Glenn Luk: China’s economic evolution, GDP, and high speed rail — #58

Steve Hsu: Welcome to Manifold. My guest today is Glenn Luk. Glenn has a very impressive background. He's worked in investment banking, private equity, and he's also been a company founder. I discovered Glenn through his Twitter handle, and he is a source of very insightful commentary and analysis about the Chinese economy, U. S. China competition and related topics. I always pay attention when someone with a real operating business background. And in his case, a cultural background in the region. He has something to say about China and East Asia because there's, as you may know from things I've said on previous podcasts, I feel like we're living in a rather unique era of propagandized narrative about what is actually happening in that very important region of the world. So Glenn, I welcome you to the show.

Glenn Luk: Hey, Steve, great, great to be on the show and thanks for having me.

Steve Hsu: So let's start by talking about your background. I kind of gave a little bit of a hint of it, but would love to hear more about it from your perspective. You can go back as far as you want. I understand you have part Taiwan, part Hong Kong heritage, which actually I myself have as well.

Maybe you can start there.

Glenn Luk: Yeah, no, sounds good. so, you know, I think one of the sort of interesting things about my background is it's, it's really, it's a real blend of Taiwan, Hong Kong, and mainland China background. And, you know, each of these influences have shaped the way that I've developed in my career as well, you know, personally and culturally.

You know, I have a living connection to historical events through my parents, through World War II, the Chinese Civil War, and it sparked an interest in me pretty early on that I might want to go to work and live out in the region. Having grown up in suburban New Jersey for my whole life, I always wanted to live in the city and actually explore the world.

And so, you know, in college, I went to school in Philadelphia you know, in an urban environment, I studied finance initially, but I also, you know, I was a, a technology, I was kind of a techie growing up and I, I was one of those kids who was programming on their, their Apple two when they're nine or 10 years old.

And so I also was interested in technology. But actually, the Asian connection was also another interesting area of mine. and it's really interesting looking back when I think about how macro events and external events sometimes shape your career. But, you know, for me, it was probably the dot com boom because I was all set to head out to Silicon Valley in 2000.

And I did a tech internship that summer. And then the bubble crashed. And so I made a pivot. and. You know, not surprisingly for a lot of my classmates in my undergrad business school, investment banking was, was one of the well-trodden paths. And, you know, I didn't, you know, I had this inclination to not want to go down the really well-trodden path.

So for me, what made it a little bit different was exploring opportunities out in Asia. This was. The winter of 2000, it was three years after the two to three years after the Asian financial crisis. And it wasn't a well trotted path at that time to go out to Asia. And I, I just fortunately had an opportunity to through some friends of mine find some job opportunities out there and eventually interview.

And, you know, that that winter it really came down to. working for a boutique tech investment bank in the States and going out to work for Deutsche Bank in Asia. And so I ended up choosing to go out to Asia. and And so I, I spent my, I spent three years out there. I, you know, met a lot of really interesting people.

It was a really fascinating time to be out there. our clients at the time were mainly. I was mainly focused on mergers and acquisitions, which in Asia at the time was working a lot with the state owned enterprises in the oil and gas and power industries for not only China, but for Japan and for Korea.

And so it was really fascinating. Journey for me, you know, having grown up, you know, in the States my whole life to go out there and suddenly be sitting across the table from you know, CEOs that, you know, from backgrounds that are completely different from yours and just seeing how, how, how different things were, there was definitely a big culture shock and just a life shock for

Steve Hsu: Can I ask you a question about how, so I've, I've had similar experience, but I'm curious what your experience was like. So, for you as a, what's called an ABC or someone who grew up primarily in the United States, but is of Chinese heritage. When you were meeting with, you know, real Chinese people, like someone who was leading a state owned enterprise and came up in maybe the communist system.

Taking the Gaokao and maybe attending, you know, one of the major Chinese universities. What, what was that like? Like was there an immediate affinity? Were there tensions? How did you get along with these folks?

Glenn Luk: Well, one, I was, I was, I was relatively junior at that time. So I think the, you know, my, my interact, my direct inter interactions with, you know, the chairman or the CEO would be quite low, but I mean, I was even quite, you know, surprised at how much of a cultural gap there was with people in Hong Kong who could speak English.

So for me, it was actually just identity wise, actually affirming how American I really was, by seeing how. Asian people in Asia were and saw how things were different. This was also Steve post nine 11. And it was, it was actually a bit of a shock to see how the rest of the world thought about the sort of issues that are talked about in a certain way in the States and the media and how, seeing how they talk about in the South China Morning Post or in other, you know, foreign publications.

So that was a big shock for me as well. Cause you kind of grow up with a certain. You know, impression, you know, you recite the, you know, you sing the national anthem, you sing America, you know, America, the beautiful. And all of a sudden you see a different side of the world. So for me, I think just going out there was really, really eye-opening.

Steve Hsu: And so you were living in Hong Kong during this time, is that right?

Glenn Luk: That's right. Yeah. So I ended up living there for three years. I, I, you know, anybody who's done investment banking during the analyst years knows it's a grind. but it was definitely, you know, work hard, play hard, you know, building a really interesting network. Yeah. You're, you're all sort of sitting in the trenches together at the same place in life.

Most people are single. And so you end up developing a really, really nice network out there, which I think has grown up with me as, as you know, I moved back to the States after three years, a lot of my network has either stayed in the region or actually, you know, dispersed in other parts of the region in Korea and Japan, mainland China, et cetera.

Steve Hsu: And I'm guessing if you traveled in China during that period and looked at Chinese companies, you saw a lot. I mean, you saw unfettered capitalism at work. Maybe more, more. More capitalism than you could possibly appreciate. You could actually ever see it in the United States or Western Europe.

Glenn Luk: I mean, yeah, I mean, I, I remember first, I think it was December 1st, 2001, which was the first time I actually crossed the border into China. And, you know, one of the things that first struck me was poverty. I just, I just never seen that level of poverty before coming out of the, the, the border you know, border control at, at Lowell and seeing, you know, beggars on the street and.

But at the same time, it was juxtaposed next to this, as you, as you call this dynamic dynamism, that was also very, very apparent. So you know, at that time, you know, one of the, this was the time when Chinese SOEs, which are most of our clients, were really venturing out into the world. So in doing M& A for them, I mean, our value add, our, our role was to help them navigate this new world of foreign acquisitions. so, you know, there were just really, really interesting stories that you know, I could talk about, but it was, a lot of it just had to do with culture clash and not understanding how a business is done abroad. And, you know, part of our role as bankers was to, you know, guide them through this process.

Steve Hsu: Do you think you could contrast what the current level of complexity is or sophistication among Chinese companies now versus what you saw 20 years ago?

Glenn Luk: Yeah, I mean, I mean, 20 years ago, I mean, in the power sector, I just dive into the power sector because we spent a lot of time there. This was the early 2000s, Enron had just happened, but, you know, the late 90s. And the early 2000s in the power sector was about deregulation. And actually, at that time, the Chinese were, well, there's a couple of things going on.

The Chinese were very. supply constraint on power. So there's a lot of power shortages going on. They just, you know, they couldn't build power plants fast enough to meet rising demand. when they imported power equipment from abroad, it was expensive relative to their level of development.

And so they were definitely constrained on, on, on, on the power side. And they're also very, very open to, you know, Western style market reforms. they had already been experimenting. partial privatizations of some of the power companies, the, the, the power producers like, like Huaneng or Datang in the nineties and they were experimenting with true Western style power reform, including dividing the power grid into, you know, transmission and distribution and breaking it up and privatizing the grid as well.

So I think one of the things we noticed was that post Enron. Some of the sort of, it was one of the first times where they kind of sat back and said, actually, maybe we should, we shouldn't move so quickly on some of that, that regulation. And so yeah, but this was still, this was still a time in general where I think there was a lot of openness.

And there was a lot of, I would say, looking up to the West as a model for, for development. And I think that's sort of changed over time as the Chinese companies themselves have gotten more sophisticated and, and, and learn on their own, learn by doing and kind of felt their way across that river of development.

