Interview: Dan Wang, China specialist
We talk about China's economy, decoupling, export controls, industrial policy, state control, and lots more.
I still recall a day seven years ago when Dan Wang invited me to lunch and asked my advice. He was considering moving to China to work for the research firm Gavekal Dragonomics, and wanted to know if I thought this would be a good career move. I answered with an unequivocal “Yes”, and I’m happy to say that I was right, because Dan quickly became one of the most incisive Western writers about China. His yearly letters — lengthy, discursive blends of travelogue, cultural analysis, historical musings, and commentary on current affairs — have become required reading. I’ve personally learned a great deal from them — my most widely read post on China, a discussion of Xi Jinping’s crackdown on the IT industry, was inspired and informed by one of Dan’s letters.
Sadly, as Dan explains, those letters have now come to an end. But happily, that’s because he has moved back to the U.S. to take a visiting scholar position at Yale Law School, where he will write many more interesting things for us to read. In this long and eye-opening interview, Dan and I discuss a whole range of timely China-related economic and policy issues — decoupling, export controls, industrial policy, increasing state control, etc. — and what ramifications these will have inside and outside of the country. If you want to understand the momentous changes taking place in and around China right now, here is a good place to start.
N.S.: Welcome back from China! Your annual newsletters from China became extremely popular, and rightly so. I miss them. Will they be continuing now that you're back in the U.S.?
D.W.: Probably not. I wrote my 2022 letter (https://danwang.co/2022-letter/ ) with the idea that it’s my last. I departed from Shanghai in January 2023 and will be based in New Haven for the rest of the year as a visiting scholar at the Yale Law School’s Tsai China Center. Some readers understood that I signaled my move to the west in my sign off: “It’s a barbarian’s life for me.”
These letters were intended to be postcards from China. Now, unless the ethnic and culinary diversity of Connecticut is just as compelling as in China’s Yunnan, I’m not expecting to write another letter.
N.S.: That's a shame. But in exchange, I'm hoping you'll give us some more detailed analysis of Chinese industrial policy and technological competitiveness, of the type you used to only provide in your private research!
So my first question is: What are two or three things that Americans need to know about Chinese industrial policy and technological competitiveness in 2023?
D.W.: The first is that there have been a lot of failures. China is achingly aware of its deficiencies in two strategic sectors in particular: semiconductors and aviation. So it has showered these sectors with bountiful money and stern policy attention. Where has that gotten them? Not far. On chips, China has built the basics of the industry, but is at best 10 years behind the leading edge of manufacturing logic chips, and even more on the tools needed to produce chips: lithography equipment and EDA software. On aviation, China’s answer to Airbus and Boeing has been years behind schedule, and is anyway substantially dependent on western engines and avionics systems.
The second is that there have been a lot of successes. I would say that China has caught up with the west on nearly all manufactured products outside of chips and aviation. It is making sophisticated electronics components. It is making boring industrial equipment that rarely grace headlines. And it is making most of the technologies we need for decarbonization. The folks at Bloomberg New Energy Finance estimate that China owns 90% of the solar supply chain: everything from polysilicon production to the tools needed to make photovoltaics to the panels themselves. It’s also doing very well in batteries and has a shot at dominating the hydrogen supply chain as well.
A central question I’m working on now is to figure out whether China’s technological capabilities in the future will more closely resemble its failures or successes. There are enormous macro headwinds for China’s economy: lousy demographics, a domineering central government, and greater political emphasis on state-led growth. But I tend to think that China will be able to solve its technological deficiencies. Its main task is to reinvent existing technologies: arguably firms like TSMC and ASML have the harder task, that is to push forward the technological frontier. On chips in particular, there’s a broad sense that it costs too much to keep pushing forward Moore’s Law. So if the leaders hit a wall, it’s only a matter of time for Chinese firms to catch up. These products are technology, not magic. And Chinese firms have already mastered a lot.
N.S.: What's different about semiconductors and advanced aviation? Why has China not been as successful in catching up in those sectors?
