Ricardo Hausmann on What it Takes to Win a Trade War

The focus of Trump's trade policies is clearly China. There are tariffs on everyone, of course, but it's the growing Chinese manufacturing might, and the various perceived risks associated with that, which have catalyzed this impulse to rethink how America trades with the rest of the world. But can the US actually move the manufacturing center of gravity? On this episode we welcome back Harvard Professor Ricardo Hausmann. We've had him on before to talk about the importance of economic complexity -- the capacity to build complex things -- in measuring the wealth of nations. On this episode we use that lens to discuss tariffs and the trade war, and the risks that the new administration's policies will play in reducing our capacity to build the most advanced things. Only Bloomberg.com subscribers can get the Odd Lots newsletter in their inbox now delivered every weekday plus unlimited access to the site and app. Subscribe at bloomberg.com/subscriptions/oddlotsSee omnystudio.com/listener for privacy information.

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• 0:00Speaker 00

  Finance is increasingly being built on digital rails. But as the adoption of virtual assets, tokenization and stable coins grows, can regulation not only keep pace but help accelerate it? Find out more later in the podcast.

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  This is the Bloomberg Tech Minute brought to you by ChatGPT. I'm Carol Muster. Getting hired at SpaceX requires exceptional ability and may include having Elon Musk review a candidate's resume. So writes Bloomberg Business Week's Lauren Grush. She reports that the company culture is defined by Musk and job candidates must understand that a commitment to SpaceX means adhering to this culture and exhibiting loyalty to Elon Musk. To get hired, candidates must demonstrate their achievements from past jobs and hands-on experience matters more to recruiters than advanced degrees, with the company looking for people with raw innate intelligence. A spokesperson for SpaceX didn't respond to a request for comment on its recruiting

• 0:58Speaker 01

  and hiring practices, but according to recruiters, advisors and those who've interviewed for jobs there, it's the space exploration dream that draws people to the company and Musk invokes that dream regularly to remind workers why they're there. Prospective hires are told that the job will require stamina, including in job ads that candidates quote "must be willing to work extended hours and weekends as needed." One major perk for all that hard work? Employees' access to equity, either the right to buy shares or payment in the form of restricted stock units that vest over time. That's the Bloomberg Tech Minute brought to you by ChatGPT. Get started at chatgpt.com.

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• 2:29Joe Weisenthal?

  Hello and welcome to another episode of the Odd Lots Podcast. I'm Joe Weisenthal.

• 2:34Tracy Alloway?

  And I'm Tracy Alloway.

• 2:36Joe Weisenthal?

  In this ongoing trade war, I don't know, I guess it's a trade war, all the trade headlines. I have to say, one of the things I always think about is, and I write about it, and we reference it, the two of us reference it all the time, the complexity and the importance of sort of building complex things as a marker of a sort of country's capacity for wealth and the sort of complex international trade webs that undergird the production of complex things.

• 3:01Tracy Alloway?

  Joe, I know what you think about. It's monkeys and trees.

• 3:05Joe Weisenthal?

  That's what you think about.

• 3:05Tracy Alloway?

  That is what I think about. Okay, yeah. I do think about that. Okay. The reason I think about monkeys and trees is because a couple of years ago, we had Ricardo Hausman on the podcast and he used this metaphor to describe why some countries are richer, more economically developed than others. And the metaphor was that certain products or industries are like trees in a forest and the firms are like monkeys. And so businesses kind of jump from tree to tree. And so what you find is if a country gets good at one particular product, then the business, the monkey will jump to the next tree, the next adjacent product and use that experience to build out their offerings.

• 3:49Tracy Alloway?

  And so you tend to see, you know, the more complex economies, the bigger forests, the more monkeys swinging from trees are indicative of greater advancement and more wealth.

• 4:00Joe Weisenthal?

  Right. And this is how you can have a, you know, a country that at one point specialized in rubber becoming a major player in cell phones, or a economy that at one point made T-shirts, which require some level of coordination of supply chains from the thread and the electricity to power the looms suddenly become, you know, much more advanced than any number of things. Anyway, I think there's a very powerful idea, but when I think about, you know, the idea that, okay, now there's this trade barrier between the US and Canada, for example, and we have these complex webs of supply. Apply chains in which goods cross the border multiple times. Do we constrain our capacity to do complex things?

• 4:39Tracy Alloway?

  Are the monkeys going to slam headfirst into a trade wall?

• 4:44Joe Weisenthal?

  Yeah, it's literally it, right? Like they're swinging around and they're making these webs and densifying. And then suddenly they slam into a wall in a very real way. What does it mean for American wealth if America sort of like constrains

• 4:58Tracy Alloway?

  Yeah.

• 4:59Joe Weisenthal?

  this ecology of trade?

• 5:01Tracy Alloway?

  I think it's a very valid question.

• 5:02Joe Weisenthal?

  Well, I'm very excited. Back on the podcast, we're going to be speaking with Ricardo Hausmann, professor at the Harvard Kennedy School and the founding director of the Harvard Growth Lab. So Professor Hausmann, thank you so much for coming back on Odd Lots.

• 5:17Speaker 05

  Thank you for having me. I'm really happy to be back.

• 5:21Joe Weisenthal?

