UC8URhgYos5fjHqFSO4RSIEg, Spotify https://open.spotify.com/show/0TK6u251zGSlMgJKH6cOaP, Stitcher https://www.stitcher.com/podcast/demetri-kofinas/hidden-forces, SoundCloud https://soundcloud.com/hiddenforces, CastBox https://castbox.fm/channel/2629539, or via our RSS Feed http://hiddenforces.libsyn.com/rss Writing us a review on Apple Podcasts https://podcasts.apple.com/us/podcast/hidden-forces/id1205359334 & Spotify https://open.spotify.com/show/0TK6u251zGSlMgJKH6cOaP Joining our mailing list at https://hiddenforces.io/newsletter/ Producer & Host: Demetri Kofinas Editor & Engineer: Stylianos Nicolaou Subscribe and support the podcast at https://hiddenforces.io https://hiddenforces.io/. Join the conversation on Facebook https://www.facebook.com/hiddenforcespod/, Instagram https://www.instagram.com/hiddenforcespod/, and Twitter https://twitter.com/hiddenforcespod at @hiddenforcespod Follow Demetri on Twitter at @Kofinas https://twitter.com/kofinas Episode Recorded on 11/24/2025

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:00Demetri Kofinas?

  What's up everybody? My name is Demetri Kofinas and you're listening to Hidden Forces, a podcast that inspires investors, entrepreneurs, and everyday citizens to challenge consensus narratives and learn how to think critically about the systems of power shaping our world. My guest in this episode of Hidden Forces is Denny McMahon. Denny is a longtime China analyst and a former Wall Street Journal reporter based out of Beijing. He's the author of China's Great Wall of Debt and co-author of a recently published nearly 200-page report that examines the deliberate efforts underway by China's leadership to redesign the country's economic model in the face of structural headwinds to growth

• 0:43Demetri Kofinas?

  and a reluctance on the part of developed economies to absorb Chinese exports. We spend the first hour of our conversation exploring why Denny and his co-author believe that China is at a transformational moment. We discuss in detail the kind of economy that Beijing intends to build by 2035 and the internal debate over whether China should rebalance toward household consumption via welfare and redistribution, or double down on its investment-driven growth model as the primary mechanism through which to raise household living standards. The second hour is devoted to understanding China's evolving industrial strategy that Denny describes as a potential China Shock 2.0, driven by legacy industry upgrading,

• 1:24Demetri Kofinas?

  innovation at the technological frontier in sectors like batteries and electric vehicles, flying cars, humanoid robots, AI, and quantum computing, and import substitution in areas like machine tools and semiconductors, all while pushing intermediate manufacturing offshore to circumvent Western trade barriers. We lay out best and worst-case scenarios, as well as what China's economy is most likely to look like by the middle of the next decade. We examine the risks of further deindustrialization and an ongoing strategic dependency by the United States and Europe on Chinese manufacturing, and discuss how all of this collides with global climate goals, the energy transition, and a world in which China's state-driven

• 2:06Demetri Kofinas?

  capitalist model is increasingly setting the pace for innovation, growth, and material abundance. If you want access to all of this conversation, go to hiddenforces.io/subscribe and join our premium feed, which you can listen to on your mobile device using your favorite podcast app, just like you're listening to this episode right now. If you want to join in on the conversation and become a member of the Hidden Forces Genius Community, which includes Q and A calls with guests, discounted access to third-party research and analysis, and in-person events like our intimate dinners and weekend retreats, you can also do that on our subscriber page.

• 2:46Demetri Kofinas?

  And if you still have questions, feel free to send an email to [email protected] and I or someone from our team will get right back to you. And with that, please enjoy this extraordinarily comprehensive and in-depth conversation with my guest, Denny McMahon. Denny McMahon, welcome to Hidden Forces.

• 3:12Speaker 01

  Hi, Dimitri. It's great to see you.

• 3:15Demetri Kofinas?

  No relation to Vincent McMahon, right?

• 3:17Speaker 01

  Not that we know of. I mean, maybe if we go back and back and back, but no, that's not a link.

• 3:23Demetri Kofinas?

  No, whatever makes that connection, they don't say Sinologist, maybe also WWE, WWF, nothing like that, no.

• 3:30Speaker 01

  Sadly not.

• 3:31Demetri Kofinas?

  So it's great to have you back on, man. You were first on my podcast some years ago before the pandemic, when we had our New York City studio open, so we had a chance to sit down in person for a recording when you published China's Great Wall of Debt. I think also Anne Stevenson Yang was the one that introduced us, who's also been on the show many times. And then you were on subsequently once with Diane Shoylava, right? Diana Shoylava, for a conversation about, what was that about? You guys had written a paper together about China's, their strategy for displacing the dollar long-term. What was that whole thing about, the Chinese Belt and Road?

• 4:07Speaker 01

  Mainly about renminbi internationalization, how they were trying to actually pursue it.

• 4:12Demetri Kofinas?

  Yeah, so you're, I would introduce you to our audience as someone that has dug into the Chinese economic and financial model pretty vigorously over the course of your career. Just give us a quick, quick, quick background, because if people want a more in-depth background, they can go back to your first appearance on the show. But just quickly, who are you? How did you get into the work that you do today? And how would you characterize what it is that you do?

• 4:36Speaker 01

  Well, I started off as a financial journalist in China, so that started back in 20 years ago now. So, you know, a stint with Dow Jones News wires and six years with the Wall Street Journal in Beijing, covering China's banks and financial system. And then from there, moved to DC for a couple of years where I wrote that book that you just mentioned, China's Great Wall of Debt. And then for the next few years, I was working at Macro Polo, which was the think tank that Hank Paulson set up, just trying to look at the things that I thought I may have missed in the book. I mean, what did I get wrong? What had kind of moved on? And for the last few years, I've been working for an outfit called Trivium, where we do, we sort of look at China policy and work out how that's affecting the macro economy. So, yeah, look, I mean, I guess I'm a China watcher in one sense,

• 5:21Speaker 01

  but my focus has always been on the economy and more specifically on the financial system. And yeah, I've been at it for a while now.

