Victor Shih on Xi Jinping's Control, AI "Brakes," Local Debt, and What Comes After Xi

Today I'm talking with Victor Shih, who is the director of the 21st Century China Center at UC San Diego. China is obviously one of the most important economic and geopolitical issues of our time, doubly so if you believe what I believe about AI. I was especially keen to talk to you because you have deep expertise not only in Chinese elite politics, but also its economic system and fiscal and banking policies. We'll get into all of that before we get into the AI topics.

Is China actually a more decentralized system than America? If you look at government spending by provincial governments vs. national government in China, it's about 85% local+provincial and 15% national. In the US, if you combine state and local it's 50%, and the federal government is 50%.

When you think of an authoritarian system, you often think of it as something very top-down, where the center controls everything. But looking at those numbers, it seems like China might actually be quite decentralized. Or is that the wrong way to look at the numbers?

For a while China was quite decentralized, from the mid-1970s all the way until the mid-1990s. China was very decentralized. Local governments generated a lot of revenue, but they also spent a lot of money. It incentivized them to do basically good things, such as trying to attract as much FDI as possible, trying to attract as much local investment as possible, give tax breaks, and so on and so forth.

China had a very good period of mainly private sector–driven growth because of this fiscal decentralization. That's the understanding of most economists.

But then there was a tax centralization in 1994, where the central government basically said, “Okay, this is ridiculous. We don't want to end up like the Soviet Union and fall into different pieces. We need to control fiscal income.” So then they grabbed the most lucrative source of taxation at that time—and it continues to be the case—which is the value-added tax.

The value-added taxes—and in subsequent decades pretty much all other tax categories—are now collected by the central government. Then they reimburse part of the money to the provinces.

Supposedly they say, “Okay, now you can spend the money as you wish.” But in reality, that's not the case. In reality it's kind of like, “If you do this thing, then I'll give you a little bit of money. But you have to do the thing that I want you to do to get this money, to get this grant.” So the fiscal autonomy, I would say, has been falling since 1994.

There are different periods. Sometimes there's a little bit more autonomy. From 2000 to recently, until 2020, the localities gained more autonomy vis-à-vis land sales. That's when the real estate market was going very well. Even though they couldn't control the tax revenue, they could control the land revenue. But then the central government basically killed the land market in 2022.

Now I think localities in China are highly dependent on the central government.

Let's start at the very top. First, I want to understand the personnel. If you look at the members of the Politburo and their pasts, a lot of them were provincial leaders, and then had some kind of local role before that. But in many cases, they'll have stints as the head of some chemical engineering SOE, or they studied engineering. Xi Jinping himself has a PhD in chemical engineering, right? Something, some kind of…

That’s what I want to ask about. If you go through the list, a lot of them are PhD economists, PhD industrial engineers, and so on. Some even have PhDs in Marxist theory. That seems fake. Are they actual technocrats? If you look at their degrees, they seem quite impressive. Or is this just fake made-up credentialism?

If there’s a PhD economist in the Politburo, should I be impressed and think they really understand economics? Or should I just think this is a fake degree?

So the former Premier of China, Li Keqiang, his undergraduate degree was in economics. He studied under one of the best economists in China. So I think he understood economics.

In the Politburo today, there’s this wing made up of military-industrialists who were trained as engineers. They indeed were trained in the best programs in China.

For example, Ma Xingrui, the Party Secretary of Xinjiang, is in the Politburo. He graduated from Tsinghua University. Zhang Guoqing, who worked in the military industry for years and, I don’t know if it was Tsinghua but he graduated from one of the top science programs in China. So they do know a lot about science. But does that mean they know how to govern? That’s a somewhat different question.

But you also have other cases, like Ding Xuexiang. He’s in charge of cybersecurity in China. He has a technical background in metallurgical forging. Graduating from, not the MIT of China but maybe closer to the IIT of China, a second-tier science institute founded by a Soviet expert who wanted to teach China how to do metallurgy.

Does that kind of very specialized technical knowledge make you a better leader? I think it depends on the person.

In the Chinese Communist Party, as people rise through the ranks, they have to have political acumen. If you don’t have political acumen, you’re not going to make it. Some people, on top of their technical expertise, turn out to have that acumen. But it’s not something you can know ex ante, except for the princelings.

The princelings are special not just because of their genes. Yes, they’re the children of high-level officials. But they grew up honing this political acumen because their parents could teach them about it. So some of them turn out to have this political acumen. They’re pretty smart. They don’t necessarily have the best degrees from the best universities in China, but they end up being very successful.

It’s not necessarily the case that all the Peking and Tsinghua graduates reach the top. They are certainly disproportionately represented in the Politburo, but they don’t dominate. At the end of the day, it is somewhat random.

I still feel confused about how to model the competence of the Party. On the one hand, they’re super educated in STEM. They’re selected at least partly on merit, etc. On the other hand you see things like… A lot of Zero-COVID was just genuinely stupid, scrubbing down airport runways and so forth. And it just went on way too long. Why was nobody steering the ship then? What’s the right way to put this picture together?

There's a lot of expertise at the lower level that can feed into the higher level. There are channels for doing that. I would say there are a lot of channels. So they're not so dysfunctional on that score.

But what time and again leads to suboptimal policy is the Party’s instinct to preserve itself, and in a way worse than that, to preserve its power. It’s not just, “Let’s do this thing because it will lead to a better public health outcome and we’ll survive politically.” Their mindset is, “Even if we would survive politically, if doing that would result in a loss of power—like having less control over the banks, or scientists becoming more independent—then let’s not do that. Because what's the cost? Some people die, whatever. We have slower growth for a couple of years. But if we get to preserve power, we will go ahead and preserve power.”

Here's a question. Traditionally, if you study economics in an American university, you learn about supply and demand. You learn why certain regulations are bad, why tariffs are bad, etc. Basic 101 teaches you that. So if a lot of the members at the highest levels of the Communist Party have that basic understanding, what’s the reason they make mistakes that many economists say they shouldn’t do?

People talk about rebalancing a lot. Why don’t they think increasing consumption is a good idea?

There’s a traditional reason, and then there’s today’s reason, which is on top of the traditional reason. The traditional reason is that, in education in China, you get tracked into sciences, STEM, or you get tracked into social science or humanities. If you get tracked into STEM, you may never learn anything about supply and demand. It’s just not required. You just learn a bunch of math. You learn a lot of engineering, if you want to be an engineer. Then there are some art classes for you to select. You can select the art classes, or maybe one econ class.

For a while, learning economics was popular. In the 1990s, all the engineering students would have taken an econ class. But for people who were trained before that, they would not.

The one class that is still required for everybody is government ideology. In fact, the requirement for government ideology has been ratcheted up in recent years.

I look at all the applications of students from China. I look at what classes they’ve taken. Now, once a year, they have to take a class called "Situation and Policy," which is basically just the Chinese government's perspective on all kinds of different issues. But that’s not economics, it’s not accounting. It’s not some basic skill. It’s just telling people what the government prefers on a given topic.

So that’s the traditional reason. You can have some very high-level officials—even if they have a PhD in nuclear engineering—who may not know very much about how the market works, how society works, and so on and so forth.

