The biggest economic story in the world

right now is China's growing dominance

across advanced manufacturing sector

after advanced manufacturing sector.

From electric vehicles, batteries to

solar panels to things that aren't even

traditional manufacturing that are

software like AI and open models where

they become a world leader.

What is happening here is very different

than what we call the first China shock

where China became a big exporter but of

things that were not that important to

advanced economies things that mattered

maybe for particular communities

mattered for many many jobs but weren't

the frontier of economic growth but now

it's different China is very much at the

frontier and they're dominating it and

that is going to transform geopolitics

it is going to transform the politics of

countries many say in Europe where China

is pushing them out of manufacturing

that has been the absolute cornerstone

of their economies. And so I think

understanding it is about as essential

to understanding economics and

geopolitics in the coming era as

literally anything else. Brad Settzer is

a person who follows this about as

closely as anyone on earth. He is a

senior fellow at the Council of Foreign

Relations. He has served in top trade

roles and economic roles in the Biden

and Obama administrations. And so I

wanted to hear his perspective on it. He

joins me now.

>> Brad Sutzer, welcome to the show.

>> Oh, thanks for inviting me.

>> So you've been arguing that the world

economy is going through a China shock

2.0. So for people not familiar with

this, what was China shock 1.0?

2002.

What happens is there's a big jump up in

China's uh exports and at the time it's

mostly in relatively low-end

manufactured goods, furniture, household

appliances,

clothing. Uh and I think there was a

sense in the US that these were not the

industries of the future. And I think

what the China shock 1.0 do academic

literature shows is that even though

these weren't the the industries of the

future, they were still employing a

meaningful number of Americans uh often

in the south, often in the Midwest. And

the China shock is how that impacted

local, not national, local labor markets

that had the most overlap with China.

And this has sort of a a shortrun

negative effect on parts of the economy.

you know, when the local factory closes

down, local real estate prices turn

down. And so, uh, and the people who

sell lunches to the factory workers have

fewer people to sell to. So, it becomes

a generalized downturn in those

communities. That was clearly

underestimated.

And then people have done all sorts of

further studies which correlate the

areas that have the most exposure to the

Chinese export wave to you know deaths

of despair to political realignments

>> voting for Donald Trump.

>> Voting for Donald Trump. But the basic

idea here is that you have a bunch of

places in the Midwest and the South

primarily that are manufacturing towns

>> that their factories are outsourced to

China or the goods are out competed by

China and basically the community goes

into sharp decline.

>> Correct.

>> And we never have a very good policy

answer.

>> I mean I think at the time we didn't

even try to have a policy answer. Uh but

it is actually conceptually difficult to

deal with uh the decline of a small town

when it's big industry. Let's live in

that debate for a minute.

>> What is the argument about whether or

not this rapidly accelerating level of

trade with China is good or bad for

America?

I think the overarching

view at the time uh was that China's

integration into the global economy was

more or less inevitable. Um

and that the negotiated terms of entry

into the WTO provided a reasonable

framework for China's entry full

integration into the global economy.

that trade was fundamentally good, that

there would be shifts across industries.

People would leave their jobs and import

competing parts of the economy, but

generally move to to exporting parts of

the economy or into the services sector.

And that we had a fairly flexible labor

market. And by the way, integration

would be a positive force for China's

political development. It might lead to

uh some forms of of liberalism within

China. It might moderate China's global

ambitions. It would sort of t commerce

would tame the dragon so to speak. And

the other dimension of the argument as

I've heard it and remember it is if

China wants to make cheap goods for

Americans,

people like low prices, they like low

inflation. like why would we fight this

gift?

>> I mean in particular because the

industries that were going to China were

not the source of top you know cutting

edge technology at the time not

generating a lot of high wage jobs. So

there was indeed a sense that you know

consumers would benefit and did benefit

from cheap goods and uh the adjustment

would not threaten the core strengths of

the American economy. I think that was

the the belief. I would put a little

tiny asterisk around the cheap prices

thing. Unambiguously, China's explosion

of exports lowered the price of

manufacturers.

If you look at the overall evolution of

consumer prices during this period,

there's not much of a change. China's

integration into the world economy led

in huge amounts of investment ended up

putting a lot of upward pressure on

commodity prices. So you see oil prices

really take off during this period and

that's an offsetting

change. So you know you got to always

look at both sides of the ledge.

>> Yeah. So when you're going to Target or

Walmart and you're buying clothes and

toys. I mean they really are cheaper. Oh

yeah. Like in real terms from when I was

a kid, but you're saying that you know

what we're not seeing there is, you

know, the price of oil, the price of

>> it cost you more to fill up your car to

get to Target.

>> Um but once you got to Target it was

cheap.

>> Okay. So China shock the reason we use

this term is that this whole argument

got re-evaluated and so which parts of

it would you say panned out and which

didn't

I think the extent to which China would

become a big export market was

overestimated.

Uh China never was fully open to US uh

exports. I mean one of the more striking

things is that after 2004 so two years

after China's WTO entry China's imports

as a share of its GDP start to fall and

then it was not expected in a sense that

China would succeed as much as it did

while retaining the core aspects of its

different economic system. there were

the sense that China would have to

converge have to become more like us

maybe politically but certainly

economically

you know the state would wither away so

stateown enterprises would be privatized

you know 20 years after China joined the

WTO China's economy was you know the

thinking was it would kind of look like

the US or maybe look like Europe it

wouldn't be distinctively Chinese and

that didn't pan out

>> what is distinctively Chinese about the

Chinese economy

>> that's a hard question. You You opened

the door, man.

>> Yeah, I did. I did. Um,

one thing that is distinctly Chinese,

which is not what you would normally

think about in a communist

le society is that China actually has a

rather thin system of social insurance.

