The End Of China’s Miracle?

Episode Summary

China's emergence from its stringent zero-COVID policy seems to be the opposite of controlled and competent, two words that have otherwise been frequently used to describe its balancing act between capitalism and one-party rule. Beyond this, we are witnessing an unprecedented convergence of factors: a government crackdown on domestic Big Tech, population decline, a persisting real estate crisis, and the Biden administration’s recent introduction of some of the most draconian export controls in history. To discuss this crossroads in China’s economy and society, Luigi and Bethany talk to Chicago Booth’s Chang-Tai Hsieh. Amidst the paradox of escalating tensions and record-breaking bilateral trade, they discuss whether we are underestimating China, what advice to give to Western businesses operating there, and the long-term prospects for the country's economy and their global implications.

Episode Notes

Show notes:

  1. On February 9th, 2023, "China’s New Covid Strategy," the next webinar in the Stigler Center's series on China's political economy, will feature Chang-Tai Hsieh, along with Schwarzman Scholars/Harvard Medical School's Joan Kaufman and the Financial Times' Nian Liu (Stigler Center Journalist in Residence, 2021). Register here.
  2. Revisit previous webinars hosted by the Stigler Center on China’s political economy and read a summary: 
  3. Economists share blame for China’s ‘monstrous’ turn, Janos Kornai in the Financial Times.

Episode Transcription

Chang-Tai Hsieh: The fundamental tension is, basically, how do you reconcile a market economy with a Leninist political system? What you have seen in the last three weeks is, I think they’re really in a sense of panic.

Bethany: I’m Bethany McLean.

Phil Donahue: Did you ever have a moment of doubt about capitalism and whether greed’s a good idea?

Luigi: And I’m Luigi Zingales.

Bernie Sanders: We have socialism for the very rich, rugged individualism for the poor.

Bethany: And this is Capitalisn’t, a podcast about what is working in capitalism.

Milton Friedman: First of all, tell me, is there some society you know that doesn’t run on greed?

Luigi: And, most importantly, what isn’t.

Warren Buffett: We ought to do better by the people that get left behind. I don’t think we should kill the capitalist system in the process.

Luigi: The Chinese economy today is the center of attention, for many reasons. First of all, we’re all very curious about how it will emerge from COVID. The strength of its recovery will have significant influence on the health of the entire world economy.

But even more importantly, the long-term prospects for China are very important for the future of the capitalist system. China is very often portrayed both as the biggest success of capitalism and as the primary alternative model to capitalism. Whether either is true and how the Chinese economy will influence not only 2023, but the rest of the first half of the 21st century, are extremely difficult but fundamental questions. To try to answer them, we invited a China expert, my colleague Chang-Tai Hsieh, professor of economics at Chicago Booth.

Chang-Tai Hsieh: Let me start off with the question that you asked about whether what’s happened in China over the last few decades is a triumph of capitalism, or whether it’s a challenge to capitalism. I very much view it as it represents a triumph of capitalism.

Let me describe what the system was like in China 15 years ago. It’s a system of what I’m going to call, for lack of a better term, crony capitalism. If you have a project, you find somebody in the Chinese local government to become your partner.

It’s also a hugely competitive system. That is, it’s not that there’s one local government for you to do this with, there’s several thousand of them. In large segments of the economy, many, many businesses start to become part of this cronyist system where they basically got access to everything that they needed. Where they had, think about it, good capitalist type of institutions.

It’s a very different way of doing it, but I think that the outcome at the end of the day is the same. If you think about what that does in terms of the loyalties of the local politicians, you have these businesses depend critically on these local politicians. And what it also does is that it basically makes the local politicians start to care a lot more about these local businesses that they are responsible for than what their bosses in the party apparatus wanted them to do.

The party has been responding to this by, basically, cracking down on all the possible sources of political opposition, including some of the most successful Chinese firms. It started in roughly 2018, when you start to see the crackdown on the big financial conglomerates, and then, starting in 2020, you start to see the crackdown on the tech firms.

The really interesting thing that we’ve seen in the last three weeks is that campaign that they have been on for the last five years of cracking down on the large firms, they have basically said, that’s over. I think that the situation that we are in now, my interpretation is that the party is really in panic. They are seeing that growth is low.