• 5:28Demetri Kofinas?

  So you've gone from writing books, which are roughly 300 to 400 pages, to writing papers now that are like 200 pages long. So you sent me a paper to read. I thought it was a paper, but it's a quasi-book, a nearly 200-page report that you published through the Center for Strategic and International Studies with your co-author Andrew Polk, titled China in Transition: Debt, Demography, Deglobalization and Scenarios for 2035. And in the report, you write that China's economy is at a transformational moment and that one of the great questions of our time is how it will emerge from this period of transformation. So obviously, I want to understand why you feel that way and what it even means to be at a transformational moment, because we've heard this a few times, I would say, at least in the past decade,

• 6:12Demetri Kofinas?

  maybe even since the Great Financial Crisis. But let's just start with establishing what the prevailing economic paradigm in China has been and how long it's operated this way.

• 6:23Speaker 01

  So the paradigm that China's sort of in at the moment, I mean, the best way to think of it is the old economic order broke in 2001 when the property market peaked. Now, that's not new. I mean, generally speaking, everyone kind of has a sense that, you know, property had driven the economy for at least a decade, probably two, since the late 90s.

• 6:46Speaker 01

  Last few years, we've just kind of seen the economy gradually weaken and all those sort of drivers of growth that, you know, there's not as much demand for the steel and cement and aluminum and glass. And, you know, we've seen household demand weaken. So clearly there's been a fundamental shift in the way the economy works over the last few years. But when we're talking transformation and why Beijing in particular thinks that we're very much at a pivotal point, that it kind of needs something different, kind of move on from the previous regime. It's more than just the basic economic model. And that's because in addition to property no longer driving growth the way it used to, there's a bunch of societal changes that absolutely unavoidable. And one of the big ones is really population.

• 7:29Speaker 01

  Now, again, this is something that people have been seeing coming down the turnpike for years and years. I mean, when I first started off as a journalist 20 years ago, even then you had the expression that China ran the risk of growing old before it grew rich. You know, the fallout of the one China policy was at some point the population would start shrinking. And the moment that happened, then all of China's aspirations of sort of converging in terms of lifestyle, in terms of affluence with the EU and the United States would just become materially more difficult. And so when we're talking about being at a transitional point, that sort of problem that we've seen coming for decades, I mean, that's now upon us. I mean, China's working age population started shrinking in 2012, but the total size of the population started shrinking in 20, it peaked in 2022.

• 8:13Speaker 01

  So there's sort of that element to it. And there's also that the other thing that sort of the other reason Beijing sees itself as being at a pivotal moment when it comes to the economy is the middle income trap. Now, you know, the middle income trap being this idea that World Bank economists developed a while, probably a couple of decades ago now. The idea that developing economies can kind of get to a certain level of income readily, easily by just investing in property, in, in factories and low in manufacturing and you can kind of get incomes up to a certain level. But you get to a certain point where just relying on low cost manufacturing just doesn't work anymore. You kind of need to fundamentally change.

• 8:56Speaker 01

  Change the way the economy works in order to keep driving up salaries and household incomes. And as far as Beijing's concerned, we are at that moment. So if you look at the World Bank's measures for at what point a country goes from being middle income to sort of being a rich nation, it's about thirteen thousand, fourteen, I think it's a bit shy of fourteen thousand dollars this year per capita income. And China's per capita GDP is just a little bit below that. So in a year or two, it will officially, by World Bank's standards, no longer be a middle income nation. It'll be a rich nation. And so Beijing is overtly aware that in terms of that moment, which an economy needs to fundamentally change its structure,

• 9:36Speaker 01

  the way it generates wealth and growth, that moment where it needs to change is upon us. And so you put all that together, you've got this unavoidable population shift, this recognition, that sort of staring down the barrel of the middle income trap, as well as having well and truly hit the expiry date of the previous growth model. You put all that together, and as far as China's powers that be concerned, we are very well and truly at a pivotal transitional moment for the economy.

• 10:03Demetri Kofinas?

  So why does your report focus on what China might look like in twenty thirty five? And is that a date that Beijing has anchored its long-term planning to?

• 10:12Speaker 01

  You know, there was a couple of reasons for that. As much as anything, it was a tool for us to kind of project forward the reforms we're seeing at the moment and try and work out what they're trying to achieve with it. Because the way that the political class works in Beijing, in China, is that there is almost a constant torrent of new policies all the time. And of course, what we've seen over the last couple of years is sort of the focus of that has changed a little bit. But you can kind of get sucked up in in all the noise and not see the signal, right? If you're just looking day in, day out, at everything that's coming out of the fire hose, it's kind of difficult to recognize big picture, what all these things are supposed to do when they come together.

• 10:53Speaker 01

  And by kind of going, okay, twenty thirty five, ten years, when we kind of play out these reforms that they're pushing forward and these changes to the system, how do they start converging when they start working? On one level, that's what we were trying to achieve. It's like, look, if we just kind of get beyond ourselves a little bit and see where the sort of the this stuff is leading to. What is China going to look like? Or ideally, what does Beijing want China to look like in 10 years' time? So that was certainly one element of it, but also 2035 because, well, there's two things. Of course, China works on a five-year plan basis. So it's kind of reasonable to go, okay, one year, five-year plan's 2030, another beyond that.

• 11:33Speaker 01

  Also, Xi Jinping himself back in 2021 set this rough target that China's GDP per capita would double between 2020 and 2035. So we're like, okay, so that's kind of a real target that they've sort of baked into the system. What's it going to look like? And then the last one, kind of related to that as well, when they started talking about common prosperity in 2021 as well. The big target is more towards 2049, 2050, they're going to properly achieve it. But 2035 was kind of a midway target as well, where they were going to more or less have put in place the basic mechanisms of common prosperity. So yeah, it is a number that's come up a few times in sort of the political dialogue.