It doesn't actually collect that much

tax. Uh, personal income tax collections

are like 1% of China's GDP. It's 8%

here. If you're not collecting personal

income tax, you're not going to be not

going to have the resources to be very

generous uh and helping, you know,

low-wage work. There's nothing like our

earned income tax credit where you get a

subsidy, basically money back from the

government if you don't get paid that

much. The taxation system relies heavily

on taxes on consumption. It's really

quite uh regressive. It hits poor

Chinese workers much more heavily. It

also does not have uh a unified national

labor market. The so-called hookos

system uh basically means, you know,

you're supposed to work where you were

born. You can migrate and leave, but

when you migrate and leave, you give up

certain social rights. You got a

financial system that is fundamentally

state controlled. uh heavily banked, not

so much, you know, like the Wall Street

part of the Chinese economy exists, but

it's much smaller. The old-fashioned put

your money on deposit in a state bank,

very much the dominant mode of savings.

And then the state banks intermediate,

so they can direct credit towards the

goals of the party, towards the goals of

the government. uh sometimes under the

direction of local government, sometimes

under the direction of the national

government. The commanding heights of

the Chinese economy are still primarily

in the hands of centrallyowned

stateowned enterprises. So this is, you

know, why it's sometimes difficult to

sell to China. You want to sell

soybeans, actually you have to generally

sell to the state oil seeds monopoly. Uh

you're not selling to an individual

soybean crusher. uh selling airplanes to

China. You're selling to the big three

state airlines who act as a coordinated

block. Telecommunications, you're

selling to three stateowned companies

whose executives are picked by the party

who take direction uh centrally.

And then on top of that when the

government sets a policy direction you

know say we want to have a semiconductor

industry

ambitious provinces will say well we

should be the province that builds up

China's national champion. Here's an

ambitious guy he or girl looks like they

got a good idea. Here's a whole bunch of

money. We're going to subsidize your

factory. Uh maybe we're going to take

equity. We're going to make sure you get

bank loans. And so a whole bunch of

different firms spring up in that sector

with support and they start competing

very intensely. So it's you know a mix

of state directed and intensely

competitive. I want to draw something

out in the description which I thought

was great of how their economy is

different. China has gotten a lot richer

and less of that wealth than you might

have thought has gone into things like a

universal health care system, a social

insurance system for the elderly.

America got richer. We built social

security, Medicare, Medicaid, welfare,

earned income tax credit, child tax

credit. It China's gotten richer because

it has not allowed a lot of that because

also you have such power over the

financial system. It has just been able

to move much more of that money into

subsidizing

production, innovation in like new

economic areas it wants to dominate.

You know, the basic retirement benefit

that anyone in China gets no matter what

your your residency status is like tens

of dollars a month. It's really really

trivial.

uh the health insurance system, you

know, people aren't confident that when

they walk into the hospital that the

cost will be covered and frequently

there's a lot of uh upfront payments.

And some people also say the the one

child policy and an incredibly

competitive marriage market has made it,

you know, a requirement for young men to

save if they want to get married. All

this has produced an economy that just

saves an incredible share of its uh

national income over 40% of GDP uniquely

high. Uh and that means the state

financial sector is just flushed with

money. So part of it is that China has

the capacity direct investment through

the state. Part of it is just it can

finance out of its own savings

levels of investment that no other

country has matched.

>> Right? So this I think this is all true

through China shock 1.0.

>> The view is maybe more of it would

change as time went on, but it didn't.

>> So what is China shock 2.0? When do you

date it? How do you describe it? So I

date the start of China shock 2.0 to the

collapse of China's property market in

2021. Now we all know there was an awful

lot going on in 2020, the pandemic. She

gets concerned that the there's too much

investment in property, probably rightly

so, that there were empty buildings

piling up. He introduces a policy, three

red lines, which sort of restricts

finance for the property sector and it

succeeds too well and the property

market basically tanks. And then in

order to offset the economic impact of

this fall, she more or less gives the

banking system guidance to lend to

finance

uh a new wave of manufacturing

investment and particularly

manufacturing in more cutting edge

sectors. So electric vehicles being the

the

leading example, but in general it's

investment in any sector where China has

import dependence and for she that's a

vulnerability and so he really directs

the states financial sector and you know

the party to throw money into building

out sectors where China has an import

dependence. The effect is China moves

back to growing on the back of net

exports. China's domestic economy is

growing three four percent. So you know

you're getting one and a half to two

percentage points of growth from net

exports. That's a lot of statistics. But

what it basically means is China's

exporting a ton of cars. China is

supplying the entire world with

batteries. Uh China is now the leading

exporter of tunnel boring machines. you

know, you name the the category of

machinery, China's exports are growing.

It's no longer just consumer

electronics. So, China starts getting uh

growth, big part of it growth from an

expanding trade surplus.

Imports stop growing.

This is, you know, I think one of the

key factors around the second China

shock. Normally, you would say imports

would grow with domestic demand. Chinese

imports basically aren't growing and in

key

>> China is selling ever more to the world

and then Chinese not buying more from

the world.

>> Exactly. And Chinese exports

particularly in the years right after

the pandemic after the currencies

depreciated start growing at two times

or three times the pace of world trade.

So China's imports of autos used to be

about a million cars a year. That's now

down. It's now under half a million cars

a year. And over this same period,

China's exports of cars have gone from

little under a million to now 10 million

in the space of 5 years. Just a stunning

shift in a range of industrial sectors

and heavily industrial sectors that

compete with Japan and compete with

Europe. And so you sort of see bad

economic performance in the

manufacturing heart of Europe in

particular, a little less so in the US.

>> So I I think this point about the Europe

versus US is really interesting. In one

of the pieces you wrote about this, you

wrote that the US share of global output

has been remarkably constant over the

last 40 years. China's rise has come at

the expense of the other G7 countries.

Can you talk about what that looks like?

I mean, I know you've Let's use maybe

Germany as an example.