I mean, the other thing that I think has really contributed to their sense of panic is the rules that the US government rolled out in October of 2022. I think they were really shocked by that. They never thought that the US government would do what they did, where they basically rolled out these draconian export controls, where it was clear that their goal was to kill the Chinese semiconductor industry, regardless of whether they were private or whether they were small or whether they were big, regardless of whether they were Chinese firms or whether they were foreign firms. The export controls apply to Intel’s facility in China.

And then the other part of the controls that were laid out is that they made it illegal for an American citizen to work for a Chinese semiconductor company, which really kills them, because all of their senior management and all their senior engineers and scientists are US citizens. And never, ever, has the US government ever done something like this. I think they’re really in a sense of panic.

Bethany: Is the messy way in which China has exited zero-COVID emblematic of this panic at all? I guess I’ve always thought that if there were two words that defined the Chinese state, it was control and competence. The exit from zero-COVID appears to be neither controlled nor competent. And that could be a misperception on the part of outsiders, or it could be accurate, but I’d love to know what that says about the state of affairs inside China.

Chang-Tai Hsieh: I think that it’s panic. The protests in November really shook them, because they were nationwide, and they were also not restricted to specific groups. It was the young, it was the elderly, there were professionals, there were blue-collar workers. I think that they were really terrified by the protests to end COVID-zero in the way that they did.

Bethany: Is the verdict from where we are now that crony capitalism works, that crony capitalism doesn’t work, or that crony capitalism can work for a period of time?

Chang-Tai Hsieh: I guess I would say that it depends. Let me give you a story to illustrate this, not from China but from another country. In the Asian financial crisis, for people in Asia, there was this picture of the managing director of the IMF standing over the shoulder of Suharto. The event there was that Suharto was being forced to sign a law where he would close down the banks that were owned by his children. That was the condition that the IMF imposed for providing financial assistance to Indonesia. This was very much the way that the people at the IMF thought about it, that one of the reasons that Indonesia was in the state that it was in in 1998 was because of the system of crony capitalism. That event was meant to send a signal to the world that the system of crony capitalism is over. You no longer need to give a 10 percent equity share to one of Suharto’s kids.

This is the story that was given to me by a wealthy Chinese entrepreneur. The way that these deals took place in Indonesia, it was almost always Chinese entrepreneurs, and they basically made deals with somebody from Suharto’s family. The question I posed to him is, “Well, is this what you thought? Is it what you thought?” And he said, “No, no, no. Of course not. What went through my mind was that, oh, my God, Suharto is so weak that he cannot even protect his children. How can he protect my property?” And then he said, “As soon as I saw this, I took all my money, and I went to Singapore.”

What happened afterwards was basically five years of economic recession for Indonesia. Because the question is, there clearly is a system of crony capitalism, and that was the way that things worked in Indonesia, but what is the counterfactual? When you get rid of the system, is the counterfactual that Indonesia is going to be like Sweden? Or are you going to get back to . . . I mean, this was exactly what the guy said. He said, “I was afraid that it was going to go back to the days of chaos under Sukarno from the 1960s, when I had no idea what was going to protect my property.” Whereas in the days of Suharto, I understood very well how to make my business grow. There were very clear rules of the game. It’s a terrible system in many ways, of course. It’s a terribly managed system. But the question is, it’s a terrible system relative to what?

Luigi: During the financial crisis, Raghu Rajan and I wrote a piece called, “Which Capitalism?” in which we compared the Suharto model with the, if you want to call it, Anglo-Saxon model. We said that when you are far from the technological frontier, both could work pretty well. The problem is, as you become more sophisticated, the system based on an influential man or party really becomes more and more difficult to sustain, and eventually you collapse.

Let me add something else. In the period of rapid growth, it’s very easy to have incentive schemes that work, because the promise of the future is very large, and the temptation to steal what you have there is very small. Italy after World War II worked exactly in this way. There wasn’t a communist party, it was called Christian Democrats, but it worked exactly in the same way.

Then, in ’92, came a crisis. We tried to clean up a bit of the corruption, but the reality is, we couldn’t go to a system of arm’s-length contracting and so on and so forth. And without the promise of a brilliant future, the system collapsed. From basically ’92 to today, Italy has not grown; it has been a complete disaster.

What are the chances that China is entering this phase? Because so far, the prospects were fantastic, and it grew like crazy, but just now we learned that population has started to decline and might go in the opposite direction.

