Ideally that's how the system would work, and I think it's at least partly intended to work in theory. But it means companies have to go bust, and as Noah points out, lots of them aren't. They're basically being rescued by local governments or the central state, to avoid the political ramifications of job losses. The result is zombie companies, which popped up in Japan too about 20-30 years ago, partly as a result of similar, failed macroeconomic policies.
This reminds me of shared cycle business in China - where the market got totally saturated while the companies never made profit and all of a sudden companies after companies go bankrupt.
In fact, I remember reading Minetoshi Yasuda, a Japanese journalist specializing in China, described that Chinese companies tend to care way more about investment flows (subsidies or stock price) than the profit itself.
He also mentioned that Chinese companies tend to follow herd mentality to join trending industries, resulting in finding themselves in the red ocean rather than try to differentiate themselves to find niche. I feel like this is an apt observation
I think a lot of it is downstream from the longstanding financial repression that has been a hallmark of Chinese economic policy for a long time. That weakens domestic demand, and makes the country vulnerable to these kinds of deflationary episodes. Trying to ensure companies can get cheap loans by lowering the interest earned on savings is a classic strategy to try and funnel capital to key sectors. But it has its downsides, which are now, I think, evident in what's happening in China. Lots of companies producing, not a big enough market to sell into.
Not sure how China gets out of this pickle, without doubling down and compounding the problem by repressing harder, providing yet more loans and subsidies to zombie companies, and rinsing and repeating. Which I guess is a Japan-style scenario. Especially if ageing populations, both in China or elsewhere, weaken global and domestic demand further.
Also, I guess it goes to show that the upsides and downsides of different approaches to industrial policy vary depending on how big you are relative to the global economy. This kind of trick is less likely to be successful when you account for a larger proportion of global GDP, manufacturing capacity, and financial flows.
Nobody likes the "destruction" part of creative destruction, one of the hallmarks of capitalism. In a free market economy, or social democracy, or whatever you'd like to call what we have in the West, various forms of protectionism and rent-seeking behavior are used to try to insulate various players from it. It is interesting that even in China, the Party is not immune to these pressures. Whether they mainly come from a disgruntled public, or midlevel party apparatchiks, it still is a big problem. Turns out people are people, wherever you go.
People interested in Noah's topic today should jump over to Dwarkesh's latest:
Doesn't this all come down to a gigantic misallocation of capital on the part of a state-owned-and-controlled banking system for the purpose of maintaining employment?
Doesn't it mean that the life savings of Chinese working people, on which they are depending for support in old age (now that they are no longer having children for that purpose) are being squandered on a similar scale? So then what happens when tomorrow's retirees start withdrawing those savings, which, in the meantime, have been lent out to unprofitable enterprises unable to repay?
I think I know the answer to that last question. The government will order the banks to start printing money, generating inflation.
Would love Noah's reflections on this general scenario. Is it Hayek's revenge?
Interesting article. Real estate bust plus manufacturing bust.
How about an article on how the Chinese governments finance their operations - national, regional and local. If the two sources of income for government are in deep trouble how are the governments paying to keep services running? If all loans are really government loans what is the "real" debt of the Chinese government. How can this situation affect defense spending.
"How can these mighty world-conquering automakers be skating on the edge of bankruptcy when the government is pouring so many subsidies and cheap loans into the auto industry? The answer is simple: China’s government is paying its car companies to compete each other to death."
There wouldn't be so many mighty world-conquering automakers in the first place without the government subsidies. Automaking is not an industry where you have a long period of lots of internal producers, it's an industry that trends towards a few national champions that battle it out in the arena. There was little international competition when the American industry consolidated into the Big Three with distant 4th place competitiors (Hudson / Nash ---> AMC) followed quickly by Chrysler becoming a perpetual sick man of the industry. The present form of the Chinese industry is greatly distorted by the subsidies from the get go.
Could the strategy be to undercut their foreign competition, put those companies out of business and then raise prices when they control the market? This would seem to be the playbook. Look at Amazon and Diapers.com.
I think it's a little less nefarious than that. The idea is more to get other people to pay for goods that are manufactured in China, not so that Chinese firms can jack up the price later, but so that China can keep and develop a lot of manufacturing capacity in China. Both for economic reasons (productivity growth is often easier to achieve in manufacturing) and for political/security reasons.
The problem, as Noah points out, is that there is only so much external demand. China has relied on someone else, especially the US but also to a lesser extent the UK and some other deficit countries, being on the other end of the great big trade and financial hosepipe. Especially since slowing global economic growth and ageing populations might be another source of demand-reducing pressure.
That's exactly what it is. The question is whether China will be able to pull off "raising prices" (which here, means removing gov't subsidies.)
Not easy, but much easier than America's debt problem - we've used debt to subsidize consumption (health care, education, cash transfers.) When the music stops, at least China will have bought themselves a dominant manufacturing sector that will continue to provide cheap domestic goods and export profits.
It would seem dealing with a bunch of unemployeed factory workers is harder than implementing automatic stabilizers for SS, Medicare and Medcaid or raising taxes or letting inflation rise, but as we have seen, the more diffuse pain lets more people complain.