Germany didn't move as heavily into you

know kind of software

platforms they retained a more

traditional manufacturing sector and

focused on exports including to China so

you know Germany after the global

financial crisis is exporting close to

3% of its GDP to China and manufactured

goods that reflects the fact that

Germany remained a very manufacturing

centric economy, you know, the tunnel

boring machines, the high-end sedans,

the, you know, a lot of fancy SUVs, you

know, also aircraft. The 320s made in

Hamburg. All these industrial sectors

tended to be industrial sectors which

had a lot of overlap with China. Uh, and

then you throw in

uh the fact that the EV industry just

took off in China. a lot of government

support and the German companies they

were made their own efforts to make EVs

in Europe but those never took off

globally in the way that China's EV

industry has and nor are they Costco

competitive so what you see is German

exports to China have fallen by about a

percentage point of German GDP and what

was a strength Germany benefited from

selling to China right after the global

financial crisis became a weakness I

want to focus in on another dimension of

this that's kind of inside the story

you're telling which is so China shock

one it's

lower on the value chain of manufactured

goods it's you know uh clothes and

consumer calculators and and all these

things that the story that was told was

we don't want these industries in the

long run

what happens in

the China shock too is that China is

starting to dominate industries on the

technological frontier. I mean, you

mentioned electric vehicles, you

mentioned batteries, right? You could

talk about solar panels, we could talk

about, you know, AI where they're, you

know, basically neck andneck with us.

How did they go

from kind of low to mid-level

manufacturing to the absolute frontier

in batteries, solar, etc.

that quickly

there was certainly something in the air

in China around manufacturing. The

critical mass was built up and the

foundations were laid and I think it's a

complicated story. So if you think about

electric vehicles being the like one of

the famous uh sectors, what do you need

to make an electric vehicle? You

actually need to be able to make a car.

It is you know a smartphone mixed with a

car. So, how does China learn how to

make cars, good cars? Well, a lot of

foreign companies come in and Ford and

GM and VW all had to partner with

generally Chinese state companies to

produce in China. That was just the rule

and they didn't have really much of a

choice because in China had a 25% auto

tariff like for a very very very long

time. So in order to, you know, if VW's

on the other side of the tariff with a

JV partner, they're going to have a big

cost advantage. So GM had to also jump

the tariff. Toyota had to jump the

tariff. Everybody does the JVS, joint

ventures. And then you want your part

suppliers to come and produce high

quality parts. So they come to China.

Well, guess what? They probably once

they learn how to make parts in China,

they are making parts at a much lower

cost in China because China's relatively

cheap. and you're starting to use those

parts to export to the world and China

and then local competitors spring up.

So, China ends up having worldclass

automotive parts production

uh well before its companies suddenly

master EVs

at a certain point. And China was sort

of they liked the results of the joint

venture, but they didn't completely like

the fact that for a while most of the

Chinese market was being met by auto

market was being met by joint venture

output. the indigenous Chinese-owned

companies were not all that competitive.

There was a sense that the auto

manufacturers who had a JV were fat and

lazy because they, you know, they were

too happy producing through their JVS.

So there was a sense that okay, well

this sector was still a little too

foreign dominated and then there was a

correct sense that well we should try to

take advantage of the transition to EVs.

So China you know makes it a priority.

When China makes something a priority,

credit is available to local firms that

want to enter the EV market. The state

banking system gets mobilized. Local

governments start throwing money at it.

You get a lot of small companies

springing up. China supports the

development of an indigenous local

battery industry. Then, you know,

Tesla's market entry is also viewed as

significant. when Tesla enters is not

required to do a JV, but in order to

qualify for Shanghai government local

support has to meet a lot of local

content requirements. So a supply chain

that serves Tesla can also serve others.

And when China sets up their consumer

subsidies in order to qualify for that

subsidy,

the car initially had to be made in

China. The battery had to be made in

China. that that supported not just the

Chinese battery industry but the

Chineseowned EV industry. And then you

get the EVs kind of just taking off. And

so all of a sudden you just get an

explosion

uh which has been built on a a

foundation from the migration of western

parts makers, copying, emulation and

then an awful lot of industrial policy.

So something people may have heard is

this argument that China is over

capacity that that over capacity is a

crisis. This is sort of related maybe to

trade imbalances. I don't think that

makes a lot of intuitive sense like why

is that a problem if they produce more

cars than they buy? So how would you

describe what the over capacity issue

is?

uh to me the most coherent way of

defining the concern about Chinese

overcapacity

is a set of sectors where China produces

more than its domestic market can absorb

and where globally

China's adding capacity in a sector that

in aggregate already has more capacity

than there is global demand. So in

batteries for example, China's ability

to make batteries is a a multiple of

current global demand. Uh so there just

no scope for anyone else to enter the

market. Um I think the concern in a

sector like autos where there is over

capacity globally, there are more

auto factories in Europe and in the US

uh with capacity than there is demand.

So many factories are operating at low

levels of capacity or being underused

and there's overcapacity in China. A lot

of Chinese factories are not being fully

used and China is adding to its

capacity. Uh so China you know has the

ability to make 55 million cars which is

you know well over a half close to

twothirds of world demand.

uh and there that is growing and so

China's expansion necessarily means the

exit of capacity elsewhere when there's

already spare capacity now you can say

that's just the operation of a market

new entrance going to displace old

capacity but it does feel different uh

when a closed market suddenly is adding

capacity to an industrial sector where

in aggregate there's plenty of capacity

and they're squeezing margin, squeezing

production out of the rest of the world.

>> One thing I've heard people ask is how

is this different than America? America

rises as a manufacturing juggernaut from

being a much more modest economy at you

know when the country is founded. It

does over time displace great companies

from other countries. It does lead to

competition that you know is harder for

other countries. But I do think

economically America's rise is not in

every respect but broadly considered to

have been win-win in a lot of ways. So

what is different about the rise of

America as a manufacturer? Like the rise

of Detroit, the rise of all these um

dimensions from what China is doing?

>> So our story is much more one of

industrial investment for our own

rapidly growing internal market. And we

only really become a big exporter uh

after World War II when the world's on

its back and that doesn't last that

long. China's industrial rise is much

more tied to exporting

uh and it's a much bigger exporter than

we ever were except for that brief

period after World War II. So one

argument here is simply China is

winning.