  It does not seem like if we're thinking from the complexity framework, right? If we're gonna start like putting up nets, maybe it's nets. If we're gonna start putting up nets in the forest between the trees from place, it does seem harder for the monkeys to swing.

• 5:37Speaker 05

  Well, the way I think about the problem is that the complexity that you were talking about in the introduction is really the amount of knowledge that you have to put together.

• 5:49Joe Weisenthal?

  Yeah.

• 5:49Speaker 05

  in order to be able to do things. And the question is a little bit, you know, how mobile is that knowledge? How, how easy it is for you to, to get to that knowledge? And that knowledge takes, if you want, three forms. It takes the form of embodied knowledge and tools and materials. So when you buy a cookbook, it says, if you want to make an omelet, it says, you know, take eggs, take milk, take this, take that. It doesn't tell you how to make eggs. It doesn't tell you how to make milk. You just, you just buy the eggs and you don't, you disregard all the, all the technologies that go into making chickens and to making eggs and to feeding the chickens. And so you disregard all of that. You just buy the eggs, right?

• 6:34Speaker 05

  And all the knowledge that was embedded in it, it's just in the egg. So embodied knowledge is one form of knowledge and trade is one way to get it, right? Codified knowledge is, is the knowledge that exists in recipes, formulas, algorithms, do files, you know, you just need to have the code and follow the instructions if you are. And then the third form of knowledge is know-how and brains. And the problem with with knowledge is that there's very little knowledge that fits in a brain. So if you want to run a company, you need a lot of knowledge. You need knowledge about accounting, about finance, about human resource management, about procurement, about production, about

• 7:19Speaker 05

  branding, about marketing, you know, about taxes, about contracts. So you you need a lot of knowledge and to bring that knowledge together, you need a team of people that you need to put together. And complexity comes from, you know, the breadth of the team that you have to put together.

• 7:36Joe Weisenthal?

  Yeah.

• 7:37Speaker 05

  Now, the more you can kind of putify stuff, then you don't need to put the brains together because it's all in the code. That's one of the things that we may talk about, artificial intelligence. It it makes things in some sense simpler because the knowledge is in the machine. It's no longer, you no longer need a brain to do it. Now, what these trade barriers are doing is that they are preventing you from, say, buying the eggs, right? So that now you need to know how to do the eggs yourself.

• 8:06Joe Weisenthal?

  Hmm.

• 8:07Speaker 05

  So in some sense, it's it's making things harder to do. As Larry Summers has pointed out, there are about sixty times more jobs using steel than jobs making steel. So, eh, you know, you protect steel. Eh, you're making it easier for all those guys that were going to make omelets eh, by making now the eggs harder to get. And that's going to come at a detriment. You're going to get maybe more jobs in steel making in the US. And you're going to make all the people who use steel have more trouble competing in the domestic market with their products and more trouble selling their products abroad because now they're buying more expensive eggs.

• 8:50Speaker 05

  More expensive steel in this metaphor. So so in some sense, yes. What you're saying is that eh, trade barriers are going to make eh, the ability to put things together harder in the US. It's going to incentivize some of the things that are being protected. But it's going to create eh, difficulties for everybody who uses those things to make other things.

• 9:14Tracy Alloway?

  Is there a way to design tariffs or other protectionist trade measures in such a way that you would preserve knowledge and I guess preserve access to some of the components you need to build out more complex industries?

• 9:29Speaker 05

  I mean, an interesting question is, what is the case for intervening in the market? And why would you need a policy? Mm-hmm. And then the second question is, would trade, would tariffs be your instrument? Okay, so I would say that economic theory gives you at least three good reasons to intervene in a market that might justify something you might want to call industrial policy. And then the question is, is tariffs the right industrial policy? Because now they're putting tariffs on steel and aluminum, they want more steel and aluminum being made in the US. If you wanted more steel and aluminum made in the US, what instruments could you have used? And is tariffs the right one, okay?

• 10:12Speaker 05

  So first, there is the argument that in order to make something, you have to know how to make it. You know, it's hard to make things you don't know how to make. And typically, when you start something, you don't, you're not particularly good at it. But maybe over time, you become better at it. There are some learning curves. And you want to get into those learning curves. And that's a compelling reason, maybe, to intervene in a relatively new industry where, you know, you haven't yet to figure things out, say, maybe like solar panels or or batteries or, you know, something that's relatively new that you still have yet to figure out. You wouldn't do it for a mature industry, like, say, like electric, gas turbines.

• 10:57Speaker 05

  Because, you know, they've optimized that to death and, and, you know, there's, there's no significant breakthroughs for, for decades now. So steel would not be the obvious thing that would come to mind, right? It's a, it's a 19th century technology. It's an industry that has, that's quite mature, et cetera. But you might have, I don't know, national security reasons to protect it or something. But definitely not learning curves. By the way, those learning curves, if they are like inside the company. If it's something that the company is learning and the company owns, markets have been super happy to fund that. I mean, markets have funded Amazon for decades while the company was losing money.