• 12:15Demetri Kofinas?

  When did China surpass the United States in a purchasing power parity basis?

• 12:19Speaker 01

  You know, Dimitri, I've never actually kept track of that because, you know, it's sort of, I mean, it's.

• 12:27Demetri Kofinas?

  We're talking about an enormous amount of growth. I just, I want listeners to really understand that. Because it has enormous implications for the rest of this conversation and the type of growth model that China decides to follow. And where that growth comes from and what that means for the rest of the world, because China is such a dominant portion of global exports. Before we get into all those details, because we're going to dig into it deeply, I'm curious to ask you where you think Western commentary still gets the picture fundamentally wrong about China? Because I remember, and we probably talked about this when we first came on the show. I remember Hugh Henry and Jim Chanos posting pictures of themselves walking around ghost cities in China.

• 13:10Demetri Kofinas?

  And that seemed like the most obviously horrible thing, right? Like, you're looking at all this wasted concrete and infrastructure that went up in all this land that could have otherwise perhaps been arable for a population that is a global importer of foodstuffs. So like, what is it that you would say we still get fundamentally wrong that makes it difficult to understand China's economy from a Western lens?

• 13:35Speaker 01

  Okay, there's a few ways to come at this, but I think probably the best way is for me kind of deeply personal, right? So when I wrote that book, China's Great Wall of Debt, at the time, looking at China's financial system on a day-to-day basis, I mean, this was the peak of China's shadow banking system. And that time that you were just talking about then, I mean, ghost cities were a real phenomenon. I mean, you could throw a rock in China and effectively hit something that looked like a ghost city. And so when I was writing the book, I'm like, you know, I don't know exactly how this thing is going to end, but it can't end well. I mean, you know, the powers that be have completely lost control of the financial system. I remember talking to a banker at one of the big four Chinese banks. It was like, you know, at the time, the government, the regulators

• 14:19Speaker 01

  were trying to crack down on shadow banking. And I'm like, well, what do you do about that? Because it's a really important business. And it's like, well, look, you know, we have a pretty idea of what those regulations will look like. And we've got three or four different potential permutations that we can roll out within a day or two after the regulations and just keep happily we go along. So you had a system where the banks and even the state-owned financial institutions were kind of willingly working around the regulations, the efforts by the government to sort of rein in risk. And I'm like, this is just a financial crisis waiting to happen. It's inevitable. I don't know when it's going to happen. I don't know the trigger, but God, they can't avoid this. And then kind of as I published the book, they rolled out the, what they ended up calling the deleveraging campaign,

• 15:04Speaker 01

  which was ultimately a de-risking campaign. And, you know, there's a lot of specific, like, wonky technicalities thing about what they did. But the real thing about the de-risking campaign is that prior to rolling that out, the financial system

• 15:19Speaker 01

  Was everybody in the system, they were complying and adhering to the letter of the law, the letter of the regulations as they were being rolled out by the government. But they were completely flouting the spirit of what was being asked of them to do. What happened with the derisking campaign is that got flipped on its head. The specifics of the regulations did not matter anymore. It was the government came down, cracked the whip, effectively imposed or stretched the anti-corruption campaign to the financial system. And so it got flipped on its head. It didn't matter anymore if you were complying with the letter of the rules. What mattered was whether you were complying with the spirit of what was being asked of you. And the spirit was that the government was doing all it could to rein in financial sector risk.

• 16:04Speaker 01

  Now, the reason I tell that story, and I think this is the thing that we often miss, is we look at the problems in China's system and go, well, I mean, if we draw a line from here to the horizon, it's all going to end in tears. But the thing is about the Chinese political system is that they can pivot on a dime. And they can do it when we don't expect it. And when they change, they have levers and they have management tools over the way they run their economy in ways that we don't have, and they can do that in ways we don't anticipate. So that's kind of the thing that I've sort of learnt over the past 20 years of looking at this thing. You can look at the problems and go, this is a mess. It can only end in one way. And then they are able to surprise you because the system is so fundamentally different.

• 16:49Demetri Kofinas?

  So I'd love to explore that a bit more later in the conversation, Dinny, because I think part of what's also happening, there are so many conversations happening in America today, especially in America, though in Western democracies as well, about the flavour of capitalism under which we operate. And a lot of people are looking at what China is doing and they're looking to draw lessons. I mean, here we are in the US trying to do industrial policy. We are not particularly good at it, or we've lost a lot of the skills associated with being successful at it that we used to have, especially in the post-World War II era. But we're trying to find some new way to operate our economies. And China has a fundamentally different model, and it's not a communist model. I mean, it's a Communist Party, but the model isn't state-controlled communism like it was

• 17:34Demetri Kofinas?

  under the USSR. So I think there'll be an opportunity to explore that more. Let's just talk a little bit more about, actually, before we talk about the old growth model, because I have a couple of questions. Is there a broad consensus among policymakers in China and among members of the Chinese Communist Party that the old model is exhausted? And if so, like, how is that story framed? Like, what is the story that's told internally about the need for change?

• 17:58Speaker 01

  Yeah, that's interesting. No, there is definitely a consensus that it's dead. I mean, and in some ways, that consensus had already been building for years before they sort of took the air out of the property market in 2020 and 2021. I mean, I think the best way to talk about it is how Xi Jinping talks about it himself. He talks all the time now about the need for high-quality development. And that is such a loaded term, because in that expression, when they're talking about the need for high-quality development, implicit is the idea that what came before was not high-quality development. And so that's almost like a moral judgment on the growth that came up till now. Yeah, it served a purpose, we had fast economic growth, but it wasn't high-quality. And what we need now is high-quality growth.