Steve Hsu: One of the things I emphasize in my tweets or when I talk about human capital or the fertility problem in China is that people with experience with China back 20 years ago would realize that the average education level was very low. So the whole generation had basically kind of missed college because of the cultural revolution.

And even for a kid graduating high school in around 2000. Maybe only a few percent, maybe 6 percent at most would get to go to college. And so most people just didn't have that much education. And whereas now, of course, the college going rate is similar to the United States and people are about twice as likely to do STEM subjects there.

As they are today. So I think if you didn't live through that, you wouldn't really appreciate the drastic change in the average level of human capital for people that are young and entering the job market today in China.

Glenn Luk: Yeah, no, no, I, I agree with that. I think, I think you've seen this, you know, explosion in, sort of the college enrollment rates starting really in the early 2000s, but really starting to ramp up in the 12 to 13 years ago. Yeah. And today you're, you're just seeing a net influx of, you know, plus 10 to 11 million college graduates.

And this includes vocational schools as well. but 10 to 11 million college or vocational level graduates, you know, entering the workforce and, you know, and one of the things I do talk about in my, in some of my tweets is this theme of, How structural change in China is actually underpinned by this demographic change.

So this, you know, when I was there, it was really about the blue collar workforce. You had the biggest generation, the biggest cohort was actually, I think 1985 or 1986 and 95 percent or more of them never went to college. So they were effectively blue collar. And these are the folks that were really building the country and developing the country in the, in the 2000s. First with the export oriented manufacturing boom, then post GFC. The switch over to property and infrastructure. And now, as you have this rising and growing labor pool of college educated. Workers now you're seeing. Not surprisingly, the rise of companies like BYD, which are hiring tens of thousands of PhDs and masters and undergrad college graduates and really switching their model from this old, you know, construction and concrete intensive, acid intensive model into really an IP technology and manufacturing or advanced manufacturing model.

Steve Hsu: Yeah, you're hitting on, you're hitting on, I think, one of the main, Conceptual things that people who are watching China from the West are missing. We should maybe put a bookmark there and come back to it because I want to just finish with your bio before we get into it. That's a pretty meaty topic for us to discuss this, this pivot from property and infrastructure driven economy to really advanced manufacturing and technology driven economy.

Let's talk about how you got into investing and went from investment banking to private equity and venture. How did that happen?

Glenn Luk: Yeah, so, you know, it was really interesting. I spent, you know, I think at the, by my, by the end of my second year, I was already feeling a little bit, a little bit homesick. And I also started to realize and this illustrates some of the shift that was going on in Asia at the time. When I joined as a 22 year old analyst, the head of my group was an Australian expatriate who had done project finance throughout the region in the 90s.

And, you know, just if you think about, you know, where investment banking, where the, where the, where the fees were going, it was, it was going to China. And so, as I mentioned before, we're, you know, we have to pitch business, we have to win mandates and work with national, you know, state owned enterprises, and so we're dealing with the Chinese people.

And so you'd have this situation where. You know, actually, our role was to really draft the, the, the content of the, the, the documents and we would actually send the documents. This is actually another interesting thing. We would send the documents up to our Beijing office and our Beijing office were you know, graduates, the, the, the top graduates from the top universities in China, like Beida and Tsinghua.

And they were, their job at the time was as glorified translators. They would take the sort of energy and power content that we had drafted in Hong Kong. And they would translate them. And then we would pitch, you know, these, these mainland Chinese executives through a translator. And, you know, investment banking is a, is a relationship business and it was, it was not tenable.

So by the end of my second year, we actually ended up hiring Transcribed. A fairly young mainland Chinese director promoted him and he was one of the first wave of mainland Chinese who had actually left China in the early 90s and gotten their finance training out in the West.

In his case it was at Rothschilds in, in London, and and, and this was the archetype of the. the type of investment banker who had both the cultural affinity as well as the specific technical skills to be able to win business. And we started, we also hired a lot of other mainland Chinese executives from other banks, and we started building a real business out there.

But to me, it sort of signaled a couple of things personally. One was, I kind of alluded to earlier. I felt like even in Hong Kong, it was not the perfect cultural fit. And. When you started seeing where the banking industry was going, it was going towards mail in China, it was an even bigger leap.

And so you know, having grown up in the States, you know, my, you know, I had language skills, but, you know. I did have a network. you know, just it would be, it would be a struggle to, to develop myself out there as sort of a mid career, mid level professional in the investment banking industry. The other reason, Steve, that I left was I was a little bit sick and tired of doing, you know, Mostly oil and gas and power.

I was a tech guy. And so I was like, okay, I want to sort of develop that, that aspect of me as well. So in 2004, I ended up moving back to New York and I pursued that. I ended up getting a job with invest Corp which was a Bahrain based private equity firm. And, specifically, I joined the technology investments group over there, which was a good fit.

It was a, it was a. Relatively large firm, but this was unique, we had our own, we had our own fund structure and it was a relatively autonomous group within a larger you know, private equity firm. And, we focused on technology and it really started with late stage venture capital and then we shifted more towards a control oriented private equity model which I can talk about as well.

But I think what was this, this was really interesting for me, because I think in the. When you're, you know, on the, what they call the sell side, which is investment banking you're really advising other companies and you have a little bit less at stake. I think what was wonderful about investing is that you're, you gotta put your money where your mouth is.

So you have to be right. That's the most important thing. It's about being rational and being a rational investor. you know, this was also the time where I started, you know, have, you know, starting to invest in the stock market. And, you know, I discovered it. Warren Buffett and Charlie Hathaway and just really gravitated towards their investing model.

But really they're, they're this, this theme of continuous lifelong learning building. I think Munger, the late Munger, called it the last work of mental models for investing in life. and that really dovetailed with the professional training I was getting at, you know, in the private equity industry where, you know, you learn how to do due diligence.

You learn how to build mental frameworks and investing frameworks. You deepen your exposure into multiple industries and sectors. uh, you know, within the technology space, I, you know, I started out looking at semiconductors and telecom equipment and later moved on and into enterprise software and digital marketing and security.

but I, I think the, the, the real takeaway for me from this was this idea that it's. You know, to be a good investor you really have to be rational and you, you have to, you know, get things right. And that's the most important thing. I think this does touch on some of the things that we're, we'll talk about later with, with China and, and trying to figure out what's actually going on out there.
If, if your point is to get things.

Steve Hsu: Yep. You know, I knew Charlie Munger a little bit when he was still alive and he had a connection to Caltech and he liked to meet scientists. And so I attended a few dinners with him. He was already quite old, but still mentally sharp. One of the things about him is I was like starstruck, you know, when I met him and I was like, wow, it's a great honor to meet you, Charlie.

And he was like, no, Steve, the honor is all mine. And he was so humble. He really admired what the scientist did. And he used to just say, like, hey, what Warren and I do. is really just common sense and, but, you know, of course, we all realize not very many people can do it. Actually, most people will deviate in some way from, even if they understand the principles that Buffett and Munger use, they can't really implement them.

So just, just a really unusual guy, I think uh, very smart. I mean, I mean, you know, he was self-deprecating, but fundamentally, I think he was actually very, very high.

Glenn Luk: Yeah. If anything, like I'm, I'm more of a Munger than a, than a Buffett fan. I, I just think his approach to, you know, learning. And be multidisciplinary and I think Buffett talked about him and his eulogy in his last letter about how much of an influence he had on building Berkshire Hathaway and really changing it from that sort of cigar butt, you know, buy something for a dollar for 30 cents to really building value over the long term by by compounding and by growing instead of just looking for deals.

Steve Hsu: Their view into China was largely influenced by an investor called Li Lu from Himalaya Capital. And some of the dinners I went to were at Lily's house. He, they all lived near, Munger and Li Lu lived kind of near the Celtic campus. And um so yeah, so I think Munger was, had a little bit more of a vision, was willing to be like a little bit of a visionary about the future rather than I think more, much more so than Buffett.

Yeah. So, that experience as an investor, as an, you know, someone who actually invested in public companies or large companies that are almost public companies, I'm sure that also helped you when you eventually became a founder of a company.

So maybe you could talk about that.