• 11:42Speaker 05

  Because they were saying, no, no, the company is figuring out how to sell stuff on the internet eventually. When they do figure it out, they will have access to a humongous market. And and that's going to be super valuable. So markets supported, you know, negative cash flows in in Amazon for a very long time. So you have to argue that these learning curves somehow spill over into the value chain, spill over into more complicated things to coordinate, and that's why you need some some kind of action. Sometimes, the reason why industries get into trouble is that you have chicken and egg problems, that you know, the supplier is not there because you are not there, and you're not there because the supplier is not there.

• 12:24Speaker 05

  So there's a good equilibrium in which both you and your suppliers are there. And there's a bad equilibrium in which neither of you is there. So how do you go from the bad equilibrium where none is there to the good equilibrium where both are there? And that's a problem that we we know how to how to solve. In each one of these cases, tariffs may not be the right instrument. So for example, you know, if you wanted the supplier and you to be there, well, maybe the government comes and says, you know, I'm going to give a supplier the guarantee that you're going to buy from them. And I'm going to give you a guarantee that the supplier is going to be there to sell you. So you install your plant, he installs his plant, and the guarantee expires worthless.

• 13:07Speaker 05

  So the government can coordinate on the good equilibrium, essentially spending no money and taxing nobody. A set of guarantees would do the trick. If you want the firm to learn, I mean, one thing is to have these temporary, what they call infant protection. And the term in the in the literature is infant industry protection.

• 13:30Speaker 05

  So you take an industry at its infancy and you give it some protection until it finds its way and then you you open up. An alternative to that is you you subsidize their capital investment or you guarantee their demand. Maybe government procurement or something else. Or you give it a special tax treatment. So you have other ways to intervene. Right. The moment you you intervene with tariffs. You're essentially dumping the cost on the consumers of that industry. And the consumers of that industry are going to become less competitive and and their size will shrink.

• 14:11Speaker 05

  And and they may become vulnerable to to other attacks. So it's not the ideal instrument. There's an additional reason why it may not be the right thing to do. The US is, and politically, part of all this policy is based on the fact that the Midwest did very poorly. The Rust Belt did very poorly. They lost a lot of manufacturing jobs and you would like jobs to go back to the Midwest. Pittsburgh lost its steel industry. Gary, Indiana, lots of steel industry. Youngstown, Ohio, Cleveland, Detroit, etc. These cities lost jobs in some industries. Now you put the barriers, you put tariffs at the national level.

• 14:55Speaker 05

  It it doesn't mean that the industries are going to go to the Midwest. Right. They may go to to right to work states in the in the south. They may go to the southwest. So it's not an obvious solution to the places that you're trying to help. Those might be better dealt with using place-based instruments.

• 15:29Speaker 00

  What's next for virtual assets? I'm Jacob Rees, host of Economy Scale, a series exploring growth in key global sectors, and in this episode, we're diving into the digital forces shaping finance. Sean McHugh from Dubai-based Virtual Assets Regulatory Authority has this to say.

• 15:45Speaker 06

  We're seeing a lot of insocial players come in, digital asset dedicated hedge funds, high-frequency traders and that sort of thing, and folks who service insocial clients.

• 15:54Speaker 00

  As more capital enters the market, adaptive regulation is likely to become increasingly key. Rees-Merica Ripple says.

• 16:02Speaker 07

  A lot of regulators globally would like to keep the industry at arm's length. That's the opposite here. I think also what you'll find is that regulation and frameworks can come out, but some of them are maybe a slight iteration on some 80-year-old policy and not actually in line with what the technology can do and offer. And again, that's very different in Dubai.

• 16:21Speaker 00

  Listen to the full episode wherever you get your podcasts. This series is brought to you by Bloomberg Media Studios and the Dubai Department of Economy and Tourism.

• 16:31Speaker 01

  This is the Bloomberg Tech Minute, brought to you by ChatGPT. I'm Carol Muster. Getting hired at SpaceX requires exceptional ability and may include having Elon Musk review a candidate's resume. So writes Bloomberg Businessweek's Lauren Grush. She reports that the company culture is defined by Musk and job candidates must understand that a commitment to SpaceX means adhering to this culture and exhibiting loyalty to Elon Musk. To get hired, candidates must demonstrate their achievements from past jobs and hands-on experience matters more to recruiters than advanced degrees, with the company looking for people with raw, innate intelligence. A spokesperson for SpaceX didn't respond to a request for comment on its recruiting

• 17:13Speaker 01

  and hiring practices, but according to recruiters, advisors and those who've interviewed for jobs there, it's the space exploration dream that draws people to the company. And Musk invokes that dream regularly to remind workers why they're there. Prospective hires are told that the job will require stamina, including in job ads that candidates, quote, "must be willing to work extended hours and weekends as needed." One major perk for all that hard work? Employees' access to equity, either the right to buy shares or payment in the form of restricted stock units that vest over time. That's the Bloomberg Tech Minute, brought to you by ChatGPT. Get started at ChatGPT.com.

• 17:55Joe Weisenthal?

  You know, I really like this idea of physical products as embedded knowledge. So that if I'm making some recipe that calls for eggs, that the eggs that I buy are the end result of all the knowledge of the farmers. I don't have to have that knowledge myself. It makes it a simpler process. I was reading a speech recently, Ellen Young. This speech was given, I think, in 1928. He was the former president of the London School of Economics. And he said, "It is generally agreed that Adam Smith, when he suggested the division of labor leads to inventions because workmen engaged in specialized routine operations come to see better ways of accomplishing the same results, missed the main point. The important thing, of course, is that with the division of labor, a group of complex processes is transformed into a succession of simpler processes.