• 18:43Speaker 01

  And this high-quality growth is growth of high productivity growth, it's innovative, it's about advanced manufacturing, it's about the future. And so I think that's kind of how they tell that story, is that, you know, property development, it's served a purpose, but it kind of got a little bit, you know, the investment in both property and infrastructure got a little bit beyond what's kind of reasonable, and now we kind of need a model that sort of better serves the interests of the Chinese public, and that is high-quality.

• 19:13Demetri Kofinas?

  So maybe just one clarifying question about the old model. How did land sales and local government financing vehicles and the property market fit together as a single system that was so central to how China's economy used to grow? Like, what do people need to understand about that old model?

• 19:28Speaker 01

  Well, okay. So one way to think about it is that for years, China has managed to maintain a incredibly low tax haul, right? I mean, tax currently taxed to GDP is about 20% in China. OECD countries is about 33%. And the way that they've been able to do that isn't because the state doesn't spend as much money, it's because they were able to extract so much money from land sales. The way to think about land sales is that because people don't actually own land in China, it's all owned by the state, that the state and the local governments who had control over the land managed to extract a huge amount of wealth from the one-time privatization of a state asset, right? That's effectively what it was.

• 20:13Speaker 01

  When Western governments sell off their, you know, water utility or their telecoms company, this was kind of the equivalent of that, except the local governments were treating it as a renewable resource. Like, you know, when we sell off the telecoms company or the gas company, that's a one-time deal. Everybody knows that this is, you know, we're going to sell it off, get a bit of income, we'll pay down our debt, or we'll use it to invest in something. That was not the mentality of China's local governments, because as far as they were concerned, they could keep selling the land year in, year out. And the way they were behaving is that we'd just be able to do this for time and eternity. So it was almost, they treated it as a renewable source of government revenue.

• 20:55Speaker 01

  And it worked like that for over 20 years because they could sell the land to property developers who would be able to build housing out of it and sell it at ever-increasing prices. And that was partly because when they first liberalized China's housing market in the late 90s, it was such a fundamental shortage of anything that even regard, you know, closely approached quality housing in China's cities. It was all provided by state firms and the government, you know, families. Were effectively living in dormitories with shared kitchens and bathrooms. And so there was this big gap of shortage of decent housing to start with. And then on top of that, you had China's industrialization, which brought people from the countryside to the cities, creating more demand for housing.

• 21:36Speaker 01

  So you did have this real demand for more and more housing and the infrastructure to support it for twenty years. And that created middle-class wealth, but it also created a way for local governments to supplement their revenue stream. Which was, you know, they were being underfunded to start with by the central government, given all the budget responsibilities they had. And so they exploited the fact that there was ever-increasing demand for housing at ever-increasing prices. And they just kept taking more and more land from the farmers and selling it at higher prices and using it to plug their budget shortfall. And then when it all came crashing down at the end, I mean, you know, the revenue from the land sales was mostly being used to service debt.

• 22:20Speaker 01

  Right? It was doing for two purposes. It was being used to service debt and it was being used to plug holes in the budget. So the problem then became, all of a sudden you had holes in the budget. You know, governments didn't have the resources to pay their bus drivers or their schoolteachers or ensure adequate sanitation or whatever. And at the same time, they also had all these debt obligations that they weren't able to meet anymore because they'd been servicing the debt with land sales. And so that's kind of the world we're living in at the moment, where local governments are sort of scrambling around to kind of get their hands on to to sort of square that circle, however that they might.

• 22:57Demetri Kofinas?

  Would it be correct to say that, on average, the burden of that hole in the budget fell on the consumption side of the of the equation? That in other words, it it only made the economy more unbalanced, not less unbalanced?

• 23:13Speaker 01

  I'm not sure it fell purely mostly on consumption because if you look at the ways that the local governments have plugged that hole, partly the central government increased transfers, right? So it's, it could be a lot worse than it is if, if the central government hadn't helped out a little bit. But the way they've done it is partly they have, yeah, it's hit a lot of families because state employees at a local level have been forced to take pay cuts. Some have seen their social security payments withheld or delayed. Some have had, just had their pay sort of postponed, but it hasn't purely fallen on households. The private sector businesses, as much as anything, have been hammered, partly because

• 23:54Speaker 01

  the easiest way for local governments to, I guess, husband cash is you just don't pay your bills. And so arrears, unpaid bills that are owed to suppliers and contractors, that is a huge problem and it's something that Beijing has been trying to resolve in particular over the last year. But that was kind of the local government's first port of call. Oh, we owe you money, uh, we'll pay you maybe next year or the year after that. In addition to that, local governments have been imposing arbitrary fees and fines pretty much on anybody they think they can extract it out of, you know, so perhaps more aggressively

• 24:33Speaker 01

  policing traffic infringements, for example, or sometimes just, uh, uh, you know, extracting sort of imposing arbitrary fines on, oh, you know, you send the local, uh, five brigade along to ensure a, a, a building is, uh, compliant. Oh, and guess what? They found an infringement here and here and here. They may be real, they might not be, but it's a way to extract cash. And one of the really big points of frustration for local businesses over the last few years is local governments have been going after back taxes, both real but also imagined. And so you kind of get called in and you're told, oh, guess what? You owe this in back taxes. And it's all, well, no, I don't. And it's like, well, yes, you do. So, yeah, in some ways, local governments being financially overstressed is hitting

• 25:18Speaker 01

  the consumption side of the equation, but it's also more directly hitting private sector firms. And of course, the second order effects of that is it's hitting consumption. Because if you're working at one of those private sector firms and the local government is your major customer and it hasn't paid its bills for the last two years, well, that affects, you know, salaries, it affects bonuses. And so there is a real trickle down effect through the entire economy. So, yeah, it is suppressing household consumption.