Chang-Tai Hsieh: I think that’s absolutely right. Another way to put this is that growing in this way, growing in the pre-1992 Italian way, growing in the Suharto way or growing in the Chinese way, it works really well until a certain point. But then what it also does is that it puts you on a path which makes it much more difficult to get to a place that is different.

Bethany: On the morning that we’re recording this podcast, the Financial Times just published the first piece in a series investigating how Apple has tied its fortunes to China. Apple seems to be a pretty extreme example in terms of US companies that have built their future on China. But what do you think the ramifications are for companies that have spent decades building supply chains in China? If you could tell them what to do, would you be telling them to disentangle, or would you be telling them to stay tangled?

Chang-Tai Hsieh: I would be telling them that they need to diversify. I don’t think that fully disentangling is an option, but they clearly need to diversify.

Bethany: Going back to your notion of a panicking China, I’m going to ask the myopic, self-centered American question. Is that good or bad for America? Or, if we broaden it out a bit, is that good or bad for the rest of the world?

Chang-Tai Hsieh: It depends on how you want to think about China. As an economist, we believe that global prosperity is good for everybody. There’s also, I think, this growing view among the American political establishment, and I’ll be blunt about it, that we in the US and the world would be better off if China were stuck at what they were in 1978. I don’t really know how to think about that. Let’s just say it depends on whether I’m putting on my hat as an economist, or whether I’m putting on my hat as, let me just say, somebody from the national-security establishment in the US.

Luigi: Even as an economist, of course there are a lot of gains from trade, and we recognize them. But I think that we should recognize more the zero-sum games where the United States is getting an enormous advantage. Think about, for example, the extraordinary privilege of everybody using the dollar and the kind of rent that we get from that every year. Those are enormous rents. It’s awesome rent, because people export goods to this country, and we give them a piece of paper. That’s, like, really valuable. Not to mention the competition in the world. Coming from a country that is a province of an empire, I think that you see that when push comes to shove, American companies have the support of the US government, which has the implicit threat of the US Army and has a comparative advantage. So, I think that the gains that US firms, and in general American citizens, are getting as a result of the dominance of the world is not trivial. And that gain is at risk from a country like China, which says, “At the very minimum, we want to be on equal footing.”

Now, you can argue that China thinks that they are the center of the world, because they’ve always been at the center of the world for most of their history. So, they want to be not on equal footing, they want to be on a superior footing. But let’s take the generous interpretation that they want to be on an equal footing, so that we have half of the international institutions, like the IMF, the World Bank, in Beijing and not in Washington.

Chang-Tai Hsieh: I take your point, but let’s ask the same question from the vantage point of somebody from Italy. Nobody is using the Italian currency. Italy has no hope of dominating world institutions like the US. So, let’s ask the question from the vantage point of an Italian, or from the vantage point of someone British, or from the vantage point of somebody from France. Are they better off if China continues to grow at 10 percent a year for the next four decades, or are they better off if China goes into economic decline?

Luigi: But that’s an easy one. Of course, they’re better off if China continues to grow, but they’re better off for two reasons. One is the strict economic reasons that you mentioned, again from trade, but that would be true also of an American. But in addition, for a European, I can say, I think having more of a balance of power at the world level may actually be beneficial. My view is that Africa benefited tremendously from the Cold War, because there were two potential sources of power, and by playing one against the other, they were getting something out of it. In a world in which there is only one hegemon, you can’t play that game.

Bethany: I have a slightly different way of asking the question, maybe, which is, what if it’s not China versus the US, but what if it’s politics versus economics? I was thinking about this, because for all the political talk and the very real moves that the Biden administration has made against China, Bloomberg just reported that Chinese-US trade is reaching record levels. You have this economic cooperation that is still taking place at the same time as the political rhetoric is escalating. At the same time, China still owns almost $1 trillion of US debt. We can’t handle it if they start selling, so does economics actually prevail at the end of all this?

Chang-Tai Hsieh: I think about this in the way that Gary Becker used to think about discrimination. Let’s say the CEO of this company is a racist. His basic answer is that that’s fine. That’s fine that the guy is a racist, because he’s going to pay a cost. He’s going to have to pay higher wages to get comparable workers. And as long as you’re willing to pay for it, it’s all monetized.