>> They're out competing the world, you

know, pretty fair and square here. And

if the world doesn't like it, it needs

to build better cars, build cheaper

solar panels, create stronger supply

chains. All this talk of China shocks

and a China problem is just kind of a

way to whine and keep China down. And

that there's no problem here. Like it

would be great to have cheap Chinese

electric vehicles. It's good for the

world and the climate transition to have

cheap Chinese solar panels. How do you

take that argument?

Look, if your only goal

is maximizing

uh benefits to consumers in the short

run,

you should certainly import uh Chinese

EVs, Chinese solar. Uh why not? open

economics say buy from whoever is

cheaper and then the competition will

raise everyone else uh up.

I think that misses a few things.

one, it misses the the shock that

happens to our economies if traditional

even like traditional but still kind of

cutting edge sectors disappear. China

could supply out of capacity that it is

already built the entire European auto

market, all of it. 10 million cars, no

problem. That's just giant compared to

the global market.

If an industry suddenly goes away, you

have all the China shock 1.0 type

effects. Communities that grew up around

building cars will just kind of

disappear. Now, in the China shock 2.0,

you're not going to be moving to an

export sector because there no one's

exporting to China. So, you're going to

move to necessarily a services sector.

So you're going to become less focused

on producing traded goods. Now you might

say, who cares? On the other hand, in

Europe, an awful lot of research and

development, an awful lot of uh of

innovation actually has emerged out of

their automotive sector. Uh so it's not

clear these people are going to jump to

a more innovative sector. They may jump

to less innovative, less well-paid

sectors. And in the end, your economy is

going to going to suffer. And then I

think there's a sense that people have

discovered that supply chain dependence

can be weaponized. Uh China dominates

magnets, rarers. If you want those

magnets, you want those rarers, you

better not tire off China. You better

not, you better say nice things about

China. You better not crit, you know,

you better not do what Japan did and uh

say you're going to come to Taiwan's

defense if something were to happen. you

kind of need to uh respect China if you

want access to their supply chain.

That's kind of the argument that they

are making. That kind of dependence

scares people.

Finally, I would just say look, if you

want to emulate China, if you admire

China, you want to emulate, you like the

way China's electric vehicle industry

has developed, it did not develop just

by throwing the

uh doors open. It did not develop

without industrial policy. China's EV

industry developed behind some of the

highest tariffs in the world at the

time, 25%.

Huge local preference, you know,

Chinese-made battery, ideally from a

Chinese company, Chinese-made car, could

be a Tesla, but it was going to be Tesla

made in China with 90% Chinese content.

And then an awful lot of local

government support. There are stories of

entire factories being built not by the

company but by the local government to

the specifications

of

the company. So there's a a story of

protection and industrial policy that

leads to the creation of this sector.

You throw your doors open to China,

you're going to get the cheap cars, but

you're not going to get the the EV

industry. And I think many countries are

are reluctant to just seed more

industrial ground to China. So for a

long time the critique that you heard in

American trade debate most often of

China is that they were a currency

manipulator. Um then you stopped hearing

that as much. I think your view is that

that has actually become a bigger part

of the story again. So let's do this in

two parts. What is currency

manipulation? Why does it matter? And

then what has been the sort of roller

coaster or where are we on the roller

coaster of Chinese currency

manipulation?

>> Sometimes currency manipulation is just

like a currency whose value we don't

like. Um which is I think how the

president sometimes uses used to use it.

He hasn't been talking as much about it.

But the the more accurate way of of

defining it would be a country that has

an undervalued currency. You can

quantify that. And so you look for a

surplus that's bigger than you would

expect given the underlying

characteristics of the economy. Factor

one. And then factor two is government

or quasi government intervention in the

foreign currency market. So it's not

just uh the outcome of differences in

monetary policy. There's a government

with its finger on the FX market buying

currency to hold the currency down.

China met both of those definitions

unambiguously from 2003 to 2012. There

was a political decision not to call

them a manipulator. Now during the

latter part of their period, they were

letting their currency appreciate. So

they're kind of correcting the

undervaluation, which is part of the

reason why they weren't named. China is

now back through its state banks buying

a lot of foreign currency in the market.

50 billion a month, 600 billion a year.

So there's a much clearer case that

China is manipulating now than there was

in the past. Trump hasn't taken interest

in this. The Europeans though have and

so I think the what you're seeing is

this become shifting from being an

American debate to being a global

debate.

When we were preparing for this

conversation, something I found myself

thinking about a lot was the question of

whether or not it matters if the

competition is fair. Mhm.

>> I'd say for a long time the narrative

that at least we were comfortable with

in this was a very procedural narrative

about China betraying the principles of

free trade. They are a currency

manipulator who is keeping their

currency artificially cheap in order to

make their exports cheaper or you know

they're doing all these industrial

subsidies and are you really supposed to

do those under the World Trade

Organization?

And it's a very sort of liberals who

believe in the system

>> way of thinking about the problem that

the problem is China's cheating.

And I'm not saying cheating can't be a

problem, but there's clearly quite a few

places now where China is just winning

or they've gotten to a place where they

can win. And so I guess my question is,

is the problem that some of China's

advantages are unfair? Right? They're

back to currency manipulation. and their

currency seems artificially cheap or is

just the problem that from a national

interest perspective, from an

interdependence and weaponization

perspective that you know Germany,

Europe, the United States,

it would be a mistake to just allow

their industries to get wiped out. That

the question here is not an abstract

commitment to free trade. It is what

creates a kind of healthy national

ecosystem.

Look, I increasingly

lean towards

the look, we just want these kinds of

industries. We don't want full-on

dependence. Uh we don't have to rely on

arguments about procedural violation of

rules, which feel a bit dated in a world

where we ourselves are clearly not

following the most basic of the rules.