The new reason is that we have one very powerful figure in the Chinese Communist Party. Being a Politburo member used to give you some autonomy in the domain that you govern over. That is no longer the case. If Xi Jinping expresses a preference over a policy direction, that is the direction you have to go toward, no matter what. Because if he observes that you're dragging your feet, or that you're pursuing a slightly different agenda, you’ll be purged. And we’ve seen cases of that.

At some point, we’ll talk about Leading Small Groups and the way they work. But the picture you get from the fact that Xi is monitoring what all these different Politburo members are doing… He’s noticing whether they’re dragging their feet. He’s leading all these small teams. They organize different leaders who are the heads of ministries or commissions relevant to a specific project. I guess every week they meet and they hammer out who’s a bottleneck, what we need to do to get a project moving.

So Xi has ratcheted up the number of these meetings. The picture you get is of someone who is micromanaging details across all these policy areas. If you read Stalin biographies, Stalin actually was a person like this, obviously not to great effect. But he was interested in micromanaging every single detail, from theater productions to steel production. Everything. Is that who Xi is?

Yeah. If you look at what he does day to day, he spends a lot of time in meetings. It’s astonishing. The Chinese leadership, they're not going to play golf 3 days out of the week. Xi Jinping and his colleagues are having meetings about policies almost every day, like 270 days out of the year.

The study sessions of the Politburo, are these meetings substantive? Are they real? Is he actually learning the intricacies of, "Here’s how Zero-COVID has impacted this province and here’s why we should..."? Because if you read the announcements from the Party or departments, they’re so vapid. It’s typical Communist-speak. How real are these meetings?

So I’ve talked to some people who’ve lectured to the Politburo. I think they’re somewhat real. Because they don’t know ex ante what questions they’ll be asked, I’m talking about the speakers. Xi Jinping and other leaders will know what the speaker will say in the main remarks. But then there’s a Q&A portion which actually is real, it’s not staged.

That’s pretty scary. If you’re some professor and Xi Jinping asks you to come in and asks you a bunch of random questions.

It's very scary. So I think they are substantive. And the thing is, Xi Jinping will make remarks after such a lecture and those remarks become policy.

You asked about the Leading Small Group. This is where ranking is very important. The head of the group always has to be the most senior-ranked person. Of course, the good thing about having Xi Jinping as the head of a leading small group is that his authority won’t be challenged by anyone else. Because everyone agrees he’s the most powerful and senior-ranked person in all of China.

The problem is, all the other members of the LSG are lower rank than him. Well not all, but before, when decisions were made in the Politburo Standing Committee, notionally the Party and even the bureaucratic ranks of all the Politburo Standing Committee members were equivalent to each other. So there were debates. There were even sometimes cases of overturning the position of the Party Secretary General. Historically, you’ve seen cases like that.

But when most of the decision-making was pushed into all these different LSGs… Usually there’s one other person who’s similarly ranked as Xi Jinping, like the Premier of China, or one of the other top people. But everyone else would be these Vice Premiers, ministers, or provincial governors, who are definitely ranked lower than Xi Jinping. In no scenario will they debate a particular policy with him.

At most, there might be one person with sort of equal standing, officially, with Xi Jinping, who could voice some kind of disagreement. But because Xi is so powerful, informally, no one would actually dare to do that.

Basically, the whole thing, once all the decisions got pushed into LSGs, became Xi Jinping. And it’s very hard on him.

Before all these meetings, there’s a briefing. Someone gives him a briefing book and says, "Okay, this is what we’re going to talk about. Here are the policy options. Which one do you want?" He has to make up his mind. Sometimes I’m sure he consults with other people. But he has to be really engaged with a large number of policy areas on a day-to-day basis, because the decisions he makes basically become law.

It's stupendous to think about. You can tell someone how big China is—the population, the size of the economy, etc.—but visiting gives you a tangible sense of just how big. You have provinces, each of which has as many people as a normal nation-state, provinces with hundreds of millions of people, 40 million, and so forth. One person will say something at the end of a meeting that determines policy for basically the population of North and South America or something.

Does he say things at the end of meetings, during speeches, that indicate he actually has a good understanding of these different policy areas? Obviously, the official speeches are very vague. It’s always something like, “We will make sure that we are robustly pursuing Chinese growth while hewing to the tenets of Mao's thought.” It’s never anything specific or interesting. But do we have any indication that behind closed doors, he’s—

You don't think there's anything specific or interesting, but if you've read thousands of these things, sometimes it's quite revealing actually.

I’m interested in what it reveals about him personally. Does he display any analytical ability? Any sort of empirical understanding of different policies, etc.?

Yeah, that is difficult. I would say, because of his upbringing as a princeling, for internal Party matters of how to control the Party, how to control the military, from some of the speeches... They’re not secret speeches but they’re more geared toward other members of the Chinese Communist Party. If you go to China, you can read some of these, which I have. He has a really good political nose. He knows what it takes to control the Party apparatus, to control the military.

Especially on economic issues, it seems like some advisor gives him some talking points, and he talks through them. There's some sense of that.

On technology issues I think he cares a lot, but only from the perspective that competition with the United States is a very important objective for the Chinese Communist Party. It’s for him personally, a very important objective. So he wants to win. But precisely the extent to which he understands all the intricacies... it's unclear to me. I don’t think he necessarily does.

But then, comparing him to American leaders, especially today, I think he’s probably better prepared.

Just because in China, the experts talk to the top leadership all the time.

Yeah. The advantage of the American system, of course, is that, at least in theory, it can survive a leader who is not up to snuff.

Okay, let’s go back to Ding Xuexiang. So the Politburo has 25 members?

Yes, 25 members. The Standing Committee has seven members. This is the key group inside the Politburo.

This person is one of those seven. He runs the Central Science and Technology Commission. The reason I’m especially interested in him is because any large-scale AI effort that China would launch would be under his purview. Do we understand what he wants, who he is, what his relationship with Xi is, what he would do if AGI is around the corner, etc.?

These are all very good questions. In addition to the Science and Technology Commission that you mentioned, another very important position that he holds is head of the Office of the Central Commission on Cybersecurity. The head of the Central Commission on Cybersecurity is Xi Jinping himself. But the head of the administrative office—which runs the day-to-day operations of that commission, basically a LSG—is Ding Xuexiang.

He took that position back in 2022, so he’s been steeped in cybersecurity for a couple of years. I think by now he knows all the major players and some of the key policy issues.

His relationship with Xi Jinping is a very interesting one. He only directly worked under Xi Jinping for one year. When Xi was in Shanghai, Ding was the very senior-level secretary who would support whoever the Party Secretary of Shanghai was. He worked under three different Party Secretaries of Shanghai and supported Xi Jinping for one year.

For some reason, Xi Jinping just trusted him absolutely after that. It’s a mystery. I’ve looked at all the open literature, I’ve asked people in Shanghai. Nobody knows why that’s the case.

Almost certainly, I think one reason is that he was gathering a lot of information about the other leaders in Shanghai and sending all of that information to Xi Jinping, to let him know. Because at that time, the previous leader of China, Jiang Zemin, had a very big stronghold in Shanghai. So Xi had to break that apart before he could assert control. Ding Xuexiang likely was one of the people who sent all the necessary information to Xi Jinping in order for him to do that.

But beyond that—lots of people do that for Xi Jinping, truth be told—what else he’s done for the big boss to earn his trust is a big mystery. But the manifested outcome is that Xi trusts him a great deal.