The question is, are we OK with that? Are we OK with somebody being a racist and being fully willing to pay the cost? You can make an argument that even if that person is willing to pay the cost, we are not OK with that. If the Chinese are willing to pay a cost for their political goals, to have this Leninist political system, they’re going to suffer some economic damage from that. Are we OK with that? And I think that there are good reasons for why we may not be OK.

I don’t really know how to think about that. Let me try to answer this by telling . . . In 2019, János Kornai had this op-ed in the Financial Times that was titled, “I Have Created a Frankenstein.” What he was referring to was that János Kornai was really a central figure in China’s economic reform in the 1980s. He basically was a central person in designing the initial package of Chinese economic reform. He was a key mentor to the first wave of young Chinese that left China. He trained them at Harvard, and some of the most senior people in the party, senior economists of the party, were former students of János.

What he said in this piece is, “In the 1980s, I believed that by helping China’s economic reform, this would be a force of good in the world. But look at what has happened. It’s become a lot more successful than what I thought it would be. The economy has grown, and look at what they have done with their economic success.” And then he said, “Mea culpa. Mea culpa. I made a mistake in the 1980s.” And he said, “It’s time for us to say, that’s enough. The best thing for us to do is to stop helping the Chinese economy grow.”

That’s one view of it, and I will say that that view really shook his former students in China, because these are some of the most senior people in the party, and he was a critical figure for them. He was like their father, mentor figure. And having him say that, I think, really shook a lot of people to their core.

But it’s a deep question that you ask, Bethany, and I don’t . . . Because there’s one part of me that I think views that growth is good for everybody, and then, there’s also this . . . I mean, that’s sort of my training. That’s generally the way I think about the world. But then, it’s also, I put on the other parts of me, and I don’t quite know how I come out.

Luigi: Let me help you in this calculation, if I may. If we have a small shop owner who is racist moving into town, we can dismiss it, right? Because it’s not going to affect the equilibrium, it’s not that important, et cetera. But if we have a big, big guy who owns half of the town with a very, very clear racist opinion, as a nonracist person, you feel completely affected and you want to politically resist this entry. I feel that the problem with China is how big it is and how influential it is.

I got really scared when the general manager of the Houston Rockets, Daryl Morey, had to apologize for having retweeted a very benign tweet supporting freedom in Hong Kong, something that we do all the time, and people do all the time, and it’s not such a big deal. And all of a sudden, this becomes a hostile gesture to China. At the beginning the NBA . . . Then, they retracted a bit, but at the beginning the NBA went and did hara-kiri in front of the Chinese government.

My concern is that Chinese buying power, which is controlled by the Chinese Communist Party, is so large in the West that, basically, it’s changing the nature of democracy in the West as a result. What do you think about that?

Chang-Tai Hsieh: I think there’s something to that argument. I would just say that the Chinese Communist Party, I don’t think they really care about what goes on in the rest of the world. I think their main focus is about domestic political control. I don’t really think that they pose a threat to democracy in the rest of the world.

They clearly pose a threat to democracy in China. Even if they only pose a threat to democracy or to China, I don’t really completely buy the view that, well, it’s China, and we shouldn’t care about what goes on, what the Chinese political system is. I think that we should still care. So, I put some weight on that. You can see that I really am conflicted here.

Luigi: I buy 100 percent the fact that China is only interested in China, and so, they’re only interested in their internal politics. However, for example, a US election could have a huge impact on that. Imagine there are two candidates, and one is more pro-China, and the other has a tougher stand on China. I don’t think it would be past the Chinese government to interfere in the election.

We went on a rampage because of some interference from Russia. We still don’t know the magnitude of it. But if we have serious interference from China, that would be massive. And I think that that’s very possible today, and maybe it’s happening today and we’re not even sure, because it is very under the radar. The pressure that companies exert not to detach from China is probably huge, and it’s not something that we can measure very easily.

Chang-Tai Hsieh: I think that’s right. I don’t have a sense that they are in the business of funneling campaign contributions to political candidates. My sense is that they don’t quite know how to do that, but there could be a day in which it happens. I don’t know. The way that they do it is that there are lots of American companies that have extensive business operations in China. Hank Greenberg and . . . I must know the CEO of Tesla. I’m drawing a blank this afternoon. Musk.

Bethany: Elon Musk.

Chang-Tai Hsieh: Musk.

Bethany: Oh, my God. That makes me so happy, that you drew a blank on his name. I think that’s fabulous.