Glenn Luk: Yeah, so you know, one of the things I think it's important to look at the That, you know, one of the quotes that, you know, either Buffett or Munger, I think Buffett said was, you know, I'm a better investor because I'm a businessman and a better businessman because I'm an investor. I think that really resonated with me.

So, you know, after 10 years or close to a decade, you know, working with invest Corp and private equity, where it really just grew up, I joined as a, you know, associate, I went through the end of the first fund, we raised the second fund, we. Raise a third fund invested. I had a decision to make, I think, where I want to take my career.

And, you know, why I think investing allows you to dive into the next layer, especially private equity investing, because you're working very closely with company executives, you're, you have an influence on, you know, trying to create value through, through active management and through operational change.

Thank you. You know, there's still a level deeper you know, really becoming a businessman. And so in, in 2014, I, you know, we had finished investing, you know, our third fund, it was, you know, in very, very good shape. And I, I decided and I had an opportunity to start a company with some, some of my friends who are, who are internet entrepreneurs.

And we ended up building a business and launching a business. It was just sort of opportune timing around the launch of the Affordable Care Act slash, you know, Obamacare. so we built a business around healthcare. com domain. That was really about making health care easier to understand and purchase for consumers, which was really this, you know, the view was that over the long term, you know, American health care, which is very much an employer-based system, was moving towards more of a consumer decision.

And that would create roles and, and, and for companies that could help consumers. learn about the very, very complex healthcare industry and you know, for, for a generation or for a country that frankly does not know how to buy health insurance. and I, I think it was you know, it was part of this move deeper into understanding how to, how to launch a business, how to, how to raise money, how to build something from nothing and, you know, subsequent to, you know, healthcare, I mean, my partners really, really grew that business.

Over time, I actually ended up taking a sabbatical and going out to Taiwan, which was the first time I spent a lot of time in Taiwan in 2014 and 15. but since then, I've been really in this mode of you know, investing and getting involved in projects that I invest in you know, actively or and, and I've, I've, I've been involved in companies, you know, from blockchain to, you know, Ed tech to, to, to internet companies.

So, I have a few in the works right now.

Steve Hsu: Great. Hey, when we get off this podcast, I got to hit you up to see if there are any potential clients of super focused on AI. that you can introduce me to, so probably some good customer support or other maybe HR related or healthcare related stuff that we can deploy our technology in.

Glenn Luk: Yeah, definitely.

Steve Hsu: So let's turn to know, you're writing about China, the development of China. You've obviously been an observer of an analyst of developments there for some time. I'm actually reminded of a blog post I put, I made a long time ago, some writing of Charlie Munger's where I think he gave a talk somewhere and he, he talked about how he, he, he liked economists, but he was a little bit disappointed in the limitations of where they would take their analysis.

And very early on, he pointed out that there was this kind of problem that the US was going to help China industrialize and advance technologically. But at the end of it. Okay. The U. S. might end up with a very formidable competitor, and it could end up being like a real problem for the United States.

And he said he talked to so many. He talked to many, many academic economists about this issue, and most of them would just not go beyond this issue of gains from trade. and you know Ricardo and things like this and, and he was very disappointed with that and wrote, actually, which I put on my blog a long time ago, and he was very insightful because what he predicted more or less came true.

Glenn Luk: Yeah. I mean, I think that I mean, I think some of the issues with economists are maybe that they don't, maybe there's less of a multidisciplinary approach to, you know, for them, it's a world of numbers and theories. And I think with China, it's just, it's just too big and too complicated to, to boil down to, just a set of metrics, especially high level metrics.

Steve Hsu: Yeah. In the same way that I think you could be an economist and have some kind of very theoretical notions about how markets work and economies develop, but develop, but maybe you've never operated a business. So you lack a certain amount of common sense about how these things really go. In the same way, you have people who maybe see some numbers related to China, but maybe they don't speak the language, maybe they have some slight ideological bias or cultural bias, and I just see people going, especially today going way off the rails in terms of their perception of what's happening there or what will happen there in the next decade. Maybe you want to comment on that.

Glenn Luk: I mean, this goes back to the comment I made earlier, Steve, about how, when I went out to Hong Kong, I just, the world looks at things in a very different place. If you grew up in Hong Kong, if you grew up in Asia, you grew up in Thailand. I mean, your experience was completely different. And I think Americans sometimes take it for granted.

They just assume, and this was especially like in the late nineties sort of the post, you know, post COVID. Post communist, you know, the glow of that era. There was, there's a bit of a triumphalism about the American way and how things should be but not everybody thinks like that. And I, so I already noticed it, you know, just going out there and just being away from you know, being surrounded by the same, you know, messages and, and sort of the same group think and just seeing, you know, putting yourself in somebody else's shoes and seeing things a little bit differently.

Okay. And so I would, you know, I would, I would still obviously keep in, you know, read, read articles. You know, we had a Bloomberg terminal and you'd read all these articles. And a lot of times I would feel there is definitely this gap in, you know, what I'm seeing, you know, on the ground. And this was the early 2000s.

And this was, you know, I think, I think. You know, there's books about the collapse of China and like, I think, you know, the, the, the, so we restructuring in the 80s with a heavily indebted banking system and how that would lead to collapse and, and, you know, I wasn't seeing it. I was, I was seeing something different.

So there was already a gap then. And I would say that it's just grown since then, because I think as China has caught up I mean, I think before it was, it was so far developmentally below the rich world, the OECD, the United States, that it was, it was actually a very good partner. I mean, China had all this labor, they needed jobs and, you know, rich countries would love to buy goods cheaper and keep inflation down. And so it was actually a really good, good it was, it was a really good relationship.

But as China has gotten closer, we've seen the geopolitical tensions rise. I think that's added another element that has, if anything, just widened the gulf between understanding of China and you know, what's actually happening on the ground over there, at least, at least between the, the, you know, the mainstream media or the Western media and, and what I think is, is more of like, you know, happening and more real on the ground,

Steve Hsu: I think, you know, going back to Mung, the way Munger thought about it, or the way that he, he juxtaposed the economists opinions of that era to himself was that, okay, you have this Ricardian complementarity that you just mentioned, like, oh, we'll do the high tech stuff in the States. We'll let these guys do the low tech, ugly manufacturing stuff.

It'll keep it. It's deflationary. It's great. Great for American consumers. But what Munger said is, well, eventually they're going to catch up and they're going to be competing at the high end. And how are you going to like them apples? And of course, the ability to compete at the high end is also going to feed into their own defense industries and military capabilities and also the fact that they can now fund very large military expansion.

So we've reached that era. Now, you would think that if I were a national security guy or a US economist, and I was just trying to help thinking only in the interest of my country. I'd be. I would need to have a realistic view of what's happening over there in order to plan, you know, like, are these hypersonic missiles for real?

Can they target them? Can they build batteries better than we can? Should we just give that up to them or can we afford to give that up to them? But underneath all that, there has to be a level of deep understanding and realism. Otherwise, there's no, there's no limit to the amount of mistakes that our policy people can make.

And I just, it kills me every time I, I, you know, I read foreign affairs or. The economist, or I just feel these people are just very, very strongly miscalibrated about what's happening in China.

Glenn Luk: Yeah, and I think to a certain extent there was this uh belief that You know because of you know, china's china just has a very different system and there was almost sort of implicit in that that it was a system that wouldn't scale or it would eventually I mean, I think people still thought about china as Just a delayed soviet union back then um, and that eventually it would You You know, the inefficiencies of its system would catch up to it.

and I think we still see that. I think there is this notion also that Chinese people could only copy and that they, they couldn't, you know, innovate. and, and so I, I think there's a lot of, I don't, I don't know if we should call it, we call it bias or there were, there was just some preconceived notions.

And so I think we've been constantly surprised at how quickly they've developed as a result. that, you know, actually in maybe the process of reverse engineering or copying, you actually develop underlying skill sets that actually take you forward. I think one of the first industries I saw was, as I mentioned earlier, we were, we were investing in, in telecom equipment.

So in the US, we invest in a software company based in Texas. And so, you know, at the meetings, we started talking about this little company out in China called Huawei. Huawei. And, and I think, I think, I think that you could already feel the sort of, I think the telecom was one of the first front lines of the national security concern.