• 25:46Demetri Kofinas?

  So Michael Pettis, who's been on this podcast before and who I'm pretty sure you cited in this paper as well, is one of many economists who have argued for years, though I think he's the one who's maybe most famous for doing so, that China needs to rebalance its economy by prioritizing consumption at the expense of investment or putting more emphasis on consumption that is currently the case. And I think you also fall in this category as well. Certainly, this is something that you've talked about in interviews and in this paper. I'm curious to understand what the perspective is in Beijing, because there does seem to be some sense of recognition that the economy is unbalanced, though maybe what they interpret

• 26:28Demetri Kofinas?

  as being balanced or what a balanced economy would look like is different than what Western economists think. So what exactly is the perspective on this particular view in Beijing? The need to emphasize consumption, how to go about rebalancing the economy, what the relationship is between investment and consumption? How would you answer that for people that want to understand the perspective of the CCP on this question?

• 26:55Speaker 01

  Yeah, so there are certainly senior Chinese economists who share Pettis's opinion. I mean, he's not a foreign voice siding with foreign ideas. I mean, his ideas do have some currency within the Chinese system, but it is not the approach that Beijing is pursuing. And I know this starts to get a little bit confusing for foreign observers, because Beijing talks a lot these days about consumption and the importance of consumption and the need to boost domestic demand and that they're going to put domestic demand at the center of the economy. All this, these are sort of things they've been saying over the last few years. And so, you know, outside of China, when people Hear this, they assume, okay, the pivot is going to finally come because there has been a school of thought,

• 27:38Speaker 01

  particularly among Western, but also some Chinese economists, which was that when the property-driven growth model hit its use-by date, the only thing China could do then is pivot to a consumption-led growth model. Because it had already invested so heavily in property and invested so heavily in infrastructure. At this stage of economic development and given the size of China's economy, it couldn't go back to an export-led economic model. It just already exports so much, it couldn't lean anymore on exports.

• 28:06Demetri Kofinas?

  What is the current percentage, do you know off the top of your head of global exports? What percentage of those are out of China?

• 28:12Speaker 01

  Of global exports, I don't know, but I know that China exports about thirty-five percent of its manufacturing by value. I know that the UN estimates that by global standards, China is responsible for about twenty-nine percent of industrial production. So, you know, given anything produced in industry globally, China accounts for between a quarter and a third. And that number is just rising with a bullet. So it's absolutely massive and absolutely huge. An economist said, well, look, it's already so huge, you can't expect an economy of that size to lean any more heavily into exports. And so there was only one legitimate, feasible, viable alternative economic model.

• 28:54Speaker 01

  And that would be for China to lean into consumption because it's so weak. And that would be the thing that would drive the economy. And so I think there's still a sense of whenever China talks about, Beijing talks about, we're going to boost consumption, domestic demand is very important, we need to increase household spending. People overseas hear, oh, okay, this is going to be demand-side stimulus. They're going to do the sort of stuff to boost consumption that we do in the United States and we do in Europe. And that is put more money into the pockets of households so that they can spend more stuff. The thing is, that is not what China is doing at all. Because if you want to rebalance the economy and make it a consumption-led economy, that's what you need to do. It is through the welfare system.

• 29:33Speaker 01

  There is no other way that you can redistribute wealth on the sort of scale that can really drive consumption. In a relatively short period in time in China, unless it's through the tax and the welfare system. But the thing is, Beijing isn't doing that. And there's a couple of reasons. And often what you hear is people say, well, the reason they're not doing it is because Xi Jinping himself. Xi Jinping has this sort of deeply felt aversion to welfareism. He just doesn't want to spend money on welfare, which couldn't be further than the, from the truth. I mean, he has used that term before, but he also talks all the time about wanting to spend more on education and on pensions and on healthcare. But the reason they don't do it is, and this is the other thing that you hear all the

• 30:17Speaker 01

  time in the official documents, is that they want to do it, but they will only do it to the extent that it is within our means. And they use a variation on that phrasing all the time. They will spend more on welfare when they can afford it. And they have this deeply ingrained fear of funding welfare from debt. And they talk about the risk of what they perceive as being Latin Americanization. They kind of see this as being the original sin of the Latin American economies in, what, the seventies and the eighties, where middle income economies that were growing really aggressively, you know, they were going to become rich nations, and yet they kind of hit a wall. And the way Beijing sees it is part of that wall was they started to sort of build the

• 30:58Speaker 01

  foundations of a European or Western style welfare system before their economies had the capability to support it. And so debt ballooned and their economic prospects went out the window. And so that's why, you know, when we hear consumption led growth, we think redistribution and we think, you know, demand side stimulus. The Chinese are like, no, we're not willing to do that until the tax base can support it.

• 31:25Demetri Kofinas?

  Well, so let's clarify something here. It's not that the tax base can't support it. It's that they want to maintain their current growth rates, they want to capture more export markets, they want to expand the share of exports that they currently have, they want to dominate certain industries. So the level to which they continue to prioritize investment, that is preventing them

• 31:46Demetri Kofinas?

  From engaging this welfare spending because in order to do that kind of welfare spending in the context of prioritizing investment, they need to expand debt. Is that right? Is that the right way of thinking about this?

• 31:56Speaker 01

  I wouldn't necessarily put the cause and effect like that. I think the way that they see it is that they've got an incredibly low tax to GDP ratio at the moment, which is about 20%. Now, to increase taxation levels in this particular economy would be potentially recessionary, right? I mean, if you started taxing households, which already feel the pressures of kind of a relatively weak post-property market, that would further suppress consumption. You can't really do it to firms at the moment because profit margins are so weak. And so you can't really expand.

• 32:32Demetri Kofinas?