Chang-Tai Hsieh: Musk. He understands well that his billions of dollars of subsidies depend on the party. Whenever the person that is responsible for giving him a subsidy says, “Hey, it would be helpful if you were to do this,” then, obviously, he’s going to do it. He’s going to do it. And they don’t directly have to say, “Oh, what you get here depends on you trying to help us out on this other dimension.” I mean, Bethany, you have covered this type of thing for a long time, so I think that you probably have a good sense of how this thing actually works.

Bethany: I do, and I think it’s a really interesting point. I guess it ties in, to me, to the discussion we are having about whether economics should win and whether we can even control whether economics wins. Given the subterranean ways in which economic pressure exerts itself politically, it makes me worried about how much of a choice we have in saying this is what the policy should be, given these, again, subterranean channels through which economic pressure is exerted. Does that make sense?

Chang-Tai Hsieh: Absolutely. Yeah.

Luigi: Let me try something. Imagine that I was aggressively anti-Chinese. I’m not, but suppose I was. And I say, “Oh, you’re telling me that they are in a panic. This is the moment to actually be tough. Because if they are in a panic, we can obtain a lot by putting them with a shoulder against the wall.”

On the other hand, somebody might say, “Wait a minute. You don’t want to put a powerful entity like China with a shoulder against the wall, because you never know how they will react.” I know the two are extremes, but where do you fall into this spectrum?

Chang-Tai Hsieh: The way I would approach it is that I would couple things. Suppose the question is, how should the University of Chicago engage with China? And I think about, what is it that the Chinese want? Science and technology stuff. They don’t really want engagement in the humanities and the social sciences, because that is politically dangerous. I would couple these two things, unless your goal is to completely blow China out of the water, and I guess I’m not at the stage where I think that is what we should be doing.

Luigi: Thank you, Chang. That was great.

Chang-Tai Hsieh: OK.

Luigi: Bye-bye.

Chang-Tai Hsieh: Thanks.

Bethany: It seems so right to me, that yes, the messy end to China’s zero-COVID strategy is an interesting analogy for the end to the Chinese economic miracle. This might be my limited imagination, and I’m going to contradict myself in a second, but I have trouble seeing a way in which it’s not. Given the other challenges in the Chinese economy, namely the property sector, and given the demographic issues that are facing China, I don’t see an easy way out.

That said, there’s a guy who’s an old China hand that I’ve talked to a lot over the years, and his position has always been that the West always, always underestimates China, and that we don’t understand, and we constantly think that it’s going to play by the same rules that the rest of the world has played by, and that we just don’t get it. And so, I’m very aware of the fact that I really just don’t get it.

Luigi: Yeah, I feel the same way. It’s a bit like Mark Twain. The news of my death has been vastly exaggerated.

Bethany: Yes.

Luigi: The news about the end of the Chinese miracle has been announced so many times—

Bethany: Yes, and it’s been wrong every time.

Luigi: —and every time, so far, it’s been wrong. Now, eventually it’s going to be right. The question is—

Bethany: While we’re on the cliché front, the broken clock is right twice a day.

Luigi: Yeah. Eventually, it is going to be right, and the question is whether this is the time. Certainly, the convergence of factors is unprecedented. As you said, it’s not out of the question that they might pull out of it in some miraculous way. They’ve done it before. But I think this time is stronger than the others.

Bethany: It is. Maybe it’s a piece of this rather than a tangent, but the fact that China insisted on developing its own vaccine rather than using the vaccines developed in the West, and that that vaccine has been shockingly less efficacious than the Western vaccines is an interesting tangent to this story. Because it does, in some ways . . . As messy and downright disgusting and wasteful as our healthcare system is, at the end of the day, that mess and waste seems to have beaten out central planning when it comes to developing a vaccine that can work. Because I was just going back and reading some of the remarks at the beginning of the pandemic, and they were both that authoritarian countries were probably better at managing pandemics than democracies were, and that China’s response to the pandemic was, whatever it was, by far more competent than the US response and then the Western response.

On top of that there’s the fact that the West lurched to copy China into lockdowns, which we could never really successfully emulate. But we lurched into copying China rather than having the self-confidence, the intellectual self-confidence anymore, to say what works for the West, and it may not be what works for China. It was all done under the guise or under the belief of extraordinary Chinese competence, and now we look back three years later, and it turns out that maybe that wasn’t quite what it was cracked up to be.