In 2013, he was promoted to Beijing to be second-in-command in Xi’s personal office, handling all the flows of data in and out of Xi’s desk. That’s a very important position. He became first-in-command a couple of years later. He took control over the entire apparatus that governs Xi Jinping’s day-to-day life back in 2017. Now he’s a Vice Premier in charge of cybersecurity. So clearly, this guy is trusted.

His preferences for AI, AGI... I tweeted this Davos speech, which you also looked at. I think it’s very revealing.

What he said was, “We need to invest in AI, but we can’t go all out in investing in it without knowing what the brakes are. We have to develop the brakes at the same time.” I think that’s extremely revealing. It’s very different from the American approach.

In America, it’s all driven by the private sector. Except for one or two companies, everyone just invests and invests and tries to reach AGI as soon as possible.

For the Chinese government, they’re very afraid that some actor—outside, but even inside the Party—is going to use it as a tool to usurp the Party’s power. So they want to know that they have a way of stopping everything if it comes to it. For them, developing the brakes is just as important as developing the AI itself.

What are the different organizational milestones we should be watching for, to understand how they’re thinking about AI, and when things have escalated?

To add more color to this question, what I expect to happen, let's say next year, in terms of raw AI capabilities is that we might have computer-use agents. Not just a chatbot, but something that can actually do real work for you. You set it loose on your computer, and it goes through your email, compiles your taxes, etc. In five years, I expect it to be able to do all white-collar work, or most white-collar work. That’s 40% of the economy, potentially. Eventually, we’ll have full AGI, even robotics and so forth.

As this is happening, how should we be tracking how the Party is thinking about what’s happening, how seriously they take it, and what they think they should do about it? I think a couple weeks ago there was a Politburo study session on AI. I don’t know if it was AGI AI, or what kind of AI they were discussing. Should we be looking for a leading group on AGI in particular? Should we be trying to just read more speeches? What should we be paying attention to?

Thus far, it seems like it’s under the cybersecurity leading group. So Ding Xuexiang would be in charge of it.

There won’t be a new group?

I don’t think so. Because for the Party, it’s the security aspect of it that’s the most important.

There’s one aspect where it’d be great to automate all industrial production. China is already doing a good job with that. I don’t think they need additional governing infrastructure to allow them to do that.

But when it comes to applying AGI or AI to governance, even to service sectors—generating video content for people, doing travel agency stuff—the Party is very paranoid that some hostile actor, outside of China—certainly they believe that very strongly—or inside China, is going to do something and the AGI is going to take off, and it’s going to undermine the Party’s authority.

So what we’re going to see in terms of institutional development is not at the top end, but at the lower end. They will want to designate human beings in all the government agencies, in all the commercial entities that are using AI or AGI, to put their foot on the brake if it comes to it.

But so far, after DeepSeek became a big deal, the immediate reaction in China… Very enthusiastic. All the different big tech companies—WeChat, Tencent—everybody was encouraged to adopt it. And they did. They adopted it as fast as possible. Xi himself met with Liang Wenfeng and did a whole meeting where all the industrial heads were there. Xi said that they have to accelerate technology in China, etc.

So it seems like so far the response has been that the greater the capabilities of AI, the more they’re excited about it, the more they think this is the beginning of Chinese greatness. But you think that changes at some point?

No, they want to develop it of course. They’ll pour a lot of money in. They’ll try to give DeepSeek as much help as possible, sourcing GPUs and all this kind of stuff.

But I am all but certain that there is one, or maybe a team of people, in the headquarters of DeepSeek who can pull the plug, if necessary. Because there is such a team of people in every major internet company in China.

What would cause them to pull the plug? Specifically?

First of all, if AGI started generating Falun Gong–related content, and it proliferated very quickly beyond the capacity of the censor to control it, then they’ll have to stop the algorithm from generating new images, new videos, and so forth.

You were saying they can help High-Flyer source GPUs and so on. What is the mechanism by which that would happen? Suppose it turns out that for DeepSeek to continue making progress, they need all the GPUs that Huawei can produce, and they need a whole bunch of other things. They need energy. They need data centers.

What would it actually look like for the government to say, “Every single Huawei GPU has to go to DeepSeek. They’re going to get access to all this spare land to build data centers”? Who would coordinate that? Would that be the leading cybersecurity group? Would that be somebody else?

It could be. That’s interesting.

The physical investment part would have to share power with some other leading group. That would be a justification for an AGI leading group of some sort. Because building power centers falls under the NDRC. It could be under Li Qiang or He Lifeng, especially He who’s in charge of investment and financing.

But if Xi Jinping doesn’t want them to share the power, then he would have to give it all to Ding Xuexiang and give him a lot of power. He could just do it by fiat or create a separate organization to make it happen.

At this point, data centers are being built in China at a very fast clip. I think they’re just using the existing command structure.

There is potentially a foreign aspect to this. You build up all this cloud computing capacity in the Gulf States. Who’s going to be the customer? Who’s willing to pay billions of dollars to use it? China, right? So then the foreign policy apparatus will have to coordinate that, and so forth.

Belt and Road v2.

Exactly.

Does it have any end implication for the progression of AI—who actually ends up controlling these leading groups, whose purview it ends up under? Or is that basically a detail? In terms of what happens with AI in China, does it actually have that big an implication?

I think it does matter. You have some decision-makers who have shown themselves to be not very good—even politically not very good—but nonetheless, for some reason, they’re trusted. Maybe precisely because they’re not very good. They’re very dependent on Xi Jinping and that’s why they get promoted.

The chief negotiator with the United States, He Lifeng, the Vice Premier in charge of finance, he’s well known for starting and perpetuating the largest real estate bubble the world has ever seen in Tianjin. I don’t know if you went to Tianjin, but there are just empty buildings everywhere. There’s this "New Manhattan"—literally the size of Manhattan—filled with empty office buildings. He made that happen.

That ironically sounds like a great tourist site. Not because it’s real Manhattan, but because it’s fake. It’s actually cool to visit.

It's like, “Wow, this is great. But what are you going to do with the buildings?”

In Emeishan we went to this huge Buddhist temple. By huge, I mean there would be this structure with a shrine, and you’d go through it, and behind it would be an even bigger shrine that was hiding from view. Then you’d go through that one, and there’d be an even bigger one. This happened five times. If you were to drive through this would take you a while.

But it’s new, not historical, right?

Oh no, it’s new. By the way, there was nobody else there. It was me, three white guys, and nobody else. I asked the head monk, “How did you guys finance this?” And he said, “We’ve got a lot of supporters, a lot of donations.”

I don’t think so, yeah.

So then it really depends who’s in charge of AGI. Ding Xuexiang really is a mystery. I think he has great political acumen. He must, in order to gain Xi Jinping’s trust. He has some technical background, but it’s in metallurgical forging. But he’s worked in Shanghai for decades, so he knows how private corporations run. He knows a lot about international trade, FDI.

If you look at the people in the Politburo and the Politburo Standing Committee, I’d say he’s definitely in the top quartile of people you’d want to be in charge of AI, if not the top two or three people.