  And why are profit margins so weak? I mean, obviously, every firm is different, but some firms could have room to expand profit margins, couldn't they? I mean, we are also facing tariffs now and pushback. I mean, I guess what I'm trying to say is that China is a rich country in the sense that they have captured a huge portion of global production. They run a chronic trade surplus. I think that an average person listening to this would be confused by the notion that they don't have the money, that they're constrained by the income to actually support these services. The only way that, and I fall in this category as well because I've heard this for years, the only way that it makes sense for me, and then help me understand why I'm getting this wrong, the only way that it makes sense for me is that there's just a very high emphasis

• 33:14Demetri Kofinas?

  on competitiveness, on global economic competitiveness, and that is the priority. And it comes at the expense of building up domestic consumption because I feel like they could do it, but they would have to pull the reins a bit on investment.

• 33:30Speaker 01

  I don't think that's quite right in the sense that I don't think the priority is global competitiveness. I think that is a consequence, but it's not a priority, right? So what they want to be able to do is they want to be able to, they definitely want higher levels of consumption, right? Ultimately, though, they see that as being coming at the end of this transformation project as opposed to the beginning. And so they don't want to do it through welfare and well-3. They want to raise incomes and increase consumption, not through redistribution, but through wealth creation. And that kind of speaks to what you were saying there about global competitiveness. But global competitiveness is kind of like, is kind of a symptom or a consequence of what they're trying to build.

• 34:12Speaker 01

  So in terms of wealth creation, what they want is to develop the sort of economy that is able to deliver eventually higher corporate profits and those more competitive companies are able to pay higher wages and greater bonuses. And once you've got a public that is earning higher incomes and hence paying higher income tax and you've got more profitable companies, that will expand the tax base, at which point the government will be able to expand welfare payments, start to raise income levels, start to deliver on the promise of of common prosperity. And that, you know, and maybe part and parcel of that as well, because you've got more profitable companies, you know, stock valuations go up, which is great for China's middle class. It becomes a driver of middle class wealth to replace the property market.

• 34:56Speaker 01

  And you put all of that stuff together and you have a China that is then able to support higher levels of consumption because the nation as a whole is more affluent. And that is the vision. They don't want to do wealth redistribution now, partly because they don't think the system can support it, but partly because they don't think that sort of consumption-led model is kind of the road to sustainable wealth and affluence. It's redistribution as opposed to creation.

• 35:20Demetri Kofinas?

  Right, but in order to accomplish that, they need to rely on selling more to the rest of the world, which means they need to pull income from the rest of the world, they need to buy debt from the rest of the world, they need to buy assets, they need to continue this model that is at the center of the political crises that are facing Western democracies at the moment and that have led to the erection of trade barriers, export controls and the like. And so, again, I hear what you're saying. I think the emphasis you're making here, it sounds like, is the causal dynamics. So then maybe the more practical question, Dinny, is How do they square this with what's going on in the world today? One, how do they square it with some of the, just the, the drag that happens?

• 36:02Demetri Kofinas?

  The diminishing law of return for raising the percentage of exports that your economy depends on, just the, the saturation amount that the rest of the world can absorb. But also the policy pushback and backlash from the rest of the world, the rise of nativism and protectionism. Like, how do China's leaders, how are they adjusting or thinking about this commitment to export-led growth, to continuing to grow investment in order to get the economy to a certain place where then they can redistribute wealth and engage in transfers, they can, you know, create a flywheel of domestic consumption? Is the focus then to shift from the developed world to the developing world? Like, what is the idea there to make this viable?

• 36:48Speaker 01

  Yeah, I think to the extent that they've certainly thought about the new model, and I think that the domestic side of things, they've clearly put a lot of thought into, right? We need higher productivity, we're going to do it through innovation and industrial upgrading and, you know, that will extend into, you know, we'll need greater exports. But I think they've focused a lot on the domestic side of the equation, but I think the international side of things, they're kind of dealing with a little bit more on the fly. Now, that said, I think they've certainly built up a toolbox of ways to kind of push back against the US when the US and the EU, when they're like, hey, we're not happy with this situation anymore. Both the EU and the US have kind of found it difficult to kind of rein in Chinese exports

• 37:31Speaker 01

  because Beijing has been so willing to push back with its own trade barriers, whether it's been with the US not buying soybeans, with Canada not buying canola, with Europe not buying pork. I mean, Beijing kind of knows where those pressure points are to push back. But I think what you were saying about the developing world was incredibly important as well, because I think we're going to find with China Shock 2.0, I mean, David Autor a few months back sort of, you know, rebranded what's happening now as, as kind of the second chapter of the China Shock. I think this one is, first and foremost, it's a Affecting countries with advanced manufacturing. So that's the United States, EU, Canada, Japan, South Korea. But for the rest of the world, and it's not just the developing world.

• 38:14Speaker 01

  It's pretty much other countries that don't have advanced manufacturing, like rich nations in the Middle East, even like Australia. I mean, I go home to Australia and it's like in the US, you don't see Chinese vehicles on the road. You get off the plane in Sydney and half the rentals that are available to you at Sydney Airport are Chinese vehicles. And there's no real debate about it. There's no sort of backlash about it because, you know, Australia doesn't have a car manufacturing industry. You know, the government stopped providing subsidies in 2017. So, you know, Chinese vehicles coming in, it's not challenging jobs. It's not challenging brands or industries. And so I think you're finding that in the developing world. I mean, what in Mexico, I think 20% of all new cars sold in Mexico were Chinese. In Israel, I think the percentage is similar.

• 38:59Speaker 01

  In Australia, it's a little bit lower. So I think the degree to which the rest of the world, the non-advanced economies are willing to accept Chinese, this expansion of Chinese manufacturers is, I think they're going to be relatively open because they stand to lose far less from it. I mean, there's going to be certain points like steel exports, which are increasingly becoming a point of tension in developed and developing countries alike. But when it comes to China's advanced manufacturers, I think there's going to be far less sensitivity to it in the developing world.