• 18:38Joe Weisenthal?

  So therefore, making something with eggs is simpler because someone else is doing the simple job of making, of growing eggs. I'm making the simple job of maybe making an omelet or something. Something becomes a succession of simpler jobs. But the question I have is, does that mean that sort of like sheer market size, as measured by even by things like population, et cetera, become important in these questions? Because if we're going to make complex things, doesn't that on some level require either through our population or our friends' population, a decent number of people who can then do all of these individually simple tasks?

• 19:16Speaker 05

  Well, I mean, if that's the reason why value chains have become longer. That you just slice it into more modules and then you bring those modules together and then some OEM, some original equipment manufacturer that is putting fifty thousand pieces together. And then each one of the fifty thousand pieces, it becomes a more manageable task. But some industries require a lot of, a lot of talent that has to come together. And for example, when you go to the, you see a film in the movies. Eh, sometimes they put at the end of a movie, it says the end. But i- it's a misnomer because after they put the end, they start showing you the credits.

• 20:00Speaker 05

  And the credits go on for minutes and minutes, you know, there's, there's the casting, there's the sound effects, there's the visual effects, there's eh editing, director of photography. So you need a whole massive team of people that are eh involved in that, in that movie making industry. Well, an industry that requires this deep pool of differentiated talent tends to locate only in very large cities, say like Los Angeles or New York. Eh, that's the only place where you would, you could put together all that necessary talent eh that is required. So industries that require a more diverse pool of talent tend to locate themselves in bigger cities.

• 20:45Speaker 08

  Hmm.

• 20:46Speaker 05

  And the ones that are kind of simpler, lower complexity, they can afford to locate in a smaller city because in, in that smaller city, they could probably find eh the more limited diversity of skills that they need. Now, eh one of the things that is a feature of the American economy over the last twenty years is that the industries that tend to locate in large cities have done dramatically better than the industries that tend to locate in smaller cities. The industries that tend to locate in smaller cities, they tend to demand more land and not that diverse a labor force. So they're not willing to pay the high prices of land of big cities.

• 21:31Speaker 05

  So they can buy more land and they don't rely so much on this diverse labor force. But the industries that require a deep, you know, diverse pool of talent, they are willing to pay the higher price of land in, in, in larger cities because they don't use that much land. So what I would put it to you is that part of the drama of the US is the fact that there's been this shift in demand in favor of the things that happen to be done in bigger cities. And by the way, let me, let me make a very important point. We just saw the elections in Poland.

• 22:09Speaker 05

  And the elections in Poland meant that, you know, uh, the president that won that election is a more, call it a more Trump-like figure. Okay, uh, in fact, his party, P I S, uh, got elected more or less ten years or eleven years before Trump. So there was already kind of like a Trumpian uh, motivation behind the election of that party. Uh, they were upset about trade and globalization and, and Europe and so on. Now, the interesting thing about Poland is that Poland is at the exact opposite experience of the US in terms of trade.

• 22:50Speaker 05

  Poland has seen rising market share across the board in all industries, in agriculture, in manufacturing, in cars, in machinery, in textiles, they have made out like bandits. Trade has exploded positively in Poland. But the, the thing that has exploded in Poland has benefited uh, these larger urban areas and, and has, has uh, hurt the smaller, less metropolitan parts of, of the country, and that has generated a political backlash.

• 23:43Speaker 01

  This is the Bloomberg Tech Minute brought to you by ChatGPT. I'm Carol Masser. Getting hired at SpaceX requires exceptional ability and may include having Elon Musk review a candidate's resume, so writes Bloomberg Businessweek's Lauren Grush. She reports that the company culture is defined by Musk and job candidates must understand that a commitment to SpaceX means adhering to this culture and exhibiting loyalty to Elon Musk. To get hired, candidates must demonstrate their achievements from past jobs and hands-on experience matters more to recruiters than advanced degrees, with the company looking for people with raw innate intelligence. A spokesperson for SpaceX didn't respond to a request for comment on its recruiting

• 24:25Speaker 01

  and hiring practices, but according to recruiters, advisors, and those who've interviewed for jobs there, it's the space exploration dream that draws people to the company and Musk invokes that dream regularly to remind workers why they're there. Prospective hires are told that the job will require stamina, including in job ads that candidates, quote, "must be willing to work extended hours and weekends as needed." One major perk for all that hard work? Employees' access to equity, either the right to buy shares or payment in the form of restricted stock units that vest over time. That's the Bloomberg Tech Minute brought to you by ChatGPT. Get started at ChatGPT.com.

• 25:06Speaker 02

  This is the Bloomberg Market Minute brought to you by Comcast Business. The markets faced plenty of challenges this year: rising energy costs, higher interest rates, pushback to massive artificial intelligence spending. But through it all, stocks keep breaking records, and some analysts think they still can with a focus on the fundamentals. Nadia Lovell is head of global equity strategy at UBS.

• 25:28Speaker 09

  Earnings has been good and continues to be good. And while, you know, we might be past the peak in earnings growth, we're not past the peak in earnings level.