D.W.: I think there has been a consistent pattern of Chinese successes and failures. Any technology that demands the complex integration of different scientific areas is challenging for Chinese firms. Semiconductors bring together electrical engineering, chemistry, computer science, and more; aviation is the integration of aerodynamics, materials science, mechanical engineering, etc. China's scientific capabilities have steadily risen, but I would say it's still fairly weak. No surprise, perhaps, that Chinese firms weren't able to produce mRNA vaccines, since its scientific establishment is unused to puttering around the fringes of new fields.
On the other hand, for any technology where the science is mature, and the complexity lies more with the manufacturing process, China tends to be strong. Take renewable technologies like solar photovoltaics or EV batteries. The science of turning light into electricity and power storage are pretty well understood. But Chinese firms have been able to outbuild their foreign competition (with plenty help from government support) in creating high-performing products. Putting together a battery, for example, involves around ten steps—from cell filling to final sealing—that demand perfect handoff at each stage. Chinese firms are really good at this, which they learned from the highly-demanding electronics supply chain.
And here the US tends to be weak. American manufacturers aren't good at making products of high intricacy at high volume. And it sometimes trips over simple products too. It’s puzzling to me that American factories weren't able to quickly retool to turn out masks and other personal protective equipment in the early days of 2020. There's something quite strange about the US where it is able to make super-advanced products like AI, jet engines, semiconductor production equipment, but can't build basic infrastructure or simple products.
N.S.: Gotcha. That's a good dichotomy. Do you think that means we can expect to see China struggle in emerging technological fields like AI and quantum computing where the science isn't mature yet? Also, probably the most famous example of Chinese technological dominance is Huawei winning the 5G race. Does that fit the general pattern you described?
D.W.: Huawei has indeed been a significant Chinese technological success, embodying a lot of the successes and problems with China's approach. On the one hand, it has faced a lot of lawsuits over intellectual property theft. And it has benefited from some degrees of state support, including overseas purchases of its equipment made possible by Chinese policy banks. But it's also emblematic of the grit among Chinese manufacturers. They tend to start out making products that western companies are willing to concede to them because shareholders sniff at their low margins. And they go into developing countries that western companies don't like to be too entangled with, because of business complexity and corruption issues. Like many Chinese companies, Huawei started by making cheap products for price-sensitive customers, gradually making more sophisticated technologies.
I confess I'm puzzled by China and AI. There has been a lot of data compiled that China has many leading researchers who claim great quantities of studies and patents. It's also obvious that the central government has thought about AI, given the number of study sessions the Politburo has dedicated to it. Now where are the results? Chinese firms may be leading in facial recognition. But they are not releasing any of the text generation and image generation tools that have been so thrilling to the public. It still doesn't look like they are publishing much of anything for consumer use. So it could be that their focus is on fairly secretive projects for the government. But I wonder if that is going to be a formula for success if they're not really learning from the market.
N.S.: Why did China struggle to break into the internal combustion car market for so long, and then suddenly succeed in breaking into -- and even dominating -- the EV market?
D.W.: Exactly because it didn’t do well on the internal combustion engine. It was too difficult for Chinese automakers to beat the likes of Toyota or Volkswagen. So both policymakers and automakers went much harder after the battery-powered car instead. And it worked. The funny thing was, there was a lot of skepticism even as much as five years ago that Chinese firms would be able to pull this off. I admit I wasn’t too confident myself back then either. But even when Beijing expressly announced this policy for all the world to see, many foreign firms were still caught flatfooted because they were so wedded to the combustion engine.
N.S.: Can we account for the difference in China's performance in internal combustion cars vs. EVs with the framework you laid out earlier? Do top-end internal combustion cars require the integration of different scientific areas than EVs? Or are we simply seeing a "leapfrog" effect, where the legacy automakers were too wedded to the old technology, and China was able to focus mostly on EVs from day 1? Does any of it have to do with China's control of the battery industry and other upstream inputs for EVs?
D.W.: A bit of everything. Certainly Chinese firms were able to leapfrog because they weren't committed to the old way of doing things. They were also helped by China's development of the electric vehicle battery industry (which grew out of their production might for consumer electronics lithium batteries) as well as state-directed efforts to secure battery minerals. But it's also just another example of China's prowess in manufacturing writ large. In general, we should not be surprised that the second-largest economy—where so many of the world's products are made—should be able to figure out how to make industrial goods.