• 39:29Demetri Kofinas?

  So is the vision for this to be, because what this seems to appear to be like is somewhat of a colonial model or a model, maybe the word colonial is not quite right. But when the British approach to industrialization during the first industrial revolution was to focus on high-end manufacturing domestically, export those goods to the colonies and to the periphery, and in return, take agricultural goods, commodities and things like this. So they maintained all the advanced manufacturing know-how, all the high-value stuff that was done in the UK. And the easy stuff was done out in the sort of, quote, in this case, developing world. Is that the vision for China? Is that also the vision through the one belt, one road?

• 40:10Speaker 01

  Yeah, to be honest, that's what it looks like, Dmitry. I think you nailed it. You know, you look at what China is doing with its manufacturing machine, right? It's doing three things. One, it's moving aggressively into advanced manufactured goods. So we're talking, you know, batteries, cars, flying cars, drones, biotech. I mean, you know, the sort of increasingly the bleeding edge of manufacturing. But the other thing is, which I think is generally overlooked, is that it is hanging on to traditional industries. I mean, it's been very explicit like this. So, you know, the old flying geese model of East Asian development, right? It's like Japan was the first country to develop. And then as wages went up, certain industries like textiles or shoe manufacturing became too expensive to continue to manufacture in Japan.

• 40:54Speaker 01

  So those factories moved to South Korea and Taiwan. Those places went through the same process. Manufacturing then moved to Malaysia and Thailand and then to China. And China, you know, I think we all assumed that at some point, these low end factories would move elsewhere. And we've seen a degree of that happening with, you know, factories moving to Bangladesh and Vietnam. But Beijing has been very explicit that it wants to hang on to what it's got. And a great example is cigarette lighters, right? Cigarette lighters.

• 41:21Demetri Kofinas?

  That's an amazing example. Look at the company in the town of Shandong in Hunan Province, right?

• 41:26Speaker 01

  Yeah, yeah.

• 41:26Demetri Kofinas?

  What an amazing story. Yeah, tell our listeners about that one.

• 41:29Speaker 01

  So cigarette lighting manufacturing, they were made in Europe originally. I think they started off in Spain. And then, you know, in the, what, seventies and eighties, I think they moved to South Korea and Japan. Then in the nineties and early two thousands, they moved to Zhejiang and Guangdong province. And then they moved to Xiaodong in Hunan. And then I think about 10 years ago, labor costs were going up and it was becoming increasingly difficult to find workers in these factories. And so you would then assume one of two things would happen. Either these factories would move to Bangladesh, Vietnam, Laos perhaps.

• 42:02Speaker 01

  Or they'd move further west into China, where there was cheaper labour. But instead, what happened is the factory owners started teaming up with local engineering and design companies to come up with machines that could start to replace some of the workers. And over the last 10 years, I think, what, there's been three, four different rounds of capital upgrading and the price of cigarette lighters have absolutely plunged, or to make it, to make them has plunged, and the number of workers have plunged. I think the biggest firm in the area, Dongyi Electric, has reduced its workforce by, I think, eighty-five percent and has reduced its costs to manufacture a lighter by ninety-five percent. And that's the model. That's what they're trying to do throughout, you know, throughout the economy.

• 42:46Speaker 01

  You're seeing this in other industries as well. I mean, I think pen manufacturing, the volume of pens that China's exporting is going up rather than down, where it's exactly the sort of thing that should be moving overseas. So Beijing wants to hold on to it because they see it as being part and parcel of their efforts to move higher up the value-added chain. So, you know, it creates demand for these engineering firms to put the R and D into coming up with, into machinery that can help improve these efficiencies. So that's the second thing. One level, they're moving into advanced manufacturing. Two, they're hanging on to what they've already got. And the third thing is import substitution, that they are, partly this is a national security issue. Beijing, as a matter of principle, does not want to be dependent on having to import

• 43:31Speaker 01

  industrial goods from anywhere, which is part of the reason why they kind of have established this almost monopolistic control over rare earths and magnets. But it's also why they're investing heavily in semiconductors, because they don't want the US to be able to shut off the supply. But it's also why they're heavily investing in machine tools and precision instruments, which they've traditionally got from, I think, the Dutch, the Germans and the Japanese. Same sort of thing, they don't want to be cut off. And so this import substitution thing is having a huge impact, particularly on the Germans, because, you know, the Germans have made absolute hay out of China's industrialisation over the last 20 years, because, you know, China needed more factories, it needed to upgrade its factories and That's what the Germans did.

• 44:14Speaker 01

  And now the Chinese are making that sort of capital equipment, the machine tools, the precision instruments, the machines that run the factories. They're making the stuff that the Germans have made to a comparable level of quality and at much lower prices. And the German economy is increasingly starting to strain under it. So yeah, going back to what you were saying, Dimitri, this is why, you know, that kind of, what you described as a colonial allocation of almost resources. There's maybe an element of truth to that because China's manufacturing sector is increasingly set up in a way where it exports industrial goods. It has less and less reason to import industrial and manufactured goods from elsewhere.

• 44:55Speaker 01

  And so ultimately, what it needs is, it needs food, it needs minerals, it needs energy, but increasing to not as much as it used to because of its increasing reliance on renewables. And I think also then you have the other thing that it would buy from overseas is tourism. People going abroad to, you know, on beach holidays to Thailand. And then the last thing I think they're also more than happy to import is luxury goods like from places like France. But I think that is the economy that they envision. Manufacturing, they do all themselves. Industrial production, they do all themselves. But it's tourism, it's primary industries and it's high-end luxury goods which they're happy to import.

• 45:35Demetri Kofinas?