And you know, the rules have a lot of

complexity. You're allowed to subsidize

under the rules. You're not supposed to

subsidize if it's to substitute for

imports. Well, if you subsidize a sector

and everything in that sector previously

was imported, are you import

substituting or you just subsidizing

that sector? Is a government guided fund

that puts money into private equity

funds and venture funds to invest in

chip manufacturing, is that a subsidy?

Yes and no. It may not be a subsidy

under the rule. So the rules themselves

are contested and not uniformly

followed. And to some degree

in certain sectors, I think we care much

more about outcomes than about the

rules. That's obvious in sectors uh of

national security

uh importance. So a lot of the rarer

famous sector uh have very very direct

and important military applications. we

should probably not even if China played

completely fairly want to want to be

100% dependent on China uh for the

supplies of those uh key materials and

then you kind of have to work further

from that where does the line come about

what do you care about where do you just

care about the outcome and where are you

going to rely more on arguments around

procedural fairness

uh and then I think on the flip side.

China itself clearly cared about the

outcome, not the procedural fairness.

What would you say the Trump

administration across its two terms, and

I realize they've been different in

important ways, has gotten right about

China? I mean, if Trump has been

disruptive on how America has thought

about anything, it has been China.

>> And what you think they've gotten wrong

in their either China orientation or

their China policy?

There is something a little strange

about Trump's first term. Um

because the first term

2017 2018

it's like the US political system

reacted to the China shock 5 to 10 years

after the first China shock happened.

So the timing was maybe strange but a a

lot of the policy direction I would

agree was more or less right. Um I think

it was right to broadly say that the WTO

rules which were thought to be

constraining China have become a

constraint on ourselves. China was

really good at finding ways of achieving

outcomes

by living on the edge of the rules.

I think the targeted

first wave of tariffs were actually sort

of in sectors where it was reasonable

generally speaking to have tariffs

>> and you're talking here in the first

term.

>> First term. Yeah. So like

>> in the first term the tariffs were

basically on China. In the second term,

the tariffs are basically on everyone.

And I am much more comfortable with

putting tariffs on China, particularly

now because, you know, China's economy

has shifted dramatically and become much

more export-oriented, much more of a

competitive threat now than it was then.

So, I think I think Trump one got that

bit right. like Bob Lighheiser, the

United States trade representative under

in Trump's first term was sort of the

first step of moving us from the like

WTO consensus to a world of reciprocal

interdependence, supply chain

vulnerability, supply chain warfare,

concerns about retal like a world where

everything is using a more militarized

vocabulary even around economic

exchange.

Trump won was still pretty unilateral.

Uh there's a famous uh story I think in

another newspaper

uh where you know uh President Mackel

asked like well maybe we should

negotiate something together. when

they're negotiating phase one the the

deal and President Trump was like no no

no no the we've done the tariffs all the

benefits should go to us this has to

flow to us and so there was an element

in the first term of of unilateralism

which obviously becomes unilateralism on

steroids over time so maybe before then

we get to Trump too it's worth talking

about Biden

>> because you know there's a lot of

Democratic criticism of the way Trump

talks about China to some degree of

Trump's tariffs on China. But the Biden

team comes in, they largely keep the

tariffs, in some cases, expand them into

new areas. They begin doing more to

limit the export of what they consider

to be strategically important

technologies like advanced chips to

China. Um they put on higher tariffs on

on EVs and they do a lot of industrial

policy that actually looks sort of like

the way you're describing Chinese

industrial policy. So the inflation

reduction act is trying to build a

domestic, you know, supply chain for

things like solar panels and wind

turbines. And now they're more okay with

it being, you know, in friendly

countries, too. But there's a lot of

bi-American

uh standards on all this and they begin

talking a lot in terms of strategic

technological competition. Uh AI is a

big thing for them in the AI competition

with China. How do you think about the

way the Biden administration

approached this and both kind of tweaked

but didn't upend like the Trump one

approach?

It probably in my view at least didn't

go far enough. Um it wasn't just clean

energy although that was certainly a big

focus. It also included semiconductors

>> and in semiconductors at the time the

concern was dependence on Taiwan which

was vulnerable to pressure from China.

Certainly vulnerable you know put the US

in a difficult position if China were

ever to put an embargo or attack Taiwan.

And at a certain point, the US just made

a decision uh that we did not want China

to have access to the world's best.

Certainly not the ability to make the

world's best chips. Too many risk

associated with that. I think that was

the right decision, but it unambiguously

was viewed by China as a directly

hostile act. And I think we if someone

had done that to us, we would have

viewed it as a directly hostile act. So

it put us into a world unambiguous world

of rivalry and competition and in a

position where we don't there is no way

China is not going to try to engineer us

out of their chip supply chains. That's

become a national priority and so we are

and we are trying to reduce our

vulnerabilities to Chinese economic

coercion at the same time. Uh but it

didn't really go far enough in

uh critical minerals rarers. I mean

there was plenty of talk about it but

there wasn't enough action not enough on

um active pharmaceutical ingredients

where either the medicine or the key

chemical precursors are almost 100%

sourced from China. So I think you know

it was a step in a necessary direction.

It was controversial because industrial

strategy industrial policy you know for

a long time the thought was that was

something other countries did. wasn't

something that America did and it wasn't

something we're necessarily very good

at. And in some cases

like uh rare earths and the magnets like

active ingredients, it means finding

ways to incentivize production in

sectors where you know you can't compete

with China on cost.

>> So that then brings us to Trump too.

>> Mhm. And so how would you rate what they

have done and where it has hit the right

balance and where it's been off?

Um so in general uh I have uh noted on

many times that I like Bob Lighheiser's

trade policy i.e. Trump's first term

better than I like Donald Trump's trade

policy i.e. Trump's second term.