OK, but the strategy of paying firms to compete seems to have paid off for several important new industries such as photovoltaics and batteries which are now utterly dominated by China.
> There are also microeconomic dangers from overcompetition. Competition could spur Chinese companies to just innovate harder. But if China’s top manufacturers are constantly skating on the edge of bankruptcy, that means they’ll have fewer resources to invest in long-term projects like technological innovation and new business models.
Intense competition may not spur much innovation in the product but it will certainly push firms to innovate in production efficiency. Minimizing cost of production is everything in a perfectly competitive market.
Noah have you written a comparison between the run-up of Japan's lost decade and what's happening in China today? There seem to be some similarities; huge property bubbles in an export economy.
Our vaunted “creative destruction” process is somewhat tainted by the enormous bailout of many failing financial companies in the wake of the so-called prime
A good book I read recently was Patrick McGee’s Apple in China which describes how China used Apple to build up its own manufacturing capabilities and supply chains, and how that has both trapped Apple to be unable to manufacture most products anywhere else, and also strengthened the local phone makers like Huawei to now be able to make phones with equivalent or better functionality.
And now of course, those Chinese OEMs will be making Trump Phones which will most likely get a big beautiful tariff exception, to further hurt Apple.
Apple played an important role in China’s capabilities in electronics and technology but I think they would have done a lot on their own . Definitely will try reading that book!
The British went through this several times when the industrial revolution moved to other countries. I am sure China is as aware of how Japan fared from the property boom of the 1990’s. British motor companies ran the gauntlet from top quality to the Austin 11 until they could hardly get the car from the end of the assembly line to the showroom. America’s rust belt is another example of bad management and failure to exist without subsidies. China is a long way from that. Careful withdrawal of subsidies from failing companies, movement of labour between industries, social movement of university graduates into financial services, AI, etc. I hope they do it better than we did.
Unemployment insurance is a better policy, because it cushions the blow of creative destruction on workers while still allowing it to happen. Policies that keep workers in suboptimal jobs may make those workers’ lives easier and more stable in the short run, but in the long run it is bad for everyone and governments should not give in to the temptation to do it.
Unemployment Insurance also keeps workers in suboptimal jobs when they're seasonal. Governments are perversely incented to craft insurance precisely to keep people in those jobs and avoid moving for better work.
It continues to be ironic that Communist Party rule in China enables them to be a kind of archetype of social Darwinist capitalism in economic policy.
Ideally that's how the system would work, and I think it's at least partly intended to work in theory. But it means companies have to go bust, and as Noah points out, lots of them aren't. They're basically being rescued by local governments or the central state, to avoid the political ramifications of job losses. The result is zombie companies, which popped up in Japan too about 20-30 years ago, partly as a result of similar, failed macroeconomic policies.
This reminds me of shared cycle business in China - where the market got totally saturated while the companies never made profit and all of a sudden companies after companies go bankrupt.
In fact, I remember reading Minetoshi Yasuda, a Japanese journalist specializing in China, described that Chinese companies tend to care way more about investment flows (subsidies or stock price) than the profit itself.
He also mentioned that Chinese companies tend to follow herd mentality to join trending industries, resulting in finding themselves in the red ocean rather than try to differentiate themselves to find niche. I feel like this is an apt observation
I think a lot of it is downstream from the longstanding financial repression that has been a hallmark of Chinese economic policy for a long time. That weakens domestic demand, and makes the country vulnerable to these kinds of deflationary episodes. Trying to ensure companies can get cheap loans by lowering the interest earned on savings is a classic strategy to try and funnel capital to key sectors. But it has its downsides, which are now, I think, evident in what's happening in China. Lots of companies producing, not a big enough market to sell into.
Not sure how China gets out of this pickle, without doubling down and compounding the problem by repressing harder, providing yet more loans and subsidies to zombie companies, and rinsing and repeating. Which I guess is a Japan-style scenario. Especially if ageing populations, both in China or elsewhere, weaken global and domestic demand further.
Also, I guess it goes to show that the upsides and downsides of different approaches to industrial policy vary depending on how big you are relative to the global economy. This kind of trick is less likely to be successful when you account for a larger proportion of global GDP, manufacturing capacity, and financial flows.
Nobody likes the "destruction" part of creative destruction, one of the hallmarks of capitalism. In a free market economy, or social democracy, or whatever you'd like to call what we have in the West, various forms of protectionism and rent-seeking behavior are used to try to insulate various players from it. It is interesting that even in China, the Party is not immune to these pressures. Whether they mainly come from a disgruntled public, or midlevel party apparatchiks, it still is a big problem. Turns out people are people, wherever you go.
People interested in Noah's topic today should jump over to Dwarkesh's latest:
https://www.dwarkesh.com/p/arthur-kroeber
Doesn't this all come down to a gigantic misallocation of capital on the part of a state-owned-and-controlled banking system for the purpose of maintaining employment?
Doesn't it mean that the life savings of Chinese working people, on which they are depending for support in old age (now that they are no longer having children for that purpose) are being squandered on a similar scale? So then what happens when tomorrow's retirees start withdrawing those savings, which, in the meantime, have been lent out to unprofitable enterprises unable to repay?