One thing I would say about AI is that content creation is going to be a big roadblock for China. Because China is so paranoid about the content that flows on the internet that they put human beings all over the place to slow things down, slow the transmission down. Now, if you have AI creating tons of content, there will still be human beings—algorithms and human beings—double- and triple-checking the content. They’re just so afraid of subversive content getting out.

But it’s still been compatible with them innovating and having leading companies in content, right? RedNote, TikTok, and so forth. Not to mention WeChat. And AI might be even more robust to these kinds of sensitive content, right? Because you can just teach the AI not to say certain things.

Even if that were the case—even if you train something that you think is pretty good—they will still want a human being checking everything.

As somebody who is trying to observe what the Party’s doing, have you found that using LLMs has been helpful? If so, which model gives you the best insight into what the CCP is thinking?

Yeah, I’ve been using AI quite a bit. Both to code data—it used to be text hand-coded stuff and now a lot of it can be automated—but in terms of finding out what the Chinese government is doing, some of the American models are okay. Grok is okay. But the most helpful has been DeepSeek.

To me, it’s quite clear that DeepSeek—which, of course, was first developed by a hedge fund to trade in the Chinese market—part of what they really trained the model for was to detect important policy documents and meetings within the Chinese government. Because when you enter the right prompts—even not especially sophisticated prompts like, “What is the Chinese government doing when it comes to AI?”—it comes out with a bunch of very high-quality links, which is very useful for my research. Immediately, you get a sense of what are the latest policies, what are the latest statements by high-level officials. It seems that DeepSeek puts some higher weighting, let’s say, on this kind of content.

I don’t dare install it on my phone. I certainly have collaborators who’ve downloaded the open-source model and installed it onto a hard drive. I use the web interface for some of my research.

Do you think it’s just because they have more Chinese-language data, and so it’s just better at understanding the Party communications?

I’ve used Baidu’s thing. I think the typical Chinese-language models are more trained on social media content, which will come back with hits that are more social media-like. If you ask about AI, it’ll talk about how AI gets used in different things instead of policy documents and meetings and so forth. So it seems, just from inductive observation, that DeepSeek is trained on this kind of content.

So that High-Flyer can make trades?

Yes. Because obviously, China being China, government policies have a huge impact on how different stocks do. That’s often where you would find alpha. In the old days, people used to call up their friends who worked for this or that ministry to get insider information. But I think what High-Flyer has discovered could also generate alpha is to use algorithms to look closely at these policy documents.

This is going to sound like a naive question. We’re talking about how the Party, in the abstract, wants to maintain control over every aspect of Chinese life and the Chinese economy. But of course, the Party is made up of individuals. Many of these individuals—Xi himself—went through periods where the Party had extraordinary control over people’s lives, during the Cultural Revolution and so forth. They personally, and their families, suffered as a result of this.

They’re educated people. Many of them have been in industry. These are not naive people. Maybe I’m just projecting too much of my Western bias here, but what is the reason they think it’s so crucial that the banks are run by the Party, the AI is run by the Party, and nothing escapes the Party-state?

So the Cultural Revolution generation, a lot of people suffered horrendously, including Xi Jinping himself. Basically, you have two types of lessons that people drew from it. The first lesson is, “Oh, the Party’s too dictatorial. China needs to liberalize,” and so on. You have a lot of people from that generation who feel that way. Many of them now live in the United States. Basically, they tried to leave China as soon as possible in the 1980s and succeeded.

But for someone like Xi Jinping himself, and others like him, the lesson was, “Just don’t be on the losing side. In any political struggle, make sure you’re on the winning side. Because if you’re on the winning side, then you can do terrible things to your enemies.” Apparently, that’s the lesson he learned. He basically honed his skills and built his coalitions—for the time that he

would take over high-level positions in the Party—for decades, as it turns out.

If you look at the data, when he was in Fujian Province, he spent an inordinate amount of time hanging out with military officers in Fujian in the late 1980s and early 1990s. You wonder, why did he bother to do that? Most local officials don’t do that. The military’s there, you need to be nice to them and all that. But he built a dormitory for them. He even joined a unit, an anti-aircraft regiment.

He tried to do as much as possible with the military, because he knew he needed the support of somebody in the military when the time came. Guess what? 30 years later, when he was about to be elevated to Secretary General of the Chinese Communist Party, many of the people he knew back in Fujian are now generals. They are in charge of important military units. And once he came to power, he really promoted some of these people. But then lately, of course, he’s been purging some of these people, which is really interesting.

He had a strategic vision about his own career trajectory, and he pursued that in a very determined fashion, I would say.

What is the main difference between him and Stalin, in the political maneuvering sense? Because all of this sounds very similar.

I would say early in their careers they’re very similar. Outwardly, they’re very low-key. Stalin was the bureaucrat, very low-key, not flamboyant, not making loud speeches like Trotsky did. He was low-key, getting things done. He was seen as a very reliable person. This was a reason why Stalin was chosen.

As far as I know—I don’t know that much about Stalin—it’s the same thing with Xi Jinping. His father actually belonged to the liberal faction in the Chinese Communist Party. His father never offended that many people within the Party. Everyone at a high level will have sort of screwed over somebody along the way, but his father was in the better category, let’s say.

He himself was very low-key. While the other princelings were fighting for good jobs in the capital city of Beijing or Shanghai, Xi Jinping said, “Oh no, it’s okay. I’ll go down to the villages. I’ll work in Hebei, in a rural area.” Then he went to Fujian, which was kind of a peripheral area, then Zhejiang, which was slightly better but still not Beijing or Shanghai. So he got out of the way of this political infighting, I think in a similar way to Stalin. Early on, he didn’t confront people too much.

But once he came to power, he knew—they both knew—what it took to control the Party they governed over. Basically, you form a whole series of coalitions to get rid of your most threatening enemy at any given time.

For Xi Jinping, it was this guy Zhou Yongkang, who controlled the police forces and the Ministry of State Security at the time. He was doing all kinds of irregular things, being fabulously corrupt. He was a threat to the whole Party. So Xi convinced Hu Jintao to join with him to purge Zhou Yongkang, which was successful. Stalin did the same thing to Trotsky.

And then, after the most threatening person is gone, you form another coalition to purge the next person, and so on and so forth. They both basically did that until they achieved absolute power within the Party.

Yeah. If you read the Stalin biography, so many of the people in the early part, half the people in the Politburo are later going to end up in the gulags. And many of the people in the later Politburo had already been to the gulag. I wonder if there’s a Trotsky-analogous person in this story, somebody who was a flamboyant speechmaker?

Yeah, Bo Xilai. So he was one competitor with Xi Jinping. But because he was so high-profile, he never had a chance to be the top leader of China. And of course, Xi Jinping made sure that he would fall.

And now he’s in prison.

And now he’s in prison, yeah, his whole life. His son is in Canada, actually. He’s on Twitter now, on X.

I should reach out, honestly. He’d be an interesting person to talk to.

Yeah, I think that would be really interesting, actually.

Let’s move on to another topic I know you’ve studied deeply, the local government debt situation. What is the newest there? What’s your sense of the situation now?

It just keeps growing in absolute size. Basically, China is trying to tell the world that they don’t have a high debt level. At the central level, that is sort of the case. It’s still 60-70% of GDP.

