Solow Residual Vs. Xi’s Residual
Recently, a term has been identified as a key to understanding Xi’s economic reform. In Chinese, it’s called 存量经济, or by translation, “residual economy.” Many, including myself, thought it relates to the Solow residual, the work of Nobel prize-winning economist Robert Solow. But we were wrong. And the comparisons of the two are revealing.
What is the Solow Residual?
According to Investopedia, the Solow residual is a growth model defining productivity growth as:
rising output with constant capital and labor. It tells you whether an economy is growing because of increases in capital or labor, or because those inputs are being used more efficiently.
Solow found that only one-eighth of the increase in labor productivity in the United States between 1909 and 1949 could be attributed to increased capital.
In other words, according to the Solow residual:
America became great because of American innovation and know-how.
What is ‘Xi’s Residual?‘
So far, the best interpretation I can find on what residual growth means in China’s economy comes from Mr. Michael Pettis, professor of finance at Peking University’s Guanghua School of Management and senior fellow at the Carnegie–Tsinghua Center for Global Policy.
In an email exchange, Pettis clarified the term for me:
By “residual,” I just mean the leftover bit required to bridge the gap between the underlying “high-quality” growth and the GDP growth target.
I made a deep dive into Pettis’ definition on this term by reading his two recent essays, What Does Evergrande Meltdown Mean for China? and Slower Third Quarter Growth Tells Us about Next Year (to be published), published on his newsletter blog China Financial Markets on Carnegie Endowment for International Peace. They led to stunning discoveries on China’s economic dilemmas.
Pettis explains how Xi’s envisioning a “genuine growth” (vs. “fictional growth”) or so-called “high-quality growth” contradicts China’s economic reality by explaining the purpose of what he calls “China’s residual growth.”
(High-quality growth) consists mainly of consumption (driven by increases in household income rather than rising household debt), exports, and business investment. By my estimates, high-quality growth has probably accounted for barely half of China’s GDP growth rate in recent years.
For China to achieve the required GDP growth rates, it needs another source of economic activity, which I will refer to as “residual growth.” This growth, for the most part, has consisted mainly of malinvestment by the property sector and by local governments building excessive amounts of infrastructure.
As long as Beijing sets GDP growth targets that exceed the country’s high-quality growth rate, China has no choice but to rely on residual growth to meet its target; and as long as it relies on residual growth, debt must rise faster than the overall economy’s debt-servicing capacity.
What Does ‘Xi’s Residual’ Reveal?
#China’s ’20 and ’21 growth numbers are one-offs
The problem is that good underlying growth this year, and a relatively small increase in the debt ratio, may convince many that the Chinese economy has turned a corner. But it hasn’t. This year is a one-off, just like last year was, in the opposite direction, and in fact, this year is simply a reaction to last year. In other words, once this reaction runs its course, we’re back to the same old pre-COVID dynamic.
#Why has Xi curbed Chinese ADRs (and/or wannabes)?
While China advocates building a pro-innovation-driven economy, it puzzled many to see Beijing’s recent crackdown on tech companies including Alibaba, TikTok, and Didi at the same time. Pettis’ essays didn’t directly address this matter, but I found some good explanations for it.
It is not as if productive investment has been constrained by scarce savings, part of which have gone to fund non-productive investment. On the contrary, for nearly two decades China has had excess savings, and has had to export a substantial portion of these excess savings through direct and indirect reserve accumulation, even though the returns in RMB terms have been very low or negative for years. The amount of savings exported in this way has actually been rising in recent years.
#(Surprise!) China’s property market might revive in 2022
While many analysts believe the Evergrande saga marked the beginning of the end of China’s property development-charged economy, Pettis thinks Beijing has good reason to keep stimulating that sector.
With between one-half and two-thirds of the GDP growth target generated by high-quality growth, Beijing will still have to rely on a substantial amount of residual growth to achieve the growth target. My guess is that Beijing will probably take steps to revive the property market next year, but if it doesn’t, we will see an acceleration of local-government spending on infrastructure, something we are already beginning to see (see here, for example). Remove the parentheses unless you are going to include a link.
#Covid-19 helped hide the fundamental problems with China’s economy in plain site
The problem the Chinese economy faces is structural, and while exogenous headwinds or tailwinds might matter at the margin, … The problem is that 10-15 years ago, once China was no longer significantly underinvested …, the healthy growth once delivered by China’s investment-driven growth model has (necessarily) degenerated into what Xi Jinping now refers to as “fictional” growth and bezzle creation. Because this is unsustainable, China must now reverse this investment-driven model.
#China’s true GDP growth in the coming years
2-3 percent, according to Pettis.