And you already felt back then this was like in 2005 2006 that they're already concerned about Huawei but there's also this feeling of, well, they're just copying the Cisco code in 2003, and they're just not going to be able to, to, to catch up. Yeah. And, and what we've, we saw through the next 15 years was not only did they catch up, they actually, you know, in 3g, they were, they're late to 3g.

So they were behind in 3g. They sort of caught up with 4g and with 5g, they just, you know, they've taken the lead. And so, and now, now it's happened with solar, it's happened with EV, with electric vehicles. it's potentially happening with chips. So, you know, I think we're, we're constantly surprised by that.

They continue to, you know, break through and innovate and develop. and it's not because of the, you know, they were like, you know, we weren't the reason. I mean, I think, I think it was a beneficial relationship. It was a symbiotic relationship for a long time. but at the same time, it was also a lot of their own hard work and, and, and nuts and bolts developing and getting educated and learning on the job and just learning by doing.

And I think one of the things that I think, you know, Americans need to understand is that Chinese policymakers have long just advocated taking on work because they realize that you actually learn through, through, through modern work, you learn on the job, you learn how to, you know, be a citizen, you learn how to, you know, you learn new skill sets.

And those are, those are spillover benefits to the, the, you know, what the economists might focus on, which is just the trade flows. There's actually the human capital aspect that's building up as an intangible asset that is significant, hard to measure but significant. and that's actually what, what, what is probably the most important thing that drives, you know, this, this long term sustainable growth that we've

Steve Hsu: Yeah, I don't want to knock economists too much, although I, you know, as a hobby, I sort of do that, but, but, but not only do they generally not understand business and entrepreneurship and innovation, they also don't really understand technology development. So, these are all blind spots for them.

These are just like exogenous things in their models, or they don't really have, I think, a deep appreciation of how they go. So I think one of the contributions to the discourse on this comes from Elon, because Elon, you know, was. He really was fighting an uphill battle when he pointed out to people that, you know what, inventing the thing is ten times easier than learning how to manufacture that thing efficiently at scale and at low cost.

You know, those are two different things. And people always just assumed, oh, we'll invent stuff in America and that other low value thing, which is figuring out how to manufacture it effectively and cheaply. We'll leave that to these Chinese guys, but that'll never be very valuable. Of course, it wasn't valuable for a long time because they were so desperate for work in China for a long time.

They were willing to underprice all of that horrible stuff, but when they're not, no longer willing to do it for free or do it on the cheap or just to learn. Suddenly, you're going to realize, wait, that's, that's the more important part, maybe of the value chain rather than the idea. Like, oh, what if I had a little phone that could fit in my hand, you know, like, to turn that into an actual iPhone is, is, is really quite difficult.

And Musk now realized this. And I think. My understanding is the Shanghai Gigafactory is probably the, like, the best of his Tesla manufacturing facilities. And I've heard privately the guy who runs the Tesla Gigafactory, a Chinese guy, is really secretly the guy who runs, like, the most important aspects of, you know, the building part of Tesla.

Glenn Luk: Yeah, no, I think that that sort of learning aspect of manufacturing is the part that we forgot about. And I think for a while, it was okay, because we had this mass of manufacturing knowledge in the United States. But manufacturing is a, is a, is a, is a mentor apprentice business. And so when we, when we ship those jobs out to to China, you know, we would teach the, the factory owners how to, you know, we would set them in molds, we teach them how to manufacture, and then they would take that, that knowledge and pass it down to their workers.

But the link was broken in the US. We didn't have a next generation of young manufacturers that were learning, starting as an entry level out of high school. On the factory floor. And so after 2030, 40, 50 years, and this, by the way, didn't start with China that started with Korea and Taiwan before after 30, that was really, I think the the, the, the major, major damage from the hollowing out of economy was that the link in terms of manufacturing knowledge and learning was, was broken.

And it's really, really hard to rebuild that. From scratch again and and not to mention just the knowledge aspect, but just having the. These whole ecosystems of supply chains that really make manufacturing work, you know, at scale and with efficiency. I mean, that all went over to Asia as well.

So I think there's, there's definitely a lot of. There's merit I think we're starting. We've realized that I think as a country, we've realized that I don't think we. At least from what I've seen, I don't think we've quite figured out how to recapture that. I think companies like Tesla are, I think what you're alluding to is kind of this reverse knowledge flow back from the manufacturing expertise in Asia back to the States.

But I don't see that necessarily happening at scale. I mean, even Tesla itself is having a hard time getting political support in the United States. And actually what we should be doing is taking that knowledge that they actually have today. And replicating it with, you know, other sectors and in other other manufacturing endeavors.

Steve Hsu: I think it's very hard to recover because you need, you need to, you know, You know, not only have huge investment in the infrastructure to do advanced manufacturing again, but you need to value it. You need to get young people excited to do it. And that still doesn't really exist. Like, you know, if you ask high school kids what they want to do in America, very few of them think like, oh, I want to get into some, you know, Factory and really learn how to use that CNC machine Extremely efficiently and build really complicated shapes.

And so how many kids are really thinking about that? So I still think about it no matter how much money the U.S. Congress appropriates to reinvigorate Manufacturing america. I still think we're lacking some key components that we need to really catch up with to revitalize it here.

Glenn Luk: Yeah, no, I would agree.

Steve Hsu: So so one of the things you you know, you i've seen you tweet about is Trying to make a more You Substantive comparison between number one, the size of the U. S. economy versus the Chinese economy, but also things like GDP per capita, the meaningful income and wealth or standard of living that people have their versus here.

All of these are very, all of these things are very complex to tease out. I don't know, maybe you could say a little bit about it for the audience.

Glenn Luk: Yeah, so I, I think that you know, everybody often gravitates towards this, this comparison between. China and the United States, and, you know, I think it's, you know, I, I approach this as sort of a. Compare and contrast, I think there are some basic ideas and concepts that the United States and China are quite similar.

Like, you know, we're both. very large countries. I think large countries can act in a way that's, you know, differently from small countries. They can, you know, be more self-sufficient because, you know, you gotta really think of it as a collection of, you know, 31 provinces or 50 states. Each of them, you know, that could be the size of an average European country. so you really have to think about them as continent sized economies. I think even culturally, I think Chinese and Americans are actually culturally quite similar. I think Chinese people are actually quite direct and they're entrepreneurial. They're hustlers and they get things done. I think Americans as well take that approach. But I think there's also a lot of things that are, that are different, that are hard, that are important to understand because it drives a lot of the ways of handling the economy or things like policy.

So just, just a few, for example, would be, you know, one is China is just you know, suffers from the opposite problem as the United States. In the United States, we have all this land, all these resources, and not enough people. So for the last 300 years, it's been this constant immigration. We've been absorbing immigration and creating wealth through, through, through immigration because actually what we need are people, whereas in China, I mean, they've, they've always been the opposite. They've had too many people compared to the amount of resources on the ground. And then that's why they were poor. and, and, you know, while this is quite obvious, I think people sometimes don't understand what sort of implications that has on things like economic policy and, and doing things differently China has to do things differently, China can't.

And, you know, this goes again back to the sort of, you know, Washington consensus or the triumphalism triumphalism after in the 90s of there's one right way of doing things. And, and actually because of some of these different differences you actually know you can't, you know, Chinese people can't, you know, live in houses with lawns.

And everybody can't have a car. I mean, it's just going to be taken away from me, it's just not possible. So I think that's something that, again, is obvious, but people sometimes don't quite link it to their analysis. The other thing is just this level of economic development. Obviously, China was poor for a long time.

I think very few Americans. understand the level of poverty that Chinese people understand within their lifetime. and, and that has a major cultural effect. It also has an effect on how you know, people think about consumption and investing and and, you know, really the last generation to really experience the kind of poverty that China had in the 80s and 90s was the greatest generation, you know, during the depression.