  So the kinds of technology-driven productivity gains that you described with the case of this lighter company and that they're seeking to employ across all sorts of legacy industries leads to labor displacement. Those workers need to find jobs higher up the value chain. How does the leadership in Beijing think about facilitating that process? And how does that show up in the way that they run the education system? So are they thinking, I mean, I imagine they are, about how to use public education and other state services to accelerate the movement up the value chain for their workforce?

• 46:18Demetri Kofinas?

  Or is this primarily thought about in terms of solving the demographic problem? Since people are going to be getting older. We need technology-driven productivity gains anyway. We're not going to need as many workers, or is it something in between?

• 46:30Speaker 01

  You know, oddly enough, it's all of those things. So you are seeing shifts in the education system to prioritize more vocational training, because there is this awareness that they're going to need fewer blue collar workers and more purple collar workers, you know, technicians. And so we're seeing shifts in the education system. But to the extent that Beijing is sort of vexed and stressed about employment issues, it's less the blue collar issue and more the white collar issue, because the degree to which the universities have expanded enrollment over the last decade has been massive. I mean, every year you have millions of young Chinese graduating from the universities and the jobs just aren't there, or specifically the jobs that they had expected to graduate into just aren't

• 47:15Speaker 01

  there, and they're white collar jobs. And I think that's perhaps the most interesting thing about this push into advanced manufacturing, because it's not just advanced, you know, advanced manufacturing needs to be supported by advanced business services. And so this is one of the things that just turned up in the proposals for the next five-year plan. And you're kind of seeing government and ex-government officials increasingly talk about the importance of business services as a source of employment and a source of growth. So to give you some context, if you take a company like Apple, right? Apple doesn't actually make anything. It's all outsourced, and it certainly doesn't make

• 47:54Speaker 01

  anything in the United States. And yet it employs 90,000 people in America, and most of those jobs are white collar jobs, right? They're software engineers, or they're coders, or they're business development people, or they're supply chain managers, they've got lawyers protecting IP, they've got human resources people, they've got, you know, there's a huge army of people in the services industry, and they're all in white collar jobs. And I think that's what Beijing envisions as well, that the push into advanced manufacturing isn't just about reallocating workers, you know, we don't need as many workers, this is going to- To improve efficiency, you know, there's going to be more people freed up to sort of help the elderly.

• 48:39Speaker 01

  Maybe there's an element of that, but I think the bigger issue here is that all these army of, you know, university grads who kind of don't have anything to do at the moment. I think the vision is this is how you develop the economy. So it starts to look more like that of Europe or the United States, where you have this huge bulk of white collar jobs that are created in support of an expansion into industry. And I think that's the really big trend that they're hoping to push for. And again, that comes back to what I was saying before. They want an economy in which you have broader corporate profits, great. But what they really want is to push people's incomes higher. And the way to do that isn't really by moving blue collar jobs into purple collar, technical jobs, because as you said, there's just going to be far fewer of them.

• 49:24Speaker 01

  The real trick is creating white collar jobs. And that's what they kind of see as being the real magic source, special source behind advanced manufacturing.

• 49:34Demetri Kofinas?

  And what are we talking about when we say white collar jobs?

• 49:37Speaker 01

  So this is everything.

• 49:39Demetri Kofinas?

  Specifically.

• 49:39Speaker 01

  Okay, so we're talking about research. So, you know, you've got PhDs doing the R and D work. You've got, on the less technical side, you've got more and more people in sales. In between, you've got marketing and design and, you know, industrial processes and, you know, engineering of supply chains. It really is the whole gamut. So you do have your lawyers and you've got your accountants, but you've also got your technical, you know, people as well.

• 50:08Demetri Kofinas?

  So I'm going to move to the second hour, Dinny. There are three sections that I really want to cover from my outline here. One is I want to dig in to what the export strategy is for China now. Because again, this is a much more complicated environment than it was 20 years ago. The rest of the world is erecting trade barriers. They're trying to, quote, de-signify or deglobalize or derisk their supply chains. China has employed some very clever and thoughtful ways to get around that. One of them has been the focus on creating intermediary goods so that they can still be a critical part of the supply chains, but in a way that still evades the tariffs. I want to look at worst, best and most likely case scenarios, which is something that you explore in the book to understand kind of what we can expect

• 50:51Demetri Kofinas?

  or what the likely paths are heading out to 2035. And then I would like to devote the rest of the conversation to the policy implications for Western policymakers as well as for investors. And I think there's also something to talk about here, which is the trade-off when thinking about climate and the energy transition. Because the Chinese are the leaders now in renewables, whether we're talking about solar, especially battery technology. They've built, what, like hundreds of new nuclear plants? How many nuclear plants are currently under commission? Again, probably not a question you can answer, but like, it's a lot. It is a lot.

• 51:33Demetri Kofinas?

  You know, so there are a lot of huge implications here for US policymakers and Western policymakers writ large, that there are a lot of costs and benefits associated with these decisions. So I want to explore that, all of those things in the second hour, Denny. For anyone new to the program, Hidden Forces is listener-supported. We don't accept advertisers or commercial sponsors. The entire show is funded from top to bottom by listeners like you. If you want access to the second hour of today's conversation with Denny, head over to hiddenforces.io/subscribe and sign up to one of our three content tiers. All subscribers get access to our premium feed, which you can use to listen to the rest of today's conversation on your mobile device, using your favorite podcast app, just like you're listening to this episode right now.

• 52:16Demetri Kofinas?

  Denny, stick around, we're going to move the rest of our conversation onto the premium feed. If you want to listen in on the rest of today's conversation, head over to hiddenforces.io/subscribe and join our premium feed. If you want to join in on the conversation and become a member of the Hidden Forces Genius Community, you can also do that through our subscriber page. Today's episode was produced by me and edited by Stylianos Nicolaou. For more episodes, you can check out our website at hiddenforces.io. You can follow me on Twitter at @Kofinas, and you can email me at [email protected]. As always, thanks for listening. We'll see you next time.