Lighheiser was careful to only threaten

things that the US economy could

sustain. So, you know, the tariff level

was set at 25%. Which, yeah, people

didn't like paying it, but you could

afford to pay it. He didn't cover all of

trade. So, there was always a little

more trade you could bring into that

tariff. Trump had a theory of the case

in his second term, which worked for

most of the world, but didn't work for

China. And the theory of the case is,

well, trade's rigged against us. We need

to raise our tariffs, and you need to

lower your tariffs, lower your barriers

to US exports to put trade on a more

fair footing. You shouldn't, in other

words, retaliate for our tariffs. China

retaliated. China said, "This is

coercive." Plus, China knew they were

going to be in the crosshairs. You know,

she did a good job of getting ready.

He'd spent four years plotting this out.

So, China retaliates. We counter

retaliate. China retaliates some more.

we retaliate again and we push tariffs

up to 145%.

You might think that gives us more

leverage. We've completely cut off

trade. It turned out to be the opposite.

Our economy couldn't sustain 145%

tariffs on pretty much everything coming

from China. So the administration was in

a position where they needed to

negotiate a roll back in the tariffs.

You know, there's a rare earth component

as well. But I

>> China where China was holding back rare

earths which would our

manufacturing.

>> Yeah. So that was real.

>> Mhm.

>> But it's I think even if China had not

done that, even without the supply chain

restrictions, the administration knew it

needed to roll back the 145% tariffs.

You know, the the the example that uh I

like to give is that in the summer of

Trump's first year with 100ish plus

tariffs, all the retailers who import

artificial Christmas trees, which like

all come from China. Think Christmas

tree ornaments. think holidays. Well,

those are are things that are actually

typically imported during the summer.

Now, if you're paying 150% tariff,

you're going to have to triple whatever

your retail price or, you know,

something crazy. And the Christmas tree

importers weren't sure because they're

building up inventory ahead of a future

sale that American consumers would be

willing to pay that high a price. So,

they just stopped importing.

And you know when there's a hole and

there are other places where companies

were having to pay that price for a part

and that would render their ability to

export utterly uncompetitive. So it was

just it was too broad, too high, too

fast. It was disrupting the US economy.

That was a mistake. And I think

Lighheiser in his first term got it uh

closer to right. Don't don't don't ever

escalate to the point where you're put

on tariffs that you aren't willing to

maintain.

the other side will realize that you

would are looking for a face- saving way

to pull things back. That was I would

say mistake uh one. Mistake two was the

breadth of the tariffs.

not targeted

reasonably by countries. Just everyone

got hit with the liberation day tariffs

in some cases very very very high

tariffs

that alienated a bunch of countries that

themselves were worried about trade with

China. So it kind of took away the

possibility of building a broader

coalition against China. So that's first

problem with these very very broad

tariffs. Second problem with the very

very broad tariffs was that they ended

up being done in kind of irrational to

my mind ways. We were tariffing at

really high levels Canadian aluminum.

All right. Canadian aluminum is, you

know, not that this administration

cares, but it's made in a kind of

greenway. H trapped hydro power in

Quebec.

It has been part of our aluminum

industry since World War II. You know

when the bombers were built with

Canadian aluminum, there is no national

security threat. It is essential to our

market. There's the primary aluminum

market doesn't clear in the US without

Canadian imports, which meant that just

prices shot up. And then the final

problem was like, hey, aluminum is

electricity distilled, incredibly uh

energy intensive and electricity

intensive. So it is competing with data

centers uh for power. And so even with

the really high tariffs, we weren't

investing more in new aluminum. So it

was pure self harm fully on board with

limiting imports of aluminum from China,

having a more self-contained North

American market. But this was kind of

silly. The getting into a trade war with

Brazil when Brazil is one of the few

countries where we have a trade surplus

didn't make sense in Trump's own terms.

And then we ended up weirdly because you

know electronics got excluded, chips got

excluded because you know you can't

penalize data center constructions right

or wrong. The richest companies

basically found ways out. So the highest

tariffs at the end of the day were on

low-end household goods coming from

Southeast Asia. So it became sort of

more of a Walmart tariff and not a

strategic tariff.

I think all these were just kind of

mistakes of design. We ended up with a

tariff policy that wasn't in the second

year of the second term not at all

focused on China. China basically they

got the same deal as everyone else which

was a huge win for them. Most important

development is China showed it can punch

back. Yeah. People worried for years

about them unwinding purchases of US

treasuries. They didn't do that. I mean

the sense that if this escalated they

had more dependencies that they could

weaponize I think has been very salient.

There are multiple

places where China has leverage.

Ironically, the Treasury market turned

out not to be one of them. It's not just

that they didn't threaten it. It's it's

been one of the harder places to

weaponize partially because China isn't

buying. I mean, some people think

they're selling. That's not true. They

just have moved to other custodians.

Gets real technical. Uh but at the end

of the day, we actually have a counter.

If China sells treasuries, the Fed can

always buy more treasuries QE than China

can sell. We showed that in 2020. We

actually showed that in ' 08 and09 when

the China was selling agencies, Freddy

Franny mortgage back securities and the

Fed started buying them. It's not maybe

ideal, but we have an alternative for

the rare earth magnets that go into

weapon systems. Unless we have

stockpiles,

we don't have alternatives. So, it's

actually a more potent form of leverage.

>> One of the charts as I was preparing for

this that struck me is that if you look

at America's trade deficit, the world

doesn't look that different than at the

beginning of Trump's term.

>> Mhm.

>> So, in terms of what we've been trying

to achieve with our various trade wars,

our trade policies,

have we achieved anything? I mean, in

Trump's own sort of conception of the

world, manufacturing, trade imbalances,

is there progress that they can point

to?

>> Um, not much. We haven't grown our

exports to China with the deals. Our

exports are actually down relative to

where they were. Certainly down as a

share of US GDP from before the trade

war. We have not stopped Chinese

industrial policy. We have not generated

a structural change in China's economy.