N.S.: OK, let's talk about that manufacturing prowess, and where it comes from, which is something you've written a lot about. You talk about China's fundamental advantage being one of broad-based engineering talent -- basically, China has a ton of engineers who know how to make a ton of things. Why are these engineers so important? What does their job look like; what do they spend their day actually doing? And why does China have so many of them?
D.W.: These engineers are a key part of China's manufacturing ecosystem. They allow manufacturers to move fast: a large pool of experienced engineers raises the tempo of design and production cycles because they can quickly try new things. It's easier to fix problems when things go wrong. And scale always helps to bring down the cost curve. I understand that the largest Foxconn facilities today have around 300,000 people, producing iPhones around the clock in three shifts per day. By contrast, the largest facilities in India are still closer to 30,000 people, for reasons that include less mature infrastructure and a lower female labor force participation rate. Manufacturers are able to gain so much in efficiency when they have more workers by one order of magnitude.
China's manufacturing advantage isn't only this deep pool of labor. It also has comparably dense clusters of component makers. Its infrastructure for shipping goods around is excellent. And instead of trying to extract their share, local governments tend to bend over backwards to help large employers. These factors aren't impossible to replicate elsewhere. But they’ve worked pretty well to slow the pace of the decline of manufacturing.
N.S.: Do these people mostly learn this engineering on the job? Does China have an apprenticeship type system? How much does formal education matter here?
D.W.: Mostly on the job, I think. The stereotype of these workers is that many of them didn't get to have a formal university education. And China's efforts to create an apprenticeship program has been halting, just as it is everywhere outside of Germany.
N.S.: OK, so suppose they put you in charge of policy in India for the next 10 years. How would you go about building something close to this body of engineers that China has?
D.W.: First, raise the labor force participation rate of women, who do a lot of the electronics assembly work. Second, encourage local government officials to take a more accommodative attitude towards manufacturing investment, for example by promoting the cadres who are able to attract investment. Third, build a lot more infrastructure. Fourth, also target building a network of component suppliers. Fifth, encourage the highly-talented executives who are running American tech giants to bring their talents to Indian firms.
N.S.: OK, let's talk about some of those macro headwinds you mentioned earlier. A lot of people are making a big deal out of the fact that China's population is falling now. Is that really going to be such an issue? Do China's leaders worry about it much?
D.W.: China's population decline is a simmering issue. But it's not a hefty blow to the economy, as you've pointed out too, only a persistent drag in the long term. Furthermore, it's not something that the leaders can immediately fix. Almost no countries have been able to reverse fertility decline. And I think it's next to impossible to see China as an immigrant-friendly country. So I think demographics are on the back of the minds of policymakers, but I don't think that they're counting on any solutions. Instead, they're going to be trying to emphasize growth in other forms. Even if the population declines, the number of people becoming affluent consumers is still growing fast; and policymakers are going to try to make the workforce more productive than before. And I don't see why a gently plateauing population should threaten China's future capabilities in something like semiconductors or electric vehicles.
N.S.: That sounds about right to me. But now let's talk about the greater emphasis on state-led growth that you mentioned earlier. How is this manifesting?
D.W.: China's semiconductor efforts are now driven by a new body, the Central Science and Technology Commission, which makes the sector's development directly supervised by a Party organization. For the past decade, the government has been working on "mixed ownership reform," which encourages entrepreneurial firms to take minority stakes in state-owned enterprises; the idea is to strengthen these SOEs, but it may end up weakening the private firms that face official pressure to take these stakes.
For the most part, Xi has buried the view that China's state sector will gradually diminish its hold over strategic sectors. And several major political initiatives—like the "whole-nation system of innovation" slogan and the Made in China 2025 plan—emphasize the role of the state in economic development. The party-state has apparently determined that it should be more involved with the economy given strategic competition with the US, not less.
N.S.: One interesting thing that China's leaders have tried to do is to actively discourage industries they want to see shrink. A lot of people were astonished at the government's crackdown on the IT industry in 2021. Now a lot of people are saying it's been substantively reversed. Would you agree with that assessment? And if so, will there be lasting scars from that incident? Can we expect other crackdowns on specific industries in the years to come?