• 25:36Speaker 02

  But others like Miller Tabak strategist Matt Maely say those challenges could eventually lead to a downturn.

• 25:42Speaker 10

  Whenever we see a significant rise in bond yields like we had. And a significant rise in oil prices like we have, the stock market always or pretty much always ignores it for a while.

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  And Wall Street may be starting to take notice. A recent Citigroup index shows more analysts cut rather than raise their earnings forecasts for corporate America for the first time in more than five months. That was the Bloomberg Market Minute brought to you by Comcast Business, one partner powering 90% of the Fortune 500 and millions of small businesses. When you add it all up, no one does business like Comcast Business.

• 26:20Tracy Alloway?

  So even even if the gains have been absolute for Poland overall, I guess the relative differences within the country are are have become a grievance.

• 26:31Speaker 05

  Yes, let me let me say one point that we often do not emphasize. No, we often think of countries as small, open economies. They're small in the sense that what they do is not going to change the global economy. The U.S. is relatively bigger, but many countries are, I think, a smaller, open economy. When you think of a city, a city tends to be an even smaller and even more open economy. It's smaller, right, much smaller than than the country it's in, right? And it's more open because it trades with not only the rest of the world, but the rest of the country. And the labor force can either come from the rest of the country or leave to the rest of the country. Right?

• 27:14Speaker 05

  So what tends to characterize a city and, you know, for a country, its export base is super important. For a city, its export base is even more important.

• 27:28Speaker 05

  Because a city is is less self sufficient than a country. A city needs to consume a lot of things that it doesn't make. Most cities don't make cars, most cities don't make antibiotics, most cities don't make X-ray machines, they don't make, you know, eggs. So all of these things have to be brought in. And to pay for these things that they want to consume in the city, they need to earn money from outside the city. They need to export in order to be able to import. So the set of export activities in a city determines very much the life of the city. If those export activities in the city get into trouble.

• 28:10Speaker 05

  Then it's not just that those jobs in those export industries eh getting eh you know eh are lost, but those workers used to, you know, go to the barber, go to a grocer, go to the dentist, so all those jobs in in all of these eh local services also get lost and get this multiplier local effect.

• 28:30Tracy Alloway?

  Hmm.

• 28:31Speaker 05

  And people start leaving the city, the moment people start leaving the city, their housing prices go down, eh there's less money eh to pay for education, so the quality of the education deteriorates and you get all of these eh negative local effects in the city, okay? That's associated with eh the export industry of your city getting into trouble. So what I'm saying is that the shift in demand has eh hurt cities eh the kinds of industries that tend to locate in smaller cities, so the kind of industries that need less of a deep pool of talent and more land. And the car industry is a good eh example.

• 29:12Speaker 05

  The whole steel, you know, steel is a dirty, complicated, large thing, so it it it may hire a lot of workers, but it doesn't want to have too many people around them, they need a lot of land, so eh they they're not gonna go to Los Angeles, they're going to to go to a place where they can acquire a lot of land to put their their big plan. And it's the fact that the export sector of cities in the Midwest, say, got into trouble, the fact that the export activities in in some parts of Poland got into trouble, that they got into this eh this eh negative spiral. As people, you know, left because they had better opportunities and maybe other parts of the country in larger cities, they leave behind a a deteriorating eh economic and social situation.

• 29:57Tracy Alloway?

  Hmm. I promise not to get too hung up on metaphors and monkeys, but I just wanna go back to the egg analogy for one second. Um, so I understand, you know, division of labor, expertise can lead to efficiency and absolute gains economically for everyone. However, you know, I'm thinking back to when egg prices were very high in the U S um earlier this year, and I joked on this podcast that I was gonna get my own chickens so that I could declare egg independence, egg autarky, and have my own supply.

• 30:34Tracy Alloway?

  Are there not arguments, you know, for certain things that you would want to have the capacity to build those components at home in order to enable you to build more complex items?

• 30:47Speaker 05

  Well, no, you would want to make sure that you have a diversified source of supply so that if there is a problem in Brazil, you can buy from somewhere else, right? So this whole thing about food security, that some countries say, you know, we need to have food security, so we need to produce food in our country at three times the international price. Well, I mean, that's not food security, that's exacerbated risk, because, you know, your country can be hit by a drought, by a storm, by et cetera, many things that could destroy your food production. So you're going to face much less risk if you have a diversified source of materials.

• 31:29Speaker 05

  And that's one reason why you would want to have a good trading relationships with many countries, because that way, you know, if you get in trouble, you can buy from somewhere else. So, no, in general, this idea that if the price of wheat worldwide goes up, that's a reason for you to have your own wheat production, that doesn't follow at all. Your wheat production might be, might subject you to even more risks than a diversified source of wheat from across, across the world. It's a different thing if you're talking militarily, right?

• 32:04Tracy Alloway?

  Yeah, I was gonna say, what about something like, I want to build semiconductors domestically, because I think they're a very important part of our defense strategy?

• 32:14Speaker 05

  Well, I can perfectly understand that you have an incredible concentration of semiconductors in Taiwan. And it's very easy to imagine a situation where you no longer have access to those semiconductors.