But the reason why that’s the case is because with a lot of things the Chinese government wants to do, they push it down to the local level. But the authorization of local debt issuance is still authorized by the central government. So at the end of the day, it’s really the central government telling local governments, “Okay, you need to do this thing. I’m not going to give you money, but I will give you the authorization to issue even more debt.” So the debt level keeps going higher and higher.

The one thing that has alleviated the cash flow pressure, late last year, was that the central government authorized again the issuance of close to 10 trillion renminbi in special local debt to repay some of the higher interest-bearing debt of local governments. But that’s an accounting exercise. It doesn’t literally decrease local debt. It just changes it from higher-yielding to lower-yielding.

Meanwhile, the overall size of local government debt in China, I would estimate to be 120-140% of GDP.

Woah, that’s on top of the 60% that’s owed by the central government?

Yeah, so total government debt is pushing 200%.

And the high-level way to understand what this debt was for… The debt in Western countries and other OECD countries is often because you owe money to pensioners. In this case, it was just that they built bridges…

Yeah, they built all the high-speed rail, all the beautiful infrastructure that you do see in China. More recently, it’s been industrial policies.

For example, if there’s a new science park for AI, the land they acquire, the infrastructure that’s built, it’s all built with borrowed money. Then there are these startups. The startups are partially financed by some of these central-level investment funds that you read about in industrial policies. But actually, the local governments also have their own seeder funds, which use borrowed money to finance some of these venture deals.

For startups, is the fact that they can get cheap credit from banks more relevant? Is the fact that they can get loans from provincial funds more important? There are also these central government funds, the “Big Fund,” and so forth. Which is the bigger piece here?

A lot of it depends on your social network and your connections. If you’re a startup at Tsinghua University, you have access to private sector funds but also to some of the central government seeder funds if it falls in the right category: semiconductors, AI, etc.

With Liang Wenfeng, I don’t know… Because it started out as a financial institution, it was mainly private sector money from financial investors. But there are other AI initiatives, especially more hardware-driven ones, in the provinces, which are seeded by local government funds.

Without financial repression, an investor in China could invest in Silicon Valley. They could go to Sequoia and invest money. But because of capital controls, they legally cannot move more than $20,000 a year out of China. They have to find domestic investments. As a result, many of them choose to invest in Chinese high-tech. Or they just put their money in the bank. Actually, a lot of people just choose to put their money in the bank. And then the state banking system has the deposits with which to finance local government seeder funds for industrial policies.

The crucial thing here is that the banking sector is totally controlled by the state.

So you're not getting a true rate of return based on what the productive value of investment is. It’s literally like 1%, right?

Yes. The deposit rate is 1%.

That’s an insanely low return.

Well, the inflation rate is very low in China.

There are a couple of mixed-up questions I want to ask here. You said if there were no capital controls, these people might want to take their money and go invest in Silicon Valley. Very basic development economics would tell you that if a country is less developed, it should have higher rates of return. People from Silicon Valley would want to invest in China. Why would getting rid of capital controls make capital go the other way?

This ties into some other questions. Why is it the case that the Chinese stock market has performed so badly, even though the economy has grown a lot? Why is it that they have a current account surplus and they’re basically accumulating T-bills? The pattern you should see is that they could earn much higher rates of return building productive things in China, rather than accumulating 4% yield T-bills?

At the deepest level, I would say there’s a deep fundamental difference between capitalism and socialism. It sounds very philosophical, but I think this might help your Gen Z listeners think about this.

For socialism, they only care about output. It’s like, “Okay, whatever capacity we’re thinking about—whether it’s grain production or metal production or, these days, robotics—we just want more of it.” So then the state can use the state banking system, which they control, to allocate huge amounts of capital to maximize the output of all these different things they care about. But when you maximize output, you don’t necessarily make money doing that.

Whereas capitalism wants to maximize profit, which is the difference between the cost of production and the amount you can earn from selling the output. For socialism, they don’t care about that.

But the companies aren’t socialist, right? The companies are profit-seeking?

But because the financial system is socialist, they’re forced into socialist-like behavior. You can’t go into a bank and say, “Look, I make robotics. This robot I’m going to make is going to be highly profitable down the road, but I can only make ten of them.” The bank would be like, “This is BS.” I know a lot of startups don’t make any money, but at some point, notionally, you have to start making money.

Whereas the socialist banking system basically says, “Even if you never make any money, or hardly any money, that’s okay. As long as the Chinese government tells us this is a strategic sector, and as long as you can prove to us that you can actually produce the thing we want you to produce, if you never, ever make money doing it, that’s perfectly fine.”

What is the sort of outer-loop feedback, the thing that keeps the system disciplined? Here there are private investors that actually care about earning a rate of return. So they’re only going to invest in companies that they think have a viable shot at becoming huge companies that are actually at the frontier of technology. If these banks aren’t actually competing against real investors—

And it’s not their money so they don’t care.

But it seems like this is still compatible with many of the world’s leading companies being developed in this system. So how is it working?

This is where the bureaucracy steps in. How would a bank tell what’s a good company and what’s not a good company? There’s a complicated system where—for something like robotics or semiconductors—there’s an expert group in the Ministry of Industry and Information Technology. They assess all these different projects. The banks will literally send something into them and say, “Okay, this company wants to borrow $10 million. Do they have real technology? Is this a good prospect?”

Then some bureaucrat—supposedly with no financial stake in the company, supposedly completely neutral, and I say “supposedly” because in reality we’ve seen many cases of corruption—along with an expert panel, who again supposedly have no relationship with the company or the bank, will sign off on these projects or reject them. Then it gets sent back to the bank, and the bank says, “Okay, these bureaucrats say your project is good, you’re good to go. Here’s $100 million.”

But it seems to work. Doesn’t this just belie the whole idea? Central planning isn’t supposed to work, right?

There’s selection bias. We see and pay attention to the cases that work. There have been some fabulous success cases. By the way, they do not include Xiaomi or BYD. Those were mainly privately funded at the beginning.

Same with CATL and DJI and High-Flyer.

Yeah, exactly. So the success cases actually are not that. But there are some. I don’t know all the cases. Huawei is one where I would say there was a lot of state funding along the way. So yes, you have success cases. But there are so many failed cases, billions and billions of dollars just thrown down a hole, basically, for the failed cases.

In fact, for semiconductors, things got so bad that they had to arrest dozens of people in the Ministry of Industry and Information Technology, who were in charge of approving these semiconductor deals. They all went to jail because they were in on a deal where some company submitted a bogus project, got it approved, took part of the money, and so on. So it doesn’t work very well. Of course, you have fraudulent cases in the US too and all that kind of stuff. But the scale in China, the waste in China, is a much larger-scale phenomenon.

And it’s all financed, as you say, with this financial repression which is basically a tax on savers. So even though there’s no meaningful income tax—it’s just value-added tax and corporate income tax—if you factor in the currency devaluation which is a tax on consumers, and then this financial repression which is a tax on savers, it might actually be a meaningful decrease in the quality of life of an average person.

Oh yeah. You definitely see it. For an economy that’s been growing over 5% for decades, by this time you’d expect pretty much the vast majority of the population in China to have all the basic necessities: shelter, medical care, etc. But you don’t see that.

A lot of migrant workers are barely getting by. Homelessness is increasingly a problem in China, especially with the labor market being so fickle these days. Elderly care is pretty abysmal, very basic level for a lot of people. It’s not the case for everyone. Some people get very good elderly care if they worked for the government or an SOE previously.