D.W.: The state has relented. But it hasn't reversed. As my colleagues at Dragonomics have written, Beijing's regulations on platform companies are now entrenched at a permanently burdensome level. The good news for these companies is that future regulations are more likely to be marginal. The bad news is that the golden age of internet platforms is over: they won't again have such an easy time making enormous profits in a lightly-regulated market.
These regulations have indeed left scars. Entrepreneurs in sectors that include ride-hailing, video games, and especially online tutoring were left shell-shocked. But pain set in for sectors that went beyond those directly targeted by the state. A common sentiment from an entrepreneur goes along the lines of: "I would like to focus on building a business and working on my product; instead I'm being forced to become a political scientist to understand the direction of policy."
The major question today is whether these scars will persist or fade over the next few years. It's undeniable that a lot of entrepreneurs were angry about the crackdown; and there are many anecdotal reports of wealthy Chinese who have decided to move to Singapore. Beijing has shifted its tone since the end of 2022, saying the most soothing words about how much it loves private businesses. But who can blame entrepreneurs for feeling skeptical, after many of their creations were strangled by the state? On the other hand, if China's growth is impressive this year and next, I expect that many of them will return. It's not obvious that they can establish themselves overseas, after all: the US has not gone out of its way to rhetorically welcome Chinese entrepreneurs. If growth can pick up, and Beijing can pause its political tightening, then scars will fade more quickly. But these are uncertain ifs.
N.S.: That's exactly how I imagine I'd feel if I were an entrepreneur in China, too. You've written about the tendency of China's government to go through "manic episodes" where it focuses on ideology for a while before returning to a focus on business and the economy. Where do you think we are in that cycle right now? And do we have any idea what drives those episodes?
D.W.: I think mostly about the various disasters since the founding of modern China. The Communist Party took over a country already in shambles. But its periods of impressive economic development were also punctuated by strange disasters: the Great Leap Forward, the Cultural Revolution, and the one-child policy most prominent among them. I say they're strange because they were government-triggered catastrophes that did not seem to be necessary. The incredible data series is that Mao twice made the average Chinese the poorest the poorest they’ve been in 300 years—worse than feudalism under the Qing and the wars of the 20th century. (https://twitter.com/PhilWMagness/status/1657908158445023234). Neighboring India didn't launch famine policies, implemented by local officials, or denunciation rallies, led by Red Guards.
I think that one of China's essential problem is one of state overcapacity. Since imperial times, state officials would rarely hesitate to entirely restructure a peasant's relationship to her land. The Communist Party has had even fewer scruples. I think that China stands out because state officials are often mesmerized by some strain of utopianism; but it has the unique capacity to pursue these visions harder than other states. And because it doesn't know when to give up, the Chinese people suffer peculiar disasters.
It would be good, I think, if the Chinese state can one day learn to leave people alone.
N.S.: Now let me ask about the general attitude among the Chinese population. Over the past couple of years they've suffered through a lot of shocks -- Zero Covid, then Covid itself, a real estate crash that's still ongoing. Growth is seen returning to a over 5% this year, at least according to official numbers. But youth unemployment is sky-high. Are people demoralized or angry after three straight decades of rapid growth? If you're a young person in China today, what's your dream?
D.W.: There are various ways to segment the population. For older folks—say those over 60—zero-Covid wasn't the biggest disaster in their lives. They've survived various other state-triggered personal catastrophes: the Great Leap Forward, the Cultural Revolution, and for some, the one-child policy. Some of these people have been happy about zero-Covid, because they believe that the state expressly prioritized their safety. Others are disappointed that the government has proven itself to be rigid in futile pursuits, making it no different from the one that has initiated Mao-era traumas.
I think a greater share of people in their middle age are upset. The generation that graduated from college between the 1980s-90s experienced the bulk of China's economic boom. It was this generation that received a house from the state, economic opportunities from China's global engagement, and assurances that the state wouldn't descend into manic episodes like the Cultural Revolution once more. Many of these people are still well off, though they're not sure where next to make money.
And yes, a still-greater share of younger people are upset. The youth unemployment rate is high, though it was high even before Covid. More importantly, they know they've missed the two great drivers of wealth in China: property and manufacturing-led exports. They might work for an internet platform, but those jobs tend to be grueling, and there's an ongoing trend of young people discovering the virtues of chilling out and going to the countryside. It's worth pointing out, however, that there are many pro-regime young people. In surveys, young Chinese report being more patriotic than the previous generation. So I feel that their views are polarized: both more young people are happy and more young people are upset.