• 32:32Speaker 05

  So in that case, I can, I can see the case that would justify things like the CHIPS Act, not necessarily things like tariffs on CHIPS, right? Because tariffs on CHIPS would make all industries that use CHIPS less competitive, et cetera. But, you know, in creating an encouragement for, and by the way, convincing TSMC, you know, the Taiwan Semiconductor Manufacturing Company, which is the best foundry in, in the world, to come in and see if they can figure out how to make it in Arizona. And by the way, it's very interesting and, and it shows you the importance of knowledge and know-how, that

• 33:13Speaker 05

  sometimes it's very, very difficult for the same firm, that supposedly the firm knows how to do something, say Boeing knows how to make airplanes in Seattle. Well, guess what? Making airplanes in South Carolina, making Boeing airplanes in South Carolina proved to be much harder than making airplanes in Seattle. And transporting the knowledge was, was a big headache. And right now, TSMC is facing serious challenges in transporting the knowledge to, to Arizona. So if you put the accent on moving the knowledge, things look a little bit different than, than just a discussion about tariffs.

• 33:52Joe Weisenthal?

  Yeah. Supposedly, the yields on the Arizona fabs are quite impressive and they're starting to gather momentum. Of course, your point is taken. But actually, this does raise some question. I mean, you talked about, okay, the importance of diversity of your supply chain. To my mind, actually, when I hear that, I think, okay, there's something legitimate about like the anxiety about China specifically, because what's happening in manufactured goods is that it's not a globally diverse supply chain. It's becoming in many areas, a China-only supply chain, that China's lead in this, that its network effects, that it's internal, whatever, is becoming so concentrated in one country

• 34:34Joe Weisenthal?

  for such a big range of goods, that at least from a non-China perspective, it feels like, from a risk management standpoint, et cetera, that there probably is a very good imperative to put forth effort towards not necessarily having an American production capacity, but a non-China production capacity.

• 34:54Speaker 05

  Well, we went through a Japan scare in the nineteen eighties, right? And what ended up happening in Japan is that Japan kept on progressing and becoming good at everything to a point that wages in Japan went up a lot. And Japan started to move their industries outside the phenomenon that was called the flying geese, right? And so Toyota started to make cars in Thailand and and put things in Korea and so on and so forth. And then they went into poorer states like Vietnam or Indonesia. So what you have is that the more advanced manufacturing or the more advanced parts of the value chain like R and D, design, et cetera,

• 35:39Speaker 05

  are retained in headquarters and you move the more labor intensive, the less skill intensive, the less complex parts, the more standardized parts you move to locations that pay lower wages. And everybody's better off because for those locations, it's a step up. For you, it's a way to save on on labor costs that you cannot afford in your country because you want to pay your workers very, very well. And you can afford to do that because you have plenty of jobs for them in the more complex part of the value chain. You don't need to hire them in the less complex part of the value chain. So, so there is a, a world in which this is a process. China is getting richer. A lot of the things that are being done in China.

• 36:23Speaker 05

  By the way, initially they were done in the coast. And so now the coast has become too expensive. They're moving to elsewhere in the country and to elsewhere in the region. And, you know, now there's more production in Vietnam, there's more production even in Cambodia, there's more production in poorer other countries, simply because the Chinese worker is now too expensive. So there's a world in which this is just part of, just a repetition of what happened in Japan. But let me make an important point. When a production is happening elsewhere, it may be happening in a country. A good question is, where does the knowledge that they're using come from?

• 37:05Speaker 05

  Because what is happening in the world today is that the rich countries are becoming more and more concentrated in producing knowledge. And then in order to monetize that knowledge, they need to put brick and mortar things that they prefer to put them in other parts of the world. So Japan, for example, has come up with a lot of innovations and a lot of R and D and a lot of patents. But the way they monetize their patents is not by hiring Japanese workers that, you know, Japanese labor force is declining and so on, and they're at full employment anyway. They monetize their knowledge by deploying that knowledge elsewhere with foreign direct investments and so on.

• 37:48Speaker 05

  And that means that a lot of the accounting of how this process happens is not well captured by our standard accounting techniques. For example, if Japan does R and D and that improves the productivity of their foreign investment, it doesn't show up as higher Japanese productivity. It is increasing productivity, but not just, not in Japan, in the places where Japan has its plants. And the same is happening in the U.S. If you think of the Magnificent Seven.

• 38:20Joe Weisenthal?

  Yeah.

• 38:21Speaker 05

  The Magnificent Seven, for example, Google, when Google sort of like displaces all the, all the small newspapers of the world, because all advertising revenue is moving to, it's moving online and Google is capturing a good chunk of that, that doesn't count as a U.S. export. Because it's some subsidiary that Google put in, in, I don't know, in South Africa or wherever, that is collecting that revenue. And that revenue, you could count it as a U.S. export, but it's not being counted as a U.S. export.

• 38:57Joe Weisenthal?

  It turns into U.S. market cap.

• 38:58Speaker 05

  Exactly. It turns into the U.S., into U.S. market cap. But U.S. market cap is very poorly captured by balance of payment statistics.