And so I think, I think sometimes, you know, we know that China was, was poor, but we haven't quite, there's, there's, there's not a visceral understanding of what that poverty means and, and, and how it might change the way that you, that you, that your policies

Steve Hsu: You know, to two specific implications of that, the fact that they are living memory can remember being very poor. And, you know, even just 20 years ago, when you and I, when I was traveling in China, we could see unbelievable levels of poverty, which, you know, largely are gone now. anybody who lived through that is number one, maybe not going to have the same kinds of expectations about the level of their retirement, right?

So these old people in China, they're probably just happy, in my experience, happy just to be around their family. Eat a good meal, play checkers with their friends. They're not thinking that good retirement means they get to go on a cruise ship, you know, around the Gulf of Mexico or something. They don't think that way.

So, I think there, well, there are like, when you look at the specific numbers of the demographic challenges that China faces, like how are they going to support these older people? I think the expectations of these older people are much lower than people who had grown up in a developed economy their whole lives and now we're about to retire.

These are people who grew up in poverty. And then we're getting ready to retire. So I think that's something Westerners can't really appreciate.

And the other one is that the idea that if China hits a rough patch, the government could collapse seems very farfetched to me because most people attribute that vast improvement over the last 20, 30, 40 years to the government.

They give a lot of credit to the government for that. And so like, if they hit a rough patch that lasts even five years, I don't think it's that brittle. I don't think the system is ready to collapse. I think people have a lot of confidence. in the system there based on what happened looking backwards over the last, say, 20 years.

And that's another thing I think Westerners don't appreciate.

Glenn Luk: Yeah, you know, one of the, my, my favorite classes from, I studied computer science and, and finance and information systems in college, but one of my favorite classes was actually demographics, sociology class. And one of the things I learned was. About demographic cohorts. And so, you know, I, I think that's proven helpful because if you really think about it, all the, all the old people right now in China, I mean, 85 percent of them were farmers and that's going to shape the way that they think about their retirement.

It's also going to shape how they feel about how they consume and what they purchase. They're, they're just not going to be going out there and splurging to your point. They want a house, they want to be around family. They want to take care of their kids. I mean, it's, it's very. It's very simple.

And so I think again, I think because I think oftentimes Americans don't, don't understand that background. I mean, China, you know, is, is, is just such a big place that, I mean, I think a lot of the problems with understanding China are just people don't have time to, to break it down to the next level, like break it down by region or break it down by, you know social socioeconomic class.

Or break it down by you know, blue collar versus white collar, but I think you need to break. If you really want to understand China, you can't look at it as you can't look at GDP. You have to, you know, you have to break it down by sector. you can't look at you know, consumption versus investment.

Again, you have to break it down by sector by industry. So, it does require work and it requires thinking along you know, at a deeper level of a country that's 1. 4 billion people. So I think the biggest problem is that 99 percent of people look at China and see it as a monolith.

They have one picture, one person, one characterization of China, and they can't really go deeper than that. Or it's very, very difficult to go deeper.

Steve Hsu: Let me, let me throw out some sort of two different ways to look at China by numbers, and I'll throw out the numbers that you could quote to make it seem like, wow, this Chinese economy is already qualitatively bigger than the U. S. economy. Whereas another set of figures I could throw out that suggests like, oh, China, China is still way behind the U.S. And so you see these dueling kinds of worldviews all the time on Twitter, and I see you sometimes engaging in this. So we could say, oh, purchasing power parity adjusted, their economy is already kind of a third bigger than the United States. And you might say, well okay, what context do you care about this?

Well, maybe you care about it in terms of. What they, how much they can build up their military. Maybe that's the right metric since the expenditures are domestic that they have to make in order to build up their military, the labor to build a tank or a ship or, or a missile is, is local. And so the PPP numbers are right.

And if so, there, if their PPP GDP, total GDP is a lot bigger than the U S and that means they can produce a lot more stuff from a military perspective. From the viewpoint of Joe economist. Though if I divide their GDP by the population, the average income is still probably, what, a third or a fourth.

Depending on whether you use PPP or exchange rates you know, somebody who's an average person in China looks like they're desperately, well, pretty poor in the U. S. standards, they're in poverty. And then someone else can come back and say, yeah, but if you look at that person's life, they have an air conditioned apartment, they ride the metro, they have a laptop, they have a cell phone, you know, their cell phone bandwidth is faster than yours.

so it becomes extremely tough too. To make these comparisons, you could also look at, for example, the amount of electricity generated and consumed in the countries and they're like China just dwarfs the United States. So, so talk, talk a little bit about the difficulty in making these comparisons between the two economies.

Glenn Luk: Yeah, I mean, you know, my, my view is that, well, first of all, I think in China, I think we have to on a per capita basis, I mean, there's, there's 1. 4 billion people, so. Even though, even if China is, you know, I think, I think the numbers are that China's manufacturing value is 30 percent and the U. S. is 18 or 19%.

I think on a per capita basis, the U. S. is still actually manufacturing more.

Steve Hsu: Yep.

Glenn Luk: so, but, you know, I think adjusting it purely based on the spot exchange rate is also counting the amount of production in China. I think there's so I think that the answer is actually closer to the purchasing power adjusted parity.

But even then, there's there's a lot of issues. You know, one of the issues that I've been studying is actually just the way that GDP itself is calculated. You know, I think there's national or global standards on how to calculate GDP, but. countries have a lot of leeway to interpret those standards, and there's also older standards and newer standards, and, and for a long time, China was actually on an, on an older standards I think the, the 2008 version of, of SNA, and so under the older, under the older versions even if there were true economic activity, sometimes it wouldn't be counted.

I think services were one of them. components of GDP that were revised in the latest accounting update on China have slowly adopted it, but it's been taking time and just even more. Fundamentally, I think China came from a communist history and their measurement systems. I mean, we have to sometimes think about it.

I mean, there's, there's always a lot of questions about, you know, the numbers coming out of China and are they being faked or are they fraudulent? And, you know, I, the way I look at it, I see a bunch of bean counters. Yeah. And bean counters have their, their, you know, good traits and their bad traits, their, their, you know, they, they, they sometimes make mistakes, they sometimes count the wrong things.

Sometimes the series, you know, the way that GDP is put together involves merging, you know, dozens and dozens of different statistical series and triangulating and, and so, you know, I just look at it as, you know, this big approximation exercise anyway. And, and of course, I think there, there's some, you know, political or, you know, propaganda elements to it, but I think that usually has mainly to do with the top level numbers.

I mean, no, the average person is not going to care about, you know, steel production per capita or anything like that. They're going to compare it to that 5 percent GDP number. And so I think we've seen some evidence of smoothing, whether it's real world smoothing by, you know, doing, using sort of, you know, stimulus and taking off stimulus or actual, you know, playing with the, for example, playing with the GDP deflator, the, the inflation assumption to make it look smoother than it really is.

But, you know, are, are they, is there wholesale you know, fraudulent or faking of number? No, I, I see, I see bean counters counting up numbers you know, sometimes imperfectly and often having to revise. You know, and it's really interesting. I, I've. You know, that was one of the, that was one of the things where if you, if you're sort of a, you know, you know, a China macro tourist and, you know, I think one of the things that you pick up on early is, well, you can't trust the numbers coming out of China.

And, you know, you know, I, I picked up on that theme as well. But, you know, I think for me, my approach was to dig into the numbers and to look into the numbers. And I think we'll talk about it later. Where, you know, picking a very specific sector like high speed rail, you know, a lot of what I, what I learned about, you know, how, you know, Chinese bean counters count things, was by looking at the detailed numbers coming out of this one sector and seeing how they triangulated with the financials and, and, and how it rolled up into the, into the rest of the economy. And very importantly, how it sometimes was very, very different from what you would hear about, you know, in the West and, and, and, and media that actually didn't take the time to look at the numbers and try to reconcile them for yourself from, from a really detailed level.

And so this, this actually, this actually, I think, plays on this idea of, you know, going deeper and deeper. And so we started with sort of, you know, global, then we talked about China, then I think you peel back that onion and you get down to a sector and you, and I think it's been, it's been really just like with my professional career where I started the big picture.