So you see a lot of problems the Chinese government has overlooked. This is why I say that they have a goal of making all Chinese people happy and fulfilled. One part of that is the “fulfilled” part, the technology part. But the part about truly helping people live a good life, they’re not making as much progress as they should.

Just to close the loop on this, sometimes we get impressed when we see things like Made in China 2025. The NDRC and MIIT have these very specific targets, like “LIDAR needs to get to this level,” or “We need EUV machines by this year,” and so forth. But your claim is that that part of the system is actually dysfunctional and in fact, the part that works is the 5% that’s totally private?

No, the private sector stuff works a lot better. You have occasional successes from the state-financed system. I wouldn’t say there are no success cases. But I would say for every success case you see, there are maybe even over a dozen failed cases. Of course, you have failed cases everywhere in VC, but the amount of money being wasted in the state financial system is much larger.

Going back to the local government debt burden, there’s a world where AI isn’t a big deal and there’s a world where AI is a big deal. If we live in the world where AI truly causes huge uplift to economic growth, is it possible that this problem doesn’t meaningfully harm China’s ability to compete at the frontier? Here’s why that might be the case. It seems like this problem is especially affecting poor provinces.

You have the actual numbers, but are Shanghai and Guangdong in a good fiscal position? And could they keep funding top-end semiconductor, AI firms, and data centers? So China could still compete at the frontier in AI, even if the poor provinces can’t fund basic services.

And in the long run, if they get advanced AI and that’s a big uplift to

economic growth, maybe they can just grow their way out of the debt problem.

Yeah, we can talk about that. I’m a bit skeptical about that in the case of China. But yes, as you said, some places like Shanghai and Guangdong are still in relatively okay fiscal positions. But there are other wealthier provinces with a lot of debt also. Zhejiang Province—where DeepSeek is located, actually, and also Alibaba and other tech companies—has a high debt load. But because they started from a pretty wealthy place, they can still service the debt without too much difficulty. Actually, the trade war is going to make it worse for Zhejiang Province, because a lot of the manufacturing and export firms are also in Zhejiang.

Nonetheless, the case of China is that the financial system is geared toward fulfilling the priorities of the Party, i.e. the priorities of Xi Jinping. So, even if they can’t do anything else, they will do the things that Xi Jinping wants them to do. And AI, apparently, is one of the higher priorities for Xi Jinping. He’s held multiple study sessions, had different Politburo meetings, and Ding Xuexiang—one of his most trusted lieutenants—is in charge of it. So I do expect a fair amount of resources to be devoted to it, regardless of the local debt situation.

In fact, at the local level, things are so bad. But they just don’t care. There are civil servants, teachers, who are not paid four or five months out of the year. You’d think, “How can you run a government like that? Wouldn’t it just collapse?” But then you have to look at the outside options. If you’re a teacher, a very low-level bureaucrat, what option do you have? Do you want to go back to delivering food to people? Or would you rather at least take six or seven months of civil service salary? At least you have healthcare. At least you get a free lunch at the workplace cafeteria every day.

People still choose to work for the Chinese government, even if that’s the case. A lot of the previously very generous fringe benefits and so forth, that’s all been cut down because of the local debt issue. Still, they’re pouring a lot of resources into national defense, into AI, into technology.

What would a solution at this point look like? If you’ve already spent all this money… First of all, why is it the case that these investments actually aren’t productive? It’s not like it’s entitlement spending where you’re doing it for old people and at the end of the day you’re not getting any return for it. Theoretically, you’re building real bridges, you’re building real airports. So why aren’t they productive? And then, what does a solution at this point look like?

So it was very productive—I think you noted this in the Arthur Kroeber book review you did—in the 1980s and 1990s, because China lacked a lot of infrastructure. But once you’ve built the first high-speed rail between Beijing and Shanghai… You build the second one and then the third one and there’s very rapidly diminishing returns. Also, the population is basically shrinking in China, especially in a lot of cities in northeastern and southwestern China. You really don’t need high-speed rail connecting those cities to other places, because nobody lives there anymore.

Can I ask about this? If the reason that the provincial leaders kept doing this construction was because they wanted to get promoted, and they wanted to get GDP numbers on the books and government spending counts as GDP, even if the ultimate thing you’re building isn’t that productive… But the central government has had a problem with this for a while. They think it’s fake, and they don’t want to keep the fake growth going. They can see the local debt numbers. Were these people still promoted nonetheless? Like, why were people doing this? Who was the person who created this? And also, a lot of these people got arrested in the aftermath, right? So they weren’t promoted, they were arrested. So what was incentivizing them to keep going?

When you invest in a large infrastructure project, a lot of money changes hands. This is a big debate in my field. Some people say, “Look, the more you invest, the more likely you are to get promoted.” My argument is that it’s not the actual investment, it’s the rent-seeking that comes along with the investment. You have to get a contractor for cement, a contractor for this and that. You get a big envelope under the table, as a kickback. That allows you to pay your superiors. Let’s say you did a billion-dollar investment to build light rail in a city. You got a hundred million dollar payout from all the contractors. You can give your superior $50 million to thank that person and increase your chance of getting promoted. So I would say that’s the more realistic mechanism for linking investment and promotion rather than, “Oh, good job, you generated investment and GDP in this city, we’re going to reward you.”

In fact, there’s really good work by James Kung showing this. When you do a real estate deal, you can sell land cheaply to politically connected princelings, and then they’ll lobby on your behalf for your promotion. Statistically, there is an effect. If you sell land cheaply to princelings, your chances of promotion go up.

I find it fascinating whether a corrupt political equilibrium can lead to more construction vs. less construction. The political equilibrium in America today… California isn’t the least corrupt state in the country, but the political equilibrium is one where there are many different factions who get their hands into the pocket, so everyone’s not like, “We need California rail to happen yesterday because I need my share of it.” It’s more like, “I’m going to get a little consulting fee to slow this down by five years.” So it's quite interesting.

If you read the Caro biography of Robert Moses and you look at the strategies he employed, it’s actually very similar to what you’re mentioning here. It was in every single faction’s interest that the bridge that Robert Moses was working on gets done, through some of the mechanisms you mentioned. For example, he would give the banks these discounted bonds for the construction so the bank lobbyists were encouraged to keep it going. The unions, obviously, wanted employment. So they wanted the construction too. Every single person at every stage was incentivized. So I find it interesting that China has maintained a political equilibrium that encourages too much building, whereas our political equilibrium discourages it.

Yeah, it is. Basically, all the regulations in the US—environmental and so on—build their own stakeholders and lobbying groups. Then it's in the interest of those groups to prolong the process so they can absorb a higher share of the rent. Whereas in China, because they have this command structure headed by the Chinese Communist Party, the secretary of the city or province can cut through all the red tape. He’s the boss of most of the regulators at the local level. So if he wants to do something, he can cut through all of it, as long as he can benefit himself somehow. So I would say that’s the difference.

Okay and what would a solution to this problem look like? Because if the debt is already over 100% of GDP, that’s tough.

Of course the Chinese government will never, ever in a million years do this in its current form, but it would be to reduce a lot of the other unnecessary spending: national defense, many of the industrial policies. And then to use the savings to bolster domestic demand with welfare policies and gradually decrease the amount of local government debt. That, I think, would be economically sound.