To understand why I think this is the most accurate prediction on China’s GDP growth, read the two essays of Pettis’ at his newsletter blog China Financial Markets.
What Technology is the Pentagon Buying, Specifically?
(TL;DR: The Pentagon is looking for more Palantir and Clear.)
China’s recent testing of its hypersonic capability is not the first signal raising concerns about the competitive advantage of U.S. defense technology. Prior to that, a pentagon official announced his resignation because U.S. cybersecurity is no match for China.
Whether the concerns are overestimated or not, to stay competitive, the Pentagon has apparently been on a shopping spree.
The Pentagon’s top science official Heidi Shyu, the defense undersecretary for research and engineering, has revealed the Pentagon’s wish list for procurement, according to Defense One .
Initially, I thought I could reduce the number (of procurement items), but I ended up adding to it.
(It used to be) only about 30 percent of Pentagon spending on a given weapons program goes to develop and procure it, while 70 percent goes to sustain it. I want to reverse that ratio.
Here is the shopping list.
Hypersonics
Keyword: right materials
To develop affordable hypersonic weapons, that ties into “Do we have the right materials? Do we have the right test facilities to enable us to do this?”
The Defense Department is asking Congress for $2.865 billion in 2022 to fund hypersonics development.
Artificial Intelligence
Key phrase: trusted AI ML, trusted autonomy
That puts a greater emphasis on testing, safety, and careful design of employment than just rushing new capabilities out. That, in turn, marks a departure from the way most tech firms experiment and then deploy artificial intelligence and machine learning tools.
Cybersecurity
Keyword: networked, rapid detection and modular
Shyu’s vision for future cybersecurity rests heavily on networked and rapid detection of threats rather than trust in firewalls.
We now need to have the ability to literally work in the intersection of cyber and electronic warfare, information operations, and communication. We have to be able to sense and react very, very quickly.
Open architectures are becoming ever more critical … What you don’t want to do is lock into one architecture and so, as the threats evolve, you’re stuck with a legacy architecture … So, if we have a modular open architecture … with a secure processor that’s able to evolve at the speed of commercial technology, that’s what’s going to be critical.
Microprocessors
Key phrase: better usage of avant garde chips in real-time operations.
(We) must learn to better use the chips they (private industry) have.
“literally buy multi-core processors and then they only use one core because that’s how they know how to program the node. So I think we need to put some money into research. If you have a 16-core processor or 32-core, you should figure out how to utilize all the cores.”
One use would be more on-board processing in low-bandwidth environments where high-tech adversaries are contesting communications.
Shyu also emphasized the need for better 3D visuals — for training, but also for command and control.
“I would like to focus on and push us towards the ability to develop interactive 3D operations via 3-D operations center, enabling geographically dispersed, distributed command and control in a low-bandwidth environment, … So we can enable rapid mission planning and mission command. That will be incredibly powerful. The technology is here. It’s not something we have to invent. It just needs a little push to mature and get into the hands of our users.”
Biotechnology
Key phrase: advanced materials to sense and avoid surprises
“(We) must …include things like biometric data on soldier physical activity and health, which could alert leaders to big changes in the wellbeing of the future force or even the public.”
“I call it sensing and avoiding surprises. If you have the ability to to look at — to be able to sense — either from your environment, or … your behavior, via your Fitbit or whatever, that you may be coming down with something because your heart rate is increasing or indications of warning of potential infections … I think we want to continue to fund those.”
Space
“Everything is classified.”
China’s Cancer Drug Breakthrough Moment?
Since the FDA approved BeiGene’s Brukinsa as the first Chinese cancer medicine to enter the U.S. market in November 2019, China has seen a surge in promising cancer drug discovery. According to Reuters, the following biotech companies are signaling this sector’s coming of age in China:
RemeGen
a major licensing deal with Seattle-based Seagen Inc. … to co-develop cancer treatments using a RemeGen antibody drug conjugate is regarded as one of the biggest of its kind between a Chinese biotech and a Western firm … underscoring China’s still small but growing role in developing innovative cancer drugs that will be used worldwide.
BeiGene
(developed) an agreement with Novartis AG worth up to $2.2 billion … the two are co-developing an antibody similar to Keytruda from Merck and Opdivo from Bristol-Myers Squibb which help the immune system attack several different types of cancer and which have reaped billions of dollars in sales.
I-Mab
partnering with AbbVie to co-develop a monoclonal antibody for several types of cancer in a deal worth up to $1.9 billion. Should it be partnering or parting at the beginning?
Additionally, I-Mab, Innovent Biologics, Junshi Biosciences, and Legend Biotech are likely candidates for further licensing deals with Western firms.