And went down to, you know, building companies in the same way, I think my, my approach to understanding China has been to have form a macro view, but then validate it by, by going deeper and deeper and actually getting a much more less abstract understanding of the numbers and actually getting a real, you know, physical or tangible understanding of what those numbers are in the case of high speed

Steve Hsu: Yeah, so we're, we're an hour in. So I would just say, let's, let's jump into high speed rail, which is something I know you've analyzed in depth. And it's a, it's a huge symbolic thing in China that you know, it's a, it's a symbol of like, where they're really world leading both in technology and the, the scale of deployment and, and, and for again, like people who've never been to China and ridden on their rail system.

It's incredibly impressive when you get on 1 of these trains. Before we do that, let me just comment that I totally agree with you. Starting with this macro view, you know, top line numbers, but then you have to drill down to really get to the reality. I would offer another example, which is the scientific and technological competitiveness of, say, China versus the U.S. There's the top line numbers like patents number of college graduates with a certain type of degree you know Number of innovations in a particular vertical. Those could be misleading. What you really need to do is and what someone like me who's a professor of physics is in a good position to do is you really see how good people are.

Glenn Luk: Right.

Steve Hsu: kids who went to Chinese universities and now they're in graduate programs in the U. S. and they are among the best grad students that we have. No department here could survive without those students across not just physics, but physical sciences and engineering, computer science.

But then you go there and you actually talk to the professors who, you know, are pretty young now. I mean, they're much younger than I am. The new professors there and you see, like, is this guy up to speed? Is this guy really at a world class level in his training and research and what his team is doing in their lab?

And the answer is yes. So the basic things like you can have all this debate on the internet, like, Oh, these are bullshit patents. These are not useful. Or they don't really know what they're doing. Well, you know what? Talk to any professor of engineering or physics or chemistry in the United States who has traveled to China recently and looked at what they're doing there.

And they will tell you. They pretty much caught up. They might not be exactly caught up. The U.S. might still be ahead. You know, largely, they've caught up and it's a qualitatively different situation than even 10 years ago. So that's my in depth report on something that I've seen firsthand. Let's switch over to high speed rail.

So there are 2 things about it. Like, I often hear the claim that this is just some huge sink of resources in China. It can't really be justified. It's a waste of money. It's all for show. And eventually they're going to run out of money and this whole system is going to collapse. maybe, maybe we can just start with that and, and then you can, you can take it wherever you want to go after that.

Glenn Luk: Yeah, well, let me, let me just, you know, preface this by saying I've always just been interested in public infrastructure and trains. You know, when I, when I first moved to Hong Kong and I, you know, the first time I stepped into the MTR I was, I was, wow, I mean, I was like, oh, my, my cell phone works, you know, while while the train is running and that was in 2001.

Steve Hsu: And now, sorry to interrupt you, but now I think, can't you get on the MTR and then, like, literally, like, go all the way to Beijing or something? You can, you, you have to transfer to a train, but then you can go, like, all the way up to Beijing now, I think, on a high speed train or something.

Glenn Luk: Yeah, well, on the high speed train, but, but but as well. Yeah, I think you can, you can take it from I mean, I used to, I used to joke that you could get from the. The Hong Kong airport to my office without ever stepping outside. You could just, you know, get on the train and go on the airport express and then take a series of covered steps and go through buildings and eventually get to my office at the Chong Kong center.

In downtown Hong Kong, but yeah, and, and, you know, I wrote the, I wrote the Shanghai Maglev in 2005. My first experience on the high speed rail was actually in Taiwan in 2007. And I used to actually keep this little blog. I think it was on Zanga. And I wrote, it was actually one of my first, like, non, like, more serious posts.

And I, I posted about how, you know, for the, the cost of the war on terror. We could have built, you know, you know, at Taiwan rates of, you know, dollars per kilometer, we could have built our own little high speed rail network by now back in, back in the mid two thousands, but you know, and so of course, when China started to to build its, its network, you know, I'll be honest, I was actually pretty skeptical.

I was, first of all, I was, I was, you know, I thought China was developing. I didn't. Think it was developing so fast that it could actually get it done. And I was frankly very, very skeptical about it. and so when the first lines open again, I, you know, I, I, you know, the first time I actually wrote it was in 2016.

So, you know, when the first lines open in 2007, 2008, you hear about it, but it doesn't really register with you. You're, you know, you and then, and then the, when the crash happened in 2011, I think that was, you know, there was this already this theme that you touched upon about how China has this investment heavy model.

And that high speed rail was just another part of that. You know, another example, if not the most egregious example of that, that over investment model. I think that narrative was also tied to some of these earlier themes that we talked about, like how the state or state. You know, companies just can't compete with private sector companies on allocating capital. so I think that's sort of perpetuated or propagated into this, this idea that, well, of course, high speed rail must be inefficient. They're spending, you know, hundreds of billions of dollars there. There's no, you know, there's no process in place. They're just, they're shooting in the dark. and, and frankly, I think that was how I felt about it as well for the first few years you know, I was open though. I was open. I had an open mind that, Hey, maybe the Chinese could actually get this right. And I was open and I saw the merits in it. You know, China is, again, it's, it's a country that can't put a car in every, every. Person's driveway, or actually everybody doesn't have a driveway to put a car in.

And so they have to rely on public transportation more. I understood the positive social externalities of rail. You didn't have to burn gasoline, less pollution, and, you know, just not being stuck in traffic and being congested. But what I really didn't understand for a long time was actually a way to think about the numbers of high speed rail. And so, you know, I started kind of borrowing from my, my investment experience started just drilling down into the numbers. and so it turns out China railway, which owns or controls the entire passenger network as well as the freight network is one of the largest bond issuers, if not the largest bond issuer in the world.

A public bond issuer in China, which means that they have public financials. Now, this happened because the ministry of transport used to be part of the ministry of transport. It was the last major ministry to corporatize this, and this followed the, you know, the Wenzhou crash as well as the corruption allegations in the early 2000, 2010s.

And they created China's China Railway out of this. They, they, they listed and financed it mostly with bonds and at the project level secured loans from the banks. And what that meant was starting in 2013, China Railway started uh, you know, publicly issuing numbers that you could actually start tracking.

Now I didn't realize this. until actually several years later. but, you know, you started seeing some numbers come out. and, and I think this is where a little bit of, you know, having a financial background helps. so being able to read like an income statement and a balance sheet. And when you're debating things like debt and thinking about things like.

Credit capacity. I mean, it helps to understand financials. The other thing is all these numbers are in Chinese. so, you know, you can, you can get it translated. But like nobody who has a passing interest in high speed rail and doesn't speak Chinese is going to translate it. So, you know, I ended up, you know, going through the, the, the Chinese language.

Financials and also the operating data that they received. And slowly, this picture began to emerge. That was a little bit different, I think, from the more popular narrative at the time, which was that it was highly inefficient. they had built. they had built routes in places where people didn't live.

And so, you know, ridership was very, very low, which is, you know, the worst thing that you can do for high fixed upfront fixed cost projects is, you know, you know, having low utilization. There was this idea that it was debt funded investment that was done because, you know, the politicians wanted GDP growth and not because there were actually real reasons for it.

And by digging into the numbers, you know, I slowly peeled that onion and you know, realized that a lot of these things weren't actually true. Number one, ridership and utilization was actually not that bad even in the early years. it actually bottomed out around 2015 and 2016 after the first phase lines had basically just, after the second phase, Construction lines had opened. And then it started to slowly improve in 2017 to 2019. You know, I looked at the debt numbers. I looked at the, the, the income statement, and I realized that actually, you know, the company could support the debt load based on not only the ticket revenue. So a lot of people were just looking at the ticket revenue.

They didn't understand that part of the rail model. And, and you would understand this if you had looked at the MTR corporation in Hong Kong, part of the. Rail model is that you generate all this foot traffic, and that's really a real estate play. So actually, you have to look at it as a combination of a, of a, of a transportation network, but also a real estate place, all the, the, the commercial leases that they rent out to, you know, catering and restaurants at the train stations, the catering on the trains, the advertisements on the trains, this is, this is all part of that economic model.

People weren't there, there's a famous Chinese economist who was critical of high speed rail and part of his analysis did not take into account the sort of real estate business portion of China.