I think I know the answer to that last question. The government will order the banks to start printing money, generating inflation.
Would love Noah's reflections on this general scenario. Is it Hayek's revenge?
Interesting article. Real estate bust plus manufacturing bust.
How about an article on how the Chinese governments finance their operations - national, regional and local. If the two sources of income for government are in deep trouble how are the governments paying to keep services running? If all loans are really government loans what is the "real" debt of the Chinese government. How can this situation affect defense spending.
"How can these mighty world-conquering automakers be skating on the edge of bankruptcy when the government is pouring so many subsidies and cheap loans into the auto industry? The answer is simple: China’s government is paying its car companies to compete each other to death."
There wouldn't be so many mighty world-conquering automakers in the first place without the government subsidies. Automaking is not an industry where you have a long period of lots of internal producers, it's an industry that trends towards a few national champions that battle it out in the arena. There was little international competition when the American industry consolidated into the Big Three with distant 4th place competitiors (Hudson / Nash ---> AMC) followed quickly by Chrysler becoming a perpetual sick man of the industry. The present form of the Chinese industry is greatly distorted by the subsidies from the get go.
Hopefully they will see the parallel and let the Chinese Nash motors go bust!
Could the strategy be to undercut their foreign competition, put those companies out of business and then raise prices when they control the market? This would seem to be the playbook. Look at Amazon and Diapers.com.
I think it's a little less nefarious than that. The idea is more to get other people to pay for goods that are manufactured in China, not so that Chinese firms can jack up the price later, but so that China can keep and develop a lot of manufacturing capacity in China. Both for economic reasons (productivity growth is often easier to achieve in manufacturing) and for political/security reasons.
The problem, as Noah points out, is that there is only so much external demand. China has relied on someone else, especially the US but also to a lesser extent the UK and some other deficit countries, being on the other end of the great big trade and financial hosepipe. Especially since slowing global economic growth and ageing populations might be another source of demand-reducing pressure.
That's exactly what it is. The question is whether China will be able to pull off "raising prices" (which here, means removing gov't subsidies.)
Not easy, but much easier than America's debt problem - we've used debt to subsidize consumption (health care, education, cash transfers.) When the music stops, at least China will have bought themselves a dominant manufacturing sector that will continue to provide cheap domestic goods and export profits.
It would seem dealing with a bunch of unemployeed factory workers is harder than implementing automatic stabilizers for SS, Medicare and Medcaid or raising taxes or letting inflation rise, but as we have seen, the more diffuse pain lets more people complain.
OK, but the strategy of paying firms to compete seems to have paid off for several important new industries such as photovoltaics and batteries which are now utterly dominated by China.
> There are also microeconomic dangers from overcompetition. Competition could spur Chinese companies to just innovate harder. But if China’s top manufacturers are constantly skating on the edge of bankruptcy, that means they’ll have fewer resources to invest in long-term projects like technological innovation and new business models.
Intense competition may not spur much innovation in the product but it will certainly push firms to innovate in production efficiency. Minimizing cost of production is everything in a perfectly competitive market.
But they also need to innovate and compete better in foreign markets. Efficiency is probably not enough.
This is very insightful and taught me some things about China that I did not know. Thanks.
Noah have you written a comparison between the run-up of Japan's lost decade and what's happening in China today? There seem to be some similarities; huge property bubbles in an export economy.
I think flooding the export market with cheap solar panels would do the world a lot of good, at least
Our vaunted “creative destruction” process is somewhat tainted by the enormous bailout of many failing financial companies in the wake of the so-called prime
A good book I read recently was Patrick McGee’s Apple in China which describes how China used Apple to build up its own manufacturing capabilities and supply chains, and how that has both trapped Apple to be unable to manufacture most products anywhere else, and also strengthened the local phone makers like Huawei to now be able to make phones with equivalent or better functionality.
And now of course, those Chinese OEMs will be making Trump Phones which will most likely get a big beautiful tariff exception, to further hurt Apple.
https://www.goodreads.com/book/show/220291748
Apple played an important role in China’s capabilities in electronics and technology but I think they would have done a lot on their own . Definitely will try reading that book!
The British went through this several times when the industrial revolution moved to other countries. I am sure China is as aware of how Japan fared from the property boom of the 1990’s. British motor companies ran the gauntlet from top quality to the Austin 11 until they could hardly get the car from the end of the assembly line to the showroom. America’s rust belt is another example of bad management and failure to exist without subsidies. China is a long way from that. Careful withdrawal of subsidies from failing companies, movement of labour between industries, social movement of university graduates into financial services, AI, etc. I hope they do it better than we did.
Unemployment insurance is a better policy, because it cushions the blow of creative destruction on workers while still allowing it to happen. Policies that keep workers in suboptimal jobs may make those workers’ lives easier and more stable in the short run, but in the long run it is bad for everyone and governments should not give in to the temptation to do it.
Unemployment Insurance also keeps workers in suboptimal jobs when they're seasonal. Governments are perversely incented to craft insurance precisely to keep people in those jobs and avoid moving for better work.