We haven't changed the fact that China

has, you know, agricultural hostages

that it takes whenever we threaten. You

know, you want to sell soybeans to us,

you want to sell beef to us, you got to

be, you know, not tariff us. We we have

leverage over you. We haven't changed

that. Uh and we haven't changed China's

broad trajectory. China is a bigger

exporter globally, runs a bigger global

trade, not not just by small amounts, by

enormous amounts.

uh a more unbalanced economy now than it

was when the trade war got started. We

haven't changed our trade deficit in

aggregate. Uh we have shifted final

assembly for the US market away from

China to Vietnam to Taiwan to Mexico but

the components are still coming from

China. Uh so I think you know the main

thing you can say that Trump's second

term trade policy you know unambiguously

has achieved is it's alienated a lot of

allies because it's not at all been

targeted. Uh it alienated the courts uh

because

not a lot of thought was put into

conforming to reasonable expectations of

what the law allowed. Uh and it

generated a bit of revenue. And there's

an oddness to the first part about

allies to me because given everything

that we were talking about with the

second China shock being very focused on

Europe uh among others, you really could

have imagined something that was more of

a like a united set of goals between us

and Europe.

>> Um we all want to protect our auto

industries. We all don't want to be

dependent on you know Chinese chips or

China taking over Taiwan and then you

know we have a huge chip problem.

I guess a question is what what do you

think our goals should be here right

what do you think the set of outcomes we

are trying to generate should be and can

they be generated

or is there an inevitability to all this

given China's size given its

manufacturing capacity people sometimes

talk about where we're going as as

having an almost a yeah an inevitability

to it I'm curious if you buy that

>> um I do not believe in the

inevitability.

Um but I do believe

uh the changes to avoid

growing dependence on China for inputs

of manufacturers and final goods are

quite uh quite significant.

Look uh I was I was part of the Biden

administration at the beginning. I'm I'm

implicated in some of those decisions.

And in the early days of the Biden

administration, the overarching goal of

the trade policy was to avoid a trade

war with Europe, which was sort of where

Trump was heading had he won re-election

that year, and convince Europe that

whatever our traditional sources of

friction, we had a common interest in

thinking through how to handle China and

taking real action against China. you

know, make, you know, bring our policies

into harmony, but by bringing European

tariffs closer to US tariffs, not by

bringing US tariffs on China down.

At the time, the Europeans were not

interested. Europe said, "The problem is

that you guys aren't following the WTO

rules. The rules are important. You got

to go back to the rules."

>> Nothing Europe loves like a procedural

argument.

>> H people love procedural. We We actually

love procedural arguments, too. But the

Europeans loved the notion that they

were the rule abiding, rule creating,

order enforcing

uh power in the system.

That has shifted and I think the Trump

administration missed the shift. Didn't

explore the possibility of shift nor was

it interested because you know I think

Trump came in and he said many times

that Europe's almost as bad as China.

Allies, not allies, not how he thinks of

the world. She great leader. We should

be doing deals with shei. Bunch of

European leaders not great leaders. You

know, they, you know, they they they've

allowed themselves to have their hands

tied by the European Union. Real leaders

like she, like Trump, don't allow their

hands to be tied by super national

institutions. Just kind of disdain. And

so he missed an opportunity to explore

if Europe was willing to join the US in

some kind of economic alliance.

North America plus Europe and North

Atlantic alliance. you know, they

wouldn't it wouldn't be called against

China, but it would effectively be an

alliance to create a bigger market

outside of China with a some common

barriers to China that would, you know,

have allied scale would be big enough

that it would easily support a

competitive EV industry that didn't rely

on Chinese parts. uh a competitive

magnets industry that didn't rely on

China so forth and so on. So I think you

know where should we have gone? I think

we should have moved in that direction.

There are ways to do better coordination

of industrial policies too. But

basically like extend our security

alliances into economic alliances.

Uh try to compete with China. Don't give

up. Don't accept that every EV in the

world is going to be made in China which

is a realistic outcome right now.

uh with fully you know China can expand

its EV production capacity and has

enough spare capacity to meet all global

demand. So the entire EV industry could

be Chinese production. You know China's

supplying 10% of the European auto

market. There's a future where it could

supply 70. If that's not an outcome you

think is acceptable, you kind of have to

work backwards from that because that is

now a realistic possibility. What do you

think about the notion of a China shock

3 that you're beginning to see on the

horizon which is we've been talking

about how China shock one was kind of

low-end middle-end manufacturing number

two has been high-end batteries and cars

and things like that but the thing that

America has had that has insulated it

that has made our stock market such a

booming part of the global financial

system is as we talked about sort of

software finance

and more recently of course AI Mhm.

>> And we are still have real leadership in

AI, but it's amazing how strong the

Chinese open- source models are, how

close they are. They're a lot cheaper.

They're cheaper to run. And China is

able to I mean, China does not have the

chips we have, but they are able to pump

energy into it. They're not going to

have the data center slowdown that we're

going to have, right? You're not going

to have, you know, local data center

protests that are stopping China from

building enough data centers. So it's

not crazy given how much more difficult

it is to create the infrastructure for

AI here that China will pull ahead in

the coming years.

>> So I do think that's that is a a

possibility

if you think of China shock 3.0 do as

sort of services but services not as in

haircuts but as you know software AI the

models uh

there is a world

uh where

China and the US compete directly in a

way that they didn't compete in the big

platforms you know

China protected its search market

because it wanted political control but

that sort of meant that China's search

engines never really that competitive

globally which left the lion share of

the globe you know using US platforms

using US software using US cloud huge

businesses incredibly profitable

businesses the businesses that have

propelled the US stock market to a

stratospheric heights that have made you

know US stocks twothirds of the global

stock market index so an enormously

important part of the US economy and an

even more important part of the stock

market.