Steve Hsu: Yeah, now, just sorry to interrupt, but just a point for Americans, maybe Europeans would understand this better, but. If you're in Taiwan or Hong Kong or Korea or Japan or China, some of the most valuable real estate is where there's a metro station or a high speed rail station because there's guaranteed flow of people there.

And sometimes you'll see the most luxurious, beautiful malls, apartment complexes, office buildings just built around that structure. Actually, even in Bangkok now you see that. So that's something to be taken into account because the rail company is creating that value by putting the station there.

So that's part of the investment. And then that creates this complex which then turns out to be super valuable in real estate terms.

Glenn Luk: No, absolutely. I mean, I think you can't really run a profitable, you know, public transportation business without thinking about retail and monetizing all of that. Yeah. The foot traffic that you generate, you know, some of the best business models are actually hidden real estate businesses like Asian food markets, you know, they don't make money on the food.

They make money by renting out all the stores based on the traffic that they generate. So, I mean, you know, I think, I think. So, I think you need to understand. Kind of understand the business model of transport and. And then I think, secondly, I think the other piece was. just all the stuff that's not measuring the positive externalities, I mean, these have real value, but it's hard to measure.

And I think this is where this discussion of whether a private sector approach versus a public sector approach becomes really, really interesting because, you know, you know, the private sector approach would be to effectively align the project sponsor As an equity holder, but if you think about public transport, it's not just about the equity owners.

It's about the travelers. It's about the local communities and sort of the spillover effects a, if you're an equity holder is your incentive, your incentive is going to be to maximize to maximize, you know, ticket prices to, you know, some, some optimal level That may not be actually optimal for society, whereas you know, I think China Railway being a state owned enterprise there, they actually don't try to optimize for return on equity.

They actually try to keep prices [down].

Steve Hsu: Yeah. It's ridiculously, it's ridiculously cheap to ride the system for, at least from a Western perspective.

Glenn Luk: And actually, increasingly from a Chinese perspective, so, you know, one of the things you'll notice with, with you know, high speed rail tickets is that prices don't really go up. So when the Beijing, Tianjin line opened in 2009, it was, I think it was 58 Yuan to take that, you know, one hour or 45 minute trip.

It's still, actually, I think some fares I saw were still actually cheaper than that, even though inflation or just the fact that household incomes have risen. Three to four X since 2009. So it's become three to four times more affordable to take that ride. And that may not be something that happens if, if these were the decision makers, the people making decisions on tariffs were the equity holders.

Steve Hsu: At this stage, though, when you're talking about the externalities, social benefits from the transportation infrastructure to average people, it gets pretty complicated. Like, in the US, we built out the freeway system after World War 2 and spent unbelievable amounts of money on that. And some environmentalists would say, you know, to the detriment of our cities and.

You know, all this stuff, walkability, all that stuff. But of course, it's an incredibly complex question. Like, was it worth it? Was that a good thing to build all these freeways? Of course. It had very strong 2nd, order effects on economic development of the whole country. Right? So I think very, I think, for me, very tough to really just get a, get the whole thing.

Like, I don't even know, like, do I, what's my opinion about all the freeway building? We do us. Is it like net good or net bad? I'm not even sure, but yeah, From a narrow perspective though, I guess, I think you're saying that the rail system, say the high speed rail system in China, is not going to need huge continued government subsidies forever, will it?

What is, what do the numbers say about that?

Glenn Luk: Well to, to grow the, the, the, the network, the, the company still has to, you know, take on debt to build out new assets. but the existing network is largely self sufficient at this point. like I said, they're, they're not maximizing revenue. They could actually increase tariffs and probably grow revenue, but they actually don't try to maximize revenue.

They basically target paying off all the debt that they've issued to support the network at like three to 4 percent interest rate and they set tariffs at that level and that's it. so they're not looking to generate a return on equity. I think the return on equity for them.

Is basically the consumer surplus and all these positive externalities that accrue to, you know, other sectors and, you know you know, other into the households in the form of higher quality of.

Steve Hsu: for the exist, for the existing networks, ignoring like building it out further, but for the existing network, future maintenance and keeping the technology up to date, does that look like it's going to be like a problem where they'll have to get a chunk of cash from government to do that, or?

Glenn Luk: No, I mean, they, the, the maintenance costs are well understood. There was this really great World Bank report. The World Bank financed four of the phase one lines back in from 2008 to 2014. So they had a. They had deep insight into how these. These projects were run. And by the way, that gave me a lot of confidence that because you had a, you had a sort of external, independent party looking at these projects that, you know, that gave me a lot of confidence that the numbers weren't being made up, right?

Because they have access to all the detailed projects implemented. They were a lender to some of these projects. so, but the World Bank came out with a report that summarized their findings. about China's high speed rail experience in 2019, and they talk about maintenance. One of the many things they talk about is that maintenance costs are well understood.

I think for every, every kilometer of rail, it costs, I think, something like between 1. 8 to 2. 3 million renminbi per year to just maintain the line so that it stays in tip top shape. so those costs are built into the, into the, you know, the, the cost recovery structure into the operating expense structure that they use to set tariffs.

Those costs don't necessarily, they don't go up, they go up probably with the cost of labor. though, you know, you can also argue, I think they've automated a lot of the maintenance by using, they've created all this, and this is, this is another really interesting thing. They created all this specialized equipment.

That was, that was geared towards high speed rail that was specialized for high speed rail. You've seen this happen in, in a bunch of other industries as well. That's unique to that sector. So they have automated maintenance equipment that will run along the line, make sure that they're, you know, smooth and that the metal isn't worn out.

And, and they're now talking about using big data and machine learning. And I don't, I'm not sure if it's really AI, but. They're using big data to really understand you know, preemptively how you can, you can maintain these lines. So those costs are all built into the, into the OPEC structure and covered by, by tariffs and by this, this ancillary non transport revenue.

Steve Hsu: Just to summarize it, I think you're saying that having looked into the details, there's enough transparency that you can conclude that this is actually a healthy system. Mm hmm. It's not a, what was the, what was the word? The not pink, not white elephant, but a gray rhino. Or there were, there's some, yeah, there were some negative ways that people had to refer to this whole thing.

It's just like a huge sink of resources for the Chinese government and people. But you're, I think you're, you're confident that's actually not the case.

Glenn Luk: Yeah. And you know what really validated for me, Steve was, you know, during, during the pandemic, when people weren't traveling, the financials didn't look great, they were basically running, running at a loss, you know, knowing that eventually they would, they would come out of the pandemic, but what really validated for me was you saw a lot of momentum going from 2016 to 2019.

And sort of the increase in ridership. And then you sort of had this dip. What validated for me was coming out of the pandemic ridership shot back up to, it's not quite on trend yet, but it's, it's back up to. You know, I think 92 or 93 percent of what would have been the trend without the pandemic and you know, you're talking, I mean, China railway is, is a company that is generating something like 200 billion of revenue and 70 billion of EBITDA.

I mean, these are, so it's sort of, there's, there's cognitive dissonance when I, when I hear about this thing being a disaster, like a financial disaster when, when I see numbers like that. you know, in the financials that are, that, you know, millions of public bond investors rely on to get their, their, their dividend payments or their interest payments,

Steve Hsu: That's great. That's a great story. And we'll, we'll put some links into that. Your analysis is available, not just on Twitter, but it's on some, is it on a blog or somewhere that people can find it.

Glenn Luk: On Substack.

Steve Hsu: Okay, we'll put some links into that. so we've been on for almost an hour, 20 minutes. I thought maybe we could close out by just talking.

Then, when we throw out a hypothesis, you can give me a reaction to it. So, my view of the problems that they're having in the Chinese economy right now, one could think of multiple drivers. So, one is, maybe she is imposing some increased centralization and less business friendly environment on what's happening in China.

Number two is still coming out of COVID to some extent. And number three is to me, maybe the most important one, a property bubble that everybody has known about for 10 years or more. They knew they were going to have to pop it. The government moved to pop it and is deliberately shifting investment so that growth in the economy is not coming from investment, mainly in property and related infrastructure, but in investment in advanced technology and advanced manufacturing.