Hutchmed
the first Chinese company to have an in-house innovative cancer drug unconditionally approved in China, is not planning to partner in the United States or at home now that it has grown, said chief executive Christian Hogg.
According to Reuters,
Nineteen Chinese biotechs made their trading debuts last year, mostly in Hong Kong, raising a combined $5.2 billion, up from 13 raising around $2 billion in 2019, Refinitiv data shows. So far this year, 20 have listed, raising $4.6 billion, and the Hong Kong bourse has flagged nearly 30 more in the pipeline.
Browser as OS
While Apple M1 is grabbing the headline space recently, let’s not forget startups are reinventing our desktop experience to be less dependent on a GPU/CPU processing power. A notable trend is browser as OS. Two startups are heading in that direction, although with different inspirations.
Arc (The Browser Company): Inspired by Power of Platform
Josh Miller, the CEO of The Browser Company, with its browser named Arc, told Protocol:
We don’t need a new web browser … We need a new successor to the web browser.”
Part of Miller’s inspiration comes from his former boss and White House Chief Digital Officer Jason Goldman, who told Miller:
“Platforms have all the leverage … And if you care about the future of the internet, or the way we use our computers, or want to improve any of the things that are broken about technology … you can’t really just build an application.”
Miller noticed something else. Companies like Figma, Notion, Airtable, and Superhuman weren’t going mobile- or desktop-first, but were building powerful, collaborative apps with web technologies. Their “native apps,” in most cases, were just wrappers around their web apps, plus a homescreen icon.
Miller became convinced that the next big platform was right in front of his face: the open web. The underlying infrastructure worked, the apps were great, and there were no tech giants in the way imposing rules and extracting huge commissions.
The only thing missing was a tool to bring it all together in a user-friendly way and make the web more than the sum of its parts.
… sees browsers as operating systems, and likes to wonder aloud what “iOS for the web” might look like.
The Arc is still not available to the public, but the promise seems enticing:
What if your browser could build you a personalized news feed because it knows the sites you go to? What if every web app felt like a native app, and the browser itself was just the app launcher? What if you could drag a file from one tab to another, and it just worked? What if the web browser was a shareable, synced, multiplayer experience? It would be nothing like the simple, passive windows to the web that browsers are now. Which is exactly the goal.
MightyAPP: Inspired by the Intersection Between Hardware and Software
Suhail Doshi, founder of MightApp, describes how MightApp came into being on its blog:
Hardware inspires software and software inspires hardware — a never-ending virtuous cycle.
If you can move the most demanding processing, then battery life can finally improve because video decode and render times (we’re streaming video here) get more efficient with better chipsets.
Supercomputers for all. When you need them.
On the software side, we can make the best choices across users running the same hardware/software stack, ranging from picking the optimal DNS provider (8.8.8.8, 1.1.1.1), to shaving a few milliseconds off page loads, to caching frequently used web apps as long as possible to make them feel “instant.”
MightApp’s master plan is:
- Create a browser that reduces the need to upgrade your computer
- Drastically improve computers in the cloud using modern advances in networking and elastic infrastructure
- Replace expensive physical computers with low-powered inexpensive ones to achieve multi-day battery life
- While doing so, improve worldwide latency of the internet
How the two will play out differently is remained to be seen.
The First Chinese Essay Published in ‘Nature’
“It will be seen that a really scientific modern correction of an old law has singularly turned up from China, and has been substantiated with the most primitive apparatus.”
This is the beginning of the first essay published in scientific journal Nature by Chinese natural scientist Shou Hsu (徐壽), circa 1881.
Hsu is a renaissance man who lived in China’s Qing Dynasty. He is responsible for the invention of China’s first steam engine, the co-founding of China’s first school teaching science and technology, and the founding of Kiangnan Arsenal (or Jiangnan Shipyard/江南機器製造總局), a symbolic establishment from China’s Self-Strengthening Movement (洋務運動/同治維新), among other accomplishments.
The essay, titled Acoustics in China, was originally a letter Hsu wrote to Professor John Tyndall, which was later forwarded by John Fryer to Nature. It detailed Hsu’s deep observation of physics laws in different variations between strings and tubes in Chinese music.
“In ancient Chinese works on music it is stated that strings or pipes produce an octave or twelve semitones higher or lower by halving or doubling their length.”
“In a work writer during the Ming Dynasty by Chen-toai-yoh, it is stated that this rule will only hold good with strings, but not with open pipes such as the flute or flageolet.”
Hsu’s observations eventually led to his correction of Bernoulli’s Law, which earned him the praise, as the beginning shows.