• 39:11Speaker 05

  So, for example, if you start in the year 2000, from 2000 to the present, according to official statistics, the US borrowed 16 trillion dollars from the rest of the world. It ran a cumulative current account deficit of 16 trillion dollars. You'd say, gee, you borrow 16 trillion dollars. Well, how much are you paying for those 16 trillion dollars? Let's say, um, 4%. No, so 4% would be 640 billion dollars in interest payments, right, on, on the debt you borrowed. Now, if you look at, at the US balance of payments and primary income, essentially, the US doesn't look like a country that has an external debt.

• 39:56Speaker 05

  They're essentially paying zero. They borrowed 16 trillion dollars, which is, say, 60% of GDP, and they're essentially not paying anything for it. So you would say, well, if I can borrow 60% of GDP for free, I would do that. Well, in some sense, that's what the US has done. The way I would like to describe it is that US didn't just borrow 16 trillion dollars. It borrowed more like 32 trillion dollars. It used 16 trillion dollars to cover that official deficit and used the other 16 trillion dollars to mix it with your knowledge and invest abroad. And that investment abroad, say, Google in South Africa,

• 40:37Speaker 05

  mixed with US knowledge, has this huge rate of return. So when you borrow 32 trillion dollars, 16 trillion dollars, you borrowed at 4%. But the other 16 trillion dollars you invested at a much higher rate of return because it was mobilizing your knowledge. And so 32 trillion, say, say you paid 4% over 32 trillion dollars you borrowed, but you make 8% on the 16 trillion dollars you invest abroad. Well, it just turns out that 8% over 16 trillion dollars is the same as 4% over 32 trillion dollars. You don't, you're not really running a deficit. You are monetizing your knowledge, but current accounting standards don't capture that wealth.

• 41:25Tracy Alloway?

  Um, this is very, this reminds me of The Matrix and that scene where they say, "There is no spoon. What if there is no US external deficit?" But, okay, one thing I'm struggling to understand, so, you know, you're arguing that the US actually has a significant amount of knowledge and know-how that is mixed up with its foreign direct investment, and that doesn't show up in the official trade statistics. And I guess one thing I'm, I'm kind of curious about is, and you're arguing that the statistics undervalue foreign direct investment, but I would have thought that, like, foreign direct investment valuations

• 42:06Tracy Alloway?

  inherently reflect market expectations. And to Joe's point, I'm channeling Joe's love of the efficient markets hypothesis here, but they should be captured in market cap and things like that. Why do we assume that the statistical agencies, the accounting systems systematically misprice these assets? Are they not included anywhere?

• 42:29Speaker 05

  They use book value. So, when, when you see the investment abroad, they count how many, how many dollars you sent abroad. But, and then they count, eh, how much money did you make abroad? And when you look at it, the rate of return on FDI is double the rate of return on debt in the accounts. So, they're not counting the foreign direct investment at the market value. By the way, it's very hard to calculate that market value because these are subsidiaries of companies that listed the S and P 500. And say if the price earnings ratio in the US is 26 or something like that, last time I checked, it means that they are thinking that all that's money that the magnificent seven are

• 43:13Speaker 05

  making abroad, they multiply by 26 or an even higher number, right?

• 43:19Speaker 05

  But that that was not the accounting was made at book value. So in most of these companies, there's a huge difference between book value and market value.

• 43:29Tracy Alloway?

  Yeah, I was about to say, this is the argument, I think we've even done an episode on this about stock market valuations and how companies with a large amount of intangibles, it's not reflected in book value.

• 43:41Speaker 05

  Right. And that, in my mind, is the market's valuation of your knowledge. Exactly. So, so in a world where knowledge is intensive, then, you know, book value becomes less of a guide on what's actually happening. And a lot of international trade statistics is book value because that's what they have to make the statistics.

• 44:00Joe Weisenthal?

  I think that's a really interesting question. I have one last question, and I wasn't expecting to go here, but I thought that was so interesting, what you were saying about Poland and some of the politics, not necessarily being about the country's overall trading position vis a vis the rest of the world, but the internal dynamics of what is happening in these countries, where the booms are happening in cities and how that is a function to some extent of exports. Um, but I'm curious, one of the things that people bemoan about the current environment in the United States and probably elsewhere, is that cities are no longer a good place for upward mobility, that you can't be poor or middle class and move to a city and find a job and move up the career ladder

• 44:41Joe Weisenthal?

  in the same way you could when cities were more centers of hard industrial activity. And I'm curious, when you talk about the types of companies that locate in big cities versus the type of companies that locate in smaller cities, et cetera, are the type of companies that locate in big cities not as conducive inherently towards upward mobility because there's just so much talent required just to get in the door anywhere at these firms?

• 45:10Speaker 05

  No, I think that the problem of big cities in the US is the fact that they have regulated urban space in such a way that housing supply is very inelastic.

• 45:22Speaker 10

  Uh huh.

• 45:22Speaker 05

  So as people try to move to a city, housing prices go up until it's unaffordable to move into a city. That if cities had a more elastic supply of housing, a more elastic supply of urban space, this dynamic would help generate more opportunities in those cities and would help maybe raise the price of labor in the cities where people are leaving because now they've become scarcer and people would be willing to pay more for them. So that's why you're seeing so much growth in cities like Boise, Idaho, or Salt Lake City, or cities in Texas, vis a vis cities in California that have incredibly inelastic supply of housing.