And that, to me, if that 3rd thing is the dominant component of the malaise that they're feeling right now. It's a gamble because maybe it's not going to work out. But on the other hand, it's a very clear strategy that they have that they're going to endure whatever it is 5 years, or maybe even 10 years to get out of this property bubble problem that they had.

But at the end of it, maybe they'll be even higher on the value add chain in manufacturing and high technology. Maybe you can just react to what I just said.

Glenn Luk: Yeah, no, and, and so just you know, I think that, you know, having watched and, and participated in looking at the Chinese economy over the last 20 years or more, I, I've seen the economy actually go through multiple shifts, you know, and, driven by some of the factors that we talked about before, like demographic change and just the natural process of moving up and climbing the, the value chain in terms of knowledge and skills and human capital.

So to me, the property and infrastructure investment of, you know, really started in the early 2000s, when they reformed property reform, and you could actually, you know, own a home for the first time and then really accelerate after the GFC. I mean, to me, property and infrastructure were necessary evils because this is pretty low on the hierarchy of needs.

Like you need shelter and you need a place to live, especially in a country of 1. 4 billion and where there's not a lot of land. And so you're going to have to build up. There's just no way of escaping that. so the, the, you know, I'm actually, I think on the. more, you know, the optimistic side that it wasn't actually as big of a bubble as people thought.

I think there was definitely some malinvestment, but I think the, the, the issue of malinvestment was more one of distribution, not one of aggregate malinvestment. I think if, you know, if you understand the way that the, the land finance mechanism work, it's sort of like a, you know, it's like, it's like a one, one size fits all financing approach that, May work well in Shanghai, but doesn't work well in, in Guizhou.

So you end up with certain areas like the tier one cities where there's actually an undersupply of housing. Because they're dealing with not, they don't want too many people to move there because they have to provide social services. And then you, you, you have other places like in Guizhou where there's actually an oversupply of housing because you have this crude financing mechanism.

So to me, it was actually more of a distribution problem because To your earlier point I think the central government plays that disciplining role. and they're the ones who stepped in and said, okay, I think it's on, on, in aggregate, we're getting a little bit too, we're building a little bit too much and we have to start deflating that bubble.

And it was a, it was actually like a 10 year process of trying to deflate that bubble. And so, that transition to me wasn't, didn't start three years ago. It started 10 years ago. and sort of laying the groundwork. I mean, this is, this is one of the challenges of dealing with an economy of 1. 4 billion people is that you can't move the ship that quickly, especially something as big as this.

So you know, you know, it's, it's, it's actually, I think the degree of difficulty is quite high. and so you're never going to get everything right. I think there's also the other, I think, big picture issue in China of just rising inequality. Okay. So 12 years ago, 15 years ago, if you talked to people, people, that was one of the biggest issues on people's minds, they're like, well, you know, you know, the economy is growing fast and, you know, it's dynamic and everything, but you're leaving the inland profit provinces behind you've got three major regions that are prospering, the rest of the country is being left behind, social inequality, which was a absolutely a 15 years ago it takes, you know, sacrifice to to correct social inequality.

And I think a lot of the slowdown and growth. I mean, I would even argue that a lot of the infrastructure investment that was sort of spread out peanut butter style across the country was one of the ways that they were actually trying to address poverty is by bringing infrastructure into regions that couldn't afford it on their own, which meant the wealthier regions are effectively subsidizing asset and infrastructure development for the poor regions.

That to me is a. Balanced social inequality balancing effect. and so I think the cost of that has been slower growth. so, I call property and infrastructure a necessary evil because it's fundamentally a very low return on investment type of activity, but it's also really necessary. You need homes and you need infrastructure.

So now you know, one of the issues with turning around this big ship of 1. 4 billion souls is. you had to make some sacrifices and I think the, the, the government made a conscious choice to have the mass affluent in society eat a lot of the pain. Over the last three years, they cracked down on property, which, you know, people, the people buying second and third homes for speculation, weren't.

We're all in that five, you know, upper five to ten percent. So they're the ones who are really hurt by, you know, speculating and by real estate prices going down, whereas everybody else who bought a home, I mean, they're living in it. It's their one home. For them, it doesn't really matter what the mark to market is, it's just where they live.

so that was one. Secondly, I think they've made a conscious effort to make sure that particularly the blue collar labor force is fully employed. I think in China, the, you know, the, the, the key stimulus, it's not like a demand, a Western style demands a side stimulus where you're just sending, cutting checks to people.

I think their form of stimulus is to make sure people are employed and, and earning incomes that are growing and out of that income, they're going to spend more and more and more and with, you know, result in rising demand. So I think they've been very focused on. Making sure that the blue collar labor pool has and the farmers and, you know, in the countryside, that their incomes are rising.

And so they're, you know, that combined group has actually been relatively has done relatively well over the last 10 years. In terms of their income, whereas the sort of the mass affluent, they've gotten hit on the capital income side. With stocks and with real estate, and their incomes are actually, I think rising a little bit below the national average as well.

So I think they were, they were the casualty in all this. And so what we're seeing right now, I think the big question is whether, I mean, people talk about this economic malaise. It's largely with that top 5 to 10 percent of the population and I think the bet is that at some point they're going to sort of accept, you know, their losses and, you know, they're, they're going to open up their pocketbooks.

I mean, it's not like they've been there, their income has been going down. I mean, it's just, they're just not rising as quickly as they were before. So I think there has, there's been a reset of expectations for the, the, you know, sort of the. The mass affluent. We've seen that that's fairly evident, you know I mean, a lot of the people in my circle, I mean, that's who I talk to.

And I sometimes have to consciously tell myself, this is not all of China. This is the top 5 to 10 percent of China. So this is not necessarily indicative. so I think that is the challenge, but that's sort of a wait and see game. I mean, you can't, yeah. You can't control, you know, consumer sentiment.

It's one of the things that the Chinese government cannot control. They, they, they tend to just try to stick to, in terms of policy, things that they can control and, and for, for things that they cannot control, they'll make sure that they have policy tools available so that you know, if consumer sentiment declines even further, can they make up for it with some stimulus?

So I think that's how we haven't seen a lot of stimulus yet, because, and that to me is actually a sign that. there, things are actually going okay, maybe not, not gangbusters but that there, you know, if things do fall off and either if there's an exogenous, if there's another round of, you know, 60 percent tariffs, you know, there's, there's an adjustment mechanism there probably with the FX rate or if consumer sentiment improves, well, then you can maybe adjust the other way.

And so to me, it's sort of a Goldilocks environment. and, and we're going through a transition phase. Now, that's your point. Of these resources flowing from the formerly from the property sector and from sort of old infrastructure. Into some of the new infrastructure stuff, like clean energy.

As well as the advanced manufacturing side, and that's just that just takes time. You know, I've been studying a lot and I've been doing a lot recently just to understand. like the electric vehicle, you know, industry and capacity. It just takes time to build up capacity. I think in my latest research you know, I sort of have a different view from the mainstream, which is, I, I think China is going to, is not suffering from EV over capacity.

In fact, I think they need to grow EV capacity by 5X over the next 15 years. And, growing it 5X means. Installing the equivalent of South Korea's auto manufacturing output every single year from now till 2033. So it's not a trivial task. I think it doesn't happen. Like, magically, you can't press a button and it happens.

You need to have the people in place, you need to have the skills and you need to coordinate the entire supply chain. So there's, there's a lot to do. I think for the economy, there's plenty of stuff to keep it occupied for the next 10 years, but the transition is happening. and, and I think we just, we just need to watch how things go.

Steve Hsu: Wow, that's great. I think this is a great place to end. We're right at 90 minutes and I think I've learned a lot. I think the audience has learned a lot from your detailed insights. Any last thing you want to say, Glenn, before we stop the recording?

Glenn Luk: Well, no, I think we, we actually ended up covering maybe like one half of the outline. so, you know, I really enjoyed the experience and, you know, we'd love to, you know, continue this conversation in the future.

Steve Hsu: Yeah, let's definitely keep in touch.

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Stephen Hsu
Stephen Hsu
Steve Hsu is Professor of Theoretical Physics and of Computational Mathematics, Science, and Engineering at Michigan State University.
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