China already has the largest navy in the world. Why does it need a navy that's even bigger than the largest navy in the world? It doesn't need that. It already has more than enough for national defense. It has some of the best jet fighters in the world, some of the best missile systems. No one is going to invade China or come close to it. So they actually don’t need it.

Now, on the tech race I’m somewhat sympathetic to China. Because now there are US policies preventing Chinese companies from buying all the chips for AI, they want their own capacity. They’re spending a lot of money on it. So that part I’m somewhat sympathetic to. But other aspects of industrial policy—for some of the battery stuff, for solar power, etc.—they could certainly reduce a lot of subsidies. They could increase taxes, actually, on many export-oriented firms. That’s one reason for the large trade surplus in China and the trade imbalance with the US. They could get more revenue that way to finance domestic demand and pay down local government debt over time.

The Chinese government, of course, will never do that because it places a very high priority on competition with the US across many different fronts, and on gaining dominance over multiple supply chains. But in a world of global trade, why do you need that? The same goes for the US. The US doesn’t need dominance over every single supply chain either.

Yeah. Why is it the case that when economists talk about rebalancing more toward consumption, they often suggest increasing welfare? It seems like the more straightforward thing to do would be to get rid of financial repression so that by default savers would have more purchasing power. You can also get rid of currency devaluation to achieve the same effect. Why not get rid of the regressive taxes instead?

Because if you just get rid of financial repression, it will only benefit the net-savers, which is the top 10-20% of households. If you look at the median household, they have very little savings besides the home they live in. So there's this misconception that China has the largest savings deposits in the world. That’s true. But if you look at the distribution, those deposits are highly concentrated in the hands of the top 10%. So even if deposit interest rates suddenly go up to 4%, it's only going to benefit the people with large amounts of savings. Most people won’t benefit. Most people, if they don’t have better welfare services, will just save like crazy in anticipation of getting sick. So you do need better medical care insurance in China.

Frankly, that’s something I worry about in the US too. If you cut back on Medicaid, it's going to encourage precautionary savings. You could say, “Well, that’s a good thing. Americans save too little.” Maybe, but then your short-term consumption is going to come down.

So you mentioned a second ago, “why do they need this big military?” Obviously the reason is not just self-defense but a potential invasion of Taiwan. Given your reading of elite politics, what’s your sense on the probability that they would actually invade Taiwan this decade?

First of all, I think we do know something about Xi Jinping’s preference mapping when it comes to this issue. He’s said a number of times that obviously China should be united and I do believe that’s sincere. But clearly, his desire to achieve that is not so strong that he would take a very risky gamble to achieve it. If that were the case, he would’ve done it already. He’s been in power for 12 years. He hasn’t done very much. Certainly the amount of pressure on Taiwan has ratcheted up. Also from his other policymaking, we know he’s not a reckless policymaker.

Zero-COVID was reckless. Do you think that was reckless? That was actually conservative, right? He preserved a lockdown longer than was necessary.

I mean it depends. You could say the same thing about Taiwan. It’s conservative because in the long run maybe they pose a national security threat. It is a change from the norm. If he wanted it so badly that he’d do whatever it takes to get it, he would’ve done it already.

I guess you could argue that he’s been trying to build up enough self-sufficiency such that in the aftermath, China wouldn’t be left in the lurch without food or power. That’s why they’re doing clean tech, why they’re investing in semis and so forth. It’s so that over the next few years, if they have enough self-sufficiency, they’re in a position where they actually could do it. You couldn’t have done the same thing in 2015.

Right. We’ve seen the Chinese government engage in all these behaviors: stockpiling oil and grain for example, enlarging the navy, building amphibious landing capabilities, and so on. One argument is that there’s a threshold. Once he feels he’s reached that threshold, then he’ll go for it. But for me, I don’t think that threshold is fixed. It’s really conditional on a lot of different things. Some exogenous factors might increase the threshold. Other exogenous factors might lower the threshold.

More recently, one factor that likely increased the threshold is what happened in Ukraine. That’s a case where Putin was very confident he could take over all of Ukraine in a short time. It turns out he was wrong. He was getting bad intelligence, and so forth. I think for Xi Jinping, he cannot discount the possibility. That likely increased the threshold. But there could be other factors that lower the threshold.

This gets to the question of how much information flow there is. How much true information is getting up to Xi Jinping? In authoritarian systems, obviously there’s the danger that the leader is not being told things they don’t want to know. But you mentioned earlier that the top leadership is in communication with experts all the time, in meetings all day, where they are learning about what’s happening. Is that your sense? Because then you read about something like Zero-COVID and by year three it was very obviously a mistake. So to the extent it wasn’t stopped at that point, was that because information wasn’t getting up to the top leadership? There was also that famous case in 2024 where Xi asked, “Why don’t we have billion-dollar unicorn tech companies in China?” And people responded, “Does he not realize the 2021 tech crackdown is the reason?” Did nobody tell him? What’s your sense of how much he’s being told things which might make him uncomfortable, like the possibility that he might not succeed in Taiwan?

This goes to the question of the role of expertise in the Chinese government. That’s a very interesting question. Frankly, I’m trying to use some data to assess it, but my intuition is this. The top leadership always listens to experts. Unlike in some cases in the US, the experts are respected and listened to. But there are interest groups close to leadership, who know that, so they’ll present different kinds of experts to tell him different expert opinions. Sometimes he’ll get conflicting advice from different experts, and Xi has to make some kind of gut call. Other times, for political reasons they’ll just ignore the experts. They’ll never say, “Fake news,” or “We don’t believe in science.” Sometimes even though they know for sure the experts are right, because of other political reasons they’ll say, “Okay, you’re right, but we’re not going to do what you want us to do for now for a bunch of political reasons.”

How did that manifest in Zero-COVID?

The timing of it. Also the decision not to buy Paxlovid on a very large scale might’ve been a political decision. We have a paper showing that they knew the experts were telling them the US vaccines were better, mRNA vaccines were better. But the Chinese government said, “Okay, we believe you, but we still want to help our domestic pharmaceutical industry so we’re only going to sell the domestic stuff in China.” That’s very clear. If you look at the propaganda, they began to denigrate Western vaccines and highlight Chinese vaccines.

But I think they do meet with experts a lot. Sometimes the experts are manipulated into saying certain things. Other times, the experts are sincere. They listen to them but they still choose not to implement what the experts recommend.

I guess I’m just trying to get a sense of where this nets out, in terms of the competence of the political system. It seems like they have a track record of making some smart calls. But then occasionally they’ll make a call so bad that it wipes out all the smart ones. Zero-COVID is an example of that and obviously, the one-child policy before that, not to mention all the things that Mao did. I’m getting the sense that they’ll consult with economists

or scientists on some things.

I guess I still don’t understand.

They’re like, “Okay, we’re not going to buy the American vaccine because of this.” This is the time of all times to be making sure the pharmaceutical industry in China is in a good position.

Sure but did they not know that people were locked in their apartments starving and that this wasn’t a viable long-term strategy? How is that compatible with this very technocratic picture we have of the Party?