I should also point out that most of these comments apply to folks in urban areas. Those in rural areas have missed the economic opportunity of receiving a property at below-market value when the state started to privatize housing a few decades ago, which has been one of the greatest wealth transfers in history. They know that they're behind urban elites, though they're not necessarily too upset about that. Xi has made a big initiative of revitalizing the countryside, which has made these rural areas nicer places to live. And the sense of political folks in China is Xi can count on broad support from those who live in rural areas and third-tier cities, since he has talks a big case of prioritizing the development of these regions.
N.S.: The Zero Covid policy is long gone, but did it make the Chinese state more intrusive into ordinary people's lives in a lasting way?
D.W.: Beijing asserted sweeping new powers to intrude into the lives of people during the pandemic. A paper by Yutian An and Taisu Zhang spell out how the most local level of the Communist Party—the neighborhood committee—now has unprecedented powers to regulate the lives of citizens (https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4356026). Beijing has tracked location history based on mobile phone usage, developed the legal authority to extricate people with Covid from their home to be deposited into centralized quarantine authorities, and declared that it would not issue new passports to prevent overseas travel. The state has since dropped nearly all controls on freedom of movement. But I have two questions for the future. First, how easily will Beijing decide to re-impose these restrictions for other crises? China's leaders don't always exercise restraint once they know they have a useful tool for social control. Second, what will the neighborhood committees do with their newfound powers? The paper by An and Zhang make clear that local authorities are the most disliked level of government: can they stop themselves from causing greater discontent?
N.S.: Are state intrusions into personal life, like Xi's edicts on video games and online fandoms, now the norm, or was that more of a brief abortive episode?
D.W.: Under Xi's rule, the state has steadily increased restrictions on freedom of speech. And I would say that it is intruding more often on freedom of conscience. China's civil society was at best fledgling at the start of Xi's rule; he has strangled it further and isn't letting go. People working on NGOs, for example, on civil equality or press freedom have faced considerable harassment. And yes, video games entered the spotlight because the parts of the state views them as "spiritual opium." Therefore I've thought of Xi's program as analogous to the God of the Old Testament: a wrathful entity that demands harrowing displays of fealty to demonstrate commitment to a values-based faith.
The celestial authorities are not just enacting a moral program, of course: they have also made life more materially comfortable. I still think of Shanghai as one of the greatest cities in the world: a highly-developed service and food sector; well-functioning infrastructure; and more greenery every year. But I wonder how long people are going to be happy about this trade. China's growth is slowing, which might make it more difficult to keep investing in urban improvements, and at some point people may feel that the cultural and intellectual environment has become unbearably stifling.
N.S.: Now let’s talk about how this new state-centric approach will affect multinational business and its relationship with China. My own sense has been that while most of the foreign business community has soured on China a bit in recent years, the U.S. finance industry is still pretty gung-ho for a policy of "engagement" and kind of hopes that if the U.S. puts less pressure on China, we can return to the old status quo of 2015 or so. And my sense is that this is being driven by China's willingness to open itself to more foreign investment, especially in real estate, which has some Western companies salivating over the possibility of big returns. How accurate do you think that impression is?
D.W.: I'm not sure I'd sign on to this argument. I agree that there is still significant cheerleading of China's growth among US financial investors. But these are people who famously make up "hot money" and who only sometimes chase long-term returns. By contrast, corporations tend to own their factories and immovable assets for a long period of time. My sense is that there are still a lot of foreign businesses that make huge profits in China; they've just learned to keep their mouths shut so that their executives don't drift into the sight of certain Congressional select committees. Meanwhile, I suspect that if growth in China disappoints the US financial community for much longer, then they will drop their cheerleading soon enough. There are always exciting frontier markets for the enterprising sell-side analyst.
N.S.: How about "decoupling", or "de-risking" as the U.S. government now wants to call it? You've written that many multinationals are now trying to manufacture in China for the Chinese market, but manufacture elsewhere (India, Vietnam, etc.) for the world market. Why are they following that strategy? Also, are we seeing Chinese manufacturers start to outsource their own labor-intensive assembly work to lower-wage countries, while maintaining higher-value component assembly, design, and branding in China -- much as Taiwanese and Korean manufacturers outsourced assembly work to China in the 2000s?