I think comparing that to the economics . . . Everybody has believed for a long time that the Chinese economic miracle was a miracle, and it was, and it would never come to an end. What if it contains within it some of the same failings?

Luigi: What we don’t fully appreciate is that in part of this miracle, like in part of every success, there might be the seeds for its own demise. Clearly, the zero-COVID policy was very successful, until it wasn’t. And I think that what I fear, or what I heard Chang say—and I think there are a lot of elements—is that maybe also, in this case . . . The Chinese miracle has been phenomenal, probably the most important in the history of the world. Because having such a large nation develop at such a fast pace for 40 years has been game-changing. But like every success sows the seeds of its own demise, the seeds are coming to a point that they may have an impact.

Number one, politically, you have a system that is about the preservation of the party. That works really well if the preservation of the party coincides with economic growth, as it has done so far, but doesn’t work equally well when it doesn’t. That’s number one.

Number two is what Chang was saying about the economy. I think it’s the best interpretation I’ve ever heard of the Chinese economy. It is an economy where there is plenty of corruption, but the corruption is given in the form of equity rather than in the form of bribes. We know that equity is very good in a world of growth. It’s a corrupt system with terrible distributional consideration, but if you have double-digit growth, who cares about the distribution? And if you have double-digit growth, who cares about the ultimate efficiency, as long as you can paper it over?

But now that the growth might slow down, this system might implode, and it is not easy to find a replacement. It’s a bit like Italy. Everything is sort of among friends, but the moment you actually have to create a more institutionalized market, you don’t have the institutions. And those institutions cannot be created overnight. All of this under the pressure of competition with the United States. Until recently, the United States was not competing with China. Now, the United States is competing with China, and beware.

Bethany: There’s actually an interesting analogy to Enron, because Enron created all these structures that only worked as long as its stock continued to go up. And if its stock ever went down, then the whole thing came crumbling down. What you and Chang have discussed with China’s method of crony capitalism is also a system that, in effect, only works—and works really beautifully—as long as the stock is going up. But if the stock ever starts to go down, then the whole thing crumbles.

Luigi: I think that what it tells us is that the Chinese government is first and foremost dedicated to the preservation of Chinese Communist Party power. Everything is instrumental to that. It’s not necessarily a government aimed at economic growth. Economic growth is functional to the survival and success of the Communist Party.

What I realized talking to Chang is that China is in panic mode. It clearly was in panic mode about the end of COVID, and that’s the reason why it ended up being so brutal. I don’t know whether we will ever know what the human cost has been, but it’s certainly very large. And also, the part that I really did not know, and Chang was very clear about, is how much what the Biden administration is doing is actually biting. The prohibition of having any US citizen involved in anything that has to do with semiconductors is a really, really big deal for China.

Bethany: If I were going to play devil’s advocate and try to challenge you—and I don’t totally understand this number, maybe you do—but the idea that trade between the US and China is hitting record levels again does seem to suggest that some of what the Biden administration is doing is, there’s a lot of rhetoric, and it does seem like this action would be a major one economically, and yet trade between the two countries isn’t slowing down. What’s true at the end of it all? Is the rhetoric between the US and China more true, or do the numbers about trade speak to a different truth?

Luigi: More the latter. I think that the Biden administration is probably smarter in its policy vis-à-vis China than the Trump administration was. Trump was not particularly well articulated in trying to hit the soft spot. If we keep importing toys from China, I don’t think this is damaging the United States nor particularly helping China. It might help China a bit because of the unemployment rate, but I don’t think it’s going to change the balance of power in the world. However, if we transfer major technology to China, this is going to change the balance of power in an irreversible way. Up to 2016, I think the United States was fairly oblivious to this fact.

I heard Chang in a different talk tell the story about how, for example, the Chinese auto industry started to copy the American one. And the American audience kind of understood, but not to the full extent. I think there’s been a lot of appropriation, which I don’t think is particularly bad, because every developing nation has done that, and the United States were masters at it when they were an infant republic. I don’t think it’s necessarily terrible, but it’s something that, if you care about the world of geopolitics, is very important. The semiconductor industry is a crucial step, and I think that the Chinese see this very clearly, and they’re fearful.

Now, the question I don’t have very clear in my mind is, how do you prevent this from turning into a dangerous panic? I think we discussed this early on, when we were talking about Ukraine last year, that the Japanese attacked Pearl Harbor because they knew that they only had oil for 12 months, and so that was the only chance of survival. When you put a power with a shoulder against the wall, you don’t know what they’re going to do.