Look, AI is up for grabs. We don't know

if the US models will uh that people are

willing to pay as much as the people who

are spending tons of money to build all

the data centers and buy all the NVIDIA

chips are willing to invest. That's an

open question. It is quite possible that

uh it will prove to be a competitive

market and no one will make the super

profits that sort of Google, Alphabet,

Microsoft, Apple generated out of the

digital world we now live in. and that

AI will either be dominated by China or

will prove to be competitive and there

won't be the kind of profits that people

expect and so it will be disruptive and

disruptive to the parts of the US

economy that have generated the most

high-end jobs and certainly the most

profits. So to assume that we're going

to have uh a lead in high-end digital

services forever and that China is not

going to compete, I think that's I

wouldn't agree with that. is what we

want or what we should want

for China to be exporting less for them

to have less of an over capacity as it

gets called

>> or is what we want for China to be more

open to imports right this sort of bit

around the fight over whether or not we

should export chips to China the B

administration really clamped down on

that Trump opened up a bit uh somewhat

under the push from Jensen Wong of of

Nvidia

>> and Nvidia's argument and the argument

that I heard from Trump people around

this was look we actually want China

somewhat dependent on Nvidia's chipset.

We have all these dependencies on China.

The idea they're somewhat dependent on

us is not a bad thing.

Now even once we sort of open that back

up, China's not been excited about

Nvidia chips. They have, you know, made

strides on their own. And yes, they

would like the very best stuff and

there's some things we're still holding

back. But I felt like in there you saw

this kind of emergent fight which is do

we want to be more separated or actually

is a problem that you know there's been

more openness in one direction than the

other. It's like that's the the thing we

should be targeting. How do you think

about that?

I have complex, conflicted and probably

incoherent thoughts. But the goal from

China and I think it's independent

whether you give them this chip or that

chip today. They may or may not achieve

it. The goal is to replicate the full

chip ecosystem to be able to make the

machines as well as make the chips and

be at the frontier. So the risk is that

you would become dependent over time on

both Chinese models and then then the

Chinese ships will displace their

dependence on you and I think that's in

that sector that's a a real risk set of

risk. So I I'd be a bit cautious there.

I think conceptually

mutual interdependence, reciprocal

vulnerabilities,

control over offsetting choke points is

a way that competing

great powers, great military powers now,

great economic powers that are rivals,

not allies, can coexist. you cannot

supply chain restrict me because I can

supply chain restrict you and the we can

deter each other. You you apply

strategic and military concepts of round

deterrence. So it's it's a vision that

allows trade but it's kind of hostile

trade so to speak where you're always

worried uh that you're you're that

interdependence is shifting towards

dependence particularly because she has

said today's goal is is dependence. He

wants the world to rely on Chinese

supply chains. Arguably, that's one

theory he has about how he could achieve

victory in Taiwan without actually

fighting. Everyone needs us so much they

can't can't react, can't respond.

The other vision is a vision where okay

either fully

uh split off into rival blocks. China

has its EVA ecosystem. the US, US and

Europe. Our block has its own EV

ecosystem, own battery supply chains,

own uh battery chemical supply chains,

own EV companies, own EV designs. China

has its there's a vast part of the world

which gets to choose, but they're rival

ecosystems that don't have a ton of of

interdependence. I think you can hive

off some of the strategic sectors and do

that trade with allies

uh and uh maintain some trade with

China. I mean, we're not going to tell

our farmers they can't sell to China.

We're just not. Uh and there are certain

products which I think we should be fine

from China, but defining the lines is

going to is is hard. On top of that,

China cannot continue to rely on the

world's demand to make up for the fact

that it doesn't generate its own demand.

There's a macroeconomic component.

China's economy, the export side of the

economy has done great. No question.

Booming, growing faster than global

trade. The domestic side of the economy,

people doubt whether the domestic side

of the Chinese economy is really growing

faster than the domestic side of the US

economy. It is not doing great. There's

a lot of unemployment. There's

deflation. There's real internal

problems.

>> An aging population.

>> We have an aging population, too. But

China's aging a little faster.

>> Yeah.

>> And now there's a looming problem of

overinvestment, not just in property,

but in manufacturing capacity. Too many

auto plants, not enough demand, internal

demand is down 20% for Chinese cars. So,

they're forced to export because their

own market is is shrinking. That's

that's a real problem because China's

internal economy is incredibly

unbalanced. Like it's second biggest

world economy in the world, but with the

biggest domestic distortions across the

board, the most unbalanced pattern of

savings and investment. There will need

to come a time when China doesn't have

to have an expanding trade surplus to

grow. So, I do think that that is a

problem. And of course, it's it's tied

on our side to our fiscal situation. You

know, we're we're going to borrow insane

amounts to build AI and we're also

borrowing 6% of GDP to keep our consumer

engine going. There there probably

eventually are limits on our side, too.

>> I think that's a good place to end.

Always our final question. What are

three books you'd recommend to the

audience?

>> Well, the the the one book that most uh

shaped my own understanding of China is

an old book actually. Uh it's by a

friend of mine, Richard McGregor,

uh longtime

Beijing correspondent for the Financial

Times, who wrote a book called The

Party. And he really showed that you

can't understand modern China without

understanding the modern Chinese

Communist Party. And you know, vivid

scenes with like red telephones where

you know, your special party line where

you get the instructions if you're the

CEO of a big company about what you

should be doing.

Second book is is another old book

actually. Um

uh it's called the volatility machine by

Michael Pettis. It is it is a thin book.

It is not an easy read. Uh it is

actually not even about China even

though Pettis is now very well known for

his work on China. It's about how to

think about financial vulnerabilities in

the global economy and in emerging

economies in particular. I think it's a

modern classic and it's really important

for understanding I think not just how

emerging markets can get into trouble

but somehow some of the financial

structures that are now being used to

finance the AI buildout could get in

trouble that kind of that kind of

framework. And the third book, a book

that exceeded my expectations is, you

know, how to win a trade war war by Chad

Bound and Somaya Kanes.

Whatever side of the trade debate you're

on, you're going to learn something. It

is not a polymic. It is, I think, the

best guide to a world where people are

thinking about trade in terms of

vulnerabilities, not just in terms of

opportunities.

>> Brad Settzer, thank you very much.

>> Uh, thanks Ezra. It's been a pleasure to

be on this show.