D.W.: The first thing to say is that China remains an enormous market. And for many multinationals, it represents their best growth story over the next decade. If you're selling certain segments of industrial equipment or health goods, China remains a better market over the next few years than India, Southeast Asia, or Africa. And even if you're not expecting China to be a great source of growth, it is still too large of a market to give up.
Nonetheless, there are plenty of reasons to diversify production out of China. Partly it's because labor costs in China are no longer so cheap: Chinese firms have taken the lead in outsourcing labor-intensive work—like making textiles or toys—to cheaper markets. For foreign firms, it's because the risks of producing in China are now higher than ever. It's way too easy to draw a parallel from western sanctions in the aftermath of Russia's invasion of Ukraine to military action over Taiwan. Furthermore, China's lockdowns during zero-Covid have made manufacturers feel that it's no longer the most reliable place to produce. And this greater centralization of power under Xi—as well as all the geopolitical rumblings from the US—are not soothing their nerves.
What to do? Well, the way to thread the needle is to continue producing goods in China for the large and possibly still growing market. At the same time, firms are trying to move the export-bound production from China to countries like Vietnam, India, and Mexico. I expect that in a decade we won't see that China makes 90% of the world's iPhones, for example, while making up around 20% of its market. That gap will steadily decline. It will be a slow process, however, with plenty of frictions.
N.S.: Finally, let's talk a bit about the U.S. response to China. The U.S. is pivoting to industrial policy, and this is clearly a response to China. In fact, the CHIPS Act and the Inflation Reduction Act seem to me a bit like scaled-down mirror images of China's industrial policies promoting the semiconductor and EV industries. Given your knowledge of Chinese technological strengths and weaknesses, and the successes and failures of Chinese industrial policy over the last decade, what advice would you have for U.S. policymakers as they embark on a new era of industrial policy?
D.W.: The US is getting ready to spend a lot of money to achieve technological leadership. But the Chinese know better than anyone that enormous spending is only the entry ticket for competition. To do well, the US needs to build.
And I think it's fair to say that US manufacturing has not covered itself in glory over the past two decades. Former champions like Intel and Boeing have stumbled. American firms struggled to retool their production to make PPE in the early days of the pandemic. And infrastructure projects are subject to ludicrous cost overruns relative to the rest of the developed world. There's no single reason that the US has done poorly on building. But it has to figure out how to improve generalized manufacturing capacity.
The challenge is even greater since—in certain sectors—the US is trying to engage in technological catch-up with a lower-wage competitor. That's the case for most of clean tech, where US firms are technologically behind their Chinese counterparts in solar and batteries. The reality is that the US will probably never produce goods more cheaply than China. So it has to work on beating China on technology.
It's also worth pointing out that China made it to where it is today by welcoming foreign investment. The likes of Apple, Tesla, and Intel have all invested large amounts in China. Most notoriously, Beijing had a policy of requiring automakers to enter into joint ventures with local firms, in which they traded process knowledge for market access. Meanwhile, the US is hostile to major investments by Chinese batterymakers domestically. I think that it should welcome investment from technological leaders.
That was a very good article. Very insightful.
He is also an especially effective communicator. In both audible and written discussion, a tendency today is hold too many ideas at one time and use an abundance of commas. Appreciated Mr. Wang's ability to pick up one item and finish with a period. And then go to the next item. I didn't have to re-read paragraphs as is too often the case. Just a side-note that became obvious early in the interview.
Truly excellent of course (Dan is excellent, your questions the right ones). One key theme emerges: that growth in both inventions and ideas that come from the 'fringes' ("its scientific establishment is unused to puttering around the fringes of new fields," "It would be good, I think, if the Chinese state can one day learn to leave people alone") won't happen when the idea of being 'left alone' is not a state or cultural value. I once met a philosophy grad student in Hangzhou working on Rawls who said his research was frowned upon because the very idea of the single individual standing behind the veil of ignorance looking out at his possible life was anathema to the Party. It is very good to consider, as you both are doing here, the economic and social trajectory of a nation that does not particularly value puttering around the edges of things.