Bethany: Yeah. I guess it goes back to my question, is this a good thing or a bad thing, or a mixture of both? And I thought Chang was very nuanced about that. I don’t think, though . . . I just wanted to make a point on your idea that no one understood what was happening. I think people absolutely understood. There were warnings going back to the 1990s about what would happen if we outsourced American technology to China. It’s just that no one cared enough to do anything about it. I can’t figure out if it was an American naïveté that, “Oh, democracy has won, and capitalism has won, and this is all going to work out to our advantage in the end, so who really cares?” Or if it was just that business trumped national politics for a long time, national identity. And so, because it was good for various companies economically, no one stopped the economic gravy train, even though it wasn’t good for national security or necessarily for our future.

But the idea that no one saw that this was happening—plenty of people saw that it was happening. I do wonder, for all the horrors of President Trump, another question I was going to ask you: did his actions make it possible for Biden to take his actions? Would President Biden have been able to act if it had not been for what the Trump administration had already done? Or did the Trump administration’s actions make it harder for Biden to act?

That was a lot. Sorry.

Luigi: Yeah. Actually, let’s divide it into two. Let’s go to the first point that you raised, and let me throw you the card that Chang used that I thought was very interesting: the case of Kornai, this economist. I had not read that op-ed in the FT at the time, and I went back and read it. I think it’s a fascinating piece, because first of all, Kornai is a Hungarian economist who grew up in a communist country, so he’s not your typical naive American who sees only one side. And while he is an economist, I don’t think he was particularly in the pocket of business or American business interests. I think he was generally a believer that by opening up the economy, giving them the chance to blossom, they would turn into a democracy and would become part of the rest of the world.

If you think about it, this is what happened with Germany and Italy, but particularly Germany that was, until the end . . . Italy, as you know, conceded way before the end of the war. But Germany went to the end, but then, it became one of the strongest US allies. The same is true, to some extent, of Japan.

I think it was a legitimate bet that went wrong. And it’s easy to say ex post that you were stupid, or you didn’t see it, but . . . And what impressed me, actually, is that János Kornai was able to say, “We made a mistake.” It’s not common to see people say we made a mistake, especially in the world of economists. We economists are all arrogant, so we never say we made a mistake.

Bethany: Certain journalists are not any better, by the way.

Luigi: And he did, and apparently it had a huge impact on China, because he had so many students there. He doesn’t pull punches in his article. He’s very harsh about what China has turned into. I think that Chang put it very strongly. Are we at the level that dealing with China is dealing with Nazi Germany? My first reaction would be, no.

Bethany: No. Right.

Luigi: But then you think a little bit more calmly and you say, “OK, if all those stories I read . . .” And I honestly don’t know whether they are true, for example, about mass sterilization of the Uyghur population. If these stories are true, what is the difference?

Bethany: For sure, I did not understand until Chang articulated it. And this might just be my failure to have read enough, but I did not understand how severe the restrictions the Biden administration had put in place were. I don’t think I realized the prohibition on US employees, et cetera, et cetera. And that feels like a lot more than rhetoric to me, to answer my own question about how much of this is rhetoric based on the trade numbers coming out of China and how much this presages a real economic change between the two countries. That feels real.

Luigi: Absolutely. Absolutely. I think it is real. And the decline in investments, I think that investments look further away than trade. Trade is basically now; investment is about the future. And if you look at the investment, particularly venture-capital investments in technology, they’re basically zero now. That is a sign that the world has changed dramatically.

Bethany: Although, countering that, the series that the Financial Times has run about Apple’s involvement in China and the extent to which Apple has bet on China and, basically, entangled its supply chain with China, also says that—and Chang seconded this—that it’s going to be very, very difficult for a company like Apple to extricate itself. And for other companies, too. That does run counter to whatever the US government wants to achieve. Just the reality of how deep and strong those ties are, it’s difficult. I remember talking to a semiconductor CEO a while ago, six months ago maybe, and he said, “We all want to get out of China. We all want to diversify our supply chains. What we’ve all realized is we can’t. We’re really stuck.” It’s very, very difficult.