• 46:05Speaker 05

  So I would put there that, you know, a more inclusive policy involves urban development that allows for that inclusion to happen.

• 46:14Joe Weisenthal?

  Ricardo Hausmann, so great chatting with you. Always extremely thought provocative, always takes us down avenues that I don't expect. Really appreciate you coming back on Outlets.

• 46:23Tracy Alloway?

  Yeah, that was great. Thank you, Ricardo.

• 46:25Speaker 05

  Thank you for having me.

• 46:40Joe Weisenthal?

  Really, like every time, like, I mean, every time, we've only spoken to Ricardo twice, but I feel like every time I talk to him, there's like a bunch of ideas that are going to stick in my head for a long time that I'll be chewing on. In this one, it's this idea that like official trade statistics don't capture the fact that market value of this trade and which you can see in the stock market trading in the United States is much higher than what just sort of like what is captured in the activity. I'm really intrigued by this idea.

• 47:12Tracy Alloway?

  I'm on board with that idea, but I kind of wonder how far you can stretch it and like, can you stretch it all the way to, oh, actually the US doesn't have an external deficit? Or could you stretch it all the way to the idea that like, okay, well, China needs to like worry about accruing liabilities from importing US expertise? Like.

• 47:34Joe Weisenthal?

  Yeah.

• 47:35Tracy Alloway?

  I don't know.

• 47:36Joe Weisenthal?

  What we need is a debate between Ricardo and Brad Seter on this. Because one of the dimensions, like one of the counter arguments to some of this stuff would be that there are actual flows because the entity that might be set up in South Africa by a US multinational might pay licensing fees back to the home country for the right to use the Google name and so forth. Obviously Brad talks a lot about this in the context. I mean, he talks a lot about this actually in the context of software. But there is some, you know, the fact is, is that like, Microsoft is gigantic. And so even, and there's, you know, these companies are worth trillions and trillions of dollars and have huge footholds all around the world.

• 48:17Joe Weisenthal?

  And whether they're accruing value to America in a way that doesn't show up strictly in trade statistics strikes me as an important load to continue to mine.

• 48:27Tracy Alloway?

  Well, that's the other thing I was going to say, which is you see this debate in markets quite a lot. And the, the difficulty in analyzing intangibles is it's hard, right? Like, how do you put a price on things like brand value or soft power and stuff like that? And so you get these arguments over, okay, well, book value doesn't include intangibles, but you know, maybe it should, but if it should, then how do you avoid the problem of over inflating because you think that this brand value is, is really good? And it's difficult to actually measure.

• 49:01Joe Weisenthal?

  Also, it doesn't matter what our trade statistics say if we can't make things critical for national security. Like to your point, whatever you say, oh, we don't really run any sort of trade issues. Except if you don't actually have the physical capacity to make important things that are necessary for having a sovereign nation, then it kind of doesn't matter.

• 49:20Tracy Alloway?

  Right.

• 49:21Joe Weisenthal?

  You could run surplus and it wouldn't matter.

• 49:22Tracy Alloway?

  I reject the idea that I need to have a diversified supply chain of eggs. I'm, I'm going full on egg autarky.

• 49:30Joe Weisenthal?

  But here's the thing, Tracy, like you could do egg autarky, but God forbid, like some wolves get in there. Like you do still have the option of going to the grocery store, right? So like, even if you, you know, it's like, um.

• 49:42Tracy Alloway?

  But see, then I just need a diversified supply of new chickens.

• 49:45Joe Weisenthal?

  It's like that Pulp song about the Greek girl with the thirst for knowledge. It's like you'll never know what it's like because you always have the option to go to the grocery stores. You know, it's like you can't actually replicate through autarky, knowing in your head that you have that backup.

• 50:00Tracy Alloway?

  Yeah, that's true. That's a good point.

• 50:02Joe Weisenthal?

  Yeah, that was a good one, wasn't it?

• 50:03Tracy Alloway?

  That was very good. Okay.

• 50:05Joe Weisenthal?

  Thank you.

• 50:05Tracy Alloway?

  All right. Shall we leave it there?

• 50:07Joe Weisenthal?

  Yeah.

• 50:07Tracy Alloway?

  This has been another episode of the Odd Lots Podcast. I'm Tracy Alockway. You can follow me at Tracy Alockway.

• 50:13Joe Weisenthal?

  And I'm Joe Weisenthal. You can follow me at the Stalwart. Follow our producers, Kermit Rodriguez, at Kermit Armin, Dashal Bennett, at Dashbot, and Kale Brooks, at Kale Brooks. For more Odd Lots content, go to Bloomberg.com/oddlots, where we have a daily newsletter and all of our episodes. And you can chat about all of these topics 24/7 in our Discord, discord.gg/oddlots.

• 50:33Tracy Alloway?

  And if you enjoy Odd Lots, if you like it when we talk about monkeys swinging from trees, or egg autarky, then please leave us a positive review on your favorite podcast platform. And remember, if you are a Bloomberg subscriber, you can listen to all of our episodes absolutely ad-free. All you need to do is find the Bloomberg channel on Apple Podcasts and follow the instructions there. Thanks for listening.

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