They’re technocrats. They’re people who know a lot. But generally speaking, protecting the Party—protecting the state apparatus and all the important tools of the Chinese government—will almost always be a higher priority than any kind of technical consideration in a given decision-making process.

Why protect all these pharmaceutical companies? Because they’re state-owned enterprises, they need to survive the ordeal. They need to have a national brand name. Also, pharmaceutical and what they call “new biology” is one of these industrial plans. In order to finance future research in advanced biology, these companies need cash flows.

What is the succession plan after Xi is gone?

There are no plans right now.

What’s your sense of what would happen? Tomorrow he drops dead. What happens next?

Oh god. That would be an issue, if he were to drop dead tomorrow. The biggest impact is this. Right now, financial repression works because… Let’s say you’re a billionaire trying to get your money out of China. You make up fake paperwork: “I’m importing a million Rolex watches from Singapore, I need to pay an invoice for a billion dollars.” That order goes from your bank to the State Administration of Foreign Exchange in Shenzhen or Shanghai. Some bureaucrat will have to okay it, all large denomination outflows.

Right now, the bureaucrat thinks: “If I approve this, someone in Beijing is going to notice it and I’ll be in jail in a week. So I will not approve it.” But if that bureaucrat thinks, “There’s nobody in Beijing. No one’s minding the store and this guy promises me $100 million if I approve it”, then he’ll go ahead and approve it. So if there’s any sense that there’s no command structure in Beijing, even for a week or two, I think we would have a financial crisis, at least.

That's interesting. Because there would be tremendous capital outflows?

Let’s put it this way. With the foreign exchange reserve people say, “Oh my god, it’s so much money, $3 trillion.” Right now, it’s less than 5% of the money supply in China. So it doesn’t even take a panic. Even if people just want to rationally reallocate 10% of their assets outside of China, the foreign exchange reserve is gone. There’s massive devaluation, etc. They’d have to jack up interest rates to something like 20% to stop it. Then there’d be mass bankruptcy, and so on.

But they can stop it?

If there’s a command structure, yes. If people believe they’re going to jail the week after, even if they get $100 million in cryptocurrency in Hong Kong or wherever.

Suppose it doesn’t happen tomorrow, but in 2028 or 2030 he just goes senile. Over the course of months, it’s clear there needs to be a successor. What does then the succession process look like then?

There’s a way we historically know doesn’t work, and then there’s a way that could work. The model we know doesn’t work is designating someone: “You’re going to be the successor.” That person is going to die for sure, in a horrible way. We’ve seen this with Stalin. We’ve seen this with Mao.

The other way is to have someone that everyone trusts to represent the leader’s opinion, but who cannot possibly become the number-one person. Mao had Jiang Qing, his wife. Xi Jinping could do something similar with his wife. Increasingly, we’re seeing his daughter take on a higher profile. The reason these individuals cannot be number one in the Party is because of this ingrained sexism in the Party against women. It’s also because they’ve never held official positions in the Party.

So I think having a transitional figure who can stabilize the situation while different factions fight it out, hopefully peacefully, will be an important ingredient. Sometimes even those transitional figures are too weak. Jiang Qing was purged within weeks of Mao dying. Now the Long March veterans were so close to each other that they worked it out among themselves. That was a pretty peaceful transition, aside from the purge of Jiang Qing and her colleagues in the Gang of Four.

These days, the Long March generation of officials who’ve spent decades with each other, governing with each other—that generation doesn’t exist anymore. There’s very high turnover. The people in the Politburo, there are different elements in there. Some of them have worked closely together over the decades, but many of them worked in such disparate bureaucracies that there’s not a lot of trust between them. That’s probably by design. Xi doesn’t want people in the Politburo to trust each other and be friends with each other too much, because they might get together and usurp his power.

So given that there isn't this social capital, the kind we saw in 1976, I think this transition is going to be more ruthless, more brutal, and potentially more disruptive.

What are the important factions in Chinese politics today? What’s the equivalent of liberal or conservative in American politics? Historically, there were things like the Shanghai clique. Do those still exist? If they do, what do they stand for?

They’re all beholden to Xi Jinping in one way or another.

But do they have different ideas about what should happen with China, or what should happen in the world?

Generally speaking, you have some people who are more pro-market. These tend to be people with more governing experience along the coastal provinces, like Zhejiang Province or Shanghai. Then you have the statists, people whose careers were mostly in state-owned enterprises. All the military industrialists, I would guess they’re more pro–state power.

Actually, those figures might ultimately be somewhat stabilizing. You basically saw this in the Soviet Union. For those people, they just wanted to preserve their vested interests. So it was like, “Okay, whoever is in charge, as long as you subsidize the state sector some more, I’ll support you.” In the Soviet Union after Stalin died between the sort of Khrushchev and post-Khrushchev transition, they were stabilizing politically, even though they ended up damaging the Soviet economy by demanding so many subsidies for their own sectors. So the fact that you have quite a number of these guys from the military-industrial sector as Politburo members could potentially be stabilizing.

What’s your forecast on Chinese growth—or the Chinese economy relative to the US—if AI is not a thing? Let’s forecast out everything else. In the year 2040, is it 2x as big as the US economy PPP? 3x? 4x? 1x?

I think it’s 1x or 1.2x the US economy.

Even PPP?

Yeah. I don’t quite believe in these PPP calculations.

Oh really? Interesting. How come?

Just because the quality is very different. In some cases, China’s quality is still worse. In other cases, it’s increasingly better than the US quality. So I’m not an expert, but even controlling for inflation—so real income—I think the overall size of the economy will be similar to the US, maybe slightly larger by 2040.

But it’s already 1.1x or 1.2x, right?

No, not as far as I know. If it’s not PPP and it’s just real income, I think it’s around 70% of the US economy.

This is quite a bearish forecast. Usually people expect China to be quite dominant by 2040.

Growth rates were slowing down anyway. Now you have trade pressure and so forth. It’s going to slow down. There’s no big consumption stimulus in sight because of the high debt level. So they can’t push growth through that mechanism. They have to double down on more investment, more supply-side.

But at some point, is the world really going to switch to 100% buying BYD as opposed to Volkswagen and all these other cars? I don’t know. I think there’ll be a pretty big pushback, or at least some kind of limit. Let’s say China takes over most of Latin America, most of Africa, most of the Middle East. That’s still not such a big market, right? Ultimately, you have to conquer Europe. You have to take North America. That’s going to be really tough.

Final question. What advice do you have for me on how to land—if not somebody on the Politburo—then someone one step away from the Politburo.

That’s very tough. Anyone who’s been a mid-level or higher official can no longer leave the People’s Republic of China. There are some former vice ministers who can go to Hong Kong. So I think that’s your best bet. Reach out to one of these vice minister-types and agree to meet with them in Hong Kong, or Shenzhen even better yet. That could be okay if they’ve been out of power.

You think it could be an interesting interview? Or would they not say anything?

Yeah, it depends on the person. Some people are willing to be a bit more open. But frankly, there is this atmosphere in China where people are afraid of deviating from the Party line, because they can really get in trouble.

This was super useful to get a much more tangible sense of how the Chinese political system actually works. We talk about China so much. Most of us have so little understanding of even the basics, like the Congress/president level understanding of the Chinese political system. Obviously a lot of it is obfuscated on purpose, so I appreciate you adding a lot more color to it.

Great. Thank you for having me.