Luigi: Yeah, but at some level you may argue this might be good, because I fear a situation in which the Chinese economy is really free-falling because everybody is running away. And the Communist Party realizes that what are its chances to remain in power, if not, for example, to start a war? Because in this situation, to blame the West . . . If there is nothing to be gained from the West, I think that escalating the tension about Taiwan . . . The Chinese feel very, very strongly about Taiwan and would be very tempted to actually invade.

On the flip side, going back to what—

Bethany: On the flip, flip side. Yes.

Luigi: On the flip, flip side, going back to what Chang was saying, the aspect that worries me the most is, in this transition period, as we have a lot of companies that are deeply entangled with the Chinese market and probably will remain so in the near future, to what extent can US policy be independent from China? To what extent is China able to really manipulate the conversation in this country?

If you have the large companies that want something, and you have a lot of the think tanks, et cetera, who are afraid to actually pick a battle on this front . . . The Stigler Center ran a series of conferences on China to debate these topics. And, by the way, they are available on the YouTube channel of the Stigler Center. But a lot of other centers did not want to associate, et cetera. People don’t want to touch, for example, the Hong Kong topic. If you want to have any relations with China, the Hong Kong topic is radioactive. Not to mention, of course, Tibet or the Uyghurs or civil rights.

Now, you are starting to have a bunch of companies who don’t want their employees to tweet about these things. If you are a company heavily invested in China, you’re putting restrictions on what your employees write on Twitter about China. That starts to really have an impact in the marketplace of ideas in a way that Nazi Germany could not even dream of doing.

Bethany: Yeah. This is a slightly different point, but I was thinking as you talked that it is interesting the number of American companies, as we covered on this podcast, that pulled out of Russia in the wake of the invasion of Ukraine. And yet, China supported Russia in the invasion of Ukraine, and you don’t have any ongoing discussion of whether American companies should be doing business in China or not, because the costs are simply too high. And so, there is a little bit of hypocrisy at work.

Now, that’s not quite fair. I was reading a Financial Times piece just before we recorded this that speculated, based on some demotions within the Chinese party, that even officials in China weren’t aware of how strong Russia’s movement against Ukraine was going to be and that they weren’t anticipating it and they were surprised by it. But, nonetheless, China has voiced support for Russia in Ukraine, and yet there’s no discussion about the morality, then, of continuing to do business in China.

Luigi: But you remember that when we interviewed Richard Edelman and he was talking about why companies were so gung-ho in boycotting Russia, I did ask him what would happen with China.

Bethany: You did. That’s right.

Luigi: Yeah. And he said, “No, China, no.”

Bethany: Right.

Luigi: Exactly. Because it’s too costly. There is a morality, but morality has a price.

Bethany: Yeah. We just finished watching The Good Place in my household. Morality is not supposed to have a price, nor is morality supposed to be outcome-driven. It’s supposed to be pure. If it’s outcome-driven, you don’t get any points by putting a price on it. I’m just kidding. But all of those are really interesting questions.

But I really liked talking to Chang for the most part, because he didn’t pretend there were easy answers. I thought that was . . . And also, my other favorite thing about our conversation with him was that he blanked on Elon Musk’s name. I thought that was priceless.

Luigi: But what I also like is that he had a very interesting strategy to engage with China that basically is playing with China with Chinese rules or Chinese strategy. Because he gave an example, which is a very delicate topic for Chicago Booth, because as you know, we have a campus in Hong Kong that at the moment is frozen because of COVID. Nobody is going in and out, but it is supposed to be active. Hong Kong used to be a place with freedom of speech, and it’s not anymore. You can be detained if you say something that is even vaguely considered inciting the independence of Hong Kong, or threatening national security, which is vague enough. Anything can threaten national security. Even an opinion about COVID can threaten the national security of China.

He said the right strategy is to engage, because they want something from you, but bundling that engagement with a part they don’t like, which is basically the operative strategy that China uses with the West. You want to come here? Yes, come here, but you have to share your technology—whether willing or unwilling, but you’re going to share your technology with us as a condition. We bundle something you don’t like with something you like. That’s what we should do.

Now, to what extent Western institutions, not just firms, but institutions like the University of Chicago, are actually willing to do that, that remains to be seen. But I think it is a very clever strategy.

Bethany: Someone should rewrite Machiavelli’s rules for our current time, and it should include this concept of bundling. Maybe it already did in some way. Maybe I need to go back and read my Machiavelli, but doesn’t it sound classically Machiavellian?

Luigi: Yeah, it is.